SERVICENOW, INC. The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year endedDecember 31, 2020 included in the Annual Report on Form 10-K filed with theSecurities and Exchange Commission (the "SEC"), onFebruary 12, 2021 . This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, impacts on our business, future financial performance and general economic conditions due to the current COVID-19 pandemic, those identified herein, and those discussed in the section titled "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K filed with theSEC onFebruary 12, 2021 and in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our otherSEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Investors and others should note that we announce material financial information to our investors using our investor relations website (https://www.servicenow.com/company/investor-relations.html),SEC filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our investors and the public about our company, our services and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the social media channels listed on our investor relations website. Our free cash flow and billings measures included in the sections entitled "-Key Business Metrics-Free Cash Flow," and "-Key Business Metrics-Billings" are not in accordance with GAAP. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from non-GAAP financial measures used by other companies, limiting their usefulness for comparison purposes. We encourage investors to carefully consider our results under GAAP, as well as our supplemental non-GAAP results, to more fully understand our business.
COVID-19 Environment
The COVID-19 pandemic has created significant global economic uncertainty, adversely impacted the business of our customers, partners and vendors, and impacted our business and results of operations. As of the filing date, the extent to which the COVID-19 pandemic may continue to impact our business and future financial condition or results of operations remains uncertain. We are continuing to monitor the actual and potential effects of the COVID-19 pandemic across our business. While our revenues, billings and earnings are relatively predictable as a result of our subscription-based business model, the effect of the COVID-19 pandemic, along with the seasonality we historically experience, may not be fully reflected in our results of operations and overall financial performance until future periods, if at all, and could cause our future results of operations to vary significantly from period to period. As the uncertainty continues, we may experience an increase in curtailed customer demand, reduced customer spend or contract duration, delayed collections, lengthened payment terms, lengthened sales cycles or competition due to changes in terms and conditions and pricing of our competitors' products and services, our business, results of operations and overall financial performance in future periods could be materially adversely affected. Additionally, it is unclear to what extent certain reductions in expenditures noted in the year endedDecember 31, 2020 into the third quarter of 2021 due to actions taken in response to the COVID-19 pandemic will continue to be reduced below historical levels. The extent and continued impact of the COVID-19 pandemic on our operational and financial performance will depend on certain developments, including: the duration and spread of the outbreak including new variant strains of the virus; government responses and its effectiveness, extent and duration of its mitigation efforts such as "shelter in place", availability of vaccinations and similar directives; impact on our customers, sales cycles and ability to generate new business; impact on our customer, industry or employee events; extent of delays in hiring and onboarding new employees mainly in our general and administrative functions; and effect on our partners, vendors and supply chains; all of which are highly uncertain and difficult to predict. 22 -------------------------------------------------------------------------------- Table of Contents In response to the COVID-19 pandemic, we continue to focus on maintaining business continuity, helping our employees, customers and communities, and preparing for the future and the long-term success of our business. We released various applications beginning in the first quarter of 2020 to help customers navigate the COVID-19 pandemic including the essential steps for returning employees to the workplace to support their health and safety and help users, healthcare providers and clinics to manage vaccinations from start to finish, as well as tools to prepare for a hybrid workplace. Further, we temporarily closed most of our offices in the first quarter of 2020 and encouraged our employees to work remotely. Beginning in the second quarter of 2021, a limited number of employees returned to our offices in certain locations, taking into consideration government restrictions, employee safety and health risks. Re-opening of our offices remains limited and may change at any time. The impact, if any, of these and any additional operational changes we may implement is uncertain but changes we have implemented have not affected and are not expected to affect our ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures. See the section "Risk Factors" in Part 1, Item 1A of our Annual Report on Form 10-K filed with theSEC onFebruary 12, 2021 and in Part II, Item 1A of this Quarterly Report on Form 10-Q for further discussion of the possible impact of the COVID-19 pandemic on our business.
Overview
ServiceNow's purpose is to make the world of work, work better for people. We believe that people want the technology they use in their work to be more efficient and easier to use. We build applications to meet that demand by automating existing processes and creating efficient, digitized workflows with a consumer grade user experience. Our products and services enable the steps of a job to flow naturally across disparate departments, systems and processes of a business. When work flows naturally, great experiences follow. We primarily deliver our software via the Internet as a service through a simple and easy-to-use interface so that we can rapidly deploy our packaged offerings, and customers can easily build their custom applications. In a minority of cases, customers choose to host our software by themselves or through a third-party service provider. We generally offer our services on an annual subscription fee basis, which includes access to the ordered subscription service and related standard and enhanced support, including updates to the subscription service during the subscription term. Pricing for our subscription services is based on a number of factors, including duration of subscription term, volume, mix of products purchased, and discounts. We generate sales through our direct sales team and, to a lesser extent, indirectly through resale partners and third-party referrals. We also generate revenues from professional services and for training of customer and partner personnel. Our professional services organization is focused on strategic advisory, implementation and consulting services to accelerate platform adoption and drive customer outcomes. We generally bill our customers annually in advance for subscription services and monthly in arrears for our professional services as the work is performed.
A majority of our revenues come from large global enterprise customers. We continue to invest in the development of our services, infrastructure and sales and marketing to drive long-term growth.
