Edgar Filing: ServiceNow, Inc.

NOW-2014.9.30-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



x	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014



¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 001-35580

SERVICENOW, INC.

(Exact name of registrant as specified in its charter)



Delaware		20-2056195
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

ServiceNow, Inc.

3260 Jay Street

Santa Clara, California 95054

(408) 501-8550

(Registrant's telephone number, including area code)

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer x	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

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

As of October 31, 2014, there were approximately 148.3 million shares of the Registrant’s Common Stock outstanding.

TABLE OF CONTENTS



		Page
	PART I
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of September 30, 2014 (Unaudited) and December 31, 2013	1
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2014 and 2013 (Unaudited)	2
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (Unaudited)	3
	Notes to Condensed Consolidated Financial Statements (Unaudited)	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	28

	PART II
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 3.	Defaults upon Senior Securities	46
Item 4.	Mine Safety Disclosures	46
Item 5.	Other Information	46
Item 6.	Exhibits	46
	Signatures

PART I

ITEM 1. FINANCIAL STATEMENTS

SERVICENOW, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



	September 30, 2014			December 31, 2013
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	235,086		$	366,303
Short-term investments	410,986			268,251
Accounts receivable, net	111,164			108,339
Current portion of deferred commissions	36,376			31,123
Prepaid expenses and other current assets	27,787			23,733
Total current assets	821,399			797,749
Deferred commissions, less current portion	25,319			21,318
Long-term investments	238,051			255,356
Property and equipment, net	96,977			75,560
Intangible assets, net	58,304			5,796
Goodwill	58,344			8,724
Other assets	6,218			3,973
Total assets	$	1,304,612		$	1,168,476
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	11,416		$	7,405
Accrued expenses and other current liabilities	69,410			68,130
Current portion of deferred revenue	338,451			252,553
Total current liabilities	419,277			328,088
Deferred revenue, less current portion	12,344			14,169
Convertible senior notes, net	436,332			414,777
Other long-term liabilities	19,244			17,183
Total liabilities	887,197			774,217
Stockholders’ equity:
Common stock	148			140
Additional paid-in capital	737,509			573,791
Accumulated other comprehensive loss	(6,322		)	(476		)
Accumulated deficit	(313,920		)	(179,196		)
Total stockholders’ equity	417,415			394,259
Total liabilities and stockholders’ equity	$	1,304,612		$	1,168,476

See accompanying notes to condensed consolidated financial statements

SERVICENOW, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

(in thousands, except share and per share data)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Revenues:
Subscription	$	150,367		$	92,992		$	400,466		$	244,926
Professional services and other	28,345			18,267			84,093			54,494
Total revenues	178,712			111,259			484,559			299,420
Cost of revenues⁽¹⁾:
Subscription	37,925			23,429			102,357			61,960
Professional services and other	28,161			18,146			75,781			47,921
Total cost of revenues	66,086			41,575			178,138			109,881
Gross profit	112,626			69,684			306,421			189,539
Operating expenses⁽¹⁾:
Sales and marketing	84,002			47,336			245,355			137,853
Research and development	39,683			20,819			106,232			54,809
General and administrative	23,440			16,179			69,985			43,783
Total operating expenses	147,125			84,334			421,572			236,445
Loss from operations	(34,499		)	(14,650		)	(115,151		)	(46,906		)
Interest and other income (expense), net	(5,949		)	600			(17,143		)	(604		)
Loss before provision for income taxes	(40,448		)	(14,050		)	(132,294		)	(47,510		)
Provision for income taxes	602			663			2,430			1,966
Net loss	$	(41,050	)	$	(14,713	)	$	(134,724	)	$	(49,476	)
Net loss per share - basic and diluted	$	(0.28	)	$	(0.11	)	$	(0.93	)	$	(0.37	)
Weighted-average shares used to compute net loss per share - basic and diluted	146,335,519			137,456,531			144,239,844			134,036,466
Other comprehensive income (loss):
Foreign currency translation adjustments	$	(6,710	)	$	758		$	(6,024	)	$	(608	)
Unrealized gain (loss) on investments	(212		)	412			178			(18		)
Other comprehensive income (loss), net of tax	(6,922		)	1,170			(5,846		)	(626		)
Comprehensive loss	$	(47,972	)	$	(13,543	)	$	(140,570	)	$	(50,102	)


(1)	Includes stock-based compensation as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
Cost of revenues:
Subscription	$	3,995	$	2,190	$	10,896	$	5,980
Professional services and other	3,572		1,209		9,188		3,095
Sales and marketing	14,956		5,945		36,382		14,752
Research and development	11,682		4,176		29,973		11,005
General and administrative	7,285		4,331		21,884		9,893

See accompanying notes to condensed consolidated financial statements

Table of Contents

SERVICENOW, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



	Nine Months Ended September 30,
	2014			2013
Cash flows from operating activities:
Net loss	$	(134,724	)	$	(49,476	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	28,734			16,316
Amortization of premiums on investments	6,044			3,441
Amortization of deferred commissions	36,398			19,825
Amortization of debt discount and issuance costs	21,608			—
Stock-based compensation	108,323			44,725
Tax benefit from exercise of stock options	(1,190		)	(1,817		)
Other	(1,973		)	1,236
Changes in operating assets and liabilities:
Accounts receivable	(6,935		)	(6,988		)
Deferred commissions	(47,115		)	(34,894		)
Prepaid expenses and other assets	(2,386		)	1,077
Accounts payable	3,892			(408		)
Deferred revenue	92,351			54,332
Accrued expenses and other liabilities	(11,751		)	(1,890		)
Net cash provided by operating activities	91,276			45,479
Cash flows from investing activities:
Purchases of property and equipment	(45,499		)	(39,059		)
Acquisition, net of cash acquired	(99,813		)	(13,330		)
Purchases of investments	(360,783		)	(233,444		)
Sale of investments	97,807			50,403
Maturities of investments	134,618			142,456
Restricted cash	(55		)	(174		)
Net cash used in investing activities	(273,725		)	(93,148		)
Cash flows from financing activities:
Offering costs paid in connection with follow-on offering	—			(698		)
Proceeds from employee stock plans	53,904			47,833
Tax benefit from exercise of stock options	1,190			1,817
Net cash provided by financing activities	55,094			48,952
Foreign currency effect on cash and cash equivalents	(3,862		)	822
Net increase (decrease) in cash and cash equivalents	(131,217		)	2,105
Cash and cash equivalents at beginning of period	366,303			118,989
Cash and cash equivalents at end of period	$	235,086		$	121,094
Supplemental disclosures of non-cash investing activities:
Property and equipment included in accounts payable and accrued expenses	$	6,220		$	5,360

See accompanying notes to condensed consolidated financial statements

SERVICENOW, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Unless the context requires otherwise, references in this report to “ServiceNow,” “we,” “us,” and “our” refer to ServiceNow, Inc. and its consolidated subsidiaries.

