APPGATE, INC. The following discussion and analysis provides information we believe is relevant to an assessment and understanding of our results of operations, financial condition, liquidity and cash flows for the periods presented. This discussion should be read in conjunction with (a) our unaudited condensed consolidated financial statements and related notes contained elsewhere in Part I, Item 1, "Financial Statements" of this Quarterly Report and (b) Part I, Item 1A "Risk Factors," Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited consolidated financial statements and related notes in our 2021 Annual Report. As discussed in the section above titled "Cautionary Statement Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that are based upon our current expectations, including with respect to our future revenues and operating results. Our actual results may differ materially from those anticipated in such forward-looking statements as a result of various factors. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included under Part II, Item 1A below and included under Part I, Item 1A in our 2021 Annual Report. We operate on a calendar year basis. Capitalized terms used in this section and not defined herein have the respective meanings given to such terms elsewhere in this Quarterly Report. Numbers and percentages presented throughout this discussion and analysis may not always add up to equivalent totals and/or to 100% due to rounding. Overview of Our Business We believe we are defining a new category ofZero Trust access for enterprises and governments. OurZero Trust platform is designed to protect against increasingly damaging breaches through innovative, identity-centric, context-aware solutions. Our pure-play focus onZero Trust has enabled us to deliver the highest ranked current Zero Trust Network Access offering as determined by the Forrester New Wave™: Zero Trust Network Access, Q3 2021. This newZero Trust paradigm is needed today because enterprises are undergoing digital transformation as they seek to automate operations, generate new revenue streams, transition business models and deliver a seamless customer experience. Simultaneously, the number and sophistication of cyberattacks have increased dramatically, as has their costs and frequency. This combination of more vulnerable networks and more malicious activity has created a cybersecurity crisis, changing the threat landscape organizations face. As a result, enterprises require security access solutions that proactively ensure the right user has authorized access to the right resources at the right time. We believe that ourZero Trust solutions secure an enterprise's exponentially increased attack surface, which occurs as a result of their digital transformation journey. We also offer digital threat protection and risk-based authentication tools to identify and eliminate attacks before they occur, across social media, phishing attacks, bogus websites, and malicious mobile apps. We sell our solutions primarily through a recurring revenue license model or subscription, and we employ a 'land and expand' strategy to generate incremental revenue through the addition of new users and the sale of additional products. Our annual recurring revenue ("ARR") was$30.8 million and$24.2 million atMarch 31, 2022 and 2021, respectively. We believe the success of our strategy is validated by our strong dollar-based net retention rates, which describe our ability to retain and grow the ARR generated from our existing subscription customers. Our dollar-based net retention rates were 106% at each ofMarch 31, 2022 and 2021. Our number of customers generating over$100,000 ARR increased 47% fromMarch 31, 2021 toMarch 31, 2022 , driven by elevated C-suite and board level dialogue and customer prioritization of aZero Trust posture. See "- Key Business Metrics" for additional information regarding ARR and dollar-based net retention rate. Our revenue increased from$10.1 million for the three months endedMarch 31, 2021 to$11.4 million for the three months endedMarch 31, 2022 , an increase of 13%. We continue to invest in growing our business and, as a result, we incurred net losses from continuing operations before income taxes of$64.4 million and$9.9 million for the three months endedMarch 31, 2022 and the three months endedMarch 31, 2021 , respectively. 28 --------------------------------------------------------------------------------
Factors Affecting Our Business
Merger with
OnOctober 12, 2021 , Legacy Appgate successfully completed its merger with a direct, wholly owned subsidiary ofNewtown Lane . Upon closing of the Merger,Newtown Lane changed its name toAppgate, Inc. , and our common stock is now quoted on the OTC Markets under the symbol "APGT." The Merger has been accounted for as a reverse capitalization, and the historical financial statements contained in this Quarterly Report are those of: (1) except for the equity, which was retroactively restated following applicable accounting guidance, Legacy Appgate with respect to all periods prior to consummation of the Merger, and (2) those of us, inclusive ofNewtown Lane for the period subsequent to the Merger. We incurred$0.3 million in transaction costs during the three months endedMarch 31, 2021 in connection with the Merger.
Risks and Uncertainties due to COVID-19
The COVID-19 pandemic continues to evolve and disrupt normal activities in many segments of theU.S. and global economies even as COVID-19 vaccines have been and continue to be administered in 2022. Much uncertainty still surrounds the pandemic, including new variants of COVID-19, its duration and ultimate overall impact on our operations. Management continues to carefully evaluate potential outcomes and has plans to mitigate related risks. While the COVID-19 pandemic did not have a material impact on our business, financial condition or results of operations for 2021 and the three months endedMarch 31, 2022 , management took measures during such periods to minimize the risks from the pandemic. Those measures were aimed at safeguarding the Company, and the health, safety and well-being of our employees and customers.
Public Company Costs
Following the consummation of the Merger, we became a public company, which will require hiring of additional staff and implementation of processes and procedures to address public company regulatory requirements and customary practices. We expect to incur substantial additional annual expenses for, among other things, directors' and officers' liability insurance, director fees and additional internal and external costs for investor relations, accounting, audit, legal, corporate secretary and other functions.
