APPIAN CORP 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those contained in or implied by any forward-looking statements. Factors that could cause or contribute to these differences include those under “Risk Factors” included in Part I, Item 1A or in other parts of this Annual Report on Form 10-K. Overview We provide a low-code automation platform that accelerates the creation of high-impact business applications, enabling our customers to automate the most important aspects of their business. Global organizations use our applications to improve customer experience, achieve operational excellence, and simplify global risk management and compliance. With our platform, organizations can rapidly and easily design, build, and implement powerful, enterprise-grade custom applications through our intuitive, visual interface with little or no coding required. Our customers have used applications built on our platform to launch new business lines, automate vital employee workflows, manage complex trading platforms, accelerate drug development, and build global procurement systems. With our platform, decision makers can reimagine their products, services, processes, and customer interactions by removing much of the complexity and many of the challenges associated with traditional approaches to software development. We have generated the majority of our revenue from sales of subscriptions, which include (1) SaaS subscriptions bundled with maintenance and support and hosting services and (2) term license subscriptions bundled with maintenance and support. Our subscription fees are based primarily on the number of users who access and utilize the applications built on our platform or, alternatively, non-user based single application licenses. Our customer contract terms generally vary from one to three years with most providing for payment in advance on an annual, quarterly, or monthly basis. Due to the variability of our billing terms and the episodic nature of our customers purchasing additional subscriptions, we do not believe changes in our deferred revenue in a given period are directly correlated with our revenue growth. Since inception, we have invested in our Customer Success organization to help ensure customers are able to build and deploy applications on our platform. We have several strategic partnerships, including with KPMG, PwC, Accenture, and Deloitte, for them to refer customers to us in order to purchase subscriptions and then to provide professional services directly to the customers using our platform. We intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. In addition, over time we expect professional services revenue as a percentage of total revenue to decline as we increasingly rely on strategic partners to help our customers deploy our software. We believe our investment in professional services, including strategic partners building their practices around Appian, will drive increased adoption of our platform. As of December 31, 2020, we had 693 customers in a variety of industries, of which 548 customers were commercial and 145 customers were government or non-commercial entities. Our customers include financial services, government, life sciences, telecommunications, media, energy, manufacturing, and transportation organizations. Generally, our sales force targets its efforts to organizations with over 2,000 employees and $2 billion in annual revenue. As of December 31, 2020, 25% of our commercial customers were Global 2000 organizations, and 60 of our customers were Fortune 500 companies. Revenue from government agencies represented 18.1%, 17.1%, and 15.7% of our total revenue in 2020, 2019, and 2018, respectively. No single end-customer accounted for more than 10% of our total revenue in 2020, 2019, and 2018. Our platform supports multiple languages to facilitate collaboration and address challenges in multinational organizations. We offer our platform globally. In 2020, 2019, and 2018, 33.8%, 32.3%, and 28.7%, respectively, of our total revenue was generated from customers outside of the United States. As of December 31, 2020, we operated in 12 countries. We believe we have a significant opportunity to grow our international footprint. We are investing in new geographies, including through investment in direct and indirect sales channels, professional services, and customer support and implementation partners. We have experienced strong revenue growth, with revenue of $304.6 million, $260.4 million, and $226.7 million in 2020, 2019, and 2018, respectively. Our subscriptions revenue was $198.7 million, $151.3 million, and $126.0 million in 2020, 2019, 45 and 2018, respectively, and includes sales of our SaaS subscriptions, on-premises term license subscriptions, and maintenance support. Our cloud subscription revenue was $129.2 million, $95.0 million, and $67.4 million in 2020, 2019, and 2018, respectively. We have invested in developing our platform, expanding our sales and marketing and research and development capabilities, and providing general and administrative resources to support our growth. We intend to continue to invest in our business to take advantage of our market opportunity. As a result, we incurred net losses of $33.5 million, $50.7 million, and $49.5 million in 2020, 2019, and 2018, respectively. We also used cash in operations of $7.6 million, $8.9 million, and $31.3 million in 2020, 2019, and 2018, respectively. COVID-19 Beginning in late 2019 and continuing into 2021, the outbreak of the novel coronavirus disease, or COVID-19, has resulted in the declaration of a global pandemic and adversely affected economic activity across virtually all sectors and industries on a local, national, and global scale. The impact of COVID-19 on the economy and our business continues to be a fluid situation. Operationally, we remain focused on supporting our customers, employees, and communities during this time. We have responded quickly to adopt a virtual corporate strategy consisting of enabling most of our employees to work productively from home while continuing to guard the health and safety of our teams, support our customers, and mitigate risk. We are focused on ensuring continuity for our customers. To the extent possible, we are conducting business as usual, with necessary or advisable modifications to employee travel, employee work locations, and marketing events. Through December 31, 2020, we have not seen a meaningful adverse impact to our financial position, results of operations, and cash flows and liquidity as a result of COVID-19. While the verticals from which we have historically generated the majority of our revenue have been less impacted by COVID-19 to date, there may be impacts to our financial condition and results of operations in 2021 as a result of reduced demand for our products and services and longer sales cycles. The ultimate impact of COVID-19 on our business is not estimable at this time and will be largely dependent upon a number of factors outside of our control including the extent and duration of the outbreak as well as any mitigating actions which may be undertaken by global governments and the general public. Our Business Model Our business model focuses on maximizing the lifetime value of customer relationships, which is a function of the duration of a customer’s deployment of Appian as well as the price and number of subscriptions of Appian a customer purchases. We incur significant customer acquisition costs, including expenses associated with hiring new sales representatives, who generally take more than one year to become productive given the length of our sales cycle, and marketing costs, all of which, with the exception of sales commissions, are expensed as incurred. At the same time, we believe the costs we incur to retain customers and drive additional purchases of software are lower than our customer acquisition costs on a relative basis. Over time, we expect a large portion of our customers to renew their subscriptions and purchase additional subscriptions as they continue to build more applications and add more users to our platform. Over the last three completed fiscal years, we had an average cloud subscription renewal rate of 98%. We calculate our cloud subscription renewal rate by dividing (i) the cloud subscription revenue from renewing cloud customers in the current 12-month period that were cloud customers during the entirety of the prior 12-month period, giving effect to price increases but excluding additional cloud subscriptions for additional users, or upsells, by (ii) our cloud subscription revenue from all cloud customers in the corresponding prior 12-month period that were cloud customers during the entirety of such prior 12-month period. For example, to obtain our cloud subscription renewal rate for the 12-month period ended December 31, 2020, we identified the amount of cloud subscription revenue in 2020 from cloud customers that were our cloud customers for all of 2019 and subtracted the amount of upsells to such cloud customers and new users from those cloud customers in 2020. We then divided the balance of 2020 cloud subscription revenue from such cloud customers by all cloud subscription revenue generated in 2019 from cloud customers that were cloud customers for the entirety of 2019. With respect to the average for our last three completed fiscal years, we calculated the average of the three applicable 12-month periods. We also expect the proportion of annual revenue from existing customers to grow relative to annual revenue from new customers. We believe this mix shift over time will have a positive impact on our operating margins, as we expect the percentage of revenue spent on sales and marketing to decline. 