KNOWBE4, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to those statements included elsewhere in this Quarterly Report on Form 10-Q. As discussed in "Cautionary Note Regarding Forward-Looking Statements," in addition to historical financial information, the following discussion and analysis may contain forward-looking statements regarding our expectations of future performance, liquidity and capital resources, our plans, estimates, beliefs and expectations that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated or implied in these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q.
Overview
KnowBe4 has developed the leading security awareness platform enabling organizations to assess, monitor and minimize the ongoing cybersecurity threat of social engineering attacks. We are pioneering an integrated approach to security awareness that incorporates cloud-based software, machine learning, artificial intelligence, advanced analytics and insights with engaging content. Our platform is designed to drive awareness, change human behavior and enable a security-minded culture that results in a reduction of social engineering risks. Our flagship product, Kevin Mitnick Security Awareness Training ("KMSAT"), focuses on enabling organizations to assess their social engineering risks and providing security awareness training to mitigate these risks.KnowBe4 Compliance Manager ("KCM"), enables organizations to manage compliance and audit cycles and PhishER, our security orchestration and automation product, enables security operations teams to prioritize and automate security workstreams in order to respond to, and remediate, social engineering attacks. Our Compliance Plus product provides our customers with relevant and engaging compliance content on a broad range of topics from data privacy to diversity, equity and inclusion. Additionally, we are currently developing the SecurityCoach product to incorporate technology gained through the SecurityAdvisor acquisition to address human behavior risks in real-time. We generate substantially all of our revenues from the sale of subscriptions to access our cloud-based platform. Subscription sales are primarily generated by our inside sales representatives and our network of channel partners. Our platform is priced individually by product then based on the subscription tier and number of subscribed users. This pricing model allows us to offer organizations flexibility to meet their individual needs without compromising the overall value of our platform. For KMSAT, Compliance Plus and PhishER, the number of subscribed users typically includes all or a majority of the employees within the customer organization. For KCM, the number of subscribed users typically includes the employees responsible for the administration of governance and compliance functions within the customer organization. KMSAT and KCM each feature premium tiers, which offer customers access to additional features, including many of our APIs and AI functionality. Additionally, the premium tiers of KMSAT offer customers access to more differentiated content options, including highly produced, serialized content, interactive modules, games and compliance modules. Our platform is designed to be powerful, yet highly scalable, intuitive and easy to deploy, in order to reduce the administrative burden of managing social engineering risk on security and IT professionals. Customers typically deploy our platform quickly across their entire organization to monitor and reduce the cybersecurity risk associated with their employees' behavior. Because our products are designed to change human behavior within the entire organization, rollout of our products is performed organization-wide at the onset of a contract rather than focused on certain departments or portions of an organization. We utilize our team of customer success managers to ensure successful adoption and use of our products, while our team of dedicated pricing specialists are tasked with negotiating customer renewals, along with upselling and cross-selling. We sell our products to customers of all sizes both directly through our dedicated inside sales teams for enterprise and small and medium businesses ("SMBs"), and indirectly through channel partners and managed service providers ("MSPs"). 32
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We have established a significant market presence, with more than 54,200 customers as ofSeptember 30, 2022 , across virtually all industries and multiple geographies. No single direct customer represented more than 1% of our revenues for the three and nine months endedSeptember 30, 2022 . Our business has experienced significant growth with total revenues, net of$85.8 million and$64.1 million for the three months endedSeptember 30, 2022 and 2021, respectively, and$241.6 million and$177.0 million for the nine months endedSeptember 30, 2022 and 2021, respectively. As ofSeptember 30, 2022 and 2021, we had annual recurring revenue ("ARR"), of$347.2 million and$262.2 million , respectively. For the three months endedSeptember 30, 2022 and 2021, we had net income of$6.5 million and net loss of$1.6 million , respectively, and for the nine months endedSeptember 30, 2022 and 2021 we had net income of$11.2 million and net loss of$16.2 million , respectively. See the sections titled "-Key Business Metrics-Annual Recurring Revenue" for additional information regarding ARR. We have built our business with a focus on cash flow generation. Our net cash provided by operating activities for the nine months endedSeptember 30, 2022 and 2021 was$80.1 million and$55.8 million and our free cash flow was$72.9 million and$51.7 million , respectively. See the sections titled "Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures-Free Cash Flow" for additional information regarding free cash flow and for a reconciliation of free cash flow to the most directly comparable financial measure calculated in accordance withU.S. generally accepted accounting principles ("GAAP").