Formation and Cyxtera Spin-Off
Prior toDecember 31, 2019 , Legacy Appgate was wholly owned by Cyxtera. OnDecember 31, 2019 , Cyxtera consummated several transactions (the "Cyxtera Spin-Off"), following which Legacy Appgate became a stand-alone entity. The transactions separated Cyxtera's data center business from Legacy Appgate's cybersecurity business. Upon consummation of the Cyxtera Spin-Off,Legacy Appgate and Cyxtera Management, Inc. , a wholly-owned subsidiary of Cyxtera (the "Management Company "), entered into a transition services agreement (the "Transition Services Agreement"), pursuant to which theManagement Company provided certain transition services to Legacy Appgate and Legacy Appgate provided certain transition services to theManagement Company . The term under the Transition Services Agreement commenced onJanuary 1, 2020 and ended onJune 30, 2021 . Substantially all of the obligations under the Transition Services Agreement ceased onDecember 31, 2020 . During the three months endedMarch 31, 2021 , theManagement Company charged Legacy Appgate$0.1 million for services rendered under the Transition Services Agreement. Such costs are included in general and administrative expenses in the condensed consolidated statement of operations. During the three months endedMarch 31, 2021 , Legacy Appgate charged theManagement Company $0.1 million of fees for services provided to theManagement Company and its affiliates by Legacy Appgate under the Transition Services Agreement. Income for these services is included in other expenses, net in the condensed consolidated statement of operations. OnFebruary 8, 2021 , Legacy Appgate made a payment of$1.0 million to Cyxtera as settlement in full of trade balances with Cyxtera and its subsidiaries and other amounts due to / from under the Intercompany Master Services Agreement and the Transition Services Agreement, which trade balances and other amounts totaled$2.6 million . Because theManagement Company was an affiliate under common control with Legacy Appgate at the time of repayment, the settlement of these amounts was recognized as a capital contribution of$1.6 million . 29 --------------------------------------------------------------------------------
Promissory Notes
OnMarch 31, 2019 , Legacy Appgate issued promissory notes to each of Cyxtera and theManagement Company (together, the "Promissory Notes"), which had a combined initial aggregate principal amount of$95.2 million and provided for additional borrowings during the term of the Promissory Notes for additional amounts not to exceed approximately$52.5 million in the aggregate. Interest accrued on the unpaid principal balance of the Promissory Notes at a rate per annum equal to 3% and was payable upon the maturity of the Promissory Notes. Each Promissory Note had an initial maturity date ofMarch 30, 2020 , which was extended untilMarch 30, 2021 by amendments entered into effective as ofMarch 30, 2020 .
During the three months ended
OnFebruary 8, 2021 , Legacy Appgate repaid Cyxtera$20.6 million , representing the entirety of the then outstanding principal and interest under the Promissory Note issued to Cyxtera, and Legacy Appgate made a partial repayment of$99.0 million to theManagement Company on the then outstanding principal and interest of$133.6 million under the Promissory Note issued to theManagement Company . On that same date, theManagement Company issued Legacy Appgate a payoff letter, extinguishing the balance remaining unpaid following such repayment. Because Cyxtera was Legacy Appgate's direct parent at the time of issuance of the Promissory Notes and an affiliate under common control with Legacy Appgate at the time of repayment, Legacy Appgate accounted for the note extinguishment of$34.6 million as a capital contribution in the three months endedMarch 31, 2021 .
Sale of Brainspace
OnSeptember 30, 2020 , Legacy Appgate adopted a plan for the sale ofBrainspace Corporation ("Brainspace"), a formerly wholly owned subsidiary of LegacyAppgate , which met the criteria for discontinued operations under ASC Topic 205-20, Presentation of Financial Statements - Discontinued Operations - see Note 4 to our condensed consolidated financial statements for discontinued operations disclosures included in Part I, Item 1 of this Quarterly Report - "Financial Statements". OnJanuary 20, 2021 , Legacy Appgate completed the sale of 100% of the outstanding equity interests of Brainspace for$125.0 million . We recorded a gain on the sale of Brainspace of$58.8 million . We have classified the results of Brainspace as discontinued operations in our condensed consolidated statements of operations for all periods presented. Unless otherwise stated, all discussion of Legacy Appgate's results of operations included in this discussion and analysis focus on continuing operations and exclude the discontinued Brainspace operations.
Key Business Metrics
Our management reviews a number of key performance indicators, each as described below, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions.
Annual Recurring Revenue
ARR is a performance indicator that management believes provides more visibility
into the growth of our revenue generated by recurring business. Our management
believes ARR is a key metric to measure our business because it is driven by our
ability to acquire new subscription customers and to maintain and expand our
relationship with existing subscription customers. ARR also mitigates
fluctuations due to seasonality, contract term, sales mix, and revenue
recognition timing resulting from revenue recognition methodologies under GAAP.
We define ARR as the annualized value of SaaS, subscription, and term-based
license and maintenance contracts from our recurring software products in effect
at the end of a given period. ARR should be viewed independently of revenue and
deferred revenue as it is an operating measure and is not intended to be
combined with or to replace GAAP revenue or deferred revenue, as they can be
impacted by contract start and end dates and renewal rates. ARR is not intended
to be a replacement or forecast of revenue or deferred revenue.
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--------------------------------------------------------------------------------The table below sets forth our ARR as of the end of the periods indicated below (in thousands):
Three Months Ended
March 31,
2022 2021
ARR $ 30,824 $ 24,205
Change $ $ 6,619
Change % 27 %
Total Customers and Number of Customers with ARR above
Our management believes that our ability to increase our number of customers is an indicator of our market penetration, the growth of our business, and our potential future business opportunities. Over time, larger customers have constituted a greater share of our total revenue, which has contributed to an increase in ARR. Our management believes there are significant upsell and cross-sell opportunities within our customer base by expanding the number of use cases. Historically, we have consistently increased our number of customers and customers with ARR above$100,000 and expect this trend to continue as a result of the growing demand for our cybersecurity solutions. Our management defines a customer as a distinct organization that has entered into a distinct agreement to access our software products for which the term has not ended or with which we are negotiating a renewal contract or the purchase of our professional services.
The below table sets forth our total customers and customers with ARR above
March 31,
2022 2021
Total customers 596 619
Customers with ARR above $100,000 69 47
We stopped offering our Compliance Sheriff product which accounted for less than
5% of our total revenue for 2021. Total Compliance Sheriff-only customers
included in our total customer count as of March 31, 2021 above was 65. As a
result, our increase in customer count from March 31, 2021 to March 31, 2022
reflected in this Quarterly Report is not indicative of our customer growth
given our one-time voluntary sunsetting of our Compliance Sheriff product and
its respective customers.