46 We measure the effectiveness of our business model by comparing the lifetime value of our customer relationships to our customer acquisition costs. For fiscal years 2018 and prior, revenue was recognized under Accounting Standards Codification Topic 605, Revenue Recognition, or ASC 605. Under ASC 605, we calculated lifetime customer value as (1) average gross margin multiplied by average subscription and maintenance and support revenue from customers for a given month divided by (2) the average percentage of monthly recurring revenue that did not renew in each month for the previous 12 months. We then divided this calculated lifetime customer value by our customer acquisition cost, which is the total sales and marketing expense incurred during the corresponding month. In response to our adoption of Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) , or ASC 606, in the year ended December 31, 2019, we revised the calculation of the lifetime value of our customer relationships by replacing subscription revenue with cloud subscription revenue in the calculation. Because we primarily recognize revenue from our on-premises term license subscriptions upfront under ASC 606, we believe cloud subscription revenue better reflects the performance of our business. The calculation of lifetime customer value as compared to customer acquisition costs for the prior years were unchanged. On a rolling 12 month basis, we estimate that for each of the past five fiscal years, the average lifetime value of a customer has exceeded 7x the associated average cost of acquiring them, including the year ended December 31, 2020. Key Factors Affecting Our Performance The following are several key factors that affect our performance: • Market Adoption of Our Platform. Our ability to grow our customer base and drive market adoption of our platform is affected by the pace at which organizations digitally transform. We expect our revenue growth will be primarily driven by the pace of adoption and penetration of our platform. We offer a leading custom software automation platform and intend to continue to invest to expand our customer base. The degree to which prospective customers recognize the need for low-code software that enables organizations to digitally transform, and subsequently allocate budget dollars to purchase our software, will drive our ability to acquire new customers and increase sales to existing customers, which, in turn, will affect our future financial performance. • Growth of Our Customer Base. We believe we have a substantial opportunity to grow our customer base. We define a customer as an entity with an active subscription or maintenance and support contract related to a perpetual software license as of the specified measurement date. To the extent we contract with one or more entities under common control, we count those entities as separate customers. We have aggressively invested, and intend to continue to invest, in our sales force in order to drive sales to new customers. We continue to make investments to enhance the expertise of our sales and marketing organization within our key industry verticals of financial services, government, and life sciences. In addition, we have established relationships with strategic partners who work with organizations undergoing digital transformations. We had a total customer count of 693, 533, and 436 as of December 31, 2020, 2019, and 2018, respectively. Our number of customers with active software subscription agreements was 654, 487, and 378 as of December 31, 2020, 2019, and 2018, respectively. As of December 31, 2020, 25% of our commercial customers were Global 2000 organizations, and 60 of our customers were Fortune 500 companies. Our ability to continue to grow our customer base is dependent, in part, upon our ability to differentiate ourselves within the increasingly competitive markets in which we participate. • Further Penetration of Existing Customers. Our sales force seeks to generate additional revenue from existing customers by adding new users to our platform. Many of our customers begin by building a single application and then grow to build dozens of applications on our platform. Generally, the development of new applications on our platform results in the expansion of our user base within an organization and a corresponding increase in revenue to us because we charge subscription fees on a per-user basis and, to a lesser degree, non-user based single application licenses. As a result of this “land and expand” strategy, we have generated significant additional revenue from our customer base. Our ability to increase sales to existing customers will depend on a number of factors, including the size of our sales force and professional services teams, customers’ level of satisfaction with our platform and professional services, pricing, economic conditions, and our customers’ overall spending levels. We have also re-focused some of our 47 professional services personnel to become customer success managers. Their role is to ensure the customer realizes value from our platform and support the "land and expand" strategy versus delivering billable hours. • Mix of Subscriptions and Professional Services Revenue. We believe our professional services have driven customer success and facilitated the adoption of our platform by customers. During the initial period of deployment by a customer, we generally provide a greater amount of support in building applications and training than later in the deployment, with a typical engagement extending from two to six months. At the same time, many of our customers have historically purchased subscriptions only for a limited set of their total potential end users. As a result of these factors, the proportion of total revenue for a customer associated with professional services is relatively high during the initial deployment period. Over time, as the need for professional services associated with user deployments decreases and the number of end users increases, we expect subscriptions revenue as a percentage of total revenue to increase. In addition, we intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. These partners perform professional services with respect to any new service contracts they sign. As the usage of partners expands, we expect the proportion of our total revenue from subscriptions to increase over time relative to professional services. In 2020, 2019, and 2018, 65.2%, 58.1%, and 55.6% of our revenue, respectively, was derived from sales of subscriptions, while the remaining 34.8%, 41.9%, and 44.4%, respectively, was derived from the sale of professional services. • Investments in Growth. We have made, and plan to continue to make, investments for long-term growth, including investment in our platform and infrastructure to continuously maximize the power and simplicity of the platform to meet the evolving needs of our customers and to take advantage of our market opportunity. In addition, we continue to pursue strategic acquisitions that enhance our product offerings. We also intend to continue to invest in sales and marketing as we further expand our sales teams, increase our marketing activities, and grow our international operations. Key Metrics We monitor the following metrics to help us measure and evaluate the effectiveness of our operations. All dollar amounts are presented in thousands. Cloud Subscription Revenue Year Ended December 31, 2020 2019 2018 Cloud Subscription Revenue $ 129,219 $ 95,028 $ 67,447 Pursuant to adoption of ASC 606 in 2019, we primarily recognize revenue from our on-premises term license subscriptions upfront. As a result, we believe our previous key business metric, subscription revenue, no longer best reflects the performance of our business and overemphasizes the volatility in our results. Therefore, we are no longer presenting subscription revenue and have transitioned to a new key metric, cloud subscription revenue. Cloud subscription revenue includes SaaS subscriptions bundled with maintenance and support and hosting services. In 2020, 2019, and 2018, 65.0%, 62.8%, and 53.5%, respectively, of subscriptions revenue was cloud subscription revenue. As we generally sell our SaaS subscriptions on a per-user basis, our cloud subscription revenue for any customer is primarily determined by the number of users who access and utilize the applications built on our platform as well as the price paid. We believe increasing cloud subscription revenue is an indicator of the demand for our platform, the pace at which the market for our solutions is growing, the productivity of our sales force and strategic relationships in growing our customer base, and our ability to further penetrate our existing customer base. The adoption of ASC 606 did not have a material impact on our cloud subscription revenue. 