Washington D.C. 20549
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“emerging growth company"company” in Rule 12b-2 of the Exchange Act.
Part III of this Annual Report on Form 10-K incorporates certain information by reference from the definitive proxy statement for the registrant’s 20192021 Annual Meeting of Stockholders to be filed within 120 days of the registrant’s fiscal year ended December 31, 20182020 (the “Proxy Statement”). 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.
SOLARWINDS CORPORATION
Table of Contents
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PART I |
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Item 1. | | | |
Item 1A. | | | |
Item 1B. | | | |
Item 2. | | | |
Item 3. | | | |
Item 4. | | | |
PART II |
Item 5. | | | |
Item 6. | | | |
Item 7. | | | |
Item 7A. | | | |
Item 8. | | | |
Item 9. | | | |
Item 9A. | | | |
Item 9B. | | | |
PART III |
Item 10. | | | |
Item 11. | | | |
Item 12. | | | |
Item 13. | | | |
Item 14. | | | |
PART IV |
Item 15. | | | |
Item 16. | | | |
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INTRODUCTORY NOTE
On December 14, 2020, we announced that we had been the victim of a cyberattack on our Orion Software Platform and internal systems, or the “Cyber Incident.” Together with outside security professionals and other third parties, we are conducting investigations into the Cyber Incident which are on-going.
Our investigations to date revealed that as part of this attack, malicious code, or Sunburst, was injected into builds of our Orion Software Platform that we released between March 2020 and June 2020. If present and activated in a customer’s IT environment, Sunburst could potentially allow an attacker to compromise the server on which the Orion Software Platform was installed. We have not located Sunburst in any of our more than seventy non-Orion products and tools.
We released remediations for the versions of our Orion Software Platform known to be affected by Sunburst and have taken and continue to take extensive efforts to support and protect our customers. In addition, we shared our proprietary code with industry researchers to enable them to validate a “kill-switch” that is believed to have rendered Sunburst inert.
The Orion Software Platform is installed “on-premises” within customers’ IT environments, so we are unable to determine with specificity the number of customers that installed an affected version or that were compromised as a result of Sunburst. We believe the actual number of customers that could have installed an affected version of the Orion Software Platform to be fewer than 18,000. Based on our discussions with customers and our investigations into the nature and function of Sunburst and the tradecraft of the threat actor, we believe the number of organizations which were exploited by the threat actors through Sunburst to be substantially fewer than the number of customers that may have installed an affected version of the Orion Platform.
It has been widely reported that, due to its nature, sophistication and operational security, this “supply-chain” cyberattack was part of a broader nation-state level cyber operation designed to target public and private sector organizations. As of the date hereof, we have not independently attributed the Cyber Incident to any specific threat actor.
Through our investigations into the Cyber Incident, we hope to understand it better, apply our findings to further adapt and enhance our security measures across our systems and our software development and build environments and share our findings and adaptations with our customers, government officials and the technology industry more broadly to help them better understand and protect against these types of attacks in the future. We refer to these adaptations and enhancements as “Secure by Design.”
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. Such statements may be signified by terms such as “aim,” “anticipate,” “believe,” “continue,” “expect,” “feel,” “intend,” “estimate,” “seek,” “plan,” “may,” “can,” “could,” “should,” “will,” “would” or similar expressions and the negatives of those terms. In this report, forward-looking statements include statements regarding our financial projections, future financial performance and plans and objectives for future operations including, without limitation, the following:
•expectations regarding our financial condition and results of operations, including revenue, revenue growth, cost of revenue, operating expenses, operating income, non-GAAP revenue, non-GAAP operating income, non-GAAP operating margin, adjusted EBITDA and adjusted EBITDA margin, cash flows and effective income tax rate;
•preliminary findings from our investigations into the Cyber Incident, including our understanding of the nature, source and duration of the attack and our plans to further investigate the attack, ensure our products and internal systems are secure and provide information regarding our findings, as well as our expectations regarding the impact of the Cyber Incident on our adoptionbusiness and reputation, the success of our related mitigation and remediation efforts and the additional costs, liabilities and other adverse consequences that we may incur as a result of the new revenue recognition standardCyber Incident;
•expectations regarding the impact the government investigations and litigation resulting from the Cyber Incident may have on our financial results;business;
•expectations regarding investment in product development and our expectations about the results of those efforts;
•expectations concerning acquisitions and opportunities resulting from our acquisitions;
•expectations regarding hiring additional personnel globally in the areas of sales and marketing and research and development;
•expectations regarding our international earnings and investment of those earnings in international operations;
•expectations regarding our capital expenditures;
•expectations regarding the impact of the COVID-19 pandemic on our business, results of operations and financial condition;
•our beliefs regarding the sufficiency of our cash and cash equivalents, cash flows from operating activities and borrowing capacity.capacity; and
•expectations regarding the potential spin-off of our MSP business into a newly created and separately traded public company.
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially and adversely different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that couldmay cause or contribute to such differences include, but are not limited to, the following: (a) the inability to generate significant volumes of high quality sales leads from our digital marketing initiatives and convert such leads into new business at acceptable conversion rates; (b) the inability to sell products to new customers or to sell additional products or upgrades to our existing customers; (c) any decline in our renewal or net retention rates; (d) our inability to successfully identify, complete, and integrate acquisitions and manage our growth effectively; (e) risks associated with our international operations; (f) our status as a controlled company; (g) the possibility that general economic conditions or uncertainty cause information technology spending to be reduced or purchasing decisions to be delayed; (h) the timing and success of new product introductions and product upgrades by SolarWinds or its competitors; (i) the possibility that our operating income could fluctuate and may decline as percentage of revenue as we make further expenditures to expand our operations in order to support additional growth in our business; (j) potential foreign exchange gains and losses related to expenses and sales denominated in currencies other than the functional currency of an associated entity; and (k) such other risks and uncertainties described in the section titled “Risk Factors” and elsewhere in this Annual Report on Form 10-K.10-K, and those discussed in other documents we file with the Securities and Exchange Commission. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this annual report on Form 10-K. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially and adversely from those anticipated in these forward-looking statements, even if new information becomes available in the future.
In this report “SolarWinds,” “Company,���” “we,” “us” and “our” refer to SolarWinds Corporation and its consolidated subsidiaries. The term “Silver Lake Funds” refers to Silver Lake Partners IV, L.P., Silver Lake Technology Investors IV, L.P., and SLP Aurora Co-Invest, L.P., and the term “Silver Lake” refers to Silver Lake Group, L.L.C., the ultimate general partner of the Silver Lake Funds. The term “Thoma Bravo Funds” refers to Thoma Bravo Fund XI, L.P., Thoma Bravo Fund XI-A, L.P., Thoma Bravo Fund XII, L.P., Thoma Bravo Fund XII-A, L.P., Thoma Bravo Executive Fund XI, L.P., Thoma Bravo Executive Fund XII, L.P., Thoma Bravo Executive Fund XII-a, L.P., Thoma Bravo Special Opportunities Fund II, L.P. and Thoma Bravo Special Opportunities Fund II-A, L.P. and the term “Thoma Bravo” refers to Thoma Bravo, LLC, the ultimate general partner of the Thoma Bravo Funds. The term “Sponsors” refers collectively to Silver Lake and Thoma Bravo, together with the Silver Lake Funds and the Thoma Bravo Funds and, as applicable, their co-investors. The term “Lead Sponsors” refers collectively to the Silver Lake Funds, the Thoma Bravo Funds and their respective affiliates.
PART I
ITEM 1. BUSINESS
Overview
SolarWinds is a leading provider of information technology, or IT, infrastructure management software. Our products give organizations worldwide, regardless of type, size or IT infrastructure complexity, the power to monitor and manage the performance of their IT environments, whether on-premise,on-premises, in the cloud, or in hybrid models. We combine powerful, scalable, affordable, easy to use products with a high-velocity, low-touch sales model to grow our business while also generating significant cash flow.
Our business is focused on building products that enable technology professionals to manage “all things IT.” We continuously engage with technology professionals to understand the challenges they face maintaining high-performing and highly available on-premise,on-premises, public and private cloud and hybrid IT infrastructures. The insights we gain from engaging with technology professionals allow us to build products that solve well-understood IT management challenges in ways that technology professionals want them solved. We sell a comprehensive portfolio of Core IT Management products that are designed for ITOps, DevOps and IT security professionals. We also sell cloud-based software solutions purpose-built to enable managed service providers, or MSPs, to support digital transformation and growth within small and medium-sized enterprises, or SMEs, around the world.
Our approach, which we call the “SolarWinds Model,” enables us to market and sell our products directly to network and systems engineers, database administrators, storage administrators, DevOps and service desk professionals and managed service providers, or MSPs. These technology professionals have become empowered to influence the selection, and often the purchase, of products needed to rapidly solve the problems they confront.
We serve the entire IT market uniquely and efficiently with our SolarWinds Model. Technology professionals use our products in organizations ranging in size from very small businesses to large enterprises. Our products are designed to do the complex work of monitoring and managing networks, systems and applications across on-premise,on-premises, cloud and hybrid IT environments without the need for customization or professional services. Many of our products are built on common technology platforms that enable our customers to easily purchase and deploy our products individually or as integrated suites as their needs evolve. We utilize a cost-efficient, integrated global product development model and have expanded our offerings over time through both organic development and strategic acquisitions.
We market and sell our products directly to technology professionals withprimarily through a high-velocity, low-touch, digital marketing and direct inside sales approach that we call “selling from the inside.” We have built a highly flexible and analytics-driven marketing model designed to efficiently drive website traffic and high-quality leads. We also engage with both existing and prospective customers using our online community, THWACK. This community iscommunities such as THWACK and MSP Institute. These communities are designed to train and inform technology professionals about our products, keep us connected to them and provide network effects to amplify word-of-mouth marketing for our products. Our sales team uses a prescriptive approach designed to manage these leads and quickly sell our products pursuant to our standard pricing and contract terms. We do not utilize an outside sales force or provide professional services.
Technology professionals often find our products when they are online searching for a solution to address a specific need and use our full-featured trials to experience our purpose-built, powerful and easy to use products in their own environments. These experiences often lead to initial purchases of one or more products and, over time, purchases of additional products and advocacy within both their organizations and their networks of technology professionals.
We also extend our sales reach through our MSP customers, who provide IT management as a service and rely on our products to deploy, manage and monitorsecure the IT environments of their end customers. Our MSP customer base enables us to reach across a fragmented end market opportunity consisting of millions of organizations and access a broader universe of customers.SMEs around the world. We benefit from the addition of end customers served by our MSP customers, the proliferation of devices managed by those MSPs and the expansion of products used by those MSPs to manageprovide managed services to their end customers’ IT infrastructures.customers. We grow with our MSP customers as they add new customers and deliver new or enhanced services based on our solutions and when their SME customers add devices and services.
We have grown while maintaining high levels of operating efficiency. We derive our revenue from a combination of subscription revenue from the sale of our cloudMSP, application performance management and MSPIT service management, or ITSM products, and license and maintenance revenue from the sale of our on-premiseon-premises network and IT operations management perpetual license products. Over time, we have significantly increased our subscription and maintenance revenue and intend to grow our revenue and cash flow by gaining new customers, increasing penetration within our existing customer base, expanding our international footprint, bringing new products to market and expanding into new markets through organic development and targeted acquisitions.
SolarWinds Corporation was incorporated in the State of Delaware in 2015 under2015.
Cyber Incident
On December 14, 2020, we announced that we had been the name Project Aurora Parent, Inc. It changed its name to SolarWinds Parent, Inc.victim of a cyberattack on our Orion Software Platform and internal systems, or the “Cyber Incident.” For further information about the Cyber Incident, see “Risk Factors” included in May 2016,Item 1A of Part I of this Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cyber Incident” included in May 2018 changed its name to SolarWinds Corporation.
Initial Public Offering
In October 2018, we completed our IPO, in which we soldItem 7 of Part II of this Annual Report on Form 10-K and issued 25,000,000 shares of our common stock at an issue price of $15.00 per share. We raised a total of $375.0 million in gross proceeds from the offering, or approximately $353.0 million in net proceeds after deducting underwriting discountsNote 16. Commitments and commissions of $17.8 million and offering-related expenses of
approximately $4.2 million. A portion of the net proceeds from the offering were used to repay the $315.0 million in borrowings outstanding under our second lien term loan. In connection with the voluntary prepayment of the second lien term loan, we paid a $14.2 million prepayment fee.
See Note 1. Organization and Nature of OperationsContingenciesin the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K10-K.
Potential Spin-Off of MSP Business
On August 6, 2020, we announced that our board of directors has authorized management to explore a potential spin-off of our MSP business into a newly created and separately traded public company, and on December 9, 2020, we announced that we confidentially submitted with the U.S. Securities and Exchange Commission (“SEC”) a Form 10 registration statement with respect to the potential spin-off. If completed, the standalone entity would provide cloud-based software solutions for additional information regardingMSPs, enabling them to support digital transformation and growth within SMEs. SolarWinds would retain our IPO.Core IT Management business focused primarily on selling software and cloud-based services to corporate IT organizations. We believe that, if completed, the potential spin-off would allow each company to more effectively pursue its distinct operating priorities, strategies and capital allocation policies, while also allowing stockholders to separately evaluate and value the companies based on their distinct markets, strategies and performance. If we proceed with the spin-off, it would be intended to be structured as a tax-free, pro-rata distribution to all SolarWinds stockholders as of a record date to be determined by the board of directors of SolarWinds. If completed, upon effectiveness of the transaction, SolarWinds stockholders would own shares of both companies. Completion of any spin-off would be subject to various conditions, including final approval of our board of directors, and there can be no assurance that the potential spin-off will be completed in the manner described above, or at all. If we proceed with the spin-off, we currently are targeting to complete the transaction in the second quarter of 2021.
The SolarWinds Model
At SolarWinds, we do things differently. The focus and discipline that we bring to our business distinguish us in a highly competitive landscape.
We believe that growth and profitability are not conflicting priorities. We designed our business to allow us to grow and generate significant positive cash flow at the same time.
At the heart of everything we do as a company is the SolarWinds Model, which consists of five principles that guide our business and help explain why technology professionals choose our products:
Focus on theTechnology Professional
We are committed to understanding technology professionals and the daily challenges that they face managing the complex, ever-changing demands of business-critical IT environments. We have a substantial customer base and community of technology professionals. We engage with them on a daily basis through digital marketing and online communications. These include THWACK, our online community that provides forums to registered members, tools and valuable resources;resources. Additionally, through our MSP Institute, our MSP customers gain access to business, sales, marketing and technical training. We also manage several company-sponsored blogs in which we provide perspectives and information relevant to the IT management market; andmarket, as well as web-based events designed to train and inform participants about deeper aspects of our products. We don’t have to guess about what they need, we just ask.
Build Great Products for the Entire Market
Organizations of all sizes have complex IT environments that make managing IT challenging. Our commitment to technology professionals allows us to deliver products that solve well-understood IT problems simply, quickly and affordably for the entire market, from very small businesses to the largest of global enterprises, regardless of whether their IT is managed internally or through an MSP.
We design our products to be easy to access, try, buy, deploy and use. Many of our products are built on common technology platforms that enable our customers to purchase and implement our products individually, and then add additional product or products as needed. Or they can buy multiple products as integrated suites. This allows customers to buy what they need, when they need it, and grow as their needs evolve.
Capture Demand Using Cost-Efficient, Mass-Reach Digital Marketing
We utilize digital marketing to directly reach technology professionals of all levels of sophistication managing IT environments of all levels of complexity and size. They are online every day interacting with their peers, learning about new technologies and searching for solutions to their problems.
Over the past decade, we have honed our use of online tools to find, communicate with and sell to our potential customers of all levels of sophistication with environments of all levels of complexity and size. We believe we build credibility and confidence in our products by being present and active in the communities and on the sites that technology professionals trust.
Sell Selling fromthe Inside
We are committed to selling from the inside. We adhere to a prescriptive process and metrics-based approach that drives predictability and consistency and has helped us add new customers and grow our relationships with existing customers.
The size and organization of our sales force enables us to reach thousands of technology professionals each day. We close the smallest and most simple transactions to our largest and most complex deals efficiently without the need for ana traditional outside sales force, product customization or professional services. Our sales team uses a prescriptive approach designed to manage these leads and quickly sell our products pursuant to our standardized pricing and contract terms. We believe our selling motion reflects how our customers prefer to do business.
Focus on the Long-Term Value of the Relationship with Our Customers
When our customers experience the value of our products, our investment in our product portfolio and our responsiveness to their changing needs, they often grow their relationship with us and become our advocates within both their organizations and their networks of technology professionals. The power of our approach is evidenced by the long-term relationships we have with our customers.customers which is reflected in our strong customer retention rates.
Growth Strategies
We intend to extend our leadership in networkIT infrastructure management and grow our market share in adjacent areas of IT managementoperations with powerful yet easy to use software products designed to manage “all things IT” across hybrid IT environments. The following are key elements of our growth strategy:
Win New Customers Using the SolarWinds Model
The SolarWinds Model allows us to win new customers in existing markets where our products and our model give us a competitive advantage. Our efficient marketing and sales model and powerful brand recognition and trust among technologyboth internal IT professionals and MSPs have enabled us to increase our customer base. We intend to leverage our ability to efficiently attract new customers to continue to increase our overall customer base.
Increase Penetration Within Our Existing Customer Base
Many of our internal IT customers make an initial purchase to meet an immediate need, such as network or application performance monitoring in a small portion of their IT infrastructure, and then subsequently purchase additional products for other use cases or expansion across their organization. Similarly, our MSP customers expand usage of our offerings over time when they add new customers and when their customers add new devices and services. For example, our MSP customers may start with remote monitoring and management or backup and recovery, and subsequently purchase additional, integrated products offerings. Once our customers have used our products within their IT environment, we are well positioned to help identify additional products that offer further value to those customers. We continue to refine our sales effort to better target our marketing and sales efforts and expand the sales of our products within organizations, particularly those that have multiple purchasers of our IT management products.
Increase Our International Footprint
We believe a substantial market opportunity exists to increase our international footprint across all of our product lines. In particular, our cloudapplication performance management and ITSM products, which are currently sold primarily in North America, have strong international expansion potential. We have made significant investments in recent years to increase our sales and marketing operations internationally, and expect to continue to invest to grow our international sales and global brand awareness.
Continue to Innovate
We intend to continue focusing on innovation and bringing new products and tools to market that address problems that technology professionals are asking us to solve. We also intend to continue providing frequent feature releases to our existing products. We are focused on enhancing the overall integration of our products to improve our value proposition and allow our customers to further benefit from expanding their usage of our products as their needs evolve.
Expand into New Markets Aligned with the SolarWinds Model
We have successfully entered new markets and expanded our product offerings to solve a broader set of challenges for customers. For example, in recent years we broadened our product offerings to address the database, storage, cloud, MSP and MSPITSM markets. We intend to further expand into markets where our SolarWinds Model provides us with competitive advantages.
Pursue Targeted Acquisitions of Products and Technologies
We have successfully acquired and integrated businesses and technologies in the past that provided us with new product offerings and capabilities and helped us to establish positions in new segments and markets. We intend to continue making targeted acquisitions that complement and strengthen our product portfolio and capabilities or provide access to new markets. We evaluate acquisition opportunities to assess whether they will be successful within the SolarWinds Model. We believe our ability to effectively transition acquired companies and products to the SolarWinds Model represents a unique opportunity for our business.
Our Customers and Market
We designed the SolarWinds Model to reach all sizes of businesses. Our customers represent organizations ranging in size from very small businesses to large enterprises. Customers often initially purchase one of our products to solve a known problem and then expand their purchases over time.
As of December 31, 2018,2020, we had over 300,000320,000 customers. We define customers as individuals or entities that have purchased one or more of our products under a unique customer identification number since our inception for our perpetual license products and individuals or entities that have an active subscription for at least one of our subscription products. Each unique customer identification number constitutes a separate customer regardless of the amount purchased. We may have multiple purchasers of our products within a single organization, each of which may be assigned a unique customer identification number and deemed a separate customer. Included among this number are more than 25,000 MSP customers serving over 500,000 SMEs globally as of December 31, 2020. We count MSP partners as active subscribers to one or more of our products at the end of the measurement period.
The SolarWinds Model allows us to both sell to a broad group of potential customers and close large transactions with significant customers. At the same time, we designed the SolarWinds Model to reach businessesmillions of SMEs around the world that outsource the management of some or
all of their IT infrastructure to MSPs. We reach SMBsSMEs through MSPs and directly, including those SMBsSMEs that may purchase a single product to solve a known problem.
Organizations across industries are using technology and software to drive business success and competitive differentiation. As the landscape for IT infrastructure and software deployment worldwide rapidly changes to meet businesses’ evolving needs, the performance, speed, availability and security of IT has become critical to business strategy. The job of the technology professionals who deploy and manage these environments is more challenging than ever.
Growing IT Complexity Creates Significant Challenges for Organizations
As organizations deploy and rely on a mix of on-premise,on-premises, public and private cloud and hybrid IT environments, they require performance monitoring and management solutions that work across their increasingly complex environments and provide full visibility into performance.
Empowerment of the Technology Professional
The technology professionals charged with managing these infrastructures are increasingly responsible for making technology choices to help ensure the performance of their IT infrastructure meets the needs of the business. Additionally, the democratization of IT spend has shifted influence in software purchase decisions from the highest levels of an organization’s IT department to technology professionals, who can have different perspectives from CIOs or other IT decision-makers. We have found that technology professionals prefer to trial software products in real time to determine if the products meet their needs. They also want the flexibility to select from a range of IT management products to find those best suited to address their specific challenges. In this environment, technology professionals are among the biggest influencers of software-purchasing decisions within their organizations.
Organizations Have Choices in Allocating Resources to Manage IT
Efficiently managing IT and quickly resolving problems are paramount for organizations of all sizes. However, asAs IT complexity grows, organizations must determine how to allocate their resources to best manage their IT needs. Organizations can choose to manage their own IT infrastructure or buy IT management as a service through MSPs. MSPs maintain and operate an organization’s IT environment and can deliver the full range of IT solutions, including network monitoring, server and desktop management, backup and recovery and IT security. For many smaller organizations that lack the
time, resources and technical expertise to manage complex IT environments, MSPs can improve the efficacy of their IT strategy without significant capital investment. For larger organizations, MSPs can replace or supplement in-house capabilities.
Limitations of Alternative Solutions
Alternative IT management solutions have limitations that impair their ability to efficiently serve the unique needs of technology professionals. These solutions can be expensive, complicated and inflexible and may require significant professional services to customize, implement, operate and maintain.
Given the challenges associated with operating across a complex range of dynamic, hybrid IT environments and the limited ability of existing solutions to address these challenges in the ways that technology professionals want them addressed, we believe there is a significant market opportunity for broad hybrid IT management solutions purpose-built to serve the needs of technology professionals.
Product Portfolio and Technology Platforms
We offer over 50a broad portfolio of products to monitor and manage network, systems, desktop, application, storage, database, and website infrastructures whether on-premise, in the public or private cloud or in a hybridand IT infrastructure.service desks. We intend to continue to innovate and invest in areas of product development that bring new products to market and enhance the functionality, ease of use and integration of our current products. We may also introduce new technology through relationships with other technology companies. We believe this will strengthen the overall value proposition of our products in any IT environment.
Our product development is guided by principles that provide a development framework that allows us to respond quickly to the market and deliver a broad suite of products designed to solve problems that are commonly understood and shared by our customers. Our core product development principles are:
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1. | We purpose-build products for technology professionals. |
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2. | Our roadmaps are guided by a large community of users rather than by a select few large customers. |
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3. | We develop products that are intended to sell themselves and be easy to use, powerful and immediately valuable to users. |
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4. | We design and develop our products to integrate and complement each other while providing a consistent user experience. |
1.We purpose-build products for technology professionals.
2.Our roadmaps are guided by a large community of users rather than by a select few large customers.
3.We develop products that are intended to sell themselves and be easy to use, powerful and immediately valuable to users.
4.We design and develop our products to integrate and complement each other while providing a consistent user experience.
We believe we have one of the broadestbroader product portfolios of IT monitoring and management software across the industry, providing deep visibility into web,network, systems, desktop, application, storage, database, website infrastructures, and virtual resources storage, and network performance. Our products monitor
applications and their supporting infrastructure, regardless of whether the applications arethat infrastructure is located on-premise,on-premises, in the cloud or in a hybrid environment.model. Our products monitor applications in the cloud via an agent, agentlessly, or by using information from cloud providers’ APIs.
Our approach toCore IT management allows us to cross-pollinate products across markets and environments. Most recently, we integrated NetPath, a product that is part of our core IT portfolio and provides deep visibility into critical network paths, into our core MSP offering.
Core ITManagement Products
Targeted for ITOps, DevOps, and IT professionals,Security Professionals, our coreCore IT Management products provide hybrid IT performance management with deep visibility into applications, IT infrastructures, and the full IT stack, while remaining infrastructure-location agnostic. Our comprehensive product portfolio covers the needs of all IT professionals and their hybrid IT environments. A one-stop shop for IT management, our product capabilities include network management, infrastructure management, application performance management, IT service management and IT infrastructure across both on-premise and cloud infrastructures. security. Our Core IT Management products include the products we categorized as IT Operations Management, or ITOM, in previous filings.
Our suite of network management software provides real-time visibility into network utilization and bandwidth as well as the ability to quickly detect, diagnose and resolve network performance problems. Our suite of systeminfrastructure management products monitors and analyzes the performance of applications and their supporting infrastructure, including websites, servers, physical, virtual and cloud infrastructure, storage and databases. We also help our customers strengthen their security and compliance posture with our automated network configuration, backup and log and event management products.
Our coresuite of application performance management software enables visibility into log data, cloud infrastructure metrics, applications, tracing, and web performance management.
Our service management software provides a robust and easy-to use comprehensive, ITIL-compliant service desk solution for companies of all sizes. We help our customers manage their employee service challenge needs whether through simple ticketing or a powerful ITSM solution, removing the manual burden of managing incoming tickets and tracking technology assets with the products cutting-edge automation, artificial intelligence and machine learning capabilities.
Our hybrid IT offerings enabled by our common technology platform, are highly scalable and can be added alongside existing products in a modular fashion. IntegratingThe integration of our network products and IT operations management products, which we previously referred to as systems management products, our platform combines data from multiple parts of the IT stack to provide a single, unified application-centric application centric
view and customer experience. Our platformCore IT Management products also enablesenable a single dashboard to view real-time application metrics regardless of whether the applications are deployed across multiple data centers or cloud vendors globally.
Our core IT products include both core licensed products and tools. Our core licensed products are typically server-based with a browser interface, have a higher average selling price than tools and are the focus of our strategies to drive revenue growth. Our tools can be server-or laptop-based, typically have a lower average selling price than our core licensed products and are primarily used by us to meet a critical need of our target customer base, but are not the focus of our revenue growth strategies.
Cloud Management Products
Targeted for DevOps and ITOps professionals, our cloud management products provide cloud-based monitoring of the full IT stack whether deployed in the cloud or on-premise. Our cloud management products enable visibility into log data, cloud infrastructure metrics, applications, tracing and web performance management. In addition to our individual products that address each of these areas, we also offer AppOptics, which integrates application performance, server infrastructure monitoring and custom metrics into one unified, cloud-based solution.MSP Products
OurWe deliver a portfolio targeted for MSPs delivers broad, scalable IT service management solutions toof integrated products that enable MSPs to deliver outsourced IT servicesdeploy, manage, and secure technologies for their SMB end-customersSME end customers, as well as and more efficiently manage their own businesses. Our corePurpose-built to address a wide range of MSP partner needs, our multi-tenant, subscription-based platform is scalable, extensible and easy to deploy. Beginning in the first quarter of 2021, we rebranded our MSP products and began selling them under the "N-able" brand.
We provide three categories of products to our MSP customers: remote monitoring and management, software, which remotely monitors desktops, laptops, serverssecurity and mobiledata protection and business management. Our broad remote monitoring and management capabilities include real-time availability and performance of networks and devices across operatingand automation of policies and workflows. We provide a layered protection approach spanning network and systems infrastructure, applications, and platforms, integrates with a broad offering of MSP-focused products on a common platform includingend user devices through our data protection, patch management, backup, anti-virus,endpoint security, web protection, risk assessment, help desk/service ticketing and application management. We also offer an email protectione-mail security and archiving platform on a standalone basis that protects businesses from phishing, malware and other email-borne threats.vulnerability assessment solutions. Our fully cloud-based data protection capabilities include storage efficient backup, high-speed restoration and disaster recovery for servers, workstations, files, data and key cloud-based applications. In addition, our business management solutions help improve the technical and service delivery efficiencies of our MSP partners and include professional services automation and password and documentation management.
Marketing and Sales
We market and sell our products directly to technology professionals with a low-touch, high-velocity digital marketing and “selling from the inside” motion that we believe is unique and hard to replicate in the software industry. Our marketing efforts and sales process allowsselling motion allow us to effectively capture demand and maintain high levels of sales productivity at low customer acquisition costs.
We target our marketing efforts and selling motion directly at network, systems, DevOps and MSP professionals within organizations versus the organizations themselves.organizations. We believe this approach provides us with a significant advantage in today’s environment in which purchasing influence and power is shifting from traditional procurement to the technology professionals themselves.
Marketing
We have built a highly flexible and analytics-driven direct marketing model designed to efficiently drive website traffic and high-quality leads that are typically trials of full-featured products from our websites. By providing trials of full-featured products we enable prospective customers to easily explore the capabilities of our products and easily transition from trial to sale. We also have a marketing motion directed at current customers designed to educate them about features of products they own, products they do not own and how to trial new products.
We make broad use of digital marketing tools including search engines, targeted email campaigns, localized websites, virtual events, free IT management tools, display advertising, affiliate marketing, social media, e-book distribution, video content, blogging and webinars.
We also engage using our online community, THWACK. Within THWACK, we provide forums, solutions, tools, webinars, content and other valuable resources relevant to the IT management market. This community is designed to train and inform technology professionals about our products, keep us connected to them and provide network effects to amplify word-of-mouth marketing for our products. Additionally, through our MSP Institute, our MSP customers gain access to business, sales, marketing and technical training from industry experts and leaders.
Sales
We refer to our selling motion as “selling from the inside.” This approach is rooted in having our sales organization physically located in our offices, selling exclusively online or over the phone, using a prescriptive approach to managing leads and adhering to standardized pricing and contract terms. We close transactions of all sizes and locations through our selling from the inside approach. We do not employ any outside sales personnel.
Our sales organization is divided into our dedicated sales team and our retention and maintenance renewal team. Our dedicated sales team focuses exclusively on sales of new products to new and existing customers. Our dedicated sales team receives high-quality leads from our marketing motion and engages with the prospect to close the sale. We adhere to a disciplined, data-driven approach to converting leads quickly and efficiently based on our understanding of the prospect’s specific product demands and the inflection points in the selling process.
Our retention and maintenance renewal team focuses exclusively on renewing our subscription and maintenance agreements with our customers. Our conversations with these customers begin months before the renewal date to support our customers, and we work with them through the renewal process.
In addition to selling to SMEs directly, our alignment with our MSP partners gives us the leverage and sales reach to efficiently and effectively serve the SME market and to grow with our MSP partners as they expand their customer bases, deliver new services powered by our solutions and when their customers add devices and services.
We also sell our software through distributors and resellers to supplement our direct sales force, expand our global presence, reach various market segments and help us to initiate and fulfill sales orders from state, local and federal governments and those commercial customers that prefer to make purchases through a particular reseller. We contract directly with end customers when
we sell our products through channel partners. We have a number of resellers who are proactively creating demand for our products and bring new opportunities and customers to us. In addition to selling to SMBs directly, we also deliver our technology to SMBs through our MSP customers, who use our products to provide outsourced IT management services to these SMBs.
Research and Development
Our research and development organization is primarily responsible for the design, development, testing and deployment of new products and improvements to existing products, with a focus on ensuring that our products integrate and complement one another. As part of our new "Secure by Design" framework, we are making adaptations and enhancements to the security of our internal environment, software development processes and deployment of our products.
We have designedIn our software development process to be responsive to customer needs, cost efficient and agile. In our process, we work closely with our user community throughout the development process to build what is needed for the problems technology professionals face every day. This includes regularly having a subset of our customers participate in validating that our product use cases and features will solve their problems.