Dollar-Based Net Retention Rate
Our management believes that our ability to retain and grow the ARR generated from our existing subscription customers is an indicator of the long-term value of our subscription customer relationships and future business opportunities. We track our performance in this area by measuring our dollar-based net retention rate, which reflects customer renewals, expansion, contraction, and customer attrition within our ARR base. We calculate dollar-based net retention rate by dividing the numerator by the denominator as set forth below:
• Denominator: As of the end of a reporting period, ARR as of the last day of the comparable reporting period in the prior year.
• Numerator: ARR for that same cohort of customers as of the end of the reporting period in the current year, including any expansion and net of any contraction and customer attrition over the trailing 12 months, excluding ARR from new subscription customers in the current period.
Our dollar-based net retention rate was 106% at each of
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--------------------------------------------------------------------------------Key Components of Results of Operations
Revenue
We recognize revenue under ASC 606, Revenue from Contracts with Customers ("ASC
606"). Under ASC 606, we recognize revenue when our customers obtain control of
goods or services in an amount that reflects the consideration that we expect to
receive in exchange for those goods or services.
We primarily sell our software through on-premise term-based license agreements,
perpetual license agreements and SaaS subscriptions, which allow our customers
to use our SaaS services without taking possession of the software. Our products
offer substantially the same functionality whether our customers receive them
through a perpetual license, a term-based license or a SaaS arrangement. Our
agreements with customers for software licenses may include maintenance
contracts and may also include professional services contracts. Maintenance
revenues consist of fees for providing unspecified software updates and
technical support for our products for a specified term, which is typically one
to three years. We offer a portfolio of professional services and extended
support contract options to assist our customers with integration, optimization,
training and ongoing advanced technical support. We also generate revenue from
threat advisory services, including penetration testing, application
assessments, vulnerability analysis, reverse engineering, architecture review
and source code review.
Subscription. Our term-based license arrangements that do not contain variable
consideration include both upfront revenue recognition when the distinct license
is made available to the customer as well as revenue recognized ratably over the
contract period for support and maintenance based on the stand-ready nature of
these elements. Revenue on our SaaS arrangements that do not contain variable
consideration, is recognized ratably over the contract period as we satisfy the
performance obligation, beginning on the date the service is made available to
our customers.
Subscription revenue represented approximately 81% and 69% of our revenue for
the three months ended March 31, 2022 and 2021, respectively. We expect that a
majority of our revenue will continue to be from subscriptions for the
foreseeable future, and we expect that subscription revenue as a percentage of
total revenue will increase over time. Changes in period-over-period
subscription revenue growth are primarily impacted by the following factors:
• the type of new and renewed subscriptions (i.e., term-based or SaaS); and
• the duration of new and renewed term-based subscriptions.
While the number of new and increased subscriptions during a period impacts our subscription revenue growth, the type and duration of those subscriptions have a significantly greater impact on the amount and timing of revenue recognized in a period. Subscription revenue from the software license components of term-based licenses is generally recognized at the beginning of the subscription term, while subscription revenue from SaaS and support and maintenance is generally recognized ratably over the subscription term. As a result, our revenue may fluctuate due to the timing and type of the software license components of term-based licensing transactions. In addition, keeping other factors constant, when the percentage of subscription term-based licenses to total subscriptions sold or renewed in a period increases relative to the prior period, revenue growth will generally increase. Conversely, when the percentage of subscription SaaS and support and maintenance to total subscriptions sold or renewed in a period increases, revenue growth will generally decrease, as compared to a prior period. Additionally, a multi-year subscription term-based license will generally result in greater revenue recognition up front relative to a one-year subscription term-based license. Therefore, keeping other factors constant, revenue growth will generally also trend higher in a period where the percentage of multi-year subscription term-based licenses to total subscription term-based licenses increases. Perpetual licenses. Our perpetual license arrangements generally include both upfront revenue recognition when the distinct license is made available to the customer as well as revenue recognized ratably over the contract period for support and maintenance based on the stand-ready nature of these elements. Revenue related to support and maintenance is included as part of subscription revenue.
For the three months ended
Services and other. Our services-related performance obligations predominantly
relate to the provision of consulting and threat advisory services, and to a
lesser extent, training and software installation. Software installation
services are distinct
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from subscriptions and do not result in significant customization of the
software. Our services are generally priced on a time and materials basis, which
is generally invoiced monthly and for which revenue is recognized as the
services are performed. Revenue from our training services and sponsorship fees
is recognized on the date the services are complete. Over time, we expect
services revenue to remain relatively stable as a percentage of total revenue.
For each of the three months ended
Concentrations. The following table summarizes revenue (in thousands) by country and main geography in which we operate, which arethe United States andCanada ("US&C"),Latin America ("LATAM"),Europe , theMiddle East andAfrica ("EMEA"), andAsia Pacific ("APAC"), based on the billing address of customers (including, for the avoidance of doubt, resellers and managed service providers) who have contracted with us. As with our aggregate revenues, as described above, within each geography described below we expect that subscription revenue as a percentage of total revenue in each such geography will increase over time. While there may be shifts in individual countries representing 10% or more of our total revenue from time to time, we expect that we will continue to derive the vast majority of our revenue fromthe United States , which is our country of domicile. We do not currently anticipate significant shifts in revenues by main geography. Three Months Ended March 31, 2022 2021 Revenues by country (a): United States$ 6,207 $ 3,866 Colombia 1,627 1,352 Canada 845 1,037 Ecuador 570 1,463 Other 2,129 2,352 Total$ 11,378 $ 10,070 Revenues by main geography: US&C$ 7,052 $ 4,903 LATAM 3,157 4,279 EMEA 653 530 APAC 516 358 Total$ 11,378 $ 10,070
(a) Only
No single customer (including, for the avoidance of doubt, resellers and managed service providers) accounted for 10% or more of our total revenue in either period presented.