Pending Merger
OnOctober 11, 2022 , we entered into the Merger Agreement with Parent and Merger Sub, providing for our acquisition by affiliates of Vista. Under the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of the Company's Class A common stock and Class B common stock (other than as specified in the Merger Agreement) will be canceled and extinguished and automatically converted into the right to receive cash in an amount equal to$24.90 , without interest. Completion of the Merger is subject to the satisfaction or waiver of customary closing conditions, including (1) approval of the Merger Agreement by our stockholders; (2) the expiration or termination of the waiting period under the HSR Act; (3) the absence of any legal restraint preventing the Merger; and (4) the absence of a material adverse effect onKnowBe4 that is continuing. The Merger is expected to close in the first half of 2023. Upon the consummation of the Merger, our Class A common stock will no longer be listed on any public market. For further discussion about the Merger and the terms of the Merger Agreement, refer to the section titled "Pending Merger" in Note 17 "Subsequent Events" in the notes to the consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Recent Events
Our business is subject to risks and uncertainties arising from current global macroeconomic and geopolitical conditions, including but not limited to, the Russian invasion ofUkraine , inflationary pressures and actions to counter those pressures, supply chain constraints, labor shortages, and the ongoing impacts of the COVID-19 pandemic. While the ultimate impact of these events on our business is uncertain, we have not experienced significant adverse impacts to our results of operations, including our number of customers, ARR and revenues, or any indications that our results of operations would be adversely impacted in the future. We expect the competitive nature of our pricing model to allow our customers, particularly SMBs, to retain their subscriptions throughout the ongoing macroeconomic challenges. Further, we believe that organizations will continue to prioritize cybersecurity spending, which may result in increases to our number of customers, ARR and revenues as organizations see a greater need for our platform.
Refer to Part II, Item 1A, "Risk Factors" in this Quarterly Report on Form 10-Q for further discussion of the possible impact of the current macroeconomic environment on our business.
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Key Business Metrics
We regularly monitor a number of financial and operating metrics, including the
following key metrics, in order to measure our current performance and estimate
our future performance, as follows:
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Number of customers 54,237 44,319 9,918 22.4 %
Annual recurring revenue $ 347,152 $ 262,172 $ 84,980 32.4 %
Number of Customers
We believe that our ability to increase and retain the number of customers on
our platform is an indicator of our market penetration, the growth of our
business and potential future business opportunities. Increasing awareness of
our platform and products, combined with further overall awareness of the need
to address the human risk within cybersecurity, has continued to expand our
customer base to include organizations of all sizes across all industries. We
define a customer as a separate and distinct buying entity, such as a company,
an educational or government institution or a distinct business unit of a large
company that has an active contract with us to access our platform. We do not
consider our channel partners as separate customers as our contracts are
executed with the end user, and we treat MSPs who may purchase our products on
behalf of multiple companies, as a single customer. As our customer base grows
and as our market penetration increases, we do not expect to continue to grow at
the same year-over-year rate.
Annual Recurring Revenue
We believe that ARR is a key metric to measure our business performance because it is driven by our ability to acquire new customers and to maintain and expand our relationship with existing customers. We define ARR as the annualized value of all contractual subscription agreements as of the end of the period. We perform this calculation on an individual contract basis by dividing the total dollar amount of a contract by the total contract term stated in months and multiplying this amount by twelve to annualize. Calculated ARR for each individual contract is then aggregated to arrive at total ARR. ARR does not have a standardized meaning and therefore may not be comparable to similarly titled measures presented by other companies. ARR should be viewed independently of revenues, deferred revenue and remaining performance obligations and is not intended to be combined with or to replace any of those items. Specifically, ARR, as calculated under the definition herein, does not adjust for the timing impact of revenue recognition for specific performance obligations identified within a contract. ARR is not a forecast and the active contracts at the date used in calculating ARR may or may not be extended by our customers. We expect ARR in total dollars to continue to grow as we execute on our growth strategies and increase our market penetration, but we do not expect to continue to grow at the same year-over-year rate as we become a larger, more mature business.
Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the
following non-GAAP measures are useful in evaluating our operating performance.
We believe that non-GAAP financial information, when taken collectively, may be
helpful to investors because it provides consistency and comparability with past
financial performance. However, non-GAAP financial information is presented for
supplemental informational purposes only, has limitations as an analytical tool,
and should not be considered in isolation or as a substitute for financial
information presented in accordance with GAAP. Other companies, including
companies in our industry, may calculate similarly-titled non-GAAP measures
differently or may use other measures to evaluate their performance, all of
which could reduce the usefulness of our non-GAAP financial measures as tools
for comparison. A reconciliation is provided below for each non-GAAP financial
measure to the most directly comparable financial measure stated 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 and not to rely on any single
financial measure to evaluate our business.