Over more than a decade, we have honed our approach to building a development organization that allows us to build products and enhance existing products quickly efficiently, and cost-effectively.efficiently. Our low-cost global development model allows us to source from a large pool of talented resources by participating in multiple labor markets to match the best person to each role, at the most efficient cost.role. We utilize small scrum teams, each dedicated to specific product modules that follow a standard set of practices to build and test their code continuously. We share our development values across our offices and aim to assign meaningful design and development work to our international locations.
We believe that we have developed a differentiated process that allows us to release new software rapidly, cost effectivelyefficiently and with a high level of quality.
Competition
We operate in a highly competitive industry that is characterized by constant change and innovation. Changes in networks, applications, devices, operating systems and deployment environments result in evolving customer requirements. Our competitors and potential competitors include:
•large network management and IT vendors such as Netscout,Cisco Systems, MicroFocus, CA Technologies, IBM and BMC Software; and
•smaller companies in the cloud and application monitoring and the MSP IT tools markets, including MSP pure-play vendors and niche or domain-specific vendors that provide solutions focused on a particular service that may be sold by MSPs, where we do not believe that a single or small group of companies has achieved market leadership.
We believe the principal competitive factors in our market are:
•brand awareness and reputation among technology professionals, including IT professionals, DevOps professionals and MSPs;
•product capabilities, including scalability, performance, security and reliability;
•ability to solve problems for companies of all sizes and infrastructure complexities;
•ease of use;
•total cost of ownership;
•flexible deployment models, including on-premise,on-premises, in the cloud or in a hybrid environment;
•strength of sales and marketing efforts; and
•focus on customer success.
We believe that we compete effectively across these factors as our products and marketing efforts have been designed with these criteria as guideposts.
Intellectual Property
We rely on a combination of patent, copyright, trademark, trade dress and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. These laws, procedures and restrictions provide only limited protection. As of December 31, 2018,2020, we owned approximately 3038 issued U.S. patents and 160194 issued foreign patents, with expiration dates ranging from OctoberDecember 2026 to November 2036.March 2038. We have also filed approximately 6566 currently pending patent applications, but we cannot guarantee that patents will be issued with respect to our current patent applications in a manner that gives us the protection that we seek or at all. Our patents and any future patents issued to us may be challenged, invalidated or
circumvented and may not provide sufficiently broad protection or may not prove to be enforceable in actions against alleged infringers.
We endeavor to enter into confidentiality and invention assignment agreements with our employees and contractors and with parties with which we do business in order to limit access to and disclosure of, and safeguard our ownership of, our proprietary information. We cannot be certain that the steps we have taken will prevent unauthorized use or reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive with ours or that infringe our intellectual property, and policing unauthorized use of our technology and intellectual property rights can be difficult. The enforcement of our intellectual property rights also depends on any legal actions against these infringers being successful, but these actions may not be successful, even when our rights have been infringed.
Furthermore, effective patent, trademark, trade dress, copyright and trade secret protection may not be available in every country in which our products are available or where we have operations. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving.
EmployeesHuman Capital Management
As of December 31, 2018,2020, we had 2,7383,340 employees fully dedicated to our business, of which 1,0301,191 were employed in the United States and 1,7082,149 were employed outside of the United States. We consider our currentstrive to be a people-centric company and believe we have a positive relationship with our employees, which we continue to be good.nurture and develop. We are not party to any collective bargaining agreement.
Our success is the result of our talented, experienced and high performing employees across our organization, including functions such as research and development, sales and marketing, partner success and general and administrative. As a global company, we have the distinct advantage of employing talented and diverse individuals across different ethnicities, genders, races, religions, sexual orientations and generations, all supported by a culture of innovation and inclusion. Our culture of collaboration enables us to deliver strong financial performance and build lasting relationships with our communities around the world.
We believe the combination of our relationship with our employees, strength of our software platform, alignment with our customers and business model differentiates us in the market. Our ability to achieve our goals has always been, and continues to be, a result of the strong values and tremendous passion of our people. We continue to invest heavily in attracting top talent, training and development initiatives and motivating and retaining high potential employees.
Additional Information
Our website address is www.solarwinds.com. Our website and the contents therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. Through a link on the Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. All such filings are available free of charge. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 1A. RISK FACTORS
Summary of Risk Factors
Below is a summary of the principal factors that make an investment in our common stock speculative or risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” and should be carefully considered, together with other information in this Form 10-K and our other filings with the SEC, before making an investment decision regarding our common stock.
Risks Related to Cybersecurity and the Cyber Incident
•Cyberattacks, including the Cyber Incident, and other security incidents have resulted, and in the future may result, in compromises or breaches of our and our customers’ systems, the insertion of malicious code, malware, ransomware or other vulnerabilities into our systems and products and in our customers’ systems, the exploitation of vulnerabilities in our and our customers’ environments, theft or misappropriation of our and our customers’ proprietary and confidential information, interference with our and our customers’ operations, expose us to legal and other liabilities, result in higher customer, employee and partner attrition and the loss of key personnel, negatively impact our sales, renewals and upgrade and expose us to reputational harm and other serious negative consequences, any or all of which could materially harm our business.
•The Cyber Incident has and is likely to continue to have an adverse effect on our business, reputation, customer, employee and partner relations, results of operations, financial condition or cash flows.
Risks Related to Our Business and Industry
•Our quarterly revenue and operating results may fluctuate in the future.
•If we are unable to capture significant volumes of high quality sales leads from our digital marketing initiatives, it could adversely affect our revenue and operating results.
•If we are unable to sell products to new customers or to sell additional products or upgrades to our existing customers, it could adversely affect our revenue.
•Any decline in renewals of maintenance or subscription agreements or a decline in our net retention rates could harm our current and future operating results.
Risks Related to the Potential Spin-Off
•The potential spin-off of our MSP business may not achieve some or all of its anticipated benefits with respect to either business and may not be completed in accordance with the expected plans or anticipated timelines, or at all.
Risks Related to Government Regulation
•We are subject to various global data privacy and security regulations, which could result in additional costs and liabilities to us.
•We are subject to governmental export controls and economic sanctions laws that could impair our ability to compete in international markets and subject us to liability.
Risks Related to Our Intellectual Property
•The success of our business depends on our ability to obtain, maintain, protect and enforce our intellectual property rights.
•Exposure related to any future intellectual property litigation could adversely affect our results of operations.
Risks Related to Our Indebtedness
•Our substantial indebtedness could adversely affect our financial health and our ability to obtain financing in the future, react to changes in our business and meet our obligations with respect to our indebtedness.
•We may be able to incur substantially more indebtedness, which could further exacerbate the risks associated with our substantial indebtedness.
Risks Related to Accounting and Taxation
•We are subject to fluctuations in interest rates.
•Failure to maintain proper and effective internal controls could have a material adverse effect on our business.
Risks Related to Ownership of Our Common Stock
•The trading price of our common stock could be volatile, which could cause the value of your investment to decline.
•The requirements of being a public company may strain our resources, increase our costs and distract management.
Risks Related to Our Organizational Structure
•Our charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts.
Risks Related to Cybersecurity and the Cyber Incident
Cyberattacks, including the Cyber Incident, and other security incidents have resulted, and in the future may result, in compromises or breaches of our and our customers’ systems, the insertion of malicious code, malware, ransomware or other vulnerabilities into our systems and products and in our customers’ systems, the exploitation of vulnerabilities in our and our customers’ environments, theft or misappropriation of our and our customers’ proprietary and confidential information, interference with our and our customers’ operations, expose us to legal and other liabilities, result in higher customer, employee and partner attrition, negatively impact our sales, renewals and upgrade and expose us to reputational harm and other serious negative consequences, any or all of which could materially harm our business.
We are heavily dependent on our technology infrastructure to operate our business, and our customers rely on our products to help manage and secure their own IT infrastructure and environments, including their and their customers’ confidential information. Despite our implementation of security measures and controls, our systems and those of third parties upon whom we rely are vulnerable to attack from numerous threat actors, including sophisticated nation-state and nation-state-supported actors. Threat actors have and may in the future be able to compromise our security measures or otherwise exploit vulnerabilities in our systems, including vulnerabilities that may have been introduced through the actions of our employees or contractors or defects in the design or manufacture of our products and systems or the products and systems that we procure from third parties. In doing so, they have and may in the future be able to breach or compromise our IT systems, including those which we use to design, develop, deploy and support our products, and misappropriate proprietary and confidential information, introduce malware, ransomware or vulnerabilities into our products and systems and create system disruptions or shutdowns. In addition, threat actors have and may in the future, access and exfiltrate our software source code. By virtue of the role our products play in helping to manage and secure the environments and systems of our customers, attacks on our systems and products can result in similar impacts on our customers’ systems and data.
Moreover, the number and scale of cyberattacks have continued to increase and the methods and techniques used by threat actors, including sophisticated “supply-chain” attacks such as the Cyber Incident, continue to evolve at a rapid pace. As a result, we may be unable to identify current attacks, anticipate future attacks or implement adequate security measures. We may also experience security breaches that may remain undetected for an extended period and, therefore, have a greater impact on our systems, our products, the proprietary data contained therein, our customers and ultimately, our business. In addition, our ability to defend against and mitigate cyberattacks depends in part on prioritization decisions that we and third parties upon whom we rely make to address vulnerabilities and security defects. While we endeavor to address all identified vulnerabilities in our products, we must make determinations as to how we prioritize developing and deploying the respective fixes, and we may be unable to do so prior to an attack. Likewise, even once a vulnerability has been addressed, for certain of our products, the fix will only be effective once a customer has updated the impacted product with the latest release, and customers that do not install and run the latest supported versions of our products may remain vulnerable to attack.
Cyberattacks, including the Cyber Incident, and other security incidents have resulted, and in the future may result, in numerous risks and adverse consequences to our business, including that (a) our prevention, mitigation and remediation efforts may not be successful or sufficient, (b) our and our customers’ confidential and proprietary information, including personal information, may be exfiltrated, misappropriated, compromised or corrupted, (c) we incur significant financial, legal, reputational and other harms to our business, including loss of business, decreased sales, severe reputational damage adversely affecting current and prospective customer, employee or vendor relations and investor confidence, U.S. or foreign regulatory investigations and enforcement actions, litigation, indemnity obligations, damages for contractual breach, penalties for violation of applicable laws or regulations, including laws and regulations in the United States and other jurisdictions relating to the collection, use and security of user and other personally identifiable information and data, significant costs for remediation, impairment of our ability to protect our intellectual property, stock price volatility and other significant liabilities, (d) our insurance coverage, including coverage relating to certain security and privacy damages and claim expenses, may not be
available or sufficient to compensate for all liabilities we incur related to these matters or that we may face increased costs to obtain and maintain insurance in the future and (e) our steps to secure our internal environment, adapt and enhance our software development and build environments and ensure the security and integrity of the products that we deliver to customers may not be successful or sufficient to protect against threat actors or cyberattacks.
The Cyber Incident has had and may continue to have an adverse effect on our business, reputation, customer, employee and partner relations, results of operations, financial condition and cash flows.
The Cyber Incident has harmed, and is likely to continue to harm, our reputation and brand positioning, our customer, employee and partner relations and our operations and business as a result of both the impact it has had on our relationships with existing and prospective customers and the significant time and resources that our personnel have had to devote to responding to the Cyber Incident. Customers have and may in the future defer purchasing or choose to cancel or not renewal their agreements or subscriptions with us.
We have and expect to continue to expend significant costs and expenses related to the Cyber Incident including in connection with our investigations, our Secure By Design and related initiatives and to address the damage to our reputation, customer, employee and partner relations. If we are unable to rebuild the trust of our current and prospective customers and partners, negative publicity continues and/or our personnel continue to have to devote significant time to the Cyber Incident, our business, market share, results of operations and financial condition will be negatively affected.
We are party to lawsuits and the subject of governmental investigations related to the Cyber Incident. Numerous domestic and foreign governmental authorities are investigating events related to the Cyber Incident, including how it occurred, the consequences thereof and our response thereto, in addition to inquiries under various data protection and privacy regulations such as the European Union’s General Data Protection Regulation. We are a party to lawsuits in the U.S. and additional claims may be asserted by or on behalf of customers, stockholders or others seeking monetary damages or other relief. These investigations and claims are resulting, and are expected to result in the future, in the incurrence of significant costs and expenses (which may not be covered by insurance), the diversion of management’s attention from the operation of our business and have a negative impact on employee morale. The resolution of these investigations and claims, including providing indemnity to our officers and directors, may result in additional costs and other liabilities, which may not be covered by insurance.
As a result of the Cyber Incident and market forces beyond our control, the cost of our insurance may increase substantially, and we may not be able to obtain additional or comparable insurance coverage on commercially reasonable terms. In addition, governmental authorities investigating the Cyber Incident may seek to impose undertakings, injunctive relief, consent decrees, or other civil or criminal penalties, which could, among other things, materially increase our software development and related expenses or otherwise require us to alter how we operate our business. Further, any legislative or regulatory changes adopted in reaction to the Cyber Incident could require us to make modifications to the operation of our business that could have an adverse effect and/or increase or accelerate our compliance costs.
In addition, we are still investigating the Cyber Incident. While our investigations to date have not identified Sunburst in any of our non-Orion products, the threat actor had access to our source code across our products and exfiltrated source code from our systems. The discovery of new or different information regarding the Cyber Incident, including with respect to its scope and impact on our systems, products or customers, could increase our costs and liabilities related to the Cyber Incident and result in further damage to our business, reputation, intellectual property, results of operations and financial condition. The Cyber Incident also may embolden other threat actors to further target our systems, which could result in additional harm to our business. Although we have and expect to continue to deploy significant resources as part of our “Secure by Design” plan, we cannot ensure that our steps to secure our internal environment, improve our software development and build environments and protect the security and integrity of the products that we deliver will be successful to protect against threat actors or cyberattacks or perceived by existing and prospective customers as sufficient to address the harm caused by the Cyber Incident.
Risks Related to Our Business and Industry
Our quarterly revenue and operating results may fluctuate in the future because of a number of factors, which makes our future results difficult to predict and could cause our operating results to fall below expectations or the guidance we may provide in the future.
We believe our quarterly revenue and operating results may vary significantly in the future. As a result, you should not rely on the results of any one quarter as an indication of future performance and period-to-period comparisons of our revenue and operating results may not be meaningful.
Our quarterly results of operations may fluctuate as a result of a variety of factors, including, but not limited to, those listed below, many of which are outside of our control:
•our ability to maintain and increase sales to existing customers and to attract new customers;
•decline in maintenance or subscription renewals;
•our ability to capture a significant volume of qualified sales leads;
•our ability to convert qualified sales leads into new business sales at acceptable conversion rates;
•the amount and timing of operating expenses and capital expenditures related to the expansion of our operations and infrastructure and customer acquisition;
•our failure to achieve the growth rate that was anticipated by us in setting our operating and capital expense budgets;
•potential foreign exchange gains and losses related to expenses and sales denominated in currencies other than the functional currency of an associated entity;
•fluctuations in foreign currency exchange rates that may negatively impact our reported results of operations;
•the timing of revenue and expenses related to the development or acquisition of technologies, products or businesses;
•potential goodwill and intangible asset impairment charges and amortization associated with acquired businesses;
•the timing and success of new product, enhancements or functionalities introduced by us or our competitors;
•our ability to obtain, maintain, protect and enforce our intellectual property rights;
•changes in our pricing policiesor licensing model or those of our competitors;
•the impact of new accounting pronouncements;
•occasional large customer orders, including in particular those placed by the U.S. federal government;
•unpredictability and timing of buying decisions by the U.S. federal government;
•general economic, industry and market conditions that impact expenditures for enterprise IT management software in the United States and other countries where we sell our software;
•significant security breaches, such as the Cyber Incident, technical difficulties or interruptions to our products; and
•changes in tax rates in jurisdictions in which we operate.operate; and
•uncertainties arising from the impact of the COVID-19 pandemic on the market and our business operations.
Fluctuations in our quarterly operating results might lead analysts to change their models for valuing our common stock. As a result, our stock price could decline rapidly, and we could face costly securities class action suits or other unanticipated issues.
If we are unable to capture significant volumes of high quality sales leads from our digital marketing initiatives, it could adversely affect our revenue growth and operating results.
Our digital marketing program is designed to efficiently and cost-effectively drive a high volume of website traffic and deliver high quality leads, which are generally trials of our products, to our sales teams. We drive website traffic and capture leads through various digital marketing initiatives, including search engine optimization, or SEO, targeted email campaigns, localized websites, social media, e-book distribution, video content, blogging and webinars. If we fail to drive a sufficient amount of website traffic or capture a sufficient volume of high quality sales leads from these activities, our revenue may not grow as expected or could decrease. If these activities are unsuccessful, we may be required to increase our sales and marketing expenses, which may not be offset by additional revenue, and could adversely affect our operating results.
Our digital marketing initiatives may be unsuccessful in driving high volumes of website traffic and generating trials of our products, resulting in fewer high quality sales leads, for a number of reasons. For example, technology professionals often find our products when they are online searching for a solution to address a specific need. Search engines typically provide two types of search results, algorithmic and purchased listings, and we rely on both. The display, including rankings, of unpaid search results can be affected by a number of factors, many of which are not in our direct control, and may change frequently. Our SEO techniques have been developed to work with existing search algorithms used by the major search engines. However, major search engines frequently modify their search algorithms and such modifications could cause our websites to receive less favorable placements, which could reduce the number of technology professionals who visit our websites. In addition, websites must comply with search engine guidelines and policies that are complex and may change at any time. If we fail to follow such guidelines and policies properly, search engines may rank our content lower in search results or could remove our content altogether from their indexes. If our websites are displayed less prominently, or fail to appear in search result listings in response to search inquiries regarding IT management problems through Internet search engines for any reason, our website traffic could significantly decline, requiring us to incur increased marketing expenses to replace this traffic. Any failure to replace this traffic could reduce our revenue.
In addition, the success of our digital marketing initiatives depends in part on our ability to collect customer data and communicate with existing and potential customers online and through phone calls. As part of the product evaluation trial process and during our sales process, most of our customers agree to receive emails and other communications from us. We
also use tracking technologies, including cookies and related technologies, to help us track the activities of the visitors to our websites. However, as discussed in greater detail below, we are subject to a wide variety of data privacy and security laws and regulations in the U.S. and internationally that affect our ability to collect and use customer data and communicate with customers through email and phone calls. Several jurisdictions have proposed or adopted laws that restrict or prohibit unsolicited email or “spam” or regulate the use of cookies, including the European Union’s recently enacted General Data Protection Regulation. These new laws and regulations may impose significant monetary penalties for violations and complex and often burdensome requirements in connection with sending commercial email or other data-driven marketing practices. As a result of such regulation, we may be required to modify or discontinue our existing marketing practices, which could increase our marketing costs.
If we are unable to sell products to new customers or to sell additional products or upgrades to our existing customers, it could adversely affect our revenue growth and operating results.
To increase our revenue, we must regularly add new customers, including new customers within existing client organizations, and sell additional products or upgrades to existing customers. Even if we capture a significant volume of leads from our digital marketing activities, we must be able to convert those leads into sales of our products in order to achieve revenue growth.
We primarily rely on our direct sales force to sell our products to new and existing customers and convert qualified leads into sales using our low-touch, high-velocity sales model. Accordingly, our ability to achieve significant growth in revenue in the future will depend on our ability to recruit, train and retain sufficient numbers of sales personnel, and on the productivity of those personnel. We plan to continue to expand our sales force both domestically and internationally. Our recent and planned personnel additions may not become as productive as we would like or in a timely manner, and we may be unable to hire or retain sufficient numbers of qualified individuals in the future in the markets where we do or plan to do business. If we are unable to sell products to new customers and additional products or upgrades to our existing customers through our direct sales force or through our channel partners, which supplement our direct sales force by distributing our products and generating sales opportunities, we may be unable to grow our revenue and our operating results could be adversely affected.
We offer and sell our products to two main groups of customers: technology professionals, who use our cloud and on-premisesCore IT Management products to manage their organization’s own IT infrastructure, and managed service providers, or MSPs, who use our MSP products to manage their end clients’ IT infrastructure. In addition to the growth in our coreCore IT Management offerings since our inception, since 2013, we have also devoted significant resources to expanding our MSP offerings, including through our acquisition of LOGICnow in 2016.offerings. If we fail to continue to add MSP customers, our business and operating results may be harmed.
Our business depends on customers renewing their maintenance or subscription agreements. Any decline in renewal or net retention rates could harm our future operating results.
The significant majority of our revenue is recurring and consists of maintenance revenue and subscription revenue. Our perpetual license products typically include the first year of maintenance as part of the initial price. Our subscription products generally have recurring monthly or annual subscription periods. Our customers have no obligation to renew their maintenance or subscription agreements after the expiration of the initial period. Additionally, customers could cancel their subscription agreements prior to the expiration of the subscription period, which could result in us recognizing less subscription revenue than expected over the term of the agreement.
It is difficult to accurately predict long-term customer retention. Our customers’ maintenance renewal rates and subscription net retention rates may decline or fluctuate as a result of a number of factors, including theirsuch as the Cyber Incident, our customers’ level of satisfaction with our products,
the prices of our products, the prices of products and services offered by our competitors or reductions in our customers’ spending levels. If our customers do not renew their maintenance or subscription arrangements or if they renew them on less favorable terms, our revenue may decline and our business will suffer. A substantial portion of our quarterly maintenance and subscription revenue is attributable to agreements entered into during previous quarters. As a result, if there is a decline in renewed maintenance or subscription agreements in any one quarter, only a small portion of the decline will be reflected in our revenue recognized in that quarter and the rest will be reflected in our revenue recognized in the following four quarters or more.
The global COVID-19 pandemic may adversely affect our business, results of operations and financial condition.
The global coronavirus disease 2019, or COVID-19, pandemic has created significant volatility, uncertainty and disruption in the global economy. Although we have implemented measures to mitigate the impact of the COVID-19 pandemic on our business, financial condition and results of operations, including reducing our expenses in certain areas of our business, these measures may not fully mitigate the impact of the COVID-19 pandemic on our business, financial condition and results of operations. The extent to which the COVID-19 pandemic may continue to impact our business, results of operations and
financial condition is uncertain and will depend on numerous evolving factors outside of our control that we are not able to accurately predict, including:
•the duration and scope of the COVID-19 pandemic;
•governmental actions taken in response to the COVID-19 pandemic that restrict or disrupt global economic activity, including restrictions imposed on the operation of our business in our U.S. and international locations;
•business failures, reductions in information technology spending, late or missed payments, or delays in purchasing decisions by our customers, their end-customers and our prospective customers, in particular among SMEs that we or our MSP customers’ serve, and the resulting impact on demand for our products, our ability to collect payments for our products or our ability to add new customers and retain existing customers;
•our ability to continue to effectively market, sell and support our products through disruptions to our operations, the operations of our customers and partners and the communities in which our and their employees are located, including disruptions resulting from the spread of the virus, quarantines, office closures, reallocation of internal resources and transitions to remote working arrangements;
•the ability of our products to address our customers’ needs in a rapidly evolving business environment and any interruptions or performance problems associated with the increased use of our products as a result of the shift to more remote working environments, including disruptions at any third-party data centers upon which we rely;
•our ability to develop new products, enhance our existing products and acquire new products in this uncertain business environment;
•delays in the U.S. federal government’s budget and appropriations process and changes in spending priorities of the U.S. federal government that result in the loss or delay of sales of our products to the U.S. federal government; and
•public and private litigation based upon, arising out of or related to COVID-19 and our actions and responses thereto.
In addition to the adverse impact any of these factors could have on our business, results of operations and financial condition, these factors and the other impacts of the COVID-19 pandemic also could cause, contribute to, or increase the likelihood of the risks and uncertainties identified elsewhere in this Annual Report on Form 10-K, any of which could materially adversely affect our business, results of operations and financial condition. Additionally, because an increasing portion of our business is based on a recurring revenue model, the effect of COVID-19 on our business will not be fully reflected in our financial results for some time.
We have experienced substantial growth in recent years, and if we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of customer satisfaction or adequately address competitive challenges, and our financial performance may be adversely affected.
Our business has rapidly grown, which has resulted in large increases in our number of employees, expansion of our infrastructure, new internal systems and other significant changes and additional complexities. We increased our total number of employees to 2,7383,340 as of December 31, 20182020 from 2,4223,251 as of December 31, 2017.2019. While we intend to further expand our overall business, customer base, and number of employees, our historical growth rate is not necessarily indicative of the growth that we may achieve in the future. The growth in our business generally and our management of a growing workforce and customer base geographically dispersed across the U.S. and internationally will require substantial management effort, infrastructure and operational capabilities. To support our growth, we must continue to improve our management resources and our operational and financial controls and systems, and these improvements may increase our expenses more than anticipated and result in a more complex business. We will also have to anticipate the necessary expansion of our relationship management, implementation, customer service and other personnel to support our growth and achieve high levels of customer service and satisfaction. Our success will depend on our ability to plan for and manage this growth effectively. If we fail to anticipate and manage our growth or are unable to provide high levels of customer service, our reputation, as well as our business, results of operations and financial condition, could be harmed.
Because our long-term success depends on our ability to operate our business internationally and increase sales of our products to customers located outside of the United States, our business is susceptible to risks associated with international operations.
We have international operations in the Republic of Ireland, the United Kingdom, Canada, the Czech Republic, Poland, Belarus, Romania, Austria, Germany, Portugal, the Netherlands, Sweden, Canada,Switzerland, Israel, Australia, Japan, Singapore and the Philippines.Philippines and we market and sell our products worldwide. We also expect to continue to expand our international operations for the foreseeable future. The continued international expansion of our operations requires significant management attention and financial resources and results in increased administrative and compliance costs. Our limited experience in operating our business in certain regions outside the United States increases the risk that our expansion efforts into those regions may not be successful. In particular, our business model may not be successful in particular countries or regions outside the United States
for reasons that we currently are unable to anticipate. In addition, conducting international operations subjects usWe are subject to risks that we have not generally faced in the United States. These include,associated with international sales and operations including, but are not limited to:
•fluctuations in currency exchange rates (which we hedge only to a limited extent at this time);
•the complexity of, or changes in, foreign regulatory requirements;
•reduced or varied protection for intellectual property rights in some countries and the risk of potential theft or compromise of our technology, data or intellectual property in connection with our international operations, whether by state-sponsored malfeasance or other foreign entities or individuals;
•difficulties in managing the staffing of international operations, including compliance with local labor and employment laws and regulations;
•potentially adverse tax consequences, including the complexities of foreign value added tax systems, overlapping tax regimes, restrictions on the repatriation of earnings and changes in tax rates;
•dependence on resellers and distributors to increase customer acquisition or drive localization efforts;
•the burdens of complying with a wide variety of foreign laws and different legal standards;
•increased financial accounting and reporting burdens and complexities;
•longer payment cycles and difficulties in collecting accounts receivable;
•longer sales cycles;
•political, social and economic instability abroad;instability;
•war, terrorist attacks and security concerns in general;
reduced or varied protection for intellectual property rights in some countries;•laws and policies of the U.S. and other jurisdictions affecting international trade (including import and export control laws, tariffs and trade barriers);
•the risk of U.S. regulation of foreign operations.operations; and
•other factors beyond our control such as natural disasters and pandemics.
The occurrence of any one of these risks could negatively affect our international business and, consequently, our operating results. We cannot be certain that the investment and additional resources required to establish, acquire or integrate operations in other countries will produce desired levels of revenue or profitability. If we are unable to effectively manage our expansion into additional geographic markets, our financial condition and results of operations could be harmed.
In particular, we operate much of our research and development activities internationally and outsource a portion of the coding and testing of our products and product enhancements to contract development vendors. We believe that performing research and development in our international facilities and supplementing these activities with our contract development vendors enhances the efficiency and cost-effectiveness of our product development. IfUnrest in certain countries, such as Belarus, may pose security risks to our people, our facilities, our operations and infrastructure, such as utilities and network services, and the disruption of any or all of them could materially adversely affect our operations and/or financial results. Whether in these countries or in others in which we experience problems withoperate, civil unrest, political instability or uncertainty, military activities, or broad-based sanctions, should they continue for the long term or escalate, could require us to re-balance our workforce or facilities internationally, we may not be able to develop new products or enhance existing products in an alternate manner that may be equally or less efficientgeographic concentrations and cost-effective.could have a material adverse effect on our operations.
We are monitoring developments related toIn June 2016, the United Kingdom’s 2016electorate voted in a referendum in which United Kingdom voters approved an exitto voluntarily depart from the European Union, commonly referred to as “Brexit.” The potentialUnited Kingdom’s withdrawal from the European Union occurred on January 31, 2020, but the United Kingdom remained in the European Union’s customs union and single market for a transition period that expired on December 31, 2020. On December 24, 2020, the United Kingdom and the European Union entered into a trade and cooperation agreement (the “Trade and Cooperation Agreement”), which was applied on a provisional basis from January 1, 2021. While the economic integration does not reach the level that existed during the time the United Kingdom was a member state of the European Union, the Trade and Cooperation Agreement sets out preferential arrangements in areas such as trade in goods and in services, digital trade and intellectual property. Negotiations between the United Kingdom and the European Union are expected to continue in relation to the relationship between the United Kingdom and the European Union in certain other areas which are not covered by the Trade and Cooperation Agreement. The long term effects of Brexit on our business will depend uponon the effects of the implementation and application of the Trade and Cooperation Agreement and any other relevant agreements between the United Kingdom makes to retain access toand the European Union markets either during a transitional period or more permanently and negotiations are ongoing. Since weUnion. We have operations in the UKUnited Kingdom and Europe,the European Union and, as a result, we face risks associated with the potential uncertainty and disruptions that may follow Brexit could potentially have corporate structural consequences, adversely change tax benefits or liabilities and disrupt somethe implementation and application of the marketsTrade and jurisdictionsCooperation Agreement, including with respect to volatility in which we operate. In addition, Brexit could leadexchange rates and interest rates, disruptions to legal uncertaintythe free movement of data, goods, services, people and potentially divergent national laws and regulations ascapital between the United Kingdom determines whichand the European Union lawsand potential material changes to replacethe regulatory regime applicable to our operations in the United Kingdom.
In addition, global privacy and data protection legislation, enforcement and policy activity are rapidly expanding and evolving, and may be inconsistent from jurisdiction to jurisdiction. For example, on July 16, 2020, the Court of Justice of the European Union, Europe’s highest court, held in the Schrems II case that the E.U.-U.S. Privacy Shield, a mechanism for the transfer of personal data from the European Union to the United States, was invalid and imposed additional obligations in connection with the use of standard contractual clauses approved by the European Commission. The impact of this decision on the ability to lawfully transfer personal data from the European Union to the United States is being assessed and guidance from European regulators and advisory bodies is awaited. It is possible that the decision will restrict the ability to transfer personal data from the European Union to the United States and we may, in addition to other impacts, experience additional costs associated with increased compliance burdens, and we and our customers face the potential for regulators in the European Economic Area (“EEA”) to apply different standards to the transfer of personal data from the EEA to the United States, and to block, or replicate.require ad hoc verification of measures taken with respect to, certain data flows from the EEA to the United States.
If one or more of these risks occurs, it could require us to dedicate significant resources to remedy, and if we are unsuccessful in finding a solution, our financial results will suffer.
We operate in highly competitive markets, which could make it difficult for us to acquire and retain customers at historic rates.
We operate in a highly competitive industry. Competition in our market is based primarily on brand awareness and reputation; product capabilities, including scalability, performance, security and reliability; ability to solve problems for companies of all sizes and infrastructure complexities; ease of use; total cost of ownership; flexible deployment models, including on-premise,on-premises, in the cloud or in a hybrid environment; strength of sales and marketing efforts; and focus on customer service. We often compete to sell our products against existing products or systems that our potential customers have already made significant expenditures to install. Many of our current and potential competitors enjoy substantial competitive advantages over us, such as greater brand awareness and substantially greater financial, technical and other resources. In addition, many of our competitors have established marketing relationships and access to larger customer bases, and have major distribution agreements with consultants, system integrators and resellers. Given their larger size, greater resources and existing customer relationships, our competitors may be able to compete and respond more effectively than we can to new or changing opportunities, technologies, standards or customer requirements.
We face competition from both large network management and IT vendors offering enterprise-wide software frameworks and services and smaller companies in the cloud and application monitoring and the MSP IT tools markets. We also compete with network equipment vendors and IT operations management product providers, as well as infrastructure providers and their native applications, whose products and services also address network and IT management requirements. Our principal competitors vary depending on the product we offer and include large network management and IT vendors such as NetScoutCisco Systems, Inc., Micro Focus International plc, CA, Inc., International Business Machines Corporation and BMC Software, Inc., and smaller companies in the cloud and application monitoring and the MSP IT tools markets, including MSP pure-play vendors and niche or domain-specific vendors that provide solutions focused on a particular service that may be sold by MSPs, where we do not believe that a single or small group of companies has achieved market leadership.
