APPIAN CORP 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with (1) our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2021 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission, or SEC, on February 17, 2022. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would,” or the negative or plural of these words or similar expressions or variations, including statements regarding our future financial and operating performance, anticipated expansion of the usage of partners to perform professional services, the increase of our subscriptions revenue as a percentage of total revenue, the fluctuation of gross margin on a quarterly basis, and our future capital requirements. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions, and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein and those discussed in the section titled “Risk Factors,” set forth in Part I, Item 1A of our Annual Report on Form 10-K filed with the SEC on February 17, 2022 and in our other filings with the SEC. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview Appian is a unified platform for change. We accelerate customers’ businesses by discovering, designing, and automating their most important processes. The Appian Low-Code Platform combines the key capabilities needed to get work done faster, Process Mining + Workflow + Automation, in a unified low-code platform. Appian is open, enterprise grade, and trusted by industry leaders. Global organizations use our applications to improve customer experience, achieve operational excellence, and simplify global risk management and compliance. With our platform, organizations can rapidly and easily discover, design, and automate powerful, enterprise-grade workflows and custom applications through our intuitive, visual interface with little or no coding required. Our customers have used workflows and applications built on our platform to launch new business lines, automate vital employee workflows, manage complex trading platforms, accelerate drug development, and build global procurement systems. With our platform, decision makers can reimagine their products, services, processes, and customer interactions by removing much of the complexity and many of the challenges associated with traditional approaches to software development. We have generated the majority of our revenue from sales of subscriptions, which include (1) cloud subscriptions bundled with maintenance and support and hosting services and (2) term license subscriptions bundled with maintenance and support. Our subscription contracts are priced based primarily on the number of users who access and utilize the applications built on our platform or, alternatively, non-user based single application licenses. Our subscription contract terms generally vary from one to three years with most providing for payment in advance on an annual, quarterly, or monthly basis. Due to the variability of our billing terms and the episodic nature of our customers purchasing additional subscriptions, we do not believe changes in our deferred revenue in a given period are directly correlated with our revenue growth. We invested in our Customer Success organization to help ensure customers are able to build and deploy applications on our platform. We have several strategic partnerships, including with KPMG, Accenture, PwC, Infosys, Wipro, and Deloitte, for them to refer customers to us in order to purchase subscriptions and then our partners provide professional services directly to the customers using our platform. We intend to further grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. In addition, over time we expect professional services revenue as a percentage of total revenue to decline as we increasingly rely on strategic partners to help our customers deploy our software. We believe our 26 investment in professional services, including strategic partners building their practices around Appian, will drive increased adoption of our platform. Our customers include financial services, government, life sciences, insurance, manufacturing, energy, healthcare, telecommunications, and transportation organizations. Generally, our sales team targets its efforts to organizations with over 2,000 employees and $2 billion in annual revenue. Revenue from government agencies represented 18.2% of our total revenue in each of the three and six months ended June 30, 2022. This compares to revenue from government agencies of 19.8% and 20.4% of our total revenue in the three and six months ended June 30, 2021, respectively. No single end-customer accounted for more than 10% of our total revenue in the three and six months ended June 30, 2022 or 2021. We offer our platform globally. Our platform supports multiple languages to facilitate collaboration and address challenges in multinational organizations. In the three and six months ended June 30, 2022, 35.0% and 34.2%, respectively, of our total revenue was generated from customers outside of the United States as compared to 35.3% and 33.7% in the three and six months ended June 30, 2021, respectively. As of June 30, 2022, we operated in 13 countries. We believe we have a significant opportunity to continue to grow our international footprint, and we are investing in new geographies, including through investment in direct and indirect sales channels, professional services, and customer support and implementation partners. Our business model focuses on maximizing the lifetime value of customer relationships, which is a function of the duration of a customer’s deployment of our platform as well as the price and number of subscriptions of our platform that a customer purchases. We incur significant customer