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Non-GAAP Gross Profit
We define non-GAAP gross profit as GAAP gross profit excluding stock
compensation expense, amortization of acquired technology and intangible assets
and acquisition and integration related costs, if applicable. Costs associated
with acquisitions and integration include legal, accounting and other
professional fees, changes in the fair value of contingent consideration
obligations and other costs related to the transition of acquired businesses. We
believe non-GAAP gross profit provides our management and investors consistency
and comparability with our past financial performance and facilitates
period-to-period comparisons of our results of operations, as this metric
generally eliminates the effects of certain variables unrelated to our overall
operating performance.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands) (in thousands)
Gross profit $ 74,399 $ 54,482 $ 209,140 $ 151,448
Add: Stock compensation expense 148 124 493 253
Add: Amortization of acquired
technology and intangible assets 715 142 2,320 383
Non-GAAP gross profit $ 75,262 $ 54,748 $ 211,953 $ 152,084
Non-GAAP Operating Income
We define non-GAAP operating income as GAAP operating income excluding stock
compensation expense, amortization of acquired technology and intangible assets,
acquisition and integration related costs and merger-related transaction
expenses. Costs associated with acquisitions and integration include legal,
accounting and other professional fees, changes in the fair value of contingent
consideration obligations and other costs related to the transition of the
acquired business. Nonrecurring transaction expenses associated with the pending
transaction with Vista include legal fees, professional fees and other costs
associated with consummating the Merger. We believe non-GAAP operating income
provides our management and investors consistency and comparability with our
past financial performance and facilitates period-to-period comparisons of
operations, as this metric generally eliminates the effects of certain variables
unrelated to our overall operating performance.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands) (in thousands)
Operating income (loss) $ 4,543 $ (680) $ 9,953 $ (13,710)
Add: Stock compensation expense 5,660 2,744 18,268 23,272
Add: Amortization of acquired
technology and intangible assets 876 302 2,802 771
Add: Acquisition and integration
related costs - 588 34 3,036
Add: Merger transaction expenses 1,538 - 1,538 -
Non-GAAP operating income $ 12,617 $ 2,954 $ 32,595 $ 13,369
Free Cash Flow
We define free cash flow as net cash provided by operating activities less
purchases of property, equipment, amounts capitalized for internal-use software
and principal payments on finance leases. We believe that free cash flow is a
meaningful indicator of liquidity to management and investors about the amount
of cash generated from
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our operations that, after the investments in property, equipment and capitalized internal-use software, can be used for strategic initiatives.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands) (in thousands)
Net cash provided by operating activities $ 32,728 $ 19,853 $ 80,121 $ 55,799
Less: Purchases of property and equipment (1,846) (1,159) (4,467) (2,214)
Less: Capitalized internal-use software (421) (774) (2,681) (1,895)
Less: Principal payments on finance leases (10) (10) (31) (30)
Free cash flow $ 30,451 $ 17,910 $ 72,942 $ 51,660 Components of Our Operating Results
Revenues, Net
We derive substantially all of our revenues from subscription services fees paid by customers for access to our cloud-based platform, which includes support services and feature upgrades throughout the duration of the customer's contract. While contracts with our customers do not provide the customer with the right to take possession of software operating on our global cloud-based platform, certain arrangements allow our customers the ability to download and use our content within their own learning management systems. Our content is only available to customers throughout the duration of their subscription and is accessed through our cloud-based platform. Subscription services fees and access to content for download are considered separate performance obligations. Invoiced amounts are allocated between subscription services fees and access to content and are recorded as deferred revenue and revenues, respectively. Deferred revenue primarily consists of amounts invoiced to customers for our subscription services and is generally recognized ratably over the subscription period while revenues related to content downloads is recognized at contract inception. Subscription terms typically range from one year to three years and generally begin on the date access to our platform is made available to the customer. Our subscriptions are generally invoiced upfront for the duration of the contract term or in annual installments. Our arrangements are primarily noncancellable and nonrefundable. We collect our receivables in advance of the subscription service period and often issue renewal invoices in advance of the renewal service period. Because we recognize revenues ratably over the terms of our subscription contracts, a substantial portion of the revenues that we report in each period is attributable to the recognition of deferred revenue relating to agreements that we entered into during previous periods. Consequently, increases or decreases in new sales or renewals in any one period may not be immediately reflected as revenues for that period. Accordingly, the effect of downturns in sales and market acceptance of our platform, and potential changes in our rate of renewals, may not be fully reflected in our results of operations until future periods. Further, current global macroeconomic conditions could impact our future revenue growth.
Cost of Revenues and Gross Margin
Cost of revenues consists of costs associated with delivering our platform and
providing support to our customers. These costs include employee-related costs
such as salaries and bonuses, stock compensation expense and benefits costs
associated with our operations and support personnel, costs associated with
third-party hosting services and other direct costs related to platform
delivery, amortization of acquired technology, amortization of capitalized
internal-use software and content and allocated overhead. We expect cost of
revenues to increase in absolute dollars and as a percentage of revenues,
relative to the extent of the growth of our business and reflective of the
impacts of wage inflation seen in the market as a whole.
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Gross margin is gross profit expressed as a percentage of total revenues. Our gross margin has been and will continue to be affected by various factors, including the timing and amount of costs associated with supporting our platform, the extent to which we expand our customer success team and the rate at which we develop or acquire new products, significant features and additional content added to our platform. We intend to continue to invest additional resources in our platform, content development and support services which we expect to result in steady gross margin over time.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related costs, including salaries and wages, stock compensation expenses and sales commissions, costs of general marketing programs and promotional activities, travel-related expenses and allocated overhead. Sales commissions earned by our sales force that are considered to be incremental to the cost of acquiring a customer are deferred and amortized over the estimated period of benefit. Marketing programs consist of advertising, events, including our KB4-CON customer conference, which has historically been held during the second quarter of each year, corporate communications, brand building and product marketing activities. We expect our sales and marketing expenses to increase on an absolute dollar basis as we continue to make significant investments in our sales and marketing organization to drive additional revenues, increase market share and expand our global customer base.
