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, 2019 included in the Annual Report on Form 10-K dated as of, and filed with theSecurities and Exchange Commission (theSEC ), onFebruary 20, 2020 (File No. 001-35580). This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (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," set forth 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 withU.S. Generally Accepted Accounting Principles (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. 23 -------------------------------------------------------------------------------- Table of Contents OverviewServiceNow's purpose is to make the world of work, work better for people. We believe that people should work the way they want to, so we build applications that help automate existing processes and create efficient, digitized workflows. 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 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. We are shifting the focus of our professional services organization from implementation services to strategic advisory 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. We increased our overall employee
headcount to 12,643 as of
InDecember 2019 , a novel strain of Coronavirus disease ("COVID-19") was reported and inJanuary 2020 , theWorld Health Organization (the "WHO") declared the outbreak a "Public Health Emergency of International Concern." InFebruary 2020 , theWHO raised the COVID-19 threat level from high to very high at a global level and inMarch 2020 , theWHO characterized the COVID-19 as a pandemic. 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. If we 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. 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; government responses, including the effectiveness, extent and duration of mitigation efforts such as "shelter in place" 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. In response to the COVID-19 pandemic, we focused on maintaining business continuity, helping our employees, customers and communities, and preparing for the future and the long-term success of our business. In the first quarter of 2020, we released four Emergency Response Apps to help customers navigate the COVID-19 pandemic management. In the second quarter of 2020, we released Safe Workplace Apps, a four-app suite and dashboard, designed to help companies manage the essential steps for returning employees to the workplace and to support their health and safety. Additionally, we canceled our in-person, annual Knowledge user conference ("Knowledge") and replaced it with a digital event experience and cancelled our Financial Analyst Day. In the first quarter of 2020, we also temporarily closed most of our offices and encouraged our employees to work remotely. These changes remain in effect in the fourth quarter of 2020 and could extend into the next year. 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" for further discussion of the possible impact of the COVID-19 pandemic on our business. 24 -------------------------------------------------------------------------------- Table of Contents Key Business Metrics 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 1,012 and 808 customers with ACV greater than$1 million as ofSeptember 30, 2020 and 2019, 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 . 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. As ofSeptember 30, 2020 , our RPO was$7.3 billion and we expect to recognize revenues on approximately 52% of these RPO over the following 12 months, with the balance to be recognized thereafter. 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 inU.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 and volatility in the market, including those resulting from the COVID-19 pandemic, 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. •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. Additionally, we may see a reduction in contract duration as a result of the COVID-19 pandemic. The contract duration will cause variability in our RPO. 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: 25
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Nine Months Ended September 30,
2020 2019 % Change
(dollars in thousands)
Free cash flow:
Net cash provided by operating activities
35 %
Purchases of property and equipment (285,327) (185,889) 53 %
Free cash flow(1) $ 815,747 $ 628,872 30 %
(1)Free cash flow for the nine months ended
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. A calculation of billings is provided below:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Billings:
Total revenues $ 1,151,972 $ 885,833 30 % $ 3,269,154 $ 2,508,663 30 %
Change in total deferred
revenue, unbilled
receivables and customer
deposits(1) (12,480) 29,382 (142 %) 52,744 135,098 (61 %)
Total billings $ 1,139,492 $ 915,215 25 % $ 3,321,898 $ 2,643,761 26 %
(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 for our subscription services, customers sometimes request, and we accommodate, billings with durations less than or greater than the typical 12-month term. •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 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 and volatility in the market, including those resulting from the COVID-19 pandemic, will cause variability in our billings. •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. 26 -------------------------------------------------------------------------------- Table of Contents •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 renewal agreements 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 the terms of our commission plans which incentivize our direct sales force to meet their annual quotas byDecember 31 and large enterprise account buying patterns typical in the software industry, which are driven primarily by the expiration of annual authorized budgeted expenditures. 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 a useful leading indicator regarding the performance of our business, due to the factors described above, an increase or decrease in new or renewed subscriptions in a reporting period may not have an immediate impact on billings 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. Foreign currency rate fluctuations had a favorable impact of$13 million and an unfavorable impact of$12 million on billings for the three and nine months endedSeptember 30, 2020 , respectively. Changes in billings duration did not have a material impact for each of the three and nine months endedSeptember 30, 2020 . 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. While the previously disclosed renewal rates for the three and nine months endedSeptember 30, 2019 were restated due to the methodology simplification to allow for comparability, there were no material changes to such previously disclosed renewal rates. Our renewal rate was 98% and 97% for the three and nine months endedSeptember 30, 2020 , and 99% and 98% for three and nine months endedSeptember 30, 2019 , 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. 27 -------------------------------------------------------------------------------- Table of Contents 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 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 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. 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 80% and 81% of our total revenues for each of the three and nine months endedSeptember 30, 2020 , and 81% and 82% for the three and nine months endedSeptember 30, 2019 , 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.
