SOLARWINDS CORPORATION The following discussion and analysis of our financial condition and results of operations should be read in conjunction with 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. OverviewSolarWinds 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-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 a broad portfolio of infrastructure location-agnostic products to monitor and manage network, systems, desktop, application, storage, database, website infrastructures and IT 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 OnDecember 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 betweenMarch 2020 andJune 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 and 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 for more information regarding these lawsuits and investigations. 41 -------------------------------------------------------------------------------- Table of Contents Expenses ThroughDecember 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 endedDecember 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 OnAugust 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 onDecember 9, 2020 , we announced that we confidentially submitted with theSEC 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 42 -------------------------------------------------------------------------------- Table of Contents 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 allSolarWinds stockholders as of a record date to be determined by the board of directors ofSolarWinds . 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 endedDecember 31, 2020 . We expect to incur additional spin-off exploration costs in future periods. Financial Highlights Our 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 year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 . Revenue Our total revenue was$1.02 billion and$932.5 million for the years endedDecember 31, 2020 and 2019, respectively. Our non-GAAP total revenue, which excludes the impact of purchase accounting, was$1.02 billion and$938.5 million for the years endedDecember 31, 2020 and 2019, respectively. Recurring revenue, which consists of subscription and maintenance revenue, represented approximately 86% of our total revenue for the year endedDecember 31, 2020 compared to 82% for the year endedDecember 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. Our 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 full IT stack, while remaining infrastructure-location agnostic. Core IT Management product revenue was$716.8 million and$669.1 million for the years endedDecember 31, 2020 and 2019, respectively. Our MSP 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$302.5 million and$263.4 million for the years endedDecember 31, 2020 and 2019, respectively. We use Subscription Annual Recurring Revenue, or Subscription ARR, and Total Annual Recurring Revenue, or Total ARR, to evaluate the results 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 ofDecember 31, 2020 , Subscription ARR was$435.1 million , up from$371.6 million as ofDecember 31, 2019 . Total ARR represents the sum of Subscription ARR and the annualized value of all maintenance contracts related to perpetual licenses active at the end of a reporting period. As ofDecember 31, 2020 , Total ARR was$959.7 million , up from$845.1 million as ofDecember 31, 2019 , reflecting an increase of 13.6%. As ofDecember 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 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. 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 2020 organically and through 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 year endedDecember 31, 2020 as compared to 897 for the year endedDecember 31, 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 43 -------------------------------------------------------------------------------- Table of Contents 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. Our license revenue has declined as a percentage of total revenue primarily due to the higher growth of our recurring revenue and represented approximately 14% of our total revenue 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 endedDecember 31, 2020 was$158.5 million compared to$18.6 million for the year endedDecember 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 endedDecember 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 endedDecember 31, 2020 and 2019, respectively. Cash Flow We have built our business to generate strong cash flow over the long term. For the years endedDecember 31, 2020 and 2019, cash flows from operations were$389.1 million and$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$67.2 million and$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 InOctober 2020 , we acquiredSQL 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 theSolarWinds portfolio also amplifies the depth and breadth of supportSolarWinds 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. 44 -------------------------------------------------------------------------------- Table of Contents 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. •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 allocate revenue to the license component based upon our estimated standalone selling prices, which is derived by evaluating our historical pricing and discounting practices in observable bundled transactions. InApril 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 software and support is recognized ratably over the contract period. 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 mix of license and recurring revenue, but this impact is difficult to predict at this time due to uncertainty regarding the level of customer adoption of the new subscription pricing options. We expect a gradual shift in the mix between license 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. Amortization of acquired technologies primarily consists of amortization related to 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 and an allocation of overhead costs based on headcount. The total number of employees as ofDecember 31, 2020 was 3,340, as compared to 3,251 as ofDecember 31, 2019 . Our stock-based compensation expense has increased due to equity awards granted to our employees and directors and 45 -------------------------------------------------------------------------------- Table of Contents 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. 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. 