The following discussion and analysis of our financial condition and results of operations should be read in conjunction with (1) our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management's discussion and analysis of financial condition and results of operations for the year endedDecember 31, 2019 included in our Annual Report on Form 10-K, filed with theSecurities and Exchange Commission , orSEC , onFebruary 20, 2020 . This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and 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 "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "will," "would," or the negative or plural of these words or similar expressions or variations, including statements regarding our future financial and operating performance, anticipated expansion of the usage of partners to perform professional services, the increase of our subscriptions revenue as a percentage of total revenue, the fluctuation of gross margin in the short term and improvement of gross margin over time, our future capital requirements, and uncertain negative impacts that COVID-19 may have on our business, financial condition, results of operations, and changes in overall level of spending and volatility in the global economy. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions, 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 I, Item 1A of our Annual Report on Form 10-K filed with theSEC onFebruary 20, 2020 and in our other filings with theSEC . You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
We provide a low-code automation platform that accelerates the creation of high-impact business applications, enabling our customers to automate the most important aspects of their business. Global organizations use our applications to improve customer experience, achieve operational excellence, and simplify global risk management and compliance. With our platform, organizations can rapidly and easily design, build, and implement powerful, enterprise-grade custom applications through our intuitive, visual interface with little or no coding required. Our customers have used applications built on our platform to launch new business lines, automate vital employee workflows, manage complex trading platforms, accelerate drug development, and build global procurement systems. With our platform, decision makers can reimagine their products, services, processes, and customer interactions by removing much of the complexity and many of the challenges associated with traditional approaches to software development. We have generated the majority of our revenue from sales of subscriptions, which include (1) software as a service subscriptions bundled with maintenance and support and hosting services and (2) term license subscriptions bundled with maintenance and support. Our subscription fees are based primarily on the number of users who access and utilize the applications built on our platform or, alternatively, non-user based single application licenses. Our customer contract terms generally vary from one to three years with most providing for payment in advance on an annual, quarterly, or monthly basis. Due to the variability of our billing terms and the episodic nature of our customers purchasing additional subscriptions, we do not believe changes in our deferred revenue in a given period are directly correlated with our revenue growth. Since inception, we have invested in our professional services organization to help ensure customers are able to build and deploy applications on our platform. We have several strategic partnerships, including withKPMG , PwC, Accenture, and Deloitte, for them to refer customers to us in order to purchase subscriptions and then to provide professional services directly to the customers using our platform. We intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. In addition, over time we expect professional services revenue as a percentage of total revenue to decline as we increasingly rely on strategic partners to help our customers deploy our software. We believe our 25 --------------------------------------------------------------------------------
investment in professional services, including strategic partners building their practices around Appian, will drive increased adoption of our platform.
Our customers include financial services, life sciences, government, telecommunications, media, energy, manufacturing, and transportation organizations. Generally, our sales force targets its efforts on organizations with over 2,000 employees and$2 billion in annual revenue. Revenue from government agencies represented 19.9% and 17.9% of our total revenue in the three and nine months endedSeptember 30, 2020 , respectively, as compared to 19.5% and 18.0% of our total revenue in the three and nine months endedSeptember 30, 2019 , respectively. No single end-customer accounted for more than 10% of our total revenue in the three and nine months endedSeptember 30, 2020 orSeptember 30, 2019 . Our platform supports multiple languages to facilitate collaboration and address challenges in multi-national organizations. We offer our platform globally. In the three and nine months endedSeptember 30, 2020 , 32.2% and 34.0%, respectively, of our total revenue was generated from customers outside ofthe United States as compared to 31.0% and 31.9% in the three and nine months endedSeptember 30, 2019 , respectively. As ofSeptember 30, 2020 , we operated in 12 countries. We believe we have a significant opportunity to grow our international footprint. We are investing in new geographies, including through investment in direct and indirect sales channels, professional services, and customer support and implementation partners.
Basis of Reporting - ASC 606
We adopted ASC 606, the new revenue recognition guidance, onJanuary 1, 2019 using the modified retrospective method. Under this method of adoption, we recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of accumulated deficit and applied the new standard only to contracts that were not completed prior toJanuary 1, 2019 . Because we were an emerging growth company untilDecember 31, 2019 , the Jumpstart Our Business Startups Act allowed us to delay adoption of ASC 606 until such time it was made applicable to private companies. We elected to use this extended transition period, and accordingly, did not report revenues under ASC 606 in our Quarterly Reports on Form 10-Q during 2019. Refer to our Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSEC onFebruary 20, 2020 , for a complete reconciliation of our revenues under the old and new guidance. Prior period amounts in this Form 10-Q have been recast as if we had reported under ASC 606 for the applicable periods.
Recent Developments
Public Offering
InJune 2020 , we completed an underwritten public offering of 2,500,000 shares of our Class A common stock, of which 1,931,206 shares of Class A common stock were sold by us and 568,794 shares of Class A common stock were sold by existing stockholders. The underwriter purchased the shares from us and the selling stockholders at a price of$56.50 per share. Our net proceeds from the offering were$107.9 million , after deducting underwriting discounts and commissions and offering expenses. We did not receive any of the proceeds from the sale of shares by the selling stockholders.