Cost of Revenue
Cost of revenue consists primarily of employee compensation costs for employees associated with supporting our licensing arrangements and service arrangements, certain third-party expenses and the amortization of developed technology assets. Employee compensation and related costs include cash compensation and benefits to employees, equity-based compensation, costs of third-party contractors and associated overhead costs. Third-party expenses consist of cloud infrastructure costs, other expenses directly associated with our customer support, including, in limited instances, equipment purchased for resale. We expect cost of revenue to increase in absolute dollars.
Gross Profit and Gross Margin
Gross profit, or revenue less cost of revenue, and gross margin, or gross profit
as a percentage of revenue, have been and will continue to be affected by
various factors, including the timing of our acquisition of new customers and
renewals of and follow-on sales to existing customers, the average sales price
of our services, mix of services offered in our solutions,
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including new product introductions, the extent to which we expand our customer
support and operations and the extent to which we can increase the efficiency of
our technology and infrastructure through technological improvements. We
currently expect gross profit to increase in absolute dollars and gross margin
to increase slightly over the long term, although our gross profit and gross
margin could fluctuate from period to period depending on the interplay of all
the above factors.
Operating Expenses
Our operating expenses consist of sales and marketing, research and development,
and general and administrative expenses. Personnel costs are the most
significant component of operating expenses and consist of salaries, benefits,
bonuses, equity-based compensation expense and, with respect to sales and
marketing expenses, sales commissions that are recognized as expenses. Operating
expenses also include overhead costs for facilities, IT, depreciation expense
and amortization expense.
Sales and Marketing
Sales and marketing expenses consist primarily of employee compensation and
related expenses, including salaries, bonuses and benefits for our sales and
marketing employees, sales commissions that are recognized as expenses over the
period of benefit, equity-based compensation expense, marketing and channel
programs, travel and entertainment expenses, expenses for conferences and events
and allocated overhead costs. We capitalize our sales commissions and associated
payroll taxes and recognize them as expenses over the estimated period of
benefit. The amount recognized in our sales and marketing expenses reflects the
amortization of cost previously deferred as attributable to each period
presented in our consolidated financial statements, as described in Note 1 -
Business and Summary of Significant Accounting Policies to our condensed
consolidated financial statements included in Part I, Item 1 of this Quarterly
Report - "Financial Statements". Advertising expenses are charged to sales and
marketing expense in the condensed consolidated statements of operations as
incurred.
We intend to continue to significantly invest in our sales and marketing
organization to drive additional revenue, further penetrate the market and
expand our global customer base. As a result, we expect our sales and marketing
expenses to continue to increase in absolute dollars and to be our largest
operating expense category for the foreseeable future. In particular, we plan to
continue to invest in growing and training our sales force, broadening our brand
awareness and expanding and deepening our channel partner relationships.
However, we currently expect sales and marketing expenses to decrease as a
percentage of our revenue over the long term, although our sales and marketing
expenses may fluctuate as a percentage of revenue from period to period due to
the timing and extent of these expenses.
Research and Development
Research and development costs to develop software to be sold, leased or marketed are expensed as incurred up to the point of technological feasibility for the related software product. We have not capitalized development costs for software to be sold, leased or marketed to date, as the software development process is essentially completed concurrent with the establishment of technological feasibility. As such, these costs are expensed as incurred and recognized in research and development costs in the condensed consolidated statements of operations. Software developed for internal use, with no substantive plans to market such software at the time of development, is capitalized and included in property and equipment, net in the condensed consolidated balance sheets. Costs incurred during the preliminary planning and evaluation and post implementation stages of the project are expensed as incurred. Costs incurred during the application development stage of the project are capitalized. Our research and development expenses support our efforts to add new features to our existing offerings and to ensure the reliability, availability and scalability of our solutions. Our research and development teams employ software engineers in the design and the related development, testing, certification and support of our solutions. Accordingly, the majority of our research and development expenses result from employee-related costs, including salaries, bonuses and benefits and costs associated with technology tools used by our engineers.
We intend to continue to make significant investments in research and development to extend the features of our existing offerings and technology capabilities.
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--------------------------------------------------------------------------------General and Administrative
General and administrative expenses consist primarily of employee-related costs, including salaries and bonuses, equity-based compensation expense and employee benefit costs for our finance, legal, human resources and administrative personnel, as well as professional fees for external legal services, accounting and other related consulting services. Litigation-related expenses, if any, include professional fees and related costs incurred by us in defending or settling significant claims that our management deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. We expect that our general and administrative expenses will increase in absolute dollars for the foreseeable future, as we incur increased compliance costs and other related costs necessary to operate as a public company. However, we currently expect our general and administrative expenses to decrease as a percentage of revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of revenue from period to period due to the timing and extent of these expenses.
Transaction Costs
In connection with the Merger, we incurred transaction costs of
Depreciation and Amortization
Acquired intangible assets consist of identifiable intangible assets, including trademarks and tradenames and customer relationships resulting from business combinations. Acquired finite-lived intangible assets are initially recorded at fair value and are amortized on a straight-line basis over their estimated useful lives. Amortization expense for trademarks and tradenames and customer relationships is recorded primarily within depreciation and amortization in the condensed consolidated statements of operations.
Loss on Abandonment of Assets
We stopped offering our Compliance Sheriff product and, as a result, recorded a
loss on abandonment of the related intangible assets of
Change in Fair Value of Embedded Derivative Liability
We have recognized an embedded derivative liability associated to the Convertible Senior Notes (as defined below). The embedded derivative is recognized at fair value and is subsequently remeasured at its estimated fair value on a recurring basis at the end of each reporting period, with changes in estimated fair value recognized as change in fair value of embedded derivative liability in our condensed consolidated statements of operations.
Interest Expense
Interest expense consists primarily of interest incurred on our obligations under the Convertible Senior Notes and, throughFebruary 8, 2021 , obligations of Legacy Appgate under the Promissory Notes. See "-Promissory Notes" above and "-Liquidity and Capital Resources" below.