Technology and Development
Technology and development costs consist primarily of research and development activities, non-capitalizable costs of developing platform features and content and certain overhead allocations. These costs include employee-related costs, including salaries and wages and stock compensation expenses, consulting services, expenses related to the design, development, testing and enhancements of our subscription services. Technology and development costs are expensed as incurred. We expect that our technology and development expenses may increase as we continue to enhance our platform functionality and develop new content and features and may fluctuate as a percentage of our revenues depending on the timing and nature of development activities. Additionally, our technology and development costs could be impacted by the ongoing trend towards remote work and overall wage inflation. General and Administrative General and administrative expenses consist primarily of employee-related costs for accounting, finance, legal, IT and human resources personnel and also include expenses related to consulting services, audit fees, tax services, legal services and other general corporate items. Our general and administrative costs also include our investment in internal initiatives and tools which we believe promotes our corporate culture and helps us attract and retain talent. We expect our general and administrative expenses to increase in absolute dollars in future periods as we continue to expand our operations, hire additional personnel, see the ongoing impact of overall wage inflation and incur other administrative costs to support the growth of the company. We also expect our general and administrative expenses to increase in absolute terms due to costs related to the Merger and potential related litigation.
Interest Income
Interest income primarily consists of interest earned on overnight cash deposits and fluctuates with market rates of interest and overall cash balances.
Interest Expense
Interest expense primarily relates to imputed interest calculated on certain contingent consideration obligations arising from our historical business combinations along with fees associated with our revolving line of credit.
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Income Tax Expense
Income tax expense consists of federal and state income taxes inthe United States and income taxes in certain foreign jurisdictions. Our provision for income taxes has not historically been significant to our business as we have incurred annual operating losses to date. We maintain a valuation allowance on ourU.S. federal, state and certain foreign deferred tax assets as we have concluded that it is not more likely than not that the deferred assets will be realized. Results of Operations The following table is a summary of our consolidated statements of operations: Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2021 (in thousands) (in thousands) Revenues, net$ 85,836 $ 64,091 $ 241,631 $ 176,991 Cost of revenues(1) 11,437 9,609 32,491 25,543 Gross profit 74,399 54,482 209,140 151,448 Operating expenses: Sales and marketing(1) 34,603 27,731 100,034 82,312 Technology and development(1) 9,716 7,579 27,389 20,081 General and administrative(1) 25,537 19,852 71,764 62,765 Total operating expenses 69,856 55,162 199,187 165,158 Operating income (loss) 4,543 (680) 9,953 (13,710) Other income (expense): Interest income 1,570 16 2,103 41 Interest expense (65) (67) (216) (329) Other income (expense) 519 114 245 (445) Income (loss) before income tax expense 6,567 (617) 12,085 (14,443) Income tax expense (52) (963) (862) (1,800) Net income (loss)$ 6,515 $ (1,580) $ 11,223 $ (16,243) ________________
(1)Amounts include stock compensation expense as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands) (in thousands)
Cost of revenues $ 148 $ 124 $ 493 $ 253
Sales and marketing 1,226 726 3,801 7,277
Technology and development 1,234 242 3,815 530
General and administrative 3,052 1,652
10,159 15,212
Total stock compensation expense
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The following table is a summary of our consolidated statements of operations as a percentage of our total revenues for the periods:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Revenues, net 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues 13.3 % 15.0 % 13.4 % 14.4 %
Gross profit 86.7 % 85.0 % 86.6 % 85.6 %
Operating expenses:
Sales and marketing 40.3 % 43.3 % 41.4 % 46.5 %
Technology and development 11.3 % 11.8 % 11.3 % 11.3 %
General and administrative 29.8 % 31.0 % 29.7 % 35.5 %
Total operating expenses 81.4 % 86.1 % 82.4 % 93.3 %
Operating income (loss) 5.3 % (1.1) % 4.1 % (7.7) %
Other income (expense):
Interest income 1.8 % - % 0.9 % - %
Interest expense (0.1) % (0.1) % (0.1) % (0.2) %
Other income (expense) 0.6 % 0.2 % 0.1 % (0.3) %
Income (loss) before income tax
expense 7.7 % (1.0) % 5.0 % (8.2) %
Income tax expense (0.1) % (1.5) % (0.4) % (1.0) %
Net income (loss) 7.6 % (2.5) % 4.6 % (9.2) %
Comparison of the Three Months Ended
Revenues, net
Three Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Revenues, net $ 85,836 $ 64,091 $ 21,745 33.9 %
Revenues, net increased by $21.7 million , or 33.9%, for the three months ended
September 30, 2022 , compared to the three months ended September 30, 2021 . The
increase in revenues, net was primarily driven by new customer acquisition and
success in cross-selling additional products into our existing customer base.