Key Business Metrics
Remaining performance obligations. Transaction price allocated to remaining
performance obligations ("RPO") represents contracted revenue that has not yet
been recognized, which includes deferred revenue and non-cancelable amounts that
will be invoiced and recognized as revenue in future periods. RPO excludes
contracts that are billed in arrears, such as certain time and materials
contracts, as we apply the "right to invoice" practical expedient under relevant
accounting guidance. Current remaining performance obligations ("cRPO")
represents RPO that will be recognized as revenue in the next 12 months.
As of September 30, 2021 , our RPO was $9.7 billion , of which 51% represented
cRPO. RPO and cRPO increased by 34% and 32%, respectively, compared to September
30, 2020 . Factors that may cause our RPO to vary from period to period include
the following:
•Foreign currency exchange rates. While a majority of our contracts have
historically been in U.S. Dollars, an increasing percentage of our contracts in
recent periods has been in foreign currencies, particularly the Euro and British
Pound Sterling. Fluctuations in foreign currency exchange rates as of the
balance sheet date will cause variability in our RPO.
•Mix of offerings. In a minority of cases, we allow our customers to host our
software by themselves or through a third-party service provider. In self-hosted
offerings, we recognize a portion of the revenue upfront upon the delivery of
the software and as a result, such revenue is excluded from RPO.
•Subscription start date. From time to time, we enter into contracts with a
subscription start date in the future and these amounts are included in RPO if
such contracts are signed by the balance sheet date.
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•Timing of contract renewals. While customers typically renew their contracts at the end of the contract term, from time to time, customers may do so either before or after the scheduled expiration date. For example, in cases where we are successful in selling additional products or services to an existing customer, a customer may decide to renew its existing contract early to ensure that all its contracts expire on the same date. In other cases, prolonged negotiations or other factors may result in a contract not being renewed until after it has expired. •Contract duration. While we typically enter into multi-year subscription services, the duration of our contracts varies. Further, we continue to see an increase in the number of 12-month agreements entered into with theU.S. Federal government throughout the year which has been the highest in the quarter endedSeptember 30 , driven primarily by timing of their annual budget expenditures. We sometimes also enter into contracts with durations that have a 12-month or shorter term to enable the contracts to co-terminate with the existing contract. The contract duration will cause variability in our RPO. Number of customers with ACV greater than$1 million . We count the total number of customers with annual contract value ("ACV") greater than$1 million as of the end of the period. We had 1,266 and 1,012 customers with ACV greater than$1 million as ofSeptember 30, 2021 and 2020, respectively. For purposes of customer count, a customer is defined as an entity that has a unique Dunn & Bradstreet Global Ultimate ("GULT") Data Universal Numbering System ("DUNS") number and an active subscription contract as of the measurement date. The DUNS number is a global standard for business identification and tracking. We make exceptions for holding companies, government entities and other organizations for which the GULT, in our judgment, does not accurately represent theServiceNow customer. For example, while allU.S. government agencies roll up to "Government ofthe United States " under the GULT, we count each government agency that we contract with as a separate customer. Our customer count is subject to adjustments for acquisitions, spin-offs and other market activity; accordingly, we restate previously disclosed number of customers with ACV greater than$1 million calculations to allow for comparability. ACV is calculated based on the foreign exchange rate in effect at the time the contract was signed. Foreign exchange rate fluctuations could cause some variability in the number of customers with ACV greater than$1 million . We believe information regarding the total number of customers with ACV greater than$1 million provides useful information to investors because it is an indicator of our growing customer base and demonstrates the value customers are receiving from the Now Platform. Free cash flow. We define free cash flow, a non-GAAP financial measure, as GAAP net cash provided by operating activities reduced by purchases of property and equipment. Purchases of property and equipment are otherwise included in cash used in investing activities under GAAP. We believe information regarding free cash flow provides useful information to investors because it is an indicator of the strength and performance of our business operations. However, our calculation of free cash flow may not be comparable to similar measures used by other companies. A calculation of free cash flow is provided below: Nine Months Ended September 30, 2021 2020 % Change (dollars in millions) Free cash flow: Net cash provided by operating activities $ 1,347$ 1,101 22 % Purchases of property and equipment (292) (285) 2 % Free cash flow(1) $ 1,055$ 816 29 % (1)Free cash flow for the nine months endedSeptember 30, 2021 includes the effect of$15 million relating to the repayments of convertible senior notes attributable to debt discount. Refer to Note 10 in the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further details. We have historically seen higher collections in the quarter endedMarch 31 due to seasonality in timing of entering into customer contracts, which is significantly higher in the quarter endedDecember 31 . Additionally, we have historically seen higher disbursements in the quarters endedMarch 31 andSeptember 30 due to payouts under our annual commission plans, purchases under our employee stock purchase plan, payouts under our bonus plans and coupon payments related to our 2030 Notes beginning in 2021. 