Some of our competitors have made acquisitions or entered into strategic relationships with one another to offer more comprehensive or bundled or integrated product offerings. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Companies and alliances resulting from these possible consolidations and partnerships may create more compelling product offerings and be able to offer more attractive pricing, making it more difficult for us to compete effectively.
Our actual operating results may differ significantly from information we may provide in the future regarding our financial outlook.
From time to time, we may provide information regarding our financial outlook in our quarterly earnings releases, quarterly earnings conference calls, or otherwise, that represents our management’s estimates as of the date of release. This information regarding our financial outlook, which includes forward-looking statements, will be based on projections, including those related to certain of the factors listed above, prepared by our management. Neither our independent registered public accounting firm nor any other independent expert or outside party will compile or examine the projections nor, accordingly, will any such person express any opinion or any other form of assurance with respect thereto.
These projections will be based upon a number of assumptions and estimates that, while presented with numerical specificity, will be inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which will be beyond our control, and will also be based upon specific assumptions with respect to future business decisions, some of which will change. We intend to state possible outcomes as high and low ranges, which will be intended to provide a sensitivity analysis
as variables are changed, but will not be intended to represent that actual results could not fall outside of the suggested ranges. The principal reason that we may in the future release such information is to provide a basis for our
management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by analysts.
Information regarding our financial outlook would be necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying such information furnished by us will not materialize or will vary significantly from actual results. Accordingly, information that we may provide regarding our financial outlook will only be an estimate of what management believes is realizable as of the date of release. Actual results will vary from our financial outlook, and the variations may be material and adverse. In light of the foregoing, investors are urged to consider these factors, not to rely exclusively upon information we may provide regarding our financial outlook in making an investment decision regarding our common stock, and to take such information into consideration only in connection with other information included in our filings filed with or furnished to the SEC, including the “Risk Factors” sections in such filings.
Any failure to implement our operating strategy successfully or the occurrence of any of the events or circumstances set forth under “Risk Factors” in this Annual Report on Form 10-K could result in our actual operating results being different from information we provide regarding our financial outlook, and those differences might be adverse and material.
If we sustain system failures, cyberattacks against our systems or against our products, or other data security incidents or breaches, we could suffer a loss of revenue and increased costs, exposure to significant liability, reputational harm and other serious negative consequences.
We are heavily dependent on our technology infrastructure to sell our products and operate our business, and our customers rely on our technology to help manage their own IT infrastructure. Our systems and those of our third-party service providers are vulnerable to damage or interruption from natural disasters, fire, power loss, telecommunication failures, traditional computer “hackers,” malicious code (such as viruses and worms), employee theft or misuse, and denial-of-service attacks, as well as sophisticated nation-state and nation-state-supported actors (including advanced persistent threat intrusions). The risk of a security breach or disruption, particularly through cyberattacks or cyber intrusion, including by computer hacks, foreign governments, and cyber terrorists, has generally increased the number, intensity and sophistication of attempted attacks, and intrusions from around the world have increased. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of our systems.
Because the techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. We may also experience security breaches that may remain undetected for an extended period and, therefore, have a greater impact on the products we offer, the proprietary data contained therein, and ultimately on our business.
The foregoing security problems could result in, among other consequences, damage to our own systems or our customers’ IT infrastructure or the loss or theft of our customers’ proprietary or other sensitive information. The costs to us to eliminate or address the foregoing security problems and security vulnerabilities before or after a cyber incident could be significant. Our remediation efforts may not be successful and could result in interruptions, delays or cessation of service and loss of existing or potential customers that may impede sales of our products or other critical functions. We could lose existing or potential customers in connection with any actual or perceived security vulnerabilities in our websites or our products.
During the purchasing process and in connection with evaluations of our software, either we or third-party providers collect and use customer information, including personally identifiable information, such as credit card numbers, email addresses, phone numbers and IP addresses. We have legal and contractual obligations to protect the confidentiality and appropriate use of customer data. Despite our security measures, unauthorized access to, or security breaches of, our software or systems could result in the loss, compromise or corruption of data, loss of business, severe reputational damage adversely affecting customer or investor confidence, regulatory investigations and orders, litigation, indemnity obligations, damages for contract breach, penalties for violation of applicable laws or regulations, significant costs for remediation and other liabilities. We have incurred and expect to incur significant expenses to prevent security breaches, including deploying additional personnel and protection technologies, training employees, and engaging third-party experts and consultants. Our errors and omissions insurance coverage covering certain security and privacy damages and claim expenses may not be sufficient to compensate for all liabilities we incur.
Acquisitions present many risks that could have a materialan adverse effect on our business and results of operations.
In order to expand our business, we have made several acquisitions and expect to continue making similar acquisitions and possibly larger acquisitions as part of our growth strategy. The success of our future growth strategy will depend on our ability to identify, negotiate, complete and integrate acquisitions and, if necessary, to obtain satisfactory debt or equity financing to fund those acquisitions. Acquisitions are inherently risky, and any acquisitions we complete may not be successful. Our past acquisitions
and any mergers and acquisitions that we may undertake in the future involve numerous risks, including, but not limited to, the following:
•difficulties in integrating and managing the operations, personnel, systems, technologies and products of the companies we acquire;
•diversion of our management’s attention from normal daily operations of our business;
•our inability to maintain the key business relationships and the reputations of the businesses we acquire;
•uncertainty of entry into markets in which we have limited or no prior experience and in which competitors have stronger market positions;
•our dependence on unfamiliar affiliates, resellers, distributors and partners of the companies we acquire;
•our inability to increase revenue from an acquisition for a number of reasons, including our failure to drive demand in our existing customer base for acquired products and our failure to obtain maintenance renewals or upgrades and new product sales from customers of the acquired businesses;
•increased costs related to acquired operations and continuing support and development of acquired products;
•our responsibility for the liabilities of the businesses we acquire;
•potential goodwill and intangible asset impairment charges and amortization associated with acquired businesses;
•adverse tax consequences associated with acquisitions;
•changes in how we are required to account for our acquisitions under U.S. generally accepted accounting principles, including arrangements that we assume from an acquisition;
•potential negative perceptions of our acquisitions by customers, financial markets or investors;
•failure to obtain required approvals from governmental authorities under competition and antitrust laws on a timely basis, if at all, which could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of an acquisition;
•potential increases in our interest expense, leverage and debt service requirements if we incur additional debt to pay for an acquisition;
•our inability to apply and maintain our internal standards, controls, procedures and policies to acquired businesses; and
•potential loss of key employees of the companies we acquire.
Additionally, acquisitions or asset purchases made entirely or partially for cash may reduce our cash reserves or require us to incur additional debt under our credit agreements or otherwise. We may seek to obtain additional cash to fund an acquisition by selling equity or debt securities. We may be unable to secure the equity or debt funding necessary to finance future acquisitions on terms that are acceptable to us. If we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders will experience ownership dilution.
The occurrence of any of these risks could have a material adverse effect on our business, results of operations, financial condition or cash flows, particularly in the case of a larger acquisition or substantially concurrent acquisitions.
Businesses that we acquire may have greater than expected liabilities for which we become responsible.
Businesses that we acquire may have liabilities or adverse operating issues, or both, that we fail to discover through due diligence or the extent of which we underestimate prior to the acquisition. For example, to the extent that any business that we acquire or any prior owners, employees or agents of any acquired businesses or properties (i) failed to comply with or otherwise violated applicable laws, rules or regulations; (ii) failed to fulfill or disclose their obligations, contractual or otherwise, to applicable government authorities, their customers, suppliers or others; or (iii) incurred tax or other liabilities, we, as the successor owner, may be financially responsible for these violations and failures and may suffer harm to our reputation and otherwise be adversely affected. An acquired business may have problems with internal control over financial reporting, which could be difficult for us to discover during our due diligence process and could in turn lead us to have significant deficiencies or material weaknesses in our own internal control over financial reporting. These and any other costs, liabilities and disruptions associated with any of our past acquisitions and any future acquisitions could harm our operating results.
Charges to earnings resulting from acquisitions may adversely affect our operating results.
When we acquire businesses, we allocate the purchase price to tangible assets and liabilities and identifiable intangible assets acquired at their acquisition date fair values. Any residual purchase price is recorded as goodwill, which is also generally measured at fair value. We also estimate the fair value of any contingent consideration. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are uncertain and involve significant judgments by management. After we complete an acquisition, the following factors could result in material charges and adversely affect our operating results and may adversely affect our cash flows:
•costs incurred to combine the operations of companies we acquire, such as transitional employee expenses and employee retention or relocation expenses;
•impairment of goodwill or intangible assets;
•a reduction in the useful lives of intangible assets acquired;
•impairment of long-lived assets;
•identification of, or changes to, assumed contingent liabilities;
•changes in the fair value of any contingent consideration;
•charges to our operating results due to duplicative pre-merger activities;
•charges to our operating results from expenses incurred to effect the acquisition; and
•charges to our operating results due to the expensing of certain stock awards assumed in an acquisition.
Substantially all of these costs will be accounted for as expenses that will decrease our net income and earnings per share for the periods in which those costs are incurred. Charges to our operating results in any given period could differ substantially from other periods based on the timing and size of our acquisitions and the extent of integration activities.
Our operating margins and cash flows from operations could fluctuate as we make further expenditures to expand our operations in order to support additional growth in our business.
We have made significant investments in our operations to support additional growth, such as hiring substantial numbers of new personnel, investing in new facilities, acquiring other companies or their assets and establishing and broadening our international operations in order to expand our business. We have made substantial investments in recent years to increase our sales and marketing operations in the EMEA and APAC regions and expect to continue to invest to grow our international sales and global brand awareness. We also expect to continue to invest to grow our research and development organization, particularly internationally. We have made multiple acquisitions in recent years and expect these acquisitions will continue to increase our operating expenses in future periods. These investments may not yield increased revenue, and even if they do, the increased revenue may not offset the amount of the investments. We also expect to continue to pursue acquisitions in order to expand our presence in current markets or new markets, many or all of which may increase our operating costs more than our revenue. As a result of any of these factors, our operating income could fluctuate and may continue to decline as a percentage of revenue relative to our prior annual periods.
The ability to recruit, retain and develop key employees and management personnel is critical to our success and growth, and our inability to attract and retain qualified personnel could harm our business.
Our business requires certain expertise and intellectual capital, particularly within our management team. We rely on our management team in the areas of operations, security, marketing, sales, support and general and administrative functions. The loss of one or more of our management team could have a material adverse effect on our business.
For us to compete successfully and grow, we must retain, recruit and develop key personnel who can provide the needed expertise for our industry and products. As we move into new geographic areas, we will need to attract, recruit and retain
qualified personnel in those locations. In addition, acquisitions could cause us to lose key personnel of the acquired businesses. The market for qualified personnel is competitive and we may not succeed in retaining and recruiting additional key personnel or may fail to effectively replace current key personnel who depart with qualified or effective successors. We believe that replacing our key personnel with qualified successors is particularly challenging as we feel that our business model and approach to marketing and selling our products are unique. Any successors that we hire from outside of the Companycompany would likely be unfamiliar with our business model and may therefore require significant time to understand and appreciate the important aspects of our business or fail to do so altogether. Our effort to retain and develop personnel may also result in significant additional expenses, including stock-based compensation expenses, which could adversely affect our profitability. New regulations and volatility or lack of performance in our stock price could also affect the value of our equity awards, which could affect our ability to attract and retain our key employees. We have made significant changes, and may make additional changes in the future, to our senior management team and other key
personnel. personnel, including, for example, the recent departure of our former chief executive officer, Kevin Thompson. We have a new chief executive officer, Sudhakar Ramakrishna, who started in January 2021. Leadership transitions can be inherently difficult to manage, and an inadequate transition may cause disruption to our business. In addition, we cannot provide assurances that key personnel, including our executive officers, will continue to be employed by us or that we will be able to attract and retain qualified personnel in the future. Failure to retain or attract key personnel could have a material adverse effect on our business.
Our success depends on our ability to maintain a product portfolio that responds to the needs of technology professionals and the evolving IT management market.
Our product portfolio has grown from on-premiseon-premises network management products to broad-based on-premiseon-premises systems monitoring and management and products for the growing but still emerging cloud and MSP markets. We offer over 50a broad portfolio of products designed to solve the day-to-day problems encountered by technology professionals managing complex IT infrastructure, spanning on-premise,on-premises, cloud and hybrid IT environments. Our long-term growth depends on our ability to continually enhance and improve our existing products and develop or acquire new products that address the common problems encountered by technology professionals on a day-to-day basis in an evolving IT management market. The success of any enhancement or new product depends on a number of factors, including its relevance to our existing and potential customers, timely completion and introduction and market acceptance. New products and enhancements that we develop or acquire may not sufficiently address the evolving needs of our existing and potential customers, may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate the amount of revenue necessary to realize returns on our investments in developing or acquiring such products or enhancements. If our new products and enhancements are not successful for any reason, certain products in our portfolio may become obsolete, less marketable and less competitive, and our business will be harmed.
If we are unable to develop and maintain successful relationships with channel partners, our business, results of operations and financial condition could be harmed.
We have established relationships with certain channel partners to distribute our products and generate sales opportunities, particularly internationally. We believe that continued growth in our business is dependent upon identifying, developing and maintaining strategic relationships with our existing and potential channel partners that can drive substantial revenue and provide additional valued-added services to our customers. Our agreements with our existing channel partners are non-exclusive, meaning our channel partners may offer customers the products of several different companies, including products that compete with ours. They may also cease marketing our products with limited or no notice and with little or no penalty. We expect that any additional channel partners we identify and develop will be similarly non-exclusive and not bound by any requirement to continue to market our products. If we fail to identify additional channel partners in a timely and cost-effective manner, or at all, or are unable to assist our current and future channel partners in independently distributing and deploying our products, our business, results of operations and financial condition could be harmed. If our channel partners do not effectively market and sell our products, or fail to meet the needs of our customers, our reputation and ability to grow our business may also be harmed.
We depend on the U.S. federal government in certain calendar quarters for a meaningful portion of our on-premiseon-premises license sales, including maintenance renewals associated with such products, and orders from the U.S. federal government are unpredictable. The delay or loss of these sales may harm our operating results.
A portion of our on-premiseon-premises license sales, including maintenance renewals associated with such products, are to a number of different departments of the U.S. federal government. In certain calendar quarters, particularly the third calendar quarter, this portion may be meaningful. Any factors that cause a decline in government expenditures generally or government IT expenditures in particular could cause our revenue to grow less rapidly or even to decline. TheseFollowing the Cyber Incident, our government contracts have received enhanced scrutiny and negative media attention. If we are unable to repair the reputational damage cause by the Cyber Incident and ensure the security of the data we maintain, our ability to maintain our existing and
acquire new government contracts may be substantially impacted. Other factors include, but are not limited to, constraints on the budgetary process, including changes in the policies and priorities of the U.S. federal government, deficit-reduction legislation, and any shutdown of the U.S. federal government. Furthermore, sales orders from the U.S. federal government tend to be dependent on many factors and therefore unpredictable in timing. Any sales we expect to make in a quarter may not be made in that quarter or at all, and our operating results for that quarter may therefore be adversely affected.
We are subject to various global data privacy and security regulations, which could result in additional costs and liabilities to us.
Our business is subject to a wide variety of local, state, national and international laws, directives and regulations that apply to the collection, use, retention, protection, disclosure, transfer and other processing of personal data. These data protection and privacy-related laws and regulations continue to evolve and may result in ever-increasing regulatory and public scrutiny and escalating levels of enforcement and sanctions and increased costs of compliance. In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, and state breach notification laws. If there is a breach of our computer systems and we know or suspect that unencrypted personal customer information has been stolen, we may be required to inform the representative state attorney general or federal or country regulator, media and credit reporting agencies, and any customers whose information was stolen, which could harm our reputation and business. Other states and countries have enacted different requirements for protecting personal information collected and maintained electronically. We expect that there will continue to be new proposed laws, regulations and industry standards concerning privacy, data protection and information
security in the United States, the European Union and other jurisdictions, and we cannot yet determine the impact such future laws, regulations and standards will have on our business or the businesses of our customers, including, but not limited to, the European Union’s recently enacted General Data Protection Regulation, which came into force in May 2018 and created a range of new compliance obligations, and significantly increased financial penalties for noncompliance.
Failure to comply with laws concerning privacy, data protection and information security could result in enforcement action against us, including fines, imprisonment of company officials and public censure, claims for damages by end customers and other affected individuals, damage to our reputation and loss of goodwill (both in relation to existing end customers and prospective end customers), any of which could have a material adverse effect on our operations, financial performance and business. In addition, we could suffer adverse publicity and loss of customer confidence were it known that we did not take adequate measures to assure the confidentiality of the personally identifiable information that our customers had given to us. This could result in a loss of customers and revenue that could jeopardize our success. We may not be successful in avoiding potential liability or disruption of business resulting from the failure to comply with these laws and, even if we comply with laws, may be subject to liability because of a security incident. If we were required to pay any significant amount of money in satisfaction of claims under these laws, or any similar laws enacted by other jurisdictions, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any of these laws, our business, operating results and financial condition could be adversely affected. Further, complying with the applicable notice requirements in the event of a security breach could result in significant costs.
Additionally, our business efficiencies and economies of scale depend on generally uniform product offerings and uniform treatment of customers across all jurisdictions in which we operate. Compliance requirements that vary significantly from jurisdiction to jurisdiction impose added costs on our business and can increase liability for compliance deficiencies.
If we fail to develop and maintain our brands cost-effectively, our financial condition and operating results might suffer.
We believe that developing and maintaining awareness and integrity of our brands in a cost-effective manner are important to achieving widespread acceptance of our existing and future products and are important elements in attracting new customers. We believe that the importance of brand recognition will increase as we enter new markets and as competition in our existing markets further intensifies. Successful promotion of our brands will depend on the effectiveness of our marketing efforts and on our ability to provide reliable, secure and useful products at competitive prices. We intend to increase our expenditures onAny brand promotion. Brand promotion activities may not yield increased revenue, and even if they do, the increased revenue may not offset the expenses we incur in building our brands. We rely on resellers and distributors to some extent in the distribution of our products. We have limited control over these third parties, and actions by these third parties could negatively impact our brand. We also rely on our customer base and community of end-users in a variety of ways, including to give us feedback on our products and to provide user-based support to our other customers through THWACK, our online community. If poor advice or misinformation regarding our products is spread among users of THWACK, it could adversely affect our reputation, our financial results and our ability to promote and maintain our brands. If we fail to promote and maintain our brands successfully, fail to maintain loyalty among our customers and our end-user community, or incur substantial expenses in an unsuccessful attempt to promote and maintain our brands, we may fail to attract new customers or retain our existing customers and our financial condition and results of operations could be harmed. Additionally, if our MSP customers do not use or ineffectively use our products to serve their end clients, our reputation and ability to grow our business may be harmed.
Adverse economic conditions may negatively affect our business.
Our business depends on the overall demand for information technology and on the economic health of our current and prospective customers. Any significant weakening of the economy in the United States, EMEA, APAC and of the global economy, more limited availability of credit, a reduction in business confidence and activity, decreased government spending, economic uncertainty, and other difficulties may affect one or more of the sectors or countries in which we sell our products. Global economic and political uncertainty may cause some of our customers or potential customers to curtail spending generally or IT management spending specifically, and may ultimately result in new regulatory and cost challenges to our international operations. In addition, a strong dollar could reduce demand for our products in countries with relatively weaker currencies. These adverse conditions could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition. Any of these events could have an adverse effect on our business, operating results and financial position.
Interruptions or performance problems associated with our internal infrastructure, and its reliance on technologies from third parties, may adversely affect our ability to manage our business and meet reporting obligations.
Currently, we use NetSuite to manage our order management and financial processes, salesforce.com to track our sales and marketing efforts and other third-party vendors to manage online marketing and web services. We believe the availability of these services is essential to the management of our high-volume, transaction-oriented business model. We also use third-party vendors to manage our equity compensation plans and certain aspects of our financial reporting processes. As we expand our operations,
we expect to utilize additional systems and service providers that may also be essential to managing our business. Although the systems and services that we require are typically available from a number of providers, it is time-consuming and costly to qualify and implement these relationships. Therefore, if one or more of our providers suffer an interruption in their business, or experience delays, disruptions or quality-control problems in their operations, or we have to change or add additional systems and services, our ability to manage our business and produce timely and accurate financial statements would suffer.
Interruptions or performance problems associated with our products, including disruptions at any third-party data centers upon which we rely, may impair our ability to support our customers.
Our continued growth depends in part on the ability of our existing and potential customers to access our websites, software or cloud-based products within an acceptable amount of time. We have experienced, and may in the future experience, service disruptions, outages and other performance problems due to a variety of factors, including infrastructure changes, human or software errors, capacity constraints due to an overwhelming number of users accessing our website simultaneously and denial of service or fraud or security attacks. In some instances, we may not be able to identify the cause or causes of these website performance problems within an acceptable period of time. It may become increasingly difficult to maintain and improve our website performance, especially during peak usage times and as our user traffic increases. If our websites are unavailable or if our customers are unable to access our software or cloud-based products within a reasonable amount of time or
at all, our business would be negatively affected. Additionally, our data centers and networks and third-party data centers and networks may experience technical failures and downtime, may fail to distribute appropriate updates, or may fail to meet the increased requirements of a growing customer base.
We provide certain of our cloudapplication performance management, MSP and MSPITSM products through third-party data center hosting facilities located in the United States and other countries. While we control and have access to our servers and all of the components of our network that are located in such third-party data centers, we do not control the operation of these facilities. Following expiration of the current agreement terms, the owners of the data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one of our data center operators is acquired, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and possible service interruptions in connection with doing so.
If we fail to integrate our products with a variety of operating systems, software applications, platforms and hardware that are developed by others or ourselves, our products may become less competitive or obsolete and our results of operations would be harmed.
Our products must integrate with a variety of network, hardware and software platforms, and we need to continuously modify and enhance our products to adapt to changes in hardware, software, networking, browser and database technologies. We believe a significant component of our value proposition to customers is the ability to optimize and configure our products to integrate with our systems and those of third parties. If we are not able to integrate our products in a meaningful and efficient manner, demand for our products could decrease and our business and results of operations would be harmed.
In addition, we have a large number of products, and maintaining and integrating them effectively requires extensive resources. Our continuing efforts to make our products more interoperative may not be successful. Failure of our products to operate effectively with future infrastructure platforms and technologies could reduce the demand for our products, resulting in customer dissatisfaction and harm to our business. If we are unable to respond to changes in a cost-effective manner, our products may become less marketable, less competitive or obsolete and our business and results of operations may be harmed.
Material defects or errors in our products could harm our reputation, result in significant costs to us and impair our ability to sell our products.
Software products are inherently complex and often contain defects and errors when first introduced or when new versions are released. Any defects or errors in our products could result in:
•lost or delayed market acceptance and sales of our products;
•a reduction in subscription or maintenance renewals;
•diversion of development resources;
•legal claims; and
•injury to our reputation and our brand.
The costs incurred in correcting or remediating the impact of defects or errors in our products may be substantial and could adversely affect our operating results.
Risks Related to the Potential Spin-Off
The potential spin-off of our MSP business into a newly created and separately traded public company could involve significant time and expense and management attention, could disrupt or adversely affect the consolidated or separate businesses, results of operations and financial condition and may not be completed in accordance with the expected plans or anticipated timelines, or at all.
On August 6, 2020, we announced that our board of directors authorized management to explore a potential spin-off of our MSP business into a newly created and separately traded public company, and on December 9, 2020, we announced that we confidentially submitted with the SEC a Form 10 registration statement with respect to the potential spin-off. We expect that the process of continuing to explore and, if approved, completing the potential spin-off of our MSP business will be time-consuming and involve significant costs and expenses, which could disrupt the ongoing businesses and adversely affect the results of operations and financial condition of the consolidated or separate businesses. We also may experience increased difficulties in attracting, retaining and motivating employees or maintaining or initiating relationships with partners, customers and other parties with which we currently do business, or may do business in the future, during the pendency of the potential spin-off and following its completion, which may adversely affect our business, results of operations and financial condition, or the businesses, results of operations and financial condition of the separate businesses following the completion of the potential spin-off.
Even if approved by our board of directors, we cannot ensure that we will be able to successfully complete the potential spin-off of our MSP business. Various factors, including changes in business or industry conditions, such as the Cyber Incident, and changes in global economic and financial market conditions, could delay or prevent the completion of the potential spin-off, or cause the potential spin-off to occur on terms or conditions that are different or less favorable than expected.
The separation may not achieve some or all of the anticipated benefits.
We may not realize some or all of the anticipated strategic, financial, operational, marketing or other benefits from the spin-off, or such benefits may be delayed by a variety of circumstances, which may not be under our control or the control of the MSP business. As independent publicly-traded companies, SolarWinds and the independent MSP business will be smaller, less diversified companies with a narrower business focus and may be more vulnerable to changing market conditions, which could materially and adversely affect their respective business, financial condition and results of operations. Following the potential spin-off, we or the newly independent MSP business, may not be successful in achieving our respective business and operational objectives and the combined value of the common stock of the two companies may not be equal to or greater than what the value of our common stock would have been had the proposed separation not occurred.
If the potential spin-off does not qualify as a transaction that is generally tax-free for U.S. federal income tax purposes, we, our stockholders or the MSP business could be subject to significant tax liabilities.
We expect to obtain an opinion of tax counsel and tax advisors regarding qualification of the separation and distribution, together with certain related transactions, as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. The opinion of tax counsel and tax advisors would be based upon and rely on, among other things, certain facts and assumptions, as well as certain representations, statements and undertakings of us and the MSP business, including those relating to the past and future conduct. If any of these representations, statements or undertakings are, or become, incomplete or inaccurate, or if we or the MSP business breaches any of the respective covenants in any of the separation-related agreements, the opinion of tax counsel and tax advisors could be invalid and the conclusions reached therein could be jeopardized.
Notwithstanding any opinion of tax counsel and tax advisors, the Internal Revenue Service (the “IRS”) could determine that the separation and distribution should be treated as a taxable transaction if it were to determine that any of the facts, assumptions, representations, statements or undertakings upon which any opinion of tax counsel and tax advisors was based were false or had been violated, or if it were to disagree with the conclusions in any opinion of tax counsel and tax advisors. Any opinion of tax counsel and tax advisors would not be binding on the IRS or the courts, and we cannot assure that the IRS or a court would not assert a contrary position. We have not requested, and do not intend to request, a ruling from the IRS with respect to the treatment of the distribution or certain related transactions for U.S. federal income tax purposes.
If the separation and distribution were to fail to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code, in general, we would recognize taxable gain as if we had sold our common stock in a taxable sale for its fair market value, and our stockholders who receive shares of MSP common stock in the distribution would be subject to tax as if they had received a taxable distribution equal to the fair market value of such shares.
Risks Related to Government Regulation
We are subject to various global data privacy and security regulations, which could result in additional costs and liabilities to us.
Our business is subject to a wide variety of local, state, national and international laws, directives and regulations that apply to the collection, use, retention, protection, disclosure, transfer and other processing of personal data. These data protection and privacy-related laws and regulations continue to evolve and may result in ever-increasing regulatory and public scrutiny and escalating levels of enforcement and sanctions and increased costs of compliance. In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, and state breach notification laws. If we experience another security incident with personal data issue, we may be required to inform the representative state attorney general or federal or country regulator, media and credit reporting agencies, and any customers whose information was stolen, which could further harm our reputation and business. Other states and countries have enacted different requirements for protecting personal information collected and maintained electronically. We expect that there will continue to be new proposed laws, regulations and industry standards concerning privacy, data protection and information security in the United States, the European Union and other jurisdictions, and we cannot yet determine the impact such future laws, regulations and standards will have on our business or the businesses of our customers, including, but not limited to, the European Union’s General Data Protection Regulation, which came into force in May 2018 and created a range of new compliance obligations, and significantly increased financial penalties for noncompliance, as well as the July 2020 Schrems II case that the E.U.-U.S. Privacy Shield, a mechanism for the transfer of personal data from the European Union to the United States, was invalid and imposed additional obligations in connection with the use of standard contractual clauses approved by the European Commission.
Failure to comply with laws concerning privacy, data protection and information security could result in enforcement action against us, including fines, imprisonment of company officials and public censure, claims for damages by end customers and other affected individuals, damage to our reputation and loss of goodwill (both in relation to existing end customers and prospective end customers), any of which could have a material adverse effect on our operations, financial performance and business. In addition, we could suffer adverse publicity and loss of customer confidence were it known that we did not take adequate measures to assure the confidentiality of the personally identifiable information that our customers had given to us. This could result in a loss of customers and revenue that could jeopardize our success. We may not be successful in avoiding potential liability or disruption of business resulting from the failure to comply with these laws and, even if we comply with laws, may be subject to liability because of a security incident such as the Cyber Incident. If we were required to pay any significant amount of money in satisfaction of claims under these laws, or any similar laws enacted by other jurisdictions, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any of these laws, our business, operating results and financial condition could be adversely affected. Further, complying with the applicable notice requirements in the event of a security breach could result in significant costs.
Additionally, our business efficiencies and economies of scale depend on generally uniform product offerings and uniform treatment of customers across all jurisdictions in which we operate. Compliance requirements that vary significantly from jurisdiction to jurisdiction impose added costs on our business and can increase liability for compliance deficiencies.
We are subject to governmental export controls and economic sanctions laws that could impair our ability to compete in international markets and subject us to liability if we are not in full compliance with applicable laws.
Certain of our products are subject to U.S. export controls, including the U.S. Department of Commerce’s Export Administration Regulations and economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control. These regulations may limit the export of our products and provision of our services outside of the United States, or may require export authorizations, including by license, a license exception or other appropriate government authorizations, including annual or semi-annual reporting and the filing of an encryption registration. Export control and economic sanctions laws may also include prohibitions on the sale or supply of certain of our products to embargoed or sanctioned countries, regions, governments, persons and entities. In addition, various countries regulate the importation of certain products, through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products. The exportation, re-exportation and importation of our products and the provision of services, including by our partners, must comply with these laws or else we may be adversely affected, through reputational harm, government investigations, penalties, and a denial or curtailment of our ability to export our products or provide services. Complying with export control and sanctions laws may be time consuming and may result in the delay or loss of sales opportunities. If we are found to be in violation of U.S. sanctions or export control laws, it could result in substantial fines and penalties for us and for the individuals working for us. Changes in export or import laws or corresponding sanctions may delay the introduction and sale of our products in international markets, or, in some cases, prevent the export or import of our products to certain countries, regions, governments, persons or entities altogether, which could adversely affect our business, financial condition and results of operations.
We are also subject to various domestic and international anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, as well as other similar anti-bribery and anti-kickback laws and regulations. These laws and regulations generally prohibit companies and their employees and intermediaries from authorizing, offering or providing improper payments or benefits to officials and other recipients for improper purposes. Although we take precautions to prevent violations of these laws, our exposure for violating these laws increases as our international presence expands and as we increase sales and operations in foreign jurisdictions.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or our failure to comply with regulations could harm our operating results.
As Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. In addition to data privacy and security laws and regulations, taxation of products and services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services and product offerings, which could harm our business and operating results.
Risks Related to Our Intellectual Property
The success of our business depends on our ability to obtain, maintain, protect and enforce our intellectual property rights.
Our success depends, in part, on our ability to protect proprietary methods and technologies that we develop or license so that we can prevent others from using our inventions and proprietary information. If we fail to protect our intellectual property
rights adequately, our competitors might gain access to our technology, and our business might be adversely affected. However, protecting and enforcing our intellectual property rights might entail significant expenses. Any of our intellectual property rights may be challenged by others, weakened or invalidated through administrative process or litigation. We rely primarily on a combination of patent, copyright, trademark, trade dress, unfair competition and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. These laws, procedures and restrictions provide only limited protection.