(1) Description of the Business

ServiceNow is a leading provider of cloud-based services to automate and manage IT service relationships across the global enterprise. Our services include a suite of IT service automation applications built on our proprietary platform that can be rapidly deployed and configured. Customers use our services to create a single system of record for enterprise IT, automate manual tasks, standardize processes and consolidate legacy systems. Using ServiceNow, enterprise IT departments can accelerate their shift from the management of IT infrastructure to the management of IT service relationships across the enterprise with greater transparency, accountability and auditability. Our proprietary platform enables our customers to create custom applications and evolve the IT service model to service domains inside and outside the enterprise.

(2) Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and condensed footnotes have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for fair financial statement presentation have been included. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the year ended December 31, 2014 or for other interim periods or for future years. The condensed consolidated balance sheet as of December 31, 2013 is derived from audited financial statements as of that date, however, does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission on February 28, 2014.

Principles of Consolidation

The condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, or GAAP, and include our accounts and the accounts of our wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated upon consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Concentration of Credit Risk and Significant Customers

Financial instruments potentially exposing us to credit risk consist primarily of cash equivalents, investments and accounts receivable. We maintain cash, cash equivalents and investments at financial institutions that management believes to have good credit ratings and represent minimal risk of loss of principal. We invest in securities issued by financial-sector firms with a minimum rating of A by Standard & Poor's and A2 by Moody's and securities issued by non-financial sector firms with a minimum rating of BBB by Standard & Poor's and Baa1 by Moody's.

Credit risk arising from accounts receivable is mitigated due to our large number of customers and their dispersion across various industries and geographies. As of September 30, 2014 and December 31, 2013, there were no customers that represented more than 10% of our accounts receivable balance. During the three and nine months ended September 30, 2014 and 2013, there were no customers that individually exceeded 10% of our total revenues.

We review the composition of the accounts receivable balance, historical write-off experience and the potential risk of loss associated with delinquent accounts to determine if an allowance for doubtful accounts is necessary. Individual accounts receivable are written off when we become aware of a specific customer’s inability to meet its financial obligation and all collection efforts are exhausted. As of September 30, 2014 and December 31, 2013, the allowance for doubtful accounts was $1.0 million and $1.1 million, respectively.

Warranties and Indemnification

Our cloud-based service to automate enterprise IT operations is typically warranted to perform in material conformance with specifications.

We include service level commitments to our customers that permit those customers to receive credits in the event we fail to meet those levels. We establish an accrual based on historical credits paid and an evaluation of the performance of our services, including an assessment of the impact of any known service disruptions. Service level credit accrual charges are recorded against revenue. As of September 30, 2014 and December 31, 2013, the service level credit accrual was $1.1 million and $0.6 million, respectively.

We have also agreed to indemnify our directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by us, arising out of that person’s services as a director or officer of our company or that person’s services provided to any other company or enterprise at our request. We maintain director and officer insurance coverage that may enable us to recover a portion of any future amounts paid.

Our contractual arrangements include provisions defending customers against intellectual property and other third-party claims. We have not incurred any costs as a result of such indemnification obligations and have not recorded any liabilities related to such obligations in the condensed consolidated financial statements.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board, or FASB, issued an update to ASC 606 Revenue from Contracts with Customers, or ASC 606, that will supersede virtually all existing revenue guidance. Under this update, an entity is required to recognize revenue upon transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. As such, an entity will need to use more judgment and make more estimates than under the current guidance. This update should be applied retrospectively either to each prior reporting period presented in the financial statements, or only to the most current reporting period presented in the financial statements with a cumulative effect adjustment recorded in the retained earnings. This guidance will become effective for us for our interim and annual reporting periods beginning January 1, 2017. We are currently evaluating the impact of this update on our consolidated financial statements.

In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The adoption of this standard is not expected to have a material impact on our financial statements.

(3) Investments

The following is a summary of our investments (in thousands):



	September 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Commercial paper	$	20,487	$	2	$	(1	)	$	20,488
Corporate notes and bonds	548,448		220		(298		)	548,370
Certificates of deposit	20,102		3		(6		)	20,099
U.S. government agency securities	60,064		20		(4		)	60,080
Total available-for-sale securities	$	649,101	$	245	$	(309	)	$	649,037



	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Commercial paper	$	124,330	$	10	$	(21	)	$	124,319
Corporate notes and bonds	399,519		129		(360		)	399,288
Total available-for-sale securities	$	523,849	$	139	$	(381	)	$	523,607

As of September 30, 2014, the contractual maturities of our investments did not exceed 24 months. The fair values of available-for-sale investments, by contractual maturity, are as follows (in thousands):



	September 30, 2014
Due in 1 year or less	$	410,986
Due in 1 year through 2 years	238,051
Total	$	649,037

We had certain available-for-sale securities in a gross unrealized loss position, all of which had been in such position for less than 12 months. There were no impairments considered "other-than-temporary" as it is more likely than not we will hold the securities until maturity or a recovery of the cost basis. The following table shows the fair values and the gross unrealized losses of these available-for-sale securities aggregated by investment types (in thousands):



	September 30, 2014					December 31, 2013
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Commercial paper	$	5,992	$	(1	)	$	81,467	$	(21	)
Corporate notes and bonds	265,948		(298		)	293,642		(360		)
Certificates of deposit	9,195		(6		)	—		—
U.S. government agency securities	20,028		(4		)	—		—
Total	$	301,163	$	(309	)	$	375,109	$	(381	)

(4) Fair Value Measurements

The following table presents our fair value hierarchy for our assets and liabilities measured at fair value on a recurring basis at September 30, 2014 (in thousands):



	Level 1		Level 2		Total
Cash and cash equivalents:
Cash	$	110,110	$	—	$	110,110
Money market funds	81,141		—		81,141
Commercial paper	—		43,835		43,835
Short-term investments:
Commercial paper	—		20,488		20,488
Corporate notes and bonds	—		359,875		359,875
Certificates of deposit	—		16,604		16,604
U.S. government agency securities	—		14,019		14,019
Long-term investments:
Corporate notes and bonds	—		188,495		188,495
Certificates of deposit	—		3,495		3,495
U.S. government agency securities	—		46,061		46,061
Total	$	191,251	$	692,872	$	884,123