Income Tax
ThroughDecember 31, 2019 , the operations of Legacy Appgate were included in the consolidatedU.S. federal, state, local and foreign income tax returns filed by Cyxtera, where applicable. Our income taxes, as presented in the condensed consolidated financial statements, may not be indicative of the income taxes we will generate in the future. In jurisdictions where Legacy Appgate was included in the tax returns filed by Cyxtera, any income taxes payable/receivable resulting from the related income tax provisions have been reflected in the balance sheets of each separate entity's provision. Benefit (provision) for income taxes consists primarily of income taxes related toU.S. federal and state income taxes and income taxes in foreign jurisdictions in which we conduct business. 35 --------------------------------------------------------------------------------
Results of Operations
The following table sets forth our consolidated results of operations for the
periods presented (in thousands). The period-to-period comparisons of our
historical results are not necessarily indicative of the results that may be
expected in the future. The results of operations data have been derived from
our unaudited condensed consolidated financial statements included in Part I,
Item 1 of this Quarterly Report, "Financial Statements".
Three Months Ended
March 31,
2022 2021 Variance %
Revenue $ 11,378 $ 10,070 13 %
Cost of revenue, exclusive of amortization shown
below 4,498 3,578 26 %
Amortization expense 954 1,131 16 %
Total cost of revenue 5,452 4,709 16 %
Gross profit 5,926 5,361 11 %
Operating expenses:
Sales and marketing 11,698 7,114 64 %
Research and development 3,334 2,197 52 %
General and administrative 4,857 3,342 45 %
Transaction costs - 330 nm
Depreciation and amortization 1,369 1,341 2 %
Loss on abandonment of assets 1,658 - nm
Total operating expenses 22,916 14,324 60 %
Loss from continuing operations (16,990) (8,963) 90 %
Change in fair value of embedded derivative liability (46,143)
- nm
Interest expense, net (1,131) (833) 36 %
Other expenses, net (104) (126) 17 %Loss from continuing operations before income taxes (64,368)
(9,922) 549 % Income tax expense of continuing operations (226) (267) 15 % Net loss from continuing operations (64,594) (10,189) 534 % Net income from discontinued operations, net of tax - 59,866 nm Net (loss) income$ (64,594) $ 49,677 230 % nm = not meaningful Revenue
Revenue from continuing operations were as follows for the three months ended
Three Months Ended
March 31,
2022 2021 Variance %
Subscription revenue $ 9,164 $ 6,902 33 %
Perpetual licenses 156 1,313 88 %
Services and other 2,058 1,855 11 %
Total $ 11,378 $ 10,070 13 %
Revenue increased by $1.3 million , or 13%, for the three months ended March 31,
2022 compared to the three months ended March 31, 2021 . The overall increase in
revenue was primarily attributable to an overall increase in subscription
term-based licenses as further explained below, partially offset by a decrease
in perpetual licenses.
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Subscription revenue accounted for 81% and 69% of our total revenue for the
three months ended March 31, 2022 and 2021, respectively. Subscription revenue
increased $2.3 million , or 33%, in the three months ended March 31, 2022 when
compared to the three months ended March 31, 2021 . This increase in subscription
revenue was driven by $1.7 million in revenue from sales to new customers and
$0.6 million in revenue from sales to existing customers. Approximately $1.3
million , or 78%, of the revenue from new customers was from multi-year
subscription term-based licenses, with the remaining $0.4 million , or 22%, from
one-year subscription term-based licenses. In turn, approximately $1.1 million
of the revenue from existing customers was from one-year subscription term-based
licenses, partially offset by a decrease of $0.5 million from multi-year
subscription term-based licenses. Our net-dollar retention rate was 106% at
March 31, 2022 , flat from March 31, 2021 .
Perpetual licenses revenue accounted for 1% and 13% of our total revenue for the
three months ended March 31, 2022 and 2021, respectively. Perpetual licenses
revenue decreased $1.2 million , or 88%, in the three months ended March 31, 2022
when compared to the three months ended March 31, 2021 . This decrease in
perpetual license revenue was driven by sale and deployment of perpetual
licenses in the three months ended March 31, 2021 , for which only maintenance
and support is recognized in the three months ended March 31, 2022 .
Services and other revenue accounted for 18% of our total revenue for each of
the three months ended March 31, 2022 and 2021. Services and other revenue
increased $0.2 million , or 11%, for the three months ended March 31, 2022 when
compared to the three months ended March 31, 2021 . This increase in services and
other revenue was primarily the result of an overall increase in service hours
billed to customers during the three months ended March 31, 2022 when compared
to the three months ended March 31, 2021 .
Cost of Revenue
Total cost of revenue from continuing operations increased by$0.7 million , or 16%, during the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 . The increase in total cost of revenue was primarily due to an increase of$0.9 million in other cost of revenue, partially offset by a decrease of$0.2 million in amortization of developed technology. The increase in other cost of revenue was primarily as a result of an increase in personnel costs from higher headcount, and to a lesser extent from an increase in subscription and hosting costs and contracted services. Operations headcount increased by 18 positions from 138 for the three months endedMarch 31, 2021 to 156 for the three months endedMarch 31, 2022 . The decrease in amortization of developed technology is related to the abandonment of the Compliance Sheriff related developed technology in 2022.
Gross Profit
Gross profit totaled
Operating Expenses
Total operating expenses from continuing operations increased by$8.6 million , or 60%, for the three months endedMarch 31, 2022 as compared to the three months endedMarch 31, 2021 . The factors that contributed to the increase in operating expenses are detailed below. Sales and marketing expenses increased by$4.6 million , or 64%, for the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 . This increase was primarily the result of an increase in personnel costs from higher headcount on both the sales and marketing teams, and to a lesser extent, higher investment in marketing and advertising costs since completion of the Merger. Sales and marketing headcount increased by 67 positions from 122 for the three months endedMarch 31, 2021 to 189 for the three months endedMarch 31, 2022 . Research and development expenses increased$1.1 million , or 52%, for the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 , as a result of an increase in personnel costs from higher headcount. Research and development headcount increased by 26 positions from 107 for the three months endedMarch 31, 2021 to 133 for the three months endedMarch 31, 2022 .
