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 our audited consolidated financial statements and related notes contained elsewhere in this Annual Report. This 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, including those set forth under "Risk Factors" and "Cautionary Statement Regarding Forward-Looking Statements" contained elsewhere in this Annual Report. We operate on a calendar year basis. Thus, references to 2022, for example, refer toAppgate's year endedDecember 31, 2022 . Capitalized terms used in this section and not defined herein have the respective meanings given to such terms elsewhere in this Annual 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$33.7 million and$31.1 million atDecember 31, 2022 and 2021, respectively. Our dollar-based net retention rates were 96% and 114% atDecember 31, 2022 and 2021, respectively. Our number of customers generating over$100,000 ARR increased 3% fromDecember 31, 2021 toDecember 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. 54 -------------------------------------------------------------------------------- We have achieved revenue of over$40.0 million in both 2022 and 2021. We continue to invest in growing our business and, as a result, we incurred losses from continuing operations of$80.1 million and$54.2 million for 2022 and 2021, respectively.
Factors Affecting Our Business
Reduction in Force
On
OnFebruary 2, 2023 , we substantially completed a reduction in force (the "February Reduction") of approximately 8% of our workforce. In connection with the February Reduction, we incurred approximately$0.5 million of costs and expenses, primarily comprising severance and termination-related costs, which we recognized in the first quarter of 2023.
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 Annual Report are those of: (1) except for the equity, which was retroactively restated following applicable accounting guidance, LegacyAppgate 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 expensed$3.1 million in transaction costs during 2021 in connection with the Merger. Public Company Costs Following the consummation of the Merger, we became a public company, which required hiring of additional staff and implementation of processes and procedures to address public company regulatory requirements and customary practices. We expect to continue to incur substantial 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 2021, the
During 2021, Legacy Appgate charged theManagement Company $0.1 million 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 expense, net in our 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 (as defined below) and the Transition Services Agreement, which trade balances and other amounts totaled$2.6 million . 55 -------------------------------------------------------------------------------- Because theManagement Company was an affiliate under common control with LegacyAppgate at the time of repayment, the settlement of these amounts was recognized as a capital contribution of$1.6 million .
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 . 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 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 Accounting Standards Codification ("ASC") Topic 205-20, Presentation of Financial Statements - Discontinued Operations - see Note 5 to our consolidated financial statements for discontinued operations disclosures included elsewhere in this Annual Report. OnDecember 17, 2020 , Legacy Appgate entered into a securities purchase agreement with respect to the sale of 100% of the outstanding equity interests of Brainspace for cash consideration of$125.0 million , and the sale transaction closed onJanuary 20, 2021 . Brainspace offered a comprehensive and advanced data analytics platform for investigations, eDiscovery, intelligence mining, and compliance. Unless otherwise stated, all discussion of LegacyAppgate'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 years indicated below
(in thousands):
2022 2021
ARR $ 33,656 $ 31,054
Change $ $ 2,602
Change % 8 %
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
2022 2021
Total customers 647 652
Customers with ARR above
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 ofDecember 31, 2021 was 45. As a result, the change in our customer count fromDecember 31, 2021 toDecember 31, 2022 reflected in this Annual 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 96% and 114% at
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.
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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 80% of our revenue for
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. We expect that perpetual license revenue as a percentage of total revenue will decrease over time.
For 2022 and 2021, approximately 4% and 5%, respectively, of our revenue was from perpetual licenses.
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 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 2022 and 2021, approximately 15% of our revenue was from services and other.
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Concentrations. The following table summarizes revenue by country and main
geography in which we operate, including in the United States and Canada
("US&C"), Latin America ("LATAM"), Europe , the Middle East and Africa ("EMEA"),
and Asia 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 (in thousands).
2022 2021
Revenues by country (a):
United States $ 21,668 $ 20,568
Colombia 5,440 6,735
Other 15,556 15,730
Total $ 42,664 $ 43,033
Revenues by main geography:
US&C $ 23,584 $ 22,694
LATAM 13,846 15,142
EMEA 3,104 2,906
APAC 2,130 2,291
Total $ 42,664 $ 43,033 (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, 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
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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 audited
consolidated financial statements included in Part II, Item 8 of this Annual
Report - "Financial Statements and Supplementary Data". Advertising expenses are
charged to sales and marketing expense in the audited consolidated statements of
operations as incurred.