acquisition costs, including expenses associated with hiring new sales representatives, who can take anywhere from six months to a year to become productive given the length of our sales cycle, and marketing costs, all of which, with the exception of sales commissions, are expensed as incurred. Key Factors Affecting Our Performance The following are several key factors that affect our performance: • Market Adoption of Our Platform. Our ability to grow our customer base and drive market adoption of our platform is affected by the pace at which organizations digitally transform. We expect our revenue growth will be primarily driven by the pace of adoption and penetration of our platform. We offer a leading custom software platform and intend to continue to invest to expand our customer base. The degree to which prospective customers recognize the need for low-code software that enables organizations to digitally transform, and subsequently allocate budget dollars to purchase our software, will drive our ability to acquire new customers and increase sales to existing customers, which, in turn, will affect our future financial performance. • Growth of Our Customer Base. We believe we have a substantial opportunity to grow our customer base. We define a customer as an entity with an active subscription or maintenance and support contract as of the specified measurement date. Furthermore, we define a new customer as an entity that has entered into its first active subscription or maintenance and support contract within one calendar year of the specified measurement date while existing customers are defined as entities that have maintained an active subscription or maintenance and support contract for at least one calendar year from the specified measurement date. Legacy customers from entities acquired in business combinations are not counted as new customers until they enter into a new active subscription or maintenance and support contract with us subsequent to the completion of the business combination. Additionally, to the extent we contract with one or more entities under common control, we count those entities as separate customers. We have aggressively invested, and intend to continue to invest, in our sales team in order to drive sales to new customers. We continue to make investments to enhance the expertise of our sales and marketing organization within our key industry verticals of financial services, government, and life sciences. In addition, we have established relationships with strategic partners who work with organizations undergoing digital transformations. Our ability to continue to grow our customer base is dependent, in part, upon our ability to differentiate ourselves within the increasingly competitive markets in which we participate. • Further Penetration of Existing Customers. Our sales team seeks to generate additional revenue from existing customers by adding new users to our platform. Many of our customers begin by building a single application and then grow to build dozens of applications on our platform. Generally, the development of new applications on our platform 27 results in the expansion of our user base within an organization and a corresponding increase in revenue to us because we charge subscription fees on a per-user basis or through non-user based single application licenses. As a result of this “land and expand” strategy, we have generated significant additional revenue from our customer base. Our ability to increase sales to existing customers will depend on a number of factors, including the size of our sales and professional services teams, customers’ level of satisfaction with our platform and professional services, pricing, economic conditions, and our customers’ overall spending levels. We have also re-focused some of our professional services personnel to become customer success managers. Their role is to ensure the customer realizes value from our platform and support strategic partners and the “land and expand” strategy versus delivering billable hours. • Mix of Subscriptions and Professional Services Revenue. We believe our professional services have driven customer success and facilitated the adoption of our platform by customers. During the initial period of deployment by a customer, we generally provide a greater amount of support in building applications and training than later in the deployment, with a typical engagement extending from two to six months. At the same time, many of our customers have historically purchased subscriptions only for a limited set of their total potential end users. As a result of these factors, the proportion of total revenue for a customer associated with professional services is relatively high during the initial deployment period. Over time, as the need for professional services associated with user deployments decreases and the number of end users increases, we expect subscriptions revenue as a percentage of total revenue to increase. In addition, we continue to grow our base of strategic partners to provide broader customer coverage and solution delivery capabilities. These partners perform professional services with respect to any new service contracts they originate. As the usage of partners expands, we expect the proportion of our total revenue from subscriptions to increase over time relative to professional services. For the six months ended June 30, 2022 and June 30, 2021 71.5% and 70.2% of our revenue, respectively, was derived from sales of subscriptions while the remaining 28.5% and 29.8%, respectively, was derived from the sale of professional services. • Investments in Growth. We have made, and plan to continue to