CS Disco, Inc. (LAW) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
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 audited consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion, particularly information with respect to our financial results of operations or financial condition, business strategy, plans and objectives of management for future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading “Special Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. You should review the disclosure under the heading “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements.
Overview
DISCO provides a cloud-native, artificial intelligence-powered legal solution that simplifies ediscovery, legal document review and case management for enterprises, law firms, legal services providers and governments. Our scalable, integrated solution enables legal departments to easily collect, process and review enterprise data that is relevant or potentially relevant to legal matters. We leverage a cloud-native architecture and powerful artificial intelligence, or AI, models to automatically identify legally relevant documents and improve the accuracy and speed of legal document review. Our AI models continuously learn from legal work conducted on our solution and can be reused across legal matters, which further strengthens our ability to help our customers find evidence and resolve matters faster as they expand usage of our solution. We provide legal departments with the ability to centralize legal data into a single solution, improving security and privacy for our customers, enabling transparent collaboration with other legal industry participants and allowing customers to reuse data and lawyer work product
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across legal matters. By automating the manual, time-consuming and error-prone parts of ediscovery, legal document review and case management, we empower legal departments to focus on delivering better legal outcomes.
We generate substantially all of our revenue from our customers’ actual usage of our solution. Customers generally do not commit to purchase a specific amount of usage on our solution and their usage can fluctuate based on the number and nature of legal matters they have at any particular time. As a result, our revenue and other financial results can fluctuate from period to period given the inherent unpredictability of the timing, duration and scope of legal casework. We also offer our customers the option to enter into subscriptions based on committed minimum usage on an annual or multi-year basis, which represented 11% and 14% of our revenue for the years ended December 31, 2021 and 2020, respectively. In addition, we generate revenue from a range of professional services aimed at accelerating the time-to-value for our customers.
After using and realizing the benefits of our solution, our customers often increase usage of our solution to cover additional legal matters and adopt more of our offerings. As our customers use our solution over time, the amount of enterprise data in our solution increases, enhancing the strategic value and stickiness of our solution within an organization. This dynamic of increased activity from our existing customers and overall user satisfaction is best demonstrated by our dollar-based net retention rate. As of December 31, 2021 and 2020 our dollar-based net retention rate was 146% and 127%, respectively.
Our customers include a diverse set of enterprises across a broad set of industries, as well as law firms, legal services providers of all sizes and government organizations. While we serve customers across many different industries, the way in which lawyers and legal professionals use our solution is similar regardless of the specific industry in which each customer operates. This commonality has created efficiencies in our sales and marketing and research and development activities because we do not need to tailor our sales and marketing activities to a wide range of different customer use cases. As of December 31, 2021, we had 1,126 customers, increasing from 825 customers as of December 31, 2020, respectively. As of December 31, 2021 we had 214 large customers, defined as customers with revenue in excess of $100,000 over the previous 12-month period, increasing from 141 large customers as of December 31, 2020. Large customers accounted for approximately 81%, and 74% of our revenue for the years ended December 31, 2021 and 2020, respectively.
Our go-to-market strategy is focused on acquiring new customers and driving continued use and increased usage of our solution for existing customers. We primarily sell through a direct sales force, which is organized based on the stages of our sales motion. Our sales organization is segmented into sales development representatives, field sales, inside sales, solution architects and our customer success team. In addition, our solution is designed such that customers can grant access to third parties, including law firms and other legal service providers, to use our applications on the customers’ behalf. This access facilitates widespread adoption of our solution, as these law firms and other legal service providers often become customers on their own or recommend our solution to other legal industry participants after realizing the benefits of working on our solution. Likewise, if a law firm is our customer, the law firm may add users from its clients’ legal departments to our solution in order to collaborate with them. These users may then become champions and encourage the companies they work for to become customers.
We have experienced rapid growth in recent periods. Since inception, we have raised $401.1 million of capital, of which $240.0 million was obtained through the proceeds of our initial public offering and $161.1 million through the sale of redeemable convertible preferred stock. We had $255.5 million of cash and cash equivalents as of December 31, 2021. We generated revenue of $114.3 million and $68.4 million in the years ended December 31, 2021 and 2020, respectively, representing a period-over-period growth of 67%. Our net loss was $24.3 million and $22.9 million for the years ended December 31, 2021 and 2020, respectively. We generated Adjusted EBITDA of $(16.3) million and $(19.9) million for the years ended December 31, 2021 and 2020, respectively. See the section titled “—Non-GAAP Financial Measure” for the definition of Adjusted EBITDA, as well as a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure stated in accordance with GAAP.