We intend to continue to 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 be our largest
operating expense category for the foreseeable future. In particular, we plan to
continue to invest in 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 audited 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 audited 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 investments in research and development to extend the features of our existing offerings and technology capabilities.
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
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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 consolidated statements of operations.
Change in Fair Value of Embedded Derivative Liability
We have recognized an embedded derivative liability associated to the Convertible Senior Notes. 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 consolidated statements of operations.
Interest Expense
Interest expense consists primarily of interest incurred on our obligations under the Convertible Senior Notes and the Revolving Credit Facility 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 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. 61
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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 audited consolidated financial statements included elsewhere in this Annual
Report.
2022 2021 Variance %
Revenue $ 42,664 $ 43,033 1 %
Cost of revenue, exclusive of amortization shown
below 18,112 16,069 13 %
Amortization expense 3,781 4,525 16 %
Total cost of revenue 21,893 20,594 6 %
Gross profit 20,771 22,439 7 %
Operating expenses:
Sales and marketing 44,575 39,167 14 %
Research and development 13,103 10,727 22 %
General and administrative 34,037 18,282 86 %
Transaction costs 2,059 3,099 34 %
Depreciation and amortization 5,484 5,408 1 %
Loss on abandonment of assets 1,658 - nm
Total operating expenses 100,916 76,683 32 %
Loss from continuing operations (80,145) (54,244) 48 %
Change in fair value of embedded derivative liability 58,797 (78,497) 175 %
Interest expense, net (6,443) (3,190) 102 %
Other expenses, net (535) (515) 4 %Loss from continuing operations before income taxes (28,326) (136,446)
79 %
Income tax expense of continuing operations (1,759) (2,396) 27 %
Net loss from continuing operations (30,085) (138,842) 78 %
Net income from discontinued operations, net of tax - 65,714 nm
Net loss $ (30,085) $ (73,128) 59 %
nm = not meaningful
Revenue
Revenue from continuing operations were as follows for 2022 and 2021:
2022 2021 Variance %
Subscription revenue $ 34,584 $ 34,335 1 %
Perpetual licenses 1,650 2,055 20 %
Services and other 6,430 6,643 3 %
Total $ 42,664 $ 43,033 1 %
Revenue decreased by $0.4 million , or 1%, during 2022 compared to 2021. The
overall decrease in revenue was primarily attributable to a net decrease in
customer count from 652 customers at December 31, 2021 to 647 customers at
December 31, 2022 given, in part, to our one-time voluntary sunsetting of our
Compliance Sheriff product and its respective customers, combined with decreased
revenue from perpetual licenses and services and other as further explained
below. These decreases were partially offset by an increase in subscription
term-based licenses.
Perpetual licenses revenue accounted for 4% and 5% of our revenue in 2022 and
2021, respectively. Perpetual licenses revenue decreased $0.4 million during
2022 compared to 2021. This decrease in perpetual license revenue was driven by
higher sale and deployment of new perpetual licenses in 2021 that did not
reoccur in 2022. We expect this trend to continue as demand for term-based
license and SaaS subscriptions continue to grow over time.
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Subscription revenue accounted for 81% and 80% of our total revenue in 2022 and
2021, respectively. Subscription revenue increased $0.2 million , or 1%, in 2022
when compared to 2021. This increase in subscription revenue was driven by $1.3
million in revenue from sales to existing customers partially offset by a
decrease of $1.1 million in revenue from sales to new customers. Almost the
entirety of the revenue from existing customers was from one-year subscription
term-based licenses. Our net-dollar retention rate was 96% at December 31, 2022 .
Approximately $0.9 million , or 81%, of the decrease in revenue from new
customers was from multi-year subscription term-based licenses, with the
remaining $0.2 million , or 19%, from one-year subscription term-based licenses.
Services and other revenue accounted for 15% of our revenue in each of 2022 and
2021. Services and other revenue decreased $0.2 million , or 3%, in 2022 when
compared to 2021. This decrease in services and other revenue was primarily the
result of an overall decrease in service hours billed to customers during 2022
when compared to 2021.