General and administrative expenses increased by
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an increase of approximately $0.8 million in personnel costs from higher
headcount in 2022, higher insurance costs of approximately $0.7 million related
to our new D&O insurance policy following completion of the Merger, and higher
bad debt of approximately $0.2 million . General and administrative headcount
increased by 23 positions from 58 for the three months ended March 31, 2021 to
81 for the three months ended March 31, 2022 . These increases were partially
offset by lower professional fees of approximately $0.4 million .
Transaction costs recognized in connection with the Merger totaled
Depreciation and Amortization
Depreciation and amortization expense remained flat for the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 . While there was an increase in depreciation and amortization primarily due to depreciation and amortization on purchases of property and equipment during 2021, we had lower amortization on intangibles following the abandonment of the Compliance Sheriff related intangibles in 2022.
Loss on Abandonment of Assets
We stopped offering our Compliance Sheriff product and, as a result, recorded a
loss on abandonment of the related intangible assets of
Change in Fair Value of Embedded Derivative Liability
For the three months ended
Interest Expense, Net
Interest expense, net increased by$0.3 million for the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 . The increase in interest expense, net was primarily attributable to the change in the mix of our debt during 2021. As described above, the Promissory Notes were repaid in part with the balance extinguished, in each case onFebruary 8, 2021 . OnFebruary 9, 2021 , Legacy Appgate issued$50.0 million aggregate principal amount of 5.00% convertible senior notes due 2024 (the "Initial Convertible Senior Notes"), which are described below, and in connection with the closing of the Merger onOctober 12, 2021 , issued an additional$25.0 million aggregate principal amount of convertible senior notes due 2024 (the "Additional Convertible Senior Notes" and, together with the Initial Convertible Senior Notes, the "Convertible Senior Notes").
Other Expenses, Net
Other expenses, net were
Income Tax Expense
Our effective tax rate for the three months endedMarch 31, 2022 and 2021 was 0.4% and 2.7%, respectively. The effective tax rate for the three months endedMarch 31, 2022 differs from theU.S. Federal income tax rate of 21% primarily due to changes in the valuation allowance, the change in the fair value of our embedded derivative liability that is not tax deductible, state taxes, and foreign withholding taxes. The effective tax rate for the three months endedMarch 31, 2021 differs from theU.S. Federal income tax rate of 21% primarily due to foreign withholding taxes.
Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the
following non-GAAP financial measures are useful to investors in evaluating our
operating performance.
These non-GAAP financial measures are presented for supplemental informational
purposes only and should not be considered a substitute for financial
information presented in accordance with GAAP and may be different from
similarly titled non-GAAP measures used by other companies. A reconciliation is
provided below for each non-GAAP financial measure to the most directly
comparable financial measure determined in accordance with GAAP. Investors are
38
--------------------------------------------------------------------------------encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures.
Non-GAAP Gross Profit and Gross Margin
Non-GAAP gross profit and non-GAAP gross margin are supplemental measures of
operating performance that are not determined in accordance with GAAP and do not
represent, and should not be considered as, an alternative to gross profit and
gross margin, the most directly comparable financial measures determined in
accordance with GAAP. We define non-GAAP gross profit as gross profit, adjusted
to add back non-cash equity-based compensation expense and developed technology
amortization expense and define non-GAAP gross margin as non-GAAP gross profit
as a percentage of revenue.
We use non-GAAP gross profit and non-GAAP gross margin to understand and
evaluate our core operating performance and trends, to prepare and approve our
annual budget, and to develop short-term and long-term operating plans. We
believe that non-GAAP gross profit and non-GAAP gross margin are useful measures
to our management and to our investors because they provide consistency and
comparability with past financial performance and between periods, as the
metrics generally eliminate the effects of the variability of amortization
expense of intangibles and non-cash equity-based compensation expense from
period to period, which may fluctuate for reasons unrelated to overall operating
performance. We believe that the use of these measures enables our management to
more effectively evaluate our performance period-over-period and relative to our
competitors, some of which use similar non-GAAP financial measures to supplement
their GAAP results. Non-GAAP gross profit and non-GAAP gross margin have
limitations as analytical tools, and you should not consider them in isolation,
or as a substitute for analysis of our results as reported under GAAP. Because
of these limitations, non-GAAP gross profit and non-GAAP gross margin should not
be considered as a replacement for gross profit and gross margin, as determined
in accordance with GAAP, or as a measure of our profitability.
A reconciliation of our non-GAAP gross profit and non-GAAP gross margin to gross
profit and gross margin, the most directly comparable financial measures
determined in accordance with GAAP, for the periods presented, is as follows (in
thousands):
Three Months Ended
March 31,
2022 2021
GAAP revenue $ 11,378 $ 10,070
GAAP gross profit 5,926 5,361
Add: amortization expense 954 1,131
Add: equity-based compensation 62 131
Non-GAAP gross profit $ 6,942 $ 6,623
GAAP gross margin 52 % 53 %
Non-GAAP gross margin 61 % 66 %
39--------------------------------------------------------------------------------
Non-GAAP Loss from Operations and Non-GAAP Operating Margin
We define non-GAAP loss from operations as GAAP loss from continuing operations
excluding amortization expense of acquired intangible assets, loss on
abandonment of assets, non-cash equity-based compensation expense, and
transaction costs. We define non-GAAP operating margin as non-GAAP loss from
continuing operations as a percentage of revenue.