COVID-19
Beginning in late 2019 and continuing into the third quarter of 2020, the outbreak of the novel coronavirus disease, or COVID-19, has resulted in the declaration of a global pandemic and adversely affected economic activity across virtually all sectors and industries on a local, national, and global scale. The impact of COVID-19 on the economy and our business continues to be a fluid situation. Operationally, we remain focused on supporting our customers, employees, and communities during this time. We have responded quickly to adopt a virtual corporate strategy consisting of enabling most of our employees to work productively from home while continuing to guard the health and safety of our teams, support our customers, and mitigate risk. We are focused on ensuring continuity for our customers. To the extent possible, we are conducting business as usual, with necessary or advisable modifications to employee travel, employee work locations, and marketing events. 26 -------------------------------------------------------------------------------- ThroughSeptember 30, 2020 , we have not seen a meaningful adverse impact to our financial position, results of operations, and cash flows and liquidity as a result of COVID-19. While the verticals from which we have historically generated the majority of our revenue have been less impacted by COVID-19 to date, there may be impacts to our financial condition and results of operations in the fourth quarter of 2020 and beyond as a result of reduced demand for our products and services and longer sales cycles. The ultimate impact of COVID-19 on our business is not estimable at this time and will be largely dependent upon a number of factors outside of our control including the extent and duration of the outbreak as well as any mitigating actions which may be undertaken by global governments and the general public.
Our Business Model
Our business model focuses on maximizing the lifetime value of customer relationships, which is a function of the duration of a customer's deployment of Appian as well as the price and number of subscriptions of Appian that a customer purchases. We incur significant customer acquisition costs, including expenses associated with hiring new sales representatives, who generally take more than one year to become productive given the length of our sales cycle, and marketing costs, all of which, with the exception of sales commissions, are expensed as incurred.
Key Factors Affecting Our Performance
The following are several key factors that affect our performance:
•Market Adoption of Our Platform. Our ability to grow our customer base and drive market adoption of our platform is affected by the pace at which organizations digitally transform. We expect our revenue growth will be primarily driven by the pace of adoption and penetration of our platform. We offer a leading custom software automation platform and intend to continue to invest to expand our customer base. The degree to which prospective customers recognize the need for low-code software that enables organizations to digitally transform, and subsequently allocate budget dollars to purchase our software, will drive our ability to acquire new customers and increase sales to existing customers, which, in turn, will affect our future financial performance. •Growth of Our Customer Base. We believe we have a substantial opportunity to grow our customer base. We define a customer as an entity with an active subscription or maintenance and support contract related to a perpetual software license as of the specified measurement date. To the extent we contract with one or more entities under common control, we count those entities as separate customers. We have aggressively invested, and intend to continue to invest, in our sales force in order to drive sales to new customers. In particular, we have recently made, and plan to continue to make, investments to enhance the expertise of our sales and marketing organization within our key industry verticals of financial services, life sciences, and government. In addition, we have established relationships with strategic partners who work with organizations undergoing digital transformations. Our ability to continue to grow our customer base is dependent, in part, upon our ability to compete within the increasingly competitive markets in which we participate. •Further Penetration of Existing Customers. Our sales force seeks to generate additional revenue from existing customers by adding new users to our platform. Many of our customers begin by building a single application and then grow to build dozens of applications on our platform. Generally, the development of new applications on our platform results in the expansion of our user base within an organization and a corresponding increase in revenue to us because we charge subscription fees on a per-user basis for the significant majority of our customer contracts. As a result of this "land and expand" strategy, we have generated significant additional revenue from our customer base. Our ability to increase sales to existing customers will depend on a number of factors, including the size of our sales force and professional services teams, customers' level of satisfaction with our platform and professional services, pricing, economic conditions, and our customers' overall spending levels. We have also refocused some of our professional services personnel to become customer success managers. Their role is to ensure the customer realizes value from our platform and support the "land and expand" strategy versus delivering billable hours. •Mix of Subscription and Professional Services Revenue. We believe our professional services have driven customer success and facilitated the adoption of our platform by customers. During the initial period of deployment by a customer, we generally provide a greater amount of support in building applications and training than later in the deployment, with a typical engagement extending from two to six months. At the same time, many of our customers have historically purchased subscriptions only for a limited set of their total potential end users. As a result of these factors, the proportion of 27 -------------------------------------------------------------------------------- total revenue for a customer associated with professional services is relatively high during the initial deployment period. Over time, as the need for professional services associated with user deployments decreases and the number of end users increases, we expect subscriptions revenue as a percentage of total revenue to increase. In addition, we intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. These partners perform professional services with respect to any new service contracts they sign. As the usage of partners expands, we expect the proportion of our total revenue from subscriptions to increase over time relative to professional services. For the three and nine months endedSeptember 30, 2020 , 65.7% and 64.0% of our revenue, respectively, was derived from sales of subscriptions while the remaining 34.3% and 36.0%, respectively, was derived from the sale of professional services. For the three and nine months endedSeptember 30, 2019 , 57.1% and 56.9% of our revenue, respectively, was derived from sales of subscriptions while the remaining 42.9% and 43.1%, respectively, was derived from the sale of professional services. •Investments in Growth. We have made and plan to continue to make investments for long-term growth, including investment in our platform and infrastructure to continuously maximize the power and simplicity of the platform to meet the evolving needs of our customers and to take advantage of our market opportunity. In addition, we continue to pursue strategic acquisitions that enhance our product offerings as evidenced by our recent acquisition of Novayre. We also intend to continue to invest in sales and marketing as we further expand our sales teams, increase our marketing activities, and grow our international operations.
Key Metrics
We monitor the following metrics to help us measure and evaluate the effectiveness of our operations. All dollar amounts are presented in thousands.