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 and spin-off exploration costs, professional fees and other general corporate expenses. •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 accounts. We expect interest expense to decrease as we repay indebtedness. 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 intoU.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 endedDecember 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 transaction will change our mix of international income from a lower non-U.S. tax jurisdiction toIreland , which is subject to a statutory tax rate of 12.5%. We recognized a discrete tax benefit of$138.2 million as a result of the IP Transfer. For additional discussion about our income taxes, see Note 15. Income Taxes in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K. Comparison of the Years EndedDecember 31, 2020 and 2019 Revenue Year Ended December 31, 2020 2019 Percentage of Percentage of Amount Revenue Amount Revenue Change (in thousands, except percentages) Subscription$ 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 46
-------------------------------------------------------------------------------- Table of Contents Total revenue increased$86.7 million , or 9.3%, for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . Revenue fromNorth America was approximately 65% and 66% of total revenue for the years endedDecember 31, 2020 and 2019, respectively. Other thanthe 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 endedDecember 31, 2020 compared to$669.1 million for the year endedDecember 31, 2019 , representing an increase of 7.1%. MSP product revenue was$302.5 million for the year endedDecember 31, 2020 compared to$263.4 million for the year endedDecember 31, 2019 , representing an increase of 14.8%. Recurring Revenue Subscription Revenue. Subscription revenue increased$75.7 million , or 23.6%, for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 , primarily due to sales of additional MSP products, with additional contribution from our acquired SolarWinds Service Desk and Database Performance Monitor products. Our subscription revenue increased as a percentage of our total revenue for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . Our net retention rate for our subscription products was approximately 105% for each of the trailing twelve-month periods endedDecember 31, 2020 and 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. Maintenance Revenue. Maintenance revenue increased$31.8 million , or 7.1%, for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 primarily due to a growing maintenance renewal customer base from sales of our perpetual license products, strong maintenance renewal rates and annual maintenance price increases. Our maintenance renewal rate for our perpetual license products was approximately 91% and 94%, respectively, for the trailing twelve-month periods endedDecember 31, 2020 and 2019. The decrease in the maintenance renewal rate for the trailing twelve-month period endedDecember 31, 2020 was primarily due a planned downgrade on one largeU.S. Federal maintenance renewal in the first quarter of 2020 and, to a lesser extent, a decline in renewals due to the Cyber Incident inDecember 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 decreased$20.9 million , or 12.6%, primarily due to decreased sales of our licensed products resulting from the difficult economic environment during the year as a result of the global recession caused by COVID-19 and the Cyber Incident inDecember 2020 and, to a lesser extent, an increase in the subscription sales of our network, systems and database management products that have historically been sold only as perpetual licenses. We expect our license sales may decline or fluctuate in future periods as a result of the Cyber Incident. Cost of Revenue Year Ended December 31, 2020 2019 Percentage of Percentage of Amount Revenue Amount Revenue Change (in thousands, except percentages) Cost of recurring revenue$ 93,255 9.1 %$ 79,571 8.5 %$ 13,684 Amortization of acquired technologies 181,361 17.8 175,883 18.9 5,478 Total cost of revenue$ 274,616 26.9 %$ 255,454 27.4 %$ 19,162 Total cost of revenue increased in the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 primarily due to increases in public cloud infrastructure and hosting fees related to our subscription products of$6.9 million , personnel costs to support new customers and additional product offerings of$4.1 million , which includes a$0.9 million increase in stock-based compensation expense and depreciation and other amortization of$3.3 million . The increase in amortization of acquired technologies is primarily related to intangibles acquired through our acquisitions in 2019. 47 --------------------------------------------------------------------------------
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Operating Expenses
Year Ended December 31,
2020 2019
Percentage of Percentage of
Amount Revenue Amount 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
Sales and Marketing. Sales and marketing expenses increased $34.3 million , or
13.0%, primarily due to increases in personnel costs of $30.6 million , which
includes an increase of $11.2 million in stock-based compensation expense and
increases in marketing program costs of $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 growth in the business and through the
acquisitions.
Research and Development. Research and development expenses increased $15.9
million , or 14.4%, primarily due to an increase in personnel costs of $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 and
through acquisitions.
General and Administrative. General and administrative expenses increased $40.0
million , or 41.0%, primarily due to a $28.8 million increase in personnel costs,
which includes a $22.4 million increase in stock-based compensation expense, a
$11.3 million increase in costs related to the exploration of a potential
spin-off of our MSP business, a $3.2 million increase in costs related to the
Cyber Incident and a $1.1 million increase in our provision for losses on
accounts receivables. These increases were partially offset by decreases in
restructuring costs of $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
increased $5.2 million , or 7.4%, for the year ended December 31, 2020 compared
to the year ended December 31, 2019 primarily due to amortization related to our
acquisitions completed in 2019 and 2020. See Note 3. Acquisitions 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 our acquisitions including the intangible
assets acquired.