Impact of COVID-19 on Our Business
The COVID-19 pandemic has caused general business disruption worldwide beginning in January 2020. The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations, cash flows and financial condition will depend on future developments that are highly uncertain and cannot be accurately predicted. As a result of the COVID-19 pandemic, governments in many of the jurisdictions in which we or our customers operate instituted shelter-in-place orders in March and April 2020 to mitigate the outbreak of COVID-19, forcing court closures and causing general delays in litigation proceedings, as well as leading to delays in the collection of enterprise data. Due to these factors, we experienced flat revenue growth in the second quarter of 2020 from the first quarter of 2020, during which we generated $15.7 million in each quarter. In addition, we executed a reduction in our workforce in March 2020 in response to the COVID-19 pandemic.
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This reduction in workforce resulted in a total impact of $0.7 million of charges related to severance. As shelter-in-place orders expired and businesses and court systems adjusted their operations to accommodate remote work policies, usage in our solution increased and our revenue in the third quarter of 2020 returned to pre-pandemic levels of growth.
We have also experienced, and may continue to experience, a modest positive impact on other aspects of our business, including slower growth in certain operating expenses due to reduced business travel, deferred hiring for some positions and the virtualization or cancellation of customer and employee events.
We cannot predict how long we will continue to experience these impacts as shelter-in-place orders and other related measures are expected to change over time. However, as certain of our customers or partners experience downturns or uncertainty in their own business operations or revenue resulting from the spread of COVID-19, they may decrease or delay their legal spending or request pricing discounts, any of which may result in decreased revenue for us. In addition, we may experience customer losses, including due to bankruptcy or our customers ceasing operations, which may result in an inability to collect accounts receivable from these customers. In addition, in response to the spread of COVID-19, we have required substantially all of our employees to work remotely to minimize the risk of the virus to our employees and the communities in which we operate. In September 2021, we opened our headquarters to employees on a voluntary basis. We may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.
The global impact of COVID-19 continues to rapidly evolve and we will continue to monitor the situation and the effects on our business and operations closely. We do not yet know the full extent of potential impacts on our business or operations or on the global economy as a whole, particularly if the COVID-19 pandemic continues and persists for an extended period of time. Given the uncertainty, we cannot reasonably estimate the impact on our future results of operations, cash flows or financial condition. For additional details, see the section titled “Risk Factors”.
Key Factors Affecting Our Performance
We believe that the growth and future success of our business depends on many factors. While each of these factors present significant opportunities for our business, they also pose important challenges that we must successfully address in order to sustain our growth, improve our results of operations and establish and maintain profitability.
Maintain and Advance Our Innovation and Brand
Our success depends in part on our ability to maintain and advance our innovation and brand. We have a strong history of innovation, demonstrated by our DISCO Ediscovery, DISCO Review and DISCO Case Builder offerings, and have built a research and development process that reliably produces applications and features that lawyers love. We intend to continue combining our deep legal domain expertise and commitment to world-class software engineering to continue delivering features that lawyers love and introducing new applications to address more areas of legal work. Our future success is dependent on our ability to successfully develop, market and sell existing and new applications of our solution to both new and existing customers.
Add New Customers
We believe we have a significant opportunity to continue to grow our customer base. As enterprises continue their digital transformation journeys and the demand for differentiation in the competitive market for legal services continues to grow, we expect more and more companies will struggle with existing legal solutions and ultimately will adopt integrated, easy-to-use solutions like DISCO to improve productivity and legal outcomes. We believe our market leadership and differentiated solution will enable us to efficiently acquire new customers across all channels. As of December 31, 2021, we had 1,126 customers, increasing from 825 customers as of December 31, 2020. Our ability to attract new customers will depend on a number of factors, including the effectiveness and pricing of our offerings, the offerings of our competitors and the effectiveness of our marketing efforts. We will need to dedicate significant resources to further develop the market for our solution and expand, retain and motivate our sales and marketing personnel.
Increase Usage and Penetration Within Our Existing Customer Base
Our large base of customers represents a significant opportunity for further sales expansion. We believe that we will be able to continue expanding customer relationships by increasing customers’ usage of offerings that they already buy from us, selling more of our existing offerings to existing customers, and, in the future, introducing additional offerings to sell to existing
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customers. Our long-term offerings strategy is aimed at building features and offerings that address more and more types of legal work so that customers can continue to centralize on our solution as the system of record and engagement for the legal function. Our ability to increase sales to existing customers will depend on a number of factors, including our customers’ satisfaction with our solution, competition, pricing and overall changes in our customers’ spending levels. Even if our customers expand their usage of our solution, we cannot guarantee that they will maintain those usage levels for any meaningful period of time or that they will renew their commitments.