During the three months ended September 30, 2022 , our customer base grew by
22.4% and the number of customers with active subscriptions to more than one of
our products has increased to 27.9% of our total customer base, in each case
compared to the three months ended September 30, 2021 . Additionally, revenues
earned in foreign jurisdictions increased by $4.3 million , or 40.4%, compared to
the prior year quarter. Further, due to the nature of our subscription-based
business model, a large portion of our revenues in a given period result from
the recognition of revenues deferred in prior periods. As such, $21.1 million of
the year-over-year increase in revenue is related to the recognition of deferred
revenues from the accumulation of contracts entered into during prior periods.
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Cost of Revenues and Gross Margin
Three Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Cost of revenues $ 11,437 $ 9,609 $ 1,828 19.0 %
Gross margin 86.7 % 85.0 %
Cost of revenues increased by $1.8 million , or 19.0%, for the three months ended
September 30, 2022 , compared to the three months ended September 30, 2021 . The
overall increase in cost of revenues is in line with our increase in revenues
over the same period, while slightly improving our margin position. The total
dollar value increase in cost of revenues is primarily driven by $1.2 million of
additional personnel costs related to increased headcount to support our
customer growth. Other increases relate to amortization expense associated with
recently acquired intangible assets and higher platform hosting costs, which are
also in line with our business growth.
Operating Expenses
Sales and Marketing
Three Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Sales and marketing $ 34,603 $ 27,731 $ 6,872 24.8 %
Sales and marketing expenses increased by $6.9 million , or 24.8%, for the three
months ended September 30, 2022 , compared to the three months ended September
30, 2021 . This increase relates to additional personnel costs of $3.7 million ,
including salaries, commissions and stock compensation, driven by headcount
increases within our sales organization, which is consistent with our overall
business growth. We have also incurred increased costs to expand our market
reach, including additional marketing and industry events, and demand generation
activities to support our growth, which totaled an additional $3.2 million
compared to the prior year quarter.
Technology and Development
Three Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Technology and development $ 9,716 $ 7,579 $ 2,137 28.2 %
Technology and development expenses increased by $2.1 million , or 28.2%, for the
three months ended September 30, 2022 , compared to the three months ended
September 30, 2021 . This increase is largely due to additional personnel costs
of $1.3 million , including salaries and stock compensation, driven by headcount
increases and is consistent with our overall business growth. The increase also
relates to higher software subscription costs and overhead allocations, which is
consistent with headcount increases, as well as additional production expenses,
which largely vary depending on the stages and timing of production.
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General and Administrative
Three Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
General and administrative $ 25,537 $ 19,852 $ 5,685 28.6 %
General and administrative expenses increased by $5.7 million , or 28.6%, for the
three months ended September 30, 2022 , compared to the three months ended
September 30, 2021 . This increase is largely due to additional personnel costs
of $2.1 million , driven by headcount increases of 33.9%, comparatively, across
our administrative support functions and an increase of $1.4 million in stock
compensation due to additional equity awards issued subsequent to the prior year
quarter. The remaining increase of $2.2 million relates to transaction expenses
associated with the Merger of approximately $1.5 million along with higher
incremental costs of subscription services that are correlated to headcount
and/or usage.
Income Tax Expense
Three Months Ended September 30, Change
2022 2021 $ %
(dollars in thousands)
Income tax expense $ (52) $ (963) $ 911 (94.6) %
Income tax expense decreased by $0.9 million , or 94.6%, for the three months
ended September 30, 2022 , compared to the three months ended September 30, 2021 ,
primarily due to a reduction in taxable income generated in foreign
jurisdictions as a result of transfer pricing adjustments.
Comparison of the Nine Months Ended
Revenues, net
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Revenues, net $ 241,631 $ 176,991 $ 64,640 36.5 %
Revenues, net increased by $64.6 million , or 36.5%, for the nine months ended
September 30, 2022 , compared to the nine months ended September 30 , 2021.The
increase in revenues, net was primarily due to the recognition of $51.6 million
of deferred revenue from the accumulation of contracts entered into during prior
periods. The remaining increase is attributable to revenues from new customers
combined with revenues from cross-selling additional products into our existing
customer base driven by our customer success teams' efforts to expand our
customers' use of our platform beyond a single product. Our customer base grew
by 22.4% and the number of customers with active subscriptions to more than one
of our products has increased to 27.9% of our total customer base. Additionally,
revenues earned in foreign jurisdictions increased by $14.5 million or 53.4%
compared to the prior year period.