The following table presents our fair value hierarchy for our assets and liabilities measured at fair value on a recurring basis at December 31, 2013 (in thousands):



	Level 1		Level 2		Total
Cash and cash equivalents:
Cash	$	69,333	$	—	$	69,333
Money market funds	35,248		—		35,248
Commercial paper	—		261,722		261,722
Short-term investments:
Commercial paper	—		124,319		124,319
Corporate notes and bonds	—		143,932		143,932
Long-term investments:
Corporate notes and bonds	—		255,356		255,356
Total	$	104,581	$	785,329	$	889,910

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

(5) Acquisition

On July 11, 2014, we completed the acquisition of a privately-held company, Neebula Systems Ltd., or Neebula, by acquiring all issued and outstanding common shares of Neebula for approximately $100 million in an all-cash transaction. Neebula’s flagship product, ServiceWatch, automates the discovery, mapping and monitoring of IT-enabled enterprise services. The acquisition will expand the overall capabilities of our IT offerings. The following table summarizes the preliminary allocation of the purchase price to the fair value of the tangible and intangible assets acquired and liabilities assumed as of the acquisition date:



	Purchase Price Allocation (in thousands)			Useful Life (in years)
Net tangible asset acquired	$	102
Intangible assets:
Developed technology	56,200			5.5
Order backlog	600			1.5
Trade names	300			1.5
Goodwill	53,958
Deferred tax liabilities, net ⁽¹⁾	(10,697		)
Total purchase price	$	100,463

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

The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. We believe the goodwill represents the synergies expected from expanded market opportunities when integrating Neebula technologies with our offerings. The goodwill balance is not deductible for U.S. income tax purposes. Acquisition-related costs of $1.2 million are primarily included in general and administrative expenses.

The results of operations of Neebula have been included in our consolidated financial statements from the date of purchase. The following pro forma consolidated financial information combines the unaudited results of operations for us and Neebula for the three and nine months ended September 30, 2014 and 2013, as if the acquisition of Neebula had occurred on January 1, 2013 (in thousands, except share and per share data):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Revenue	$	178,736		$	111,512		$	485,422		$	299,855
Net loss	(44,565		)	(18,368		)	(139,685		)	(61,721		)
Weighted-average shares used to compute net loss per share attributable to common stockholders - basic and diluted	146,335,519			137,456,531			144,239,844			134,036,466
Net loss per share attributable to common stockholders - basic and diluted	(0.30		)	(0.13		)	(0.97		)	(0.46		)

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

(6) Goodwill and Intangible Assets

Goodwill balances are presented below (in thousands):



	Carrying Amount
Balance as of December 31, 2013	$	8,724
Goodwill acquired	53,958
Foreign currency translation adjustments	(4,338		)
Balance as of September 30, 2014	$	58,344

Intangible assets consist of the following (in thousands):



	September 30, 2014
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Developed technology	$	60,650	$	(3,962	)	$	56,688
Backlog	593		(87		)	506
Other acquisition-related intangible assets	614		(309		)	305
Acquisition-related intangible assets	61,857		(4,358		)	57,499
Other intangible assets	1,075		(270		)	805
Total intangible assets	$	62,932	$	(4,628	)	$	58,304



	December 31, 2013
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Developed technology	$	5,783	$	(723	)	$	5,060
Other acquisition-related intangible assets	348		(115		)	233
Acquisition-related intangible assets	6,131		(838		)	5,293
Other intangible assets	650		(147		)	503
Total intangible assets	$	6,781	$	(985	)	$	5,796

Amortization expense for intangible assets for the three months ended September 30, 2014 and 2013 was approximately $2.8 million and $0.4 million, respectively, and for the nine months ended September 30, 2014 and 2013 was approximately $3.7 million and $0.5 million, respectively.

(7) Property and Equipment

Property and equipment, net consists of the following (in thousands):



	September 30,			December 31,
	2014			2013
Computer equipment and software	$	122,398		$	90,617
Furniture and fixtures	15,672			13,751
Leasehold improvements	13,978			8,371
Construction in progress	4,609			928
	156,657			113,667
Less: Accumulated depreciation	(59,680		)	(38,107		)
Total property and equipment, net	$	96,977		$	75,560

Construction in progress consists primarily of in-process software development costs and leasehold improvements. Depreciation expense for the three months ended September 30, 2014 and 2013 was $9.3 million and $6.2 million, respectively, and for the nine months ended September 30, 2014 and 2013 was $25.0 million and $15.8 million, respectively.

(8) Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following (in thousands):



	September 30,		December 31,
	2014		2013
Taxes payable	$	3,697	$	4,187
Bonuses and commissions	23,517		22,322
Accrued compensation	14,325		16,610
Other employee expenses	10,543		11,926
Other	17,328		13,085
Total accrued expenses and other current liabilities	$	69,410	$	68,130

(9) Convertible Senior Notes

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

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

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

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

•

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


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


•	upon the occurrence of specified corporate events.

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

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

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

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



	September 30, 2014			December 31, 2013
Liability:
Principal	$	575,000		$	575,000
Less: debt discount, net of amortization	(138,668		)	(160,223		)
Net carrying amount	$	436,332		$	414,777

We consider the fair value of the Notes at September 30, 2014 and December 31, 2013 to be a Level 2 measurement. The fair value of the Notes is primarily affected by the trading price of our common stock and interest rate. Based on the closing price of our common stock of $58.78 and $56.01 on September 30, 2014 and December 31, 2013, respectively, the if-converted value of the Notes was less than its principal amount.

As of September 30, 2014, the remaining life of the Notes is 49 months. The following table sets forth total interest expense recognized related to the Notes (in thousands):



	Three months ended September 30, 2014		Nine months ended September 30, 2014
Amortization of debt issuance cost	$	393	$	1,158
Amortization of debt discount	6,932		20,450
Total	$	7,325	$	21,608
Effective interest rate of the liability component	6.5%

No interest expense related to the Notes was recognized for the three and nine months ended September 30, 2013.