Allocation of Overhead Costs
Overhead costs associated with office facilities, IT and certain depreciation related to infrastructure that is not dedicated for customer use or research and development use are allocated to cost of revenues and operating expenses based on headcount. 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, 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 9% and 10% for each of the three and nine months endedSeptember 30, 2020 , and 15% for the three and nine months endedSeptember 30, 2019 , respectively. 28
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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. From time to time, third parties provide us referrals for which we pay a referral fee. We include revenues associated with these referrals as part of revenues from our direct sales organization. Referral fees paid to these third parties are generally 10% of the customer's net new ACV. We defer referral fees paid as they are considered incremental selling costs associated with acquiring customer contracts, and include the amortization of these referral fees in sales and marketing expense. In addition, sales and marketing expenses include branding expenses, expenses offset by proceeds related to Knowledge, other marketing program expenses, which include events other than 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.
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 ourU.S. deferred tax assets as ofSeptember 30, 2020 . 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 ourU.S. and foreign deferred tax assets. Results of Operations Revenues Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 % Change 2020 2019 % Change (dollars in thousands) (dollars in thousands) Revenues: Subscription$ 1,091,386 $ 834,910 31 %$ 3,101,616 $ 2,355,885 32 % Professional services and other 60,586 50,923 19 % 167,538 152,778 10 % Total revenues$ 1,151,972 $ 885,833 30 %$ 3,269,154 $ 2,508,663 30 % Percentage of revenues: Subscription 95% 94% 95% 94% Professional services and other 5% 6% 5% 6% Total 100% 100% 100% 100% 29
-------------------------------------------------------------------------------- Table of Contents Subscription revenues increased by$256 million and$746 million for the three and nine months endedSeptember 30, 2020 compared to the three and nine months endedSeptember 30, 2019 , respectively, primarily driven by increased purchases by existing customers and an increase in our customer count. Included in subscription revenues is$37 million and$35 million of revenues recognized upfront from the delivery of software associated with self-hosted offerings during the three months endedSeptember 30, 2020 and 2019, respectively, and$149 million and$119 million during the nine months endedSeptember 30, 2020 and 2019, respectively. We expect subscription revenues for the year endingDecember 31, 2020 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 total revenues compared to the year endedDecember 31, 2019 . However, we continue to monitor the COVID-19 pandemic carefully and its impact on customer acquisition and renewal rates.
Our expectations for revenues, cost of revenues and operating expenses for the
remainder of 2020 are based on foreign exchange rates as of
Subscription revenues consist of the following:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Digital workflow products $ 958,612 $ 721,161 33 % $ 2,712,136 $ 2,034,872 33 %
ITOM products 132,774 113,749 17 % 389,480 321,013 21 %
Total subscription revenues $ 1,091,386 $ 834,910 31 % $ 3,101,616 $ 2,355,885 32 %
Our digital workflow products include the Now Platform, Now IT Service
Management, Now IT Business Management, Now DevOps, Now IT Asset Management, Now
Security Operations, Now Integrated Risk Management, Now HR Service Delivery,
Now Customer Service Management, and Now Field Service Management, and are
generally priced on a per user basis. Our ITOM products are generally priced on
a per node (physical or virtual server) basis. In previously issued consolidated
financial statements, we referred to digital workflow products as "service
management products."
