This section of our Annual Report on Form 10-K discusses our financial condition and results of operations for the fiscal years endedDecember 31, 2021 and 2020, and year-to-year comparisons between fiscal 2021 and fiscal 2020 in accordance withU.S. Generally Accepted Accounting Principles ("GAAP"). A discussion of our financial condition and results of operations for the fiscal year endedDecember 31, 2019 and year-to-year comparisons between fiscal 2020 and fiscal 2019 that is not included in this Annual Report on Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 , filed onFebruary 12, 2021 . 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.
Overview
ServiceNow was founded on a simple premise: a better technology platform will help work flow better. The company's purpose is to make the world work better for everyone. We help global enterprises across industries, universities and governments to digitize their workflows. The Now Platform enables us to connect systems, silos, departments and processes with digital workflows that are simple and easy to use. We categorize the workflows we provide into four primary areas: IT, Employee, Customer and Creator. The products under each of our workflows are helping customers connect work across systems and silos to enable great experiences for people. The Now Platform is uniquely positioned to enable our customers' digital transformation from non-integrated enterprise technology solutions with manual and disconnected processes and activities, to integrated enterprise technology solutions with automation and connected processes and activities. The transformation to digital operations, enabled by the Now Platform, increases our customers' resiliency and security and delivers great experiences and additional value to their employees and consumers. 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 are continuing to monitor the actual and potential effects of the COVID-19 pandemic across our business. The extent and continued impact of the COVID-19 pandemic on our business will depend on certain developments including the duration and spread of the outbreak and new variant strains of the virus; the availability and distribution of effective vaccines; the severity of the economic decline attributable to the pandemic and timing, nature and sustainability of economic recovery; and government responses, including vaccination or testing mandates, all of which are highly uncertain and unpredictable. Starting late 2021, many employees began to return to our offices for at least part of the week. Our return to work approach may vary among geographies depending on appropriate health protocols, and may change at any time depending on the severity of or spikes in COVID-19. 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 this Annual Report for further discussion of the possible impact of the COVID-19 pandemic on our business.
Basic 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.
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As of December 31, 2021 , our RPO was $11.5 billion , of which 49% represented
cRPO. RPO and cRPO increased by 29%, respectively, compared to December 31,
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.
•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 the U.S. Federal
government throughout the year, with the highest number of agreements entered
into in the quarter ended September 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 1,359, 1,085, and 882 customers with ACV greater
than $1 million as of December 31, 2021 , 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
the ServiceNow customer. For example, while all U.S. government agencies roll up
to "Government of the 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:
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Year Ended December 31,
2021 2020 2019
(in millions)
Free cash flow:
Net cash provided by operating activities $ 2,191 $ 1,786 $ 1,236
Purchases of property and equipment (392) (419) (265)
Free cash flow (1) $ 1,799 $ 1,367 $ 971
(1)Free cash flow for the years ended December 31, 2021 and 2020 include the
effect of $15 million and $82 million , respectively relating to the repayments
of convertible senior notes attributable to debt discount. Refer to Note 11 in
the notes to our consolidated financial statements included elsewhere in this
Annual Report on Form 10-K for further details.
We have historically seen higher collections in the quarter ended March 31 due
to seasonality in timing of entering into customer contracts which is
significantly higher in the quarter ended December 31 . Additionally, we have
historically seen higher disbursements in the quarters ended March 31 and
September 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.
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 years ended
December 31, 2021 , 2020 and 2019. 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 consolidated statements of cash flows.
The calculation of billings is provided below:
Year Ended December 31,
2021 2020 2019
(dollars in millions)
Billings:
Total revenues $ 5,896
Changes in deferred income, unbilled receivables and customer deposits (1)
954 710 542 Total billings$ 6,850 $ 5,229 $ 4,002 Year-over-year percentage change in total billings 31 % 31 % 30 %
(1) As shown in or derived from our consolidated cash flow statements.
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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 $38 million and an
immaterial impact on billings for the years ended December 31, 2021 and 2020,
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 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 in U.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 $74 million and $21 million for the years ended December 31, 2021 and
2020, respectively.
•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 by December 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 a gross domestic product contraction and other impacts unknown
on our customers and sales cycles caused by the COVID-19 pandemic.
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 than U.S. Dollars into U.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.
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. As a result, our
billings metric has become less indicative of the actual performance of our
business over time and we do not plan to disclose this metric in future filings.