48 Cloud Subscription Revenue Retention Rate As of December 31, 2020 2019 2018 Cloud Subscription Revenue Retention Rate 119 % 115 % 131 % A key factor to our success is the renewal and expansion of subscription agreements with our existing customers. We calculate this metric over a set of customers who have been with us for at least one full year. To calculate our cloud subscription revenue retention rate for a particular trailing 12-month period, we first establish the recurring cloud subscription revenue for the previous trailing 12-month period. This effectively represents recurring dollars we should expect in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period without any expansion or contraction. We subsequently measure the recurring cloud subscription revenue in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period. Cloud subscription revenue retention rate is then calculated by dividing the aggregate recurring cloud subscription revenue in the current trailing 12-month period by the previous trailing 12-month period. This calculation includes the impact on our revenue from customer non-renewals, pricing changes, and growth in the number of users on our platform. Our cloud subscription revenue retention rate can fluctuate from period to period due to large customer contracts in any given period. The cloud subscription revenue retention rate as of December 31, 2018 was elevated as we focused on converting customers with on-premises term license subscriptions to cloud subscriptions. The adoption of ASC 606 did not have a material impact on our cloud subscription revenue retention rate. Non-GAAP Financial Measures To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP operating loss, non-GAAP net loss, non-GAAP net loss per share, non-GAAP weighted average shares outstanding, and adjusted EBITDA, which we collectively refer to as non-GAAP financial measures. As reflected in the following reconciliation tables, these non-GAAP financial measures exclude either or both stock-based compensation expense and gain or loss on disposal of asset. We define non-GAAP operating loss as operating loss before stock-based compensation expense. We define non-GAAP net loss as net loss before stock-based compensation expense and gain or loss on disposal of assets. In periods we report non-GAAP net income, we calculate non-GAAP weighted average shares outstanding as GAAP weighted average shares outstanding adjusted for the effect of potentially dilutive securities that would otherwise be antidilutive under GAAP. We define adjusted EBITDA as net loss before (1) other (income) expense, net, (2) interest expense, (3) income tax expense, (4) depreciation and amortization expense, and (5) stock-based compensation expense. We exclude stock-based compensation expense because of varying available valuation methodologies, subjective assumptions, and the variety of equity instruments that can impact our non-cash expense. We believe providing non-GAAP financial measures excluding stock-based compensation expense allow for more meaningful comparisons between our operating results from period to period. We exclude gains or losses on disposals of assets as these transactions are unrelated to current operations nor predictive of future results, which we believe allows for a more meaningful comparison between our operating results from period to period. Accordingly, we believe excluding these expenses and income provides investors and management with greater visibility into the underlying performance of our business operations, facilitates comparison of our results with other periods, and may also provide comparison with the results of other companies in our industry. The presentation of non-GAAP financial measures is not intended to be considered in isolation from, as a substitute for, or superior to the financial information prepared and presented in accordance with GAAP. We use non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons. We believe our non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to metrics used by our management in its financial and operational decision making. A reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures is included below for review. Reliance should not be placed on any single financial measure to evaluate our business. Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry as other companies in our industry may calculate non-GAAP financial results differently, particularly 49 with respect to non-recurring, unusual items. Non-GAAP financial measures do not have uniform definitions, and our definitions will likely differ from the definitions used by other companies, including peer companies. In addition, non-GAAP financial measures exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense will continue to be a significant recurring expense in our business and an important part of the compensation provided to our employees for the foreseeable future. Note for the years ended December 31, 2020 and 2019, revenue was recognized under ASC 606 while for the year ended December 31, 2018, revenue was recognized under ASC 605. Consequently, our non-GAAP financial measures across those years are not directly comparable to one another. For a reconciliation of the impact of the adoption of ASC 606 on our non-GAAP financial measures for the year ended December 31, 2019, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 20, 2020. The table below reconciles GAAP operating loss to non-GAAP operating loss for the years ended December 31, 2020, 2019, and 2018 (in thousands): Year Ended December 31, 2020 2019 2018 GAAP operating loss $ (37,902) $ (50,468) $ (46,719) Add back: Stock-based compensation expense 15,279 16,443 16,054 Non-GAAP operating loss $ (22,623) $ (34,025) $ (30,665) The following table reconciles GAAP net loss to non-GAAP net loss for the years ended December 31, 2020, 2019, and 2018 (in thousands): Year Ended December 31, 2020 2019 2018 GAAP net loss $ (33,477) $ (50,714) $ (49,451) Add back: Stock-based compensation expense 15,279 16,443 16,054 Loss (gain) on disposal of asset 22 146 (4) Non-GAAP net loss $ (18,176) $ (34,125) $ (33,401) The following table sets forth non-GAAP net loss per share for the years ended December 31, 2020, 2019, and 2018 (in thousands except share and per share data): Year Ended December 31, 2020 2019 2018 Non-GAAP net loss $ (18,176) $ (34,125) $ (33,401) Non-GAAP weighted average shares used to compute net loss per share, basic and diluted 69,050,565 65,479,327 62,140,684 Non-GAAP net loss per share, basic and diluted $ (0.26) $ (0.52) $ (0.54) GAAP basic and diluted weighted average shares outstanding were equal to non-GAAP basic and diluted weighted average shares outstanding for each of the years ended December 31, 2020, 2019, and 2018. 