# VARONIS SYSTEMS INC (VRNS) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from VARONIS SYSTEMS INC's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1361113/000162828022002017/vrns-20211231.htm
Accession: 0001628280-22-002017
Filing date: 2022-02-08
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/VRNS/
All MD&A years: /company/VRNS/mda/
Next year: /company/VRNS/mda/fy2022/ (FY 2022)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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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 appearing elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those discussed in the section titled “Risk Factors” included under Part I, Item 1A and elsewhere in this Annual Report. See “Special Note Regarding Forward-Looking Statements and Summary Risk Factors” in this Annual Report.

COVID-19 and the Digital Transformation

In December 2019, COVID-19 was first reported in China; in January 2020, the World Health Organization (”WHO”) declared it a Public Health Emergency of International Concern; and in March 2020, the WHO declared it a pandemic. The ongoing measures taken by many governments around the world in response to the pandemic together with its unpredictability and duration, have meaningfully impacted businesses and changed the threat landscape of company data.

We believe that COVID-19 accelerated the global digital transformation, which, as it continues to gain traction across almost all industries, changes the way we live and work, and impacts how data is stored, managed and accessed. This transformation has fueled, and we expect will continue to fuel, the secular trends that drive demand for our products, including the shift to the cloud; increase in cybercrime; and compliance with data-driven regulations. These trends impact the way organizations operate and have increased our long-term opportunity to help our customers protect their data, detect threats and achieve regulatory compliance.

Companies around the world are focused on the elevated risks associated with having a highly distributed workforce collaborating on multiple platforms and we believe this trend will continue in the long-term and that we are well positioned to capitalize on the opportunity ahead. As companies of all sizes and industries are increasingly facing cyberattacks, they understand that a data-centric approach to security is critical and that the aforementioned elevated risks are here for the long-term. This has caused significant customer engagement which has converted into new business and expansion of existing business.

Overview

Varonis is a pioneer in data security and analytics, fighting a different battle than conventional cybersecurity companies. We are pioneers because more than 15 years ago we recognized that enterprise capacity to create and share data far exceeded its capacity to protect it. We believed that rapid data growth combined with increasing information dependence would change both the global economy and the risk profiles of corporations and governments. This conviction has only strengthened over time. Since our founding, our focus has been on using innovation to address the cyber-implications of these trends, creating software that provides new ways to track, alert and protect data wherever it is stored.

In 2021, we introduced an update to our platform to help customers combat insider and collaboration risks in Microsoft 365. The update increases insight into organization-wide exposures related to Microsoft 365, adds new threat detection capabilities in Azure AD, adds support for additional NAS solutions and versions, and enhances search granularity for locating sensitive and personal data. We also launched DatAdvantage Cloud, introducing licenses and support for additional cloud applications and infrastructure, including AWS, Box, GitHub, Google Drive, Jira, Okta, Salesforce, Slack and Zoom. DatAdvantage Cloud will help customers visualize and prioritize their biggest cloud risks, proactively reduce their blast radius, and conduct faster cross-cloud investigations. Additionally, we introduced Data Classification Cloud for Google Drive and Box to help automatically identify sensitive information in these mission-critical SaaS applications. While we do not expect these products to meaningfully contribute to our 2022 revenues, we believe they offer significant potential in extending the Varonis Data Security Platform to cloud applications where our customers continue to move sensitive data. For a full business and product overview, see "Part I, Item 1. Business."

In the first quarter of 2019, we announced our strategic shift to a subscription-based business model, which allows our customers to better unleash the power of our platform through faster adoption of our integrated products. The transition, which we completed in 2020, has positioned us well for the future, and, although revenues are still primarily front-end loaded, they are more predictable and recurring in nature. For the year ended December 31, 2021, 99% of our licenses revenues are subscriptions and 99% of our total revenues are recurring. We currently have over thirty-five licenses. As of December 31, 2021, 73% of our customers with 500 employees or more had purchased four or more licenses, compared to 63% a year ago, and 41% purchased six or more licenses, compared to 30% a year ago. Our maintenance renewal rate for each of the years ended December 31, 2021, 2020 and 2019 continued to be over 90%. Our key strategies to ensure and maintain a high subscription and maintenance renewal rate include focusing on the quality and reliability of our customer service and support to

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ensure our customers receive value from our products and providing software upgrades and enhancements when and if they are available.