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Critical Accounting Policies and Significant Judgments and Estimates
Our management's discussion and analysis of financial condition and results of
operations is based on our consolidated financial statements, which have been
prepared in accordance with GAAP. The preparation of these consolidated
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the consolidated financial statements, as
well as the reported revenues and expenses during the reporting periods. These
items are monitored and analyzed by us for changes in facts and circumstances,
and material changes in these estimates could occur in the future. We base our
estimates on historical experience and on various other factors that we believe
are reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Changes in estimates are reflected in
reported results for the period in which they become known. Actual results may
differ from these estimates under different assumptions or conditions and such
differences could be material.
While our significant accounting policies are more fully described in Note 2 in
the notes to our consolidated financial statements included elsewhere in this
Annual Report on Form 10-K, we believe that the following accounting policies
are critical to the process of making significant judgments and estimates in the
preparation of our audited consolidated financial statements.
Income Recognition
We derive our revenues predominately from subscription revenues which are
primarily comprised of subscription fees that give customers access to the
ordered subscription service, related support and updates, if any, to the
subscribed service during the subscription term. For our cloud services, we
recognize subscription revenues ratably over the contract term beginning on the
commencement date of each contract, the date we make our services available to
our customers. Our contracts with customers typically include a fixed amount of
consideration and are generally non-cancelable and without any refund-type
provisions.
Subscription revenues also include revenues from self-hosted offerings in which
customers deploy, or we grant customers the option to deploy without significant
penalty, our subscription service internally or contract with a third party to
host the software. For these contracts, we account for the software element
separately from the related support and updates as they are distinct performance
obligations. The transaction price is allocated to separate performance
obligations on a relative standalone selling price ("SSP") basis. The
transaction price allocated to the software element is recognized when transfer
of control of the software to the customer is complete. The transaction price
allocated to the related support and updates are recognized ratably over the
contract term.
We enter into contracts that can include various combinations of products and
services, which are generally capable of being distinct and accounted for as
separate performance obligations. For these contracts, the transaction price is
allocated to the separate performance obligations on a relative SSP basis.
Evaluating the terms and conditions included within our customer contracts for
appropriate revenue recognition and determining whether products and services
are considered distinct performance obligations that should be accounted for
separately versus together may require significant judgment.
Deferred Commissions
Deferred commissions are the incremental selling costs that are associated with
acquiring customer contracts and consist primarily of sales commissions paid to
our sales organization and referral fees paid to independent third parties.
Commissions and referral fees earned upon the execution of initial and expansion
contracts are primarily deferred and amortized over a period of benefit that we
have determined to be five years consistent with prior year. Commissions earned
upon the renewal of customer contracts are deferred and amortized over the
average renewal term. Additionally, for self-hosted offerings, consistent with
the recognition of subscription revenues for self-hosted offerings, a portion of
the commission cost is expensed upfront when the self-hosted offering is made
available. Determining the period of benefit including average renewal term
requires judgment for which we take into consideration our customer contracts,
our technology life cycle and other factors.
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Business combinations
The allocation of the purchase price in a business combination requires
management to make significant estimates in determining the fair value of
acquired assets and assumed liabilities, especially with respect to intangible
assets. The excess of the purchase price in a business combination over the fair
value of these tangible and intangible assets acquired and liabilities assumed
is recorded as goodwill. Critical estimates in valuing certain intangible assets
include, but are not limited to, future expected cash flows, discount rates, the
time and expense to recreate the assets and profit margin a market participant
would receive. These estimates are inherently uncertain and unpredictable and,
as a result, actual results may differ from estimates. The Company evaluates
these estimates and assumptions as new information is obtained and may record
adjustments to the fair value of the tangible and intangible assets acquired and
liabilities assumed but not later than one year from the acquisition date.