24 -------------------------------------------------------------------------------- Table of Contents Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the ACV from customers lost during the period, divided by the sum of (i) the total ACV from all customers that renewed during the period, excluding changes in price or users, and (ii) the total ACV from all customers lost during the period. Accordingly, our renewal rate is calculated based on ACV and is not based on the number of customers that have renewed. Further, our renewal rate does not reflect increased or decreased purchases from our customers to the extent such customers are not lost customers or lapsed renewal. A lost customer is a customer that did not renew an expiring contract and that, in our judgment, will not be renewed. Typically, a customer that reduces its subscription upon renewal is not considered a lost customer. However, in instances where the subscription decrease represents the majority of the customer's ACV, we may deem the renewal as a lost customer. For our renewal rate calculation, we define a customer as an entity with a separate production instance of our service and an active subscription contract as of the measurement date, instead of an entity with a unique GULT or DUNS number. We adjust our renewal rate for acquisitions, consolidations and other customer events that cause the merging of two or more accounts occurring at the time of renewal. Additionally, starting in 2020, we simplified our methodology related to contracts less than 12 months to derive ACV used to calculate renewal rate. Previously disclosed renewal rates may be restated to reflect such adjustments or methodology simplification to allow for comparability. However, there were no material changes to such previously disclosed renewal rates. Our renewal rate was 98% for each of the three and nine months endedSeptember 30, 2021 and 98% and 97% for the three and nine months endedSeptember 30, 2020 , respectively. As our renewal rate is impacted by the timing of renewals, which could occur in advance of, or subsequent to the original contract end date, period-to-period comparison of renewal rates may not be meaningful. Billings. We define billings, a non-GAAP financial measure, as GAAP revenues recognized plus the change in total GAAP unbilled receivables, deferred revenue and customer deposits as presented on the condensed consolidated statements of cash flows. The calculation of billings is provided below: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 % Change 2021 2020 % Change (dollars in millions) (dollars in millions) Billings: Total revenues$ 1,512 $ 1,152 31 %$ 4,282 $ 3,269 31 % Change in deferred revenue, unbilled receivables and customer deposits(1) (47) (12) 292 % 35 53 (34 %) Total billings$ 1,465 $ 1,140 29 %$ 4,317 $ 3,322 30 % Year over year percentage 29 % 25 % 30 % 26 % change in total billings
(1)As presented on or derived from our condensed consolidated statements of cash flows.
Billings consists of amounts invoiced for subscription contracts with existing customers, renewal contracts, expansion contracts, contracts with new customers, and contracts for professional services and training. Factors that may cause our billings results to vary from period to period include the following: •Billings duration. While we typically bill customers annually in advance for our subscription services, customers sometimes request, and we accommodate, billings with durations less than or greater than the typical 12-month term. Changes in billings duration had a favorable impact of$5 million and$25 million for the three and nine months endedSeptember 30, 2021 , respectively. •Contract start date. From time to time, we enter into contracts with a contract start date in the future, and we exclude these amounts from billings as these amounts are not included in our condensed consolidated balance sheets, unless such amounts have been paid as of the balance sheet date. •Foreign currency exchange rates. While a majority of our billings have historically been inU.S. Dollars, an increasing percentage of our billings in recent periods has been in foreign currencies, particularly the Euro and British Pound Sterling. Fluctuations in foreign currency exchange rates will cause variability in our billings. Foreign currency rate fluctuations had a favorable impact of$10 million and$99 million on billings for the three and nine months endedSeptember 30, 2021 , respectively. 25 -------------------------------------------------------------------------------- Table of Contents •Timing of contract renewals. While customers typically renew their contracts at the end of the contract term, from time to time customers may do so either before or after the scheduled expiration date. For example, in cases where we are successful in selling additional products or services to an existing customer, a customer may decide to renew its existing contract early to ensure that all its contracts expire on the same date. In other cases, prolonged negotiations or other factors may result in a contract not being renewed until after it has expired. •Seasonality. We have historically experienced seasonality in terms of when we enter into customer agreements for our services. We sign a significantly higher percentage of agreements with new customers, as well as expansion with existing customers, in the fourth quarter of each year. The increase in customer agreements for the fourth quarter is primarily a result of both large enterprise account buying patterns typical in the software industry, which are driven primarily by the expiration of annual authorized budgeted expenditures, and the terms of our commission plans, which incentivize our direct sales organization to meet their annual quotas byDecember 31 . Furthermore, we usually sign a significant portion of these agreements during the last month, and often the last two weeks, of each quarter. This seasonality in the timing of entering into customer contracts is sometimes not immediately apparent in our billings, due to the fact that we typically exclude cloud-offering contracts with a future start date from our billings, unless such amounts have been paid as of the balance sheet date. Similarly, this seasonality is reflected to a much lesser extent, and sometimes is not immediately apparent in our revenues, due to the fact that we recognize subscription revenues from our cloud offering contracts over the term of the subscription agreement, which is generally 12 to 36 months. Although these seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance. Further, the seasonal factors could be heightened due to the impact of the current gross domestic product contraction and other impacts unknown at this time on our customers and sales cycles caused by the COVID-19 pandemic. While we believe billings is one indicator of the performance of our business, due to the factors described above, an increase or decrease in billings may not reflect the actual performance for that reporting period. To facilitate greater year-over-year comparability in our billings results, we disclose the impact that foreign currency rate fluctuations and fluctuations in billings duration had on our billings. The impact of foreign currency rate fluctuations is calculated by translating the current period results for entities reporting in currencies other thanU.S. Dollars intoU.S. Dollars at the exchange rates in effect during the prior period presented, rather than the actual exchange rates in effect during the current period. The impact of fluctuations in billings duration is calculated by replacing the portion of multi-year billings in excess of 12 months during the current period with the portion of multi-year billings in excess of 12 months during the prior period presented. Notwithstanding the adjustments described above, the comparability of billings results from period to period remains subject to the impact of variations in the dollar value of contracts with future start dates and the timing of contract renewals, for which no adjustments have been presented.