Cloud Subscription Revenue Three Months Ended
2020 2019 2020 2019 Cloud subscription revenue$ 34,312 $ 24,573 $ 92,282 $ 68,647 Cloud subscription revenue includes SaaS subscriptions bundled with maintenance and support and hosting services. As we generally sell our SaaS subscriptions on a per-user basis, our cloud subscription revenue for any customer is primarily determined by the number of users who access and utilize the applications built on our platform as well as the price paid. We believe increasing cloud subscription revenue is an indicator of the demand for our platform, the pace at which the market for our solutions is growing, the productivity of our sales force and strategic relationships in growing our customer base, and our ability to further penetrate our existing customer base.
Cloud Subscription Revenue Retention Rate
As ofSeptember 30, 2020
2019
Cloud subscription revenue retention rate 115 %
121 %
A key factor to our success is the renewal and expansion of subscription agreements with our existing customers. We calculate this metric over a set of customers who have been with us for at least one full year. To calculate our cloud subscription revenue retention rate for a particular trailing 12-month period, we first establish the recurring cloud subscription revenue for the previous trailing 12-month period. This effectively represents recurring dollars we should expect in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period without any expansion or contraction. We subsequently measure the recurring cloud subscription revenue in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period. Cloud subscription revenue retention rate is then calculated by dividing the aggregate recurring cloud subscription revenue in the current trailing 12-month period by the previous trailing 12-month period. This calculation includes the impact on our revenue from customer non-renewals, pricing changes, and growth in the number of users on our platform. Our cloud subscription revenue retention rate can fluctuate from period to period due to large 28 --------------------------------------------------------------------------------
customer contracts in any given period. The cloud subscription revenue retention
rate as of
Key Components of Results of Operations
Revenue
We generate revenue primarily through sales of subscriptions to our platform as well as professional services. We generally sell our software on a per-user basis and, to a lesser degree, non-user based single application licenses. We generally bill customers and collect payment for subscriptions to our platform in advance on an annual, quarterly, or monthly basis. In certain instances, we have had customers pay their entire contract value up front.
Our revenue is comprised of the following:
Subscriptions
Subscriptions revenue is primarily derived from:
•SaaS subscriptions bundled with maintenance and support and hosting services; and
•On-premise term license subscriptions bundled with maintenance and support.
Our maintenance and support agreements provide customers with the right to unspecified software upgrades, maintenance releases and patches released during the term of the maintenance and support agreement on a when-and-if-available basis, and rights to technical support. When our platform is deployed within a customer's own data center or private cloud, it is installed on the customer's infrastructure and generally offered as a term license. When our platform is delivered as a SaaS subscription, we handle its operational needs in third-party hosted data centers.
Professional Services
Our professional services revenue is comprised of fees for consulting services, including application development and deployment assistance and training related to our platform. Over time, as the need for professional services associated with user deployments decreases and the number of end users increases, we expect professional services revenue as a percentage of total revenue to decrease. Additionally, if there is a decline in our procurement of new customers as a result of the COVID-19 pandemic, we may also see a similar decline in professional services revenue. We have several strategic partnerships, including withKPMG , PwC, Accenture, and Deloitte. Our agreements with our strategic partners have indefinite terms and may be terminated for convenience by either party. We intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. These partners refer software subscription customers to us and generally perform professional services with respect to any new service contracts they originate, increasing our subscriptions revenue without any change to our professional services revenue. As we expand the network of strategic partners, we expect professional services revenue to decline as a percentage of total revenue over time since our strategic partners may perform professional services associated with software subscriptions that we sell.
Cost of Revenue
Subscriptions
Cost of subscriptions revenue consists primarily of fees paid to our third-party managed hosting providers and other third-party service providers, personnel costs, including payroll and benefits for our technology operations and customer support teams, and allocated facility costs and overhead. We expect cost of revenue to continue to increase in absolute dollars for the foreseeable future as our customer base grows. 29 --------------------------------------------------------------------------------
Professional Services
Cost of professional services revenue includes all direct and indirect costs to deliver our professional services and training, including employee compensation for our global professional services and training personnel, travel costs, third-party contractor costs, and allocated facility costs and overhead as well as the costs of billable expenses such as travel and lodging. The unpredictability of the timing of entering into significant professional services agreements sold on a standalone basis may cause significant fluctuations in our quarterly financial results.
Gross Margin
Gross profit and gross margin, or gross profit as a percentage of total revenue, have been, and will continue to be, affected by various factors, including the mix of SaaS subscriptions and on-premise term license subscriptions, the mix of total subscriptions revenue and professional services revenue, subscription pricing, the costs associated with third-party hosting facilities, and the extent to which we expand our professional services to support future growth. Our gross margin may fluctuate from period to period based on the above factors.
Subscriptions Gross Margin
Subscriptions gross margin is primarily affected by the growth in our subscriptions revenue as compared to the growth in, and timing of, costs to support such revenue. We expect to continue to invest in customer support and SaaS operations to support growth in the business, and the timing of those investments is expected to cause gross margins to fluctuate in the short term but improve over time.
Professional Services Gross Margin
Professional services gross margin is affected by the growth in our professional services revenue as compared to the growth in, and timing of, the cost of our professional services organization as we continue to invest in the growth of our business. Professional services gross margin is impacted by the amount of services performed by subcontractors as opposed to internal resources. Our professional services gross margin is also impacted by the amount of services performed by partners as opposed to internal resources. Operating Expenses Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Salaries, bonuses, and other personnel-related costs are the most significant components of each of these expense categories. In general, our operating expenses are expected to continue to increase as we invest resources in growing our various teams.
Sales and Marketing Expense
Sales and marketing expense primarily includes personnel costs, including salaries, bonuses, commissions, stock-based compensation, and other personnel costs related to sales teams. Additional expenses in this category include travel and entertainment, marketing and promotional events, marketing activities, subcontracting fees, and allocated facility costs and overhead.