Note Hedge

To minimize the impact of potential economic dilution upon conversion of the Notes, we entered into convertible note hedge transactions (the "Note Hedge") with respect to our common stock concurrent with the issuance of the Notes. The Note Hedge covers approximately 7.8 million shares of our common stock at a strike price per share that corresponds to the initial conversion price of the Notes, subject to adjustment, and is exercisable upon conversion of the Notes. We paid an aggregate amount of $135.8 million for the Note Hedge. The Note Hedge will expire upon maturity of the Notes. The Note Hedge is intended to reduce the

potential economic dilution upon conversion of the Notes in the event that the fair value per share of our common stock at the time of exercise is greater than the conversion price of the Notes. The Note Hedge is a separate transaction and is not part of the terms of the Notes. The Note Hedge does not impact earnings per share, as it was entered into to offset any dilution from the Notes.

Warrants

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

(10) Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss, net of tax, consist of the following (in thousands):



	September 30,			December 31,
	2014			2013
Foreign currency translation adjustment	$	(6,258	)	$	(234	)
Net unrealized loss on investments	(64		)	(242		)
Accumulated other comprehensive loss, net of tax	$	(6,322	)	$	(476	)

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

(11) Stockholders' Equity

We were authorized to issue 600,000,000 shares of common stock as of September 30, 2014. Holders of our common stock are not entitled to receive dividends unless declared by our board of directors. As of September 30, 2014, we had 147,433,125 shares of common stock outstanding and had reserved shares of common stock for future issuance as follows:



	September 30, 2014
Stock option plans:
Options outstanding	17,824,088
RSUs	9,410,497
Stock awards available for future grants:
2005 Stock Option Plan⁽¹⁾	—
2012 Equity Incentive Plan⁽¹⁾	15,124,772
2012 Employee Stock Purchase Plan⁽¹⁾	6,529,516
Total reserved shares of common stock for future issuance	48,888,873


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

During the nine months ended September 30, 2014 and 2013, we issued a total of 7,078,520 shares and 12,369,068 shares, respectively, from stock option exercises, vesting of restricted stock units, or RSUs, and purchases from the employee stock purchase plan, or ESPP.

(12) Stock Awards

We have a 2005 Stock Option Plan, or 2005 Plan, which provides for grants of stock awards, including options to purchase shares of common stock, stock purchase rights and RSUs to certain employees, officers, directors and consultants.

Our 2012 Equity Incentive Plan, or 2012 Plan, provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, RSUs, performance-based stock awards and other forms of equity compensation, or collectively, stock

awards. In addition, the 2012 Plan provides for the grant of performance cash awards. Incentive stock options may be granted only to employees. All other awards may be granted to employees, including officers, as well as directors and consultants. The share reserve may increase to the extent outstanding stock options under the 2005 Plan expire or terminate unexercised. The share reserve also automatically increases on January 1 of each year until January 1, 2022, by up to 5% of the total number of shares of common stock outstanding on December 31 of the preceding year as determined by the board of directors. On January 1, 2014, 7,017,730 shares of common stock were automatically added to the 2012 Plan pursuant to the provision described in the preceding sentence.

Our 2012 Employee Stock Purchase Plan, or 2012 ESPP, authorizes the issuance of shares of common stock pursuant to purchase rights granted to our employees. The number of shares of common stock reserved for issuance automatically increases on January 1 of each year until January 1, 2022, by up to 1% of the total number of shares of common stock outstanding on December 31 of the preceding year as determined by the board of directors. The price at which common stock is purchased under the 2012 ESPP is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. Offering periods are six months long and begin on February 1 and August 1 of each year. On January 1, 2014, 1,403,546 shares of common stock were automatically added to the 2012 ESPP pursuant to the provision described in the preceding sentence.

Stock Options

A summary of the stock option activity for the nine months ended September 30, 2014 is as follows:



	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2013	23,399,374		$	9.07
Granted	657,144		60.73
Exercised	(5,616,272	)	6.34			$	301,371
Canceled	(616,158	)	20.06
Outstanding at September 30, 2014	17,824,088		$	11.44	7.08	$	845,641
Vested and expected to vest as of September 30, 2014	17,577,162		$	11.18	7.06	$	836,644
Vested and exercisable as of September 30, 2014	9,597,716		$	6.43	6.65	$	502,480

Aggregate intrinsic value represents the difference between the estimated fair value of our common stock and the exercise price of outstanding, in-the-money options. The weighted-average grant date fair value per share of options granted was $29.36 for the nine months ended September 30, 2014. The total fair value of shares vested was $30.0 million for the nine months ended September 30, 2014.

As of September 30, 2014, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options was approximately $61.9 million. The weighted-average remaining vesting period of unvested stock options at September 30, 2014 was 2.45 years.

RSUs

A summary of RSU activity for the nine months ended September 30, 2014 is as follows:



	Number of Shares		Weighted Average Grant Date Fair Value (Per Share)		Aggregate Fair Value (in thousands)
Outstanding at December 31, 2013	5,427,509		$	34.02
Granted	5,569,859		61.03
Vested	(1,046,742	)	28.59		$	58,932
Forfeited	(540,129	)	44.16
Non-vested and outstanding at September 30, 2014	9,410,497		$	50.03	$	553,149
Expected to vest as of September 30, 2014	8,928,425				$	524,813

RSUs granted under the 2005 Plan and the 2012 Plan to employees generally vest annually over a four-year period. As of September 30, 2014, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested RSUs was approximately $376.7 million and the weighted-average remaining vesting period was 3.26 years.

In the nine months ended September 30, 2014, we issued restricted stock units with both service and performance-based vesting criteria to certain executives. These restricted stock units will be eligible to vest based on our attainment of the 2014 financial performance goal as well as each executive's continued employment through the vesting date. In order to earn the restricted stock units, the low end of the predetermined goal must be met. The number of restricted stock units to be earned will range from 0% to 200% of the target awards based on the actual level of achievement of the financial performance goal. Shares earned will vest in four quarterly increments from February 2016 contingent on the continuous employment of each executive. We recognize stock-based compensation expense associated with these awards on a graded vesting basis over the vesting period, after assessing the probability of achieving the 2014 financial performance goal. As of September 30, 2014, we estimated 129% of the target awards will be earned. As actual results are achieved, the probability assessment is updated and stock-based compensation expense is adjusted accordingly.