As of December 31, 2018,2020, we had approximately 3038 issued U.S. patents and have also filed patent applications, but patents may not be issued with respect to these applications. The process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Even if issued, there can be no assurance that these patents, or our existing patents, will adequately protect our intellectual property, as the legal standards relating to the validity, enforceability and scope of protection of patent and other intellectual property rights are uncertain. Our patents and any future patents issued to us may be challenged, invalidated or circumvented, and may not provide sufficiently broad protection or may not prove to be enforceable in actions against alleged infringers. Any patents that are issued may subsequently be invalidated or otherwise limited, allowing other companies to develop offerings that compete with ours, which could adversely affect our competitive business position, business prospects and financial condition. In addition, issuance of a patent does not guarantee that we have a right to practice the patented invention. Patent applications in the United States are typically not published until 18 months after filing or, in some cases, not at all, and publications of discoveries in industry-related literature lag behind actual discoveries. We cannot be certain that third parties do not have blocking patents that could be used to prevent us from marketing or practicing our patented software or technology.
We endeavor to enter into agreements with our employees and contractors and with parties with which we do business in order to limit access to and disclosure of our trade secrets and other proprietary information. We cannot be certain that the steps we have taken will prevent unauthorized use, misappropriation or reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive to ours and may infringe our intellectual property. The enforcement of our intellectual property rights also depends on our legal actions against these infringers being successful, but these actions may not be successful, even when our rights have been infringed. Further, any litigation, whether or not resolved in our favor, could be costly and time-consuming.
Our exposure to risks related to the protection of intellectual property may be increased in the context of acquired technologies as we have a lower level of visibility into the development process and the actions taken to establish and protect proprietary rights in the acquired technology. In connection with past acquisitions, we have found that some associated intellectual property rights, such as domain names and trademarks in certain jurisdictions, are owned by resellers, distributors or other third parties. In the past, we have experienced difficulties in obtaining assignments of these associated intellectual property rights from third parties.
Furthermore, effective patent, trademark, trade dress, copyright and trade secret protection may not be available in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States (in particular, some foreign jurisdictions do not permit patent protection for software), and mechanisms for enforcement of intellectual property rights may be inadequate. In addition, the legal standards, both in the United States and in foreign countries, relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving. Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property.
We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert counterclaims against us. We may not prevail in any lawsuits that we initiate, and the damages or other remedies awarded, if any, may not be commercially viable. Any litigation, whether or not resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may adversely affect our business, results of operations, financial condition and cash flows.
Exposure related to any future litigation could adversely affect our results of operations, profitability and cash flows.
From time to time, we have been and may be involved in various legal proceedings and claims arising in our ordinary course of business. At this time,Other than the litigation relating to the Cyber Incident, neither we nor any of our subsidiaries is a party to, and none of our respective property is the subject of, any material legal proceeding. However, the outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. Future litigation may result in a diversion of management’s attention and resources, significant costs, including
monetary damages and legal fees, and injunctive relief, and may contribute to current and future stock price volatility. No assurance can be made that future litigation will not result in
material financial exposure or reputational harm, which could have a material adverse effect upon our results of operations, profitability or cash flows.
In particular, the software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. We have received, and from time to time may receive, letters claiming that our products infringe or may infringe the patents or other intellectual property rights of others. As we face increasing competition and as our brand awareness increases, the possibility of additional intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use. Additionally, we have licensed from other parties proprietary technology covered by patents and other intellectual property rights, and these patents or other intellectual property rights may be challenged, invalidated or circumvented. These types of claims could harm our relationships with our customers, might deter future customers from acquiring our products or could expose us to litigation with respect to these claims. Even if we are not a party to any litigation between a customer and a third party, an adverse outcome in that litigation could make it more difficult for us to defend our intellectual property in any subsequent litigation in which we are named as a party. Any of these results would have a negative effect on our business and operating results.
Any intellectual property rights claim against us or our customers, with or without merit, could be time-consuming and expensive to litigate or settle and could divert management resources and attention. As a result of any successful intellectual property rights claim against us or our customers, we might have to pay damages or stop using technology found to be in violation of a third party’s rights, which could prevent us from offering our products to our customers. We could also have to seek a license for the technology, which might not be available on reasonable terms, might significantly increase our cost of revenue or might require us to restrict our business activities in one or more respects. The technology also might not be available for license to us at all. As a result, we could also be required to develop alternative non-infringing technology or cease to offer a particular product, which could require significant effort and expense and/or hurt our revenue and financial results of operations.
Our exposure to risks associated with the use of intellectual property may be increased as a result of our past and any future acquisitions as we have a lower level of visibility into the development process with respect to acquired technology or the care taken to safeguard against infringement risks. Third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition.
Our use of open source software could negatively affect our ability to sell our products and subject us to possible litigation.
Some of our products incorporate open source software, and we intend to continue to use open source software in the future. Some terms of certain open source licenses to which we are subject have not been interpreted by U.S. or foreign courts, and there is a risk that open source software licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to monetize our products. Additionally, we may from time to time face claims from third parties claiming ownership of, or demanding release of, the open source software or derivative works that we developed using such software, which could include our proprietary source code, or otherwise seeking to enforce the terms of the applicable open source software license. These claims could result in litigation and could require us to make our software source code freely available, purchase a costly license to continue offering the software or cease offering the implicated services unless and until we can re-engineer them to avoid infringement or violation. This re-engineering process could require significant additional research and development resources, and we may not be willing to entertain the cost associated with updating the software or be able to complete it successfully. In addition to risks related to license requirements, use of certain open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of software and, thus, may contain security vulnerabilities or infringing or broken code. Additionally, if we utilize open source licenses that require us to contribute to open source projects, this software code is publicly available; and our ability to protect our intellectual property rights with respect to such software source code may be limited or lost entirely. We may be unable to prevent our competitors or others from using such contributed software source code. Any of these risks could be difficult to eliminate or manage, and if not addressed, could have a negative effect on our business, operating results and financial condition.
Our products use third-party software that may be difficult to replace or cause errors or failures of our products that could lead to a loss of customers or harm to our reputation and our operating results.
We license third-party software from various third parties for use in our products. In the future, this software may not be available to us on commercially reasonable terms, or at all. Any loss of the right to use any of the software could result in decreased functionality of our products until equivalent technology is either developed by us or, if available from another provider, is identified, obtained and integrated, which could harm our business. In addition, any vulnerabilities, errors or defects in or failures of the third-party software could result in cyberattacks on or errors or defects in our products or cause our products to fail, which could harm our business and be costly to correct. Many of these providers attempt to impose limitations on their
liability for such errors, defects or failures, and if enforceable,
we may have additional liability to our customers or third-party providers that could harm our reputation and increase our operating costs.
Risks Related to Our Indebtedness
We have substantial indebtedness, which could adversely affect our financial health and our ability to obtain financing in the future, react to changes in our business and meet our obligations with respect to our indebtedness.
We entered into credit agreements in 2016 and 2018. Although we used a portion of the proceeds from our initial public offering to repay $315.0 million in borrowings outstanding, plus accrued interest, under our second lien term loan, as of December 31, 2018,2020, our total indebtedness was $2.0$1.9 billion and we had $125.0 million available for additional borrowing under our credit facilities. Our net interest expense during the years ended December 31, 2018, 20172020, 2019 and 2016 (on a combined basis)2018 was approximately $142.0$75.9 million, $169.8$108.1 million and $170.4$142.0 million, respectively.
Our substantial indebtedness incurred under the credit agreements could have important consequences, including:
•requiring us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the funds available for operations;
•increasing our vulnerability to adverse economic and industry conditions, which could place us at a competitive disadvantage compared to our competitors that have relatively less indebtedness;
•limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate;
•restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
•requiring us under certain circumstances to repatriate earnings from our international operations in order to make payments on our indebtedness, which could subject us to local country income and withholding taxes and/or state income taxes that are not currently accrued in our financial statements;
•requiring us to liquidate short-term or long-term investments in order to make payments on our indebtedness, which could generate losses;
•exposing us to the risk of increased interest rates as borrowings under the credit agreements are subject to variable rates of interest; and
•limiting our ability to borrow additional funds, or to dispose of assets to raise funds, if needed, for working capital, capital expenditures, acquisitions, product development and other corporate purposes.
Despite our current indebtedness level, we and our restricted subsidiaries may be able to incur substantially more indebtedness, which could further exacerbate the risks associated with our substantial indebtedness.
Although the terms of the agreements governing our outstanding indebtedness contain restrictions on the incurrence of additional indebtedness, such restrictions are subject to a number of important exceptions and indebtedness incurred in compliance with such restrictions could be substantial. If we and our restricted subsidiaries incur significant additional indebtedness, the related risks that we face could increase. If new debt is added to our or our subsidiaries’ current debt levels, the related risks that we now face would increase, and we may not be able to meet all our debt obligations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
The agreements governing our indebtedness contain restrictions and limitations that may restrict our business and financing activities and expose us to risks that could adversely affect our liquidity and financial condition.
The credit agreements governing our credit facilities contain various covenants that are operative so long as our credit facilities remain outstanding. The covenants, among other things, limit our and certain of our subsidiaries’ abilities to:
•incur additional indebtedness;
•incur liens;
•engage in mergers, consolidations, liquidations or dissolutions;
•pay dividends and distributions on, or redeem, repurchase or retire our capital stock;
•make investments, acquisitions, loans or advances;
•create negative pledges or restrictions on the payment of dividends or payment of other amounts owed from subsidiaries;
•sell, transfer or otherwise dispose of assets, including capital stock of subsidiaries;
•make prepayments of material debt that is subordinated with respect to right of payment;
•engage in certain transactions with affiliates;
•modify certain documents governing material debt that is subordinated with respect to right of payment;
•change our fiscal year; and
•change our lines of business.
Our credit agreements also contain numerous affirmative covenants, including a financial covenant which requires that, at the end of each fiscal quarter, for so long as the aggregate principal amount of borrowings under our revolving credit facility exceeds 35% of the aggregate commitments under the revolving credit facility, our first lien net leverage ratio cannot exceed 7.40 to 1.00. A breach of this financial covenant will not result in a default or event of default under the term loan facility under our first lien credit agreement unless and until the lenders under our revolving credit facility have terminated the commitments under the revolving credit facility and declared the borrowings under the revolving credit facility due and payable.
Our ability to comply with the covenants and restrictions contained in the credit agreements governing our credit facilities may be affected by economic, financial and industry conditions beyond our control. The restrictions in the credit agreements governing our credit facilities may prevent us from taking actions that we believe would be in the best interests of our business and may make it difficult for us to execute our business strategy successfully or effectively compete with companies that are not similarly restricted. Even if any of our credit agreements are terminated, any additional debt that we incur in the future could subject us to similar or additional covenants.
The credit agreements include customary events of default, including, among others, failure to pay principal, interest or other amounts; material inaccuracy of representations and warranties; violation of covenants; specified cross-default and cross-acceleration to other material indebtedness; certain bankruptcy and insolvency events; certain ERISA events; certain undischarged judgments; material invalidity of guarantees or grant of security interest; and change of control. Any default that is not cured or waived could result in the termination of our credit agreements or an acceleration of the obligations under the credit agreements. Any such default would permit the applicable lenders to declare all amounts outstanding thereunder to be due and payable, together with accrued and unpaid interest. In addition, such a default or acceleration may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. If we are unable to repay our indebtedness, lenders having secured obligations, such as the lenders under our credit facilities, could proceed against the collateral securing the indebtedness. In any such case, we may be unable to borrow under our credit facilities and may not be able to repay the amounts due under our credit facilities. This could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent.
Certain of our indebtedness may be denominated in foreign currencies, which subjects us to foreign exchange risk, which could cause our debt service obligations to increase significantly.
Our credit facilities include a senior secured revolving credit facility, which permits borrowings denominated in Euros and other alternative currencies that may be approved by the applicable lenders. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.” Such non-U.S. dollar-denominated debt may not necessarily correspond to the cash flow we generate in such currencies. Sharp changes in the exchange rates between the currencies in which we borrow and the currencies in which we generate cash flow could adversely affect us. In the future, we may enter into contractual arrangements designed to hedge a portion of the foreign currency exchange risk associated with any non-U.S. dollar-denominated debt. If these hedging arrangements are unsuccessful, we may experience an adverse effect on our business and results of operations.
Risks Related to Accounting and Taxation
We are subject to fluctuations in interest rates.
Borrowings under our credit facilities are subject to variable rates of interest and expose us to interest rate risk. Borrowings outstanding under our credit agreement currently bears interest at variable rates equal to applicable margins plus specified base rates or London Interbank Offered Rate, or LIBOR, with a 0% floor. In July 2017, the Chief Executive of the U.K. Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of US Dollar LIBOR after 2021. On November 30, 2020, the ICE Benchmark Administration (IBA) which compiles and oversees LIBOR, announced that it intended to extend most US Dollar LIBOR (USD LIBOR) tenors until June 30, 2023. The Alternative Reference Rates Committee (ARCC), which was convened by the Federal Reserve Board and the New York Fed, has identified the Secured Oversight Financing Rate (SOFR) as the recommended risk-free alternative rate for USD LIBOR. While the timing of the transition from USD LIBOR is still under discussion, our credit agreement allows for our LIBOR tenor elections to be replaced at that time by the accepted market rate. The Company may also elect to convert our borrowings at a specified base rate.
At present, we do not have any existing interest rate swap agreements, which involve the exchange of floating for fixed rate interest payments to reduce interest rate volatility. However, we may decide to enter into such swaps in the future. If we do, we
may not maintain interest rate swaps with respect to all of our variable rate indebtedness and any swaps we enter into may not fully mitigate our interest rate risk, may prove disadvantageous or may create additional risks.
See Quantitative and Qualitative Disclosures About Market Risk in Item 7A of Part II of this Annual Report on Form 10-K for additional information regarding our interest rate risk.
Failure to maintain proper and effective internal controls could have a material adverse effect on our business, operating results and stock price.
As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal controls. Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting and, beginning with our second annual report following our initial public offering, provide a management report on internal control over financial reporting. However, while we remain anHaving transitioned out of emerging growth company in 2019, we
will not be also are required to include an attestation report on internal control over financial reporting issued by our independent registered public accounting firm.
Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results, cause us to fail to meet our reporting obligations, result in a restatement of our financial statements for prior periods or adversely affect the results of management evaluations and independent registered public accounting firm audits of our internal control over financial reporting that we will eventually be required to include in our periodic reports that will be filed with the SEC. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock.
If we are unable to assert that our internal control over financial reporting is effective, or when required in the future, if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports, the market price of our common stock could be adversely affected and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources.
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.
A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way in which we conduct our business.
Our business and financial performance could be negatively impacted by other changes in tax laws or regulations.
New income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. Any changes to these existing tax laws could adversely affect our domestic and international business operations, and our business and financial performance. Additionally, these events could require us or our customers to pay additional tax amounts on a prospective or retroactive basis, as well as require us or our customers to pay fines and/or penalties and interest for past amounts deemed to be due. If we raise our product and maintenance prices to offset the costs of these changes, existing customers may elect not to renew their maintenance arrangements and potential customers may elect not to purchase our products. Additionally, new, changed, modified or newly interpreted or applied tax laws could increase our customers’ and our compliance, operating and other costs, as well as the costs of our products. Further, these events could decrease the capital we have available to operate our business. Any or all of these events could adversely impact our business and financial performance.
On December 22, 2017,Additionally, the U.S. Tax Cuts and Jobs Act orof 2017 (the “U.S. Tax Act”) which was enacted on December 22, 2017, requires complex computations to be performed, significant judgments to be made in the interpretation of the provisions of the U.S. Tax Act, was enacted, which significantly revisessignificant estimates in calculations, and the Internal Revenue Codepreparation and analysis of 1986, as amended,information not previously relevant or regularly produced. The U.S. Treasury Department continues to interpret or issue guidance on how provisions of the Code. TheU.S. Tax Act among other things, contains significant changeswill be applied or otherwise administered. As additional guidance is issued, we may make adjustments to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for net interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for NOLs to 80% of current year taxable income and elimination of NOL carrybacks, in each case, for losses arising in taxable years beginning after December 31, 2017 (though any such NOLs may be carried forward indefinitely), one-time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, elimination of U.S. tax on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. The final impact of the one-time taxation of offshore earnings has been completed during 2018 and discussed further in Note15. Income Taxes in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
The U.S. Department of Treasury has broad authority to issue regulations and interpretative guidanceamounts that we have previously recorded that may significantly impact how we will apply the law andmaterially impact our results of operationsfinancial statements in the period issued. As additional regulatoryin which the adjustments are made.
The results of the U.S. presidential election could lead to changes in tax laws that could negatively impact our effective tax rate. President Biden has provided some informal guidance is issued byon what tax law changes he would support. Among other things, his proposals would raise the applicable taxing authorities,rate on both domestic income (from 21% to 28%) and as accounting treatment is clarified, the final analysis may be different from our current amounts, whichforeign income and impose a new alternative minimum tax on book income. If these proposals are ultimately enacted into legislation, they could materially affectimpact our tax obligations
provision, cash tax liability and effective tax rate. TheIf any or all of these (or similar) proposals are ultimately enacted into law, in whole or in part, they could have a negative impact of thisto our cash tax reform on holders of our common stock is also uncertainliability and could be adverse. We urge our stockholders to consult with their legal andeffective tax advisors with respect to this legislation and the potential tax consequences of investing in or holding our common stock.rate.
Additional liabilities related to taxes or potential tax adjustments could adversely impact our business and financial performance.
We are subject to tax and related obligations in various federal, state, local and foreign jurisdictions in which we operate or do business. The taxing rules of the various jurisdictions in which we operate or do business are often complex and subject to differing interpretations. Tax authorities could challenge our tax positions we historically have taken, or intend to take in the future,
or may audit the tax filings we have made and assess additional taxes. Tax authorities may also assess taxes in jurisdictions where we have not made tax filings. Any assessments incurred could be material, and may also involve the imposition of substantial penalties and interest. Significant judgment is required in evaluating our tax positions and in establishing appropriate reserves, and the resolutions of our tax positions are unpredictable. The payment of additional taxes, penalties or interest resulting from any assessments could adversely impact our business and financial performance.
Our corporate structure and intercompany arrangements are subject to the tax laws of various jurisdictions, and we could be obligated to pay additional taxes, which would harm our operating results.
Based on our current corporate structure, we may be subject to taxation in several jurisdictions around the world with increasingly complex tax laws, the application of which can be uncertain. The amount of taxes we pay in these jurisdictions could increase substantially as a result of changes in the applicable tax rules, including increased tax rates, new tax laws or revised interpretations of existing tax laws and precedents. In addition, the authorities in these jurisdictions could challenge our methodologies for valuing developed technology or intercompany arrangements, including our transfer pricing. The relevant taxing authorities may determine that the manner in which we operate our business does not achieve the intended tax consequences. If such a disagreement were to occur, and our position were not sustained, we could be required to pay additional taxes, interest and penalties. Such authorities could claim that various withholding requirements apply to us or our subsidiaries or assert that benefits of tax treaties are not available to us or our subsidiaries. Any increase in the amount of taxes we pay or that are imposed on us could increase our worldwide effective tax rate and adversely affect our business and operating results.
We are subject to governmental export controls and economic sanctions laws that could impair our ability to compete in international markets and subject us to liability if we are not in full compliance with applicable laws.
Certain of our products are subject to U.S. export controls, including the U.S. Department of Commerce’s Export Administration Regulations and economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control. These regulations may limit the export of our products and provision of our services outside of the United States, or may require export authorizations, including by license, a license exception or other appropriate government authorizations, including annual or semi-annual reporting and the filing of an encryption registration. Export control and economic sanctions laws may also include prohibitions on the sale or supply of certain of our products to embargoed or sanctioned countries, regions, governments, persons and entities. In addition, various countries regulate the importation of certain products, through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products. The exportation, re-exportation and importation of our products and the provision of services, including by our partners, must comply with these laws or else we may be adversely affected, through reputational harm, government investigations, penalties, and a denial or curtailment of our ability to export our products or provide services. Complying with export control and sanctions laws may be time consuming and may result in the delay or loss of sales opportunities. If we are found to be in violation of U.S. sanctions or export control laws, it could result in substantial fines and penalties for us and for the individuals working for us. Changes in export or import laws or corresponding sanctions may delay the introduction and sale of our products in international markets, or, in some cases, prevent the export or import of our products to certain countries, regions, governments, persons or entities altogether, which could adversely affect our business, financial condition and results of operations.
We are also subject to various domestic and international anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, as well as other similar anti-bribery and anti-kickback laws and regulations. These laws and regulations generally prohibit companies and their employees and intermediaries from authorizing, offering or providing improper payments or benefits to officials and other recipients for improper purposes. Although we take precautions to prevent violations of these laws, our exposure for violating these laws increases as our international presence expands and as we increase sales and operations in foreign jurisdictions.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or our failure to comply with regulations could harm our operating results.
As Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. In addition to data privacy and security laws and regulations, taxation of products and services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services and product offerings, which could harm our business and operating results.
Risks Related to Ownership of Our Common Stock
The trading price of our common stock could be volatile, which could cause the value of your investment to decline.
Technology stocks have historically experienced high levels of volatility. The trading price of our common stock has and may continue to fluctuate significantly. Factors that have and could cause fluctuations in the trading price of our common stock include the following:
•adverse developments with respect to the Cyber Incident;
•announcements of new products or technologies, commercial relationships, acquisitions or other events by us or our competitors;
•changes in how customers perceive the benefits of our products;
•shifts in the mix of revenue attributable to perpetual licenses and to subscriptions from quarter to quarter;
•departures of key personnel;
•price and volume fluctuations in the overall stock market from time to time;
•fluctuations in the trading volume of our shares or the size of our public float;
•sales of large blocks of our common stock, including sales by our Sponsors;
•actual or anticipated changes or fluctuations in our operating results;
•whether our operating results meet the expectations of securities analysts or investors;
•changes in actual or future expectations of investors or securities analysts;
•litigation involving us, our industry or both;
•regulatory developments in the United States, foreign countries or both;
•general economic conditions and trends, including market impacts related to the COVID-19 pandemic;
•major catastrophic events in our domestic and foreign markets; and
•“flash crashes,” “freeze flashes” or other glitches that disrupt trading on the securities exchange on which we are listed.
In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition.
The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. In the past, following periods of volatility in the trading price of a company’s securities, securities class-action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business, which could have an adverse effect on our business, operating results and financial condition.
The requirements of being a public company, including compliance with the reporting requirements of the Exchange Act, the requirements of the Sarbanes-Oxley Act and the requirements of the NYSE, may strain our resources, increase our costs and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.
As a public company, we are subject to laws, regulations and requirements, certain corporate governance provisions of the Sarbanes-Oxley Act, related regulations of the SEC and the requirements of the NYSE, with which we were not required to comply as a private company. As a newly public company, complying with these statutes, regulations and requirements occupies a significant amount of time of our board of directors and management and significantly increases our costs and expenses as compared to when we were a private company. For example, as a newly public company, we have had to institute a more comprehensive compliance function, comply with rules promulgated by the NYSE, prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws, establish new internal policies, such as those relating to insider trading, and involve and retain to a greater degree outside counsel and accountants in the above activities. In addition, being a public company subject to these rules and regulations has made it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers as compared to when we were a private company.
Furthermore, whilebecause we generally must comply with Section 404have ceased to be an emerging growth company as of the Sarbanes-Oxley Act for the year ending December 31, 2018,2019, we are notnow required to have our independent registered public accounting firm attest to the effectiveness of our internal controls. Ensuring that we have adequate internal financial and accounting controls until our first annual report subsequent to our ceasingand procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be an emerging growth company. Accordingly,re-evaluated frequently, including if we may not be requiredacquire additional businesses and integrate their operations. Our internal control over financial reporting is a process designed to have our independent registered public accounting firm attestprovide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements in accordance with GAAP. We continue to evaluate opportunities to further strengthen the effectiveness and efficiency of our internal controls until as late asand procedures for compliance with Section 404 of the Sarbanes-Oxley Act. If we make additional acquisitions, we will need to similarly assess and ensure the adequacy of the internal financial and accounting controls and procedures of such acquisitions. If we fail to maintain proper and effective internal controls, including with respect to acquired businesses, our annual report for the year ending December 31, 2023. Once it is requiredability to do so, 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, operated or reviewed. Compliance with these requirements may strain our resources, increase our costsproduce accurate and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.
The trading price of our common stockfinancial statements could be volatile,impaired, which could cause the value of your investmentharm our operating results, harm our ability to decline.
Our initial public offering occurred in October 2018. Therefore, there has only been a public market foroperate our common stock for a short period of time. Although our common stock is listed on the NYSE, an active trading market for our common stock may not develop or, if developed, be sustained. Technology stocks have historically experienced high levels of volatility. The trading price of our common stock may fluctuate significantly. Since shares of our common stock were sold in our initial public offering in October 2018 at a price of $15.00 per share, our stock price has fluctuated significantly. Factors that could cause fluctuations inbusiness and reduce the trading price of our common stock include the following:
announcements of new products or technologies, commercial relationships, acquisitions or other events by us or our competitors;
changes in how customers perceive the benefits of our products;
shifts in the mix of revenue attributable to perpetual licenses and to subscriptions from quarter to quarter;
departures of key personnel;
price and volume fluctuations in the overall stock market from time to time;
fluctuations in the trading volume of our shares or the size of our public float;
sales of large blocks of our common stock, including sales by our Sponsors;
actual or anticipated changes or fluctuations in our operating results;
whether our operating results meet the expectations of securities analysts or investors;
changes in actual or future expectations of investors or securities analysts;
litigation involving us, our industry or both;
regulatory developments in the United States, foreign countries or both;
general economic conditions and trends;
major catastrophic events in our domestic and foreign markets; and
“flash crashes,” “freeze flashes” or other glitches that disrupt trading on the securities exchange on which we are listed.
In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. In the past, following periods of volatility in the trading price of a company’s securities, securities class-action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business. This could have an adverse effect on our business, operating results and financial condition.stock.
If securities analysts or industry analysts were to downgrade our stock, publish negative research or reports or fail to publish reports about our business, our competitive position could suffer, and our stock price and trading volume could decline.
The trading market for our common stock, to some extent, depends on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. If our results fail to meet the expectations of one or more of the analysts who cover our stock, or if one or more of such analysts should downgrade our stock or publish negative research or reports, cease coverage of our company or fail to regularly publish reports about our business, our competitive position could suffer, and our stock price and trading volume could decline.
Sales of substantial amounts of our common stock in the public markets, or the perception that such sales could occur, could reduce the market price of our common stock.
Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock. As of December 31, 2018,2020, we had 309,927,849314,307,447 shares of common stock outstanding. Of these shares, the 25,000,000 shares of common stock sold in our initial public offering are freely tradeable. In addition, approximately 281 million shares of our common stock will be eligible for sale in the public market on April 16, 2019 following the expiration of the 180-day lock-up period in connection with our initial public offering, subject to volume, manner of sale and other limitations of Rule 144, as applicable, and the terms of our insider trading policy.
In addition, as of December 31, 2018,2020, there were 3,129,9001,259,835 shares of common stock subject to outstanding options, 6,277,4669,786,550 shares of common stock to be issued upon the vesting of outstanding restricted stock units and 970,922306,023 shares of common stock to be issued upon the vesting of outstanding performance stock units. We have registered all of the shares of common stock issuable upon the exercise of outstanding options, upon the vesting of outstanding restricted stock units and performance stock units and upon exercise of settlement of any options or other equity incentives we may grant in the future, for public resale under the Securities Act. Accordingly, these shares may be freely sold in the public market upon issuance as permitted by any applicable vesting requirements, subject to the lock-up agreements described above and compliance with applicable securities laws.
Furthermore, holders of 275,327,427approximately 260 million shares of our common stock have certain rights with respect to the registration of such shares (and any additional shares acquired by such holders in the future) under the Securities Act.
Our issuance of additional capital stock in connection with financings, acquisitions, investments, our stock incentive plans or otherwise will dilute all other stockholders.
We may issue additional capital stock in the future that will result in dilution to all other stockholders. We may also raise capital through equity financings in the future. As part of our business strategy, we may acquire or make investments in complementary companies, products or technologies and issue equity securities to pay for any such acquisition or investment. Any such issuances of additional capital stock may cause stockholders to experience significant dilution of their ownership interests and the per-share value of our common stock to decline.
We do not intend to pay dividends on our common stock.
We do not intend to pay dividends on our common stock.stock other than potentially to the extent that we proceed with the spin-off of our MSP business. We intend to retain any earnings to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends in the foreseeable future.
Risks Related to Our Organizational Structure
Our restated charter and restated bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
Our restated charter and restated bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it difficult for stockholders to elect directors who are not nominated by the current members of our board of directors or take other corporate actions, including effecting changes in our management. These provisions include:
•a classified board of directors with three-year staggered terms, which could delay the ability of stockholders to change the membership of a majority of our board of directors;
•after the Lead Sponsors cease to beneficially own, in the aggregate, at least 30% of the outstanding shares of our common stock, removal of directors only for cause;
•the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;
•subject to the rights of the Sponsors under the stockholders’ agreement, allowing only our board of directors to fill vacancies on our board of directors, which prevents stockholders from being able to fill vacancies on our board of directors;
•after the Lead Sponsors cease to beneficially own, in the aggregate, at least 40% of the outstanding shares of our common stock, a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
•after the Lead Sponsors cease to beneficially own, in the aggregate, at least 40% of the outstanding shares of our common stock, our stockholders may not take action by written consent but may take action only at annual or special meetings of our stockholders. As a result, a holder controlling a majority of our capital stock would not be able to amend our bylaws or remove directors without holding a meeting of our stockholders called in accordance with our bylaws;
•after the Lead Sponsors cease to beneficially own, in the aggregate, at least 40% of the outstanding shares of our common stock, the requirement for the affirmative vote of holders of at least 66 2/3% of the voting power of all of the then-outstanding shares of the voting stock, voting together as a single class, to amend the provisions of our restated charter relating to the management of our business (including our classified board structure) or certain provisions of our bylaws, which may inhibit the ability of an acquirer to effect such amendments to facilitate an unsolicited takeover attempt;
•the ability of our board of directors to amend the bylaws, which may allow our board of directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquirer to amend the bylaws to facilitate an unsolicited takeover attempt;
•advance notice procedures with which stockholders must comply to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us; and
•a prohibition of cumulative voting in the election of our board of directors, which would otherwise allow less than a majority of stockholders to elect director candidates.
Our restated charter also contains a provision that provides us with protections similar to Section 203 of the Delaware General Corporation Law, or the DGCL, and prevents us from engaging in a business combination, such as a merger, with an interested stockholder (i.e., a person or group that acquires at least 15% of our voting stock) for a period of three years from the date such person became an interested stockholder, unless (with certain exceptions) the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. However, our restated charter also provides that the Sponsors, including the Silver Lake Funds and the Thoma Bravo Funds and any persons to whom any Silver Lake Fund or Thoma Bravo Fund or any of their respective affiliates sells its common stock, will not constitute “interested stockholders” for purposes of this provision.
The Lead Sponsors have a controlling influence over matters requiring stockholder approval, which could delay or prevent a change of control.
The Sponsors beneficially owned in the aggregate 88.8%78.3% of our common stock as of December 31, 2018.2020. The Sponsors have entered into a stockholders’ agreement whereby they each agreed, among other things, to vote the shares each beneficially owns in favor of the director nominees designated by Silver Lake and Thoma Bravo, respectively. As a result, Silver Lake and Thoma Bravo could exert significant influence over our operations and business strategy and would together have sufficient voting power to effectively control the outcome of matters requiring stockholder approval. These matters may include:
•the composition of our board of directors, which has the authority to direct our business and to appoint and remove our officers;
•approving or rejecting a merger, consolidation or other business combination;
•raising future capital; and
•amending our restated charter and restated bylaws, which govern the rights attached to our common stock.
Additionally, for so long as the Sponsors beneficially own, in the aggregate, 40% or more of our outstanding shares of common stock, the Sponsors will have the right to designate a majority of our board of directors. For so long as the Sponsors have the right to designate a majority of our board of directors, the directors designated by the Sponsors are expected to constitute a majority of each committee of our board of directors, other than the audit committee, and the chairman of each of the committees, other than
the audit committee, is expected to be a director serving on such committee who is designated by the Sponsors. However, as soon as we are no longer a “controlled company” under the NYSE corporate governance standards, our committee membership will comply with all applicable requirements of those standards and a majority of our board of directors will be “independent directors,” as defined under the rules of the NYSE, subject to any phase-in provisions.
This concentration of ownership of our common stock could delay or prevent proxy contests, mergers, tender offers, open-market purchase programs or other purchases of our common stock that might otherwise give you the opportunity to realize a premium over the then-prevailing market price of our common stock. This concentration of ownership may also adversely affect our share price.
Certain of our directors have relationships with the Lead Sponsors, which may cause conflicts of interest with respect to our business.