make, investments for long-term growth, including investment in our platform and infrastructure to continuously maximize their power and speed, to meet the evolving needs of our customers, and to take advantage of our market opportunity. In addition, we continue to pursue strategic acquisitions that enhance our product offerings. We also intend to continue to invest in sales and marketing as we further expand our sales teams, increase our marketing activities, and grow our international operations. Key Metrics We monitor the following metrics to help us measure and evaluate the effectiveness of our operations. All dollar amounts are presented in thousands. Cloud Subscription Revenue Three Months Ended June 30, Six Months Ended June 30, 2022 2021 % Change 2022 2021 % Change Cloud subscription revenue $ 57,083 $ 42,486 34 % $ 110,462 $ 81,539 35 % Cloud subscription revenue includes cloud subscriptions bundled with maintenance and support and hosting services. We generally sell our cloud subscriptions on a per-user basis or through non-user based single application licenses. As such, our cloud subscription revenue for any customer is primarily determined by the number of users who access and utilize the applications built on our platform or by the number of application licenses purchased, as well as the price paid. We believe increasing cloud subscription revenue is an indicator of the demand for our platform, the pace at which the market for our solutions is growing, the productivity of our sales team and strategic relationships in growing our customer base, and our ability to further penetrate our existing customer base. Cloud Subscription Revenue Retention Rate 28 As of June 30, 2022 2021 Cloud subscription revenue retention rate 116 % 121 % A key factor to our success is the renewal and expansion of subscription agreements with our existing customers. We calculate this metric over a set of customers who have been with us for at least one full year. To calculate our cloud subscription revenue retention rate for a particular trailing 12-month period, we first establish the recurring cloud subscription revenue for the previous trailing 12-month period. This effectively represents recurring dollars we should expect in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period without any expansion or contraction. We subsequently measure the recurring cloud subscription revenue in the current trailing 12-month period from the cohort of customers from the previous trailing 12-month period. Cloud subscription revenue retention rate is then calculated by dividing the aggregate recurring cloud subscription revenue in the current trailing 12-month period by the previous trailing 12-month period. This calculation includes the combined impact on our revenue from customer non-renewals, pricing changes, and growth in the number of users on our platform. Our cloud subscription revenue retention rate can fluctuate from period to period due to large customer contracts in any given period. Key Components of Results of Operations Revenue We generate revenue primarily through sales of subscriptions to our platform as well as professional services. We generally sell our software on a per-user basis or through non-user based single application licenses. We generally bill customers and collect payment for subscriptions to our platform in advance on an annual, quarterly, or monthly basis. In certain instances, we have had customers pay their entire contract value up front. Our revenue is comprised of the following: Subscriptions Subscriptions revenue is primarily derived from: • Cloud subscriptions bundled with maintenance and support and hosting services; and • On-premises term license subscriptions bundled with maintenance and support. Our maintenance and support agreements provide customers with the right to unspecified software upgrades, maintenance releases and patches released during the term of the maintenance and support agreement on a when-and-if-available basis, and rights to technical support. On-premises term license subscriptions are offered when the customer prefers to self-manage the deployment of our platform within their own infrastructure. When our platform is delivered as a cloud subscription, we manage their operational needs in third-party hosted data centers. Professional Services Our professional services revenue is comprised of fees for consulting services, including application development, deployment assistance, and training related to our platform. Over time, we expect professional services revenue as a percentage of total revenue to decrease as the usage of our partner network expands. Cost of Revenue Subscriptions Cost of subscriptions revenue consists primarily of fees paid to our third-party managed hosting providers and other third-party service providers, personnel costs, including payroll and benefits for our technology operations and customer support 29 teams, and allocated overhead costs. We expect cost of revenue to continue to increase in absolute dollars for the foreseeable future as our customer base grows. Professional Services Cost of professional services revenue includes all direct and indirect costs to deliver our professional services and training, including employee compensation for our global professional services and training personnel, third-party contractor costs, allocated overhead costs, and the costs of billable expenses such as travel and lodging. The unpredictability of the timing of entering into significant professional services agreements sold on a standalone basis may cause significant fluctuations in our cost of professional services which, in turn, may impact our quarterly financial