Professional services and other revenues increased by $10 million and $15
million during the three and nine months ended September 30, 2020 compared to
the three and nine months ended September 30, 2019 , 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 ending December 31,
2020 to increase in absolute dollars. 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.
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Cost of Revenues and Gross Profit Percentage
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Cost of revenues:
Subscription $ 189,280 $ 139,330 36 % $ 520,935 $ 401,398 30 %
Professional services and
other 62,424 61,463 2 % 187,074 183,794 2 %
Total cost of revenues $ 251,704 $ 200,793 25 % $ 708,009 $ 585,192 21 %
Gross profit percentage:
Subscription 83% 83% 83% 83%
Professional services and
other (3%) (21%) (12%) (20%)
Total gross profit percentage 78% 77% 78% 77%
Gross profit $ 900,268 $ 685,040 $ 2,561,145 $ 1,923,471
Cost of subscription revenues increased $50 million and $120 million for the
three and nine months ended September 30, 2020 compared to the three and nine
months ended September 30, 2019 , respectively. The increase was 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 $21 million and $53 million for
the three and nine months ended September 30, 2020 , respectively, compared to
the same periods in the prior year. Depreciation expense relating to data center
hardware and software and maintenance costs to support the expansion of our data
center capacity increased by $26 million and $57 million for the three and nine
months ended September 30, 2020 , respectively, compared to the same periods in
the prior year. In addition, amortization of intangibles increased by $3 million
and $11 million for the three and nine months ended September 30, 2020 ,
respectively, compared to the same period in the prior year mainly as a result
of acquisitions.
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. However, we continue to monitor the COVID-19 pandemic
carefully and its impact on our customers.
Our subscription gross profit percentage was 83% for each of the three and nine
months ended September 30, 2020 , respectively, compared to 83% for each of the
three and nine months ended September 30, 2019 . We expect our subscription gross
profit percentage to remain relatively flat for the year ending December 31,
2020 compared to the year ended December 31, 2019 . 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 remained relatively flat and
increased by $3 million for the three and nine months ended September 30, 2020 ,
respectively, as 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 offset by a decrease in third-party
implementation costs as we continue to invest and deploy our internal
professional service organization and increase their utilization and a reduction
in travel expenses resulting from travel restrictions due to the COVID-19
pandemic.
Our professional services and other gross loss percentage decreased to 3% and
12% for the three and nine months ended September 30, 2020 , respectively, from
21% and 20% for the three and nine months ended September 30, 2019 ,
respectively, driven by the increased utilization of our internal professional
services organization and the reduction in certain travel expenses, both of
which are expected to continue for the remainder of the year. As such, we expect
our professional services and other gross loss percentage to decrease for the
year ending December 31, 2020 compared to the year ended December 31, 2019 .
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Sales and Marketing
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Sales and marketing $ 453,410 $ 362,975 25 % $ 1,321,163 $ 1,118,279 18 %
Percentage of revenues 39% 41% 40% 45%
Sales and marketing expenses increased by $90 million and $203 million for the
three and nine months ended September 30, 2020 compared to the three and nine
months ended September 30, 2019 , respectively. The increase was primarily due to
increased headcount, resulting in an increase in personnel-related costs
including stock-based compensation and overhead expenses of $65 million and $172
million for the three and nine months ended September 30, 2020 ,
respectively, compared to the same periods in the prior year. Amortization
expenses associated with deferred commissions and third-party referral fees
increased $14 million and $37 million for the three and nine months ended
September 30, 2020 , 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
expenses and costs associated with purchasing advertising and market data and
outside services, increased by $24 million and $40 million during the three and
nine months ended September 30, 2020 , respectively, compared to the same period
in the prior year.
Amid the ongoing regulatory restrictions imposed by governments worldwide in
response to the COVID-19 pandemic, we temporarily closed most of our offices to
ensure the well-being and safety of our global employees, office staff and
communities, and encouraged our employees to work remotely and limit travel.
Further, in response to the pandemic, we canceled Knowledge and other events and
either replaced them with digital events or postponed them to future periods. As
a result, expenses related to Knowledge, net of proceeds, decreased by $10
million for the nine months ended September 30, 2020 , compared to the same
period in the prior year. Additionally, travel expenses decreased by $17 million
and $42 million as a result of travel restrictions due to the COVID-19 pandemic
for the three and nine months ended September 30, 2020 , respectively, compared
to the same periods in the prior year.