50 The following table reconciles GAAP net loss per share to non-GAAP net loss per share for the years ended December 31, 2020, 2019, and 2018: Year Ended December 31, 2020 2019 2018 GAAP net loss per share, basic and diluted $ (0.48) $ (0.77) $ (0.80) Add back: Non-GAAP adjustments to net loss per share 0.22 0.25 0.26 Non-GAAP net loss per share, basic and diluted $ (0.26) $ (0.52) $ (0.54) The following table reconciles GAAP net loss to adjusted EBITDA for the years ended December 31, 2020, 2019, and 2018 (in thousands): Year Ended December 31, 2020 2019 2018 GAAP net loss $ (33,477) $ (50,714) $ (49,451) Other (income) expense, net (5,786) (941) 2,295 Interest expense 478 367 198 Income tax expense 883 820 239 Depreciation and amortization expense 5,851 4,742 2,020 Stock-based compensation expense 15,279 16,443 16,054 Adjusted EBITDA $ (16,772) $ (29,283) $ (28,645) Key Components of Results of Operations Revenue We generate revenue primarily through sales of subscriptions to our platform as well as professional services. We generally sell our software on a per-user basis and, to a lesser degree, non-user based single application licenses. We generally bill customers and collect payment for subscriptions to our platform in advance on an annual, quarterly, or monthly basis. In certain instances, we have had customers pay their entire contract value up front. Our revenue is comprised of the following: Subscriptions Subscriptions revenue is primarily derived from: • SaaS subscriptions bundled with maintenance and support and hosting services; and • On-premises term license subscriptions bundled with maintenance and support. Our maintenance and support agreements provide customers with the right to unspecified software upgrades, maintenance releases and patches released during the term of the maintenance and support agreement on a when-and-if-available basis, and rights to technical support. On-premises term license subscriptions are offered when the customer prefers to self-manage the deployment of our platform within their own infrastructure. When our platform is delivered as a SaaS subscription, we manage their operational needs in third-party hosted data centers. Professional Services 51 Our professional services revenue is comprised of fees for consulting services, including application development, deployment assistance, and training related to our platform. Over time, as the need for professional services associated with user deployments decreases and the number of end users increases, we expect professional services revenue as a percentage of total revenue to decrease. Additionally, if there is a decline in our procurement of new customers as a result of the COVID-19 pandemic, we may also see a similar decline in professional services revenue. We have several strategic partnerships, including with KPMG, PwC, Accenture, and Deloitte. Our agreements with our strategic partners have indefinite terms and may be terminated for convenience by either party. We intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. These partners refer software subscription customers to us and generally perform professional services with respect to any new service contracts they originate, increasing our subscriptions revenue without any change to our professional services revenue. As we expand the network of strategic partners, we expect professional services revenue to decline as a percentage of total revenue over time since our strategic partners may perform professional services associated with software subscriptions we sell. Cost of Revenue Subscriptions Cost of subscriptions revenue consists primarily of fees paid to our third-party managed hosting providers and other third-party service providers, personnel costs, including payroll and benefits for our technology operations and customer support teams, and allocated facility costs and overhead. We expect cost of revenue to continue to increase in absolute dollars for the foreseeable future as our customer base grows. Professional Services Cost of professional services revenue includes all direct and indirect costs to deliver our professional services and training, including employee compensation for our global professional services and training personnel, third-party contractor costs, allocated facility costs and overhead, and the costs of billable expenses such as travel and lodging. The unpredictability of the timing of entering into significant professional services agreements sold on a standalone basis may cause significant fluctuations in our quarterly financial results and allocated facility costs and overhead. Gross Margin Gross profit and gross margin, or gross profit as a percentage of total revenue, have been, and will continue to be, affected by various factors, including the mix of SaaS subscriptions and on-premises term license subscriptions, the mix of total subscriptions revenue and professional services revenue, subscription pricing, the costs associated with third-party hosting facilities, and the extent to which we expand our professional services to support future growth. Our gross margin may fluctuate from period to period based on the above factors. Subscriptions Gross Margin Subscriptions gross margin is primarily affected by the growth in our subscriptions revenue as compared to the growth in, and timing of, costs to support such revenue. We expect to continue to invest in customer support and SaaS operations to support growth in our business, and the timing of those investments is expected to cause gross margins to fluctuate in the short term but improve over time. Professional Services Gross Margin Professional services gross margin is affected by the growth in our professional services revenue as compared to the growth in, and timing of, the cost of our Customer Success organization as we continue to invest in the growth of our business. Professional services gross margin is also impacted by the amount of services performed by subcontractors and partners as opposed to internal resources. More recently, we have reduced our usage of subcontractors, and the COVID-19 pandemic has resulted in fewer in-person professional services engagements and deployments, both of which have reduced certain classes of expenses and improved professional services margins. However, our improved margins may not be indicative of future trends 52 and are subject to fluctuation based on factors discussed above and uncertainties related to the COVID-19 pandemic outside of our control. Operating Expenses Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Salaries, bonuses, and other personnel-related costs are the most significant components of each of these expense categories. In general, our operating expenses are expected to continue to increase as we invest resources in growing our various teams. We grew from 1,275 employees at December 31, 2019 to 1,460 employees at December 31, 2020, and we expect to continue to hire new employees in order to support our anticipated revenue growth. Sales and Marketing Expense Sales and marketing expense primarily includes personnel costs, including salaries, bonuses, commissions, stock-based compensation, and other personnel costs related to sales teams. Additional expenses in this category include travel and entertainment, marketing activities and promotional events, subcontracting fees, and allocated facility costs and overhead. The number of employees in sales and marketing functions grew from 403 at December 31, 2019 to 445 at December 31, 2020. In order to continue to grow our business, geographical footprint, and brand awareness, we expect to continue investing resources in sales and marketing by increasing the number of sales and account management teams. As a result, we expect sales and marketing expense to increase in absolute dollars as we continue to invest to acquire new customers and further expand usage of our platform within our existing customer base. Research and Development Expense Research and development expense consists primarily of personnel costs for our employees who develop and enhance our platform, including salaries, bonuses, stock-based compensation, and other personnel costs. Also included are non-personnel costs such as subcontracting, consulting, and professional fees to third party development resources, allocated facility costs, and overhead. Our research and development efforts are focused on enhancing the speed and power of our software platform. The number of employees in research and development functions grew from 332 at December 31, 2019 to 381 at December 31, 2020. We expect research and development expense to continue to increase as they are critical to maintain and improve the quality of applications and our competitive position. General and Administrative Expense General and administrative expense consists primarily of personnel costs, including salaries, bonuses, stock-based compensation, and other personnel costs for our administrative, legal, information technology, human resources, finance and accounting employees, and executives. Additional expenses included in this category are non-personnel costs such as travel-related expenses, contracting and professional fees, audit fees, tax services and legal fees, insurance and other corporate expenses, allocated facility costs and overhead, bad debt expenses, and depreciation and amortization costs. The number of employees in general and administrative functions grew from 156 at December 31, 2019 to 206 at December 31, 2020. We expect our general and administrative expense to increase in absolute dollars as we continue to support our growth. Other (Income) Expense Other (Income) Expense, Net Other (income) expense, net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates, interest income on our cash and cash equivalents, gains or losses on the disposal of property and equipment, and other sources of income or expense not related to our core business. 