We sell substantially all of our products and services to channel partners, including distributors and resellers, which sell to end-user customers, which we refer to in this report as our customers. We believe that our sales model, which combines the leverage of a channel sales model with our highly trained and professional sales force, has and will continue to play a major role in our ability to grow and to successfully deliver our unique value proposition for enterprise data. While our products serve customers of all sizes, across industries and across geographies, the marketing focus and majority of our sales focus is on targeting organizations with 1,000 users or more who can make larger initial purchases with us and, over time, have a greater potential lifetime value. Our customers span leading firms in the financial services, public, healthcare, industrial, insurance, energy and utilities, technology, consumer and retail, media and entertainment and education sectors. We believe our existing customer base serves as a strong source of incremental future revenues given our broad platform of products, their growing volumes and complexity of enterprise data and related security concerns. We will continue our focus on targeting organizations with 1,000 users or more who can make larger purchases with us initially and over time.

We believe there is a significant long-term growth opportunity in both domestic and foreign markets, which could include any organization that uses file shares, SaaS applications, intranets and email for collaboration. For the year ended December 31, 2021, 72% of our revenues were derived from North America, while approximately 26% of our revenues were derived from EMEA and approximately 2% from ROW. Additionally, total revenues grew approximately 33% for the year ended December 31, 2021. We continue to expect sales growth in North America and international expansion to be key components of our long-term growth strategy.

We continue to expand our domestic and international operations as part of our long-term growth strategy. While the expansion of our domestic operations is focused primarily on our underpenetrated territories, the expansion of our international operations depends in particular on our ability to hire, integrate and retain local sales personnel in these international markets, acquire new channel partners and implement an effective marketing strategy. Given the nominal amount of our ROW revenues, our ROW revenue growth rates have fluctuated in the past and may fluctuate in the future based on the timing of deal closures. In addition, the further expansion of our international operations will increase our sales and marketing and general and administrative expenses and will subject us to a variety of risks and challenges, including those related to economic and political conditions in each region, compliance with foreign laws and regulations, and compliance with domestic laws and regulations applicable to our international operations.

Since inception, we have continued to scale our business and execute on strategic initiatives which we believe have positioned us for durable long-term growth. For the years ended December 31, 2021, 2020 and 2019, subscription revenues were $268.9 million, $161.2 million, and $76.7 million, respectively, representing year-over-year growth of 67% and 110%. For the years ended December 31, 2021, 2020 and 2019, our total revenues were $390.1 million, $292.7 million and $254.2 million, respectively. This represents year-over-year growth of 33% for the year ended December 31, 2021 and 15% for the year ended December 31, 2020, the year we transitioned to a subscription-based business model. For the years ended December 31, 2021, 2020 and 2019, we had operating losses of $98.7 million, $78.4 million and $76.0 million and net losses of $116.9 million, $94.0 million and $78.8 million, respectively.

Key Performance Indicators and Recent Business Highlights

Annual Recurring Revenues

Annual recurring revenues is a key performance indicator defined as the annualized value of active term-based subscription license contracts and maintenance contracts related to perpetual licenses in effect at the end of that period. Subscription license contracts and maintenance for perpetual license contracts are annualized by dividing the total contract value by the number of days in the term and multiplying the result by 365.

As of December 31, 2021, 2020 and 2019, ARR was $387.1 million, $287.3 million and $210.5 million, respectively, an increase of 35% and 37% period over period. The annualized value of contracts is a legal and contractual determination made by assessing the contractual terms with our customers. The annualized value of maintenance contracts is not determined by reference to historical revenues, deferred revenues or any other GAAP financial measure over any period. ARR is not a forecast of future revenues and can be impacted by contract start and end dates and renewal rates. We expect ARR to continue to increase in absolute dollars.

Components of Operating Results

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Revenues

Our revenues consist of licenses and maintenance and services revenues.

Subscription Revenues. Subscription revenues are sold on-premises and are recognized at the point of time when the software license has been delivered and the benefit of the asset has transferred. Maintenance associated with subscription licenses is recognized ratably over the term of the agreement. In 2021, we launched our cloud offering that allow customers to use hosted software and its revenue is recognized ratably over the associated contract period. As we only introduced these licenses in the second half of 2021, the contribution to total revenues has not yet been significant, nor is it expected to be significant in 2022. Subscription licenses have become the largest component of our revenues and are expected to be an even more significant portion of our total revenues in the future. Due to the timing of the renewals and the subscription renewal rates, we could produce significant variation in the revenues we recognize in a given period. We are focused on acquiring new subscription customers and increasing subscription revenues from our existing customers.