Income Taxes
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense (benefit) and in evaluating our tax positions, including evaluating uncertainties and the complexity of taxes on foreign earnings. We review our tax positions quarterly and adjust the balances as new information becomes available. Deferred tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including future growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, historical earnings, taxable income in prior years, if carryback is permitted under the law, carryforward periods and prudent and feasible tax planning strategies. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. To the extent sufficient positive evidence becomes available, we may release all or a portion of our valuation allowance in one or more future periods. A release of the valuation allowance, if any, would result in the recognition of certain deferred tax assets and a material income tax benefit for the period in which such release is recorded. Due to cumulative losses including tax deductible stock compensation and based on all available positive and negative evidence, we have determined that it is more likely than not that ourU.S. deferred tax assets will not be realizable as ofDecember 31, 2021 . Management applied significant judgment in assessing the positive and negative evidence available in the determination of the amount of deferred tax assets that were more likely than not to be realized in the future. In determining the need, or continued need, for a valuation allowance, we considered the weighting of the positive and negative evidence which includes, among other things, cumulative losses including tax deductible stock compensation expense , future growth, forecasted earnings, and future taxable income. Our tax positions are subject to income tax audits by multiple tax jurisdictions throughout the world. We recognize the tax benefit of an uncertain tax position only if it is more likely than not the position is sustainable upon examination by the taxing authority based on the technical merits. We measure the tax benefit recognized as the largest amount of benefit which is more likely than not to be realized upon settlement with the taxing authority. We recognize interest accrued and penalties related to unrecognized tax benefits in our tax provision. Significant judgment is required to evaluate uncertain tax positions. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law or guidance, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results. We calculate the current and deferred income tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years and record adjustments based on filed income tax returns when identified. The amount of income taxes paid is subject to examination byU.S. federal, state and foreign tax authorities. The estimate of the potential outcome of any uncertain tax issue is subject to management's assessment of relevant risks, facts and circumstances existing at that time. To the extent the assessment of such tax position changes, we record the change in estimate in the period in which we make the determination. 38 -------------------------------------------------------------------------------- Table of Contents Change in Accounting Estimate InJanuary 2022 , we completed an assessment of the useful life of our data center equipment and determined we should increase the estimated useful life of data center equipment from three to four years. This change in accounting estimate will be effective beginning fiscal year 2022. Based on the carrying amount of data center equipment included in property and equipment, net that are in-service as ofDecember 31, 2021 , it is estimated this change will increase our fiscal year 2022 operating income by approximately$80 million .
New Accounting Statements Pending Adoption
The impact of recently released accounting standards is set out in Note 2, Summary of Significant Accounting Policies, of the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K .
Components of the Results of Operations
Earnings
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. 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%, 81% and 82% of our total revenues for the years endedDecember 31, 2021 , 2020 and 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.
Revenue Amount
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.
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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 14%, 10% and 15% for the years ended December
31, 2021 , 2020 and 2019, 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.
Provision for (benefit from) Income Taxes
Provision for (benefit from) income taxes consist of federal, state and foreign income taxes. Due to cumulative losses, we maintain a valuation allowance against ourU.S. deferred tax assets as ofDecember 31, 2021 and 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.
Comparison of years ended
Revenues
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Revenues:
Subscription $ 5,573 $ 4,286 30 %
Professional services and other 323 233 39 %
Total revenues $ 5,896 $ 4,519 30 %
Percentage of revenues:
Subscription 95 % 95 %
Professional services and other 5 % 5 %
Total 100 % 100 %
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-------------------------------------------------------------------------------- Table of Contents Subscription revenues increased by$1.3 billion for the year endedDecember 31, 2021 , compared to the prior year, driven by increased purchases by existing customers and an increase in customer count. Included in subscription revenues is$241 million and$205 million of revenues recognized upfront from the delivery of software associated with self-hosted offerings during the years endedDecember 31, 2021 and 2020, respectively. We expect subscription revenues for the year endingDecember 31, 2022 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 endedDecember 31, 2021 . We will continue to monitor the COVID-19 pandemic in 2022 and its impact on customer acquisition and renewal rates.
Our expectations for revenues, amount of revenues and operating costs for the end of the year
Subscription revenues consist of the following:
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Digital workflow products $ 4,882 $ 3,749 30 %
ITOM products 691 537 29 %
Total subscription revenues $ 5,573 $ 4,286 30 %
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, Industry Solutions, 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 and increasingly on a
subscription unit basis which allows us to measure customers' management of
physical IT resources.
Professional services and other revenues increased by $90 million for the year
ended December 31, 2021 , compared to the prior year, 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, 2022
to increase in absolute dollars, but remain relatively flat as a percentage of
revenue compared to the year ended December 31, 2021 . 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.