Interest Expense, Net
Year Ended December 31,
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Interest expense, net $ (75,884) (7.4) % $ (108,071) (11.6) % $ 32,187
Interest expense, net decreased by $32.2 million , or 29.8%, in the year ended
December 31, 2020 compared to the year ended December 31, 2019 . The decrease in
interest expense is primarily due to decreases in interest rates on our debt.
The weighted-average effective interest rate on our debt during the year ended
December 31, 2020 was 3.4% compared to 5.0% for the year ended December 31,
2019 . See Note 9. Debt in the Notes to Consolidated Financial Statements
included in Item 8 of Part II of this Annual Report on Form 10-K for additional
information regarding our debt.
48
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Other Income (Expense), Net
Year Ended December 31,
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(inthousands, except percentages)
Total other income (expense), net$ (1,240) (0.1) %$ 402 - %$ (1,642) Other income (expense), net decreased by$1.6 million in the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 primarily due to the impact of changes in foreign currency exchange rates related to various accounts for the period. Income Tax Expense (Benefit) Year Ended December 31, 2020 2019 Percentage of Percentage of Amount Revenue Amount Revenue Change (in thousands, except percentages) Income before income taxes$ 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) % Our income tax benefit for the year endedDecember 31, 2020 was$128.2 million as compared to income tax expense of$8.9 million for the year endedDecember 31, 2019 . 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 deferred tax asset related to the 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 EndedDecember 31, 2019 and 2018 For a comparison of our results of operations for the years endedDecember 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 endedDecember 31, 2019 , filed with theSEC onFebruary 24, 2020 . 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. 49 -------------------------------------------------------------------------------- Table of Contents 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 from our Take Private transaction in early 2016 and 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. Year Ended December 31, 2020 2019 2018 (in thousands) Revenue:
GAAP subscription revenue
2,540 5,930 1,166
Non-GAAP subscription revenue 399,036 326,677 266,757 GAAP maintenance revenue
478,284 446,450 402,938
Impact of purchase accounting - -
2,550
Non-GAAP maintenance revenue 478,284 446,450
405,488
GAAP total recurring revenue 874,780 767,197
668,529
Impact of purchase accounting 2,540 5,930
3,716
Non-GAAP total recurring revenue 877,320 773,127 672,245 GAAP license revenue
144,461 165,328 164,560
Impact of purchase accounting - - - Non-GAAP license revenue 144,461 165,328 164,560 Total GAAP revenue$ 1,019,241 $ 932,525 $ 833,089
Impact of purchase accounting
$ 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 other costs, spin-off exploration costs, restructuring costs and 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 and Related Employer-Paid Payroll Taxes. We provide non-GAAP information that excludes expenses related to stock-based 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 Other 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 50 -------------------------------------------------------------------------------- Table of Contents 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 other 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 Costs. We provide non-GAAP information that excludes restructuring costs such as severance and the estimated costs of exiting and terminating facility lease commitments, as they relate to our corporate restructuring and exit activities and costs related to the separation of employment with executives of the Company. These costs 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 costs 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 %
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Adjusted EBITDA and 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 costs, 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,
2020 2019 2018
(in thousands, except margin data)
Net income (loss) $ 158,475 $ 18,642 $ (102,066)
Amortization and depreciation 277,856 263,244 258,362
Income tax expense (benefit) (128,156) 8,862 (19,644)
Interest expense, net 75,884 108,071 142,008
Impact of purchase accounting on total revenue 2,540 5,930 3,716
Unrealized foreign currency (gains) losses(1) 2,645 (913) 14,367
Acquisition and other costs 5,854 8,544 20,401
Spin-off exploration costs 12,227 - -
Debt related costs(2) 364 385 81,535
Stock-based compensation expense and related employer-paid
payroll taxes 76,174 35,270 5,833
Restructuring costs 2,368 5,598 2,999
Cyber Incident costs 3,485 - -
Adjusted EBITDA $ 489,716 $ 453,633 $ 407,511
Adjusted EBITDA margin 47.9 % 48.3 % 48.7 %
________________
(1)Unrealized foreign currency (gains) losses primarily relate to the
remeasurement of our intercompany loans and unrealized foreign currency (gains)
losses on selected assets and liabilities. We established a foreign currency
denominated intercompany loan 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 were unrealized non-cash events.