A further indication of the propensity of our customers to continue to work with and expand their relationship with us over time is our dollar-based net retention rate, which compares our revenue from the same set of customers in one period to the prior year period. As of December 31, 2021 and 2020, our dollar-based net retention rate was 146% and 127%, respectively. We calculate our dollar-based net retention rate as of the end of a period by using (a) the revenue from all customers during the twelve months ending one year prior to such period as the denominator and (b) the revenue from all customers during the twelve months ending as of the end of such period minus the revenue from all customers who are new customers during those twelve months as the numerator. Our dollar-based net retention rate could decrease over time as our customer base matures and the amount of revenue used in the denominator to calculate net retention grows.
Expand Our Sales Coverage and Establish a Digital Sales Channel
We intend to continue to increase our sales force headcount in strategic locations across the United States and globally. Additionally, we plan to develop a digital, self-service sales channel that can simplify the sales process and enable customers to easily adopt our solution through our website without the need to speak with a sales representative. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training and retaining sufficient numbers of sales personnel to support our growth. We will need to spend significant resources to expand, retain and motivate our sales and marketing personnel.
Expand Internationally
Our market is global and we believe there is a significant opportunity to expand internationally. In 2021, less than 10% of our revenue was generated by customers outside of the United States. International expansion, including our global sales efforts, will add increased complexity and cost to our business.
Extend and Strengthen Our Channel Partnerships and Integrations
Our partnerships, including with legal services providers and cloud infrastructure providers, assist us in driving awareness and adoption of DISCO and extending our reach. We intend to cultivate and leverage channel partners to grow our market presence, enhance the virality of our solution and drive greater sales efficiency. Our future success is dependent in part on our ability to develop and maintain relations with these partners.
Expand Our Offering Portfolio
We believe that our technology, and especially our approach to automation and AI, is applicable to a wider range of legal processes outside of our current core offerings. We intend to leverage our technology to introduce further offerings that increase lawyer productivity across more and more areas of legal work over time. We may expend significant resources in the development of additional offerings. Our ability to successfully develop, market and sell new offerings will depend on a number of factors, including the availability of capital to invest in innovation, our customers’ satisfaction with such offerings, competition, pricing and overall changes in our customers’ spending levels.
Pursue Strategic Acquisitions and Strategic Investments
We intend to selectively pursue acquisitions and strategic investments that we believe can expand the functionality and value of our solution and bring talent to our company. We believe that the combination of our market leadership, deep legal expertise and powerful end-to-end solution provides an advantage in pursuing select acquisitions. We may be required to expend significant resources in connection with the pursuit of acquisitions and investments.
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Key Components of Statement of Operations
Revenue
All of our revenue-generating activities directly relate to the sale and support of our legal solution within a single operating segment. We have two primary types of contractual arrangements: usage-based and subscription solutions. Our usage-based revenue is derived from contracts under which customers are billed monthly based on their usage of our offerings. Subscription revenue is derived from contracts where customers are contractually committed to a minimum data volume over a period of time. Revenue received from usage amounts above the fixed data volume in our subscription contracts is considered usage-based revenue.
In the years ended December 31, 2021 and 2020, usage-based revenue represented 89% and 86% of our total revenue, respectively. In the years ended December 31, 2021 and 2020, subscription revenue fees represented 11% and 14% of total revenue, respectively.
Cost of Revenue
Cost of revenue consists primarily of third-party cloud infrastructure expenses incurred in connection with our customers’ use of our solution. Cost of revenue also includes outsourced staffing costs, amortization of internal-use software and personnel costs from employees involved in the delivery of our solution. Personnel costs include salaries, benefits, bonuses, stock-based compensation and allocated overhead costs. We intend to continue to invest additional resources in our infrastructure to expand the capability of solutions and ensure that our customers are realizing the full benefit of our solutions. The level, timing and relative investment in our cloud infrastructure could affect our cost of revenue in the future. Additionally, cost of revenue in future periods could be impacted by changes in outsourced staffing costs and amortization associated with capitalized internal-use software costs.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, general and administrative expenses and refund of sales and use taxes. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, share-based compensation expenses and sales commissions. Operating expenses also include overhead costs for facilities and shared IT related expenses, including depreciation expense. During the year ended December 31, 2020, certain operating expenses decreased as a result of the COVID-19 pandemic and a related reduction in force. Certain expenses impacted by COVID-19 resumed in 2021, although the magnitude of these expenses did not reach pre-pandemic levels.