(13) Net Loss Per Share

The following table presents the calculation of basic and diluted net loss per share (in thousands, except share and per share data):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Numerator:
Net loss	$	(41,050	)	$	(14,713	)	$	(134,724	)	$	(49,476	)
Denominator:
Weighted-average shares outstanding—basic and diluted	146,335,519			137,456,531			144,239,844			134,036,466
Net loss per share:
Basic	$	(0.28	)	$	(0.11	)	$	(0.93	)	$	(0.37	)
Diluted	$	(0.28	)	$	(0.11	)	$	(0.93	)	$	(0.37	)

Potentially dilutive securities that are not included in the calculation of diluted net loss per share because doing so would be antidilutive are as follows:



	September 30,
	2014	2013
Common stock options	17,824,088	25,453,497
Restricted stock units	9,410,497	4,755,522
Common stock subject to repurchase	29,712	118,963
ESPP obligations	280,355	236,006
Convertible senior notes	7,783,023	—
Warrants related to the issuance of convertible senior notes	7,783,023	—
Total potentially dilutive securities	43,110,698	30,563,988

(14) Income Taxes

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

Our effective tax rate for the three and nine months ended September 30, 2014 was (1)% and (2)%, respectively, which was lower than the U.S. federal statutory tax rate of 34%. The lower tax rate was primarily attributable to our loss from operations, the foreign tax rate differential, and non-deductible expenses arising from stock-based compensation.

Our effective tax rate for the three and nine months ended September 30, 2013 was (5)% and (4)%, which was lower than

the federal statutory tax rate of 34%. The lower tax rate was primarily attributable to our loss from operations, the foreign tax rate differential, and non-deductible expenses arising from stock-based compensation, partially offset by state income taxes.

We are subject to taxation in the United States and foreign jurisdictions. As of September 30, 2014, our tax years 2005 to 2013 remain subject to examination in most jurisdictions. We are currently under examination by the Internal Revenue Service for the year ended June 30, 2011 and the six months ended December 31, 2011.

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

(15) Commitments and Contingencies

Leases

We lease facilities for data center capacity and office space under non-cancelable operating lease agreements with various expiration dates. There have been no material changes in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

Legal Proceedings

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

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

On February 6, 2014, Hewlett-Packard Company filed a lawsuit against us in the U.S. District Court for the Northern District of California that alleges that some of our services infringe the claims of eight of Hewlett-Packard's patents. Hewlett-Packard is seeking unspecified damages and an injunction. We filed an answer to the complaint on March 28, 2014 denying the allegations and asserting various affirmative defenses. The court held a first case management conference on June 26, 2014 and a second case management conference on September 4, 2014. The parties are currently conducting discovery. Hewlett-Packard served its infringement contentions on July 3, 2014. Hewlett-Packard's amended infringement contentions are due on November 18, 2014, and our invalidity contentions are due on January 9, 2015.

On September 23, 2014, BMC Software, Inc. filed a lawsuit against us in the U.S. District Court for the Eastern District of Texas that alleges that some of our services willfully infringe the claims of seven of BMC’s patents. BMC is seeking unspecified damages and an injunction.

We intend to vigorously defend these lawsuits. We cannot make a reasonable estimate of the potential loss or range of loss, if any, arising from these matters.

(16) Information about Geographic Areas

Revenues by geographic area, based on the billing location of the customer, were as follows for the periods presented (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
Revenues by geography:
North America ⁽¹⁾	$	120,435	$	76,851	$	329,660	$	208,851
EMEA ⁽²⁾	46,521		27,621		125,021		72,403
Asia Pacific and other	11,756		6,787		29,878		18,166
Total revenues	$	178,712	$	111,259	$	484,559	$	299,420

Long-lived assets by geographic area were as follows (in thousands):



	September 30,		December 31,
	2014		2013
Long-lived assets:
North America	$	65,312	$	52,937
EMEA⁽²⁾	19,887		18,017
Asia Pacific and other	11,778		4,606
Total long-lived assets	$	96,977	$	75,560

(1) Revenues attributed to the United States were approximately 94% of North America revenues for the three months ended September 30, 2014 and 2013 and the nine months ended September 30, 2014 and 2013.

(2) Europe, the Middle East and Africa

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2013 included in the form 10-K dated as of, and filed with the Securities and Exchange Commission, or the SEC, on February 28, 2014 (File No. 001-35580). This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We offer our services under a SaaS business model. Our subscription fees include access to the ordered subscription service and related support and include updates of the subscribed service during the subscription term. We provide a scaled pricing model based on the duration of the subscription term and we frequently extend discounts to our customers based on the number of users. We generate sales through our direct sales team and indirectly through channel partners and third-party referrals. We also generate revenues from professional services for implementation and training of customer personnel. We generally bill our customers annually in advance for subscription services and monthly in arrears for our professional services as the work is performed.

Many customers initially subscribe to our services to solve a specific and immediate problem. Once that problem is solved, many of our customers deploy additional applications as they become more familiar with our services and apply them to new IT processes. In addition, many customers either repurpose our IT applications or build custom applications that automate various processes for business uses outside of IT such as human resources, facilities and quality control management. A majority of our revenues come from large global enterprise customers. We continue to invest in the development of our services, infrastructure and sales and marketing to drive long-term growth. We increased our overall employee headcount to 2,611 as of September 30, 2014 from 1,654 as of September 30, 2013.

Key Factors Affecting Our Performance

Upsell rate. To grow our business it is important for us to generate additional sales from existing customers, which we refer to as our upsell rate. We calculate our upsell rate as the annual contract value of upsells signed during the period, net of any decreases in annual contract value of renewals during the period, divided by our total annual contract value signed during the period. Annual contract value is equal to the first 12 months of expected subscription revenues under a contract. The upsell rate was 35% and 29% for the three months ended September 30, 2014 and 2013, respectively, and 34% and 29% for the nine months ended September 30, 2014 and 2013, respectively. Our upsells are primarily derived by an increase in the number of seat licenses purchased by our customers and are also derived from the addition of other subscription services.

Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the annual contract value from lost customers, divided by the total annual contract value from all customers that renewed during the period and from all lost customers. A lost customer is a customer that did not renew a contract expiring in the period and that, in our judgment, will not renew. In certain instances, when a customer informs us of their intent not to renew in a period prior to the expiration of their contract, we record the customer as lost immediately in our renewal rate calculation. Typically a customer that reduces its subscription upon renewal is not considered a lost customer. However, in instances where the subscription decrease represents the majority of the customer's annual contract value, we may deem the renewal as a lost customer. We believe our renewal rate is an important metric to measure the long-term value of customer agreements and our ability to retain our customers. Our renewal rate was 98% and 97% for the three months ended September 30, 2014 and 2013, respectively, and 98% and 96% for the nine months ended September 30, 2014 and 2013, respectively.