Maintenance and Services Revenues. Maintenance and services revenues consist of revenues from maintenance agreements of perpetual license sales and, to a lesser extent, professional services. Customers with maintenance agreements are entitled to receive support and unspecified upgrades and enhancements when and if they become available. We recognize the revenues associated with maintenance ratably over the associated contract period. We measure the maintenance renewal rate for our customers over a 12-month period, based on a dollar maintenance renewal rate for contracts expiring during that time period. Our maintenance renewal rate for each of the years ended December 31, 2021, 2020 and 2019 continued to be over 90%. We have seen and expect to continue to see insignificant perpetual license revenues in the future and, therefore, we expect maintenance and support of perpetual licenses to continue to decline despite the strong renewal rates. We also offer professional services, generally provided on a time and materials basis, focused on training our customers in the use of our products. We recognize the revenues associated with these professional services as we deliver the services, provide the training or when the service term has expired. Although professional services have always been a small percentage of our total revenues, we have recently seen, and expect to continue to see, that percentage decline as many of our newer licenses can provide remediation in more automated ways. As such, our overall maintenance and services revenues is also expected to continue to decline.

Perpetual License Revenues. Perpetual license revenues are generally recognized with the license fee portion of the arrangement upon delivery as the benefit of the asset has transferred. Due to the successful completion of our transition to a subscription-based business model, perpetual license revenues have meaningfully decreased and now represent an immaterial percentage of our total revenues.

The following table sets forth the percentage of our revenues that have been derived from licenses and maintenance and services revenues for the periods presented.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["","(as a percentage of total revenues)"],["Revenues:"],["Subscriptions","68.9","%","","55.1","%","","30.1","%"],["Maintenance and services","30.6","%","","44.4","%","","53.3","%"],["Perpetual licenses","0.5","%","","0.5","%","","16.6","%"],["Total revenues","100.0","%","","100.0","%","","100.0","%"]]
[[/GREPCENT_TABLE]]

Our products are used by a wide range of enterprises, including Fortune 500 corporations and small and medium-sized businesses. Our customers span a broad array of industries and are located in over 85 countries.

Cost of Revenues, Gross Profit and Gross Margin

Our cost of revenues consists of cost of maintenance and services revenues. Cost of maintenance and services revenues consist primarily of salaries (including payroll tax expense related to stock-based compensation), employee benefits (including commissions and bonuses) and stock-based compensation for our maintenance and services employees; amortization of acquired intangible assets; travel expenses; and allocated overhead costs for facilities, IT and depreciation. We recognize expenses related to maintenance and services as they are incurred. We expect that our cost of maintenance and services

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revenues will increase in absolute dollars as we continue to invest in our customer success and support teams and programs that play a critical role in our subscription-based business model and our overall renewals.

Gross profit is total revenues less total cost of revenues. Gross margin is gross profit expressed as a percentage of total revenues. As the majority of our expenses are relatively fixed quarter over quarter and due to the seasonality of our business, the first quarter typically results in the lowest gross margin as our first quarter revenues have historically been the lowest for the year. Conversely, the fourth quarter typically results in the highest gross margin as our fourth quarter revenues have historically been the highest for the year.

Operating Expenses

Our operating expenses are classified into three categories: research and development, sales and marketing and general and administrative. For each category, the largest component is personnel costs, which consists of salaries (including payroll tax expense related to stock-based compensation), employee benefits (including commissions and bonuses) and stock-based compensation. Operating expenses also include allocated overhead costs for facilities, IT and depreciation. Allocated costs for facilities primarily consist of rent and office maintenance. Operating expenses are generally recognized as incurred. As a company, we have always aimed to tie our level of investment in the business to the revenues we expect to achieve and we actively manage expenses across the business. We expect personnel costs to continue to increase in absolute dollars as we continue to grow our business.

Research and Development. Research and development expenses primarily consist of personnel costs attributable to our research and development personnel, as well as allocated overhead costs. We expense research and development costs as incurred. We expect that our research and development expenses will continue to increase in absolute dollars as we further strengthen our technology platform and invest in the development of both existing and new products through the hiring of talented and capable employees.

Sales and Marketing. Sales and marketing expenses are the largest component of our operating expenses and consist primarily of personnel costs, as well as marketing and business development costs, travel expenses, training and education and allocated overhead costs. We expect that sales and marketing expenses will continue to increase in absolute dollars as we plan to expand our sales and marketing efforts, both domestically and internationally. We also expect sales and marketing expenses to continue to be our largest category of operating expenses.

General and Administrative. General and administrative expenses mostly consist of personnel and facility-related costs for our executive, finance, legal, human resources and administrative personnel. Other expenses are comprised of legal, accounting and other consultant fees and other corporate expenses and allocated overhead. We expect that general and administrative expenses will increase in absolute dollars as we expand our operations.