Research and Development
Research and development expenses consist primarily of personnel-related costs for our development team, including salaries, benefits, bonuses, stock-based compensation expenses and allocated overhead costs. Research and development expenses also include contractor or professional services fees and third-party cloud infrastructure expenses incurred in developing our solution. During the year ended December 31, 2020, growth in research and development expenses was offset by a one-time reduction in force in response to the COVID-19 pandemic. We expect that our research and development expenses will increase in absolute dollars as our business grows, particularly as we incur additional costs related to continued investments in our solution. Our research and development expenses may fluctuate as a percentage of our revenue over time. In addition, research and development expenses that qualify as internal-use software development costs are capitalized, the amount of which may fluctuate significantly from period to period.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel-related costs directly associated with our sales and marketing staff, including salaries, benefits, bonuses, commissions, stock-based compensation and allocated overhead costs. Sales and marketing expenses also include advertising costs and other expenses associated with our marketing and business development programs. In addition, sales and marketing expenses are comprised of travel-related expenses, software services dedicated for use by our sales and marketing organizations and outside services contracted for sales and marketing purposes. Travel-related expenses decreased in the year ended December 31, 2020 due to the COVID-19 pandemic and resumed in the second half of 2021, although the magnitude of these expenses has not reached pre-pandemic levels. We expect that our sales and marketing expenses will increase in absolute dollars and continue to be our largest operating expense for the foreseeable future as we grow our business. Our sales and marketing expenses may fluctuate as a percentage of our revenue over time.
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General and Administrative
General and administrative expenses consist of personnel-related costs associated with our finance, legal, human resources and administrative personnel, including salaries, benefits, bonuses, stock-based compensation and allocated overhead costs. General and administrative expenses also include external legal, accounting and other professional services fees, software services dedicated for use by our general and administrative functions, insurance and other corporate expenses.
In the year ended December 31, 2021, we incurred additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a national securities exchange, costs related to compliance and reporting obligations and increased expenses for insurance, investor relations and professional services. We expect that our general and administrative expenses will increase in absolute dollars as our business grows but may fluctuate as a percentage of total revenue from period to period.
Refund of Sales and Use Taxes
Refund of sales and uses taxes consist of a one-time gain due to a sales tax refund related to sales tax paid in prior periods based on the resolution of a sales tax audit.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income, income related to non-operating activities, interest expense and gains and losses from foreign currency transactions and remeasurements of foreign currency-denominated monetary assets and liabilities to the U.S. Dollar.
Provision for Income Taxes
Provision for income taxes consists primarily of income taxes related to foreign and state jurisdictions in which we conduct business. We maintain a valuation allowance on our federal and state deferred tax assets as we have concluded that it is not more likely than not that the deferred assets will be utilized.
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Results of Operations
The following tables set forth our results of operations and such data as a percentage of our revenue for each of the periods presented.
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| (in thousands) | 2021 | 2020 | |||||
| Revenue | $ | 114,342 | $ | 68,444 | |||
| Cost of revenue(1) | 31,098 | 20,449 | |||||
| Gross profit | 83,244 | 47,995 | |||||
| Operating expenses: | |||||||
| Research and development(1) | 34,414 | 26,599 | |||||
| Sales and marketing(1) | 47,045 | 31,061 | |||||
| General and administrative(1) | 25,614 | 13,893 | |||||
| Refund of sales and use taxes | — | (1,057) | |||||
| Total operating expenses | 107,073 | 70,496 | |||||
| Loss from operations | (23,829) | (22,501) | |||||
| Other income (expense): | |||||||
| Interest and other income | 106 | 155 | |||||
| Interest and other expense | (540) | (456) | |||||
| Total other income (expense) | (434) | (301) | |||||
| Loss from operations before income taxes | (24,263) | (22,802) | |||||
| Income tax provision | (81) | (71) | |||||
| Net loss | $ | (24,344) | $ | (22,873) | |||
| Less accretion of redeemable convertible preferred stock | (56) | (92) | |||||
| Net loss attributable to common stockholders | $ | (24,400) | $ | (22,965) |
______________
(1)Includes stock-based compensation expense as follows:
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| (in thousands) | 2021 | 2020 | |||||
| Cost of revenue | $ | 57 | $ | 28 | |||
| Research and development | 2,081 | 864 | |||||
| Sales and marketing | 1,258 | 335 | |||||
| General and administrative | 2,207 | 766 | |||||
| Total | $ | 5,603 | $ | 1,993 |
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| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2021 | 2020 | ||||
| Consolidated Statement of Operations and Comprehensive Loss as a percentage of revenue:** | |||||
| Revenue | 100 | % | 100 | % | |
| Cost of revenue | 27 | 30 | |||
| Gross profit | 73 | 70 | |||
| Operating expenses: | |||||
| Research and development | 30 | 39 | |||
| Sales and marketing | 41 | 45 | |||
| General and administrative | 22 | 20 | |||
| Refund of sales and use taxes | — | (2) | |||
| Total operating expenses | 94 | 103 | |||
| Loss from operations | (21) | (33) | |||
| Other income (expense): | |||||
| Interest and other income | * | * | |||
| Interest and other expense | * | (1) | |||
| Total other income (expense) | * | * | |||
| Loss from operations before income taxes | (21) | (33) | |||
| Income tax provision | * | * | |||
| Net loss | (21) | (33) | |||
| Less accretion of redeemable convertible preferred stock | * | * | |||
| Net loss attributable to common stockholders | (21) | (34) |
______________
* Less than 0.5% of revenue.