Cost of Revenue
Total cost of revenue from continuing operations increased by $1.3 million , or
6%, during 2022 compared to 2021. The increase in total cost of revenue was
primarily due to an increase of $2.0 million in other cost of revenue, partially
offset by a decrease in amortization of developed technology of $0.7 million .
The increase in other cost of revenue was primarily as a result of an increase
in personnel costs from higher average headcount during 2022, and, to a lesser
extent, from an increase in subscription and hosting costs and contracted
services. Operations headcount increased by 13 positions from 132 at December
31, 2021 to 145 at December 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$20.8 million for 2022, a decrease of$1.7 million , or 7%, as compared to 2021. This decrease was the result of the factors described above under "Revenue" and "Cost of Revenue".
Operating Expenses
Total operating expenses from continuing operations increased by
Sales and marketing expenses increased by$5.4 million , or 14%, for 2022 as compared to 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. While sales and marketing headcount has recently decreased as described above, prior to the Reduction, there was overall higher headcount in both the sales and marketing teams in 2022 as compared to 2021. Research and development increased$2.4 million , or 22%, for 2022 as compared to 2021. This increase was primarily the result of an increase in personnel costs from higher headcount. Research and development headcount increased by 6 positions from 120 atDecember 31, 2021 to 126 atDecember 31, 2022 . General and administrative expenses increased by$15.8 million , or 86%, for 2022 as compared to 2021. This increase was primarily the result of equity-based compensation expense recognized during 2022 in connection with the 2021 Plan, and an increase in personnel costs from higher headcount throughout 2021 and 2022 prior to the Reduction. General and administrative headcount decreased by 11 positions from 76 atDecember 31, 2021 to 65 atDecember 31, 2022 . Transaction costs. InJune 2022 , we expensed$2.1 million of transaction costs related to a contemplated registered equity offering. Transaction costs expensed in connection with the Merger totaled$3.1 million in 2021. Depreciation and amortization expense remained relatively flat for 2022 as compared to 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 expense related to 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
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During 2022, we recognized a gain of$58.8 million in connection with the embedded derivative associated with the conversion feature under the Convertible Senior Notes, while we recognized a loss of$78.5 million in 2021. Refer to Note 7 to the audited consolidated financial statements in this Annual Report for a discussion of the key inputs affecting the value of the derivative.
Interest Expense, Net
Interest expense, net increased by$3.3 million for 2022 as compared to 2021. The increase in interest expense, net was primarily attributable to the change in the mix of our debt during 2021 and 2022. 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 the Initial Convertible Senior Notes, which are described below, and in connection with the closing of the Merger onOctober 12, 2021 , issued the Additional Convertible Senior Notes. Additionally, onApril 26, 2022 , Legacy Appgate,Appgate , the other guarantors party thereto andSIS Holdings entered into the Revolving Credit Agreement which provides for the Revolving Credit Facility. Interest accrues on amounts drawn under the Revolving Credit Facility at a rate of 10.0% per annum, payable in cash on the Final Maturity Date. During 2022, we borrowed$46.5 million under the Revolving Credit Facility, all of which remained outstanding as ofDecember 31, 2022 .
Other Expenses, Net
Other expenses, net remained flat at
Income Tax Expense
Our effective tax rate for 2022 and 2021 was (6.2)% and (1.8)%, respectively. The effective tax rate for 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, share-based compensation write-off, and foreign withholding taxes. The effective tax rate for 2021 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.
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 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
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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 2022 and 2021, is as follows (in
thousands):
2022 2021
GAAP revenue $ 42,664 $ 43,033
GAAP gross profit 20,771 22,439
Add: amortization expense 3,781 4,525
Add: equity-based compensation 62 504
Non-GAAP gross profit $ 24,614 $ 27,468
GAAP gross margin 49 % 52 %
Non-GAAP gross margin 58 % 64 %
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
2022 and 2021, is as follows (in thousands):
2022 2021
GAAP revenue $ 42,664 $ 43,033 GAAP loss from continuing operations (80,145) (54,244) Add: amortization expense
8,355 9,196
Add: loss on abandonment of assets 1,658 -
Add: equity-based compensation 14,653 3,460
Add: transaction costs 2,059 3,099
Non-GAAP loss from operations $ (53,420) $ (38,489)
GAAP operating margin (188) % (126) %
Non-GAAP operating margin (125) % (89) %
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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.