Amount of Earnings and Percentage of Gross Profit
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Cost of revenues:
Subscription $ 1,022 $ 731 40 %
Professional services and other 331 256 29 %
Total cost of revenues $ 1,353 $ 987 37 %
Gross profit percentage:
Subscription 82 % 83 %
Professional services and other (2) % (10) %
Total gross profit percentage 77 % 78 %
Gross profit: $ 4,543 $ 3,532 29 %
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-------------------------------------------------------------------------------- Table of Contents Cost of subscription revenues increased by$291 million for the year endedDecember 31, 2021 , compared to the prior year, primarily due to increased headcount and increased costs to support the growth of our subscription offerings including costs to support customers in regulated markets. Personnel-related costs including stock-based compensation and overhead expenses increased by$123 million as compared to prior year. Depreciation expense related to data center hardware and software and maintenance costs to support the expansion of our data center capacity including public cloud service costs increased by$141 million and amortization of intangibles increased by$29 million as a result of acquisitions as compared to the prior year. We expect our cost of subscription revenues for the year endingDecember 31, 2022 to increase in absolute dollars as we provide subscription services to more customers and increase usage within our customer instances but slightly decrease as a percentage of revenue resulting from the change in estimated useful life of data center equipment from three to four years beginning in 2022. Our subscription gross profit percentage was 82% and 83% for each of the years endedDecember 31, 2021 and 2020, respectively. We expect our subscription gross profit percentage to slightly increase for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 driven by the change in estimated useful life of data center equipment from three to four years beginning in 2022. However, we will continue to incur incremental costs to attract 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$75 million for the year endedDecember 31, 2021 as compared to the prior year. The increase was primarily due to increased headcount to support growth resulting in an increase in personnel-related costs including stock-based compensation and overhead expenses by$55 million and an increase in outside service costs by$20 million compared to prior period. Our professional services and other gross loss percentage improved to 2% for the year endedDecember 31, 2021 , compared to 10% in the prior year, primarily driven by the increased utilization of our internal professional services organization and the reduction in certain travel expenses. However, we expect our professional services and other gross loss percentage to worsen for the year endingDecember 31, 2022 as we expect additional cost to support business growth and increases in travel expenses compared to the year endedDecember 31, 2021 . Sales and Marketing Year Ended December 31, 2021 2020 % Change (dollars in millions) Sales and marketing$ 2,292 $ 1,855 24 % Percentage of revenues 39 % 41 % Sales and marketing expenses increased by$437 million for the year endedDecember 31, 2021 , compared to the prior year. The increase was primarily due to increased headcount resulting in an increase in personnel-related costs including stock-based compensation and overhead expenses of$329 million , compared to the prior year. Amortization of deferred commissions and third-party referral fees increased by$79 million , compared to 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, purchase of advertising and market data and outside services, increased by$29 million compared to the prior year. We converted certain in-person events to digital events in the first half of 2021 amid COVID-19 travel restrictions which resulted in certain savings for the year endedDecember 31, 2021 compared to the same period in the prior year. We expect sales and marketing expenses for the year endingDecember 31, 2022 to increase in absolute dollars, but remain relatively flat as a percentage of revenue compared to the year endedDecember 31, 2021 , as we continue to see leverage from increased sales productivity and marketing efficiencies offset by growth in our international operations and increases in travel expenses in 2022. 42
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Research and Development
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Research and development $ 1,397 $ 1,024 36 %
Percentage of revenues 24 % 23 %
Research and development expenses increased by $373 million during the year
ended December 31, 2021 , compared to the prior year. The increase was primarily
due to increased headcount resulting in an increase in personnel-related costs
including stock-based compensation and overhead expenses of $346 million
compared to prior year. The remaining increase was primarily due to $22 million
increase in outside services and 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,
2022 to increase in absolute dollars, but remain relatively flat as a percentage
of revenue compared to the year ended December 31, 2021 , 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
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
General and administrative $ 597 $ 454 31 %
Percentage of revenues 10 % 10 %
General and administrative expenses increased by $143 million during the year
ended December 31, 2021 , compared to the prior year. The increase was primarily
due to increased headcount resulting in an increase in personnel-related costs
including stock-based compensation and overhead expenses of $113 million . The
remaining increase was primarily due to $21 million of outside service 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 ("ESG").
We expect general and administrative expenses for the year ending December 31,
2022 to increase in absolute dollars but remain relatively flat as a percentage
of revenue compared to the year ended December 31, 2021 , as we continue to see
leverage from continued G&A productivity, offset by higher stock-based
compensation related to the 2021 Performance Awards, increased investment in
cyber security and our ESG efforts.