Three of our ten directors are affiliated with Silver Lake and three are affiliated with Thoma Bravo. These directors have fiduciary duties to us and, in addition, have duties to the respective Sponsor and their affiliated funds, respectively. As a result, these directors may face real or apparent conflicts of interest with respect to matters affecting both us and the Sponsors, whose interests may be adverse to ours in some circumstances.
The Sponsors and their affiliated funds may pursue corporate opportunities independent of us that could present conflicts with our and our stockholders’ interests.
The Sponsors and their affiliated funds are in the business of making or advising on investments in companies and hold (and may from time to time in the future acquire) interests in or provide advice to businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. The Sponsors and their affiliated funds may also pursue acquisitions that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.
Our restated charter provides that no officer or director of the Company who is also an officer, director, employee, partner, managing director, principal, independent contractor or other affiliate of either of the Sponsors will be liable to us or our stockholders for breach of any fiduciary duty by reason of the fact that any such individual pursues or acquires a corporate opportunity for its own account or the account of an affiliate, as applicable, instead of us, directs a corporate opportunity to any other person instead of us or does not communicate information regarding a corporate opportunity to us.
We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.
Our restated charter authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations, preferences, limitations and relative rights, including preferences over our common stock respecting dividends and distributions, as our board of directors may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of our common stock.
Our restated charter designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents.
Our restated charter provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the DGCL, our charter or bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery of the State of Delaware having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our restated charter described in the preceding sentence. This exclusive forum provision does not apply to establish the Delaware Court of Chancery as the forum for actions or proceedings brought to enforce a duty or liability created by the Securities Act or the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. This choice-of-forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our restated charter inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or operating results.
For as long as we are an emerging growth company, we will not be required to comply with certain requirements that apply to other public companies.
We are an emerging growth company, as defined in the JOBS Act. For as long as we are an emerging growth company, which may be up to five full fiscal years, we, unlike other public companies, will not be required to, among other things: (i) provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act; (ii) comply with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer; (iii) provide certain disclosures regarding executive compensation required of larger public companies; or (iv) hold nonbinding advisory votes on executive compensation and any golden-parachute payments not previously approved. In addition, the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for adopting new or revised financial accounting standards. We have elected to take advantage of the longer phase-in periods for the adoption of new or revised financial accounting standards permitted under the JOBS Act until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to the JOBS Act.
We will remain an emerging growth company for up to five years, although we will lose that status sooner if we have more than $1.07 billion of revenue in a fiscal year, have more than $700.0 million in market value of our common stock held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period.
For so long as we rely on any of the exemptions available to emerging growth companies, you will receive less information about our executive compensation and internal control over financial reporting than issuers that are not emerging growth companies. We cannot predict whether investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock to be less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
When we lose our emerging growth company status or if we elect to no longer take advantage of the longer phase-in periods for the adoption of new or revised financial accounting standards permitted under the JOBS Act, the emerging growth company exemptions will cease to apply and we expect we will incur additional expenses and devote increased management effort toward ensuring compliance with the non-emerging growth company requirements. We cannot predict or estimate the amount of these expenses, which may be substantial.
We will be a controlled company within the meaning of the NYSE rules and, as a result, will qualify for and intend to rely on exemptions from certain corporate governance requirements.
The Sponsors beneficially own a majority of the combined voting power of all classes of our outstanding voting stock. As a result, we are a controlled company within the meaning of the NYSE corporate governance standards. Under the NYSE rules, a company of which more than 50% of the voting power is held by another person or group of persons acting together is a controlled company and may elect not to comply with certain NYSE corporate governance requirements, including the requirements that:
•a majority of the board of directors consist of independent directors as defined under the rules of the NYSE;
•the nominating and governance committee be composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and
•the compensation committee be composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.
These requirements will not apply to us as long as we remain a controlled company. We have elected to take advantage of these exemptions. Accordingly, you may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We lease our offices and do not own any real estate. Our corporate headquarters is located in Austin, Texas and currently consists of approximately 348,000 square feet. We also lease office space domestically and internationally in various locations for our operations, including facilities located in Cork, Ireland; Manila, Philippines; Brno, Czech Republic; Durham,Morrisville, North Carolina; Manila, Philippines; Ottawa, Canada; Dundee, United Kingdom; Krakow, Poland; Lehi, Utah and Singapore.
We believe our current facilities will be adequate for the foreseeable future. If we require additional or substitute space, we believe that we will be able to obtain such space on acceptable, commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
FromFor a description of the lawsuits and government investigations or inquiries related to the Cyber Incident, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 16. Commitments and Contingencies in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K, which description is incorporated herein by reference.
In addition, from time to time, we have been and may be involved in variousother legal proceedings and claims arising in our ordinary course of business. At this time,Other than with respect to the Cyber Incident, neither we nor any of our subsidiaries is a party to, and none of our respective property is the subject of, any material legal proceeding. However, the outcome of any other legal proceedings and claims brought against us are subject to significant uncertainty. Therefore, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of management’s expectations, our consolidated financial statements for a particular period could be materially adversely affected.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDERS MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock has been listed on the New York Stock Exchange, ("NYSE")or NYSE, under the symbol "SWI" since October 19, 2018. Prior to that date, there was no public trading market for our common stock. Our initial public offering, ("IPO")or IPO, was priced at $15.00 per share on October 18, 2018.
On February 21, 2019,24, 2021, the last reported sales price of our common stock on the NYSE was $18.49$15.72 per share and, as of February 15, 201924, 2021 there were 27979 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of our stockholders, this number is not representative of the total number of stockholders represented by these stockholders of record.
Dividend Policy
We have never declared or paid any cash dividends on our common stock. Neither Delaware law nor our restated charter requires our board of directors to declare dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not expect to pay any dividends on our common stock in the foreseeable future.future other than potentially to the extent that we proceed with the spin-off of our MSP business. Any future determination to declare cash dividends on our common stock will be made at the discretion of our board of directors and will depend on a number of factors, including our financial condition, results of operations, capital requirements, contractual restrictions, general business conditions and other factors that our board of directors may deem relevant. In addition, our credit facilities place restrictions on our ability to pay cash dividends.
Performance Graph
The graph set forth below compares the cumulative total stockholder return on our common stock for the period between October 19, 2018 (the date of our IPO) and December 31, 2018,2020, with the cumulative total return of (i) the Russell Midcap Index and (ii) the Nasdaq Computer Index, or the Industry Index. This graph assumes the investment of $100 at market close on October 19, 2018 in our common stock, the Russell Midcap Index and the Industry Index, and assumes the reinvestment of dividends, if any. The Industry Index consists of NASDAQ-listed computer hardware and software companies that provide products or services. Note that historic stock price performance is not necessarily indicative of future stock price performance.
The information contained in the Stock Performance Graph shall not be deemed to be soliciting material or to be filed with the SEC nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or the Exchange Act, except to the extent we specifically incorporate it by reference into such filing.
Unregistered Sales of Equity Securities
In the three years preceding the filing of this annual report, the Company has sold and issued the following unregistered securities:
Class A Common Stock and Class B Common Stock Issuances
In May 2016, we sold an aggregate of 188,099.99 shares of our Class A common stock at a purchase price of $1,000 per share and an aggregate of 7,021,691.15 shares of our Class B common stock at a purchase price of $0.2706 per share, for an aggregate purchase price of approximately $190 million.
In multiple closings in August 2016 through October 2017, we sold shares of Class A common stock and Class B common stock to certain of our employees through our co-investment program. In multiple closings in August through December 2016, we sold an aggregate of 8,965 shares of our Class A common stock at a purchase price of $1,000 per share and an aggregate of 334,643 shares of our Class B common stock at a purchase price of $0.2706 per share, for an aggregate purchase price of approximately $9.06 million. In May 2017, we sold an aggregate of 29.7 shares of our Class A common stock at a purchase price of $1,000 per share and an aggregate of 536 shares of our Class B common stock at a purchase price of $0.56 per share, for an aggregate purchase price of approximately $30,000. In October 2017, we sold an aggregate of 45 shares of our Class A common stock at a purchase price of $1,000 per share and an aggregate of 608 shares of our Class B common stock at a purchase price of $0.74 per share, for an aggregate purchase price of approximately $45,000.
Upon the closing of our IPO, all shares of Class A common stock that were outstanding immediately prior to the closing of the offering converted into shares of common stock in accordance with the terms of our certificate of incorporation, as amended. In addition, we converted the accrued and unpaid dividends on the Class A common stock into shares of common stock equal to the result of the accrued and unpaid dividends on each share of Class A common stock divided by the conversion price of $19.00 per share. See Note 10. Redeemable Convertible Class A Common Stock and Note 11. Stockholders’ Equity (Deficit) and Stock-Based Compensationin the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional details. Upon the closing of our IPO, our Class B common stock was reclassified as common stock.
Stock Option and Restricted Stock Issuances
We have granted to our employees, consultants and other service providers options to purchase an aggregate of 3,927,600 shares of our common stock under our SolarWinds Corporation Equity Plan, or 2016 Plan, at exercise prices ranging from $0.2706 to $10.08 per share.
From April 2017 to October 2018, we issued an aggregate of 44,350 shares of common stock to employees, consultants and directors upon exercise of stock options under the 2016 Plan, for an aggregate consideration of approximately $15,000.
From August 2016 to April 2018, we issued an aggregate of 8,663,954 shares of restricted common stock to employees, consultants and directors pursuant to restricted stock awards under our 2016 Plan at purchase prices ranging from $0.2706 to $2.10 per share, for an aggregate consideration of approximately $4.0 million.
None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, or any public offering. We believe the offers, sales and issuances of the above securities were exempt from registration under the Securities Act by virtue of Section 4(a)(2) of the Securities Act (or Regulation D or Regulation S promulgated thereunder) because the issuance of securities to the recipients did not involve a public offering, or in reliance on Rule 701 because the transactions were pursuant to compensatory benefit plans or contracts relating to compensation as provided under such rule. The recipients of the securities in each of these transactions represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were placed upon the stock certificates issued in these transactions. All recipients had adequate access, through their relationships with us, to information about us. The sales of these securities were made without any general solicitation or advertising.
Use of Proceeds from Initial Public Offering of Common Stock
On October 18, 2018, the Registration Statement on Form S-1 (File No. 333-227479) (the “Registration Statement”) relating to our initial public offering was declared effective by the SEC. Pursuant to the Registration Statement, we registered an aggregate of 25,000,000 shares of our common stock, all of which were sold by us at a price to the public of $15.00 per share. Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC acted as the representatives of the underwriters in our initial public offering. We received approximately $353.0 million in net proceeds after deducting underwriting discounts and commissions of $17.8 million and offering-related expenses of approximately $4.2 million. No payments of the net proceeds were made to our directors or officers or their associates, holders of 10% or more of any class of our equity securities or any affiliates.
We used a portion of the net proceeds from the offering to repay $315.0 million in borrowings outstanding and $2.3 million of accrued interest under our second lien term loan and a related voluntary prepayment fee of approximately $14.2 million concurrently with the closing of our initial public offering in October 2018. As of December 31, 2018, all of the remaining net proceeds had been used to make monthly interest payments under our first lien credit agreement.
Issuer Purchases of Equity Securities
During the fourth quarter of the fiscal year covered by this report, the Company repurchased shares of its common stock as follows. |
| | | | | | | | | | | | | |
Period | Number of Shares Purchased (1) | | Average Price Paid Per Share | | Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program | | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plan or Program (in thousands) |
October 1-31, 2018 | 3,000 |
| | $ | 0.27 |
| | — |
| | $ | — |
|
November 1-30, 2018 | — |
| | — |
| | — |
| | — |
|
December 1-31, 2018 | 18,800 |
| | 0.49 |
| | — |
| | — |
|
Total | 21,800 |
| | | | — |
| | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | |
Period | | | | | Number of Shares Purchased (1) | | Average Price Paid Per Share | | Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program | | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plan or Program (in thousands) |
October 1-31, 2020 | | | | | — | | | $ | — | | | — | | | $ | — | |
November 1-30, 2020 | | | | | 57,700 | | | 0.27 | | | — | | | — | |
December 1-31, 2020 | | | | | 7,000 | | | 0.27 | | | — | | | — | |
Total | | | | | 64,700 | | | | | — | | | |
________________
| |
(1) | (1)All repurchases relate to employee held restricted stock that is subject to vesting. Unvested shares are subject to a right of repurchase by us in the event the employee stockholder ceases to be employed or engaged (as applicable) by us prior to vesting. All shares in the above table were shares repurchased as a result of us exercising this right and not pursuant to a publicly announced plan or program. |
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this Annual Report on Form 10-K. The following selected consolidated financial data is not intended to replace, and is qualified in its entirety by, the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
On February 5, 2016, we were acquired by the Sponsors in a take private transaction, or the Take Private. As a result of the Take Private, we applied purchase accounting on the dateus exercising this right and not pursuant to a publicly announced plan or program.
The selected consolidated statements of operations presented below from January 1, 2016 to February 4, 2016 relate to the Predecessor. The selected consolidated statements of operations presented below for the periods from February 5, 2016 to December 31, 2018 and the consolidated balance sheet data as of December 31, 2018, 2017 and 2016, relate to the Successor. We have derived the following consolidated statement of operations and consolidated balance sheet data from audited consolidated financial statements that are included in this Annual Report on Form 10-K.
Although the period from January 1, 2016 to February 4, 2016 relates to the Predecessor and the period from February 5, 2016 to December 31, 2016 relates to the Successor, to assist with the period-to-period comparison we have combined these periods as a sum of the amounts without any other adjustments and refer to the combined period as the combined year ended December 31, 2016. This combination does not comply with GAAP or with the rules for pro forma presentation. Our historical results are not necessarily indicative of the results to be expected in any future period.
|
| | | | | | | | | | | | | | | | | | | | |
Consolidated Statement of Operations Data: |
| Successor | | Combined(1) | | Successor(1) | | | Predecessor |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | Period From February 5 Through December 31, | | | Period From January 1 Through February 4, |
| 2018 | | 2017 | | 2016 | | 2016 | | | 2016 |
| | | (in thousands, except per share data) | | | |
Revenue: | | | | | | | | | | |
Subscription | $ | 265,591 |
| | $ | 213,754 |
| | $ | 133,511 |
| | $ | 126,960 |
| | | $ | 6,551 |
|
Maintenance | 402,938 |
| | 357,630 |
| | 174,734 |
| | 145,234 |
| | | 29,500 |
|
Total recurring revenue | 668,529 |
| | 571,384 |
| | 308,245 |
| | 272,194 |
| | | 36,051 |
|
License | 164,560 |
| | 156,633 |
| | 161,176 |
| | 149,900 |
| | | 11,276 |
|
Total revenue | 833,089 |
| | 728,017 |
| | 469,421 |
| | 422,094 |
| | | 47,327 |
|
Cost of revenue: | | | | | | | | | | |
Cost of recurring revenue | 70,744 |
| | 60,698 |
| | 55,789 |
| | 46,238 |
| | | 9,551 |
|
Amortization of acquired technologies | 175,991 |
| | 171,033 |
| | 149,703 |
| | 147,517 |
| | | 2,186 |
|
Total cost of revenue | 246,735 |
| | 231,731 |
| | 205,492 |
| | 193,755 |
| | | 11,737 |
|
Gross profit | 586,354 |
| | 496,286 |
| | 263,929 |
| | 228,339 |
| | | 35,590 |
|
Operating expenses: | | | | | | | | | | |
Sales and marketing | 227,468 |
| | 205,631 |
| | 212,419 |
| | 165,355 |
| | | 47,064 |
|
Research and development | 96,272 |
| | 86,618 |
| | 97,989 |
| | 65,806 |
| | | 32,183 |
|
General and administrative | 80,641 |
| | 67,303 |
| | 150,647 |
| | 71,011 |
| | | 79,636 |
|
Amortization of acquired intangibles | 66,788 |
| | 67,080 |
| | 59,470 |
| | 58,553 |
| | | 917 |
|
Total operating expenses | 471,169 |
| | 426,632 |
| | 520,525 |
| | 360,725 |
| | | 159,800 |
|
Operating income (loss) | 115,185 |
| | 69,654 |
| | (256,596 | ) | | (132,386 | ) | | | (124,210 | ) |
Other income (expense): | | | | | | | | | | |
Interest expense, net | (142,008 | ) | | (169,786 | ) | | (170,373 | ) | | (169,900 | ) | | | (473 | ) |
Other income (expense), net | (94,887 | ) | | 38,664 |
| | (57,243 | ) | | (56,959 | ) | | | (284 | ) |
Total other income (expense) | (236,895 | ) | | (131,122 | ) | | (227,616 | ) | | (226,859 | ) | | | (757 | ) |
Loss before income taxes | (121,710 | ) | | (61,468 | ) | | (484,212 | ) | | (359,245 | ) | | | (124,967 | ) |
Income tax expense (benefit) | (19,644 | ) | | 22,398 |
| | (149,807 | ) | | (96,651 | ) | | | (53,156 | ) |
Net loss | $ | (102,066 | ) | | $ | (83,866 | ) | | $ | (334,405 | ) | | $ | (262,594 | ) | | | $ | (71,811 | ) |
Net income (loss) available to common stockholders | $ | 364,635 |
| | $ | (351,873 | ) | | $ | (552,309 | ) | | $ | (480,498 | ) | | | $ | (71,811 | ) |
Net income (loss) available to common stockholders per share: | | | | | | | | | | |
Basic earnings (loss) per share | $ | 2.60 |
| | $ | (3.50 | ) | | | | $ | (4.98 | ) | | | $ | (1.00 | ) |
Diluted earnings (loss) per share | $ | 2.56 |
| | $ | (3.50 | ) | | | | $ | (4.98 | ) | | | $ | (1.00 | ) |
Weighted-average shares used to compute net income (loss) available to common stockholders per share: | | | | | | | | | | |
Shares used in computation of basic earnings (loss) per share | 140,301 |
| | 100,433 |
| | | | 96,465 |
| | | 71,989 |
|
Shares used in computation of diluted earnings (loss) per share | 142,541 |
| | 100,433 |
| | | | 96,465 |
| | | 71,989 |
|
|
| | | | | | | | | | | |
Consolidated Balance Sheet Data: | |
| As of December 31, |
| 2018 | | 2017 | | 2016 |
| | | | | |
| (in thousands) |
Cash and cash equivalents | $ | 382,620 |
| | $ | 277,716 |
| | $ | 101,643 |
|
Working capital, excluding deferred revenue | 402,639 |
| | 302,012 |
| | 158,637 |
|
Total assets | 5,194,649 |
| | 5,327,064 |
| | 5,202,689 |
|
Deferred revenue, current and non-current portion (2) | 296,132 |
| | 261,791 |
| | 217,722 |
|
Long-term debt, net of current portion | 1,904,072 |
| | 2,245,622 |
| | 2,242,892 |
|
Total liabilities | 2,578,549 |
| | 2,909,938 |
| | 2,842,828 |
|
Redeemable convertible Class A common stock (3) | — |
| | 3,146,887 |
| | 2,879,504 |
|
Total stockholders’ equity (deficit) (3) | 2,616,100 |
| | (729,761 | ) | | (519,643 | ) |
________________ | |
(1) | The operating results of LOGICnow are included in our consolidated financial statements from the acquisition date of May 27, 2016 to December 31, 2016. |
| |
(2) | At December 31, 2017 and 2016, deferred revenue reflects a write-down of $3.0 million and $14.8 million, respectively, associated with purchase accounting adjustments. These cumulative purchase price adjustments did not have an impact on the December 31, 2018 deferred revenue balances. |
| |
(3) | At the completion of our IPO in October 2018, we converted each outstanding share of our Class A common stock into 140,053,370 shares of common stock equal to the result of the liquidation value of such share of Class A common stock, divided by $19.00 per share. At the time of the conversion of the Class A common stock, we also converted $717.4 million of accrued and unpaid dividends on the Class A common stock into 37,758,109 shares of common stock equal to the result of the accrued and unpaid dividends on each share of Class A common stock, divided by $19.00 per share. See Note 10. Redeemable Convertible Class A Common Stock and Note 11. Stockholders’ Equity (Deficit) and Stock-Based Compensation in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information regarding the conversion of the Class A common stock.
|
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OEPRATIONSOPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the 'Selected Consolidated Financial Data' and our consolidated financial statements and related notes thereto included elsewhere in this report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially and adversely from those anticipated in the forward-looking statements. Please see the sections entitled “Special Note Regarding Forward-Looking Statements” and "Risk Factors" above for a discussion of the uncertainties, risks and assumptions associated with these statements.
On February 5, 2016, we were acquired by affiliates of Silver Lake and Thoma Bravo in a take private transaction, or the Take Private. We applied purchase accounting on the date of the Take Private. We refer to the Company as Predecessor in the periods before the Take Private and Successor in the subsequent periods.
Although the period from January 1, 2016 to February 4, 2016 relates to the Predecessor and the period from February 5, 2016 to December 31, 2016 relates to the Successor, to assist with the period-to-period comparison, we have combined these periods as a sum of the amounts without any other adjustments and refer to the combined period as the combined year ended December 31, 2016. Unless otherwise indicated, all results presented for 2016 represent the combined year ended December 31, 2016. This combination does not comply with GAAP or with the rules for pro forma presentation.
Overview
SolarWinds is a leading provider of information technology, or IT, infrastructure management software. Our products give organizations worldwide, regardless of type, size or IT infrastructure complexity, the power to monitor and manage the performance of their IT environments, whether on-premise,on-premises in the cloud, or in hybrid models. We combine powerful, scalable, affordable, easy to use products with a high-velocity, low-touch sales model to grow our business while also generating significant cash flow.
We offer over 50a broad portfolio of infrastructure location-agnostic products to monitor and manage network, systems, desktop, application, storage, database, and website infrastructures whether on-premise, in the public or private cloud or in a hybridand IT infrastructure.service desks. We intend to continue to innovate and invest in areas of product development that bring new products to market and enhance the functionality, ease of use and integration of our current products. We believe this will strengthen the overall value proposition of our products in any IT environment.
Cyber Incident
On December 14, 2020, we announced that we had been the victim of a cyberattack on our Orion Software Platform and internal systems, or the “Cyber Incident.” Together with outside security professionals and other third parties, we are conducting investigations into the Cyber Incident which are on-going.
Our investigations to date revealed that as part of this attack, malicious code, or Sunburst, was injected into builds of our Orion Software Platform that we released between March 2020 and June 2020. If present and activated in a customer’s IT environment, Sunburst could potentially allow an attacker to compromise the server on which the Orion Software Platform was installed. We have not located Sunburst in any of our more than seventy non-Orion products and tools.
We released remediations for the versions of our Orion Software Platform known to be affected by Sunburst and have taken and continue to take extensive efforts to support and protect our customers. In addition, we shared our proprietary code with industry researchers to enable them to validate a “kill-switch” that is believed to have rendered Sunburst inert.
The Orion Software Platform is installed “on-premises” within customers’ IT environments, so we are unable to determine with specificity the number of customers that installed an affected version or that were compromised as a result of Sunburst. We believe the actual number of customers that could have installed an affected version of the Orion Software Platform to be fewer than 18,000. Based on our discussions with customers and our investigations into the nature and function of Sunburst and the tradecraft of the threat actor, we believe the number of organizations which were exploited by the threat actors through Sunburst to be substantially fewer than the number of customers that may have installed an affected version of the Orion Platform.
It has been widely reported that, due to its nature, sophistication and operational security, this “supply-chain” cyberattack was part of a broader nation-state level cyber operation designed to target public and private sector organizations. As of the date hereof, we have not independently attributed the Cyber Incident to any specific threat actor.
Through our investigations into the Cyber Incident, we hope to understand it better, apply our findings to further adapt and enhance our security measures across our systems and our software development and build environments and share our findings and adaptations with our customers, government officials and the technology industry more broadly to help them better understand and protect against these types of attacks in the future. We refer to these adaptations and enhancements as “Secure by Design.”
As described below, we have incurred and expect to incur significant costs related to the Cyber Incident.We are also party to lawsuits and the subject of governmental investigations related to the Cyber Incident. See Part I, Item 1A. Risk Factors – Risks Related to the Cyber Incident andNote 16. Commitments and Contingencies in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for more information regarding these lawsuits and investigations.
Expenses
Through December 31, 2020, we recorded $3.5 million of pretax expenses related to the Cyber Incident. We have included $0.1 million of these expenses in cost of recurring revenue, $0.3 million in sales and marketing expense and $3.2 million in general and administrative expense in our consolidated statements of operations for the year ended December 31, 2020. Expenses include costs to investigate and remediate the Cyber Incident, and legal and other professional services related thereto, and consulting services being provided to customers at no charge, all of which were expensed as incurred.
Litigation, Claims and Government Investigations
As a result of the Cyber Incident, we are subject to numerous lawsuits and investigations or inquiries as described in Note 16. Commitments and Contingencies in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K. While we will incur costs and other expenses associated with these proceedings and investigations, it is not possible to estimate the amount of any loss or range of possible loss that might result from adverse judgments, settlements, penalties or other resolutions of such proceedings and investigations based on the early stage thereof, the fact that alleged damages have not been specified, the uncertainty as to the certification of a class or classes and the size of any certified class, as applicable, and the lack of resolution on significant factual and legal issues. We will continue to evaluate information as it becomes known and will record an estimate for losses at the time or times when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable.
Future Costs
We expect to incur significant legal and other professional services costs and expenses associated with the Cyber Incident in future periods. We expect to recognize these expenses as services are received. Costs related to the Cyber Incident that will be incurred in future periods will include increased expenses associated with ongoing and any new claims, investigations and inquiries, as well as increased expenses and capital investments related to our “Secure By Design” initiatives, increased customer support activities and other related matters. We expect to incur increased expenses for insurance, finance, compliance activities, and to meet increased legal and regulatory requirements. We are also providing, at our cost, free third-party support services to customers related to the Cyber Incident. Although the ultimate magnitude and timing of expenses or other impacts to our business or reputation related to the Cyber Incident are uncertain, they could be significant.
Insurance Coverage
We maintain $15 million of cybersecurity insurance coverage to limit our exposure to losses such as those related to the Cyber Incident. Although our policy contains standard exclusions, we expect that a significant portion of the incremental expenses related to the remediation of and response to the Cyber Incident will be covered by insurance. Insurance reimbursements will also be treated as adjusting items, and the timing of recognizing insurance reimbursements may differ from the timing of recognizing the associated expenses.
Impacts of COVID-19
The impact from the rapidly changing market and economic conditions due to the COVID-19 pandemic on our business is uncertain. We initially responded to the COVID-19 pandemic by executing our business continuity plan and transitioning nearly all of our workforce to a remote working environment to prioritize the safety of our personnel. Substantially all of our workforce is currently working remotely. Due to the nature of our business, at this time, we have seen an impact on our financial results, including a decline in license revenue and increase in loss provision for accounts receivable, but do not expect to experience a significant impact on our financial results due to the COVID-19 pandemic. However, we are unable to predict with a level of precision the longer term impact it may have on our business, results of operations and financial condition due to numerous uncertainties, including the duration of the pandemic, actions that may be taken by governmental authorities in response to the pandemic, its impact to the business of our customers and their end-customers and other factors identified in “Risk Factors” included in this Annual Report on Form 10-K. We will continue to evaluate the nature and extent of the impact of the COVID-19 pandemic to our business, consolidated results of operations and financial condition.
Potential Spin-Off of MSP Business
On August 6, 2020, we announced that our board of directors has authorized management to explore a potential spin-off of our MSP business into a newly created and separately traded public company, and on December 9, 2020, we announced that we confidentially submitted with the SEC a Form 10 registration statement with respect to the potential spin-off. If completed, the standalone entity would provide cloud-based software solutions for MSPs, enabling them to support digital transformation and growth within SMEs. SolarWinds would retain our Core IT Management business focused primarily on selling software and cloud-based services to corporate IT organizations. We believe that, if completed, the potential spin-off would allow each company to more effectively pursue its distinct operating priorities, strategies and capital allocation policies, while also
allowing stockholders to separately evaluate and value the companies based on their distinct markets, strategies and performance. If we proceed with the spin-off, it would be intended to be structured as a tax-free, pro-rata distribution to all SolarWinds stockholders as of a record date to be determined by the board of directors of SolarWinds. If completed, upon effectiveness of the transaction, SolarWinds stockholders would own shares of both companies. Completion of any spin-off would be subject to various conditions, including final approval of our board of directors, and there can be no assurance that the potential spin-off will be completed in the manner described above, or at all. If we proceed with the spin-off, we currently are targeting to complete the transaction in the second quarter of 2021.
We have incurred and expect to incur significant costs in connection with exploring the potential spin-off transaction of our MSP business into a newly created and separately traded public company. Spin-off exploration costs include legal, accounting and advisory fees, implementation and integration costs, duplicative costs for subscriptions and information technology systems, employee and contractor costs and other incremental separation costs related to the potential spin-off of the MSP business. The potential MSP spin-off transaction results in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. Spin-off exploration costs incurred were $12.2 million during the year ended December 31, 2020. We expect to incur additional spin-off exploration costs in future periods.
Financial Highlights
KeyOur approach, which we call the “SolarWinds Model,” is based on our commitment to building a business that is focused on growth and profitability. Below are our key financial highlights for the period includeyear ended December 31, 2020 as compared to the following:year ended December 31, 2019.
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| | | | | | | | | | |
| Year Ended December 31, |
| 2018 | | 2017 | | Change |
| | | | | |
| (in thousands, except percentages) |
GAAP Results | | | | | |
Total revenue | $ | 833,089 |
| | $ | 728,017 |
| | 14.4 | % |
Total recurring revenue | 668,529 |
| | 571,384 |
| | 17.0 | % |
Net loss | (102,066 | ) | | (83,866 | ) | | 21.7 | % |
Net cash flow provided by operations | 254,142 |
| | 232,693 |
| | 9.2 | % |
Non-GAAP Results(1) | | | | | |
Non-GAAP total revenue | $ | 836,805 |
| | $ | 740,998 |
| | 12.9 | % |
Non-GAAP total recurring revenue | 672,245 |
| | 584,362 |
| | 15.0 | % |
Adjusted EBITDA | 407,511 |
| | 361,871 |
| | 12.6 | % |
______________ | |
(1) | See "Non-GAAP Financial Measures" for a reconciliation of our GAAP to non-GAAP results. |
Business HighlightsRevenue
Highlights for the fourth quarter of 2018 include:
SolarWinds introduced SolarWinds APM (Application Performance Monitor) to deliver application support for IT Operations and DevOps teams. SolarWinds APM extends the application monitoring capabilities of SolarWinds Server & Application Monitor (SAM) to provide in-depth, code-level monitoring of custom applications. The new solution is designed to deliver deeper performance insights and distributed transaction tracing capabilities across applications hosted in or across on-premise, hybrid IT, and cloud environments.
SolarWinds released Database Performance Analyzer v12.0, a powerful database and query performance monitoring, analysis, and tuning tool built for many of today’s popular databases. The latest enhancements are designed to help database professionals quickly identify and pinpoint the root cause of slow database queries, and easily optimize database tables to help ensure the speed of business-critical applications that rely on them.
SolarWinds also expanded its RMM capabilities for MSPs with Network Device Monitoring. Network Device Monitoring is built to give MSPs the visibility they need to monitor customer switches, printers, routers, and firewalls—in addition to servers and workstations—from a single pane of glass. With greater visibility into the complete network, MSPs can proactively maintain network devices by getting information on hardware health, performance, and utilization.
Initial Public Offering
In October 2018, we completed our IPO, in which we sold and issued 25,000,000 shares of our common stock at an issue price of $15.00 per share. We raised a total of $375.0 million in gross proceeds from the offering, or approximately $353.0 million in net proceeds after deducting underwriting discounts and commissions of $17.8 million and offering-related expenses of approximately $4.2 million. A portion of the net proceeds from the offering were used to repay the $315.0 million in borrowings outstanding under our second lien term loan. In connection with the voluntary prepayment of the second lien term loan, we paid a $14.2 million prepayment fee.
Financial Model
Our SolarWinds Model has allowed us to grow while maintaining high levels of operating efficiency. Our total revenue was $833.1 million, $728.0 million$1.02 billion and $469.4$932.5 million for the years ended December 31, 2018, 20172020 and 2016,2019, respectively. Our non-GAAP total revenue, which excludes the impact of purchase accounting, was $836.8 million, $741.0 million$1.02 billion and $630.8$938.5 million for the years ended December 31, 2018, 20172020 and 2016,2019, respectively. Recurring revenue, which consists of subscription and maintenance revenue, represented over 80%approximately 86% of our total revenue for the year ended December 31, 2018.2020 compared to 82% for the year ended December 31, 2019. We have increased our recurring revenue as a result of the growth in our subscription sales and the continued growth of our maintenance revenue.