 Financial Income (Expenses), Net

Financial income (expenses), net consist primarily of foreign exchange gains or losses, amortization of debt discount and issuance costs, interest expense and interest income. Foreign exchange gains or losses relate to our business activities in foreign countries with different operational reporting currencies. As a result of our business activities in foreign countries, we expect that foreign exchange gains or losses will continue to occur due to fluctuations in exchange rates in the countries where we do business. Other factors such as economic instability could also contribute to volatility in the global financial and foreign exchange markets, including volatility in the value of Pounds Sterling, Euros and other currencies. Amortization of debt discount and issuance costs relate to the 2025 Notes we issued in May 2020 and the Credit Facility we entered into in August 2020. Interest expense consists of the contractual interest expenses associated with the 2025 Notes. Interest income represents interest received on our cash, cash equivalents, marketable securities and short-term deposits.

Income Taxes

We operate in several tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may be subject to U.S. income tax. To date, on a consolidated basis, we have incurred accumulated net losses and have not recorded any U.S. federal tax provision. 

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Because of our history of U.S. net operating losses, we have established a full valuation allowance against potential future benefits for deferred tax assets, including loss carryforwards, in that jurisdiction. Our income tax provision could be significantly impacted by estimates surrounding our uncertain tax positions and changes to our valuation allowance in future periods. We reevaluate the judgments surrounding our estimates and make adjustments as appropriate each reporting period.

In addition, we are subject to the regular examinations of our income tax returns by different tax authorities. For example, we are currently subject to a withholding tax audit in Israel and state tax audits in the United States. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

Results of Operations

The following tables are a summary of our consolidated statements of operations in dollars and as a percentage of our total revenues.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["","(in thousands)"],["Statement of Operations Data:"],["Revenues:"],["Subscriptions","$","268,942","","","$","161,188","","","$","76,730"],["Maintenance and services","119,302","","","130,028","","","135,367"],["Perpetual licenses","1,890","","","1,473","","","42,093"],["Total revenues","390,134","","","292,689","","","254,190"],["Cost of revenues","59,399","","","44,261","","","35,144"],["Gross profit","330,735","","","248,428","","","219,046"],["Operating expenses:"],["Research and development","137,882","","","99,363","","","80,764"],["Sales and marketing","230,314","","","179,902","","","169,898"],["General and administrative","61,233","","","47,578","","","44,371"],["Total operating expenses","429,429","","","326,843","","","295,033"],["Operating loss","(98,694)","","","(78,415)","","","(75,987)"],["Financial expenses, net","(12,145)","","","(7,483)","","","(389)"],["Loss before income taxes","(110,839)","","","(85,898)","","","(76,376)"],["Income taxes","(6,022)","","","(8,112)","","","(2,388)"],["Net loss","$","(116,861)","","","$","(94,010)","","","$","(78,764)"]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["","(as a percentage of total revenues)"],["Statement of Operations Data:"],["Revenues:"],["Subscriptions","68.9","%","","55.1","%","","30.1","%"],["Maintenance and services","30.6","","","44.4","","","53.3"],["Perpetual licenses","0.5","","","0.5","","","16.6"],["Total revenues","100.0","","","100.0","","","100.0"],["Cost of revenues","15.2","","","15.1","","","13.8"],["Gross profit","84.8","","","84.9","","","86.2"],["Operating expenses:"],["Research and development","35.4","","","33.9","","","31.8"],["Sales and marketing","59.0","","","61.5","","","66.8"],["General and administrative","15.7","","","16.3","","","17.5"],["Total operating expenses","110.1","","","111.7","","","116.1"],["Operating loss","(25.3)","","","(26.8)","","","(29.9)"],["Financial expenses, net","(3.1)","","","(2.5)","","","(0.1)"],["Loss before income taxes","(28.4)","","","(29.3)","","","(30.0)"],["Income taxes","(1.6)","","","(2.8)","","","(1.0)"],["Net loss","(30.0)","%","","(32.1)","%","","(31.0)","%"]]
[[/GREPCENT_TABLE]]

Comparison of Years Ended December 31, 2021 and 2020

Revenues

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","% Change"],["","(in thousands)"],["Revenues:"],["Subscriptions","$","268,942","","","$","161,188","","","66.8","%"],["Maintenance and services","119,302","","","130,028","","","(8.2)","%"],["Perpetual licenses","1,890","","","1,473","","","28.3","%"],["Total revenues","$","390,134","","","$","292,689","","","33.3","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020"],["","(as a percentage of total revenues)"],["Revenues:"],["Subscriptions","68.9","%","","55.1","%"],["Maintenance and services","30.6","%","","44.4","%"],["Perpetual licenses","0.5","%","","0.5","%"],["Total revenues","100.0","%","","100.0","%"]]
[[/GREPCENT_TABLE]]