** Columns may not add up to 100% due to rounding.
Comparison of the Years Ended December 31, 2021 and 2020
Revenue
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Revenue | $ | 114,342 | $ | 68,444 | $ | 45,898 | 67 | % |
Total revenue increased by $45.9 million, or 67%, for the year ended December 31, 2021 compared to the same period in 2020. Approximately 70% of the increase is related to additional usage and adoption of our solution by our existing customers. The remaining 30% increase in revenue is related to new customers added throughout the period.
Cost of Revenue
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Cost of revenue | $ | 31,098 | $ | 20,449 | $ | 10,649 | 52 | % | ||||||
| Percentage of revenue | 27 | % | 30 | % |
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Total cost of revenue increased by $10.6 million, or 52%, for the year ended December 31, 2021 compared to the same period in 2020. The increase was primarily driven by an increase in outsourced staffing vendor fees of $5.3 million and costs for cloud hosting of $2.0 million related to increased usage of our solution. Additionally, cost of revenue increased $2.9 million due to increased personnel costs, including stock-based compensation, as a result of increased headcount.
Operating Expenses
Research and Development
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Research and development | $ | 34,414 | $ | 26,599 | $ | 7,815 | 29 | % | ||||||
| Percentage of revenue | 30 | % | 39 | % |
Research and development expenses increased by $7.8 million, or 29%, for the year ended December 31, 2021 compared to the same period in 2020. The increase was primarily driven by an additional $8.3 million in personnel costs, including stock-based compensation, as a result of increased headcount. Additionally, professional services expense increased $0.2 million related to security and compliance. These increases were offset by a decrease of $0.5 million of restructuring charges related to the one-time reduction in force that occurred in the first quarter of 2020.
Sales and Marketing
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Sales and marketing | $ | 47,045 | $ | 31,061 | $ | 15,984 | 51 | % | ||||||
| Percentage of revenue | 41 | % | 45 | % |
Sales and marketing expenses increased by $16.0 million, or 51%, for the year ended December 31, 2021 compared to the same period in 2020. The increase was primarily related to an additional $12.3 million in personnel costs, including stock-based compensation, as a result of increased headcount and variable compensation for our sales personnel. Software expense also increased $0.7 million to support the additional headcount. Additionally, marketing expenses increased $2.5 million and professional services expense increased $0.5 million to support our growth.
General and Administrative
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| General and administrative | $ | 25,614 | $ | 13,893 | $ | 11,721 | 84 | % | ||||||
| Percentage of revenue | 22 | % | 20 | % |
General and administrative expenses increased by $11.7 million, or 84%, for the year ended December 31, 2021 compared to the same period in 2020. This increase was primarily attributable to an additional $6.2 million in personnel costs, including stock-based compensation, as a result of increased headcount and a $3.0 million increase in professional services related to additional compliance requirements of being a public company. Additionally, corporate insurance expense and franchise taxes increased $2.2 million as a result of our recent initial public offering.
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Refund of Sales and Use Taxes
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Refund of sales and use taxes | $ | — | $ | (1,057) | $ | 1,057 | (100 | %) | ||||||
| Percentage of revenue | — | % | 2 | % |
During the year ended December 31, 2020, we received a sales tax refund of $1.1 million related to sales tax paid in prior periods based on the resolution of a sales tax audit. There were no similar transactions in the current period.
Non-GAAP Financial Measure
We report our financial results in accordance with generally accepted accounting principles, or GAAP. However, management believes that Adjusted EBITDA, a non-GAAP financial measure, provides investors with additional useful information in evaluating our performance. We define Adjusted EBITDA as net loss, adjusted to exclude: depreciation and amortization expense, provision for income taxes, interest and other, net, stock-based compensation expense, payroll tax expense on employee stock transactions, refund of sales and use taxes related to sales tax in prior periods and other one-time, non-recurring items, when applicable. We monitor Adjusted EBITDA as a non-GAAP financial measure to supplement the financial information we present in accordance with generally accepted accounting principles, or GAAP, to provide investors with additional information regarding our financial results.
Adjusted EBITDA is a financial measure that is not required by or presented in accordance with GAAP. We believe that Adjusted EBITDA, when taken together with our financial results presented in accordance with GAAP, provides meaningful supplemental information regarding our operating performance and facilitates internal comparisons of our historical operating performance on a more consistent basis by excluding certain items that may not be indicative of our business, results of operations or outlook. In particular, we believe that the use of Adjusted EBITDA is helpful to our investors as it is a measure used by management in assessing the health of our business and evaluating our operating performance, as well as for internal planning and forecasting purposes.