results and allocated overhead costs. Gross Profit and Gross Margin Gross profit and gross margin (defined as gross profit as a percentage of total revenue), have been, and will continue to be, affected by various factors, including the mix of cloud subscriptions and on-premises term license subscriptions, the mix of total subscriptions revenue and professional services revenue, subscription pricing, the costs associated with third-party hosting providers, and the extent to which we expand our professional services to support future growth. Our gross margin may fluctuate from period to period based on the above factors. Subscriptions Gross Margin Subscriptions gross margin is primarily affected by the growth in our subscriptions revenue as compared to the growth in, and timing of, costs to support such revenue. We expect to continue to invest in customer support and cloud operations to support growth in our business, and the timing of those investments is expected to cause subscriptions gross margin to fluctuate on a quarterly basis. Professional Services Gross Margin Professional services gross margin is affected by the growth in our professional services revenue as compared to the growth in, and timing of, the cost of our Customer Success organization as we continue to invest in the growth of our business. Professional services gross margin is also impacted by the amount of services performed by subcontractors and partners as opposed to internal resources. At the outset of the COVID-19 pandemic, we lowered our usage of subcontractors and performed in fewer in-person professional services engagements and deployments, both of which reduced certain classes of expenses and improved professional services margins. In 2021 and continuing into 2022, these margins have declined but remain subject to fluctuation based on the factors discussed above and uncertainties related to the COVID-19 pandemic outside of our control. Operating Expenses Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Personnel-related costs such as salaries, bonuses, commissions, payroll tax payments, and stock-based compensation expense are the most significant components of each of these expense categories. Other components of each category include professional fees for third-party services such as contract labor, legal, development resources, and consulting as well as allocated facility and overhead, which can include, among other types of costs, travel and entertainment expenditures, human resources costs such as placement fees, referral bonuses, training costs, and employee relations spending, office-related expenditures, and information technology costs for such items as infrastructure, software, and cloud computing services. In general, our operating expenses are expected to continue to increase in absolute dollars as we invest resources in growing our various teams. Sales and Marketing Expense Sales and marketing expense primarily includes personnel costs, including salaries, bonuses, commissions, stock-based compensation, and other personnel costs related to sales teams. Additional expenses in this category include travel and entertainment, marketing activities and promotional events, subcontracting fees, and allocated overhead costs. 30 In order to continue to grow our business, geographical footprint, and brand awareness, we expect to continue investing resources in sales and marketing by increasing the number of sales and account management teams. Additionally, as the COVID-19 pandemic improves and certain restrictions are loosened, we would expect certain classes of expense such as travel and entertainment and in-person marketing events to increase relative to recent years. As a result, we expect sales and marketing expense to increase in absolute dollars as we continue to invest to acquire new customers and further expand usage of our platform within our existing customer base. Research and Development Expense Research and development expense consists primarily of personnel costs for our employees who develop and enhance our platform, including salaries, bonuses, stock-based compensation, and other personnel costs. Also included are non-personnel costs such as subcontracting, consulting and professional fees to third party development resources, allocated facility costs, and overhead. Our research and development efforts are focused on enhancing the speed and power of our software platform. We expect research and development expense to continue to increase in absolute dollars as such costs are critical to maintain and improve the quality of applications and our competitive position. General and Administrative Expense General and administrative expense consists primarily of personnel costs, including salaries, bonuses, stock-based compensation, and other personnel costs for our administrative, legal, information technology, human resources, finance, and accounting, as well as our senior executives. Additional expenses included in this category are non-personnel costs such as travel-related expenses, contracting and professional fees for such services as audits, taxation, and legal, insurance and other corporate expenses, including allocated overhead costs, bad debt expenses, and amortization of intangible assets. Absent certain non-recurring legal expenses incurred in 2022 and prior years, we expect our general and administrative expense to increase in absolute dollars as we continue to support our growth. Other Non-Operating Expense Other Expense, Net Other expense, net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates, interest income on our cash and cash equivalents and investments, and other sources of income or expense not related to our core business operations. Interest Expense Interest expense consists primarily of unused credit facility fees and commitment fees on our letters of credit. 