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
enactment of the U.S. Tax Cuts and Jobs Act of 2017, or 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). As of December 31, 2019 , we determined that the
intercompany loan will not be repaid and it was reclassified as a capital
contribution.
(2)Debt related costs include fees related to our credit agreements, debt
refinancing costs and the related write-off of debt issuance costs. See Note 9.
Debt in the Notes to Consolidated Financial Statements in Item 8 of Part II of
this Annual Report on Form 10-K for additional information regarding our debt.
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Liquidity and Capital Resources
Cash and cash equivalents were $370.5 million as of December 31, 2020 . Our
international subsidiaries held approximately $163.4 million of cash and cash
equivalents, of which 39.6% were held in Euros. We intend either to invest our
foreign earnings permanently in foreign operations or to remit these earnings to
our U.S. entities in a tax-free manner with the exception for immaterial state
income taxes. The Tax Act imposed a mandatory transition tax on accumulated
foreign earnings and eliminates U.S. federal income taxes on foreign subsidiary
distribution.
Our primary source of cash for funding operations and growth has been through
cash provided by operating activities. Given 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.
Indebtedness
As of December 31, 2020 , our total indebtedness was $1.9 billion , with up
to $125.0 million of available borrowings under our revolving credit facility.
See Note 9. 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.
First Lien Credit Agreement
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 .
The First Lien Credit Agreement provides us the right to request additional
commitments for new incremental term loans and revolving loans, in an aggregate
principal amount not to exceed (a) the greater of (i) $400.0 million and
(ii) 100% of our consolidated EBITDA, as defined in the First Lien Credit
Agreement (calculated on a pro forma basis), for the most recent four fiscal
quarter period, or the First Lien Fixed Basket, plus (b) the amount of certain
voluntary prepayments of the First Lien Credit Facilities, plus (c) an unlimited
amount subject to pro forma compliance with a first lien net leverage ratio not
to exceed 4.75 to 1.00.
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.
Summary of Cash Flows
Summarized cash flow information is as follows:
Year Ended December 31,
2020 2019
(in thousands)
Net cash provided by operating activities $ 389,094 $ 299,907
Net cash used in investing activities (180,127) (482,453)
Net cash used in financing activities (25,556) (25,624)
Effect of exchange rate changes on cash and cash equivalents 13,715 (1,078)
Net increase (decrease) in cash and cash equivalents 197,126 (209,248)
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Operating Activities
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.
For 2020 compared to 2019, the increase in cash provided by operating activities
was primarily due to an increase in net income adjusted for the net effect of
non-cash items including deferred taxes, depreciation and amortization and
stock-based compensation expense. The change in deferred taxes is primarily
related the deferred tax asset recognized as a result of the IP Transfer during
the year ended December 31, 2020 . The net cash inflow resulting from the changes
in our operating assets and liabilities was $41.4 million for 2020 as compared
to $12.9 million in 2019 and was primarily due to the timing of sales and cash
payments and receipts. Cash flow from operations for the year ended December 31,
2020 was reduced by $54.6 million of cash paid for taxes which includes an $8.1
million cash payment related to the transition tax as a result of the Tax Act.
Investing Activities
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.
Net cash used in investing activities decreased in 2020 compared to 2019 due to
a decrease in cash used for acquisitions. 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 information regarding our
acquisitions. Purchases of property and equipment increased in 2020 as compared
to 2019 primarily due to purchases of leasehold improvements to expand certain
office locations and servers and equipment.
Financing Activities
Financing cash flows consist primarily of issuance and repayments associated
with our long-term debt, the proceeds from the issuance of shares of common
stock through equity incentive plans and the repurchase of unvested incentive
restricted stock and common stock to satisfy withholding tax requirements
related to the settlement of restricted stock units.