Total customers. We believe our total customer count is a key indicator of our market penetration, growth and future revenues. We have aggressively invested in, and intend to continue to invest in, our direct sales force and additional partnerships with our indirect sales channel. We generally define a customer as an entity with an active service contract as of the measurement date. In situations where there is a single contract that applies to entities with multiple subsidiaries or divisions, universities or governmental organizations, each entity that has contracted for a separate production instance of our services is counted as a separate customer. As of September 30, 2014 and 2013, our total customer count was 2,514 and 1,900, respectively. Our customer count excludes customers of our recently developed product offering for mid-sized IT departments.

Investment in growth. We have invested, and intend to continue to invest in, expanding our operations, including increasing our headcount, expanding our cloud-based infrastructure, increasing access for our partners to utilize our tools and resources, and developing technology to support our growth. We have recently, and may in the future, also enter into acquisition transactions.

Expansion beyond IT. Our customers can purchase access to our application suite for use outside of the IT department. Customers may also purchase access to our services to develop custom applications using our platform. Although in the near term we expect our revenue growth to be primarily driven by adoption and penetration of our suite of applications for use within IT, we continue to enhance the development capabilities within our platform, allowing custom application development to expand within our customer base. We believe the extensibility and simplicity of our platform is resulting in an increased use of our application suite outside of the IT department as well as an increase in customer application development.

Components of Results of Operations

Revenues

Subscription revenues. Subscription revenues are primarily comprised of fees that give customers access to the ordered subscription service, related support and updates to the subscribed service during the subscription term. Pricing includes multiple instances, hosting and support services, data backup and disaster recovery services, as well as future upgrades, when and if available, offered during the subscription period. We typically invoice our customers for subscription fees in annual increments upon execution of the initial contract or subsequent renewal. Our average initial contract term was approximately 33 months and 34 months for the three and nine months ended September 30, 2014, respectively, and 35 months and 33 months for the three and nine months

ended September 30, 2013. Our contracts are generally non-cancelable, though customers can terminate for breach if we materially fail to perform.

We generate sales directly through our sales team and, to a lesser extent, through our channel partners. Sales to our channel partners are made at a discount and revenues are recorded at the discounted price when all revenue recognition criteria are met. From time to time, our channel partners also provide us referrals for which we pay a referral fee. We pay referral fees to channel partners and other third parties typically ranging from 3% to 23% of the first year’s annual contract value. These fees are included in sales and marketing expense.

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

Allocation of Overhead Costs

Overhead costs associated with office facilities, IT and certain depreciation related to noncloud-based infrastructure are allocated to cost of revenues and operating expenses based on headcount. Facility costs associated with our data centers as well as depreciation related to our cloud-based infrastructure hardware equipment are classified as cost of subscription revenues.

Cost of Revenues

Cost of subscription revenues. Cost of subscription revenues consists primarily of expenses related to hosting our services and providing support to our customers. These expenses are comprised of data center capacity costs; personnel related costs directly associated with our cloud-based infrastructure and customer support, including salaries, benefits, bonuses and stock-based compensation; and allocated overhead.

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

Professional services associated with the implementation and configuration of our subscription services are performed directly by our services team, as well as by contracted third-party vendors. Fees paid to third-party vendors are primarily recognized as cost of revenues as the professional services are delivered. Cost of revenues associated with our professional services engagements contracted with third-party vendors as a percentage of professional services and other revenues was 20% and 19% in the three months ended September 30, 2014 and 2013, respectively, and 16% and 17% in the nine months ended September 30, 2014 and 2013, respectively.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses, commissions and stock-based compensation. Sales and marketing expenses also includes third-party referral fees, marketing and promotional events, including our annual Knowledge user conference and other customer forums, online marketing, product marketing and allocated overhead.

Research and Development Expenses

Research and development expenses consist primarily of personnel related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation, and allocated overhead.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel related expenses for our executive, finance, legal, human resources and administrative personnel, including salaries, benefits, bonuses and stock-based compensation; external legal, accounting and other professional services fees; other corporate expenses; and allocated overhead.

Provision for Income Taxes

Provision for income taxes consists of federal, state and foreign income taxes. Due to cumulative losses, we maintain a valuation allowance against our U.S. deferred tax assets as of September 30, 2014 and 2013. We consider all available evidence, both positive and negative, including but not limited to, earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets in assessing the extent to which a valuation allowance should be applied against our U.S. deferred tax assets.

Recent Accounting Pronouncements

Results of Operations

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



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(in thousands)						(in thousands)
Revenues:
Subscription	$	150,367		$	92,992		$	400,466		$	244,926
Professional services and other	28,345			18,267			84,093			54,494
Total revenues	178,712			111,259			484,559			299,420
Cost of revenues⁽¹⁾:
Subscription	37,925			23,429			102,357			61,960
Professional services and other	28,161			18,146			75,781			47,921
Total cost of revenues	66,086			41,575			178,138			109,881
Gross profit	112,626			69,684			306,421			189,539
Operating expenses⁽¹⁾:
Sales and marketing	84,002			47,336			245,355			137,853
Research and development	39,683			20,819			106,232			54,809
General and administrative	23,440			16,179			69,985			43,783
Total operating expenses	147,125			84,334			421,572			236,445
Loss from operations	(34,499		)	(14,650		)	(115,151		)	(46,906		)
Interest and other income (expense), net	(5,949		)	600			(17,143		)	(604		)
Loss before provision for income taxes	(40,448		)	(14,050		)	(132,294		)	(47,510		)
Provision for income taxes	602			663			2,430			1,966
Net loss	$	(41,050	)	$	(14,713	)	$	(134,724	)	$	(49,476	)


(1)	Stock-based compensation included in the statements of operations above was as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(in thousands)				(in thousands)
Cost of revenues:
Subscription	$	3,995	$	2,190	$	10,896	$	5,980
Professional services and other	3,572		1,209		9,188		3,095
Sales and marketing	14,956		5,945		36,382		14,752
Research and development	11,682		4,176		29,973		11,005
General and administrative	7,285		4,331		21,884		9,893



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
Revenues:
Subscription	84	%	84	%	83	%	82	%
Professional services and other	16		16		17		18
Total revenues	100		100		100		100
Cost of revenues:
Subscription	21		21		21		21
Professional services and other	16		16		16		16
Total cost of revenues	37		37		37		37
Gross profit	63		63		63		63
Operating expenses:
Sales and marketing	47		43		50		46
Research and development	22		19		22		18
General and administrative	13		15		14		15
Total operating expenses	82		77		86		79
Loss from operations	(19	)	(14	)	(24	)	(16	)
Interest and other income, net	(4	)	1		(3	)	—
Loss before provision for income taxes	(23	)	(13	)	(27	)	(16	)
Provision for income taxes	—		—		1		1
Net loss	(23	)%	(13	)%	(28	)%	(17	)%