Components of Results of Operations
Revenues
Subscription revenues. Subscription revenues are primarily comprised of fees
that give customers access to the ordered subscription service for both
self-hosted offerings and cloud-based subscription offerings, and related
standard and enhanced support and updates, if any, to the subscription service
during the subscription term. For our cloud-based offerings, we recognize
revenue ratably over the subscription term. For self-hosted offerings, a
substantial portion of the sales price is recognized upon delivery of the
software, which may cause greater variability in our subscription revenues and
subscription gross margin. Pricing includes multiple instances, hosting and
support services, data backup and disaster recovery services, as well as future
updates, when and if available, offered during the subscription term. We
typically invoice our customers for subscription fees in annual increments upon
execution of the initial contract or subsequent renewal. Our contracts are
generally non-cancelable during the subscription term, though a customer can
terminate for breach if we materially fail to perform.
Professional services and other revenues. Our arrangements for professional
services are primarily on a time-and-materials basis and we generally invoice
our customers monthly in arrears for the professional services based on actual
hours and expenses incurred. Some of our professional services arrangements are
on a fixed fee or subscription basis. Professional services revenues are
recognized as services are delivered. Other revenues primarily consist of fees
from customer training delivered on-site or through publicly available classes.
Typical payment terms require our customers to pay us within 30 days of invoice.
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We sell our subscription services primarily through our direct sales
organization. We also sell services through managed service providers and resale
partners. We also generate revenues from certain professional services and from
training of customers and partner personnel, through both our direct team and
indirect channel sales. Revenues from our direct sales organization represented
79% of our total revenues for each of the three and nine months ended September
30, 2021 and 80% and 81% of our total revenues for the three and nine months
ended September 30, 2020 , respectively. For purposes of calculating revenues
from our direct sales organization, revenues from systems integrators and
managed services providers are included as part of the direct sales
organization.
Cost of Revenues
Cost of subscription revenues. Cost of subscription revenues consists primarily of expenses related to hosting our services and providing support to our customers. These expenses are comprised of data center capacity costs, which include colocation costs associated with our data centers as well as interconnectivity between data centers, depreciation related to our infrastructure hardware equipment dedicated for customer use, amortization of intangible assets, expenses associated with software, public cloud service costs. IT services and dedicated customer support, personnel-related costs directly associated with data center operations and customer support, including salaries, benefits, bonuses and stock-based compensation and allocated overhead. Cost of professional services and other revenues. Cost of professional services and other revenues consists primarily of personnel-related costs directly associated with our professional services and training departments, including salaries, benefits, bonuses and stock-based compensation, the costs of contracted third-party partners, travel expenses and allocated overhead. Professional services are performed directly by our services team, as well as by contracted third-party partners. Fees paid by us to third-party partners are primarily recognized as cost of revenues as the professional services are delivered. Cost of revenues associated with our professional services engagements contracted with third-party partners as a percentage of professional services and other revenues was 15% and 13% for the three and nine months endedSeptember 30, 2021 , respectively, and 9% and 10% for the three and nine months endedSeptember 30, 2020 , respectively.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel-related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses and stock-based compensation. Sales and marketing expenses also include the amortization of commissions paid to our sales employees, including related payroll taxes and fringe benefits. In addition, sales and marketing expenses include branding expenses, marketing program expenses, which include events such as Knowledge, and costs associated with purchasing advertising and marketing data, software and subscription services dedicated for sales and marketing use and allocated overhead.
Research and Development
Research and development expenses consist primarily of personnel-related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation and allocated overhead. Research and development expenses also include data center capacity costs, costs associated with outside services contracted for research and development purposes and depreciation of infrastructure hardware equipment that is used solely for research and development purposes.
General and Administrative
General and administrative expenses consist primarily of personnel-related
expenses for our executive, finance, legal, human resources, facilities and
administrative personnel, including salaries, benefits, bonuses and stock-based
compensation, external legal, accounting and other professional services fees,
other corporate expenses, amortization of intangible assets and allocated
overhead.
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Provision for Income Taxes
Provision for income taxes consists of federal, state and foreign income taxes.
Due to cumulative losses, we maintain a valuation allowance against our U.S.
deferred tax assets as of September 30, 2021 . We consider all available
evidence, both positive and negative, including but not limited to earnings
history, projected future outcomes, industry and market trends and the nature of
each of the deferred tax assets in assessing the extent to which a valuation
allowance should be applied against our U.S. and foreign deferred tax assets.
Results of Operations
Revenues
Three Months Ended September
30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Revenues:
Subscription $ 1,427 $ 1,091 31 % $ 4,050 $ 3,102 31 %
Professional services and other 85 61 39 % 232 167 39 %
Total revenues $ 1,512 $ 1,152 31 % $ 4,282 $ 3,269 31 %
Percentage of revenues:
Subscription 94% 95% 95% 95%
Professional services and other 6% 5% 5% 5%
Total 100% 100% 100% 100%
Subscription revenues increased by $336 million and $948 million for the three
and nine months ended September 30, 2021 compared to the three and nine months
ended September 30, 2020 , respectively, primarily driven by increased purchases
by existing customers and an increase in customer count. Included in
subscription revenues is $54 million and $37 million of revenues recognized
upfront from the delivery of software associated with self-hosted offerings
during the three months ended September 30, 2021 and 2020, respectively, and
$168 million and $149 million during the nine months ended September 30, 2021
and 2020, respectively.