A reconciliation of our non-GAAP loss from operations and non-GAAP operating
margin to loss from continuing operations and operating margin, the most
directly comparable financial measures determined in accordance with GAAP, for
the periods presented, is as follows (in thousands):
Three Months Ended
March 31,
2022 2021
GAAP revenue $ 11,378 $ 10,070 GAAP loss from continuing operations
2,098 2,299
Add: Loss on abandonment of assets 1,658 -
Add: equity-based compensation 143 1,010
Add: transaction costs - 330
Non-GAAP loss from operations $ (13,091) $ (5,324)
GAAP operating margin (149) % (89) %
Non-GAAP operating margin (115) % (53) %
40--------------------------------------------------------------------------------
Free Cash Flow and Free Cash Flow Margin
Free cash flow is a non-GAAP financial measure that we define as net cash
provided by (used in) operating activities of continuing operations less cash
used for purchases of property and equipment and repayment of finance leases. We
believe that free cash flow is a useful indicator of liquidity that provides
information to management and investors, even if negative, as it provides useful
information about the amount of cash generated (or consumed) by our operating
activities that is available (or not available) to be used for other strategic
initiatives. For example, if free cash flow is negative, we may need to access
cash reserves or other sources of capital to invest in strategic initiatives.
While we believe that free cash flow is useful in evaluating our business, free
cash flow is a non-GAAP financial measure that has limitations as an analytical
tool, and free cash flow should not be considered as an alternative to, or
substitute for, net cash provided by (used in) operating activities in
accordance with GAAP. The utility of free cash flow as a measure of our
liquidity is limited as it does not represent the total increase or decrease in
our cash balance for any given period and does not reflect our future
contractual commitments. In addition, other companies, including companies in
our industry, may calculate free cash flow differently or not at all, which
reduces the usefulness of free cash flow as a tool for comparing our results to
those of other companies.
Three Months Ended
March 31,
2022 2021Net cash, cash equivalents and restricted cash used in operating activities of continuing operations
$ (14,301) $ (15,352) Less: Purchases of property and equipment (417) (111) Repayment of finance leases - (6) Free cash flow$ (14,718) $ (15,469) As a percentage of revenue: GAAP revenue$ 11,378
(126) % (152) %
Less:
Purchases of property and equipment (4) % (1) % Repayment of finance leases - % - % Free cash flow (129) % (154) %
Liquidity and Capital Resources
As ofMarch 31, 2022 , we had cash and cash equivalents of$11.3 million . Historically, Legacy Appgate's principal source of liquidity was borrowing availability under the Promissory Notes and cash generated from Legacy Appgate's operations. As discussed above, onFebruary 8, 2021 , Legacy Appgate repaid Cyxtera the full amount of the Promissory Note issued to Cyxtera and made a partial repayment on the then accumulated principal and interest under the Promissory Note issued to theManagement Company . On that same date, theManagement Company issued a payoff letter to Legacy Appgate extinguishing the balance remaining unpaid of$34.6 million following such repayment. The payoff letter resulted in the full settlement and extinguishment of the Promissory Note held by theManagement Company . We have generated significant operating losses and negative cash flows from operations as reflected in our accumulated deficit and condensed consolidated statements of cash flows. We expect to continue to incur operating losses and negative cash flows from operations for the foreseeable future. Currently, our principal sources of liquidity are the proceeds from the issuance of the Convertible Senior Notes and cash generated from our operations, which have enabled us to make continued investments to support the growth of our business. We expect that proceeds from the Convertible Senior Notes and cash generated from our operations, as well as our borrowing capacity under the Revolving Credit Facility (as defined below), will provide sufficient cash to fund working capital and capital expenditures for at least the next 12 months. We may also issue up to an additional$25.0 million in aggregate principal amount of Convertible Senior Notes at the election of the holders of the Convertible Senior Notes, subject to our consent, in one or more closings, which may occur on or prior to the earlier of (i) seventy-five (75) days after the Company closes a registered offering of equity securities in an aggregate 41 --------------------------------------------------------------------------------
amount of no less than
We have based our estimates as to how long we expect we will be able to fund our operations on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. In the long-term, we may be required to obtain additional financing to fund our current planned operations, which may consist of, at Magnetar's election and our consent, issuing the additional$25.0 million of Convertible Senior Notes, borrowings under the Revolving Credit Facility or an alternative financing arrangement, which may not be available to us on acceptable terms, or at all. Our failure to raise capital as and when needed may have a negative impact on our financial condition and our ability to pursue our business strategy. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.
Debt
As of
Convertible Senior Notes
OnFebruary 9, 2021 , Legacy Appgate issued the Initial Convertible Senior Notes to various funds managed by Magnetar. In connection with the closing of the Merger, Legacy Appgate issued the Additional Convertible Senior Notes. The Convertible Senior Notes are subject to the terms and conditions of the Note Issuance Agreement and Note Purchase Agreement. During 2021, we received net proceeds of$72.8 million from the issuance of the Convertible Senior Notes, after deducting fees and expenses of$2.2 million . We recorded these fees and expenses as debt issuance costs that will be amortized over the term of the Convertible Senior Notes. The Convertible Senior Notes are senior, unsecured obligations of LegacyAppgate , and the payment of the principal and interest is unconditionally guaranteed, jointly and severally by Legacy Appgate'sU.S. subsidiaries and, as of the closing of the Merger, also by the Company. The Convertible Senior Notes mature onFebruary 9, 2024 , unless earlier converted, redeemed, or repurchased. The Note Issuance Agreement under which the Convertible Senior Notes were issued was amended effectiveFebruary 9, 2022 to, among other things, provide that Magnetar may elect, with our consent, to invest up to an additional$25.0 million in aggregate principal amount of such notes, in one or more closings, on or prior to the earlier of (i) seventy-five (75) days after the Company closes a registered offering of equity securities in an aggregate amount of no less than$40.0 million and (ii)October 31, 2022 . Interest on the Convertible Senior Notes is payable either entirely in cash or entirely in kind ("PIK Interest"), or a combination of cash and PIK Interest atAppgate's discretion. The Convertible Senior Notes bear interest at the annual rate of 5% with respect to interest payments made in cash and 5.50% with respect to PIK Interest, with interest payable semi-annually onFebruary 1 andAugust 1 of each year, commencing onAugust 1, 2021 . Additional notes ("PIK Notes") issuable in respect of PIK Interest would have the same terms and conditions as the Convertible Senior Notes. The Note Issuance Agreement includes certain affirmative and financial covenants we are required to satisfy. We were in compliance with all covenants as ofMarch 31, 2022 and expect to remain in compliance with such covenants for at least the next 12 months.