53 Interest Expense Interest expense consists primarily of interest on our finance leases and debt, unused credit facility fees, and commitment fees on our letters of credit. Results of Operations The following table sets forth our consolidated statement of operations data (in thousands): Year Ended December 31, 2020 2019 2018 Consolidated Statement of Operations Data: Revenue: Subscriptions $ 198,710 $ 151,299 $ 126,012 Professional services 105,863 109,053 100,731 Total revenue 304,573 260,352 226,743 Cost of revenue (1) : Subscriptions 20,826 17,098 11,997 Professional services 67,940 76,743 72,928 Total cost of revenue 88,766 93,841 84,925 Gross profit 215,807 166,511 141,818 Operating expenses (1) : Sales and marketing 130,316 117,440 105,992 Research and development 70,241 58,043 44,724 General and administrative 53,152 41,496 37,821 Total operating expenses 253,709 216,979 188,537 Operating loss (37,902) (50,468) (46,719) Other (income) expense: Other (income) expense, net (5,786) (941) 2,295 Interest expense 478 367 198 Total other (income) expense (5,308) (574) 2,493 Loss before income taxes (32,594) (49,894) (49,212) Income tax expense 883 820 239 Net loss $ (33,477) $ (50,714) $ (49,451) (1) Stock-based compensation as a component of these line items is as follows: Year Ended December 31, 2020 2019 2018 (in thousands) Cost of revenue Subscriptions $ 943 $ 647 $ 514 Professional services 1,477 2,748 1,717 Operating expenses Sales and marketing 2,821 4,742 3,473 Research and development 2,718 3,480 2,416 General and administrative 7,320 4,826 7,934 Total stock-based compensation expense $ 15,279 $ 16,443 $ 16,054 54 The following table sets forth our consolidated statement of operations data expressed as a percentage of total revenue: Year Ended December 31, 2020 2019 2018 Consolidated Statement of Operations Data: Revenue: Subscriptions 65.2 % 58.1 % 55.6 % Professional services 34.8 41.9 44.4 Total revenue 100.0 100.0 100.0 Cost of revenue: Subscriptions 6.8 6.6 5.3 Professional services 22.3 29.5 32.2 Total cost of revenue 29.1 36.1 37.5 Gross margin 70.9 63.9 62.5 Operating expenses: Sales and marketing 42.8 45.1 46.7 Research and development 23.1 22.3 19.7 General and administrative 17.5 15.9 16.7 Total operating expenses 83.4 83.3 83.1 Operating loss (12.5) (19.4) (20.6) Other (income) expense: Other (income) expense, net (1.9) (0.4) 1.0 Interest expense 0.2 0.1 0.1 Total other (income) expense (1.7) (0.3) 1.1 Loss before income taxes (10.8) (19.1) (21.7) Income tax expense 0.3 0.3 0.1 Net loss (11.1) % (19.4) % (21.8) % Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019 Revenue Year Ended December 31, % Change 2020 2019 (dollars in thousands) Revenue: Subscriptions $ 198,710 $ 151,299 31.3% Professional services 105,863 109,053 (2.9)% Total revenue $ 304,573 $ 260,352 17.0% Total revenue increased $44.2 million, or 17.0%, in 2020 compared to 2019 due to an increase in our subscriptions revenue of $47.4 million, which was partially offset by a decrease in our professional services revenue of $3.2 million. Of the increase in subscriptions revenue, $34.2 million was attributable to cloud subscription revenue, $11.0 million was attributable to on-premises software revenue, and $2.2 million was attributable to maintenance and support revenue. With respect to new versus existing customers, $36.5 million of the increase in subscriptions revenue stemmed from expanded deployments and corresponding sales of additional subscriptions to existing customers while the remaining increase of $10.9 million was the result of sales of subscriptions to new customers, $2.8 million of which related to a three-year on-premises contract which closed in the first quarter of 2020. The decrease in professional services revenue was due primarily to a $16.9 million decrease 55 in revenue from existing customers which was substantially offset by $13.7 million in sales to new customers. Further contributing to the decrease in professional services revenue was our increased usage of partners to perform professional services in 2020 as compared to 2019, which has resulted in increases to our subscriptions revenue without any change to our professional services revenue. Cost of Revenue Year Ended December 31, % Change 2020 2019 (dollars in thousands) Cost of revenue: Subscriptions $ 20,826 $ 17,098 21.8% Professional services 67,940 76,743 (11.5)% Total cost of revenue $ 88,766 $ 93,841 (5.4)% Subscriptions gross margin 89.5 % 88.7 % Professional services gross margin 35.8 % 29.6 % Total gross margin 70.9 % 64.0 % Cost of revenue decreased $5.1 million, or 5.4%, in 2020 compared to 2019, primarily due to a $10.4 million decrease in contractor costs, a $4.1 million decrease in billable expenses, and a $0.4 million decrease in facility and overhead costs. These decreases were partially offset by a $6.8 million increase in professional services and product support personnel costs and a $3.0 million increase in other cost of revenue. Contractor costs decreased in 2020 compared to 2019 because of a decrease in the usage of subcontractors for professional service engagements. Billable expenses decreased primarily due to lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020 while the decrease in facility and overhead costs was largely due to a reduction in rent expense. Personnel costs increased due to an increase in professional services and product support staff personnel headcount of 11.5% from December 31, 2019 to December 31, 2020. The increase in other cost of revenue was due to increased hosting costs as sales of our cloud offering increased in 2020. Subscriptions gross margin was 89.5% in 2020 compared to 88.7% in 2019 due to an increase in subscriptions revenue in 2020, partially offset by increased hosting costs as sales of our cloud offering increased and became a larger proportion of our overall subscriptions revenue. Professional services gross margin was 35.8% in 2020 compared to 29.6% in 2019 due to a decrease in the usage of subcontractors for professional services engagements, a decrease in travel and entertainment related expenses, a decrease in rent expenses, and a $1.3 million decrease in stock-based compensation expense. Due to the higher percentage of subscriptions revenue for the comparable periods as well as the aforementioned declines in professional services expenses, gross margin was 70.9% in 2020 as compared to 64.0% in 2019. Sales and Marketing Expense Year Ended December 31, % Change 2020 2019 (dollars in thousands) Sales and marketing $ 130,316 $ 117,440 11.0% % of revenue 42.8 % 45.1 % Sales and marketing expense increased $12.9 million, or 11.0%, in 2020 compared to 2019, primarily due to a $17.6 million increase in sales and marketing personnel costs and a $2.3 million increase in professional fees, which were partially offset by a $6.7 million decrease in facility and overhead costs and a $0.4 million decrease in marketing costs. Personnel costs increased due to an increase in sales and marketing personnel headcount of 10.4% from December 31, 2019 to December 31, 2020 and increased sales commissions driven by our subscriptions revenue growth, partially offset by a $1.9 million decrease in stock-based compensation expense. Professional fees increased due to an increase in consulting fees and contract labor to support our growth. Facility and overhead costs decreased due to lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Marketing costs decreased due to reduced costs incurred as a result of moving our 56 annual user conference, Appian World, to virtual-only as well as a reduction in the number of in-person marketing events held in 2020, partially offset by an increase in advertising expenses. Research and Development Expense Year Ended December 31, % Change 2020 2019 (dollars in thousands) Research and development $ 70,241 $ 58,043 21.0% % of revenue 23.1 % 22.3 % Research and development expense increased $12.2 million, or 21.0%, in 2020 compared to 2019, primarily due to a $13.1 million increase in research and development personnel costs, partially offset by a $0.5 million decrease in facility and overhead costs and a $0.3 million decrease in professional fees. Personnel costs increased due to an increase in research and development personnel headcount of 14.8% from December 31, 2019 to December 31, 2020, partially offset by a $0.8 million decrease in stock-based compensation expense. Facilities and overhead costs decreased due to non-recurring charges incurred in 2019 to support our personnel growth coupled with lower travel and entertainment related expenses as a result of our shift to largely remote work in 2020. Professional fees decreased due to a decrease in consulting fees. General and Administrative Expense Year Ended December 31, % Change 2020 2019 (dollars in thousands) General and administrative expense $ 53,152 $ 41,496 28.1% % of revenue 17.5 % 15.9 % General and administrative expense increased $11.7 million, or 28.1%, in 2020 compared