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Subscription revenues increased 67% from $161.2 million for the year ended December 31, 2020 to $268.9 million for the year ended December 31, 2021. The increase in subscription revenues was driven by existing customers expanding their licenses, new customer acquisitions and our high subscription renewal rate. Total revenues increased approximately 33% for the year ended December 31, 2021 as compared to the year ended December 31, 2020. ARR was $387.1 million and $287.3 million as of December 31, 2021 and 2020, respectively, representing an increase of 35%. The anticipated decrease in maintenance and services revenues was due to insignificant new perpetual licenses revenue despite our maintenance renewal rate continuing to be over 90% for each of the years ended December 31, 2021 and 2020, as well as, newer licenses providing remediation in more automated ways, requiring less professional services time. As a result, we expected, and continue to expect less associated maintenance and services revenues in the future. As of December 31, 2021, 73% of our customers with 500 employees or more had purchased four or more licenses, compared to 63% a year ago, and 41% purchased six or more licenses, compared to 30% a year ago.

Cost of Revenues and Gross Margin

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","% Change"],["","(in thousands)"],["Cost of revenues","$","59,399","","","$","44,261","","","34.2","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020"],["","(as a percentage of total revenues)"],["Total gross margin","84.8","%","","84.9","%"]]
[[/GREPCENT_TABLE]]

The increase in cost of revenues was primarily related to an increase of $13.4 million in salaries and benefits and stock-based compensation expense due to increased headcount for customer success and support personnel to ensure high customer satisfaction and maintain our strong renewal rates. The increase was also due to a $1.5 million increase in amortization of acquired intangible assets and facilities and allocated overhead costs.

Operating Expenses

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","% Change"],["","(in thousands)"],["Operating costs and expenses:"],["Research and development","$","137,882","","","$","99,363","","","38.8","%"],["Sales and marketing","230,314","","","179,902","","","28.0","%"],["General and administrative","61,233","","","47,578","","","28.7","%"],["Total operating expenses","$","429,429","","","$","326,843","","","31.4","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020"],["","(as a percentage of total revenues)"],["Operating costs and expenses:"],["Research and development","35.4","%","","33.9","%"],["Sales and marketing","59.0","%","","61.5","%"],["General and administrative","15.7","%","","16.3","%"],["Total operating expenses","110.1","%","","111.7","%"]]
[[/GREPCENT_TABLE]]

The increase in research and development expenses was primarily related to an increase of $36.7 million in salaries and benefits and stock-based compensation expense resulting from increased headcount as part of our focus on enhancing and developing our existing and new products, including personnel costs related to our acquisition in the fourth quarter of 2020.

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The increase in sales and marketing expenses was primarily related to a $49.3 million increase in salaries and benefits and stock-based compensation expense due to increased headcount to expand our sales force and commissions on increased customer orders.

The increase in general and administrative expenses was primarily related to an increase of $13.0 million in salaries and benefits and stock-based compensation expense primarily due to increased headcount to support the overall growth of our business.

Financial Expenses, Net

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","% Change"],["","(in thousands)"],["Financial expenses, net","$","(12,145)","","","$","(7,483)","","","62.3","%"]]
[[/GREPCENT_TABLE]]

The increase in financial expenses, net was primarily due to the amortization of debt discount and issuance costs and interest expense on our convertible senior notes and revolving credit facility.

Income Taxes

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","% Change"],["","(in thousands)"],["Income taxes","$","(6,022)","","","$","(8,112)","","","(25.8)","%"]]
[[/GREPCENT_TABLE]]

Income taxes for the year ended December 31, 2021 were comprised primarily of foreign income taxes and state taxes. Income taxes for the year ended December 31, 2020 were comprised primarily of a one-time tax expense related to our acquisition, foreign income taxes and state taxes.

Inflation

We do not believe that inflation rates have had a material effect on our business, financial condition or results of operations in the last three fiscal years. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

Comparison of Years Ended December 31, 2020 and 2019

For a comparison of our results of operations for the years ended December 31, 2020 and 2019, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on February 9, 2021, which comparative information is herein incorporated by reference.

Seasonality and Quarterly Trends

Our quarterly results reflect seasonality in the sale of our products and services. Historically, we have experienced a pattern of increased sales in the fourth quarter. This trend makes it difficult to achieve sequential revenue growth in the first quarter of the following year. Because of purchasing trends, demand for our products and services is typically slowest in the first quarter, resulting in a decrease in quarterly revenues from the fourth quarter to the first quarter of the subsequent fiscal year. We expect these seasonal patterns to continue in the future. Our gross margins and operating margins have been affected by these historical trends because the majority of our expenses are relatively fixed quarter over quarter. Our expenses, which do not vary directly with revenues, and the seasonal pattern described above have an impact on the cost of revenues, research and development expenses, sales and marketing expenses and general and administrative expenses as a percentage of revenues in each calendar quarter during the year. The majority of our expenses are personnel-related costs, which consists of salaries (including payroll tax expense related to stock-based compensation), employee benefits (including commissions and bonuses) and stock-based compensation. As a result, we have not experienced significant seasonal fluctuations in the timing of expenses

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from period to period. Although these seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance.