31 Results of Operations The following table sets forth our consolidated statements of operations data (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Revenue Subscriptions $ 76,668 $ 56,946 $ 160,388 $ 120,712 Professional services 33,395 26,053 63,941 51,142 Total revenue 110,063 82,999 224,329 171,854 Cost of revenue Subscriptions (1) 8,528 6,860 16,751 12,714 Professional services (1) 24,765 18,975 47,563 36,650 Total cost of revenue 33,293 25,835 64,314 49,364 Gross profit 76,770 57,164 160,015 122,490 Operating expenses Sales and marketing (1) 56,166 40,520 102,192 76,504 Research and development (1) 33,842 23,862 63,778 44,552 General and administrative (1) 29,509 17,358 60,658 36,500 Total operating expenses 119,517 81,740 226,628 157,556 Operating loss (42,747) (24,576) (66,613) (35,066) Other non-operating expense (income) Other expense (income), net 6,153 (1,081) 6,940 1,812 Interest expense 60 80 134 161 Total other non-operating expense (income) 6,213 (1,001) 7,074 1,973 Loss before income taxes (48,960) (23,575) (73,687) (37,039) Income tax expense (benefit) 394 250 (1,179) 373 Net loss $ (49,354) $ (23,825) $ (72,508) $ (37,412) (1) Stock-based compensation as a component of these line items is as follows: Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Cost of revenue Subscriptions $ 249 $ 295 $ 428 $ 592 Professional services 1,330 865 2,387 1,506 Operating expenses Sales and marketing 2,266 1,197 4,054 2,305 Research and development 3,063 1,069 5,377 2,084 General and administrative 2,240 1,172 3,845 6,005 Total stock-based compensation expense $ 9,148 $ 4,598 $ 16,091 $ 12,492 32 The following table sets forth our consolidated statements of operations data expressed as a percentage of total revenue: Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Revenue Subscriptions 69.7 % 68.6 % 71.5 % 70.2 % Professional services 30.3 31.4 28.5 29.8 Total revenue 100.0 100.0 100.0 100.0 Cost of revenue Subscriptions 7.7 8.3 7.5 7.4 Professional services 22.5 22.9 21.2 21.3 Total cost of revenue 30.2 31.1 28.7 28.7 Gross profit 69.8 68.9 71.3 71.3 Operating expenses Sales and marketing 51.0 48.8 45.6 44.5 Research and development 30.7 28.7 28.4 25.9 General and administrative 26.8 20.9 27.0 21.2 Total operating expenses 108.6 98.5 101.0 91.7 Operating loss (38.8) (29.6) (29.7) (20.4) Other non-operating expense (income) Other expense (income), net 5.6 (1.3) 3.1 1.1 Interest expense 0.1 0.1 0.1 0.1 Total other non-operating expense (income) 5.6 (1.2) 3.2 1.1 Loss before income taxes (44.5) (28.4) (32.8) (21.6) Income tax expense (benefit) 0.4 0.3 (0.5) 0.2 Net loss (44.8) % (28.7) % (32.3) % (21.8) % Comparison of the Three Months Ended June 30, 2022 and 2021 Revenue Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Revenue Subscriptions $ 76,668 $ 56,946 $ 19,722 34.6 % Professional services 33,395 26,053 7,342 28.2 % Total revenue $ 110,063 $ 82,999 $ 27,064 32.6 % Total revenue increased $27.1 million, or 32.6%, in the three months ended June 30, 2022 compared to the same period in 2021 due to an increase in our subscriptions revenue of $19.7 million and an increase in our professional services revenue of $7.3 million. The increase in subscriptions revenue was driven largely by a $14.6 million increase in cloud subscription revenue and a $4.7 million increase in on-premises subscription revenue. With respect to new versus existing customers, there was a $13.4 million increase in subscriptions revenue stemming from expanded deployments and corresponding sales of additional subscriptions to existing customers while $6.3 million of the increase was the result of sales of subscriptions to new customers. The remainder of the increase is attributable to revenue recognized from Lana Labs. The increase in professional services revenue was due primarily to a $7.9 million increase in sales to new customers, which was partially offset by a $0.6 million decrease in revenue from existing customers. Professional services revenue was also impacted by the level of usage of partners to perform professional services in the three months ended June 30, 2022 as compared to the same period in 2021. 33 Cost of Revenue Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Cost of revenue Subscriptions $ 8,528 $ 6,860 $ 1,668 24.3 % Professional services 24,765 18,975 5,790 30.5 % Total cost of revenue $ 33,293 $ 25,835 $ 7,458 28.9 % Subscriptions gross margin 88.9 % 88.0 % Professional services gross margin 25.8 % 27.2 % Total gross margin 69.8 % 68.9 % Cost of revenue increased $7.5 million, or 28.9%, in the three months ended June 30, 2022 compared to the same period in 2021, primarily due to a $4.8 million increase in professional services and product support personnel costs, a $0.9 million increase in hosting costs, a $0.7 million increase in contractor costs, a $0.6 million increase in overhead costs, and a $0.5 million increase in travel and entertainment expenses. Personnel costs increased due to an increase in professional services and product support personnel headcount of 17.0% from June 30, 2021 to June 30, 2022, coupled with a $0.4 million increase in stock-based compensation. Hosting costs increased as sales of our cloud offering increased in the three months ended June 30, 2022. Contractor costs increased in the three months ended June 30, 2022 compared to the same period in 2021 due to an increase in the usage of subcontractors and consultants for professional services engagements. The increase in overhead costs was due largely to an increase