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Stock-based Compensation
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Cost of revenues:
Subscription $ 128 $ 98 31 %
Professional services and other 59 52 13 %
Sales and marketing 389 320 22 %
Research and development 395 282 40 %
General and administrative 160 118 36 %
Total stock-based compensation $ 1,131 $ 870 30 %
Percentage of revenues 19 % 19 %
Stock -based compensation increased by
Stock-based compensation is inherently difficult to forecast due to fluctuations in our stock price. Based upon our stock price as ofDecember 31, 2021 , we expect stock-based compensation to continue to increase in absolute dollars for the year endingDecember 31, 2022 as we continue to issue stock-based awards to our employees, but remain relatively flat as a percentage of revenue compared to the year endedDecember 31, 2021 . We expect stock-based compensation as a percentage of revenue 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 36% and 35% of total revenues for the years endedDecember 31, 2021 and 2020, respectively. 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) during the year endedDecember 31, 2021 had a favorable impact on our revenues. For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the year endedDecember 31, 2021 at the exchange rates in effect for the year endedDecember 31, 2020 rather than the actual exchange rates in effect during the period, our reported subscription revenues would have been$77 million lower. The impact from the foreign currency movements was not material for professional services and other revenues for the year endedDecember 31, 2021 . 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 revenue and sales and marketing expense during the year endedDecember 31, 2021 . For entities reporting in currencies other than theU.S. Dollar, if we had translated our results for the year endedDecember 31, 2021 at the exchange rates in effect for the year endedDecember 31, 2020 rather than the actual exchange rates in effect during the period, our reported cost of revenues and sales and marketing expenses would have been$22 million and$25 million lower for the year endedDecember 31, 2021 , respectively. The impact from the foreign currency movements from the year endedDecember 31, 2020 to the year endedDecember 31, 2021 was not material to research and development and general and administrative expenses. 44 --------------------------------------------------------------------------------
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Interest Expense
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Interest expense $ (28) $ (33) (15 %)
Percentage of revenues - % (1 %)
Interest expense decreased during the year ended December 31, 2021 , compared to
the prior year, due to the decrease in amortization expense of debt discount and
issuance costs as a result of lower outstanding principal balance of the 2022
Notes. For the year ending December 31, 2022 , we expect to incur approximately
$25 million related to the 2030 Notes and 2022 Notes.
Other Income (Expense), net
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Interest income $ 20 $ 39 (49) %
Loss on extinguishment of 2022 Notes (3) (47) 94 %
Other 3 (8) 138 %
Other income (expense), net $ 20 $ (16) 225 %
Other income (expense), net increased by $36 million during the year ended
December 31, 2021 , compared to the prior year, primarily driven by the lower
loss on extinguishment of the 2022 Notes due primarily to the 2022 Notes
Repurchase which occurred in 2020 and a larger amount of early conversions of
the 2022 Notes and lower foreign currency exchange losses, mainly offset by a
decrease in interest income resulting from the decline in interest rates.
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 (benefit from) Income Taxes
Year Ended December 31,
2021 2020 % Change
(dollars in millions)
Income before income taxes $ 249 $ 150 66 %
Provision for (benefit from) income taxes 19 31 (39 %)
Effective tax rate 8 % 21 % (62) %
Our effective tax rate was 8% and 21% for the years ended December 31, 2021 and
December 31, 2020 . The difference in rates was primarily attributable to the mix
of earnings and losses in foreign jurisdictions with differing tax rates,
including a revaluation of our deferred taxes to account for a change in the
United Kingdom tax rate, and a partial valuation allowance release related to
acquired Lightstep, Inc. deferred tax liabilities. See Note 16 in the notes to
our consolidated financial statements included elsewhere in this Annual Report
on Form 10-K for our reconciliation of income taxes at the statutory federal
rate to the provision for (benefit from) income taxes.
We maintained a full valuation allowance on our U.S. federal and state deferred
tax assets as of December 31, 2021 and 2020, respectively. 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 on our U.S. federal and state deferred tax assets,
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. To the extent
sufficient positive evidence becomes available, we may release all or a portion
of our valuation allowance in one or more future periods. A release of the
valuation allowance, if any, would result in the recognition of certain deferred
tax assets and a material income tax benefit for the period in which such
release is recorded.