Liquidity and Capital Resources

The following table shows our liquidity and capital resources as of and our cash flows from operating activities, investing activities and financing activities for the years ended December 31, 2021 and 2020. For a discussion of our liquidity and capital resources as of and our cash flow activities for the fiscal year ended December 31, 2019, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on February 9, 2021, which discussion is herein incorporated by reference.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020"],["","(in thousands)"],["Net cash provided by (used in) operating activities","$","7,178","","","$","(5,842)"],["Net cash provided by (used in) investing activities","54,379","","","(54,748)"],["Net cash provided by financing activities","510,112","","","225,753"],["Increase in cash and cash equivalents","$","571,669","","","$","165,163"]]
[[/GREPCENT_TABLE]]

On December 31, 2021, our cash and cash equivalents and short-term deposits of $807.6 million were held for working capital purposes and were held primarily in cash and money market funds. We have proactively taken steps to increase available cash, including, but not limited to, issuing a follow-on equity offering and the 2025 Notes, and we believe that our existing cash and cash equivalents, short-term deposits and cash flow from operations will be sufficient to fund our operations and capital expenditures for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, timing of renewals and subscription renewal rates, the expansion of our sales and marketing activities, the timing and extent of spending to support product development efforts and expansion into new geographic locations, the timing of introductions of new software products and enhancements to existing software products, the continuing market acceptance of our software offerings and our use of cash to pay for acquisitions, if any.

Operating Activities

Our operating activities are driven by sales of our products less costs and expenses, primarily payroll and related expenses, and adjusted for certain non-cash items, mainly depreciation and amortization, stock-based compensation, amortization of deferred commissions, noncash operating lease costs and amortization of debt discount and issuance costs, and changes in operating assets and liabilities. Changes in operating assets and liabilities are driven mainly by collection of accounts receivable from the sales of our software products and deferred revenues which represents unearned amounts billed to our channel partners, related to these sales.

For 2021, cash provided by operating activities were $7.2 million. We have observed two seasonal patterns that impact our net cash provided by operating activities. First, a majority of our sales are made during the last three weeks of the quarter. Second, the highest dollar amount of sales of our products and services occurs in the fourth quarter. Consequently, we end the fourth quarter with our highest accounts receivable balance of any quarter which in turn generates the greatest amount of collections in the following quarter. In addition, there is negative sequential revenue in the first quarter, which results in a relatively lower amount collected during the second quarter. These seasonal trends also impact our operating loss because the majority of our expenses are relatively fixed in the short-term. For 2021, sources of cash inflows were $33.0 million, which included our net loss of $116.9 million, offset by non-cash charges of $149.9 million. Additional sources of cash inflows were from changes in our working capital, including a $5.9 million increase in accrued expenses and other liabilities, a $5.4 million increase in deferred revenues, a $4.5 million increase in trade payables, a $1.6 million increase in other long-term liabilities and a $1.4 million decrease in other long-term assets. This was partially offset by a $23.0 million increase in accounts receivable. Our days’ sales outstanding (“DSO”) for the three months and year ended December 31, 2021 was 74 and 69, respectively. Other sources of cash outflows were from a $21.7 million increase in prepaid expenses and other current assets (including deferred commissions).

For 2020, cash used in operating activities were $5.8 million.  For 2020, sources of cash outflows were from changes in working capital, including a $19.7 million increase in prepaid expenses and other current assets (including deferred commissions) and a $19.1 million increase in accounts receivable. Our DSO for the three months and year ended December 31, 2020 was 77 and 76, respectively. Additional sources of cash outflows were from a $0.3 million decrease in trade payables and

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a $0.2 million decrease in deferred revenues. This was partially offset by $10.4 million from our net loss excluding non-cash charges, a $16.1 million increase in accrued expenses and other liabilities, a $5.5 million increase in other long-term liabilities and a $1.4 million decrease in other long-term assets.

Investing Activities

Our investing activities consist primarily of capital expenditures to purchase property and equipment, including leasehold improvements, purchase and sale of deposits and changes in our marketable securities. In the future, we expect to continue to incur capital expenditures to support our expanding operations.