We derive subscription revenue fromOur Core IT Management products are targeted for ITOps, DevOps, and IT security Professionals and provide hybrid IT performance management with a deep visibility into applications, databases, IT infrastructures, and the sale of our cloud management and MSP products. Our subscriptionfull IT stack, while remaining infrastructure-location agnostic. Core IT Management product revenue was $265.6 million, $213.8$716.8 million and $133.5$669.1 million for the years ended December 31, 2018, 20172020 and 2016,2019, respectively.
Our non-GAAP subscriptionMSP products enable MSPs to deploy, manage, and secure technologies for their SME end customers, as well as and more efficiently manage their own businesses. MSP product revenue was $266.8 million, $215.2$302.5 million and $140.7$263.4 million for the years ended December 31, 2018, 20172020 and 2016,2019, respectively.
We derive licenseuse Subscription Annual Recurring Revenue, or Subscription ARR, and maintenance revenue fromTotal Annual Recurring Revenue, or Total ARR, to evaluate the sale of our on-premise network and IT operations management perpetual license products. Our license revenue has declined as a percentage of total revenue primarily due to the higher growthresults of our recurring revenue model. Subscription ARR represents the annualized recurring value of all active subscription contracts at the end of a reporting period. As of December 31, 2020, Subscription ARR was $435.1 million, up from $371.6 million as of December 31, 2019. Total ARR represents the sum of Subscription ARR and represented approximately 20%the annualized value of all maintenance contracts related to perpetual licenses active at the end of a reporting period. As of December 31, 2020, Total ARR was $959.7 million, up from $845.1 million as of December 31, 2019, reflecting an increase of 13.6%.
As of December 31, 2020, we had over 320,000 customers. We have a broad and diverse customer base that is not concentrated in any segment or vertical industry. We define customers as individuals or entities that have purchased one or more of our total revenueproducts under a unique customer identification number since our inception for our perpetual license products and individuals or entities that have an active subscription for at least one of our subscription products. Each unique customer identification number constitutes a separate customer regardless of the amount purchased. We may have multiple purchasers of our products within a single organization, each of which may be assigned a unique customer identification number and deemed a separate customer.
The SolarWinds Model allows us to both sell to a broad group of potential customers and close large transactions with significant customers. We increased our customer base by over 20,000 new customers in 2018. Our license revenue was $164.6 million, $156.6 million2020 organically and $161.2 millionthrough acquisitions. While some customers may spend as little as $100 with us over a twelve-month period, we had 1,057 customers who had spent more than $100,000 with us for the yearsyear ended December 31, 2018, 2017 and 2016, respectively. Our non-GAAP license revenue was $164.6 million, $156.6 million and $162.1 million2020 as compared to 897 for the yearsyear ended December 31, 2018, 2017 and 2016, respectively.
Our maintenance revenue grows as we add new customers and as existing customers add new products and renew maintenance services. Our maintenance revenue was $402.9 million, $357.6 million and $174.7 million for the years ended December 31, 2018, 2017 and 2016, respectively. Our non-GAAP maintenance revenue was $405.5 million, $369.1 million and $328.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. The difference between our GAAP and non-GAAP maintenance revenue is primarily the result of the adjustment of our deferred revenue balance to fair value on the date of the Take Private.
Our customers typically renew their maintenance contracts at our standard list maintenance renewal pricing for their applicable products. Our maintenance revenue has grown historically due to the combination of high maintenance renewal rates, typically at list price, list price increases and on-going perpetual license sales to new and existing customers.2019.
We expect that the continued growth in the use of public and private clouds, increased outsourcing of IT management services to MSPs and cross-selling of subscription products into our existing customer base could result in an increase in our
subscription revenue. We believe this increase, coupled with continued growth in maintenance revenue, could cause our recurring revenue to increase as a percentage of total revenue over time.
We have also increased internationalOur license revenue has declined as a percentage of total revenue reaching 35% in 2018, comparedprimarily due to 33%the higher growth of our recurring revenue and 31% in 2017 and 2016, respectively. We expectrepresented approximately 14% of our international total revenue to increase slightly as a percentage of total revenue as we expand our international sales and marketing efforts across our product lines.
in 2020. We believe we have the potential to grow license revenue over time as we continue to invest in international sales growth, new product development and enhancements and increased productivity and efficiency of our sales and marketing operations.
Profitability
We have grown while maintaining high levels of operating efficiency. Our net income for the year ended December 31, 2020 was $158.5 million compared to $18.6 million for the year ended December 31, 2019. The increase in net income for the period includes the impact of a discrete tax benefit of $138.2 million recorded during the year ended December 31, 2020 related to an intra-group transfer of certain of our intellectual property rights. For additional discussion about our income taxes, see Note 15. Income Taxes in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K. Our Adjusted EBITDA was $489.7 million and $453.6 million for the years ended December 31, 2020 and 2019, respectively.
Cash Flow
We are also buildinghave built our business to generate strong cash flow over the long term. For the years ended December 31, 2018, 20172020 and 2016,2019, cash flows from operations were $254.1 million, $232.7$389.1 million and $90.2$299.9 million, respectively. During those periods, our cash flows from operations were reduced by cash payments for interest on our long-term debt of $142.9 million, $147.1$67.2 million and $141.0$100.5 million, respectively and cash payments for income taxes of $54.6 million and $48.0 million, respectively.
Cyber Incident
The Cyber Incident is expected to negatively impact revenue, profitability and cash flows in 2021 and beyond. Certain of our customers have, and others may, defer renewals or cancel subscriptions which would have a negative impact on our revenue. In addition, we expect to incur significant expenses associated with the Cyber Incident in future periods, primarily related to legal proceedings and regulatory investigations, increased expenses and capital investments associated with our “Secure By Design” initiatives, increased customer support activities and other related matters, and increased costs and expenses for insurance, compliance activities, and to meet increased legal and regulatory requirements. See Note 16. Commitments and Contingencies in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for information related to the legal proceedings and governmental investigations related to the Cyber Incident. While we will incur costs and other expenses associated with these proceedings and investigations, it is not possible to estimate the amount of any loss or range of possible loss that might result from adverse judgments, settlements, penalties or other resolutions of such proceedings and investigations based on the early stage thereof, the fact that alleged damages have not been specified, the uncertainty as to the certification of a class or classes and the size of any certified class, as applicable, and the lack of resolution on significant factual and legal issues.
Acquisitions
SentryOne
In October 2020, we acquired SQL Sentry Holdings, LLC, or SentryOne, a leading technology provider of database performance monitoring and DataOps solutions for approximately $145.1 million. We funded the transaction with cash on hand. The SentryOne offering complements our existing on-premises and cloud-native database management offerings to serve the full needs of the mid-market and better serve larger organizations. The addition of the SentryOne products to the SolarWinds portfolio also amplifies the depth and breadth of support SolarWinds can offer for Microsoft and Microsoft Azure environments.
See Note 3. Acquisitions in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional discussion of our acquisition of SentryOne.
Components of Our Results of Operations
Revenue
Our revenue consists of recurring revenue and perpetual license revenue.
•Recurring Revenue.The significant majority of our revenue is recurring and consists of subscription and maintenance revenue.
•Subscription Revenue. We primarily derive subscription revenue from fees received for subscriptions to our SaaS offerings, and to a lesser extent, our time-based license arrangements. Subscription revenue includes sales of our MSP products as well as our cloud infrastructure, application performance management and IT service management, or ITSM products. We generally recognize revenue ratably over the subscription term once the service is made available to the customer or when we have the right to invoice for services performed. We generally invoice subscription agreements monthly based on usage or in advance over the subscription period on either a monthly or annual basis. Our subscription revenue grows as customers add new subscription products, upgrade the capacity level of their existing subscription products or increase the usage of their subscription products. Our revenue from MSP products increases with the addition of end customers served by our MSP customers, the proliferation of devices managed by those MSPs and the expansion of products used by those MSPs to manage end customers’ IT infrastructures.
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▪ | Subscription Revenue. We derive subscription revenue from fees received for subscriptions to our cloud management and MSP products. Subscription revenue is recognized ratably over the subscription term after all revenue recognition criteria have been met. We generally invoice subscription agreements monthly in arrears based on usage or monthly in advance over the subscription period. Our subscription revenue grows as customers add new subscription products, upgrade the capacity level of their existing subscription products or increase the usage of their subscription products. Our revenue from MSP products increases with the addition of end customers served by our MSP customers, the proliferation of devices managed by those MSPs and the expansion of products used by those MSPs to manage end customers’ IT infrastructures.
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•Maintenance Revenue. We derive maintenance revenue from the sale of maintenance services associated with our perpetual license products. Perpetual license customers pay for maintenance services based on the products they have purchased. We recognize maintenance revenue ratably on a daily basis over the contract period. Our maintenance revenue grows when we renew existing maintenance contracts and add new perpetual license customers, and as existing customers add new products. In addition, we typically implement annual price increases for our maintenance services. Customers typically renew their maintenance contracts at our standard list maintenance renewal pricing for their applicable products. We generally invoice maintenance contracts annually in advance.
•License Revenue.We derive license revenue from sales of perpetual licenses of our on-premises network, systems, storage and database management products to new and existing customers. We include one year of maintenance services as part of our customers’ initial license purchase. License revenue is recognized at a point in time upon delivery of the electronic license key. We calculate the amount ofallocate revenue allocated to the license by subtracting the fair value,component based upon our estimated standalone selling prices, which is determinedderived by evaluating our standard maintenance renewal price list,historical pricing and discounting practices in observable bundled transactions.
In April 2020, we launched subscription pricing options for certain of our network, systems and database management products that have historically been sold as perpetual licenses. The new on-premises subscription option gives customers additional flexibility when purchasing our products. The on-premises subscription offerings are time-based revenue arrangements recognized at a point in time upon delivery of the applicable maintenance services fromsoftware and support is recognized ratably over the total invoice or contract amount. If we increase list prices for maintenance services without increasing prices by a similar percentage forperiod. On-premises subscription offerings are recorded in subscription revenue in our consolidated statement of operations. We plan to continue to sell perpetual licenses for these products and not require customers to transition to a subscription pricing model. The subscription pricing option may impact the amountmix of license and recurring revenue, we recognizebut this impact is difficult to predict at this time due to uncertainty regarding the timelevel of customer adoption of the sale ofnew subscription pricing options. We expect a gradual shift in the perpetualmix between license could be adversely affected.
and recurring revenue in each quarter as new customers purchase these on-premises subscription offerings.Cost of Revenue
•Cost of Recurring Revenue.Cost of recurring revenue consists of technical support personnel costs, royalty fees, public cloud infrastructure and hosting fees and an allocation of overhead costs for our subscription revenue and maintenance services. Allocated costs consist of certain facilities, depreciation, benefits and IT costs allocated based on headcount.
•Amortization of Acquired Technologies.We amortize Amortization of acquired technologies primarily consists of amortization related to cost of revenue the capitalized costs of technologies acquired in connection with the take private transaction in 2016, or Take Private, and to a lesser extent, acquired technologies from our other acquisitions.
Operating Expenses
Operating expenses consists of sales and marketing, research and development and general and administrative expenses as well as amortization of acquired intangibles. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, sales commissions, stock-based compensation contractor fees and an allocation of overhead costs based on headcount. The total number of employees as of December 31, 2020 was 3,340, as compared to 3,251 as of December 31, 2019. Our stock-based compensation expense has increased due to equity awards granted to our employees and directors and
we intend to continue to grant equity awards which will result in additional stock-based compensation expense in future periods. In addition, our stock-based compensation expense increased during 2020 due to modifications to certain stock awards to amend award terms and eliminate performance vesting conditions applicable to such awards. Our travel costs declined in 2020 due to COVID-19 and we expect this to continue for the duration of the pandemic.
•Sales and Marketing. Sales and marketing expenses primarily consist of related personnel costs, including our sales, marketing and maintenance renewal and subscription retention teams. Sales and marketing expenses also includes the cost of digital marketing programs such as paid search, search engine optimization and management, website maintenance and design. We expect to continue to hire personnel globally to drive new sales and maintenance renewals.
•Research and Development.Development. Research and development expenses primarily consist of related personnel costs. We expect to continue to grow our research and development organization, particularly internationally.
•General and Administrative.Administrative. General and administrative expenses primarily consist of personnel costs for our executive, finance, legal, human resources and other administrative personnel, general restructuring charges and other acquisition-relatedacquisition and spin-off exploration costs, professional fees and other general corporate expenses. In the periods after the Take Private and prior to
our initial public offering, these expenses also included management fees payable to our Sponsors, which were eliminated upon the completion of our initial public offering.
•Amortization of Acquired Intangibles. We amortize to operating expenses the capitalized costs of intangible assets acquired in connection with the Take Private and our other acquisitions.
Other Income (Expense)
Other income (expense) primarily consists of interest expense and gains (losses) resulting from changes in exchange rates on foreign currency denominated intercompany loans, and losses on extinguishment of debt.accounts. We expect interest expense to decrease as we repay indebtedness.
We established a foreign currency denominated intercompany loan as part of the Take Private to provide a conduit to utilize foreign earnings effectively. Until any cash payments are made with respect to this loan, the gains (losses) associated with the changes in exchange rates on amounts borrowed are unrealized non-cash events. Substantially all of these unrealized amounts are related to this one foreign currency denominated loan. As of July 1, 2018, this foreign currency denominated intercompany loan was designated as long-term due to a change in our investment strategy and the new Tax Act. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from remeasurement are recognized as a component of accumulated other comprehensive income (loss).
Foreign Currency
As a global company, we face exposure to adverse movements in foreign currency exchange rates. Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. See “Item 7A: Quantitative and Qualitative Disclosures About Market Risk”for additional information on how foreign currency impacts our financial results.
Income Tax Expense
Income tax expense consists of domestic and foreign corporate income taxes related to the sale of products. The tax rate on income earned by our North American entities is higher than the tax rate on income earned by our international entities. We expect the income earned by our international entities to grow over time as a percentage of total income, which may result in a decline in our effective income tax rate. However, our effective tax rate will be affected by many other factors including changes in tax laws, regulations or rates, new interpretations of existing laws or regulations, shifts in the allocation of income earned throughout the world and changes in overall levels of income before tax.
During the fourth quarter ended December 31, 2020, we completed an intra-group transfer of certain of our intellectual property to our Irish subsidiary, where our international business is headquartered, or the IP Transfer. The Tax Act was enacted on December 22, 2017. The Tax Act reduces the U.S. federal corporatetransaction will change our mix of international income from a lower non-U.S. tax jurisdiction to Ireland, which is subject to a statutory tax rate from 35% to 21%, requires companies to payof 12.5%. We recognized a one-time transitiondiscrete tax on earningsbenefit of certain foreign subsidiaries that have not been taxed previously in$138.2 million as a result of the U.S. and creates new taxes on certain foreign sourced earnings.IP Transfer. For additional discussion about our income taxes, see Note 15. Income Taxes in the Notes to Consolidated Financial Statements Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in conformity with GAAP and require our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates, and such estimates may change if the underlying conditions or assumptions change. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected, perhaps materially.
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that these accounting policies requiring significant management judgment and estimates are critical to understanding our historical and future performance, as these policies relate to the more significant areas of our financial results. These critical accounting policies are:
the valuation of goodwill, intangibles, long-lived assets and contingent consideration;
revenue recognition;
stock-based compensation;
income taxes; and
loss contingencies.
Acquisitions, Goodwill and Identifiable Intangible Assets
When we acquire businesses, we allocate the purchase price to the fair value of the assets acquired and liabilities assumed, including identifiable intangible assets. Any residual purchase price is recorded as goodwill. Goodwill is allocated to our reporting units expected to benefit from the business combination based on the relative fair value at the acquisition date. We must also estimate the fair value of any contingent consideration.
The fair value of identifiable intangible assets is based on significant judgments made by management. We typically engage third-party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from management, and also include, but are not limited to, future expected cash flows earned from the intangible asset and discount rates applied in determining the present value of those cash flows.
An impairment of goodwill is recognized when the carrying amount of the assets exceeds their fair value. The process of evaluating the potential impairment is highly subjective and requires the application of significant judgment. For purposes of the annual impairment test, we assess qualitative factors to determine if it is more likely than not that goodwill might be impaired and whether it is necessary to perform the quantitative impairment test which considers the fair value of the reporting unit compared with the carrying value on the date of the test. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our goodwill, the revision could result in a non-cash impairment charge that could have a material impact on our financial results. In the fourth quarter of 2018 and 2017, we performed our annual review of goodwill and concluded that no impairment existed for our reporting units during any of the periods presented. No impairment charges have been required to date.
We evaluate long-lived assets, including finite-lived intangible assets and other assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events or changes in circumstances that could result in an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our property and equipment or our finite-lived intangibles and other assets, that revision could result in a non-cash impairment charge that could have a material impact on our financial results.
Revenue Recognition
We generate recurring revenue from fees received for subscriptions and from the sale of maintenance services associated with our perpetual license products and license revenue from the sale of perpetual license products. In accordance with current guidance, we recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Our return policy generally does not allow our customers to return software products.
We generally use a purchase order, an authorized credit card, an electronic or manually signed license agreement or the receipt of a cash payment as evidence of an arrangement. We consider delivery to have occurred and recognize revenue when risk of loss transfers to the customer, reseller or distributor or the customer has access to their subscription which is generally upon electronic transfer of the license key or password that provides immediate availability of the product to the purchaser. We account for sales incentives to customers, resellers or distributors as a reduction of revenue at the time we recognize the revenue from the related product sale. We generally deliver licenses and subscriptions directly to the end user whether the customer buys direct or through a reseller or distributor. We report revenue net of any sales tax collected.
We sell our software products through our direct sales force and through our distributors and other resellers. Our distributors and resellers do not carry inventory of our software and we generally require them to specify the end user of the software at the time of the order.
Subscription revenue is recognized ratably over the subscription term after all revenue recognition criteria have been met. We generally invoice subscription agreements monthly in arrears based on usage or to a lesser extent in advance of the subscription period.
License revenue reflects the revenue recognized from sales of perpetual licenses of our products. We include one year of maintenance services as part of our customers’ initial license purchase. We calculate the amount of revenue allocated to the license by determining the fair value of the maintenance services, which in most cases equals the list price of our maintenance renewal as that is what we charge the customer at the renewal date, and subtracting it from the total invoice or contract amount. We generally recognize maintenance revenue ratably on a daily basis over the contract period which is typically one year.
Stock-Based Compensation
We have granted our employees and directors stock-based incentive awards. Our stock awards vest based on service-based or performance-based vesting conditions. These awards are in the form of stock options and restricted stock units for Predecessor and stock options, restricted stock and restricted stock units for Successor. We measure stock-based compensation expense for all share-based awards granted based on the estimated fair value of those awards on the date of grant. The fair values of stock option awards are estimated using a Black-Scholes valuation model. The fair value of restricted stock unit awards and restricted stock is determined using the fair market value of our common stock on the date of grant less any amount paid at the time of the grant, or intrinsic value.
We use various assumptions in estimating the fair value of options at the date of grant using the Black-Scholes option model including expected dividend yield, volatility, risk-free rate of return and expected life. We have not paid and do not anticipate paying cash dividends on our common stock; therefore, we assume the expected dividend yield to be zero. We estimate the expected volatility using a weighted average of the historical volatility of our common stock (Predecessor) and historical volatility of comparable public companies from a representative industry peer group (Successor). We based the risk-free rate of return on the average U.S. treasury yield curve for five- and seven-year terms. As allowed under current guidance, we have elected to apply the “simplified method” in developing our estimate of expected life for “plain vanilla” stock options by using the midpoint between the vesting date and contractual termination date since we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. For all dates, we granted employees options at exercise prices equal to the fair value of the underlying common stock on the date the award was approved. Performance-based awards are not considered granted under the applicable accounting guidance until the performance attainment targets for each applicable tranche have been defined. We recognize the impact of forfeitures in stock-based compensation expense when they occur.
For share-based awards with performance-based vesting conditions, stock-based compensation expense is recognized on a graded-vesting basis over the service period of each separately vesting tranche of the award, if it is probable that the performance target will be achieved. Based on the extent to which the performance targets are achieved, vested shares may range from 0% to 150% of the target award amount. At each reporting period, we estimate the probability of the performance-based awards vesting upon the achievement of the specified performance targets. Changes in the probability estimates associated with performance-based awards are accounted for in the period of change using a cumulative expense adjustment to apply the new probability estimate. In any period in which we determine the achievement of the performance targets is not probable, we cease recording compensation expense and all previously recognized compensation expense for the performance-based award is reversed.
Restricted stock is purchased at fair market value by the employee and common stock is issued at the date of grant. Restricted stock is subject to certain restrictions, such as vesting and a repurchase right. The common stock acquired by the employee is restricted stock because vesting is conditioned upon (i) continued employment through the applicable vesting date and (ii) for employees at the level of group vice president and above, the achievement of certain financial performance targets determined by our board of directors. The restricted stock is subject to repurchase in the event the stockholder ceases to be employed or engaged (as applicable) by us for any reason or in the event of a change of control or due to certain regulatory burdens. As the restricted stock is purchased at fair market value at the time of grant, there is no stock-based compensation expense recognized related to these awards.
Income Taxes
We use the liability method of accounting for income taxes as set forth in the authoritative guidance for accounting for income taxes. Under this method, we recognize deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the respective carrying amounts and tax basis of our assets and liabilities.
In calculating our effective tax rate, we make judgments regarding certain tax positions, including the timing and amount of deductions and allocations of income among various tax jurisdictions.
The guidance requires us to identify, evaluate and measure all uncertain tax positions taken or to be taken on tax returns and to record liabilities for the amount of these positions that may not be sustained, or may only partially be sustained, upon examination by the relevant taxing authorities. Although we believe that our estimates and judgments are reasonable, actual results may differ from these estimates. Some or all of these judgments are subject to review by the taxing authorities. To the extent that the actual results of these matters is different than the amounts recorded, such differences will affect our effective tax rate.
We establish valuation allowances when necessary to reduce deferred tax assets to the amounts expected to be realized. On a quarterly basis, we evaluate the need for, and the adequacy of, valuation allowances based on the expected realization of our deferred tax assets. The factors used to assess the likelihood of realization include our latest forecast of future taxable income, available tax planning strategies that could be implemented, reversal of taxable temporary differences and carryback potential to realize the net deferred tax assets. As of December 31, 2018, we had a valuation allowance of $1.8 million.
The Tax Act contains several provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the expected realization of our deferred tax assets and liabilities. In response to the Tax Act, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, or SAB 118, which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation was expected over the next 12 months, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018.
Beginning January 1, 2018, we began recognizing the tax impact of including certain foreign earnings in U.S. taxable income as a period cost. We have not recognized deferred income taxes for local country income and withholding taxes that could be incurred on distributions of certain foreign earnings or for outside basis differences in our subsidiaries, because we plan to indefinitely reinvest such earnings and basis differences.
For additional information on the estimated transition tax payment schedule, see “Contractual Obligations and Commitments.” For additional discussion about our income taxes including the effect of the Tax Act, components of income before income taxes, our provision for income taxes charged to operations, components of our deferred tax assets and liabilities, a reconciliation of income taxes at the U.S. federal statutory rate to our effective tax rate and other tax matters, see Note15. Income Taxes in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.
Results of Operations
The comparability of our operating results in fiscal 2018 and 2017 compared to fiscal 2016 was impacted by our accounting for acquisitions, including the Take Private, and related activities. We account for acquired businesses using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed, including deferred revenue, be recorded at the date of acquisition at their respective fair values which could differ from the historical book values. In most cases, adjusting the acquired deferred revenue balances to fair value on the date of the relevant acquisition had the effect of reducing the historical deferred revenue balance and therefore reducing the revenue recognized in subsequent periods.
The following table sets forth our results of operations for the periods indicated:
|
| | | | | | | | | | | | | | | | | | | | |
| Successor | | Combined | | Successor | | | Predecessor |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | Period From February 5 Through December 31, | | | Period From January 1 Through February 4, |
| 2018 | | 2017 | | 2016 | | 2016 | | | 2016 |
| | | (in thousands, except per share data) | | | |
Revenue: | | | | | | | | | | |
Subscription | $ | 265,591 |
| | $ | 213,754 |
| | $ | 133,511 |
| | $ | 126,960 |
| | | $ | 6,551 |
|
Maintenance | 402,938 |
| | 357,630 |
| | 174,734 |
| | 145,234 |
| | | 29,500 |
|
Total recurring revenue | 668,529 |
| | 571,384 |
| | 308,245 |
| | 272,194 |
| | | 36,051 |
|
License | 164,560 |
| | 156,633 |
| | 161,176 |
| | 149,900 |
| | | 11,276 |
|
Total revenue | 833,089 |
| | 728,017 |
| | 469,421 |
| | 422,094 |
| | | 47,327 |
|
Cost of revenue: | | | | | | | | | | |
Cost of recurring revenue | 70,744 |
| | 60,698 |
| | 55,789 |
| | 46,238 |
| | | 9,551 |
|
Amortization of acquired technologies | 175,991 |
| | 171,033 |
| | 149,703 |
| | 147,517 |
| | | 2,186 |
|
Total cost of revenue | 246,735 |
| | 231,731 |
| | 205,492 |
| | 193,755 |
| | | 11,737 |
|
Gross profit | 586,354 |
| | 496,286 |
| | 263,929 |
| | 228,339 |
| | | 35,590 |
|
Operating expenses: | | | | | | | | | | |
Sales and marketing | 227,468 |
| | 205,631 |
| | 212,419 |
| | 165,355 |
| | | 47,064 |
|
Research and development | 96,272 |
| | 86,618 |
| | 97,989 |
| | 65,806 |
| | | 32,183 |
|
General and administrative | 80,641 |
| | 67,303 |
| | 150,647 |
| | 71,011 |
| | | 79,636 |
|
Amortization of acquired intangibles | 66,788 |
| | 67,080 |
| | 59,470 |
| | 58,553 |
| | | 917 |
|
Total operating expenses | 471,169 |
| | 426,632 |
| | 520,525 |
| | 360,725 |
| | | 159,800 |
|
Operating income (loss) | 115,185 |
| | 69,654 |
| | (256,596 | ) | | (132,386 | ) | | | (124,210 | ) |
Other income (expense): | | | | | | | | | | |
Interest expense, net | (142,008 | ) | | (169,786 | ) | | (170,373 | ) | | (169,900 | ) | | | (473 | ) |
Other income (expense), net | (94,887 | ) | | 38,664 |
| | (57,243 | ) | | (56,959 | ) | | | (284 | ) |
Total other income (expense) | (236,895 | ) | | (131,122 | ) | | (227,616 | ) | | (226,859 | ) | | | (757 | ) |
Loss before income taxes | (121,710 | ) | | (61,468 | ) | | (484,212 | ) | | (359,245 | ) | | | (124,967 | ) |
Income tax expense (benefit) | (19,644 | ) | | 22,398 |
| | (149,807 | ) | | (96,651 | ) | | | (53,156 | ) |
Net loss | $ | (102,066 | ) | | $ | (83,866 | ) | | $ | (334,405 | ) | | $ | (262,594 | ) | | | $ | (71,811 | ) |
Net income (loss) available to common stockholders | $ | 364,635 |
| | $ | (351,873 | ) | | $ | (552,309 | ) | | $ | (480,498 | ) | | | $ | (71,811 | ) |
Net income (loss) available to common stockholders per share: | | | | | | | | | | |
Basic earnings (loss) per share | $ | 2.60 |
| | $ | (3.50 | ) | | | | $ | (4.98 | ) | | | $ | (1.00 | ) |
Diluted earnings (loss) per share | $ | 2.56 |
| | $ | (3.50 | ) | | | | $ | (4.98 | ) | | | $ | (1.00 | ) |
Weighted-average shares used to compute net income (loss) available to common stockholders per share: | | | | | | | | | | |
Shares used in computation of basic earnings (loss) per share | 140,301 |
| | 100,433 |
| | | | 96,465 |
| | | 71,989 |
|
Shares used in computation of diluted earnings (loss) per share | 142,541 |
| | 100,433 |
| | | | 96,465 |
| | | 71,989 |
|
Comparison of the Years Ended December 31, 20182020 and 20172019
Revenue
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Subscription | $ | 265,591 |
| | 31.9 | % | | $ | 213,754 |
| | 29.4 | % | | $ | 51,837 |
|
Maintenance | 402,938 |
| | 48.4 |
| | 357,630 |
| | 49.1 |
| | 45,308 |
|
Total recurring revenue | 668,529 |
| | 80.2 |
| | 571,384 |
| | 78.5 |
| | 97,145 |
|
License | 164,560 |
| | 19.8 |
| | 156,633 |
| | 21.5 |
| | 7,927 |
|
Total revenue | $ | 833,089 |
| | 100.0 | % | | $ | 728,017 |
| | 100.0 | % | | $ | 105,072 |
|
The impact to revenue as a result of purchase accounting adjustments during the relevant periods were as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2020 | | 2019 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| (in thousands, except percentages) | | |
Subscription | $ | 396,496 | | | 38.9 | % | | $ | 320,747 | | | 34.4 | % | | $ | 75,749 | |
Maintenance | 478,284 | | | 46.9 | | | 446,450 | | | 47.9 | | | 31,834 | |
Total recurring revenue | 874,780 | | | 85.8 | | | 767,197 | | | 82.3 | | | 107,583 | |
License | 144,461 | | | 14.2 | | | 165,328 | | | 17.7 | | | (20,867) | |
Total revenue | $ | 1,019,241 | | | 100.0 | % | | $ | 932,525 | | | 100.0 | % | | $ | 86,716 | |
|
| | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Amount | | Change |
| | | | | |
| | | (in thousands) | | |
Subscription | $ | 1,166 |
| | $ | 1,464 |
| | $ | (298 | ) |
Maintenance | 2,550 |
| | 11,514 |
| | (8,964 | ) |
Total recurring revenue | 3,716 |
| | 12,978 |
| | (9,262 | ) |
License | — |
| | 3 |
| | (3 | ) |
Total revenue | $ | 3,716 |
| | $ | 12,981 |
| | $ | (9,265 | ) |
Total revenue increased $105.1$86.7 million, or 14.4%9.3%, for the year ended December 31, 20182020 compared to the year ended December 31, 2017.2019. Revenue from North America was approximately 65% and 67%66% of total revenue for the years ended December 31, 20182020 and 2017,2019, respectively. Other than the United States, no single country accounted for 10% or more of our total revenue during these periods. We expect our international total revenue to increase slightly as a percentage of total revenue as we expand our international sales and marketing efforts across our product lines. Core IT Management product revenue was $716.8 million for the year ended December 31, 2020 compared to $669.1 million for the year ended December 31, 2019, representing an increase of 7.1%. MSP product revenue was $302.5 million for the year ended December 31, 2020 compared to $263.4 million for the year ended December 31, 2019, representing an increase of 14.8%.
Recurring Revenue
Subscription Revenue. Subscription revenue increased $51.8$75.7 million, or 24.3%23.6%, for the year ended December 31, 20182020 compared to the year ended December 31, 2017,2019, primarily due to sales of additional cloud managementMSP products, with additional contribution from our acquired SolarWinds Service Desk and MSPDatabase Performance Monitor products. Our subscription revenue increased as a percentage of our total revenue for the year ended December 31, 20182020 compared to the year ended December 31, 2017.2019.
Our net retention rate for our subscription products was approximately 105% and 104%, respectively, for each of the yearstrailing twelve-month periods ended December 31, 20182020 and 2017.2019 and was driven primarily by strong customer retention and expansion in our MSP products. We define our net retention rate for subscription products as the implied monthly subscription revenue at the end of a period for the base set of customers from which we generated subscription revenue in the year prior to the calculation, divided by the implied monthly subscription revenue one year prior to the date of calculation for that same customer base. We are investing to improve our net retention rate, including by enhancing and expanding our cloud management and MSP products.
Maintenance Revenue. Maintenance revenue increased $45.3$31.8 million, or 12.7%7.1%, for the year ended December 31, 20182020 compared to the year ended December 31, 2017. Of this change, $36.3 million was attributable2019 primarily due to growth in oura growing maintenance renewal customer base from sales of our perpetual license products, strong maintenance renewal rates and to a lesser extent, aannual maintenance price increase. The remaining $9.0 million increase was attributable to a smaller purchase accounting adjustment to deferred revenue in the year ended December 31, 2018 as compared to the year ended December 31, 2017.increases.