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Cost of Revenues and Gross Margin
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Cost of revenues $ 32,491 $ 25,543 $ 6,948 27.2 %
Gross margin 86.6 % 85.6 %
Cost of revenues increased by $6.9 million , or 27.2%, for the nine months ended
September 30, 2022 , compared to the nine months ended September 30, 2021 . The
overall increase in cost of revenues is in line with our increase in revenues
over the same period, while slightly improving our margin position. The total
dollar value increase in cost of revenues is primarily driven by $4.7 million of
additional personnel costs related to increased headcount to support our
customer growth. Other increases relate to additional amortization expense
associated with recently acquired intangible assets and higher platform hosting
costs, which are in line with our business growth.
Operating Expenses
Sales and Marketing
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Sales and marketing $ 100,034 $ 82,312 $ 17,722 21.5 %
Sales and marketing expenses increased by $17.7 million , or 21.5%, for the nine
months ended September 30, 2022 , compared to the nine months ended September 30,
2021 . This increase primarily relates to increased personnel costs of $11.8
million , including salaries and commissions, and $2.8 million of additional
subscription and corporate allocation costs driven by headcount increases within
our sales organization, which is consistent with our overall business growth.
The increase also relates to $7.2 million of additional marketing expenses for
expanded programs, specifically industry events, including our KB4-CON customer
conference, corporate communications, brand building and product marketing
activities. These increases were offset by a decrease in stock compensation
expense for the nine months ended September 30, 2022 of $3.5 million , driven by
the $5.0 million of additional stock compensation expense recognized in
conjunction with our IPO completed in April 2021 .
Technology and Development
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Technology and development $ 27,389 $ 20,081 $ 7,308 36.4 %
Technology and development expenses increased by $7.3 million , or 36.4%, for the
nine months ended September 30, 2022 , compared to the nine months ended
September 30, 2021 . This increase is due to additional personnel costs of $5.4
million , including additional stock compensation expense of $3.1 million and
other headcount driven increases in salaries. Increases to headcount-related
costs for the period were offset by additional capitalization of labor costs
primarily associated with the SecurityCoach product development. The remainder
of the increase primarily relates to higher costs of subscription services and
corporate allocations which fluctuate with growth of the business.
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General and Administrative
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
General and administrative $ 71,764 $ 62,765 $ 8,999 14.3 %
General and administrative expenses increased by $9.0 million , or 14.3%, for the
nine months ended September 30, 2022 , compared to the nine months ended
September 30, 2021 . This increase primarily relates to additional personnel
costs of $9.2 million , driven by headcount increases of 33.9%, comparatively,
across our administrative support functions. Current year expenses include
approximately $1.5 million of merger transaction expenses, $1.7 million of
additional subscription services that are correlated to headcount and/or usage
and $0.6 million of additional professional fees related to corporate legal and
accounting matters. These increases were partially offset by a decrease in stock
compensation expense for the nine months of $5.1 million , driven by the $10.0
million of additional stock compensation expense recognized in conjunction with
our IPO completed in April 2021 .
Income Tax Expense
Nine Months Ended
September 30, Change
2022 2021 $ %
(dollars in thousands)
Income tax expense $ (862) $ (1,800) $ 938 (52.1) %
Income tax expense decreased by
Liquidity and Capital Resources
AtSeptember 30, 2022 , our principal sources of liquidity were cash and cash equivalents totaling$343.9 million and accounts receivable of$64.0 million . Our cash and cash equivalents are comprised of time deposits with financial institutions. To date, we have financed our operations primarily through payments received from customers using our platform supplemented by proceeds from sales of our equity securities. Our positive cash flows from operations enable us to make continued investments in the growth of our business. We expect our operating cash flows to further improve as we increase our operational efficiency and experience economies of scale. We typically invoice our subscription customers annually in advance. Therefore, a substantial source of our cash is from customer prepayments, which are included on our consolidated balance sheets as deferred revenue. Deferred revenue consists of invoiced fees for our subscription services, prior to satisfying the criteria for revenue recognition, which are subsequently recognized as revenues in accordance with our revenue recognition policy. As ofSeptember 30, 2022 , we had deferred revenue of$329.6 million , of which$227.7 million was recorded as a current liability and is expected to be recorded as revenues in the next 12 months, provided all other revenue recognition criteria are met. Our remaining performance obligation represents contracted revenues that has not yet been recognized and includes deferred revenue, which has been invoiced and is recorded on the consolidated balance sheets, and unbilled amounts that are not yet recorded on the balance sheets, that will be recognized as revenues in future periods. As ofSeptember 30, 2022 , our remaining performance obligation was$397.2 million . We believe our existing cash and cash equivalents, cash provided by operating activities, available borrowings under our Revolving Credit Facility, and unbilled amounts related to contracted non-cancelable subscription agreements, which are not reflected on the balance sheet, will be sufficient to meet our working capital and capital 43
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expenditure needs over the next 12 months. In the future, we may enter into arrangements to acquire or invest in complementary businesses, products and technologies, and intellectual property rights, though we currently have no agreements or commitments to do so. To facilitate these acquisitions or investments, we may seek additional equity or debt financing, which may not be available on terms favorable to us or at all, impacting our ability to complete subsequent acquisitions or investments.