Adjusted EBITDA is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Some of these limitations include that: (i) it does not properly reflect capital commitments to be paid in the future; (ii) although depreciation and amortization expense is a non-cash charge, the underlying assets may need to be replaced and Adjusted EBITDA does not reflect these capital expenditures; (iii) it does not consider the impact of stock-based compensation expense and payroll tax expense on employee stock transactions; (iv) it does not reflect other non-operating expenses, including interest expense; (v) it does not consider the impact of any contingent consideration liability valuation adjustments; and (vi) it does not reflect tax payments that may represent a reduction in cash available to us. In addition, our use of Adjusted EBITDA may not be comparable to similarly titled measures of other companies because they may not calculate Adjusted EBITDA in the same manner, limiting its usefulness as a comparative measure. Because of these limitations, when evaluating our performance, you should consider Adjusted EBITDA alongside other financial measures, including our net loss and other results stated in accordance with GAAP. We expect Adjusted EBITDA to fluctuate in the near term as we continue to invest in our business and improve over the long term as we achieve greater scale in our business and efficiencies in our operating expenses.
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The following table presents a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure stated in accordance with GAAP, for the periods presented (in thousands):
| Year Ended December 31, | ||||
|---|---|---|---|---|
| 2021 | 2020 | |||
| Net loss | $(24,344) | $(22,873) | ||
| Depreciation and amortization expense | 1,674 | 1,624 | ||
| Provision for income taxes | 81 | 71 | ||
| Interest and other, net | 434 | 301 | ||
| Stock-based compensation expense | 5,603 | 1,993 | ||
| Payroll tax expense on employee stock transactions | 264 | 20 | ||
| Refund of sales and use taxes | — | (1,057) | ||
| Adjusted EBITDA | $(16,288) | $(19,921) |
Liquidity and Capital Resources
We have financed operations since our inception primarily through customer payments and net proceeds from sales of equity securities, including our IPO in July 2021, as well as borrowings under our former revolving credit facility. As of December 31, 2021 and 2020, our principal sources of liquidity were cash and cash equivalents, totaling $255.5 million and $58.6 million, respectively. Cash equivalents include highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less. We believe our existing cash and cash equivalents will be sufficient to fund anticipated cash requirements for the next 12 months. We believe we will meet our longer-term expected future cash requirements primarily from a combination of cash flow from operating activities and available cash and cash equivalents. We may also engage in equity or debt financings to secure additional funds.
The following table presents our material cash requirements for future periods as of December 31, 2021:
| Payments Due by Period | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 1 Year | 2-3 Years | 4-5 Years | Total | |||||||||||
| (in thousands) | ||||||||||||||
| Operating lease commitments(a) | $ | 911 | $ | — | $ | — | $ | 911 | ||||||
| Finance lease commitments(b) | 101 | — | — | 101 | ||||||||||
| Cloud platform purchase commitments(c) | 17,900 | 36,000 | 18,000 | 71,900 | ||||||||||
| Other purchase commitments(d) | 903 | 457 | — | 1,360 | ||||||||||
| Total | $ | 19,815 | $ | 36,457 | $ | 18,000 | $ | 74,272 |
a.We occupy certain facilities under non-cancelable lease arrangements. Our only lease agreement is set to expire in October 2022. We may lease or purchase additional space as needed to accommodate our needs.
b.We lease certain furniture and fixtures classified as a finance lease. The leased furniture is depreciated on a straight-line basis over the life of the lease and is included in depreciation expense.
c.Cloud platform purchase commitments encompass non-cancellable agreements to support our software. These expenses are incurred as services are performed and are in the normal course of business.
d.Other purchase commitments encompass non-cancellable software agreements to support our internal functions. These expenses are incurred as services are performed and are in the normal course of business.
Our future capital requirements will depend on many factors, including our revenue growth rate, usage of our solution, billing frequency, the timing and extent of spending to support further sales and marketing and research and development efforts, and the continuing market acceptance of our solution. Although the COVID-19 pandemic has not materially impacted our liquidity to date, we plan to continue to evaluate aspects of our spending, including capital expenditures, discretionary spending, and strategic investments in 2022. We have considered the impacts of the COVID-19 pandemic on our liquidity and capital resources to date, and we do not currently expect it to impact our ability to meet future liquidity needs.