Net cash used in financing activities decreased slightly in 2020 compared to
2019 primarily due to an increase in proceeds from issuance of common stock
under our employee stock purchase plan and option exercises, partially offset by
an increase in repurchases of common stock. In 2020 we withheld and retired
shares of common stock to satisfy $12.1 million of statutory withholding tax
requirements that we pay in cash to the appropriate taxing authorities on behalf
of our employees related to the settlement of restricted stock units during the
period. These shares are treated as common stock repurchases in our consolidated
financial statements. Net cash used in financing activities for 2019 includes
the proceeds and repayment of $35.0 million in borrowings under our Revolving
Credit Facility. For each period, we made quarterly principal payments of $19.9
million due under our First Lien Credit Agreement.
Contractual Obligations and Commitments
The following table summarizes our outstanding contractual obligations as of
December 31, 2020 that require us to make future cash payments:
Payments Due by Period
Less than 1 More than
Total year 1-3 years 3-5 years 5 years
(in thousands)
Long-term debt obligations(1) $ 1,930,300 $ 19,900 $ 39,800 $ 1,870,600 $ -
Cash interest expense(1) 172,781 56,472 111,191 5,118 -
Operating leases(2) 157,368 23,497 46,014 40,556 47,301
Purchase obligations(3) 143,636 108,248 35,388 - -
Transition tax payable(4) 87,034 8,914 23,574 47,208 7,338
Total(5) $ 2,491,119 $ 217,031 $ 255,967 $ 1,963,482 $ 54,639
________________
(1)Represents principal maturities of our Senior Secured First Lien Credit
Facility in effect at
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(2)Represents maturities of operating lease liabilities, see Note 7. Leases in
the Notes to Consolidated Financial Statements included in Item 8 of Part II of
this Annual Report on Form 10-K for additional details. As of December 31, 2020 ,
we had a lease agreement in which the lease did not commence prior to year-end
and therefore the lease liabilities had not been recorded in our consolidated
balance sheet. The future minimum lease payments under this lease are
approximately $29.0 million over a lease term of eleven years.
(3)Purchase obligations primarily represent outstanding purchase orders for
purchases of software license and support fees, public cloud infrastructure and
hosting fees, corporate health insurance costs, marketing activities,
accounting, legal and contractor fees and computer hardware and software costs.
(4)Represents the provisional one-time transition tax as a result of the Tax Act
which we have elected to pay over eight years. 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 for additional details.
(5)Other long-term obligations on our balance sheet at December 31, 2020
included non-current income tax liabilities of $32.7 million , which are
primarily related to unrecognized tax benefits. We have not included this amount
in the table above because we cannot reasonably estimate the period during which
this obligation may be incurred, if at all.
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. The impact
from the rapidly changing market and economic conditions due to the COVID-19
pandemic on our business, results of operations and financial condition is
uncertain. We have made estimates of the impact of COVID-19 within our financial
statements as of and for the year ended December 31, 2020 which did not result
in material adjustments. The estimates assessed included, but were not limited
to, allowances for credit losses, the carrying values of goodwill and intangible
assets and other long-lived assets, valuation allowances for tax assets and
revenue recognition. 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
The purchase price of our acquired businesses is allocated to the assets
acquired and the liabilities assumed based on their estimated fair values, with
the excess recorded as goodwill. 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. The valuation 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. Unanticipated events and circumstances may
occur that could affect the accuracy or validity of such assumptions, estimates
or actual results.
Goodwill
Our goodwill was derived from the Take Private transaction and acquisitions
where the purchase price exceeded the fair value of the net identifiable assets
acquired. Goodwill is assigned to our reporting units and tested for impairment
at least annually during the fourth quarter or sooner when circumstances
indicate an impairment may exist. An impairment of goodwill is recognized when
the carrying amount of a reporting unit exceeds its fair value. 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.
Qualitative factors include industry and market considerations, overall
financial performance, changes in management or key personnel, changes in
strategy, changes in customers and other relevant events and circumstances
affecting the reporting unit.
In the fourth quarter, we performed a qualitative assessment for our reporting
units. As of October 1, 2020 our Core IT, Application Management, ITSM and MSP
reporting units had allocated goodwill of $2.9 billion , $65.1 million , $286.2
million
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and $853.7 million , respectively. For the annual impairment analysis, we
assessed several events and circumstances that could affect the significant
inputs used to determine the fair value of our reporting units, including the
significance of the amount of excess fair value over carrying value, consistency
of operating margins and cash flows, budgeted-to-actual performance from prior
year, overall change in economic climate, changes in the industry and
competitive environment, key management turnover, and earnings quality and
sustainability. As of October 1, 2020 , there were no unanticipated changes or
negative indicators in the above qualitative factors that would impact the fair
value of our reporting units as of the annual impairment analysis date. As such,
we determined there were no indicators of impairment and that it was more likely
than not that the fair value of our reporting units was greater than their
carrying values and therefore performing the next step of impairment test was
unnecessary.