In order to continue to grow our business, geographical footprint, and brand awareness, we expect sales and marketing expense to increase in absolute dollars as we continue to invest to acquire new customers and further expand usage of our platform within our existing customer base.
Research and Development Expense
Research and development expense consists primarily of personnel costs for our employees who develop and enhance our platform, including salaries, bonuses, stock-based compensation, and other personnel costs. Also included are non-personnel costs such as subcontracting, consulting and professional fees to third party development resources, allocated facility costs, and overhead. 30 -------------------------------------------------------------------------------- Our research and development efforts are focused on enhancing the speed and power of our software platform. We expect research and development expenses to continue to increase as they are critical to maintain and improve the quality of applications and our competitive position.
General and Administrative Expense
General and administrative expense consists primarily of personnel costs, including salaries, bonuses, stock-based compensation, and other personnel costs for our administrative, legal, information technology, human resources, finance and accounting employees, and executives. Additional expenses included in this category are non-personnel costs such as travel-related expenses, contracting and professional fees, audit fees, tax services and legal fees, insurance and other corporate expenses, allocated facility costs and overhead, and depreciation and amortization costs.
We expect our general and administrative expense to increase in absolute dollars as we continue to support our growth.
Other (Income) Expense
Other (Income) Expense, Net
Other (income) expense, net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates, interest income on our cash and cash equivalents, and gains or losses on the disposal of property and equipment. Interest Expense
Interest expense consists primarily of interest on our finance leases and debt, unused credit facility fees, and commitment fees on our letters of credit.
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Results of Operations
The following table sets forth our consolidated statement of operations data (in thousands):
Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue Subscriptions$ 50,760 $ 37,774 $ 142,614 $ 109,191 Professional services 26,544 28,381 80,329 82,543 Total revenue 77,304 66,155 222,943 191,734 Cost of revenue Subscriptions(1) 5,101 4,484 15,185 12,105 Professional services(1) 16,450 19,467 51,641 58,963 Total cost of revenue 21,551 23,951 66,826 71,068 Gross profit 55,753 42,204 156,117 120,666 Operating expenses Sales and marketing(1) 31,633 27,603 94,891 86,186 Research and development(1) 18,150 15,697 51,366 42,418 General and administrative(1) 13,485 11,191 38,076 29,468 Total operating expenses 63,268 54,491 184,333 158,072 Operating loss (7,515) (12,287) (28,216) (37,406) Other (income) expense Other (income) expense, net (4,277) 2,262 (1,845) 1,881 Interest expense 119 96 390 236 Total other (income) expense (4,158) 2,358 (1,455) 2,117 Loss before income taxes (3,357) (14,645) (26,761) (39,523) Income tax expense 255 5 335 394 Net loss$ (3,612) $ (14,650) $ (27,096) $ (39,917) (1) Stock-based compensation as a component of these line items is as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Cost of revenue Subscriptions$ 236 $ 147 $ 678 $ 462 Professional services 406 243 935 2,461 Operating expenses Sales and marketing 427 776 1,837 3,971 Research and development 669 433 1,841 2,983 General and administrative 1,840 1,542 5,377 3,178
Total stock-based compensation expense
$ 10,668 $ 13,055 32
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The following table sets forth our consolidated statement of operations data expressed as a percentage of total revenue:
Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue Subscriptions 65.7 % 57.1 % 64.0 % 56.9 % Professional services 34.3 42.9 36.0 43.1 Total revenue 100.0 100.0 100.0 100.0 Cost of revenue Subscriptions 6.6 6.8 6.8 6.3 Professional services 21.3 29.4 23.2 30.8 Total cost of revenue 27.9 36.2 30.0 37.1 Gross profit 72.1 63.8 70.0 62.9 Operating expenses Sales and marketing 40.9 41.7 42.6 45.0 Research and development 23.5 23.7 23.0 22.1 General and administrative 17.4 16.9 17.1 15.4 Total operating expenses 81.8 82.4 82.7 82.4 Operating loss (9.7) (18.6) (12.7) (19.5) Other (income) expense Other (income) expense, net (5.5) 3.4 (0.8) 1.0 Interest expense 0.2 0.1 0.2 0.1 Total other (income) expense (5.4) 3.6 (0.7) 1.1 Loss before income taxes (4.3) (22.1) (12.0) (20.6) Income tax expense 0.3 - 0.2 0.2 Net loss (4.7) % (22.1) % (12.2) % (20.8) %
Comparison of the Three Months Ended
Revenue Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Revenue Subscriptions $ 50,760$ 37,774 34.4 % Professional services 26,544 28,381 (6.5) % Total revenue $ 77,304$ 66,155 16.9 % Total revenue increased$11.1 million , or 16.9%, in the three months endedSeptember 30, 2020 compared to the same period in 2019 due to an increase in our subscriptions revenue of$13.0 million , partially offset by a decrease in our professional services revenue of$1.8 million . The increase in subscriptions revenue was driven largely by a$9.7 million increase in cloud subscription revenue and a$2.6 million increase in on-premise software revenue. With respect to new versus existing customers, there was a$9.2 million increase stemming from expanded deployments and corresponding sales of additional subscriptions to existing customers while the remaining increase of$3.8 million was the result of sales of subscriptions to new customers. The decrease in professional services revenue was due primarily to a$7.5 million decrease in revenue from existing customers which was substantially offset by a$5.7 million increase in sales to new customers. Further contributing to the 33 -------------------------------------------------------------------------------- decrease in professional services revenue was our increased usage of partners to perform professional services in the three months endedSeptember 30, 2020 as compared to the same period in 2019, which has resulted in increases to our subscriptions revenue without any change to our professional services revenue. Cost of Revenue Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Cost of revenue Subscriptions $ 5,101$ 4,484 13.8 % Professional services 16,450 19,467 (15.5) % Total cost of revenue$ 21,551 $ 23,951 (10.0) % Subscriptions gross margin 90.0 % 88.1 % Professional services