We may, in the future, enter into arrangements to acquire or invest in complementary businesses, products and technologies. We may be required to seek additional equity or debt financing. In the event that we require additional financing, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital or
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generate cash flows necessary to expand our operations and invest in continued innovation, we may not be able to compete successfully, which would harm our business, operations and financial condition.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
| Year Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | % Change | ||||||||||||
| (dollars in thousands) | |||||||||||||||
| Cash used in operating activities | $ | (21,642) | $ | (22,712) | $ | 1,070 | (5) | % | |||||||
| Cash used in investing activities | (3,107) | (1,904) | (1,203) | 63 | % | ||||||||||
| Cash provided by financing activities | 221,657 | 59,961 | 161,696 | 270 | % | ||||||||||
| Net increase in cash and cash equivalents | $ | 196,908 | $ | 35,345 | $ | 161,563 | 457 | % |
Operating Activities
Our largest source of operating cash is payments received from our customers. Our primary uses of cash from operating activities are for personnel-related expenses, marketing expenses, hosting expenses and overhead expenses. We have historically generated negative cash flows and have supplemented working capital requirements primarily through net proceeds from the sale of equity securities.
Net cash used in operating activities for the year ended December 31, 2021 was $21.6 million, a decrease of $1.1 million from net cash used in operating activities of $22.7 million for the year ended December 31, 2020. The change in cash flow used in operations was primarily due to an increase in net loss of $1.5 million. Fluctuations in net loss are further explained in the Comparison of Years Ended December 31, 2021 and 2020 section included elsewhere in Management’s Discussion and Analysis. The increase in cash used in operating activities was also due to an increase in accounts receivable of $2.7 million related to revenue growth and an increase in other current assets of $3.1 million related to various prepaid expenses. These increases in cash used in operating activities were partially offset by an increase in stock-based compensation of $3.6 million due to additional equity awards issued during the period with increased underlying share values and an increase in accounts payable and accrued expenses of $3.8 million related to growth of our operations.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2021 was $3.1 million, an increase of $1.2 million from net cash used in investing activities of $1.9 million for the year ended December 31, 2020. The increase in cash used in investing activities was related to purchases of property and equipment to support the growth of our business and the capitalization of internal-use software associated with additional features in our solution.
Financing Activities
Net cash provided by financing activities for the year ended December 31, 2021 was $221.7 million, an increase of $161.7 million from net cash provided by financing activities of $60.0 million for the year ended December 31, 2020. The change in cash flows were primarily related to an increase in net proceeds from equity financings of $159.9 million. In the year ended December 31, 2021 we received $219.8 million in net proceeds from our IPO. In the year ended December 31, 2020, we received $59.9 million in net proceeds from issuance of redeemable convertible preferred stock. Additionally, proceeds from exercises of stock options increased $1.8 million due to an increase in option exercise activity related to our stock being publicly traded.
During the year ended December 31, 2020, we received and repaid $23.3 million of proceeds from our revolving credit facility and the Paycheck Protection Program. We had no borrowings in the year ended December 31, 2021.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial
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statements and the reported amounts of revenue and expenses during the reporting periods. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors and adjust those estimates and assumptions when facts and circumstances dictate. Actual results could differ materially from those estimates and assumptions.
While our significant accounting policies are more fully described in Note 2 in the notes to our consolidated financial statements included elsewhere in this Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the accounting policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
Revenue Recognition
We recognize revenue from contracts with customers using the five-step method described in Note 3 of the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Our performance obligations consist of usage-based and subscription solutions. Our usage-based revenue is generated from solutions that are typically billed on a monthly basis based on actual usage. Subscription revenue is derived from contracts where customers are contractually committed to a minimum data volume over a period of time. Usage amounts above the minimum data volume are considered usage-based revenue. Subscription arrangements are typically billed on a monthly, quarterly or annual basis with revenue recognized on a ratable basis over the contractual term. On a limited basis, we enter into contracts whereby the consideration payable is contingent upon the conclusion of the legal matter. We do not recognize the revenue related to these contracts until the legal matter is resolved. Such amounts recognized have been immaterial to date.
In general, we satisfy the majority of our performance obligations over time as we transfer the promised solutions to our customers. We review the contract terms and conditions to evaluate the timing and amount of revenue recognition, the related contract balances, and our remaining performance obligations. These evaluations involve uncertainty because they may require significant judgment that could affect the timing and amount of revenue recognized. Usage-based revenue is recognized monthly based on actual usage and subscription revenue is recognized on a ratable basis over the contractual term, which is generally one year.