Our maintenance renewal rate for our perpetual license products was approximately 95%91% and 93%94%, respectively, for the yearstrailing twelve-month periods ended December 31, 20182020 and 2017.2019. The decrease in the maintenance renewal rate for the trailing twelve-month period ended December 31, 2020 was primarily due a planned downgrade on one large U.S. Federal maintenance renewal in the first quarter of 2020 and, to a lesser extent, a decline in renewals due to the Cyber Incident in December 2020. We expect our maintenance renewals rates may decline or fluctuate in future periods as a result of the Cyber Incident. We define our maintenance renewal rate as the sales of maintenance services for all existing maintenance contracts expiring in a period, divided by the sum previous sales of maintenance services corresponding to those
services expiring in the current period. Sales of maintenance services includes sales of maintenance renewals for a previously purchased product and the amount allocated to maintenance revenue from a license purchase.
License Revenue
License revenue increased $7.9decreased $20.9 million, or 5.1%12.6%, primarily due to increaseddecreased sales of our licensed products particularlyresulting from the difficult economic environment during the year as a result of the global recession caused by COVID-19 and the Cyber Incident in December 2020 and, to a lesser extent, an increase in the subscription sales of our international locations.network, systems and database management products that have historically been sold only as perpetual licenses. We believeexpect our more tenuredlicense sales and marketing leadership teamsmay decline or fluctuate in international regions during 2018 was primarilyfuture periods as a result of the reason for the increased growth in these regions.Cyber Incident.
Cost of Revenue
| | | Year Ended December 31, | | | | Year Ended December 31, | |
| 2018 | | 2017 | | | | 2020 | | 2019 | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change | | Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | | | | | | | | | | | |
| | | (in thousands, except percentages) | | | | (in thousands, except percentages) | |
Cost of recurring revenue | $ | 70,744 |
| | 8.5 | % | | $ | 60,698 |
| | 8.3 | % | | $ | 10,046 |
| Cost of recurring revenue | $ | 93,255 | | | 9.1 | % | | $ | 79,571 | | | 8.5 | % | | $ | 13,684 | |
Amortization of acquired technologies | 175,991 |
| | 21.1 |
| | 171,033 |
| | 23.5 |
| | 4,958 |
| Amortization of acquired technologies | 181,361 | | | 17.8 | | | 175,883 | | | 18.9 | | | 5,478 | |
Total cost of revenue | $ | 246,735 |
| | 29.6 | % | | $ | 231,731 |
| | 31.8 | % | | $ | 15,004 |
| Total cost of revenue | $ | 274,616 | | | 26.9 | % | | $ | 255,454 | | | 27.4 | % | | $ | 19,162 | |
Total cost of revenue increased in the year ended December 31, 20182020 compared to the year ended December 31, 20172019 primarily due to increases in amortization of acquired technologies of $5.0 million, royaltypublic cloud infrastructure and hosting fees related to our subscription products of $4.0$6.9 million, depreciation and other amortization of $3.1 million and personnel costs to support new customers and additional product offerings of $3.0$4.1 million, which includes a $0.9 million increase in stock-based compensation expense and depreciation and other amortization of $3.3 million. AmortizationThe increase in amortization of acquired technologies includes $165.6 million and $163.0 million of amortizationis primarily related to the Take Private for the years ended December 31, 2018 and 2017, respectively, with the remaining balance related primarily to the LOGICnow acquisitionintangibles acquired through our acquisitions in May 2016.2019.
Operating Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2020 | | 2019 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| (in thousands, except percentages) | | |
Sales and marketing | $ | 298,452 | | | 29.3 | % | | $ | 264,199 | | | 28.3 | % | | $ | 34,253 | |
Research and development | 126,216 | | | 12.4 | | | 110,362 | | | 11.8 | | | 15,854 | |
General and administrative | 137,541 | | | 13.5 | | | 97,525 | | | 10.5 | | | 40,016 | |
Amortization of acquired intangibles | 74,973 | | | 7.4 | | | 69,812 | | | 7.5 | | | 5,161 | |
Total operating expenses | $ | 637,182 | | | 62.5 | % | | $ | 541,898 | | | 58.1 | % | | $ | 95,284 | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Sales and marketing | $ | 227,468 |
| | 27.3 | % | | $ | 205,631 |
| | 28.2 | % | | $ | 21,837 |
|
Research and development | 96,272 |
| | 11.6 |
| | 86,618 |
| | 11.9 |
| | 9,654 |
|
General and administrative | 80,641 |
| | 9.7 |
| | 67,303 |
| | 9.2 |
| | 13,338 |
|
Amortization of acquired intangibles | 66,788 |
| | 8.0 |
| | 67,080 |
| | 9.2 |
| | (292 | ) |
Total operating expenses | $ | 471,169 |
| | 56.6 | % | | $ | 426,632 |
| | 58.6 | % | | $ | 44,537 |
|
Sales and Marketing. Sales and marketing expenses increased $21.8$34.3 million, or 10.6%13.0%, primarily due to increases in personnel costs of $18.1$30.6 million, which includes an increase of $11.2 million in stock-based compensation expense and increases in marketing program costs of $2.8$5.5 million. These increases were partially offset by reductions in travel and acquisition related costs of $4.6 million. We increased our sales and marketing employee headcount and marketing program costs to support the sales of additional products and growth in the business.business and through the acquisitions.
Research and Development. Research and development expenses increased $9.7$15.9 million, or 11.1%14.4%, primarily due to an increase in personnel costs of $12.5$17.6 million, which includes an increase in stock-based compensation expense of $6.4 million, partially offset by a reduction in travel costs of $1.4 million. We increased our worldwide research and development employee headcount to expedite delivery of product enhancements and new product offerings to our customers. This increase was partially offset by reductions in contract services of $1.7 millioncustomers and acquisition and Take Private related costs of $1.4 million.through acquisitions.
General and Administrative. General and administrative expenses increased $13.3$40.0 million, or 19.8%41.0%, primarily due to a $11.7$28.8 million increase in personnel costs, to support the growth of the business andwhich includes a $4.1$22.4 million increase in offeringstock-based compensation expense, a $11.3 million increase in costs related to the exploration of a potential spin-off of our IPO, public companyMSP business, a $3.2 million increase in costs related to the Cyber Incident and other professional fees.a $1.1 million increase in our provision for losses on accounts receivables. These increases were partially offset by a decreasedecreases in acquisition and Take Private relatedrestructuring costs of $3.7$2.7 million and offering and travel costs of $1.9 million. The increase in stock-based compensation expense is primarily related to modifications of stock awards during the year. See Note 11. Stockholders’ Equity (Deficit) and Stock-Based Compensation in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of the stock award modifications. The increase in our provision for losses on accounts receivables is primarily related to a settlement with a distributor, from customers acquired in recent acquisitions and customers potentially impacted by the current economic uncertainty resulting from the COVID-19 pandemic.
Amortization of Acquired Intangibles. Amortization of acquired intangibles decreased $0.3increased $5.2 million, or 0.4%7.4%, for the year ended December 31, 20182020 compared to the year ended December 31, 20172019 primarily due to certain intangible assets from the Take Private being fully amortized during the year, partially offset by additional expense from the addition of intangible assets related to acquisitions. Amortization of intangible assets includes $48.2 million and $50.4 million of amortization related to our acquisitions completed in 2019 and 2020. See Note 3. Acquisitions in the Take PrivateNotes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of our acquisitions including the years ended December 31, 2018 and 2017, respectively, with the remaining balance related primarily to the LOGICnow acquisition in May 2016.intangible assets acquired.
Interest Expense, Net
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2020 | | 2019 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| (in thousands, except percentages) | | |
Interest expense, net | $ | (75,884) | | | (7.4) | % | | $ | (108,071) | | | (11.6) | % | | $ | 32,187 | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Interest expense, net | $ | (142,008 | ) | | (17.0 | )% | | $ | (169,786 | ) | | (23.3 | )% | | $ | 27,778 |
|
Interest expense, net decreased by $27.8$32.2 million, or 16.4%29.8%, in the year ended December 31, 20182020 compared to the year ended December 31, 2017.2019. The decrease in interest expense is primarily due to decreases in interest rates on our debt. The weighted-average effective interest rate on our debt during the reductionyear ended December 31, 2020 was 3.4% compared to 5.0% for the year ended December 31, 2019. See Note9. Debt in the interest rate spread under our credit facilities resulting from the refinancing transaction we completed in March 2018. In addition, in October 2018 we repaid the $315.0 million in outstanding borrowings under our second lien term loan. See Note9. Debt in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information regarding our debt.
Other Income (Expense), Net
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2020 | | 2019 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| (in thousands, except percentages) | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Total other income (expense), net | $ | (1,240) | | | (0.1) | % | | $ | 402 | | | — | % | | $ | (1,642) | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Unrealized net transaction gains (losses) related to remeasurement of intercompany loans | $ | (12,565 | ) | | (1.5 | )% | | $ | 56,539 |
| | 7.8 | % | | $ | (69,104 | ) |
Loss on extinguishment of debt | (80,137 | ) | | (9.6 | ) | | (18,559 | ) | | (2.5 | ) | | (61,578 | ) |
Other income (expense) | (2,185 | ) | | (0.3 | ) | | 684 |
| | 0.1 |
| | (2,869 | ) |
Total other income (expense), net | $ | (94,887 | ) | | (11.4 | )% | | $ | 38,664 |
| | 5.3 | % | | $ | (133,551 | ) |
Other income (expense), net decreased by $133.6$1.6 million in the year ended December 31, 20182020 compared to the year ended December 31, 20172019 primarily due to the impact of changes in foreign currency exchange rates related to various intercompany loansaccounts for the period, a loss of $80.1 million on extinguishment of debt related to the refinancing of our credit facilities in March 2018 and the repayment of the second lien term loan in October 2018. See Note9. Debt in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information regarding our debt.period.
Income Tax Expense (Benefit)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2020 | | 2019 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| (in thousands, except percentages) | | |
Income before income taxes | $ | 30,319 | | | 3.0 | % | | $ | 27,504 | | | 2.9 | % | | $ | 2,815 | |
Income tax expense (benefit) | (128,156) | | | (12.6) | | | 8,862 | | | 1.0 | | | (137,018) | |
Effective tax rate | (422.7) | % | | | | 32.2 | % | | | | (454.9) | % |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2018 | | 2017 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Income tax expense (benefit) | $ | (19,644 | ) | | (2.4 | )% | | $ | 22,398 |
| | 3.1 | % | | $ | (42,042 | ) |
Effective tax rate | 16.1 | % | | | | (36.4 | )% | | | | 52.5 | % |
Our income tax benefit for the year ended December 31, 2018 increased by $42.02020 was $128.2 million as compared to income tax expense of $8.9 million for the year ended December 31, 20172019. The change in the effective tax rate for the period was primarily due to a discrete tax benefit of $138.2 million that was recognized as a result ofdeferred tax asset related to the one–time tax impacts recorded in 2017 from the enactment of the Tax Act.IP Transfer. For additional discussion about our income taxes, see Note 15. Income Taxes in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Comparison of the Years Ended December 31, 20172019 and 2016 (Combined)2018
Our combinedFor a comparison of our results of operations for the years ended December 31, 2019 and 2018, see Part II, Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2016 represent the addition of the Predecessor period from January 1, 2016 through February 4, 2016 and the Successor period from February 5, 2016 to December 31, 2016. This combination does not comply with GAAP or2019, filed with the rules for pro forma presentation, but is presented because we believe it provides the most meaningful comparison of our results.SEC on February 24, 2020.
Revenue
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Subscription | $ | 213,754 |
| | 29.4 | % | | $ | 133,511 |
| | 28.4 | % | | $ | 80,243 |
|
Maintenance | 357,630 |
| | 49.1 |
| | 174,734 |
| | 37.2 |
| | 182,896 |
|
Total recurring revenue | 571,384 |
| | 78.5 |
| | 308,245 |
| | 65.7 |
| | 263,139 |
|
License | 156,633 |
| | 21.5 |
| | 161,176 |
| | 34.3 |
| | (4,543 | ) |
Total revenue | $ | 728,017 |
| | 100.0 | % | | $ | 469,421 |
| | 100.0 | % | | $ | 258,596 |
|
The impact to revenue as a result of purchase accounting adjustments during the relevant periods were as follows:
|
| | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Amount | | Change |
| | | | | |
| | | (in thousands) | | |
Subscription | $ | 1,464 |
| | $ | 7,219 |
| | $ | (5,755 | ) |
Maintenance | 11,514 |
| | 153,220 |
| | (141,706 | ) |
Total recurring revenue | 12,978 |
| | 160,439 |
| | (147,461 | ) |
License | 3 |
| | 921 |
| | (918 | ) |
Total revenue | $ | 12,981 |
| | $ | 161,360 |
| | $ | (148,379 | ) |
Total revenue increased $258.6 million, or 55.1%, in 2017 compared to 2016 primarily due to the impact of the purchase accounting adjustment to deferred revenue recorded in 2016 related to the Take Private, as well as increases in our recurring revenue due to a larger maintenance revenue base in 2017 while maintaining strong renewal rates and increased sales of our subscription products.
Revenue from North America was approximately 67% and 69% of total revenue in 2017 and 2016, respectively. Other than the United States, no single country accounted for 10% or more of our total revenue during these periods.
Recurring Revenue
Subscription Revenue. Subscription revenue increased $80.2 million, or 60.1%, which includes $5.8 million less impact in 2017 of purchase accounting as compared to 2016. The increase in subscription revenue was primarily due to increased sales of new subscription products introduced by us in 2017 and 2016. LOGICnow products contributed approximately $57.5 million of subscription revenue in 2016 prior to their integration with our existing MSP products. Our net retention rate for our subscription products averaged approximately 104% over each of the years ended December 31, 2017 and 2016.
Maintenance Revenue. Maintenance revenue increased $182.9 million, or 104.7%, which includes $141.7 million less impact in 2017 of purchase accounting as compared to 2016. The increase in maintenance revenue other than as a result of the impact of purchase accounting was primarily due to a growing maintenance renewal customer base from sales of our perpetual license products and upgrades from existing customers, a strong maintenance renewal rate, and to a lesser extent, a maintenance price
increase. Our maintenance renewal rate for our perpetual license products was approximately 93% and 94%, respectively, for the years ended December 31, 2017 and 2016.
License Revenue
License revenue decreased $4.5 million, or 2.8%, in 2017 compared to 2016 due to a reduction in license sales that we believe was a result of our reduction in sales and marketing expenses beginning in the second half of 2016 and into 2017 as we focused on driving a higher level of efficiency and managed our business to increase cash flow after the Take Private.
Cost of Revenue
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Cost of recurring revenue | $ | 60,698 |
| | 8.3 | % | | $ | 55,789 |
| | 11.9 | % | | $ | 4,909 |
|
Amortization of acquired technologies | 171,033 |
| | 23.5 |
| | 149,703 |
| | 31.9 |
| | 21,330 |
|
Total cost of revenue | $ | 231,731 |
| | 31.8 | % | | $ | 205,492 |
| | 43.8 | % | | $ | 26,239 |
|
Cost of recurring revenue increased in absolute dollars primarily due to a $5.0 million increase in personnel costs to support new customers and additional product offerings from acquisitions. However, cost of recurring revenue decreased as a percentage of revenue primarily as a result of our integration of LOGICnow and related restructuring activities to improve operating efficiencies.
Amortization of acquired technologies increased in 2017 compared to 2016 primarily due to a full year of amortization expense in 2017 related to the Take Private and LOGICnow acquisition, which occurred in February and May 2016, respectively. Amortization of acquired technologies includes $163.0 million and $143.0 million of amortization related to the Take Private for 2017 and 2016, respectively, with the remaining primarily related to the LOGICnow acquisition in May 2016.
Operating Expenses
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Sales and marketing | $ | 205,631 |
| | 28.2 | % | | $ | 212,419 |
| | 45.3 | % | | $ | (6,788 | ) |
Research and development | 86,618 |
| | 11.9 |
| | 97,989 |
| | 20.9 |
| | (11,371 | ) |
General and administrative | 67,303 |
| | 9.2 |
| | 150,647 |
| | 32.1 |
| | (83,344 | ) |
Amortization of acquired intangibles | 67,080 |
| | 9.2 |
| | 59,470 |
| | 12.7 |
| | 7,610 |
|
Total operating expenses | $ | 426,632 |
| | 58.6 | % | | $ | 520,525 |
| | 110.9 | % | | $ | (93,893 | ) |
Sales and Marketing. Sales and marketing expenses decreased $6.8 million, or 3.2%, in 2017 as compared to 2016. Personnel and marketing program costs increased in 2017 by $18.9 million and $7.7 million, respectively, to support the growth of the business and as a result of a full year of sales and marketing expenses related to our increased product portfolio primarily related to the products from the LOGICnow acquisition which we completed in May 2016. These increases were offset by a reduction of $30.7 million in stock-based compensation expense due to higher costs related to stock-based compensation in 2016 as a result of the Take Private.
Research and Development. Research and development expenses decreased $11.4 million, or 11.6%, in 2017 as compared to 2016. Personnel costs increased in 2017 by $14.9 million as we invested in the development of our cloud management products
and as a result of a full year of research and development expenses for the LOGICnow products we acquired in May 2016. This increase was more than offset by a reduction of $23.8 million in stock-based compensation in 2016 as a result of the Take Private.
General and Administrative. General and administrative expenses decreased $83.3 million, or 55.3%, in 2017 as compared to 2016. Personnel costs increased in 2017 by $5.1 million to support company growth. This increase was more than offset by a reduction of $27.6 million in stock-based compensation expense in 2017 and a reduction of $64.0 million in acquisition-related costs due to expenses incurred in 2016 primarily related to the Take Private and to a lesser extent the LOGICnow acquisition in May 2016.
Amortization of Acquired Intangibles. Amortization of acquired intangible assets increased $7.6 million, or 12.8%, in 2017 compared to 2016 primarily due to the increased amortization related to the intangible assets acquired as part of the May 2016 LOGICnow acquisition. Amortization of intangible assets includes $50.4 million and $47.8 million of amortization related to the Take Private for 2017 and 2016, respectively, with the remaining balance related to other acquisitions.
Interest Expense, Net
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Interest expense, net | $ | (169,786 | ) | | (23.3 | )% | | $ | (170,373 | ) | | (36.3 | )% | | $ | 587 |
|
Interest expense, net decreased by $0.6 million, or 0.3%, in 2017 compared to 2016. The decrease in interest expense was due to the reduction in interest rates on our credit facilities resulting from a refinancing of such facilities in February 2017. See Note9. Debtin the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information regarding our debt.
Other Income (Expense), Net
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Unrealized net transaction gains (losses) related to remeasurement of intercompany loans | $ | 56,539 |
| | 7.8 | % | | $ | (26,651 | ) | | (5.7 | )% | | $ | 83,190 |
|
Loss on extinguishment of debt | (18,559 | ) | | (2.5 | ) | | (22,767 | ) | | (4.9 | ) | | 4,208 |
|
Other income (expense) | 684 |
| | 0.1 |
| | (7,825 | ) | | (1.7 | ) | | 8,509 |
|
Total other income (expense), net | $ | 38,664 |
| | 5.3 | % | | $ | (57,243 | ) | | (12.2 | )% | | $ | 95,907 |
|
Other income (expense), net increased by $95.9 million in 2017 compared to 2016 primarily related to an increase of $83.2 million of net unrealized foreign currency exchange transaction gains related to various intercompany loans, a decrease of $5.6 million in foreign currency losses and a reduced loss on extinguishment of debt related to the refinancing of our credit facilities in February 2017 as compared to the refinancing of our credit facilities in August 2016.
Income Tax Expense (Benefit)
|
| | | | | | | | | | | | | | | | | |
| Successor | | Combined | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | |
| 2017 | | 2016 | | |
| Amount | | Percentage of Revenue | | Amount | | Percentage of Revenue | | Change |
| | | | | | | | | |
| | | (in thousands, except percentages) | | |
Income tax expense (benefit) | $ | 22,398 |
| | 3.1 | % | | $ | (149,807 | ) | | (31.9 | )% | | $ | 172,205 |
|
Effective tax rate | (36.4 | )% | | | | 30.9 | % | | | | (67.3 | )% |
Our income tax benefit for 2016 decreased by $172.2 million to an income tax expense for 2017. The decrease is primarily related to the change in income (loss) before income taxes of $422.7 million, the deferred tax assets remeasurement and a one-time transition tax due to the Tax Act. Excluding the tax impact from the Tax Act, the 2017 effective tax rate would have been 21.3%, which was relatively consistent with 2016. For additional discussion about our income taxes, see Note 15. Income Taxes in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Non-GAAP Financial Measures
In addition to financial measures prepared in accordance with GAAP, we use certain non-GAAP financial measures to clarify and enhance our understanding, and aid in the period-to-period comparison, of our performance. We believe that these non-GAAP financial measures provide supplemental information that is meaningful when assessing our operating performance because they exclude the impact of certain amounts that our management and board of directors do not consider part of core operating results when assessing our operational performance, allocating resources, preparing annual budgets and determining compensation. Accordingly, these non-GAAP financial measures may provide insight to investors into the motivation and decision-making of management in operating the business. Investors are encouraged to review the reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure included below.
While we believe that these non-GAAP financial measures provide useful supplemental information, non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, their most comparable GAAP measures. These non-GAAP financial measures are not prepared in accordance with GAAP, do not reflect a comprehensive system of accounting and may not be comparable to similarly titled measures of other companies due to potential differences in their financing and accounting methods, the book value of their assets, their capital structures, the method by which their assets were acquired and the manner in which they define non-GAAP measures. Items such as the amortization of intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition related adjustments, costs related to the exploration of a potential spin-off of our MSP business and the Cyber Incident and restructuring charges, as well as the related tax impacts of these items can have a material impact on our GAAP financial results.
Non-GAAP Revenue
We define non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue, as subscription revenue, maintenance revenue, license revenue and total revenue, respectively, excluding the impact of purchase accounting primarily from our Take Private transaction in early 2016 and the acquisition of LOGICnow.acquisitions. We monitor these measures to assess our performance because we believe our revenue growth rates would be overstated without these adjustments. We believe presenting non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue aids in the comparability between periods and in assessing our overall operating performance. This adjustment to GAAP revenue impacted our revenue through the fourth quarter of 2018. Our 2019 revenue results will no longer be impacted by this adjustment.
| | | Successor | | Combined | | Successor | | | Predecessor | | | | | | | | | | | | | | | |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | Period From February 5 Through December 31, | | | Period From January 1 Through February 4, | | Year Ended December 31, |
| 2018 | | 2017 | | 2016 | | 2016 | | | 2016 | | 2020 | | 2019 | | 2018 |
| | | | | | | | | | | | | | | | |
| | | (in thousands) | | | | | (in thousands) |
Revenue: | | | | | | | | | | | Revenue: | |
GAAP subscription revenue | $ | 265,591 |
| | $ | 213,754 |
| | $ | 133,511 |
| | $ | 126,960 |
| | | $ | 6,551 |
| GAAP subscription revenue | $ | 396,496 | | | $ | 320,747 | | | $ | 265,591 | |
Impact of purchase accounting | 1,166 |
| | 1,464 |
| | 7,219 |
| | 7,219 |
| | | — |
| Impact of purchase accounting | 2,540 | | | 5,930 | | | 1,166 | |
Non-GAAP subscription revenue | 266,757 |
| | 215,218 |
| | 140,730 |
| | 134,179 |
| | | 6,551 |
| Non-GAAP subscription revenue | 399,036 | | | 326,677 | | | 266,757 | |
GAAP maintenance revenue | 402,938 |
| | 357,630 |
| | 174,734 |
| | 145,234 |
| | | 29,500 |
| GAAP maintenance revenue | 478,284 | | | 446,450 | | | 402,938 | |
Impact of purchase accounting | 2,550 |
| | 11,514 |
| | 153,220 |
| | 153,220 |
| | | — |
| Impact of purchase accounting | — | | | — | | | 2,550 | |
Non-GAAP maintenance revenue | 405,488 |
| | 369,144 |
| | 327,954 |
| | 298,454 |
| | | 29,500 |
| Non-GAAP maintenance revenue | 478,284 | | | 446,450 | | | 405,488 | |
GAAP total recurring revenue | 668,529 |
| | 571,384 |
| | 308,245 |
| | 272,194 |
| | | 36,051 |
| GAAP total recurring revenue | 874,780 | | | 767,197 | | | 668,529 | |
Impact of purchase accounting | 3,716 |
| | 12,978 |
| | 160,439 |
| | 160,439 |
| | | — |
| Impact of purchase accounting | 2,540 | | | 5,930 | | | 3,716 | |
Non-GAAP total recurring revenue | 672,245 |
| | 584,362 |
| | 468,684 |
| | 432,633 |
| | | 36,051 |
| Non-GAAP total recurring revenue | 877,320 | | | 773,127 | | | 672,245 | |
GAAP license revenue | 164,560 |
| | 156,633 |
| | 161,176 |
| | 149,900 |
| | | 11,276 |
| GAAP license revenue | 144,461 | | | 165,328 | | | 164,560 | |
Impact of purchase accounting | — |
| | 3 |
| | 921 |
| | 921 |
| | | — |
| Impact of purchase accounting | — | | | — | | | — | |
Non-GAAP license revenue | 164,560 |
| | 156,636 |
| | 162,097 |
| | 150,821 |
| | | 11,276 |
| Non-GAAP license revenue | 144,461 | | | 165,328 | | | 164,560 | |
Total GAAP revenue | $ | 833,089 |
| | $ | 728,017 |
| | $ | 469,421 |
| | $ | 422,094 |
| | | $ | 47,327 |
| Total GAAP revenue | $ | 1,019,241 | | | $ | 932,525 | | | $ | 833,089 | |
Impact of purchase accounting | $ | 3,716 |
| | $ | 12,981 |
| | $ | 161,360 |
| | $ | 161,360 |
| | | $ | — |
| Impact of purchase accounting | $ | 2,540 | | | $ | 5,930 | | | $ | 3,716 | |
Total non-GAAP revenue | $ | 836,805 |
| | $ | 740,998 |
| | $ | 630,781 |
| | $ | 583,454 |
| | | $ | 47,327 |
| Total non-GAAP revenue | $ | 1,021,781 | | | $ | 938,455 | | | $ | 836,805 | |
Non-GAAP Operating Income and Non-GAAP Operating Margin
We provide non-GAAP operating income and related non-GAAP margin using non-GAAP revenue as discussed above and excluding such items as the write-down of deferred revenue related to purchase accounting, amortization of acquired intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition and Sponsor relatedother costs, spin-off exploration costs, restructuring costs and restructuring charges and other.Cyber Incident costs. Management believes these measures are useful for the following reasons:
•Amortization of Acquired Intangible Assets. We provide non-GAAP information that excludes expenses related to purchased intangible assets associated with our acquisitions. We believe that eliminating this expense from our non-GAAP measures is useful to investors, because the amortization of acquired intangible assets can be inconsistent in amount and frequency and is significantly impacted by the timing and magnitude of our acquisition transactions, which also vary in frequency from period to period. Accordingly, we analyze the performance of our operations in each period without regard to such expenses.
•Stock-Based Compensation Expense. Expense and Related Employer-Paid Payroll Taxes. We provide non-GAAP information that excludes expenses related to stock-based compensation.compensation and related employer-paid payroll taxes. We believe that the exclusion of stock-based compensation expense provides for a better comparison of our operating results to prior periods and to our peer companies as the calculations of stock-based compensation vary from period to period and company to company due to different valuation methodologies, subjective assumptions and the variety of award types. Employer-paid payroll taxes on stock-based compensation is dependent on our stock price and the timing of the taxable events related to the equity awards, over which our management has little control, and does not correlate to the core operation of our business. Because of these unique characteristics of stock-based compensation and related employer-paid payroll taxes, management excludes these expenses when analyzing the organization’s business performance.
•Acquisition and Sponsor RelatedOther Costs. We exclude certain expense items resulting from the Take Private and other acquisitions, such as legal, accounting and advisory fees, changes in fair value of contingent consideration, costs related to integrating the acquired businesses, deferred compensation, severance and retention expense. In addition, we exclude
certain other costs including expense related to our offerings. We consider these adjustments, to some extent, to be unpredictable and dependent on a significant number of factors that are outside of our control. Furthermore, acquisitions result in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing these non-GAAP measures that exclude acquisition and Sponsor relatedother costs, allows users of our financial statements to better review and understand the historical and current results of our continuing operations, and also facilitates comparisons to our historical results and results of less acquisitive peer companies, both with and without such adjustments.
•Spin-off Exploration Costs. We exclude certain expense items resulting from the exploration of a potential spin-off transaction of our MSP business into a newly created and separately traded public company. These costs include legal, accounting and advisory fees, implementation and integration costs, duplicative costs for subscriptions and information technology systems, employee and contractor costs and other incremental separation costs related to the potential spin-off of the MSP business. The potential MSP spin-off transaction results in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing non-GAAP measures that exclude these costs facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance.
•Restructuring Charges and Other. Costs. We provide non-GAAP information that excludes restructuring chargescosts such as severance and the estimated costs of exiting and terminating facility lease commitments, as they relate to our corporate restructuring and exit activities.activities and costs related to the separation of employment with executives of the Company. These restructuring chargescosts are inconsistent in amount and are significantly impacted by the timing and nature of these events. Therefore, although we may incur these types of expenses in the future, we believe that eliminating these chargescosts for purposes of calculating the non-GAAP financial measures facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance.
•Cyber Incident Costs. We exclude certain expenses resulting from the Cyber Incident. Expenses include costs to investigate and remediate the Cyber Incident, and legal and other professional services related thereto, and consulting services being provided to customers at no charge. Cyber Incident costs are provided net of insurance reimbursements, although the timing of recognizing insurance reimbursements may differ from the timing of recognizing the associated expenses. We expect to incur significant legal and other professional services expenses associated with the Cyber Incident in future periods. The Cyber Incident results in operating expenses that would not have otherwise been incurred by us in the normal course of our organic business operations. We believe that providing non-GAAP measures that exclude these costs facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance. We continue to invest significantly in cybersecurity and expect to make additional investments. These estimated investments are in addition to the Cyber Incident costs and not included in the net Cyber Incident costs reported.