gross margin 38.0 % 31.4 % Total gross margin 72.1 % 63.8 % Cost of revenue decreased$2.4 million , or 10.0%, in the three months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to a$3.4 million decrease in contractor costs coupled with a$1.2 million decrease in billable expenses and a$0.2 million decrease in facility and overhead costs. These decreases were partially offset by a$1.7 million increase in professional services and product support personnel costs and a$0.6 million increase in other cost of revenue. Contractor costs decreased in the three months endedSeptember 30, 2020 compared to the same period in 2019 because of a decrease in the usage of subcontractors for professional services engagements. Billable expenses decreased primarily due to lower travel and entertainment related expenses as a result of our shift to largely remote work while the decrease in facility and overhead costs was due largely to a reduction in rent expense. Personnel costs increased due to an increase in professional services and product support staff headcount of 15.4% fromSeptember 30, 2019 toSeptember 30, 2020 . The increase in other cost of revenue was due to increased hosting costs as sales of our cloud offering increased in the three months endedSeptember 30, 2020 . Subscriptions gross margin increased to 90.0% for the three months endedSeptember 30, 2020 compared to 88.1% in the same period in 2019 due to an increase in subscriptions revenue during the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 , partially offset by increased hosting costs as sales of our cloud offering increased and became a larger proportion of our overall subscriptions revenue. Professional services gross margin increased to 38.0% for the three months endedSeptember 30, 2020 compared to 31.4% in the same period in 2019 due to a decrease in the usage of subcontractors for professional services engagements, a decrease in travel and entertainment related expenses, and a decrease in rent expenses. Due to the higher percentage of subscriptions revenue for the comparable periods and the aforementioned declines in professional services expenses, gross margin rose to 72.1% in the three months endedSeptember 30, 2020 as compared to 63.8% in the same period in 2019. Sales and Marketing Expense Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Sales and marketing $ 31,633$ 27,603 14.6 % % of revenue 40.9 % 41.7 % Sales and marketing expense increased$4.0 million , or 14.6%, in the three months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to a$4.4 million increase in sales and marketing personnel costs, a$1.0 million increase in marketing costs, and a$0.8 million increase in professional fees, which were partially offset by a$2.1 million decrease in 34 -------------------------------------------------------------------------------- facility and overhead costs. Personnel costs increased due to an increase in sales and marketing personnel headcount of 12.1% fromSeptember 30, 2019 toSeptember 30, 2020 and increased sales commissions driven by our subscriptions revenue growth, partially offset by a$0.3 million decrease in stock-based compensation expense. Marketing costs increased largely due to increased advertising and business development costs during the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 . Professional fees increased due to an increase in consulting fees and contract labor to support our growth. Facility and overhead costs decreased due to lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020.
Research and Development Expense
Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Research and development $ 18,150$ 15,697 15.6 % % of revenue 23.5 % 23.7 % Research and development expense increased$2.5 million , or 15.6%, in the three months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to a$3.1 million increase in research and development personnel costs, partially offset by a$0.4 million decrease in facility and overhead costs and a$0.1 million decrease in professional fees. Personnel costs increased due to an increase in research and development personnel headcount by 13.5% fromSeptember 30, 2019 toSeptember 30, 2020 . Facility and overhead costs decreased due to non-recurring charges which were incurred in 2019 to support our personnel growth coupled with lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Professional fees decreased due to a decrease in consulting fees.
General and Administrative Expense
Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) General and administrative expense $ 13,485$ 11,191 20.5 % % of revenue 17.4 % 16.9 % General and administrative expense increased$2.3 million , or 20.5%, in the three months endedSeptember 30, 2020 compared to the same period in 2019 due to a$1.3 million increase in general and administrative personnel costs, a$0.6 million increase in facility and overhead costs, and a$0.4 million increase in professional fees. Personnel costs increased due to an increase in general and administrative personnel headcount by 30.7% fromSeptember 30, 2019 toSeptember 30, 2020 . Facility and overhead costs increased primarily due to an increase in bad debt expense during the three months endedSeptember 30, 2020 , partially offset by lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Professional fees increased due to increased legal fees. Other (Income) Expense, Net Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Other (income) expense, net $ (4,277)$ 2,262 *** % of revenue (5.5) % 3.4 %
*** - Indicates a percentage that is not meaningful
35 -------------------------------------------------------------------------------- Other (income) expense, net increased by$6.5 million in the three months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to$3.3 million in foreign exchange gains in the three months endedSeptember 30, 2020 compared to$2.4 million in foreign exchange losses in the three months endedSeptember 30, 2019 . The increase in foreign exchange gains was primarily due to currency fluctuations of the Australian dollar, British Pound Sterling, Euro, Swedish krona,Singapore dollar, and Swiss franc versus theU.S. dollar during the three months endedSeptember 30, 2020 compared to the same period in 2019. Additionally, we recognized$1.0 million in other income during the three months endedSeptember 30, 2020 due to a payment received from a state government as a result of our achievement of certain job creation and capital investment goals. Interest Expense Three Months Ended September 30, 2020 2019 % Change (dollars in thousands) Interest expense $ 119$ 96 24.0% % of revenue 0.2 % 0.1 %
Interest expense increased by a nominal amount in the three months ended