Revolving Credit Facility
OnMarch 12, 2021 , we entered into a three-year$100.0 million revolving credit facility withBank of America, N.A . (the "Revolving Credit Facility"). Interest on any borrowings under the Revolving Credit Facility bear interest, at our option, at (i) a base rate equal to the highest of (a) the federal funds rate plus 0.5%, (b) the rate of interest in effect for such date as publicly announced from time to time by Bank of America as its "prime rate", or (c) the eurodollar rate plus 1.0%, provided that such rate will not be less than 0.5%. We are obligated to pay other customary fees for a credit facility of this size and type, including letter of credit fees, an upfront fee, and an unused commitment fee. The terms of our Revolving Credit Facility include a number of covenants that limit our ability and our subsidiaries' ability to, among other things, incur additional indebtedness, grant liens, merge or consolidate with other companies or sell substantially all of our assets, pay dividends, make redemptions and repurchases of stock, make investments, loans and acquisitions, or engage in transactions with affiliates. We expect to use the revolving credit facility for general corporate purposes, including potential future acquisitions and expansions. As ofSeptember 30, 2022 , we were in compliance with all covenants and there were no amounts outstanding under this facility.
Initial Public Offering
OnApril 26, 2021 , we completed our IPO, in which we sold 10,925,000 shares of our Class A common stock at a price to the public of$16.00 per share, including 1,425,000 shares pursuant to the exercise in full of the underwriters' option to purchase additional shares. We received net proceeds of$153.0 million , after deducting underwriting discounts and commissions of$10.8 million and offering expenses paid by us of approximately$3.0 million .
Merger Agreement
The Merger Agreement contains customary covenants regarding the conduct of our business prior to the closing of the Merger and contains certain termination rights for us and Parent which require, in certain specified circumstances, (i) us to pay Parent a termination fee of$138.0 million or (ii) Parent to pay us a termination fee of$276.0 million . In addition, pursuant to the Merger Agreement, we have agreed, subject to certain exceptions, not to take, authorize, agree or commit to do certain actions outside of the ordinary course of business, including incurring or assuming indebtedness exceeding$0.6 million in the aggregate or incurring capital expenditures in excess of$0.5 million individually or$1.0 million in the aggregate. We do not believe that the restrictions in the Merger Agreement will prevent us from meeting our debt obligations, ongoing costs of operations, working capital needs, or capital expenditure requirements. For further discussion about the Merger and the terms of the Merger Agreement, refer to the section titled "Pending Merger" above, the section titled "Pending Merger" in Note 17 "Subsequent Events" in the notes to the consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Current Report on Form 8-K filed with theSEC onOctober 13, 2022 , our preliminary proxy statement in connection with the solicitation of proxies to approve the Merger filed with theSEC onNovember 14, 2022 , as well as the definitive proxy statement and any other documents or materials related to the Merger we may file when they become available. 44
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Cash Flows
The following table presents a summary of our consolidated cash flows from operating, investing and financing activities.
Nine Months Ended September 30,
2022 2021
(in thousands)
Net cash provided by operating activities $ 80,121 $ 55,799
Net cash used in investing activities $ (10,483) $ (15,336)
Net cash provided by financing activities $ 3,454 $ 145,925
Operating Activities
Our largest source of cash flows from operations is cash collections from our
customers for subscription services while our primary use of cash for operating
activities is for employee-related expenses, including salaries, commissions and
monthly performance bonuses. We have historically generated positive cash flows
from operations as a result of our efficient sales model and period-over-period
growth in subscription services.
Net cash provided by operating activities during the nine months ended September
30, 2022 was $80.1 million , which consisted of net income of $11.2 million ,
adjusted for non-cash charges of $39.9 million and net cash inflows of $29.0
million provided by changes in our operating assets and liabilities. Non-cash
charges primarily consisted of $18.3 million of stock compensation expense,
$16.7 million of amortization of deferred commissions and $11.4 million of
depreciation and amortization of our capital assets partially offset by a $5.8
million increase in additions to capitalized content due to continuous
improvements to our content. Cash inflows from changes in operating assets and
liabilities primarily relate to a $63.8 million increase in the total deferred
revenue balance resulting from the sale of additional subscription services
under our standard advanced invoicing practices and a $4.2 million increase in
accounts payable resulting from payment timing. These inflows were offset by
cash outflows from changes in operating assets and liabilities related to a $6.0
million increase in the total deferred commissions balance as we increase sales
to new customers and renew our existing contracts, a $9.9 million increase in
accounts receivable due to a substantial increase in sales close to the end of
quarter and a $5.1 million increase in the prepaid and other assets balance
primarily due to advanced payroll funding, renewed insurance policies for
directors and officers and future in-person marketing events.