We expect subscription revenues for the year ending December 31, 2021 to
increase in absolute dollars as we continue to add new customers and existing
customers increase their usage of our products but remain relatively flat as a
percentage of revenue compared to the year ended December 31, 2020 . We continue
to monitor the COVID-19 pandemic in 2021 and its impact on customer acquisition
and renewal rates.
Our expectations for revenues, cost of revenues and operating expenses for the
remainder of 2021 are based on
Subscription revenues consist of the following:
Three Months Ended September
30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Digital workflow products $ 1,253 $ 959 31 % $ 3,548 $ 2,712 31 %
ITOM products 174 132 32 % 502 390 29 %
Total subscription revenues $ 1,427 $ 1,091 31 % $ 4,050 $ 3,102 31 %
28-------------------------------------------------------------------------------- Table of Contents Our digital workflow products include the Now Platform, IT Service Management, IT Business Management, IT Asset Management, Security Operations, Governance, Risk and Compliance, HR Service Delivery, Safe Workplace Suite of applications, Workplace Service Delivery, Legal Service Delivery, Customer Service Management, Field Service Management, Connected Operations, Financial Services Operations, Telecommunications Service Management, Telecommunications Network Performance Management, App Engine and IntegrationHub, and are generally priced on a per user basis. Our ITOM products are generally priced on a per node (physical or virtual server) basis. Professional services and other revenues increased by$24 million and$65 million during the three and nine months endedSeptember 30, 2021 compared to the three and nine months endedSeptember 30, 2020 , respectively, due to an increase in services and trainings provided to new and existing customers. We expect professional services and other revenues for the year endingDecember 31, 2021 to increase in absolute dollars but remain relatively flat as a percentage of revenue compared to the year endedDecember 31, 2020 . We are increasingly focused on deploying our internal professional services organization as a strategic resource and relying on our partner ecosystem to contract directly with customers for implementation services delivery.
Cost of Revenues and Gross Profit Percentage
Three Months Ended September
30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Cost of revenues:
Subscription $ 264 $ 189 40 % $ 740 $ 521 42 %
Professional services and other 86 63 37 % 239 187 28 %
Total cost of revenues $ 350 $ 252 39 % $ 979 $ 708 38 %
Gross profit percentage:
Subscription 81% 83% 82% 83%
Professional services and other (1%) (3%) (3%) (12%)
Total gross profit percentage 77% 78% 77% 78%
Gross profit $ 1,162 $ 900 $ 3,303 $ 2,561
Cost of subscription revenues increased by $75 million and $219 million for the
three and nine months ended September 30, 2021 compared to the three and nine
months ended September 30, 2020 , respectively, primarily due to increased
headcount and increased costs to support the growth of our subscription
offerings. Personnel-related costs including stock-based compensation and
overhead expenses increased by $31 million and $92 million for the three and
nine months ended September 30, 2021 , respectively, compared to the same periods
in the prior year. In addition, depreciation expense related to data center
hardware, software and maintenance costs to support the expansion of our data
center capacity including public cloud service costs increased by $34 million
and $111 million and amortization of intangible assets increased by $8 million
and $15 million for the three and nine months ended September 30, 2021 ,
respectively, compared to the same periods in the prior year.
We expect our cost of subscription revenues to increase in absolute dollars as
we provide subscription services to more customers and increase usage within our
customer instances. Our subscription gross profit percentage was 81% and 82% for
the three and nine months ended September 30, 2021 , respectively, compared to
83% for each of the three and nine months ended September 30, 2020 . We expect
our subscription gross profit percentage to slightly decrease for the year
ending December 31, 2021 compared to the year ended December 31, 2020 primarily
due to incremental costs to acquire customers in regulated markets by adopting
public cloud offerings as well as increased support for customers impacted by
new and evolving data residency requirements. To the extent future acquisitions
are consummated, our cost of subscription revenues may increase due to
additional non-cash charges associated with the amortization of intangible
assets acquired.
Cost of professional services and other revenues increased by $23 million and
$52 million for the three and nine months ended September 30, 2021 ,
respectively, compared to the same periods in the prior year, primarily due to
increased headcount, resulting in an increase in personnel-related costs
including stock-based compensation.
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Our professional services and other gross margin percentage increased to loss of
1% and 3% for the three and nine months ended September 30, 2021 , respectively,
from loss of 3% and 12% for the three and nine months ended September 30, 2020 ,
respectively, primarily driven by the increased utilization of our internal
professional services organization and the reduction in certain travel expenses.
We expect our professional services and other gross margin percentage to
increase for the year ending December 31, 2021 compared to the year ended
December 31, 2020 as we continue to optimize our utilization of our internal
professional services organization.