In December 2020 , subsequent to our annual goodwill impairment analysis, we
became aware that we were the target of a cybersecurity attack that involved the
insertion of a vulnerability within our Orion Software Platform, which, if
present and activated, could potentially allow an attacker to compromise the
server on which the Orion products run. The Orion Software Platform is part of
our portfolio of products in our Core IT reporting unit. We considered the
impact of the Cyber Incident on our evaluation of goodwill impairment indicators
made during our October 1, 2020 annual test. As part of the analysis, we
considered the decline in the stock price subsequent to the Cyber Incident and
estimated impacts to new license sales, maintenance renewals and incremental
costs as a result of the Cyber Incident and determined it appropriate to perform
a quantitative assessment of our reporting units as of December 31, 2020 . As of
December 31, 2020 our Core IT, Application Management, ITSM and MSP reporting
units had allocated goodwill of $3.0 billion , $61.6 million , $286.2 million and
$874.1 million , respectively. We also engaged a third-party valuation specialist
to assist in the performance of the impairment analysis of our reporting units.
For the quantitative goodwill impairment analysis, we utilized a combination of
both an income and market approach to evaluate each of our reporting units. The
income approach is based on the present value of projected cash flows and a
terminal value. The discounted cash flow models reflect our assumptions
regarding revenue growth rates, estimated implications of the Cyber Incident to
our cost structure, economic and market trends and other expectations about the
anticipated operating results of our reporting units. We discounted the
estimated cash flows for each of the reporting units using rates that represent
a market participant's weighted average cost of capital commensurate with the
reporting unit's underlying business operations and utilized discount rates of
9%, 11%, 12% and 10% for our Core IT, Application Management, ITSM and MSP
reporting units, respectively. The market approach develops an indication of
fair value by calculating average market pricing multiples of revenues and
EBITDA for selected peer publicly-traded companies. The developed multiples were
applied to applicable financial measures of the respective reporting unit to
determine an estimated fair value. We applied a 66.7% weighting to the income
approach and a 33.3% weighting to the market approach to arrive at the total
fair value used for impairment testing. We applied a greater weighting to the
income approach as we believe the income approach is a better indicator of fair
value by using projected cash flows of the reporting units being valued. After
determining the fair value of each of our reporting units, we reconciled the
aggregate fair values of the reporting units to the Company's market
capitalization as of December 31, 2020 . As a result of the impairment analysis,
our Core IT and ITSM reporting units were determined to have fair values that
exceeded their carrying values by approximately 15.6% and 17.4%, respectively,
and therefore no impairment was recognized. The other reporting units' fair
values significantly exceed their carrying values.
Fair value determinations of our reporting units require considerable judgment
and are sensitive to changes in underlying assumptions and factors. As a result,
there can be no assurance that the estimates and assumptions made for purposes
of the quantitative goodwill impairment tests will prove to be an accurate
prediction of future results. Examples of events or circumstances that could
reasonably be expected to negatively affect the underlying key assumptions and
ultimately impact the estimated fair value of our Core IT and ITSM reporting
units may include such items as: (i) a decrease in future cash flows due to
lower than expected license sales or maintenance renewals and higher than
estimated costs to respond to the cybersecurity attack, (ii) higher than
expected customer attrition resulting from customer concerns related to the
cyber matter, (iii) adverse loss exposure from claims, fines or penalties from
the Cyber Incident; and (iv) volatility in the equity and debt markets or other
macroeconomic factors which could result in a higher weighted-average cost of
capital. Accordingly, if our current cash flow assumptions are not realized, it
is possible that an impairment charge may be recorded in the future.
Identifiable Intangible Assets
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.
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Revenue Recognition
We generate revenue from fees received for subscriptions, the sale of
maintenance services associated with our perpetual license products and the sale
of perpetual license products. We recognize revenue related to contracts from
customers when we transfer promised goods or services to customers in an amount
that reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services. This is determined by following a
five-step process which includes (1) identifying the contract with a customer,
(2) identifying the performance obligations in the contract, (3) determining the
transaction price, (4) allocating the transaction price and (5) recognizing
revenue when or as we satisfy a performance obligation.