Promissory Notes
OnMarch 31, 2019 , Legacy Appgate issued the Promissory Notes to each of Cyxtera and theManagement Company . As discussed above and in our condensed consolidated financial statements included elsewhere in Part I, Item 1 of this Quarterly Report, "Financial Statements", onFebruary 8, 2021 , Legacy Appgate repaid Cyxtera the full amount on the then outstanding principal and interest of$20.6 million under the Promissory Note issued to Cyxtera and made a partial repayment of$99.0 million to theManagement Company on the then outstanding principal and interest of$133.6 million under the Promissory Note issued to theManagement Company . On that same date, theManagement Company issued a payoff letter to Legacy Appgate extinguishing the balance remaining unpaid following such repayment. Because Cyxtera was Legacy Appgate's direct parent at the time of issuance of the Promissory Notes and an affiliate under common control with Legacy Appgate at the time of repayment, we recognized the note extinguishment of$34.6 million as a capital contribution in the three months endedMarch 31, 2021 . 42 --------------------------------------------------------------------------------
Revolving Credit Agreement
OnApril 26, 2022 , Legacy Appgate,Appgate , the other guarantors party thereto andSIS Holdings entered into a revolving credit agreement (the "Revolving Credit Agreement") which provides for a$50.0 million unsecured, revolving credit facility (the "Revolving Credit Facility"). This indebtedness is contractually subordinated to the Convertible Senior Notes and matures, on the earlier to occur of (a)June 30, 2023 , (b) the closing of a registered offering of Capital Stock (as defined in the Revolving Credit Agreement) of the Company in an aggregate amount equal to$50.0 million or more or (c) the date of which the Loans (as defined in the Revolving Credit Agreement) are accelerated upon an Event of Default (as defined in the Revolving Credit Agreement). Interest will accrue on amounts drawn under the Revolving Credit Facility at a rate of 10.0% per annum, payable in cash on the Final Maturity Date (as defined in the Revolving Credit Agreement). The Revolving Credit Agreement is subject to customary terms, covenants and conditions. All obligations under the Revolving Credit Agreement are guaranteed byAppgate and Legacy Appgate's domestic subsidiaries. OnApril 29, 2022 , we borrowed$5.0 million under the Revolving Credit Facility.
Other Contractual Obligations and Commitments
In addition to our debt obligations under the Convertible Senior Notes, the Revolving Credit Facility, and lease obligations under several operating lease arrangements,Appgate has other contractual commitments. Refer to Note 9 - Leases and Note 10 - Convertible Senior Notes, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report, "Financial Statements" for additional information on maturities. Refer to Note 11 - Commitments and Contingencies to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report, "Financial Statements" for additional information regarding cash amounts committed under other contractual obligations.
Cash Flow
Cash Flows for the Three Months EndedMarch 31, 2022 and 2021. The following table sets forth our historical cash flows for the periods indicated (in thousands): Three Months EndedMarch 31, 2022 2021
Net cash, cash equivalents and restricted cash used in operating activities
$ (14,301)
$ (417)
$ - $ (69,826)
Operating Activities
Our largest source of operating cash is cash collections from customers for sales of licenses and services. Our primary uses of cash from operating activities are for employee-related expenditures, marketing expenses and third-party hosting costs.
Net cash used in operating activities during the three months endedMarch 31, 2022 was$14.3 million , which resulted from a net loss of$64.6 million , adjusted for non-cash charges of$51.6 million and net cash outflow of$1.3 million from changes in assets and liabilities. Non-cash charges primarily consisted of a$46.1 million change in the fair value of our embedded derivative liability,$2.3 million of depreciation and amortization,$1.7 million of loss on abandonment of assets,$1.0 million of amortization of deferred contract acquisition costs, and$0.1 million in equity-based compensation. . The net cash outflow from changes in assets and liabilities was primarily due to increases in deferred contract acquisition costs and cash used in working capital. The main changes in working capital were increases in accounts receivable, accounts payable and accrued expenses. Net cash used in operating activities during the three months endedMarch 31, 2021 was$14.5 million , which resulted from a net loss of$49.7 million , adjusted for the net income from discontinued operations, net of tax of$59.9 million , non-cash charges of$4.1 million , net cash outflow of$9.3 million from changes in assets and liabilities and$0.8 million net cash provided by operating activities of discontinued operations. Non-cash charges primarily consisted of$2.5 million of depreciation and amortization,$1.0 million in equity-based compensation, and$0.7 million of amortization of deferred contract acquisition costs. The net cash outflow from changes in assets and liabilities was primarily due to settlement of 43 -------------------------------------------------------------------------------- cash due to affiliates and changes in working capital combined with increases in contract assets and deferred contract acquisition costs. The main changes in working capital were lower accounts payable and accrued expenses and higher prepaid and other current assets.
Investing Activities
During the three months endedMarch 31, 2022 , we used cash in our investing activities of$0.4 million as compared to cash provided by investing activities of$124.9 million during the three months endedMarch 31, 2021 . The change in cash flows from investing activities during the three months endedMarch 31, 2022 when compared to the three months endedMarch 31, 2021 was primarily due to receipt of$125.0 million from the sale of Brainspace inJanuary 2021 .
Financing Activities
During the three months endedMarch 31, 2021 , we used$69.8 million of cash in financing activities, primarily for the repayment of$119.6 million to Cyxtera and/or theManagement Company inFebruary 2021 as settlement and extinguishment of the Promissory Notes, net of gross proceeds of$50.0 million received from the issuance of the Convertible Senior Notes. We did not have any cash movement in financing activities during the three months endedMarch 31, 2022 .
Critical Accounting Policies and Estimates
For information regarding our critical accounting policies and estimates, see "Critical Accounting Estimates" included in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2021 Annual Report.
Recent Accounting Pronouncements
Recently issued accounting pronouncements are described in Note 1 of our consolidated financial statements included in Part I, Item 1 of this Quarterly Report, "Financial Statements".
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