Comparison of the Nine Months Ended
Revenue Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) Revenue Subscriptions$ 142,614 $ 109,191 30.6 % Professional services 80,329 82,543 (2.7) % Total revenue$ 222,943 $ 191,734 16.3 % Total revenue increased$31.2 million , or 16.3%, in the nine months endedSeptember 30, 2020 compared to the same period in 2019 due to an increase in our subscriptions revenue of$33.4 million which was partially offset by a decrease in our professional services revenue of$2.2 million . Of the increase in subscriptions revenue,$23.6 million , was attributable to cloud subscription revenue while$8.1 million , was attributable to on-premise software revenue. With respect to new versus existing customers,$24.4 million of the increase in revenue stemmed from expanded deployments and corresponding sales of additional subscriptions to existing customers while the remaining increase of$9.0 million was the result of sales of subscriptions to new customers,$2.8 million of which related to a three year on-premise contract which closed in the first quarter of 2020. The decrease in professional services revenue was due primarily to a$15.6 million decrease in revenue from existing customers which was substantially offset by$13.4 million in sales to new customers. Further contributing to the decrease in professional services revenue was our increased usage of partners to perform professional services in the nine months endedSeptember 30, 2020 as compared to the same period in 2019, which has resulted in increases to our subscriptions revenue without any change to our professional services revenue. 36 --------------------------------------------------------------------------------
Cost of Revenue Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) Cost of revenue Subscriptions$ 15,185 $ 12,105 25.4 % Professional services 51,641 58,963 (12.4) % Total cost of revenue$ 66,826 $ 71,068 (6.0) % Subscriptions gross margin 89.4 % 88.9 % Professional services gross margin 35.7 % 28.6 % Total gross margin 70.0 % 62.9 % Cost of revenue decreased$4.2 million , or 6.0%, in the nine months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to an$8.2 million decrease in contractor costs, a$2.6 million decrease in billable expenses, and a$0.3 million decrease in facility and overhead costs. These decreases were partially offset by a$4.6 million increase in professional services and product support personnel costs and a$2.2 million increase in other cost of revenue. Contractor costs decreased in the nine months endedSeptember 30, 2020 compared to the same period in 2019 because of a decrease in the usage of subcontractors for professional service engagements. Billable expenses decreased primarily due to lower travel and entertainment related expenses as a result of our shift to largely remote work while the decrease in facility and overhead costs was due largely to a reduction in rent expense. Personnel costs increased due to an increase in professional services and product support staff personnel headcount of 15.4% fromSeptember 30, 2019 toSeptember 30, 2020 . The increase in other cost of revenue was due to increased hosting costs as sales of our cloud offering increased in the nine months endedSeptember 30, 2020 . Subscriptions gross margin was 89.4% for the nine months endedSeptember 30, 2020 compared to 88.9% in the same period in 2019 due to an increase in subscriptions revenue during the nine months endedSeptember 30, 2020 , partially offset by increased hosting costs as sales of our cloud offering increased and became a larger proportion of our overall subscriptions revenue. Professional services gross margin was 35.7% for the nine months endedSeptember 30, 2020 compared to 28.6% in the same period in 2019 due to a decrease in the usage of subcontractors for professional services engagements, a decrease in travel and entertainment related expenses, a decrease in rent expenses, and a$1.3 million decrease in stock-based compensation expense due to the vesting of restricted stock units granted to three of our co-founders during the nine months endedSeptember 30, 2019 . Due to the higher percentage of subscriptions revenue for the comparable periods as well as the aforementioned declines in professional services expenses, gross margin was 70.0% in the nine months endedSeptember 30, 2020 as compared to 62.9% in the same period in 2019. Sales and Marketing Expense Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) Sales and marketing $ 94,891$ 86,186 10.1 % % of revenue 42.6 % 45.0 % Sales and marketing expense increased$8.7 million , or 10.1%, in the nine months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to a$12.4 million increase in sales and marketing personnel costs and a$1.8 million increase in professional fees, which were partially offset by a$4.5 million decrease in facility and overhead costs and a$0.9 million decrease in marketing costs. Personnel costs increased due to an increase in sales and marketing personnel headcount by 12.1% fromSeptember 30, 2019 toSeptember 30, 2020 and increased sales commissions driven by our subscriptions revenue growth, partially offset by a$2.1 million decrease in stock-based compensation expense. Professional fees increased due to an 37 -------------------------------------------------------------------------------- increase in consulting fees and contract labor to support our growth. Facility and overhead costs decreased due to lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Marketing costs decreased due to reduced costs incurred as a result of moving our annual user conferenceAppian World to virtual-only as well as a reduction in the number of in-person marketing events.
Research and Development Expense
Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) Research and development $ 51,366$ 42,418 21.1 % % of revenue 23.0 % 22.1 % Research and development expense increased$8.9 million , or 21.1%, in the nine months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to a$9.6 million increase in research and development personnel costs, partially offset by a$0.4 million decrease in facility and overhead cost and a$0.2 million decrease in professional fees. Personnel costs increased due to an increase in research and development personnel headcount by 13.5% fromSeptember 30, 2019 toSeptember 30, 2020 , partially offset by a$1.1 million decrease in stock-based compensation expense. Facilities and overhead costs decreased due to non-recurring charges which were incurred in 2019 to support our personnel growth coupled with lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Professional fees decreased due to a decrease in consulting fees.