Internal-Use Software Development
We capitalize certain costs related to the development of our solution and other software applications for internal use. In accordance with authoritative guidance, we begin to capitalize our costs to develop software when preliminary development efforts are successfully completed, management has authorized and committed project funding, and it is probable that the project will be completed and the software will be used as intended. We stop capitalizing these costs when the software is substantially complete and ready for its intended use, including the completion of all significant testing. These costs are amortized on a straight-line basis over the estimated useful life of the related asset, generally estimated to be four years. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditure will result in additional functionality and expense costs incurred for maintenance and minor upgrades and enhancements. Costs incurred prior to meeting these criteria together with costs incurred for training and maintenance are expensed as incurred and recorded within product development expenses in our consolidated statements of operations and comprehensive loss. The capitalization of internal-use software development contains uncertainties because it requires management to exercise judgment in determining the point at which various projects may be capitalized, in assessing the ongoing value of the capitalized costs and in determining the estimated useful lives over which the costs are amortized. To the extent that we change the manner in which we develop and test new features and functionalities related to our solution, assess the ongoing value of capitalized assets or determine the estimated useful lives over which the costs are amortized, the amount of internal-use software development costs we capitalize and amortize could change in future periods.
Stock-Based Compensation
We account for stock-based compensation in accordance with the authoritative guidance on stock compensation. Under the fair value recognition provisions of this guidance, stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, over the requisite service period, which is generally the vesting period of the respective award.
Determining the fair value of stock-based awards at the grant date requires judgment. Prior to the completion of our IPO in July 2021, we used the Black-Scholes option-pricing model to determine the fair value of stock options granted to our employees and directors. Subsequent to the completion of our IPO, the grant date fair value of equity awards is determined
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using the fair value of our common stock on the date of grant. The determination of the grant date fair value of stock options using an option-pricing model is affected by our estimated common stock fair value as well as assumptions regarding a number of other complex and subjective variables. These variables include the fair value of our common stock, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates and expected dividends, which are estimated as follows:
•Fair value of the common stock. Prior to our IPO, the fair value of common stock underlying the stock options had historically been determined by our Board of Directors, with input from our management. Our Board of Directors previously determined the fair value of the common stock at the time of grant of the options by considering a number of objective and subjective factors, including the results of contemporaneous independent third-party valuations of our common stock; the prices, rights, preferences, and privileges of our redeemable convertible preferred stock relative to those of our common stock; the prices of redeemable convertible preferred stock sold by us to third-party investors in arms-length transactions; the lack of marketability of our common stock; actual operating and financial results; current business conditions and projections; our history and the timing of the introduction of new applications; our stage of development; the likelihood of achieving a liquidity event, such as an initial public offering or a merger or acquisition of our company given prevailing market conditions; the market performance of comparable publicly-traded companies; recent secondary stock sales transactions; and U.S. and global market conditions. Subsequent to our IPO, the fair value of our underlying common stock is determined by the closing price of our common stock on the date of grant, as reported by the NYSE.
•Expected term. The expected term represents the period that the stock-based awards are expected to be outstanding. We use the simplified calculation of expected term, as we do not have sufficient historical data to use any other method to estimate expected term.
•Expected volatility. The expected volatility is derived from an average of the historical volatilities of the common stock of several entities with characteristics similar to ours, such as the size and operational and economic similarities to our principle business operations.
•Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the expected term of the stock-based awards.
•Expected dividend. The expected dividend is assumed to be zero as we have never paid dividends and have no current plans to pay any dividends on our common stock.
The following table summarizes the assumptions used in the Black-Scholes option-pricing model to determine the fair value of our stock options:
| Year Ended December 31, | |||
|---|---|---|---|
| 2021 | 2020 | ||
| Stock options: | |||
| Risk-free interest rate | 0.8%-1.3% | 0.4%-1.7% | |
| Weighted-average expected term of the options | 6.25 years | 6.25 years | |
| Expected dividend rate | — % | — % | |
| Expected volatility | 52%-54% | 49%-52% |
If any assumptions used in the Black-Scholes option-pricing model change significantly, stock-based compensation expense may differ. For example, a 10% increase in the fair value of common stock would cause a $0.5 million increase in stock-based compensation recognized over the requisite service period for stock options granted in 2021.
We have also granted restricted stock awards (“RSAs”), and commencing in 2021, we granted restricted stock units (“RSUs”). Stock-based compensation related to RSAs and RSUs is measured based on the fair value of the common stock on the grant date. It is recognized in our consolidated statement of operations over the period the recipient is required to perform services in exchange for the award, which is generally the vesting period.
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Recent Accounting Pronouncements
See “Summary of Significant Accounting Policies” in Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information.
JOBS Act Accounting Election
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or JOBS Act, and, for so long as we continue to be an emerging growth company, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, pursuant to Section 107 of the JOBS Act, as an emerging growth company, we have elected to take advantage of the extended transition period for complying with new or revised accounting standards until those standards would otherwise apply to private companies. If we cease to be an emerging growth company, we will no longer be able to take advantage of these exemptions or the extended transition period for complying with new or revised accounting standards.
7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company, as defined by Rule 12b-2 under the Securities and Exchange Act of 1934 and in Item 10(f)(1) of Regulation S-K, and are not required to provide the information under this item.
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