Sales and Marketing
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Sales and marketing $ 579 $ 454 28 % $ 1,660 $ 1,321 26 %
Percentage of revenues 38% 39% 39% 40%
Sales and marketing expenses increased by $125 million and $339 million for the
three and nine months ended September 30, 2021 compared to the three and nine
months ended September 30, 2020 , respectively, primarily due to increased
headcount, resulting in an increase in personnel-related costs including
stock-based compensation and overhead expenses of $96 million and $255 million
for the three and nine months ended September 30, 2021 , respectively, compared
to the same periods in the prior year. Amortization expenses associated with
deferred commissions and third-party referral fees increased $19 million and $55
million for the three and nine months ended September 30, 2021 , respectively,
compared to the same periods in the prior year, due to an increase in contracts
with new customers, expansion and renewal contracts. Other sales and marketing
program expenses, which include branding, costs associated with purchasing
advertising and market data and outside services, increased by $12 million and
$33 million during the three and nine months ended September 30, 2021 ,
respectively, compared to the same periods in the prior year.
Amid the ongoing regulatory restrictions imposed by governments worldwide in
response to the COVID-19 pandemic, we continue to temporarily close many of our
offices to ensure the well-being and safety of our global employees, office
staff and communities. Further, we converted certain in-person events to digital
events in the first half of 2021, which resulted in certain savings for the nine
months ended September 30, 2021 compared to the same period in the prior year.
Despite the uncertainty around the continued impact of the COVID-19 pandemic and
its duration, we expect sales and marketing expenses to increase in absolute
dollars but slightly decrease as a percentage of revenue compared to the year
ended December 31, 2020 , as we continue to expand our direct sales organization,
increase our marketing activities, grow our international operations and
continue to build brand awareness.
Research and Development
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Research and development $ 358 $ 268 34 % $ 1,005 $ 740 36 %
Percentage of revenues 24% 23% 23% 23%
Research and development expenses increased by $90 million and $265 million for
the three and nine months ended September 30, 2021 compared to the three and
nine months ended September 30, 2020 , respectively, primarily due to increased
headcount, resulting in an increase in personnel-related costs including
stock-based compensation and overhead expenses of $86 million and $250 million
for the three and nine months ended September 30, 2021 , respectively, compared
to the same periods in the prior year. The remaining increase was primarily due
to an increase in outside service costs, hosting costs and data center related
depreciation costs to support research and development activities.
We expect research and development expenses for the year ending December 31,
2021 to increase in absolute dollars but remain relatively flat as a percentage
of revenue compared to the year ended December 31, 2020 as we continue to
improve the existing functionality of our services, develop new applications to
fill market needs and enhance our core platform.
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General and Administrative
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
General and administrative $ 151 $ 109 39 % $ 416 $ 319 30 %
Percentage of revenues 10% 9% 10% 10%
General and administrative expenses increased by $42 million and $97 million for
the three and nine months ended September 30, 2021 compared to the three and
nine months ended September 30, 2020 , respectively, primarily due to increased
headcount, resulting in an increase in personnel-related costs including
stock-based compensation and overhead expenses of $34 million and $74 million
for the three and nine months ended September 30, 2021 , respectively, compared
to the same periods in the prior year. The remaining increase was primarily due
to costs to support digital transformation projects across functions to improve
processes as we scale as well as incremental investment in environmental, social
and corporate governance initiatives.
We expect general and administrative expenses to increase in absolute dollars
for the year ending December 31, 2021 but remain relatively flat as a percentage
of revenue compared to the year ended December 31, 2020 , as we continue to
increase headcount.
Stock-based Compensation
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Cost of revenues:
Subscription $ 33 $ 26 27 % $ 95 $ 72 32 %
Professional services and other 15 13 15 % 43 38 13 %
Operating expenses:
Sales and marketing 101 79 28 % 293 228 29 %
Research and development 102 74 38 % 288 203 42 %
General and administrative 40 28 43 % 110 84 31 %
Total stock-based compensation $ 291 $ 220 32 % $ 829 $ 625 33 %
Percentage of revenues 19% 19% 19% 19%
Stock-based compensation increased by $71 million and $204 million for the three
and nine months ended September 30, 2021 , respectively, compared to the same
periods in the prior year, primarily due to additional grants to current and new
employees.
Stock-based compensation is inherently difficult to forecast due to fluctuations
in our stock price. Based upon our stock price as of September 30, 2021 , we
expect stock-based compensation to continue to increase in absolute dollars for
the year ending December 31, 2021 as we continue to issue stock-based awards to
our employees, but remain relatively flat as a percentage of revenues compared
to the year ended December 31, 2020 , and we expect this to decline over time as
we continue to grow.