Liquidity and Capital Resources
We generate cash inflows from operations primarily from selling subscription services which are generally paid in advance of provisioning services, and cash outflows to develop new services and core technologies that further enhance the Now Platform, engage our customer and enhance their experience, and enable and transform our business operations. Subscription services arrangements typically have a three-year duration, and we have experienced a renewal rate of 98% over the last three years. Cash outflows from operations are principally comprised of the salaries, bonuses, commissions, and benefits for our workforce; licenses and services arrangements that are integral to our business operations and data centers; and operating lease arrangements that underlie our facilities. We have generated positive operating cash flows over the last ten years as we continue to grow our business in pursuit of our business strategy, and we expect to grow our business and generate positive cash flows from operations during 2022. When assessing sources of liquidity, we also include cash and cash equivalents, short-term investments and long-term investments totaling$4.9 billion as ofDecember 31, 2021 . Our working capital requirements are principally comprised of non-contract workforce salaries, bonuses, commissions, and benefits and, to a lesser extent, cancellable and non-cancelable licenses and services arrangements that are integral to our business operations, and operating lease obligations. Non-cancelable purchase commitments for business operations total$383 million as ofDecember 31, 2021 , due primarily over the next five years. In addition. we expect payment for the investment in Celonis SE of$100 million in the first quarter of 2022. Operating lease obligations totaling$741 million are principally associated with leased facilities and have varying maturities with$418 million due over the next five years. To grow our business, we also invest in capital and expand our facilities to enable our data centers and workforce and consider strategic acquisitions of technology and businesses to supplement our technology portfolio. Our capital expenditures are typically under cancelable arrangements primarily used to support the installed base and growth of our hosted business. We have also issued long-term debt to finance our business. 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"). In May andJune 2017 , we issued the 2022 Notes with an aggregate principal amount of$782.5 million . The remaining principal amount of the 2022 Notes, totaling$92 million , will be settled in cash during the first half of 2022. 46 -------------------------------------------------------------------------------- Table of Contents Our free cash flows, together with our other sources of liquidity, are available to service our liabilities as well as our cancellable and non-cancellable arrangements. We anticipate cash flows generated from operations, cash, cash equivalents and investments will be sufficient to meet our liquidity needs for at least the next 12 months. As we look beyond the next 12 months, we seek to continue to grow free cash flows necessary to fund our operations and grow our business. If we require additional capital resources, we may seek to finance our operations from the current funds available or additional equity or debt financing. Year Ended December 31, 2021 2020 (in millions) Net cash provided by operating activities$ 2,191 $ 1,786 Net cash used in investing activities (1,607) (1,507) Net cash provided by (used in) financing activities (506) 597 Net increase in cash, cash equivalents and restricted cash 53 901 Operating Activities Net cash provided by operating activities was$2.2 billion for the year endedDecember 31, 2021 compared to$1.8 billion for the prior year. The net increase in operating cash flow was primarily due to increase in operating income and higher collections driven by revenue growth compared to settlement of payables. In addition, we benefited from a reduction in repayments of 2022 Notes attributable to debt discount.
Investment Activities
Net cash used in investing activities for the year endedDecember 31, 2021 was$1.6 billion compared to$1.5 billion for the prior year. The net increase in cash used in investing activities was primarily due to$678 million increase in business combinations, net of cash and restricted cash acquired, and$59 million purchase of new strategic investments offset by$586 million decrease in net purchases of investments. Financing Activities Net cash used in financing activities for the year endedDecember 31, 2021 was$506 million compared to net provided by financing activities of$597 million for the prior year. The change was primarily driven by the$1.5 billion proceeds from the issuance of 2030 Notes in the year endedDecember 31, 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 . The remaining change was due to$103 million increase in taxes paid related to net share settlement of equity awards offset by$21 million increase in proceeds from employee equity plans primarily driven by higher share price compared to prior year.
Contract Obligations and Commitments
Our estimated future obligations consist of leases, an agreement to purchase$100 million of common and preferred shares in Celonis SE, purchase obligations, debt and unrecognized tax benefits as ofDecember 31, 2021 . Refer to Note 17 "Commitments and Contingencies" and Note 19 "Subsequent Events" to our consolidated financial statements included in this Annual Report on Form 10-K for more information. 47
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