to 2019, primarily due to a $7.2 million increase in general and administrative personnel costs, a $3.0 million increase in professional fees, and a $1.5 million increase in facility and overhead costs. Personnel costs increased due to an increase in general and administrative personnel headcount of 32.1% from December 31, 2019 to December 31, 2020 coupled with a $2.5 million increase in stock-based compensation expense in 2020, which was primarily attributable to a stock option to purchase 700,000 shares of our Class A common stock granted to our Chief Executive Officer in May 2019. Professional fees increased due to increased legal fees. Facility and overhead costs increased due to costs incurred to support our personnel growth, an increase in bad debt expense, and an increase in amortization expense stemming from our intangible assets which were acquired in 2020. Other Income, Net Year Ended December 31, % Change 2020 2019 (dollars in thousands) Other income, net $ (5,786) $ (941) *** % of revenue (1.9) % (0.4) % *** - Indicates a percentage that is not meaningful Other income, net increased by $4.8 million in 2020 compared to 2019, primarily due to $4.3 million in foreign exchange gains in 2020 compared to $0.2 million in foreign exchange losses in 2019. The increase in foreign exchange gains was primarily due to currency fluctuations of the Euro, Swedish krona, British pound sterling, and Swiss franc versus the U.S. dollar in 2020 compared to the same period in 2019. Additionally, we recognized $1.0 million of other income in 2020 due to a payment received from a state government as a result of our achievement of certain job creation and capital investment goals. 57 Interest Expense Year Ended December 31, % Change 2020 2019 (dollars in thousands) Interest expense $ 478 $ 367 30.2% % of revenue 0.2 % 0.1 % Interest expense increased by $0.1 million, or 30.2%, in 2020 compared to the same period in 2019, primarily due to commitment fees on the letter of credit outstanding. Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018 For a discussion and analysis of changes in financial condition and results of operations for the year ended December 31, 2019 as compared to the year ended December 31, 2018, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 20, 2020. Seasonality We have historically experienced seasonality in terms of when we enter into agreements with customers. We typically enter into a significantly higher percentage of agreements with new customers, as well as renewal agreements with existing customers, in the fourth quarter. The increase in customer agreements for the fourth quarter is attributable to large enterprise account buying patterns typical in the software industry. Furthermore, we usually enter into a significant portion of agreements with customers during the last month of each quarter. However, we recognize the majority of our subscriptions revenue ratably over the terms of our subscriptions agreements, which are generally one to three years in length. As a result, a substantial portion of the subscriptions revenue we report in each period will be derived from the recognition of deferred revenue relating to agreements entered into during previous periods. Consequently, a decline in new sales or renewals in any one period may not be immediately reflected in our revenue results for that period. This decline, however, will negatively affect our revenue in future periods. Accordingly, the effect of significant downturns in sales and market acceptance of our platform and potential changes in our rate of renewals may not be fully reflected in our results of operations until future periods. While we will continue to recognize the majority of our subscriptions revenue ratably over the terms of our subscription agreements, we may experience greater variability and reduced comparability of our quarterly revenue and results with respect to the timing and nature of our term license subscription agreements due to the upfront revenue recognition. Backlog Backlog represents non-cancellable future amounts to be recognized under SaaS and term license subscription agreements and is representative of our remaining performance obligations. As of December 31, 2020 and 2019, we had backlog of $206.2 million and $176.0 million, respectively. Approximately 32% of our backlog as of December 31, 2020 is not expected to be recognized in 2021. The increase in backlog is due to an increase in the number of multiple-year SaaS agreements entered into during 2020. We expect the amount of backlog relative to the total value of our contracts will change from quarter to quarter and year to year for several reasons, including the specific timing and duration of SaaS and term license subscription agreements with large customers, the specific timing of customer renewals, changes in customer financial circumstances, and foreign currency fluctuations. We often sign multiple-year SaaS subscription agreements. Backlog may vary based on changes in the average non-cancellable term of SaaS and term license subscription agreements. The change in backlog resulting from changes in the average non-cancellable term of SaaS and term license subscription agreements may not be an indicator of the likelihood of renewal or expected future revenue. Accordingly, we believe fluctuations in backlog may not be a reliable indicator of future revenue, and we do not utilize backlog as a key management metric internally. 58 Liquidity and Capital Resources The following table presents selected financial information and statistics as of and for the years ended December 31, 2020, 2019, and 2018 (in thousands): As of December 31, 2020 2019 2018 Cash and cash equivalents $ 112,462 $ 159,755 $ 94,930 Short-term investments and marketable securities 109,826 — — Long-term investments 36,120 — — Property and equipment, net 35,404 39,554 7,539 Working capital 209,532 165,381 81,225 Year Ended December 31, 2020 2019 2018 Net cash used in operating activities $ (7,620) $ (8,926) $ (31,321) Net cash used in investing activities (153,357) (32,421) (7,010) Net cash provided by financing activities 110,468 105,549 60,962 As of December 31, 2020, we ha d $112.5 million of cash and cash equivalents and $109.8 million of short-term investments and marketable securities. We believe our existing cash and cash equivalents and short-term investments and marketable securities, together with any positive cash flows from operations and available borrowings under our revolving line of credit, will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and functions as well as platform enhancements and professional services offerings, the level of market acceptance of our applications, spending we may incur on our new headquarters, and the global economic uncertainty caused by the COVID-19 pandemic and its impact on financial market conditions and our business. In the event additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. To the extent existing cash and cash equivalents, short-term investments, and cash from operations are not sufficient to fund future activities, we may need to raise additional funds. We may seek to raise additional funds through equity, equity-linked, or debt financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness may have rights that are senior to holders of our equity securities and could contain covenants that restrict operations. Any additional equity financing may be dilutive to our existing stockholders. We recently have and in the future may enter into investments in, or acquisitions of, complementary businesses, products, or technologies, which could also require us to seek additional equity financing, incur indebtedness, or use cash resources. We have no present binding agreements or commitments to enter into any such acquisitions. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected. Sources of Funds We have financed our operations in large part with equity and debt financing arrangements, specifically proceeds raised from our initial public offering in 2017 and subsequent underwritten public offerings as summarized in the table below (in thousands except share and per share information): 59 Shares Sold by Us Price per Share Proceeds to Us * May 2017 initial public offering 7,187,500 $ 12.00 $ 77,789 August 2018 public offering 1,675,000 35.15 57,829 September 2019 public offering 1,825,000 55.70 101,303 June 2020 public offering 1,931,206 56.50 107,914 Total 12,618,706 $ 344,835 * Net of underwriting discounts and commissions and offering expenses In addition, we have financed our operations through sales of subscriptions and professional services. We also have the ability to draw upon a $20.0 million revolving line of credit which we entered into in November 2017. The facility matures in November 2022. We may elect whether amounts drawn on the revolving line of credit bear interest at a floating rate per annum equal to either the LIBOR or the Prime rate plus an additional interest rate margin determined by the availability of borrowings under the revolving line of credit. The additional interest rate margin will range from 2.00% to 2.50% in the case of LIBOR advances and from 1.00% to 1.50% in the case of Prime rate advances. The revolving line of credit contains an unused facility fee in an amount between 0.15% and 0.25% of the average unused portion of the revolving line of credit, which is payable quarterly. The agreement contains certain customary affirmative and negative covenants and requires us to maintain (i) an adjusted quick ratio of at least 1.35 and (ii) minimum adjusted EBITDA in the amounts and for the periods set forth in the agreement. Any amounts borrowed under the credit facility are collateralized by substantially all of our assets. We were in compliance with all covenants as of December 31, 2020. As of December 31, 2020, we had not made any borrowings under this revolving line of credit, and we had outstanding letters of credit totaling $11.2 million in connection with securing our leased office space. Uses of Funds Our current principal uses of cash are funding operations and other working capital requirements. More recently, we have utilized cash to pay for the acquisition of Novayre, which we believe is complementary to our business. Over the past several years, revenue has increased significantly from year to year and, as a result, cash flows from customer collections have increased. However, operating expenses have also increased as we have invested in growing our business. Our uses of cash in 2020 included purchases of investments, the acquisition of Novayre, and modest capital expenditures while cash uses in 2019 and 2018 included the build out of our new headquarters, which included spending approximately $21.0 million above the $18.4 million tenant improvement allowance provided by the landlord for the build out, $4.5 million of which related to the financing of office furniture and fixtures and computer hardware. With respect to future uses of funds, we expect to incur annual royalty fees of $0.3 million for the foreseeable future related to a non-cancellable agreement for the use of technology that is integral in the development of our software. Additionally, we expect to incur capital expenditures in relation to the expanded occupancy of our headquarters which commenced in July 2020, although such expenditures do not represent capital commitments. Furthermore, we are contractually obligated to make cash payments on our various operating leases through October 2031. As of December 31, 2020, the amount of funds we expect to utilize over this time period for our lease commitments is approximately $99.0 million. Refer to Note 13 for discussion on our commitments and contingencies and to Note 4 for further information related to our current lease portfolio. Historical Cash Flows Operating Activities For the year ended December 31, 2020, net cash used in operating activities of $7.6 million consisted of a net loss of $33.5 million, offset by $22.0 million in adjustments for non-cash items and $3.9 million of cash provided by changes in working capital. Adjustments for non-cash items consisted primarily of stock-based compensation of $15.3 million, depreciation and amortization expense of $5.9 million, and bad debt expense of $1.0 million, offset by a provision for deferred income taxes of $0.2 million. The increase in cash and cash equivalents resulting from changes in working capital primarily consisted of a $27.6 million increase in deferred revenue as a result of increased subscription sales, an $11.8 million increase in accrued compensation and related benefits as a result of higher employee benefit accruals such as vacation and bonuses, a $3.7 million increase in other liabilities due to the deferral of social security tax payments pursuant to the provisions of the CARES Act and 60 a contract liability arising from a three year deal that included a termination for convenience clause, a $3.7 million decrease in prepaid expenses and other assets attributable to timing, and a $3.4 million increase in operating lease liabilities as a result of recognizing a new right-of-use liability related to the expanded occupancy of our headquarters building. The increase to working capital was partially offset by a $33.6 million increase in accounts receivable stemming from increased sales as well as the timing of billings and collections, an $8.6 million increase in deferred commissions due to increased sales activity, and a $4.2 million decrease in accounts payable and accrued expenses due to the timing of payments. For the year ended December 31, 2019, net cash used in operating activities of $8.9 million consisted of a net loss of $50.7 million, offset by $21.1 million in adjustments for non-cash items and $20.7 million of cash provided by changes in working capital. Adjustments for non-cash items consisted of stock-based compensation of $16.4 million, depreciation and amortization expense of $4.7 million, a loss on disposal of equipment of $0.1 million, and bad debt expense of $0.1 million, offset by a provision for deferred income taxes of $0.3 million. The increase in cash and cash equivalents resulting from changes in working capital primarily consisted of a $12.6 million increase in deferred revenue adjusted for the impact of the $35.4 million reduction to the opening balance resulting from the adoption of ASC 606. The increase in deferred revenue was due to increased subscription sales. There was also a $9.0 million decrease in prepaid expenses and other assets adjusted for the impact of the $20.4 million increase to the opening balance from the adoption of ASC 606. The decrease in prepaid expenses and other assets was primarily due to the receipt of the non-trade receivable resulting from our tenant improvement allowance. In accordance with GAAP, the $17.0 million of tenant improvement allowance reimbursements received during the year ended December 31, 2019 are a source of cash in operating activities, whereas the capital expenditures are recorded as cash used in investing activities. There was also a $7.4 million decrease in accounts receivable due to increased cash collections during the year ended December 31, 2019. There was also a $6.8 million increase in operating lease liabilities following the adoption of ASC 842, as a result of taking initial possession of the second phase of our new headquarters in February 2019. There was also a $1.3 million increase in other current liabilities. These increases were partially offset by a $9.3 million increase in deferred commissions adjusted for the impact of the $5.1 million increase to the opening balance from the adoption of ASC 606. The increase was due to increased sales as well as an increase in the estimated economic life over which deferred commissions are amortized. There was also a $4.0 million decrease in accounts payable and accrued expenses, primarily due to the timing of payments and a $3.1 million decrease in accrued compensation and related benefits, primarily due to a decrease in accrued vacation expense because of our new paid-time off policy, which took effect on January 1, 2019. Investing Activities For the year ended December 31, 2020, net cash used in investing activities was $153.4 million, which was primarily the result of $146.0 million in purchases of investments and $6.1 million in payments, net of cash acquired, related to the acquisition of Novayre. In addition, there were approximately $1.3 million in purchases of property and equipment. For the year ended December 31, 2019, net cash used in investing activities was $32.4 million which was related to the build-out of our new headquarters and the purchase of property and equipment. Financing Activities For the year ended December 31, 2020, net cash provided by financing activities was $110.5 million, consisting of $108.3 million in proceeds from our underwritten public offering, net of underwriting discounts and commissions, and $6.4 million in proceeds received from stock option exercises. These increases were offset by principal payments on finance lease obligations of $3.8 million and payment of public offering costs of $0.3 million. For the year ended December 31, 2019, net cash provided by financing activities was $105.5 million, consisting of $101.7 million in proceeds from our underwritten public offering, net of underwriting discounts and commissions, and $4.9 million in proceeds received from stock option exercises. These increases were offset by principal payments on finance lease obligations of $0.7 million and payment of public offering costs of $0.4 million. For a discussion and analysis of net cash used in or provided by operating, investing, and