Foreign Currency Exchange
Our international operations have provided and will continue to provide a significant portion of our total revenues. Revenues outsideNorth America represented 37% and 36% for the three and nine months endedSeptember 30, 2021 , respectively, and 34% of total revenues for each of the three and nine months endedSeptember 30, 2020 . 31 -------------------------------------------------------------------------------- Table of Contents Because we primarily transact in foreign currencies for sales outside ofthe United States , the general weakening of theU.S. Dollar relative to other major foreign currencies had a favorable impact on our revenues for each of the three and nine months endedSeptember 30, 2021 . For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the three and nine months endedSeptember 30, 2021 at the exchange rates in effect for the three and nine months endedSeptember 30, 2020 rather than the actual exchange rates in effect during the period, our reported subscription revenues would have been$11 million and$92 million lower, respectively. The impact from the foreign currency movements from the three and nine months endedSeptember 30, 2020 to the three and nine months endedSeptember 30, 2021 was not material for professional services and other revenues. In addition, because we primarily transact in foreign currencies for cost of revenues and operating expenses outside ofthe United States , the general weakening of theU.S. Dollar relative to other major foreign currencies had an unfavorable impact on our cost of revenues and sales and marketing expenses for each of the three and nine months endedSeptember 30, 2021 . For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the three and nine months endedSeptember 30, 2021 at the exchange rates in effect for the three and nine months endedSeptember 30, 2020 rather than the actual exchange rates in effect during the period, our reported cost of revenues would have been$3 million and$24 million lower and sales and marketing expenses would have been$4 million and$28 million lower for the three and nine months endedSeptember 30, 2021 , respectively. The impact from the foreign currency movements from the three and nine months endedSeptember 30, 2020 to the three and nine months endedSeptember 30, 2021 was not material to research and development and general and administrative expenses. Interest Expense Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 % Change 2021 2020 % Change (dollars in millions) (dollars in millions) Interest expense $ (7)$ (8) (13 %)$ (21) $ (25) (16 %) Percentage of revenues - % (1%) 0% (1%) Interest expense decreased for each of the three and nine months endedSeptember 30, 2021 compared to the same periods in the prior year, due to decrease in amortization expense of debt discount and issuance costs as a result of the 2022 Notes Repurchase offset by increase in debt discount, issuance cost and interest related to the 2030 Notes. For the year endingDecember 31, 2021 , we expect to incur approximately$7 million of additional interest expense related to the 2022 Notes and the 2030 Notes.
Other Income (Expense), net
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)
Interest income $ 5 $ 8 (38 %) $ 15 $ 33 (55 %)
Loss on extinguishment of 2022
Notes - (41) NM (3) (42) NM
Other (4) (2) NM 4 (11) (136 %)
Other income (expense), net $ 1 $ (35) (103 %) $ 16 $ (20) (180 %)
Percentage of revenues -% (3%) 0% (1)%
NM - Not meaningful
Other income, net increased by $36 million for each of the three and nine months
ended September 30, 2021 , compared to the same periods in the prior year,
primarily driven by a decrease in loss on extinguishment of 2022 Notes due to
the 2022 Notes Repurchase in the three and nine months ended September 30, 2020 ,
partially offset by a decrease in interest income resulting from the decline in
interest rates. Additionally, for the nine months ended September 30, 2021 ,
other income, net increased compared to the same period in the prior year due to
lower foreign currency exchange losses and unrealized gains on equity
investments in privately-held companies.
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To mitigate our risks associated with fluctuations in foreign currency exchange
rates, we enter into foreign currency derivative contracts with maturities of 12
months or less to hedge a portion of our net outstanding monetary assets and
liabilities. These hedging contracts may reduce, but cannot entirely eliminate,
the impact of adverse currency exchange rate movements.
Provision for Income Taxes
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
(dollars in millions) (dollars in millions)Income before income taxes $ 68$ 26 162 %$ 217 $ 136 60 % Provision for income taxes 5 13 (62 %) 13 34 (62 %) Effective tax rate 7% 50% 6% 25% Our income tax provision was$5 million and$13 million for the three and nine months endedSeptember 30, 2021 , respectively. The income tax provision was primarily attributable to the mix of earnings and losses in countries with differing statutory tax rates, the valuation allowance inthe United States , a tax rate change in a foreign jurisdiction, a valuation allowance release resulting from an acquisition and excess tax benefits of stock-based compensation. Our income tax provision was$13 million and$34 million for the three and nine months endedSeptember 30, 2020 , respectively. The income tax provision was primarily attributable to the mix of earnings and losses in countries with differing statutory tax rates, the valuation allowance inthe United States and the intercompany sale of certain intellectual property rights. We continue to maintain a full valuation allowance on ourU.S. federal and state deferred tax assets and the significant components of the tax expense recorded are current cash taxes payable in various jurisdictions. The cash tax expenses are impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions, and availability of net operating losses and tax credits. Given the full valuation allowance, sensitivity of current cash taxes to local rules and our foreign structuring, we expect that our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates.