Given the unprecedented nature of this pandemic and the uncertainty around its
duration, we expect sales and marketing expenses to decrease as a percentage of
total revenues given the reduction in certain travel expenses and cancellation
of live events that has occurred during each of the three and nine months ended
September 30, 2020 and is expected to continue for the remainder of the year
ending December 31, 2020 . However, we intend to continue to expand our direct
sales organization, increase our marketing activities, grow our international
operations and build brand awareness and expect sales and marketing expenses to
increase in absolute dollars, but decrease as a percentage of revenue for the
year ending December 31, 2020 compared to the year ended December 31, 2019 .
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Research and Development
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Research and development $ 268,292 $ 190,099 41 % $ 740,030 $ 546,041 36 %
Percentage of revenues 23% 21% 23% 22%
Research and development expenses increased by $78 million and $194 million for
the three and nine months ended September 30, 2020 compared to the three and
nine months ended September 30, 2019 , respectively. The increase was primarily
due to increased headcount, resulting in an increase in personnel-related costs
including stock-based compensation and overhead expenses of $70 million and $179
million for the three and nine months ended September 30, 2020 ,
respectively, compared to the same periods in the prior year. The remaining
increase for the three and nine months ended September 30, 2020 was primarily
due to increases in 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,
2020 to increase in absolute dollars and increase slightly as a percentage of
revenue compared to the year ended December 31, 2019 , as we continue to improve
the existing functionality of our services, develop new applications to fill
market needs and enhance our core platform.
General and Administrative
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
General and administrative $ 109,234 $ 75,642 44 % $ 319,019 $ 245,540 30 %
Percentage of revenues 9% 9% 10% 9%
General and administrative expenses increased by $34 million and $73 million for
the three and nine months ended September 30, 2020 compared to the three and
nine months ended September 30, 2019 , respectively. The increase was primarily
due to increased headcount, resulting in an increase in personnel-related costs
including stock-based compensation and overhead expenses of $26 million and $60
million for the three and nine months ended September 30, 2020 ,
respectively, compared to the same periods in the prior year. In March 2020 , we
amended the employment agreement with our Chief Executive Officer and paid
$4 million to restore the benefit of certain non-competition payments our Chief
Executive Officer was entitled to receive from his prior employer.
We expect general and administrative expenses to increase in absolute dollars
for the year ending December 31, 2020 as we continue to hire new employees, but
remain relatively flat as a percentage of total revenues compared to the year
ended December 31, 2019 .
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Stock-based Compensation
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Cost of revenues:
Subscription $ 25,602 $ 18,880 36 % $ 72,086 $ 54,019 33 %
Professional services and other 13,054 10,867 20 % 37,857 31,749 19 %
Operating expenses:
Sales and marketing 78,871 68,712 15 % 227,998 200,071 14 %
Research and development 74,213 50,636 47 % 203,279 144,259 41 %
General and administrative 28,189 13,839 104 % 83,834 62,046 35 %
Total stock-based compensation $ 219,929 $ 162,934 35 % $ 625,054 $ 492,144 27 %
Percentage of revenues 19% 18% 19% 20%
Stock-based compensation increased by $57 million and $133 million for the three
and nine months ended September 30, 2020 compared to the three and nine months
ended September 30, 2019 , respectively, primarily due to additional grants to
current and new employees and increased weighted-average grant date fair value
of stock awards.
Stock-based compensation is inherently difficult to forecast due to fluctuations
in our stock price. Based upon our stock price as of September 30, 2020 , we
expect stock-based compensation to continue to increase in absolute dollars for
the year ending December 31, 2020 as we continue to issue stock-based awards to
our employees, but remain relatively flat as a percentage of total revenues
compared to the year ended December 31, 2019 .