financing activities for the year ended December 31, 2018, refer to our 2019 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, or SEC, on February 20, 2020. Off-Balance Sheet Arrangements 61 During the year ended December 31, 2020, we did not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. As a result, we believe we are not materially exposed to any financing, liquidity, market, or credit risks that could arise if we had engaged in these relationships. Critical Accounting Estimates The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and judgments that affect the amounts reported in those financial statements and accompanying notes. Although we believe the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates. We believe the following accounting estimates involve a high degree of judgment and complexity. Accordingly, these are the estimates we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of our operations. See Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a description of our other significant accounting policies and estimates. Revenue Recognition We generate subscriptions revenue primarily through the sale of SaaS subscriptions bundled with maintenance and support and hosting services and term license subscriptions bundled with maintenance and support. We generate professional services revenue from fees for our consulting services, including application development and deployment assistance and training related to our platform. Significant judgments and estimates inherent in our revenue recognition are as follows: Determining the Transaction Price The transaction price, or the amount of consideration we expect to be entitled to receive in exchange for transferring services to our customers, includes both fixed and variable components. The variable components of our contracts, which have been nominal to date, include performance penalties, extended payment terms or implied price concessions, and warranty refunds. If necessary, we estimate these components using the expected value method, which estimates variable consideration as the sum of probability-weighted amounts in a range of possible consideration amounts. We believe this method is the most appropriate to utilize because our variable components could vary by contract, leading to multiple potential outcomes. Our variable consideration estimates are subject to subsequent true-up adjustments which may result in changes to transaction prices, but such true-up adjustments are not expected to be material. Variable consideration is also included in the transaction price only to the extent it is probable a significant reversal will not occur. Factors considered when determining to incorporate variable consideration in the transaction price include, but are not limited to, whether the variable consideration is highly susceptible to factors outside of the company's influence, the length of time the uncertainty surrounding reversal is expected to last, our experience levels with similar types of contracts, our historical practices for similar contracts in similar circumstances, and the number and range of possible consideration amounts. The amount of variable consideration excluded from the transaction price for the year ended December 31, 2020 was insignificant. Allocating the Transaction Price Based on Standalone Selling Prices We allocate the transaction price to each performance obligation in a contract based on its relative standalone selling price, or SSP. The SSP is the observable price at which we sell the product or service separately. In the absence of observable pricing, we estimate SSP using the residual approach. We establish SSP as follows: 1. SaaS subscriptions - Given the highly variable selling price of our SaaS subscriptions, we establish the SSP of our SaaS subscriptions using a residual approach after first determining the SSP of consulting and training services. 2. Term license subscriptions - Given the highly variable selling price of our term license subscriptions, we have established the SSP of term license subscriptions using a residual approach after first determining the SSP of 62 maintenance and support. Maintenance and support is sold on a standalone basis with renewals of our legacy perpetual software licenses and within a narrow range of the net license fee, resulting in a defined economic relationship existing between the license and maintenance and support. 3. Maintenance and support - We establish the SSP of maintenance and support as a percentage of the stated net subscription fee based on observable pricing of maintenance and support renewals from our legacy perpetual software licenses. 4. Consulting services and training services - The SSP of consulting services and training services is established based on the observable pricing of standalone sales within each geographic region where the services are sold. Stock-Based Compensation We measure and recognize compensation expense for all instrument types, including stock options, awards with market conditions, and restricted stock units, or RSUs, based on the estimated fair value of the award on the grant date. The methods for determining fair value vary by instrument type. Options For the vast majority of our stock options, we estimate fair value using the Black-Scholes Option Pricing Model. For the option to purchase 700,000 shares of our Class A common stock granted to our Chief Executive Officer in May 2019, we estimated fair value using a Monte Carlo simulation because the award contains a market condition. Both valuation methods require the use of subjective assumptions, including but not limited to, the following: 1. The expected term of the option - The expected term represents the period of time the stock options are expected to be outstanding. Due to the lack of sufficient historical exercise data to provide a reasonable basis upon which to otherwise estimate the expected term of the stock options, we use the simplified method to estimate the expected term. Under the simplified method, the expected term of an option is presumed to be the mid-point between the vesting date and the end of the contractual term. 2. Current trading price - The current price of our stock is based on the closing market price of our Class A common stock as quoted on the Nasdaq Global Market on the date of grant. 3. The expected stock price volatility - Expected volatility is based on historical volatilities of our publicly traded stock as well as the publicly traded stock of comparable companies within our industry over the estimated expected term of the stock options. Expected volatility is sensitive to market- and company-specific conditions which may cause our stock price or the stock prices of our peers to fluctuate. Furthermore, expected volatility can be impacted by the companies we select as peers for inclusion in the analysis. 4. Expected dividend yield - We assume no dividend yield because dividends on our common stock are not expected to be paid in the near future, which is consistent with our history of not paying dividends on our common stock. 5. The risk-free interest rate - We utilize the yields of U.S. government securities, typically U.S. Treasury bonds, that have maturities commensurate with the expected term of the options. RSUs The fair value of RSUs is based on the closing market price of our Class A common stock as quoted on the Nasdaq Global Market on the date of grant. We will continue to use judgment in evaluating the assumptions related to our stock-based compensation on a prospective basis. As we continue to accumulate additional data related to our common stock, we may have refinements to our estimates, which could materially impact our future stock-based compensation expense. Income Taxes We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed. We establish a valuation allowance against our deferred tax 63 assets to the extent it is more likely than not that some or all of the deferred tax assets will not be realized. This requires us to make judgments and estimates regarding future reversals of existing taxable temporary differences, future taxable income, and the impact of tax planning strategies. 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 that the position is sustainable upon examination by the taxing authority. 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. This determination involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. 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 by U.S. federal, state, and foreign tax authorities. The estimate of the potential outcome of any uncertain tax issue is subject to our 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 that determination. Recent Accounting Pronouncements See Note 2 of our consolidated financial statements for information related to recently issued accounting standards.