General and Administrative Expense
Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) General and administrative expense $ 38,076$ 29,468 29.2 % % of revenue 17.1 % 15.4 % General and administrative expense increased$8.6 million , or 29.2%, in the nine months endedSeptember 30, 2020 compared to the same period in 2019 due to a$5.6 million increase in general and administrative personnel costs, a$1.8 million increase in professional fees, and a$1.2 million increase in facility and overhead costs. Personnel costs increased due to an increase in general and administrative personnel headcount by 30.7% fromSeptember 30, 2019 toSeptember 30, 2020 coupled with a$2.2 million increase in stock-based compensation expense during the nine months endedSeptember 30, 2020 which was primarily attributable to a stock option to purchase 700,000 shares of our Class A common stock granted to our Chief Executive Officer inMay 2019 . Professional fees increased due to increased legal fees. Facility and overhead costs increased to support our personnel growth as well as a result of an increase in bad debt expense.
Other (Income) Expense, Net
Nine Months EndedSeptember 30, 2020
2019 % Change
(dollars in thousands) Other (income) expense, net $ (1,845)$ 1,881 *** % of revenue (0.8) % 1.0 %
*** - Indicates a percentage that is not meaningful
38 -------------------------------------------------------------------------------- Other (income) expense, net increased by$3.7 million in the nine months endedSeptember 30, 2020 compared to the same period in 2019, primarily due to$0.4 million in foreign exchange gains compared to$2.5 million in foreign exchange losses in the nine months endedSeptember 30, 2019 . The increase in foreign exchange gains was primarily due to currency fluctuations of the Euro, Swedish krona, and Swiss franc versus theU.S. dollar during the nine months endedSeptember 30, 2020 compared to the same period in 2019. Additionally, we recognized$1.0 million of other income in the nine months endedSeptember 30, 2020 due to a payment received from a state government as a result of our achievement of certain job creation and capital investment goals. Interest Expense Nine Months Ended September 30, 2020 2019 % Change (dollars in thousands) Interest expense $ 390$ 236 65.3% % of revenue 0.2 % 0.1 %
Interest expense increased by
Liquidity and Capital Resources
As of
InJune 2020 , we completed an underwritten public offering of 2,500,000 shares of our Class A common stock, of which 1,931,206 shares of Class A common stock were sold by us and 568,794 shares of Class A common stock were sold by existing stockholders. The underwriter purchased the shares from us and the selling stockholders at a price of$56.50 per share. Our net proceeds from the offering were$107.9 million , after deducting underwriting discounts and commissions and offering expenses. We did not receive any of the proceeds from the sale of shares by the selling stockholders. We believe our existing cash and cash equivalents, together with any positive cash flows from operations and available borrowings under our line of credit, will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and functions as well as platform enhancements and professional services offerings, the level of market acceptance of our applications, spending we may incur on our new headquarters, and the global economic uncertainty and financial market conditions caused by the COVID-19 pandemic and its impact on our business. In the event additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. To the extent existing cash and cash equivalents and investments and cash from operations are not sufficient to fund future activities, we may need to raise additional funds. We recently have raised and may continue to seek to raise additional funds through equity, equity-linked, or debt financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness may have rights that are senior to holders of our equity securities and could contain covenants that restrict operations. Any additional equity financing may be dilutive to our existing stockholders. We recently have, and in the future may continue to, invest or acquire stakes in complementary businesses, products, or technologies, which could also require us to seek additional equity financing, incur indebtedness, or use cash resources. We have no present binding agreements or commitments to enter into any such acquisitions. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected. 39 --------------------------------------------------------------------------------
The following table shows a summary of our cash flows for the nine months ended
Nine Months Ended
2020 2019 Cash used in operating activities $ (13,453)$ (2,880) Cash used in investing activities (7,174) (31,430) Cash provided by financing activities 110,337 105,394 Sources of Funds We have financed our operations in large part with equity and debt financing arrangements, including net proceeds of$77.8 million from our initial public offering inMay 2017 , net proceeds of$57.8 million from our underwritten public offering inAugust 2018 , net proceeds of$101.3 million from our underwritten public offering inSeptember 2019 , and net proceeds of$107.9 million from our underwritten public offering inJune 2020 . In addition, we have financed our operations through sales of subscriptions and professional services and borrowings under our credit facilities. We also financed$3.7 million of office furniture and fixtures and$0.8 million of equipment, both associated with the build out of our new headquarters. InNovember 2017 , we entered into a$20.0 million revolving line of credit with a lender. The facility matures inNovember 2022 . We may elect whether amounts drawn on the revolving line of credit bear interest at a floating rate per annum equal to either the LIBOR or the prime rate plus an additional interest rate margin that is determined by the availability of borrowings under the revolving line of credit. The additional interest rate margin will range from 2.00% to 2.50% in the case of LIBOR advances and from 1.00% to 1.50% in the case of prime rate advances. The revolving line of credit contains an unused facility fee in an amount between 0.15% and 0.25% of the average unused portion of the revolving line of credit, which is payable quarterly. The agreement contains certain customary affirmative and negative covenants and requires us to maintain (1) an adjusted quick ratio of at least 1.35 and (ii) minimum adjusted EBITDA in the amounts and for the periods set forth in the agreement. Any amounts borrowed under the credit facility are collateralized by substantially all of our assets. We were in compliance with all covenants as ofSeptember 30, 2020 . As ofSeptember 30, 2020 , we had not made any borrowings under this revolving line of credit, and we had outstanding letters of credit totaling$11.2 million in connection with securing our leased office space.
Use of Funds
Our principal uses of cash are funding operations and other working capital requirements. More recently, we have utilized cash to pay for the acquisition of an entity we believe is complementary to our business. Over the past several years, revenue has increased significantly from year to year and, as a result, cash flows from customer collections have increased. However, operating expenses have also increased as we have invested in growing our business. Our uses of cash in 2020 to date have included the acquisition of Novayre and modest capital expenditures while cash uses in 2019 included the build out of our new headquarters, which included spend approximately$21.0 million above the$18.4 million tenant improvement allowance provided by the landlord for the build out, of which$4.5 million related to office furniture and fixtures and computer hardware that has been financed. For the nine months endedSeptember 30, 2020 , the majority of the$7.2 million of cash used in investing activities was related to the acquisition of Novayre.