During 2021, net cash provided by investing activities of $54.4 million was primarily attributable to $34.1 million of net proceeds from marketable securities and $30.8 million of net proceeds from short-term and long-term deposits. This was partially offset by $10.5 million in capital expenditures to support our growth during the period including hardware, software, office equipment and leasehold improvements mainly in connection with existing office space.

During 2020, net cash used in investing activities of $54.7 million was attributable to $29.4 million of cash paid for an acquisition, a $22.7 million increase in short-term and long-term deposits and $10.1 million in capital expenditures to support our growth during the period including hardware, software, office equipment and leasehold improvements mainly in connection with new office space that we entered into prior to the outbreak of the pandemic. This was partially offset by a $7.4 million decrease in marketable securities.

Financing Activities

In 2021, net cash provided by financing activities of $510.1 million was attributable to $500.0 million of net proceeds from a public follow-on offering of equity and $10.1 million of net proceeds from employee stock plans.

In 2020, net cash provided by financing activities of $225.8 million was attributable to $245.3 million of net proceeds from the issuance of convertible senior notes and $9.8 million of net proceeds from employee stock plans. This was partially offset by $29.3 million related to purchases of capped calls associated with the convertible senior notes.

Revolving Credit Facility

On August 21, 2020, we entered into the Credit and Security Agreement, for a three-year secured revolving credit facility of $70.0 million, with a letter of credit sublimit of $15.0 million and an accordion feature under which we can increase the credit facility to up to $90.0 million. For information regarding the revolving credit facility, refer to Note 2 of our consolidated financial statements.

As of December 31, 2021, we had no balance outstanding on the Credit Facility and we were in compliance with all financial covenants and non-financial covenants.

Convertible Notes

On May 11, 2020, we issued $253.0 million aggregate principal amount of the 2025 Notes. The net proceeds from the offering, after deducting initial purchaser discount and issuance costs, were approximately $245.2 million. In connection with the issuance of the 2025 Notes, we entered into the Capped Call Transactions. We used $29.3 million of the net proceeds from the 2025 Notes to purchase the Capped Call Transactions, as further discussed in Note 7 of our consolidated financial statements.

Common Stock Split

On February 8, 2021, we announced a three-for-one split of our common stock to stockholders of record as of the close of business on March 12, 2021. Trading of our common stock began on a split-adjusted basis on March 15, 2021. Common stock and per share data in this Annual Report on Form 10-K have been adjusted for the impact of the split.

Contractual Payment Obligations

Our principal commitments primarily consist of obligations under leases for office space and motor vehicles. Aggregate minimum rental commitments under non-cancelable leases as of December 31, 2021 for the upcoming years were as follows:

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We have obligations related to unrecognized tax benefit liabilities totaling $9.3 million and others related to severance pay, which have been excluded from the table above as we do not believe it is practicable to make reliable estimates of the periods in which payments for these obligations will be made.

Off-Balance Sheet Arrangements

As of December 31, 2021, we did not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of the matters that are inherently uncertain.

Revenue Recognition:

We generate revenues in the form of software license fees and related maintenance and services fees. Subscription revenues are sold on-premises and are comprised of time-based licenses whereby customers use our software (including support and unspecified upgrades and enhancements when and if they are available) for a specified period. Perpetual licenses have the same functionality as subscriptions. Maintenance and services primarily consist of fees for maintenance and services of perpetual license sales (including support and unspecified upgrades and enhancements when and if they are available) and to a lesser extent professional services, which focus on both operationalizing the software and training our customers to fully leverage the use of our products, although the user can benefit from the software without our assistance. In 2021, we launched our cloud offering that allows customers to use hosted software. We sell our products worldwide directly to a network of distributors and value-added resellers, and payment is typically due within 30 to 60 calendar days of the invoice date.

We recognize revenues in accordance with ASC No. 606, “Revenue from Contracts with Customers.” As such, we identify a contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to each performance obligation in the contract and recognize revenues when (or as) we satisfy a performance obligation.

Subscription software and perpetual license revenues are recognized at the point of time when the software license has been delivered and the benefit of the asset has transferred. Maintenance associated with subscription licenses is recognized ratably over the term of the agreement. In 2021, we launched our cloud offering that allows customers to use hosted software and its revenue is recognized ratably over the associated contract period. As we only introduced these licenses in the second half of 2021, the total revenues have not yet been significant.

We recognize revenues from maintenance of perpetual license sales ratably over the term of the underlying maintenance contract. The term of the maintenance contract is usually one year. Renewals of maintenance contracts create new performance obligations that are satisfied over the new term with the revenues recognized ratably over the period.

Revenues from professional services consist mostly of time and material services. The performance obligations are satisfied, and revenues are recognized, when the services are provided or once the service term has expired.