We identify performance obligations in a contract based on the goods and
services that will be transferred to the customer that are identifiable from
other promises in the contract, or distinct. If not considered distinct, the
promised goods or services are combined with other goods or services and
accounted for as a combined performance obligation. Determining the distinct
performance obligations in a contract requires judgment. Our performance
obligations primarily include perpetual and time-based licenses, maintenance
support including unspecified upgrades or enhancements to new versions of our
software products and SaaS offerings.
We allocate the transaction price of the contract to each distinct performance
obligation based on a relative standalone selling price basis. Determining
standalone selling prices for our performance obligations requires judgment and
are based on multiple factors including, but not limited to historical selling
prices and discounting practices for products and services, internal pricing
policies and pricing practices in different regions and through different sales
channels. For our subscription products and maintenance services, our standalone
selling prices are generally observable using standalone sales or renewals. For
our perpetual and time-based license products, given there are no observable
standalone sales, we estimate our standalone selling prices by evaluating our
historical pricing and discounting practices in observable bundled transactions.
We review the standalone selling price for our performance obligations
periodically and update, if needed, to ensure that the methodology utilized
reflects our current pricing practices.
Stock-Based Compensation
We have granted our employees, directors and certain contractors stock-based
incentive awards. Our stock awards vest on service-based or performance-based
vesting conditions. These awards are in the form of stock options, restricted
stock and restricted stock units. 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 that can be subjective 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.
In addition, we estimate the probability of the performance-based awards vesting
upon the achievement of the specified performance targets at each reporting
period. Based on the extent to which the performance targets are achieved,
shares vest at a specified percent of the target award amount. 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. Because the actual number of shares to be awarded is not
known until the end of the performance period, the actual compensation expense
related to these awards could differ from our current expectations.
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.
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Table of Contents 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 ofDecember 31, 2020 , we had a valuation allowance of$14.5 million . During the year endedDecember 31, 2020 , we completed an intra-group transfer of certain of our intellectual property rights to our Irish subsidiary which resulted in the recognition of a deferred tax asset and related tax benefit of$138.2 million based on the current fair value of the intellectual property transferred. We applied significant judgment when determining the fair value of the intellectual property, which serves as the tax basis of the deferred tax asset, and in evaluating the associated tax laws in the applicable jurisdictions. The fair value of the intellectual property is based on the present value of projected cash flows related to the intellectual property, which reflects management's assumptions regarding projected revenues, operating expenses and discount rate. The deferred tax asset and the tax benefit were measured based on the Irish tax rate expected to apply in the years the asset will be recovered. We expect to realize the deferred tax asset resulting from the transfer of the intellectual property rights and will assess the realizability of the deferred tax asset quarterly. Unanticipated events and circumstances may occur that could affect either the accuracy or validity of such assumptions, estimates or actual results. The sustainability of our future tax benefits is dependent upon the acceptance of the valuation estimates and assumptions by the taxing authorities. Loss Contingencies We account for claims and contingencies in accordance with authoritative guidance that requires we record an estimated loss from a claim or loss contingency when information available prior to issuance of our consolidated financial statements indicates a liability has been incurred at the date of our consolidated financial statements and the amount of the loss can be reasonably estimated. If we determine that it is reasonably possible but not probable that an asset has been impaired or a liability has been incurred, we disclose the amount or range of estimated loss if material or that the loss cannot be reasonably estimated. Accounting for claims and contingencies requires us to use our judgment. We consult with legal counsel on those issues related to litigation and seek input from other experts and advisors with respect to matters in the ordinary course of business. We are involved in various lawsuits, claims, investigations and proceedings related to the Cyber Incident. Litigation is inherently unpredictable. However, we believe we have valid defenses with respect to legal matters pending against us. Nevertheless, cash flows or results of operations could be materially affected in any particular period by the resolution of one or more of these contingencies. See 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 for a discussion of contingencies. Off-Balance Sheet Arrangements During the year endedDecember 31, 2020 , we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Recent Accounting Pronouncements See Note 2. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K, for a full description of recent accounting pronouncements, which is incorporated herein by reference.
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