Historical Cash Flows
Operating Activities
For the nine months endedSeptember 30, 2020 , net cash used in operating activities of$13.5 million consisted of a net loss of$27.1 million and$2.1 million of cash used from changes in working capital, offset by$15.8 million in adjustments for non-cash items. Adjustments for non-cash items consisted primarily of stock-based compensation of$10.7 million , depreciation and amortization expense of$4.5 million , and bad debt expense of$0.8 million . The decrease in cash and cash equivalents resulting from changes in working capital primarily consisted of a$22.6 million increase in accounts receivable stemming from increased sales as well as the timing of billings and collections, a$10.5 million increase in deferred revenue as a result of 40 -------------------------------------------------------------------------------- increased subscription sales, a$5.8 million increase in accrued compensation and related benefits as a result of higher employee benefit accruals such as vacation and bonuses, a$4.3 million increase in deferred commissions due to increased sales activity, a$3.4 million increase in operating lease liabilities as a result of recognizing a new right-of-use liability related to the expanded occupancy of our headquarters building, and a$3.0 million increase in other liabilities due to the deferral of social security tax payments pursuant to the provisions of the CARES Act. These decreases to working capital were partially offset by a$4.5 million decrease in prepaid expenses and other assets and a$2.5 million decrease in accounts payable and accrued expenses, both of which were primarily due to the timing of payments. For the nine months endedSeptember 30, 2019 , net cash used in operating activities of$2.9 million consisted of a net loss of$39.9 million , offset by$16.4 million in adjustments for non-cash items and$20.7 million of cash provided by changes in working capital. Adjustments for non-cash items consisted of stock-based compensation of$13.1 million , depreciation and amortization expense of$3.3 million , a loss on disposal of equipment of$0.1 million , and bad debt expense of$0.1 million , offset by a provision for deferred income taxes of$0.2 million . The increase in cash and cash equivalents resulting from changes in working capital primarily consisted of a$23.3 million decrease in prepaid expenses and other assets, primarily due to the receipt of the non-trade receivable resulting from our tenant improvement allowance. In accordance with accounting principles generally accepted inthe United States of America , orU.S. GAAP, the$17.0 million of tenant improvement allowance reimbursements received during the nine months endedSeptember 30, 2019 were a source of cash in operating activities, whereas the capital expenditures were recorded as cash used in investing activities. There was also a$1.9 million decrease in accounts receivable due to increased cash collections and a$5.7 million increase in deferred rent, non-current, as a result of taking initial possession of the second phase of our new headquarters inFebruary 2019 and recording an additional lease incentive obligation. There was also a$2.3 million increase in deferred revenue as a result of increased subscription sales. These increases were partially offset by a$3.9 million decrease in accounts payable and accrued expenses, primarily due to the timing of payments, a$6.2 million increase in deferred commissions due to increased sales, and a$2.2 million decrease in accrued compensation and related benefits primarily due to a decrease in accrued vacation expense because of our new paid-time off policy, which took effect onJanuary 1, 2019 . There was also a$0.3 million decrease in other current liabilities.
Investing Activities
For the nine months endedSeptember 30, 2020 , net cash used in investing activities was$7.2 million which was primarily the result of$6.1 million in payments, net of cash acquired, related to the acquisition of Novayre. In addition, there were approximately$1.0 million in purchases of property and equipment.
For the nine months ended
Financing Activities
For the nine months endedSeptember 30, 2020 , net cash provided by financing activities was$110.3 million , consisting of$108.2 million in proceeds from our underwritten public offering inJune 2020 , net of underwriting discounts and commissions and the payment of offering expenses, and$3.2 million in proceeds received from stock option exercises, partially offset by$1.1 million in principal payments on finance leases. For the nine months endedSeptember 30, 2019 , net cash provided by financing activities was$105.4 million , consisting of$101.7 million in proceeds from our underwritten public offering inSeptember 2019 , net of underwriting discounts and commissions and the payment of offering expenses, and$4.1 million in proceeds received from stock option exercises. These increases were offset by principal payments on capital lease obligations of$0.3 million .
Contractual Obligations and Commitments
As ofSeptember 30, 2020 , there was no material change in our contractual obligations and commitments from those disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSEC onFebruary 20, 2020 .
Off-Balance Sheet Arrangements
41 -------------------------------------------------------------------------------- As ofSeptember 30, 2020 , we did not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. We therefore believe we are not materially exposed to any financing, liquidity, market, or credit risks that could arise if we had engaged in these relationships.
Critical Accounting Policies and Estimates
The preparation of our condensed consolidated financial statements in conformity withU.S. GAAP requires us to make estimates and judgments that affect the amounts reported in our financial statements and accompanying notes. Although we believe the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates. Significant estimates and judgments embedded in the consolidated financial statements for the periods presented include revenue recognition, stock-based compensation, the valuation of goodwill and intangible assets, leases, costs to obtain a contract with a customer, and income taxes. While we continue to monitor the developments surrounding the COVID-19 pandemic, we are not aware of any specific events or circumstances that would require us to update our estimates, assumptions, and judgments.
There have been no material changes in our critical accounting policies from
those disclosed in our Annual Report on Form 10-K for the year ended
Recent Accounting Pronouncements
See Note 2 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements.
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