2022 2021Net cash, cash equivalents and restricted cash used in operating activities of continuing operations
$ (58,548) $ (52,915) Less: Purchases of property and equipment (568) (920) Repayment of finance leases - (22) Free cash flow$ (59,116) $ (53,857) As a percentage of revenue: GAAP revenue$ 42,664
(137) % (123) %
Less:
Purchases of property and equipment (1) % (2) % Repayment of finance leases - % - % Free cash flow (138) % (125) %
Liquidity and Capital Resources
As ofDecember 31, 2022 , we had cash and cash equivalents and remaining borrowing capacity under the Revolving Credit Facility of$11.5 million and of$3.5 million , respectively. 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 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, our borrowings and remaining borrowing capacity under the Revolving Credit Facility and cash generated from our operations, which have enabled us to make continued investments to support the growth of our business. As a result of our recurring losses from operations and current liquidity, management is of the opinion that there is a substantial doubt as to the Company's ability to continue as a going concern. The audited consolidated financial statements included herein have been prepared assuming that we will continue as a going concern and do not include adjustments that might result from the outcome of this uncertainty. If we are unable to raise the requisite funds, we will need to curtail or cease operations. See Note 1 to the audited consolidated financial statements for more information and Part I, Item 1A, "Risk Factors-Management has performed an analysis of our ability to continue as a going concern, and 66 -------------------------------------------------------------------------------- has determined that, based on our current financial position, there is a substantial doubt about our ability to continue as a going concern. In addition, our independent registered public accounting firm has raised substantial doubt as to our ability to continue as a going concern in this Annual Report." 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. In the long-term, we will be required to obtain additional financing to fund our current planned operations, which may consist of 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 ofDecember 31, 2022 , we had$121.5 million in aggregate principal amount of debt outstanding:$75.0 million under the Convertible Senior Notes and$46.5 million under the Revolving Credit Facility. As ofDecember 31, 2021 , we had$75.0 million in aggregate principal amount of debt outstanding, all of which was under the Convertible Senior Notes.
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. We received net proceeds of$72.8 million from the issuance of the Initial Convertible Senior Notes and Additional 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. 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 . PIK Notes issued or issuable in respect of PIK Interest have the same terms and conditions as the Convertible Senior Notes. OnFebruary 1, 2023 , Legacy Appgate issued approximately$2.1 million in PIK Notes with respect to a single interest payment date. The Note Issuance Agreement includes certain affirmative and financial covenants we are required to satisfy. Revolving Credit Agreement OnApril 26, 2022 , Legacy Appgate,Appgate , the other guarantors party thereto andSIS Holdings entered into the Revolving Credit Agreement which provides for a$50.0 million unsecured, revolving credit facility, or 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 and (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 accrues 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. As ofDecember 31, 2022 , we had$46.5 million in aggregate principal amount of debt outstanding under the Revolving Credit Facility. 67
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Promissory Notes
OnMarch 31, 2019 , Legacy Appgate issued the Promissory Notes to each of Cyxtera and theManagement Company . As discussed above and in our audited consolidated financial statements included elsewhere in Part II, Item 8 of this Annual Report - "Financial Statements and Supplementary Data", onFebruary 8, 2021 , LegacyAppgate 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 2021.