Foreign Currency Exchange
Our international operations have provided and will continue to provide a significant portion of our total revenues. Revenues outsideNorth America represented 34% and 33% of total revenues for the three months endedSeptember 30, 2020 and 2019, respectively, and 34% of total revenues for the nine months endedSeptember 30, 2020 and 2019. 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 (primarily the Euro and British Pound Sterling) had a favorable impact on our revenues for the three months endedSeptember 30 , 2020,and an unfavorable impact for nine months endedSeptember 30, 2020 . For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the three and nine months endedSeptember 30, 2020 at the exchange rates in effect for the three and nine months endedSeptember 30, 2019 rather than the actual exchange rates in effect during the period, our reported subscription revenues would have been$14 million lower and$9 million higher for the periods, respectively. The impact from the foreign currency movements from the three and nine months endedSeptember 30, 2019 to the three and nine months endedSeptember 30, 2020 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 (primarily the Euro and British Pound Sterling) had an unfavorable impact on our sales and marketing expenses for the three months endedSeptember 30, 2020 and no material impact on other operating expense for the same period. However, it had a favorable impact on our cost of revenues and sales and marketing expenses for the nine months endedSeptember 30, 2020 , and no material impact on other operating expenses for the same period. For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the three and nine months endedSeptember 30, 2020 at the exchange rates in effect for the three and nine months endedSeptember 30, 2019 rather than the actual exchange rates in effect during the period, our reported sales and marketing expenses would have been lower by$3 million for the three months endedSeptember 30, 2020 and our cost of revenues and sales and marketing expenses would have been$5 million and$4 million higher for the nine months endedSeptember 30, 2020 , respectively. 34
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Interest Expense
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Interest expense $ (7,980) $ (8,371) (5 %) $ (25,038) $ (24,808) 1 %
Percentage of revenues (1 %) (1%) (1%) (1%)
Interest expense decreased for the three months ended September 30, 2020 and
increased for the nine months ended September 30, 2020 compared to the same
period in the prior year primarily 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 ending December 31, 2020 , we expect to incur
approximately $8 million in amortization expense of debt discount, issuance
costs and interest related to the 2022 Notes and 2030 Notes.
Interest Income and Other Income (Expense), net
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)
Interest income $ 8,245 $ 14,562 (43 %) $ 32,733 $ 41,495 (21 %)
Foreign currency exchange loss,
net of derivative contracts (3,322) (1,951) NM (13,213) (637) NM
Loss on extinguishment of 2022
Notes (40,750) - NM (41,657) 0 NM
Other (92) 206 (145 %) 2,067 3,338 (38 %)
Interest income and other
income (expense), net $ (35,919) $ 12,817 (380 %) $ (20,070) $ 44,196 (145 %)
Percentage of revenues (3%) 1%
(1%) 1%
NM - Not meaningful.
Interest income and other income, net decreased $49 million and $64 million for
the three and nine months ended September 30, 2020 compared to the three and
nine months ended September 30, 2019 , respectively, primarily driven by loss on
extinguishment on 2022 Notes Repurchase and early conversions of $41 million and
$42 million for the three and nine months ended September 30, 2020 ,
respectively, and increase in foreign currency exchange loss, net of derivative
contracts of $13 million for the nine months ended September 30, 2020 compared
to same periods in the prior year. Additionally, interest income decreased
compared to the same periods in the prior year due to decline in interest rates
and change in our investment strategy to higher quality bonds in response to the
global market disruptions and uncertainties resulting from the COVID-19
pandemic.
To mitigate our risks associated with fluctuations in foreign currency exchange
rates, we enter into foreign currency derivative contracts with maturities of 12
months or less to hedge a portion of our net outstanding monetary assets and
liabilities. These hedging contracts may reduce, but cannot entirely eliminate,
the impact of adverse currency exchange rate movements.
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Provision for Income Taxes
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % Change 2020 2019 % Change
(dollars in thousands) (dollars in thousands)Income before income taxes$ 25,433 $ 60,770 NM$ 135,825 $ 32,999 NM Provision for income taxes 12,575 20,172 NM 33,970 5,025 NM Effective tax rate 49% 33% 25% 15% NM - Not meaningful.