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(in thousands)				(in thousands)
Revenues by geography
North America	$	120,435	$	76,851	$	329,660	$	208,851
EMEA ⁽¹⁾	46,521		27,621		125,021		72,403
Asia Pacific and other	11,756		6,787		29,878		18,166
Total revenues	$	178,712	$	111,259	$	484,559	$	299,420

(1) Europe, the Middle East and Africa

Comparison of the three months ended September 30, 2014 and 2013

Revenues



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Revenues:
Subscription	$	150,367		$	92,992		62	%
Professional services and other	28,345			18,267			55	%
Total revenues	$	178,712		$	111,259		61	%
Percentage of revenues:
Subscription	84		%	84		%
Professional services and other	16			16
Total	100		%	100		%

Subscription revenues increased $57.4 million during the three months ended September 30, 2014, compared to the same period in the prior year, driven by our upsells, renewals and an increase in our customer count. Our upsell rate and renewal rate for the trailing twelve months ending September 30, 2014 was 34% and 97%, respectively, compared to 30% and 96%, respectively for the trailing 12 months ending September 30, 2013. Total customer count at September 30, 2014 was 2,514 compared to 1,900 at September 30, 2013, an increase of 32%. Revenues from our direct sales organization and channel partners represented 88% and 12%, respectively, for the three months ended September 30, 2014 and 2013.

Professional services and other revenues increased $10.1 million during the three months ended September 30, 2014, compared to the same period in the prior year, due to an increase in the services provided to our growing customer base and improvements in pricing of our professional services engagements. We expect professional services and other revenues to increase at a slower rate than subscription revenues as we continue to focus on strengthening and supporting our network of professional services partners.

Revenues outside North America represented 33% of total revenues for the three months ended September 30, 2014. The U.S. Dollar has recently begun to strengthen relative to the Euro and other currencies. Although it is particularly difficult to forecast any impact from exchange rate movements, if this trend continues it would have a negative impact on our consolidated revenues.

Our average total annual revenues per customer increased to approximately $275,000 for the three months ended September 30, 2014, compared to approximately $227,000 for the three months ended September 30, 2013. Our average total annual revenues per customer is the sum of average quarterly revenues for the trailing four quarters. We calculate average quarterly revenues per customer by dividing the quarter’s revenues by the average number of customers in the quarter. In the second quarter 2014, we made a change to our calculation to improve the accuracy of our average revenues per customer. We used this changed calculation for both the three months ended September 30, 2014, and the three months ended September 30, 2013. The change in methodology increased the average annual revenues per customer that we had disclosed in a prior period for the three months ended September 30, 2013, by 4%.

Cost of Revenues and Gross Profit Percentage



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Cost of revenues:
Subscription	$	37,925		$	23,429		62	%
Professional services and other	28,161			18,146			55	%
Total cost of revenues	$	66,086		$	41,575		59	%
Gross profit percentage:
Subscription	75		%	75		%
Professional services and other	1		%	1		%
Total gross profit percentage	63		%	63		%
Gross Profit	$	112,626		$	69,684
Headcount (at period end)
Subscription	446			299			49	%
Professional services and other	385			278			38	%
Total headcount	831			577			44	%

Cost of subscription revenues increased $14.5 million during the three months ended September 30, 2014, compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $5.1 million in personnel related costs excluding stock-based compensation, an increase of $1.8 million in stock-based compensation, an increase of $1.6 million in other overhead expenses and an increase of $1.5 million in depreciation expense primarily due to purchases of cloud-based infrastructure hardware equipment for our data centers. Amortization of intangible assets increased $2.2 million as a result of the acquisition of Neebula Systems Ltd., or Neebula in July 2014. Hosting expenses increased $1.1 million primarily due to the expansion of our data centers.

Our subscription gross profit percentage was 75% for the three months ended September 30, 2014 and 2013. We expect our subscription gross profit percentage to remain relatively flat for the remainder of the year as we anticipate our cost of subscription revenues to grow at the same rate as our subscription revenues.

Cost of professional services and other revenues increased $10.0 million during the three months ended September 30, 2014 as compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $5.3 million in personnel related costs excluding stock-based compensation, an increase of $2.4 million in stock-based compensation, an increase of $1.8 million in outside services costs and an increase of $1.2 million in overhead expenses.

Our professional services and other gross profit percentage was 1% during the three months ended September 30, 2014 and 2013. We expect our professional services and other gross profit percentage to increase for the remainder of the year due to an anticipated increase in other revenues related to customer forums held during the fourth quarter of 2014.

Sales and Marketing



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Sales and marketing	$	84,002		$	47,336		77	%
Percentage of revenues	47		%	43		%
Headcount (at period end)	929			581			60	%

Sales and marketing expenses increased $36.7 million during the three months ended September 30, 2014 compared to the same period in the prior year, primarily due to increased headcount that resulted in an increase of $17.3 million in personnel related costs excluding stock-based compensation, an increase of $9.0 million in stock-based compensation, an increase of $3.2 million in overhead expenses and an increase of $4.8 million in commissions expense. Commissions increased primarily due to an increase

in bookings. Commissions and referral fees amounted to 9% and 10% of subscription revenues for three months ended September 30, 2014 and 2013, respectively.

Marketing program expenses, which include events, advertising and market data, increased $1.7 million during the three months ended September 30, 2014 compared to the same period in the prior year. We expect sales and marketing expenses to increase for the remainder of the year, in absolute dollar terms, and increase as a percentage of total revenues as we continue to expand our direct sales force, increase our marketing activities, grow our international operations, build brand awareness and sponsor additional marketing events.

Research and Development



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Research and development	$	39,683		$	20,819		91	%
Percentage of revenues	22		%	19		%
Headcount (at period end)	542			296			83	%

Research and development expenses increased $18.9 million during the three months ended September 30, 2014 compared to the same period in the prior year, primarily due to increased headcount, which resulted in an increase of $9.4 million in personnel related costs excluding stock-based compensation, an increase of $7.5 million in stock-based compensation and an increase of $2.4 million in overhead expenses.

We expect research and development expenses to increase for the remainder of the year in absolute dollar terms, but remain flat as a percentage of total revenues, as we continue to expand the development organization and improve the existing functionality of our services, develop new applications to fill market needs and continue to enhance our core platform.