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We enter into contracts that can include combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations.  The license is distinct upon delivery as the customer can derive the economic benefit of the software without any professional services, updates or technical support. We allocate the transaction price to each performance obligation based on our relative standalone selling price out of the total consideration of the contract. For maintenance, we determine the standalone selling prices based on the price at which we separately sell a renewal contract. For professional services, we determine the standalone selling prices based on the price at which we separately sell those services. For software licenses, we use the residual approach to determine the standalone selling prices due to the lack of history of selling software license on a standalone basis and the highly variable sales price.

Trade receivables are generally recorded at the invoice amount mostly for a one year period, net of an allowance for credit losses.

Deferred revenues represent mostly unrecognized fees billed or collected for maintenance and professional services. Deferred revenues are recognized as (or when) we perform under the contract. Pursuant to these contracts, customers are not invoiced for subsequent years until the annual renewal occurs. The amount of revenues recognized in the period that was included in the opening deferred revenues balance was $98.1 million for the year ended December 31, 2021.

We do not grant a right of return to our customers, except for one of our resellers. During the years ended December 31, 2021, 2020 and 2019, there were no returns from this reseller.

For information regarding disaggregated revenues, please refer to Note 14 to our consolidated financial statements.

Contract Costs:

We pay sales commissions to sales and marketing and certain management personnel based on their attainment of certain predetermined sales goals. Sales commissions earned by employees are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions paid for initial contracts, which are not commensurate with sales commissions paid for renewal contracts, are capitalized and amortized over an expected period of benefit. Based on our technology, customer contracts and other factors, we have determined the expected period of benefit to be approximately four years. Sales commissions for renewal contracts are capitalized and then amortized on a straight-line basis. Amortization expenses related to these costs are included in sales and marketing expenses in the accompanying consolidated statements of operations.

Accounting for Stock-Based Compensation:

We account for stock-based compensation in accordance with ASC No. 718, “Compensation-Stock Compensation.” ASC No. 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an Option-Pricing Model. We recognize compensation expenses for the value of our equity awards granted based on the straight-line method over the requisite service period of each of the awards.

Business Combinations:

We account for our business combinations using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill if new information is obtained related to facts and circumstances that existed as of the acquisition date. After the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. Acquisition costs, such as legal and consulting fees, are expensed as incurred.

Convertible Senior Notes:

We account for our convertible senior notes in accordance with ASC 470-20 "Debt with Conversion and Other Options" and separated the Notes into liability and equity components. The carrying amounts of the liability component of the Notes were calculated by measuring the fair value of similar debt instruments that do not have an associated convertible feature. The

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carrying amounts of the equity components, representing the conversion option, were determined by deducting the fair value of the liability components from the par value of the 2025 Notes. This difference represents the debt discount that is amortized to interest expense over the terms of the 2025 Notes using the effective interest rate method. The carrying amount of the equity components representing the conversion option was approximately $31.8 million for the 2025 Notes and is recorded in additional paid-in capital and are not remeasured as long as they continue to meet the conditions for equity classification.

The Company allocates transaction costs related to the issuance of the 2025 Notes to the liability and equity components using the same proportions as the initial carrying value of the Notes. Transaction costs attributable to the liability component were approximately $6.9 million and are being amortized to interest expense at an effective interest method rate of 4.51% over the term of the 2025 Notes. Transaction costs attributable to the equity component were approximately $1.0 million and are netted with the equity component of the 2025 Notes in additional paid-in capital.

Recently Adopted Accounting Pronouncements

We did not adopt any new accounting standards in the period ended December 31, 2021.

Recently Issued Accounting Pronouncements Not Yet Adopted

In August 2020, the FASB issued ASU 2020-06, ASC Subtopic 470-20 “Debt—Debt with “Conversion and Other Options” and ASC subtopic 815-40 “Hedging—Contracts in Entity’s Own Equity.” The standard reduced the number of accounting models for convertible debt instruments and convertible preferred stock. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative, and that do not qualify for a scope exception from derivative accounting and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in capital. Among other potential impacts, ASU 2020-06 will reduce reported interest expense, and thereby decrease reported net loss, and result in a reclassification of certain conversion feature balance sheet amounts from stockholder’s equity to liabilities as it relates to the Company’s 2025 Notes. Additionally, ASU 2020-06 requires the application of the if-converted method to calculate the impact of convertible instruments on earnings per share. The amendments in this update are effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years, and can be adopted on either a fully retrospective or modified retrospective basis. We adopted this standard on January 1, 2022 using a modified retrospective basis which resulted in a decrease to accumulated deficit of $8.6 million, a decrease in additional paid-in capital of $30.8 million and an increase in liabilities of $22.1 million on our consolidated balance sheets.