Our income tax expense was
Our income tax provision was$20 million and$5 million for the three and nine months endedSeptember 30, 2019 , respectively, primarily attributable to foreign taxes and the mix of earnings and losses in countries with differing statutory tax rates. Governments in certain countries where we do business have enacted legislation in response to the COVID-19 pandemic, including the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") enacted bythe United States onMarch 27, 2020 . We are continuing to analyze these legislative developments and believe that they have not had a material impact on our provision for income taxes for the three months endedSeptember 30, 2020 . 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, 2020 , we had$3.0 billion in cash and cash equivalents and short-term investments, of which$288 million represented cash held by foreign subsidiaries and$234 million is denominated in currencies other thanU.S. Dollar. In addition, we had$1.3 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 99.626% 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. 36 -------------------------------------------------------------------------------- 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, 2020 , 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, 2020 , 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, 2020 , we paid cash to settle$43 million in principal of the 2022 Notes. Additionally, we repurchased$496.8 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 we have received through the filing date, we expect to settle in cash an aggregate amount of approximately$70 million in principal of the 2022 Notes during the fourth quarter of 2020. We may receive additional conversion requests that require settlement in the fourth quarter of 2020. During the nine months endedSeptember 30, 2020 , we issued 2.3 million shares of our common stock upon partial unwind of the 2022 Warrants. 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 . In addition, we issued 4.3 million shares of our common stock upon the automatic exercise of a portion of the 2018 Warrants during the nine months endedSeptember 30, 2019 . The 2018 Warrants were no longer outstanding as ofJune 30, 2019 . 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 Part II, Item 1A titled "Risk Factors". However, we anticipate our current cash, cash equivalents and investment balances 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
2020 2019
(dollars in thousands)
Net cash provided by operating activities $ 1,101,074 $ 814,761
Net cash used in investing activities (1,330,353) (525,745)
Net cash provided by (used in) financing activities 800,139 (225,575)
Net increase in cash, cash equivalents and restricted cash, net
of foreign currency effect 573,819 57,002
Operating Activities
Cash provided by operating activities mainly consists of our net income adjusted
for repayments of convertible senior notes attributable to debt discount,
certain non-cash items, including, depreciation and amortization, amortization
of deferred commissions, amortization of issuance cost and debt discount, loss
on extinguishment of 2022 Notes, stock-based compensation and changes in
operating assets and liabilities during the year.
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Net cash provided by operating activities was $1.1 billion for the nine months
ended September 30, 2020 compared to $815 million for the nine months ended
September 30, 2019 . The increase in operating cash flow was primarily due to an
increase in net income compared to same period in the prior year and an increase
in adjustments for non-cash items to reconcile net income to net cash provided
by operations, driven by loss on extinguishment of 2022 Notes, increase in
stock-based compensation from increased headcount and depreciation and
amortization from increased capital expenditures to support the business growth
offset by the repayment of 2022 Notes attributable to debt discount and the
favorable impact on operating cash flow from changes in operating assets and
liabilities.
Investing Activities
Net cash used in investing activities for the nine months ended September 30,
2020 was $1.3 billion compared to $526 million for the nine months ended
September 30, 2019 . The increase in cash used in investing activities was mainly
due to $606 million increase in net purchases of investments, $108 million
increase in cash outflow for business combinations and $99 million increase in
capital expenditures.
Financing Activities
Net cash provided by financing activities was $800 million for the nine months
ended September 30, 2020 compared to net cash used in financing activities of
$226 million for the nine months ended September 30, 2019 . The increase is
primarily due to proceeds of $1.5 billion from the issuance of the 2030 Notes,
net of discount and issuance costs, offset by the 2022 Notes Repurchase of $1.6
billion attributable to principal, 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 an increase in proceeds from employee stock plans by $37
million , offset by a $30 million increase in taxes paid related to net share
settlement of equity awards.
Contractual Obligations and Commitments
Except for those disclosed in Note 16 "Commitments and Contingencies" and Note 10 "Long-Term Debt" of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, there have been no material changes outside the ordinary course of business to our contractual obligations and commitments in the contractual obligations and commitments disclosed in our Annual Report on 10-K for the year endedDecember 31, 2019 , which was filed with theSEC onFebruary 20, 2020 .
Off-Balance Sheet Arrangements
During all periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for purposes of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships.
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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