General and Administrative



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
General and administrative	$	23,440		$	16,179		45	%
Percentage of revenues	13		%	15		%
Headcount (at period end)	309			200			55	%

General and administrative expenses increased $7.3 million during the three months ended September 30, 2014 compared to the same period in the prior year, primarily due to increased headcount which resulted in an increase of $1.6 million in personnel related costs excluding stock-based compensation, an increase of $3.0 million in stock-based compensation and an increase of $0.9 million in overhead expenses. Outside services costs increased $1.4 million primarily due to an increase in legal fees, an increase in contractors for internal information technology support and costs associated with the acquisition of Neebula.

We expect general and administrative expenses to increase for the remainder of the year in absolute dollar terms, but to remain relatively flat as a percentage of total revenues.

Interest and Other Income (Expense), net



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Interest and other income (expense), net	$	(5,949	)	$	600		(1,092	)%
Percentage of revenues	(4		)%	1		%

Interest and other income (expense), net, decreased $6.5 million during the three months ended September 30, 2014 compared to the same period in the prior year, primarily due to $7.3 million in amortization expense of debt discount and issuance costs

related to our convertible senior notes (the "Notes") issued in November 2013, partially offset by a gain from foreign currency transactions and increased interest income. We had a foreign currency transaction gain of $0.7 million for the three months ended September 30, 2014 compared to a gain of $0.3 million for the three months ended September 30, 2013, primarily due to the strengthening of the U.S. Dollar against other major currencies. Interest income increased $0.5 million due to the higher investment balances during the three months ended September 30, 2014 compared to the same period in the prior year.

Our expanding international operations will continue to increase our exposure to currency risks, though we cannot presently predict the impact of this exposure on our consolidated financial statements. While we have not engaged in the hedging of our foreign currency transactions to date, we are conducting an ongoing evaluation of the costs and benefits of initiating such a program and may hedge selected significant transactions denominated in currencies other than the U.S. dollar in the future.

Provision for Income Taxes



	Three Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Loss before income taxes	$	(40,448	)	$	(14,050	)	188	%
Provision for income taxes	602			663			(9	)%
Effective tax rate	(1		)%	(5		)%

Our effective tax rate changed to (1)% for the three months ended September 30, 2014 compared to (5)% for the three months ended September 30, 2013 due to a higher loss from operations, the foreign rate differential and an increase in non-deductible stock-based compensation expense.

We continue to maintain a full valuation allowance on our federal and state deferred tax assets, and the significant components of the tax expense recorded are current cash taxes in various jurisdictions. The cash tax expenses are impacted by each jurisdiction’s individual tax rates, laws on timing of recognition of income and deductions, and availability of net operating losses and tax credits. Given the full valuation allowance, sensitivity of current cash taxes to local rules and our foreign operations, we expect that our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. We consider the earnings of our foreign subsidiaries to be indefinitely reinvested outside of the United States.

Comparison of the nine months ended September 30, 2014 and 2013

Revenues



	Nine Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Revenues:
Subscription	$	400,466		$	244,926		64	%
Professional services and other	84,093			54,494			54	%
Total revenues	$	484,559		$	299,420		62	%
Percentage of revenues:
Subscription	83		%	82		%
Professional services and other	17			18
Total	100		%	100		%

Subscription revenues increased $155.5 million during the nine months ended September 30, 2014, compared to the same period in the prior year, driven by our upsells, renewals and an increase in our customer count. Revenues from our direct sales organization and channel partners represented 87% and 13%, respectively, for the nine months ended September 30, 2014 and 88% and 12% for the nine months ended September 30, 2013, respectively.

Professional services and other revenues increased $29.6 million during the nine months ended September 30, 2014, compared to the same period in the prior year, due to an increase in the services provided to our growing customer base and improvements

in pricing of our professional services engagements. In addition, revenues from our Knowledge conference increased from $5.0 million for the nine months ended September 30, 2013 to $8.2 million for the nine months ended September 30, 2013 due to increased sponsorship and paid registration in the current year.

Cost of Revenues and Gross Profit Percentage



	Nine Months Ended September 30,						% Change
	2014			2013			% Change
	(dollars in thousands)
Cost of revenues:
Subscription	$	102,357		$	61,960		65	%
Professional services and other	75,781			47,921			58	%
Total cost of revenues	$	178,138		$	109,881		62	%
Gross profit percentage:
Subscription	74		%	75		%
Professional services and other	10		%	12		%
Total gross profit percentage	63		%	63		%
Gross Profit	$	306,421		$	189,539
Headcount (at period end)
Subscription	446			299			49	%
Professional services and other	385			278			38	%
Total headcount	831			577			44	%

Cost of subscription revenues increased $40.4 million during the nine months ended September 30, 2014, compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $17.1 million in personnel related costs excluding stock-based compensation, an increase of $4.9 million in stock-based compensation, an increase of $4.4 million in depreciation expense primarily due to purchases of cloud-based infrastructure hardware equipment for our data centers and an increase of $4.2 million in other overhead expenses. Hosting expenses increased $4.3 million primarily due to the expansion of our data centers. Amortization of intangible assets increased $2.9 million as a result of the acquisition of Neebula in July 2014.

Our subscription gross profit percentage was 74% for the nine months ended September 30, 2014 compared to 75% for the nine months ended September 30, 2013 due to additional amortization expense incurred related to the Neebula developed technology beginning in the third quarter of 2014.

Cost of professional services and other revenues increased $27.9 million during the nine months ended September 30, 2014 as compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $16.1 million in personnel related costs excluding stock-based compensation, an increase of $6.1 million in stock-based compensation, an increase of $2.8 million in overhead expenses, and an increase of $3.3 million in outside services costs.

Our professional services and other gross profit percentage decreased to 10% during the nine months ended September 30, 2014 compared to 12% for the nine months ended September 30, 2013 primarily due to increased stock-based compensation. The decrease in gross profit percentage was partially offset by the increase in revenues from our annual Knowledge user conference. Costs associated with Knowledge are included in sales and marketing expense. Knowledge contributed $8.2 million in revenue, or 10 percentage points to the professional services and other gross profit percentage for the nine months ended September 30, 2014. During the nine months ended September 30, 2013, Knowledge contributed $5.0 million in revenue, or 9 percentage points to the professional services and other gross profit percentage.

Sales and Marketing



	Nine Months Ended September 30,				% Change
	2014		2013		% Change
	(dollars in thousands)
Sales and marketing	$	245,355	$	137,853	78	%
Percentage of revenues	50