Liquidity and Capital Resources
Our principal sources of liquidity are our cash and cash equivalents, investments, and cash generated from operations. As ofSeptember 30, 2021 , we had$3.0 billion in cash and cash equivalents and short-term investments, of which$387 million represented cash held by foreign subsidiaries and$366 million is denominated in currencies other than theU.S. Dollar. In addition, we had$1.4 billion in long-term investments that provide additional capital resources. We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. InAugust 2020 , we issued 1.40% fixed rate ten-year notes with an aggregate principal amount of$1.5 billion due onSeptember 1, 2030 (the "2030 Notes"). The 2030 Notes were issued at 99.63% of principal and we incurred approximately$13 million for debt issuance costs. Interest is payable semi-annually in arrears onMarch 1 andSeptember 1 of each year, beginning onMarch 1, 2021 , and the entire outstanding principal amount is due at maturity onSeptember 1, 2030 . The 2030 Notes are unsecured obligations and the indentures governing the 2030 Notes contain customary events of default and customary covenants that, among others and subject to exceptions, restrict the Company's ability to incur or guarantee debt secured by liens on specified assets or enter into sale and lease-back transactions with respect to specified properties. 33 -------------------------------------------------------------------------------- Table of Contents In May andJune 2017 , we issued the 2022 Notes with an aggregate principal amount of$782.5 million . In connection with the issuance of the 2022 Notes, we entered into the 2022 Note Hedge transactions and 2022 Warrants transactions with certain financial institutions. The price of our common stock was greater than or equal to 130% of the conversion price of the 2022 Notes for at least 20 trading days during the 30 consecutive trading days ending on the last trading day of the quarters endedJune 30, 2018 throughSeptember 30, 2021 , except for the quarter endedDecember 31, 2018 . Therefore, our 2022 Notes became convertible at the holders' option beginning onJuly 1, 2018 and continue to be convertible throughDecember 31, 2021 , except for the quarter endedMarch 31, 2019 because the Conversion Condition for the 2022 Notes was not met for the quarter endedDecember 31, 2018 . The impact of the 2022 Notes on our liquidity will depend on the settlement method we elect. We currently intend to settle the principal amount of any converted 2022 Notes in cash. During the nine months endedSeptember 30, 2021 , we paid cash to settle$73 million in principal of the 2022 Notes. Additionally, inAugust 2020 , we repurchased$497 million in aggregate principal amount of the 2022 Notes (the "2022 Notes Repurchase") which was accounted for as a debt extinguishment. We used proceeds from the partial unwind of the 2022 Note Hedge of$1.1 billion for the 2022 Notes Repurchase. Based on conversion requests received through the filing date, we expect to settle in cash an aggregate of approximately$2 million in principal amount of the 2022 Notes during the fourth quarter of 2021. We may receive additional conversion requests that require settlement in the fourth quarter of 2021 and future periods. During the nine months endedSeptember 30, 2021 and year endedDecember 31, 2020 , we issued 0.5 million and 2.3 million shares of our common stock upon partial unwind of the 2022 Warrants, respectively. We expect to issue additional shares of our common stock in the second half of 2022 upon the automatic exercise of the remaining portion of the 2022 Warrants. As the remaining portion of the 2022 Warrants will be net share settled, there will be no impact on our liquidity. The total number of shares of our common stock we will issue depends on the daily volume-weighted average stock prices over a 60 trading day period beginning on the first expiration date of the remaining portion of the 2022 Warrants, which will beSeptember 1, 2022 . Refer to Note 10 in the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information. Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic and other risks detailed in the section "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K filed with theSEC onFebruary 12, 2021 and in Part II, Item 1A of this Quarterly Report on Form 10-Q. However, we anticipate our current cash, cash equivalents and investments balance and anticipated cash flows generated from operations based on our current business plan and revenue prospects will be sufficient to meet our liquidity needs, including the repayment of any early conversions of our 2022 Notes, debt service costs, expansion of data centers, lease obligations, expenditures related to the growth of our headcount and the acquisition of property and equipment, intangibles, and investments in office facilities, to accommodate our operations for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our growth, operating results, cash utilized for acquisitions and/or debt retirements if any are consummated, and the capital expenditures required to meet possible increased demand for our services. If we require additional capital resources to grow our business or repay our 2022 Notes at any time in the future, we may seek to finance our operations from the current funds available or seek additional equity or debt financing. Nine Months Ended September 30, 2021 2020 (dollars in millions) Net cash provided by operating activities $ 1,347$ 1,101 Net cash used in investing activities (1,248) (1,330) Net cash (used in) provided by financing activities (351) 800 Net change in cash, cash equivalents and restricted cash (273) 574 Operating Activities Net cash provided by operating activities was$1,347 million for the nine months endedSeptember 30, 2021 compared to$1,101 million for the nine months endedSeptember 30, 2020 . The net increase in operating cash flow was primarily due to increases in operating income, higher increase in cash collections from customers compared to increase in settlement of payables. In addition, we benefited from a reduction in repayments of convertible senior notes attributable to debt discount primarily from the 2022 Notes Repurchase in the nine months endedSeptember 30, 2020 . 34 -------------------------------------------------------------------------------- Table of Contents Investing Activities Net cash used in investing activities for the nine months endedSeptember 30, 2021 was$1,248 million compared to$1,330 million for the nine months endedSeptember 30, 2020 . The decrease in cash used in investing activities was primarily due to$740 million decrease in net purchases of investments partially offset by$670 million for business combinations, net of cash and restricted cash acquired. Financing Activities Net cash used in financing activities was$351 million for the nine months endedSeptember 30, 2021 compared to net cash provided by financing activities of$800 million for the nine months endedSeptember 30, 2020 . The change was primarily driven by the$1.5 billion proceeds from the issuance of 2030 Notes in the nine months endedSeptember 30, 2020 . offset by the 2022 Notes Repurchase of$1.6 billion which was funded in part by the proceeds received from the partial unwind of the 2022 Note hedge of$1.1 billion . In addition, the change was due to a$96 million increase in taxes paid related to net share settlement of equity awards partially offset by an increase in proceeds from employee equity plans by$23 million .
Critical Accounting Policies and Significant Judgments and Estimates
There have been no changes to our critical accounting policies and estimates as
described in our Annual Report on Form 10-K for the year ended
New Accounting Pronouncements Pending Adoption
The impact of recently issued accounting standards is set forth in Note 2, Summary of Significant Accounting Policies, of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
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