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 10 - Leases and Note 11 - Debt, to our audited consolidated financial statements included elsewhere in this Annual Report for additional information on maturities. Refer to Note 12 - Commitments and Contingencies to our audited consolidated financial statements included elsewhere in this Annual Report for additional information regarding cash amounts committed under other contractual obligations. Cash Flow
Cash Flows for 2022 and 2021. The following table sets forth our historical cash flows for the periods indicated (in thousands):
2022 2021
Net cash, cash equivalents and restricted cash used in operating activities
$ (58,548)
$ (568)
$ (48,408) 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 2022 was$58.5 million , which resulted from a net loss of$30.1 million , non-cash charges of$24.9 million and net cash outflow of$3.6 million from changes in assets and liabilities. Non-cash charges primarily consisted of a$58.8 million change in the fair value of our embedded derivative liability,$14.7 million in equity-based compensation,$9.3 million of depreciation and amortization,$6.0 million of amortization of deferred contract acquisition costs, and$1.7 million loss on abandonment of assets following our decision to stop offering our Compliance Sheriff product. The net cash outflow from changes in assets and liabilities was primarily due to more cash used in working capital, primarily driven by higher employee-related expenses in 2022 as discussed above under "Results of Operations," and higher costs associated to the Merger and related initiatives, increases in deferred contract acquisition costs, and a decrease in deferred revenue, partially offset by increased collections. Net cash used in operating activities during 2021 was$52.1 million , which resulted from a net loss of$73.1 million , adjusted for the net income from discontinued operations, net of tax of$65.7 million , net cash provided by operating activities of discontinued operations of$0.8 million , non-cash charges of$97.6 million and net cash outflow of$11.6 million from changes in assets and liabilities. Non-cash charges primarily consisted of a$78.5 million change in the fair value of our embedded derivative liability,$9.9 million of depreciation and amortization,$5.3 million of amortization of deferred contract acquisition costs, and$3.5 million in equity-based compensation. The net cash outflow from changes in assets and liabilities was primarily due to more cash used in working capital, primarily driven by higher headcount in 2021 as discussed above under "Results of Operations," and higher costs associated to the Merger and related initiatives, 68 --------------------------------------------------------------------------------
increases in contract assets and deferred contract acquisition costs, and a decrease in deferred revenue, partially offset by increased collections.
Investing Activities
During 2022, we used cash in our investing activities of$0.6 million as compared to cash provided by investing activities of$124.1 million during 2021. The change in cash flows from investing activities during 2022 when compared to 2021 was primarily due to receipt of$125.0 million in net proceeds from the sale of Brainspace inJanuary 2021 .
Financing Activities
During 2022, we borrowed$46.5 million under the Revolving Credit Facility. We did not have any other cash movement in financing activities during 2022. During 2021, we used$48.4 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$75.0 million received from the issuance of the Initial Convertible Senior Notes and Additional Convertible Senior Notes. In 2022, we paid$2.2 million in debt issuance costs in connection with the issuance of the Initial Convertible Senior Notes and Additional Convertible Senior Notes and spent$1.5 million on the recapitalization of the Company following the Merger (see Note 2).
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities at the date of our financial statements. We evaluate our estimates and assumptions on an ongoing basis. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, impacting our reported results of operations and financial condition. Critical accounting policies 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 matters that are inherently uncertain. Based on this definition, we have identified the following critical accounting estimates: revenue from contracts with customers, accounting for income taxes, and accounting for goodwill and intangible assets. These critical accounting estimates are addressed below. In addition, we have other key accounting estimates that are described in Note 1 - Business and Summary of Significant Accounting Policies to our audited consolidated financial statements included elsewhere in this Annual Report.
Revenue Recognition
We recognize revenue under 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, or 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.
If a contract contains a single performance obligation, the entire transaction
price is allocated to the single performance obligation. For contracts that
contain multiple distinct performance obligations, we allocate the transaction
price to each performance obligation based on a relative standalone selling
price ("SSP"). We determine the transaction price with reference to the SSP of
the various performance obligations inherent within a contract. The SSP is
determined based on the prices at which we separately sell these products,
assuming the majority of these fall within a pricing range. In instances
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where SSP is not directly observable, such as when we do not sell the software
license separately, we derive the SSP utilizing market conditions and other
factors, including customer type, market conditions and pricing objectives,
historical sales data, and negotiated discounts from price lists, if any, that
can require significant judgement.
Derivatives
We have concluded that the conversion feature under the Convertible Senior Notes requires bifurcation from the debt host agreement in accordance with ASC 815. Accordingly, we recognize a derivative liability at fair value for this instrument in our consolidated balance sheet and adjust the carrying value of the liability to fair value at each reporting period until the conversion feature underlying the instrument is exercised, redeemed, cancelled or expires. The changes in fair value are recorded as other expense in our consolidated statement of operations. The derivative is valued using Level 3 inputs which are highly subjective and require a high degree of judgment. Refer to Note 7 to our consolidated financial statements included elsewhere in this Annual Report for disclosures regarding those significant unobservable inputs and how a change in those significant unobservable inputs to a different amount might produce a significantly higher or lower derivative value at the reporting date.