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2020 | | 2019 | | 2018 |
| | | | | |
| (in thousands, except margin data) |
GAAP operating income | $ | 107,443 | | | $ | 135,173 | | | $ | 115,185 | |
Impact of purchase accounting | 2,540 | | | 5,930 | | | 3,716 | |
Stock-based compensation expense and related employer-paid payroll taxes | 76,174 | | | 35,270 | | | 5,833 | |
Amortization of acquired technologies | 181,361 | | | 175,883 | | | 175,991 | |
Amortization of acquired intangibles | 74,973 | | | 69,812 | | | 66,788 | |
Acquisition and other costs | 5,854 | | | 8,544 | | | 20,401 | |
Spin-off exploration costs | 12,227 | | | — | | | — | |
Restructuring costs | 2,368 | | | 5,598 | | | 2,999 | |
Cyber Incident costs | 3,485 | | | — | | | — | |
Non-GAAP operating income | $ | 466,425 | | | $ | 436,210 | | | $ | 390,913 | |
GAAP operating margin | 10.5 | % | | 14.5 | % | | 13.8 | % |
Non-GAAP operating margin | 45.6 | % | | 46.5 | % | | 46.7 | % |
|
| | | | | | | | | | | | | | | | | | | | |
| Successor | | Combined | | Successor | | | Predecessor |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | Period From February 5 Through December 31, | | | Period From January 1 Through February 4, |
| 2018 | | 2017 | | 2016 | | 2016 | | | 2016 |
| | | | | | | | | | |
| | | (in thousands, except margin data) | | | |
GAAP operating income (loss) | $ | 115,185 |
| | $ | 69,654 |
| | $ | (256,596 | ) | | $ | (132,386 | ) | | | $ | (124,210 | ) |
Impact of purchase accounting | 3,716 |
| | 12,981 |
| | 161,360 |
| | 161,360 |
| | | — |
|
Stock-based compensation expense | 5,833 |
| | 80 |
| | 87,780 |
| | 17 |
| | | 87,763 |
|
Amortization of acquired technologies | 175,991 |
| | 171,033 |
| | 149,703 |
| | 147,517 |
| | | 2,186 |
|
Amortization of acquired intangibles | 66,788 |
| | 67,080 |
| | 59,470 |
| | 58,553 |
| | | 917 |
|
Acquisition and Sponsor related costs | 20,401 |
| | 23,580 |
| | 97,556 |
| | 44,512 |
| | | 53,044 |
|
Restructuring costs and other | 2,999 |
| | 2,858 |
| | 4,526 |
| | 2,962 |
| | | 1,564 |
|
Non-GAAP operating income | $ | 390,913 |
|
| $ | 347,266 |
| | $ | 303,799 |
| | $ | 282,535 |
| | | $ | 21,264 |
|
GAAP operating margin | 13.8 | % | | 9.6 | % | | (54.7 | )% | | (31.4 | )% | | | (262.5 | )% |
Non-GAAP operating margin | 46.7 | % | | 46.9 | % | | 48.2 | % | | 48.4 | % | | | 44.9 | % |
Adjusted EBITDAand Adjusted EBITDA Margin
We regularly monitor adjusted EBITDA and adjusted EBITDA margin, as it is a measure we use to assess our operating performance. We define adjusted EBITDA as net income or loss, excluding the impact of purchase accounting on total revenue, amortization of acquired intangible assets and developed technology, depreciation expense, stock-based compensation expense and related employer-paid payroll taxes, restructuring costs, acquisition and other charges, acquisition and Sponsor relatedcosts, spin-off exploration costs, Cyber Incident costs, interest expense, net, debt related costs including fees related to our credit agreements, debt extinguishment and refinancing costs, unrealized foreign currency (gains) losses, and income tax expense (benefit). We define adjusted EBITDA margin as adjusted EBITDA divided by non-GAAP revenue. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; adjusted EBITDA excludes the impact of the write-down of deferred revenue due to purchase accounting in connection with our acquisition, and therefore includes revenue that will never be recognized under GAAP; adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and other companies, including companies in our industry, may calculate adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including net income (loss) and our other GAAP results. In evaluating adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the types of items excluded from the calculation of adjusted EBITDA. Adjusted EBITDA is not a presentation made in accordance with GAAP and the use of the term varies from others in our industry.
| | | | | | | | | | | | | | Year Ended December 31, |
| Successor | | Combined | | Successor | | | Predecessor | | 2020 | | 2019 | | 2018 |
| Year Ended December 31, | | (Unaudited) Year Ended December 31, | | Period From February 5 Through December 31, | | | Period From January 1 Through February 4, | | | | | | |
| 2018 | | 2017 | | 2016 | | 2016 | | | 2016 | | (in thousands, except margin data) |
| | | | | | | | | | | |
| | | (in thousands, except margin data) | | | | |
Net loss | $ | (102,066 | ) | | $ | (83,866 | ) | | $ | (334,405 | ) | | $ | (262,594 | ) | | | $ | (71,811 | ) | |
Net income (loss) | | Net income (loss) | $ | 158,475 | | | $ | 18,642 | | | $ | (102,066) | |
Amortization and depreciation | 258,362 |
| | 250,876 |
| | 219,233 |
| | 215,325 |
| | | 3,908 |
| Amortization and depreciation | 277,856 | | | 263,244 | | | 258,362 | |
Income tax expense (benefit) | (19,644 | ) | | 22,398 |
| | (149,807 | ) | | (96,651 | ) | | | (53,156 | ) | Income tax expense (benefit) | (128,156) | | | 8,862 | | | (19,644) | |
Interest expense, net | 142,008 |
| | 169,786 |
| | 170,373 |
| | 169,900 |
| | | 473 |
| Interest expense, net | 75,884 | | | 108,071 | | | 142,008 | |
Impact of purchase accounting on total revenue | 3,716 |
| | 12,981 |
| | 161,360 |
| | 161,360 |
| | | — |
| Impact of purchase accounting on total revenue | 2,540 | | | 5,930 | | | 3,716 | |
Unrealized foreign currency (gains) losses(1) | 14,367 |
| | (56,368 | ) | | 34,598 |
| | 34,462 |
| | | 136 |
| Unrealized foreign currency (gains) losses(1) | 2,645 | | | (913) | | | 14,367 | |
Acquisition and Sponsor related costs | 20,401 |
| | 23,580 |
| | 97,598 |
| | 44,512 |
| | | 53,086 |
| |
Acquisition and other costs | | Acquisition and other costs | 5,854 | | | 8,544 | | | 20,401 | |
Spin-off exploration costs | | Spin-off exploration costs | 12,227 | | | — | | | — | |
Debt related costs(2) | 81,535 |
| | 19,546 |
| | 23,907 |
| | 23,907 |
| | | — |
| Debt related costs(2) | 364 | | | 385 | | | 81,535 | |
Stock-based compensation expense | 5,833 |
| | 80 |
| | 87,780 |
| | 17 |
| | | 87,763 |
| |
Restructuring costs and other | 2,999 |
| | 2,858 |
| | 4,526 |
| | 2,962 |
| | | 1,564 |
| |
Stock-based compensation expense and related employer-paid payroll taxes | | Stock-based compensation expense and related employer-paid payroll taxes | 76,174 | | | 35,270 | | | 5,833 | |
Restructuring costs | | Restructuring costs | 2,368 | | | 5,598 | | | 2,999 | |
Cyber Incident costs | | Cyber Incident costs | 3,485 | | | — | | | — | |
Adjusted EBITDA | $ | 407,511 |
| | $ | 361,871 |
| | $ | 315,163 |
| | $ | 293,200 |
| | | $ | 21,963 |
| Adjusted EBITDA | $ | 489,716 | | | $ | 453,633 | | | $ | 407,511 | |
Adjusted EBITDA margin | 48.7 | % | | 48.8 | % | | 50.0 | % | | 50.3 | % | | | 46.4 | % | Adjusted EBITDA margin | 47.9 | % | | 48.3 | % | | 48.7 | % |
Our primary source of cash for funding operations and growth has been through cash provided by operating activities. WeGiven the uncertainty in the rapidly changing market and economic conditions related to the COVID-19 pandemic, we continue to evaluate the nature and extent of the impact to our business and financial position. In addition, currently it is not possible to estimate the amount of loss or range of possible loss that might result from adverse judgments, settlements, penalties, or other resolution of the proceedings and investigations resulting from the Cyber Incident. Such potential payments, if great enough, could have an adverse effect on our liquidity. However, despite these uncertainties, we believe that our existing cash and cash equivalents, our cash flows from operating activities and our borrowing capacity under our credit facilities will be sufficient to fund our operations, fund required debt repayments and meet our commitments for capital expenditures for at least the next 12 months.
Although we are not currently a party to any material definitive agreement regarding potential investments in, or acquisitions of, complementary businesses, applications or technologies, we may enter into these types of arrangements, which could reduce our cash and cash equivalents, require us to seek additional equity or debt financing or repatriate cash generated by our international operations that could cause us to incur withholding taxes on any distributions. Additional funds from financing arrangements may not be available on terms favorable to us or at all.
The First Lien Credit Agreement, as amended, provides for a senior secured revolving credit facility in an aggregate principal amount of $125.0 million, or the Revolving Credit Facility, consisting of a $25.0 million U.S. dollar revolving credit facility, or the U.S. Dollar Revolver, and a $100.0 million multicurrency revolving credit facility, or the Multicurrency Revolver. The Revolving Credit Facility includes a $35.0 million sublimit for the issuance of letters of credit. The First Lien Credit Agreement also contains a term loan facility (which we refer to as the First Lien Term Loan, and together with the Revolving Credit Facility, as the First Lien Credit Facilities) in an original aggregate principal amount of $1,990.0 million.
Under the U.S. Dollar Revolver, $7.5 million of commitments will mature on February 5, 2021, and $17.5 million along with all commitments under the Multicurrency Revolver will mature on February 5, 2022. The First Lien Term Loan will mature on February 5, 2024.
The First Lien Term Loan requires equal quarterly repayments equal to 0.25% of the original principal amount.
Our primary source of cash from operating activities is cash collections from our customers. We expect cash inflows from operating activities to be affected by the timing of our sales. Our primary uses of cash from operating activities are for personnel-related expenditures, and other general operating expenses, as well as payments related to taxes, interest and facilities.
Investing cash flows consist primarily of cash used for acquisitions, capital expenditures and intangible assets. Our capital expenditures primarily relate to purchases of leasehold improvements, computers, servers and equipment to support our domestic and international office locations. Purchases of intangible assets consist primarily of capitalized research and development costs.
The following table summarizes our outstanding contractual obligations as of December 31, 20182020 that require us to make future cash payments:
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have material exposure to market risk with respect to our cash and cash equivalents, as these consist primarily of highly liquid investments purchased with original maturities of three months or less at December 31, 2018.2020.
We do not have material exposure to fair value market risk with respect to our total long-term outstanding indebtedness which consists of $2.0$1.9 billion U.S. dollar term loans as of December 31, 2018,2020, not subject to market pricing.
As a global company, we face exposure to adverse movements in foreign currency exchange rates. We primarily conduct business in the following locations: the United States, Europe, Canada, South America and Australia. This exposure is the result of selling in multiple currencies, growth in our international investments, additional headcount in foreign countries and operating in countries where the functional currency is the local currency. Specifically, our results of operations and cash flows are subject to fluctuations in the following currencies: the Euro, British Pound Sterling and Australian Dollar against the United States Dollar, or USD. These exposures may change over time as business practices evolve and economic conditions change.change, including as a result of the impact of the COVID-19 pandemic on the global economy or governmental actions taken in response to the COVID-19 pandemic. Changes in foreign currency exchange rates could have an adverse impact on our financial results and cash flows.
Our consolidated statements of operations are translated into USD at the average exchange rates in each applicable period. Our international revenue, operating expenses and significant balance sheet accounts denominated in currencies other than the USD primarily flow through our United Kingdom and European subsidiaries, which have British Pound Sterling and Euro functional currencies, respectively. This results in a two-step currency exchange process wherein the currencies other than the British Pound Sterling and Euro are first converted into those functional currencies and then translated into USD for our consolidated financial statements. As an example, revenue for sales in Australia is translated from the Australian Dollar to the Euro and then into the USD.
Our statement of operations and balance sheet accounts are also impacted by the re-measurement of non-functional currency transactions such as intercompany loans, cash accounts held by our overseas subsidiaries, accounts receivable denominated in foreign currencies, deferred revenue and accounts payable denominated in foreign currencies. Our foreign currency denominated intercompany loan was established as part of the Take Private to provide a conduit to utilize foreign earnings effectively. The gains (losses) associated with the changes in exchange rates on amounts borrowed are unrealized non-cash events. As of July 1, 2018, the foreign currency denominated intercompany loan is designated as long-term due to a change in our investment strategy and the new Tax Act. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from remeasurement are recognized as a component of accumulated other comprehensive income (loss).
Our foreign currency exposures typically arise from selling annual and multi-year maintenance contracts and subscriptions in multiple currencies, accounts receivable, intercompany transfer pricing arrangements and other intercompany transactions. Our foreign currency management objective is to minimize the effect of fluctuations in foreign exchange rates on selected assets or liabilities without exposing us to additional risk associated with transactions that could be regarded as speculative.
We utilize purchased foreign currency forward contracts to minimize our foreign exchange exposure on certain foreign balance sheet positions denominated in currencies other than the Euro. We do not enter into any derivative financial instruments for trading or speculative purposes. Our objective in managing our exposure to foreign currency exchange rate fluctuations is to reduce the impact of adverse fluctuations in such exchange rates on our earnings and cash flow. The notional amounts and currencies underlying our foreign currency forward contracts will fluctuate period to period as they are principally dependent on the balances of the balance sheet positions that are denominated in currencies other than the Euro held by our global entities. There can be no assurance that our foreign currency hedging activities will substantially offset the impact of fluctuation in currency exchange rates on our results of operations and functional positions. As of December 31, 20182020 and 2017,2019, we did not have any forward contracts outstanding and while we do not have a formal policy to settle all derivatives prior to the end of each quarter, our current practice is to do so. The effect of derivative instruments on our consolidated statements of operations was insignificant for the years ended December 31, 20182020 and 2017.2019.
We are exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments, but we do not expect any counterparties to fail to meet their obligations given their high credit ratings. In addition, we diversify this risk across several counterparties and actively monitor their ratings.
Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. If there is a change in foreign currency exchange rates, the amounts of assets, liabilities, revenue, operating expenses and cash flows that we report in U.S. dollars for foreign subsidiaries that transact in international currencies may be higher or lower to what we would have reported using a constant currency rate. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these
foreign currency denominated transactions results in reduced assets, liabilities, revenue, operating expenses and cash flows for our international operations. Similarly, our assets, liabilities, revenue, operating expenses and cash flows will increase for our international operations if the U.S. dollar weakens against foreign currencies. The conversion of the foreign subsidiaries’ financial statements into U.S. dollars will also lead to remeasurement gains and losses recorded in income, or translation gains or losses that are recorded as a component of accumulated other comprehensive income (loss).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to the Consolidated Financial Statements set forth on pages F-1 through F-44F-46 hereof.
ITEM 9. CHANGES IN DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with our accountants on accounting and financial disclosure matters.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed
ITEM 9B. OTHER INFORMATION
None.
Certain information required by Part III is omitted from this report. We intend to include such information in our definitive proxy statement ("Proxy Statement") related to our 20192021 annual meeting of stockholders pursuant to Regulation 14A under the Exchange Act, which we intend to file with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this report.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Except as set forth below, the information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.
Our board of directors has adopted a code of business conduct and ethics for all employees, including our Chief Executive Officer and President, Chief Financial Officer, and other executive and senior financial officers. The code of business ethics and conduct is available on the investor relations portion of our website at www.solarwinds.com. To the extent and in the manner required by applicable rules of the SEC and NYSE, we intend to disclose any amendments to our code of business conduct and ethics, or waivers of its requirements, on our website or in filings under the Exchange Act. Our website and the contents therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form 10-K:
We estimated the fair value for stock options at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
The impact to our income (loss) before income taxes due to stock-based compensation expense and the related income tax benefits were as follows:
We calculate basic and diluted net income (loss) per share attributable to common stockholders in conformity with the two-class method required for companies with participating securities. Under the two-class method, basic and diluted net income (loss) per share is determined by calculating net income (loss) per share for common stock and participating securities based on participation rights in undistributed earnings. We computed basic net income (loss) per share available to common stockholders by dividing net income (loss) available to common stockholders by the weighted averageweighted-average number of common shares outstanding during the reporting period. Redeemable convertible Class A Common Stock was not included in the basic or diluted net income (loss) per share calculations for the periods it was outstanding as it was contingently convertible upon a future event. Net income (loss) available to common stockholders is defined as net loss,income (loss), less the accretion of dividends on our redeemable convertible Class A Common Stock and earnings allocated to unvested restricted stock plus the gain on conversion of our redeemable convertible Class A Common Stock at our IPO. Our unvested incentive restricted stock has the right to receive non-forfeitable dividends on an equal basis with common stock and therefore are considered participating securities that must be included in the calculation of net income per share using the two-class method.
The holders of unvested incentive restricted stock do not have a contractual obligation to share in our losses. As such, in periods in which we had net losses available to common stockholders, our net losses were not allocated to these participating securities.
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. We consider all highly liquid investments with original maturities of three months or less to be cash equivalents. Our cash and cash equivalents consisted of the following:
Our cash deposited with banks in demand deposit accounts may exceed the amount of insurance provided on these deposits. Our cash equivalents invested in money market funds are not insured and we are therefore at risk of losing our full investment. Generally, we may withdraw our cash deposits and redeem our invested cash equivalents upon demand. We strive to maintain our cash deposits and invest in money market funds with multiple financial institutions of reputable credit and therefore bear minimal credit risk.
We provide credit to distributors, resellers and direct customers in the normal course of business. We generally extend credit to new customers based upon industry reputation and existing customers based upon prior payment history. For the year ended December 31, 2019 a certain distributor represented 12.5% of our revenue. For the years ended December 31, 20182020 and 2017, the period from February 5, 2016 through December 31, 2016 and the period from January 1, 2016 through February 4, 20162018, no distributor, reseller or direct customer represented a significant concentration of our revenue.
The expected amortization expense is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, changes in foreign currency exchange rates, impairment of intangible assets, future changes to expected asset lives of intangible assets and other events. We had $82.8$84.3 million and $83.8$82.4 million of trademarks recorded with an indefinite life that are not amortized at December 31, 20182020 and 2017,2019, respectively. Our indefinite-lived trademarks primarily include the SolarWinds and THWACK trademarks.
The following table summarizes the fair value of our financial assets that were measured on a recurring basis as of December 31, 20182020 and 2017.2019. There have been no transfers between fair value measurement levels during the year ended December 31, 2018.2020.
8. Accrued Liabilities and Other
In March 2018, we entered into Amendment No. 4 to the Initial First Lien Credit Agreement, or Amendment No. 4, which replaced the outstanding borrowings with a new $1.99 billion U.S. dollar term loan, or First Lien Term Loan. The Initial First Lien Credit Agreement, as amended, by Amendment No. 1, Amendment No. 2, Amendment No. 3 and Amendment No. 4 is referred to here as the First Lien Credit Agreement. The proceeds of the First Lien Term Loan were used to repay all outstanding borrowings including accrued interest under the 2017 Refinancingthen outstanding First Lien Term Loan and a portion of the Second Lien Notes (as defined below), including accrued interest and related transaction costs. In connection with Amendment No. 4, a loss on debt extinguishment of $21.4 million was recorded to other income (expense) in the consolidated statement of operations for the year ended December 31, 2018.
The First Lien Credit Agreement provides for senior secured first lien credit facilities, consisting of the following as of December 31, 2018 of:2020:
The Eurodollar rate is equal to an adjusted London Interbank Offered Rate, or LIBOR, for a one-, two-, three- or six-month interest period with a LIBOR floor of 0%. The base rate for any day is a fluctuating rate per annum equal to the highest of (a) the rate of interest in effect for such day as publicly announced by Credit Suisse as its “prime rate” and (b) the federal funds effective rate in effect on such day plus 0.50% and (c) the one-month adjusted LIBOR plus 1.0% per annum.
The First Lien Term Loan requires equal quarterly repayments equal to 0.25% of the original principal amount.
In addition to paying interest on loans outstanding under the Revolving Credit Facility and the First Lien Term Loan, we are required to pay a commitment fee of 0.50% per annum of unused commitments under the Revolving Credit Facility. The commitment fee is subject to a reduction to 0.375% per annum based on our first lien net leverage ratio.
The First Lien Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to: incur additional indebtedness; incur liens; engage in mergers, consolidations, liquidations or dissolutions; pay dividends and distributions on, or redeem, repurchase or retire our capital stock; and make certain investments, acquisitions, loans, or advances. In addition, the terms of the First Lien Credit Agreement include a financial covenant which requires that, at the end of each fiscal quarter, if the aggregate amount of borrowings under the Revolving Credit Facility exceeds 35% of the aggregate commitments under the Revolving Credit Facility, our first lien net leverage ratio cannot exceed 7.40 to 1.00. The First Lien Credit Agreement also contains certain customary representations and warranties, affirmative covenants and events of default. As of December 31, 2018,2020, we were in compliance with all covenants of the First Lien Credit Agreement.
The following table summarizes the future minimum principal payments under the First Lien Term Loan outstanding as of December 31, 2018:2020:
In February 2016, in connection with the Take Private, we issued senior secured second lien floating rate notes, or the Second Lien Notes, with approximately $580.0 million aggregate principal amount due in February 2024. In May 2016, we entered into
Amendment No.1 to the Second Lien Notes and issued an additional $100.0 million to finance a portion of the acquisition of LOGICnow.an acquisition. The Second Lien Notes bore interest at a rate per annum, reset quarterly, equal to a three-month Adjusted LIBOR Rate, with a “floor” of 1.0%, plus 8.75%.
In March 2018, we terminated the agreements governing our Second Lien Notes and repaid or exchanged the then-outstanding principal on our Second Lien Notes of $680.0 million and replaced the Second Lien Notes with a new second lien credit agreement, or the Second Lien Credit Agreement, with Wilmington Trust, National Association or Wilmington Trust, as administrative agent and collateral agent, and certain other financial institutions. The Second Lien Credit Agreement provided for a $315.0 million U.S. dollar term loan, or the Second Lien Term Loan, with a final maturity of February 5, 2025 and did not require periodic principal payments. In connection with the redemption and exchange of our Second Lien Notes, a loss on debt
extinguishment of $39.2 million, which includes a $22.7 million redemption premium, was recorded to other income (expense) in the consolidated statement of operations for the year ended December 31, 2018.
In October 2018, we completed our IPO and used a portion of the net proceeds from the offering to repay the $315.0 million in borrowings outstanding under our Second Lien Term Loan. In connection with the repayment of our Second Lien Term Loan, a loss on debt extinguishment of $19.5 million, which includes a $14.2 million prepayment fee, was recorded to other income (expense) in the consolidated statement of operations for the year ended December 31, 2018.
In October 2018, we amended our certificate of incorporation to modify the conversion price of the Class A Common Stock from the initial public offering price per share to a stated conversion price of $19.00 per share. Therefore, immediately prior to the completion of our IPO, we converted each outstanding share of our Class A Common Stock into 140,053,370 shares of common stock equal to the result of the liquidation value of such share of Class A Common Stock, divided by $19.00 per share. The liquidation value for each share of Class A Common Stock was equal to $1,000. At the time of the conversion of the Class A Common Stock, we also converted $717.4 million of accrued and unpaid dividends on the Class A Common Stock into 37,758,109 shares of common stock equal to the result of the accrued and unpaid dividends on each share of Class A Common Stock, divided by $19.00 per share. Upon the modification and conversion of the Class A Common Stock into common stock, we recognized a $711.2 million gain related to the difference between the fair value of the consideration transferred to the Class A Common Stock shareholdersstockholders and the carrying value of the Class A Common Stock. The gain on conversion of Class A Common Stock was recorded in accumulated deficit and included in net income (loss) available to common shareholdersstockholders in the computation of net income (loss) per share.share for the year ended December 31, 2018.
The board of directors adopted, and the stockholders approved, the SolarWinds Corporation Equity Plan, or 2016 Plan, in June 2016. Under the 2016 Plan, the Company was able to sell or grant shares of Class A Common Stock and Class B Common Stock and common stock-based awards, including nonqualified stock options, to the Company’s employees, consultants, directors, managers and advisors. Our ability to grant any future equity awards under the 2016 Plan terminated in October 2018 following the consummation of our IPO. Our 2016 Plan will continue to govern the terms and conditions of all outstanding equity awards granted under the 2016 Plan.
lesser of (i) the price the stockholder paid for those shares and (ii) the fair market value of those shares. The repurchase price for any vested shares will beis equal to the fair market value of those shares unless the stockholder was terminated for cause or the stockholder violated any restrictive covenants in its agreements with the Company. If a stockholder is terminated for cause or violates any restrictive covenants, the repurchase price for the stockholder’s vested shares will beis the same as for unvested shares.
We have granted employees restricted stock and options at exercise prices equal to the fair value of the underlying common stock at the time of grant, as determined by our board of directors on a contemporaneous basis. As of December 31, 2018,2020, common stock-based incentive awards of 8,115,3342,528,060 were outstanding under the 2016 Plan consisting of 3,129,9001,259,835 stock options and 4,985,4341,268,225 shares of restricted common stock. For the years ended December 31, 20182020, 2019 and 2017, and for the period of February 5, 2016 to December 31, 2016,2018, the Company repurchased 272,133, 640,454105,100, 407,200 and 14,000272,133 shares, respectively, of vested and unvested restricted common stock upon employee terminations.
In October 2018, the board of directors adopted, and the stockholders approved, the SolarWinds Corporation 2018 Equity Incentive Plan, or 2018 Plan. Under the 2018 Plan, the Company is able to sell or grant shares of common stock-based awards, including nonstatutory stock options or incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance stock units and other cash-based or stock-based awards, to the Company’s employees, contractors, consultants, directors, managers and advisors. The term of a stock option and stock appreciation right granted under our 2018 Plan may not exceed ten years. We reserved 30,000,000 shares of our common stock for issuance under the 2018 Plan. As of December 31, 2018,2020, stock-based incentive awards of 7,248,3889,900,827 were outstanding under the 2018 Plan, consisting of 6,277,4669,594,804 restricted stock units, or RSUs, and 970,922306,023 performance stock units, or PSUs, at the target award amount and 22,751,61232,488,980 shares were reserved for future grants.
Additional information regarding options follows (in thousands except for per share amounts):
The unrecognized stock-based compensation expense related to unvested stock options and subject to recognition in future periods was approximately $2.2$0.7 million as of December 31, 2018.2020. We expect to recognize this expense over weighted average periods of approximately 3.31.2 years at December 31, 2018.2020.
The following table summarizes information about restricted stock activity subject to vesting under the 2016 Plan:
Restricted stock is subject to certain restrictions, such as vesting and a repurchase right. The common stock acquired by the employee is restricted stock because vesting is conditioned upon (i) continued employment through the applicable vesting date and (ii) for employees at the level of group vice president and above, the achievement of certain financial performance targets
determined by the board of directors. The restricted stock is subject to repurchase in the event the stockholder ceases to be employed or engaged (as applicable) by the Company for any reason or in the event of a change of control or due to certain
regulatory burdens. As the restricted stock is purchased at fair market value at the time of grant, there is no0 stock-based compensation expense recognized related to these awards.awards prior to the 2020 Performance Modification. The related liability for unvested shares is included in other long-term liabilities on the consolidated balance sheet and was $2.9$1.0 million and $1.7$1.9 million as of December 31, 20182020 and 2017,2019, respectively.
The following table summarizes information about restricted stock unit activity under the 2018 Plan:Plan and other awards granted outside of a plan:
The following table summarizes information about performance stock unit activity under the 2018 Plan:
In October 2018, our board of directors adopted and our stockholders approved our 2018 Employee Stock Purchase Plan, or the ESPP. We reserved a total of 3,750,000 shares of our common stock are available for sale under our ESPP.
Our ESPP permits eligible participants to purchase common stock through payroll deductions of up to 20% of their eligible compensation during the offering period. The ESPP will typically be implemented through consecutive six-month offering periods. Amounts deducted and accumulated from participant compensation, or otherwise funded in any participating non-U.S. jurisdiction in which payroll deductions are not permitted, are used to purchase shares of our common stock at the end of each offering period. The purchase price of the shares will be 85% of the lesser of the fair market value of our common stock on the first day of the offering period and the fair market value on the last day of the offering period. No participant may purchase more than $25,000 worth of common stock per calendar year.
The following weighted-average outstanding shares of common stock equivalents were excluded from the computation of the diluted net income (loss) per share attributable to common stockholders for the periods presented because their effect would have been anti-dilutive or for which the performance condition had not been met at the end of the period:
The calculation of diluted earnings per share requires us to make certain assumptions related to the use of proceeds that would be received upon the assumed exercise of stock options, or purchase of restricted stock.stock or proceeds from the employee stock purchase plan.
13. Employee Benefit Plans
We maintain a 401(k) matching program for all eligible employees. We, as sponsor of the plan, use an independent third party to provide administrative services to the plan. We have the right to terminate the plan at any time. Employees are fully vested in all contributions to the plan. Our expense related to the plan was as follows:
Management Fee Agreement with Silver Lake Management, Thoma Bravo and TB Partners
On February 5, 2016, we entered into a Management Fee Agreement with Silver Lake Management Company IV, L.L.C. (Silver Lake Management), Thoma Bravo, LLC (Thoma Bravo) and Thoma Bravo Partners XI, L.P. (TB Partners and, collectively with Silver Lake Management and Thoma Bravo, the Managers), pursuant to which the Managers provided business and organizational strategy and financial and advisory services. Under the Management Fee Agreement, we paid to the Managers quarterly payments of $2.5 million in the aggregate, plus fees for certain corporate transactions in the Managers’ discretion. Each payment of fees under the Management Fee Agreement was allocated among the Managers as follows: 50% to Silver Lake Management, 40.73% to Thoma Bravo and 9.27% to TB Partners. We also reimbursed each of the Managers for all out-of-pocket costs incurred in connection with activities under the Management Fee Agreement, and we indemnified the Managers and their respective related parties from and against all losses, claims, damages and liabilities related to the performance of the Managers obligations under the Management Fee Agreement. The Management Fee Agreement terminated upon the consummation of the IPO in October 2018 and no future payments are required.
15. Income Taxes
U.S. and international components of lossincome (loss) before income taxes were as follows:
The difference between the income tax expense (benefit) derived by applying the federal statutory income tax rate to our income (loss) before income taxes and the amount recognized in our consolidated financial statements is as follows:
During 2018, we completed our accounting for the income tax effects of the Tax Act. Upon further analysis of the Tax Act, additional guidance issued by the U.S. Treasury Department, state taxing authorities, and other standard-setting bodies, we finalized our calculation of the transition tax during the year ended December 31, 2018. We recognized an additional expense of $0.1 million to the provisional amounts noted aboverecognized during the year ended December 31, 2017 and included these adjustments as a component of income tax expense from continuing operations. We reduced our liability related to the transition tax by $9.6 million. The final transition tax liability of $111.2 million will be paid over eight years.
The components of the net deferred tax amounts recognized in the accompanying consolidated balance sheets were:
We establish valuation allowances when necessary to reduce deferred tax assets to amounts expected to be realized. As of December 31, 20182020 and 2017,2019, we have recorded a valuation allowance of $1.8$14.5 million and $1.8$9.9 million, respectively. The valuation allowance is all related to the deferred tax assets of the entities acquired in the Samanage acquisition and a Canadian subsidiary.
The Tax Act imposes a mandatory transition tax on accumulated foreign earnings as of December 31, 2017. Effective January 1, 2018, the Tax Act creates a new territorial tax system in which we will recognize the tax impact of including certain
foreign earnings in U.S. taxable income as a period cost. For the year ended December 31, 2018,2020, we do not anticipate incurring a global intangible low-taxed income, or GILTI, liability; however, to the extent that we incur expense under the GILTI provisions, we will treat it as a component of income tax expense in the period incurred. AlthoughAs a result of the Tax Act, our accumulated foreign earnings have been subject
Gross unrecognized tax benefits, all of which, if recognized, would affect our effective tax rate were as follows:
The aggregate changes in the balance of our gross unrecognized tax benefits, excluding accrued interest and penalties, were as follows:
We do not believe that it is reasonably possible that our unrecognized tax benefits will significantly change in the next twelve months.
We file U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2011 through 20172019 tax years generally remain open and subject to examination by federal tax authorities. The 2011 through 20172019 tax years generally remain open and subject to examination by the state tax authorities and foreign tax authorities. We are currently under examination by the IRS for the tax years 2011 through the period ending February 2016. In December 2020, we received a settlement offer from the IRS for the years 2011 and 2012 which we accepted and recorded the impacts in our consolidated financial statements for the year ended December 31, 2020. We are under audit by the Indian Tax Authority for the 2014 and 2017 tax years. We are currently under audit by the California Franchise Tax Board for the 2012 through 2014 tax years. We were notified in January 2019 thatare currently under audit by the Massachusetts Department of Revenue would auditfor the 2015 through February 2016 tax years. We were notified in December 2017 that the Swiss Tax Authorities would audit the 2014 through 2016 tax years. This audit concluded in April 2018 with no adjustments. We are not currently under audit in any other taxing jurisdictions.
We operate as a single segment. Our chief operating decision-maker, or CODM, is considered to be our Chief Executive Officer. The chief operating decision-maker allocates resources and assesses performance of the business at the consolidated level.
The authoritative guidance for disclosures about segments of an enterprise establishes standards for reporting information about operating segments. It defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. Our Chief Executive Officer manages the business as a multi-product business that utilizes its model to deliver software products to customers regardless of their geography or IT environment. Operating results including new license and subscription sales, maintenance renewals and discrete financial information and profitability metrics are reviewed at the consolidated entity level for purposes of making resource allocation decisions and for evaluating financial performance. Accordingly, we considered ourselves to be in a single operating and reporting segment structure.
We based revenue by geography on the shipping address of each customer. Other than the United States, no single country accounted for 10% or more of our total revenues during these periods. The following tables set forth revenue and net long-lived assets by geographic area:
18. Quarterly Results of Operations
The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the quarters indicated. The information for each quarter has been prepared on a basis consistent with our audited consolidated financial statements included in this Annual Report on Form 10-K, and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair statement of the financial information contained in those statements. Our historical results are not necessarily indicative of the results that may be expected in the future. The following quarterly
financial data should be read in conjunction with our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.