Net cash provided by operating activities during the nine months ended September
30, 2021 was $55.8 million , which consisted of a net loss of $16.2 million ,
adjusted for non-cash charges of $42.8 million and net cash inflows of $29.3
million provided by changes in our operating assets and liabilities. Non-cash
charges primarily consisted of $13.8 million of amortization of deferred
commissions, $10.0 million of depreciation and amortization of our capital
assets and $23.2 million of stock compensation expense, which was primarily
incurred in conjunction with our IPO. Cash outflows from changes in operating
assets and liabilities primarily resulted from a $9.2 million increase in the
total deferred commissions balance, a $6.2 million increase in the total
accounts receivable balance and a $6.3 million increase in prepaid and other
assets. The increases in deferred commissions balance is due to the addition of
new customers and renewal of existing contracts during the period while the
increase in accounts receivable is due to the timing of billings and collections
combined with growth in sales. The increase in prepaid and other assets is due
to $3.1 million of assets held for the purposes of funding expanding operations
at our international subsidiaries and $2.6 million of prepayments made on
insurance policies for directors and officers taken out in conjunction with our
IPO. Cash inflows from changes in operating assets and liabilities primarily
relate to a $54.9 million increase in the total deferred revenue balance
resulting from the sale of additional subscription services under our standard
advanced invoicing practices and a $16.8 million increase in the accounts
payable and accrued expense balances due primarily to increases in payroll
related accruals resulting from payment timing and overall headcount growth.
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Investing Activities
Net cash used in investing activities during the nine months endedSeptember 30, 2022 related to the purchase of property and equipment for$4.5 million as we continue update our office space requirements and$2.7 million for the development of internal-use software as we develop new products and features, including our SecurityCoach product. We also purchased$3.4 million of investments during the period. Net cash used in investing activities during the nine months endedSeptember 30, 2021 primarily related to the$11.2 million of net cash paid for the acquisition ofMediaPro Holdings, LLC , completedMarch 1, 2021 , combined with$1.9 million and$2.2 million of capital expenditures for internal-use software and the purchase of property and equipment, respectively.
Financing Activities
Net cash provided by financing activities during the nine months endedSeptember 30, 2022 primarily related to$2.9 million of proceeds from the issuance of common stock under the employee stock purchase plan and$3.2 million of proceeds from the exercise of stock options, partially offset by$2.7 million of taxes paid for the net share settlement of equity awards that vested during the period. Net cash provided by financing activities during the nine months endedSeptember 30, 2021 primarily related to$156.0 million of net proceeds received from the issuance of common stock in connection with the IPO, as well as$3.4 million of cash received upon the exercise of stock options. These financing activities proceeds were offset by$11.9 million paid for taxes related to the net settlement of our outstanding equity instruments and$1.2 million paid to repurchase shares of our common stock, prior to the IPO.
Commitments and Contractual Obligations
There were no material changes to our commitments and contractual obligations during the nine months endedSeptember 30, 2022 . Refer to Note 15 "Commitments and Contingencies" to the consolidated financial statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details. In addition, under the Merger Agreement, we may in certain circumstances be obligated to pay a termination fee of$138.0 million . For more details, refer to the section titled "Pending Merger" in Note 17 "Subsequent Events" in the notes to the consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Current Report on Form 8-K filed with theSEC onOctober 13, 2022 , our preliminary proxy statement in connection with the solicitation of proxies to approve the Merger filed with theSEC onNovember 14, 2022 , as well as the definitive proxy statement and any other documents or materials related to the Merger we may file when they become available.
Indemnification Agreements
Our subscription agreements generally contain standard indemnification obligations. Pursuant to these agreements, we will indemnify, defend and hold the other party harmless with respect to a claim, suit, or proceeding brought against the other party by a third party alleging that our intellectual property infringes upon the intellectual property of the third party, or results from a breach of our representations and warranties or covenants, or that results from any acts of negligence or willful misconduct. The term of these indemnification agreements is generally perpetual any time after the execution of the agreement. Typically, these indemnification provisions do not provide for a maximum potential amount of future payments we could be required to make. However, in the past we have not been obligated to make significant payments for these obligations and no liabilities have been recorded for these obligations on our consolidated balance sheets as ofSeptember 30, 2022 orDecember 31, 2021 . We also indemnify our officers and directors for certain events or occurrences, subject to certain limits, while the officer is or was serving at our request in such capacity. The maximum amount of potential future indemnification is unlimited. However, our director and officer insurance policy limits our exposure and enables us to recover a portion of any future amounts paid. Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these obligations on our consolidated balances sheet as ofSeptember 30, 2022 orDecember 31, 2021 . 46
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Critical Accounting Policies and Estimates
Our management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements and notes to our financial statements, which were prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these estimates. Our significant accounting policies are more fully described in Note 2, "Summary of Significant Accounting Policies" of our consolidated financial statements. Our critical accounting policies and our more significant judgments and estimates used in the preparation of our consolidated financial statements are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 10, 2022 , and there have been no significant changes to these policies during the nine months endedSeptember 30, 2022 .
Recent Accounting Pronouncements
See Note 2 "Summary of Significant Accounting Policies" to our consolidated financial statements contained within this Quarterly Report on Form 10-Q for more information.
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