Income Taxes
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. We account for income taxes using the asset and liability method. Deferred income taxes are recognized by applying the enacted statutory tax rates applicable to future years to differences between the carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance to amounts that are more likely than not to be realized. In addition, certain Federal and state NOL carryforward assets are reduced by a valuation allowance and/or may be limited by Code Section 382 or 383.
We use an estimate of the annual effective income tax rate at each interim period based on the facts and circumstances available at that time, while the actual effective income tax rate is calculated at year-end.
See Note 18 - Income Taxes to our audited consolidated financial statements included elsewhere in this Annual Report for additional information about accounting for income taxes.
Goodwill represents the excess of the fair value of purchase consideration in a business combination over the fair value of net tangible and intangible assets acquired.Goodwill amounts are not amortized, but rather tested for impairment at least annually or more often if circumstances indicate that the carrying value may not be recoverable. Upon the Cyxtera Spin-Off, Legacy Appgate's opening carve-out consolidated financial statements included the goodwill balances carried over from Cyxtera in connection with Cyxtera's acquisition of the entities that formed Legacy Appgate, less impairments. We perform annual impairment tests of goodwill onOctober 1st of each year or whenever an indicator of impairment exists. We did not record any impairment of goodwill in 2022 or 2021. Our annual impairment tests of goodwill may be completed through qualitative assessments. We may elect to bypass the qualitative assessment and proceed directly to a quantitative impairment test, for any reporting unit, in any period. We can resume the qualitative assessment for any reporting unit in any subsequent period. Under a qualitative approach, our impairment review for goodwill consists of an assessment of whether it is more-likely-than-not that a reporting unit's fair value is less than its carrying amount. If we elect to bypass the qualitative assessment for any reporting units, or if a qualitative assessment indicates it is more-likely-than-not that the estimated carrying value of a reporting unit exceeds its fair value, we perform a quantitative goodwill impairment test that requires us to estimate the fair value of the reporting unit. If the fair value of the reporting unit is less than its carrying amount, we will measure any goodwill impairment loss as the amount by which the carrying amount of a reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit. We use an income approach and a market approach, when available, to estimate a reporting unit's fair value, which discounts the reporting unit's projected cash flows using a discount rate we determine from a market participant's perspective under the income approach or utilizing similar publicly traded companies as 70 -------------------------------------------------------------------------------- guidelines for determining fair value under the market approach. We make significant assumptions when estimating a reporting unit's projected cash flows, including revenue, driven primarily by sales growth, operating expenses, capital expenditures and income tax rates, among others. We completed our impairment reviews for goodwill as ofOctober 1, 2022 and 2021 and no impairment resulted. The estimates and assumptions we use to estimate fair values when performing quantitative assessments are highly subjective judgments based on our experience and knowledge of our operations. Significant changes in the assumptions used in our analysis could result in an impairment charge related to goodwill. Circumstances that could result in changes to future estimates and assumptions include, but are not limited to, expectations of sales growth, which can be caused by a variety of factors, increases in income tax rates and increases in discount rates. Acquired intangible assets consist of identifiable intangible assets, including developed technology, 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 of trademarks and tradenames, and customer relationships is recorded primarily within depreciation and amortization in our consolidated statements of operations. Amortization expense of developed technology is recorded within cost of revenue in our consolidated statements of operations. Long-lived assets, such as property and equipment and acquired intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. We measure the recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that these assets are expected to generate. If the total of the future undiscounted cash flows are less than the carrying amount of an asset, we record an impairment charge for the amount by which the carrying amount of the asset exceeds the fair value. When assessing the recoverability of our long-lived assets, we make assumptions regarding estimated future cash flows and other factors. Some of these assumptions involve a high degree of judgment and also bear a significant impact on the assessment conclusions. Included among these assumptions are estimating undiscounted future cash flows, including the projection of sales and revenue, operating expenses, and capital requirements, among others. We formulate estimates from historical experience and assumptions of future performance, based on business plans and forecasts, recent economic and business trends, and competitive conditions. In the event that our estimates or related assumptions change in the future, we may be required to record an impairment charge. We did not record any impairment of long-lived assets in 2022 or 2021.
Recent Accounting Pronouncements
Recently issued accounting pronouncements are described in Note 1 of our audited consolidated financial statements included elsewhere in this Annual Report.
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