in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Subscriptions gross margin slightly increased to 88.9% for the three months ended June 30, 2022 compared to 88.0% in the same period in 2021 due to an increase in subscriptions revenue during the three months ended June 30, 2022 as compared to the three months ended June 30, 2021. This increase was partially offset by an increase in hosting costs as sales of our cloud offering increased and became a larger proportion of our overall subscriptions revenue. Professional services gross margin decreased to 25.8% for the three months ended June 30, 2022 compared to 27.2% in the same period in 2021 due largely to higher personnel and other allocated costs such as human resources, information technology, and office-related spending in the comparable periods, partially offset by an increase in professional services revenue. Furthermore, fewer in-person professional services engagements and deployments during the three months ended June 30, 2021 as compared to the three months ended June 30, 2022 led to temporarily improved margins in the prior year. Gross margin rose slightly to 69.8% in the three months ended June 30, 2022 as compared to 68.9% in the same period in 2021, due largely to the increase in professional services revenue and improved subscriptions margins. Sales and Marketing Expense Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Sales and marketing $ 56,166 $ 40,520 $ 15,646 38.6 % % of revenue 51.0 % 48.8 % Sales and marketing expense increased $15.6 million, or 38.6%, in the three months ended June 30, 2022 compared to the same period in 2021, primarily due to an $8.0 million increase in sales and marketing personnel costs, a $4.4 million increase in marketing costs, and a $3.4 million increase in overhead costs, which were partially offset by a $0.2 million decrease in professional fees. Personnel costs increased due to an increase in sales and marketing personnel headcount of 19.2% from June 30, 2021 to June 30, 2022, a $1.2 million increase in commissions expense due to increased sales, and a $1.1 million increase in stock-based compensation expense. Marketing costs increased due to an increase in the number of marketing events held during the three months ended June 30, 2022 as compared to the three months ended June 30, 2021, including spending on 34 our annual user conference Appian World, which resumed its in-person format in April 2022. Additionally, marketing costs increased due to an increase in spending on advertising campaigns. Overhead costs increased due to increases in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Additionally, travel and entertainment expenses increased due to a higher number of in-person engagements and events relative to the prior year. Professional fees decreased due to a decrease in the use of third-party sales and marketing consultants for certain initiatives. Research and Development Expense Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Research and development $ 33,842 $ 23,862 $ 9,980 41.8 % % of revenue 30.7 % 28.7 % Research and development expense increased $10.0 million, or 41.8%, in the three months ended June 30, 2022 compared to the same period in 2021, primarily due to an $8.5 million increase in research and development personnel costs, a $1.4 million increase in overhead costs, and a $0.1 million increase in professional fees. Personnel costs increased due to an increase in research and development personnel headcount of 32.2% from June 30, 2021 to June 30, 2022, coupled with a $2.0 million increase in stock-based compensation expense. Overhead costs increased due to increases in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Professional fees increased due to an increase in consulting fees stemming from higher usage of external resources to assist in our platform development efforts. General and Administrative Expense Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) General and administrative expense $ 29,509 $ 17,358 $ 12,151 70.0 % % of revenue 26.8 % 20.9 % General and administrative expense increased $12.2 million, or 70.0%, in the three months ended June 30, 2022 compared to the same period in 2021, primarily due to a $6.2 million increase in professional fees, a $3.2 million increase in overhead costs, and a $2.7 million increase in general and administrative personnel costs. Professional fees increased due to higher legal fees incurred in connection with two separate lawsuits, one involving an effort to enforce our intellectual property and one involving reciprocal false advertising and related claims with a competitor. Refer to Item 1. Legal Proceedings, within Part II of this Form 10-Q for further information. Overhead costs increased primarily due to an increase in certain allocated costs tied to our growth such as insurance premiums, information technology spending, human resources costs, and office-related expenses. Personnel costs increased due to an increase in general and administrative personnel headcount of 27.4% from June 30, 2021 to June 30, 2022 as well as a $1.1 million increase in stock-based compensation. Other Non-Operating Expense (Income), Net Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Other expense (income), net $ 6,153 $ (1,081) $ 7,234 *** % of revenue 5.6 % (1.3) % *** Indicates a percentage that is not meaningful. 35 Other expense (income), net was $6.2 million in the three months ended June 30, 2022 compared to other income, net of $1.1 million in the three months ended June 30, 2021. This change was primarily due to $6.5 million in foreign exchange losses in the three months ended June 30, 2022 as compared to $1.0 million in foreign exchange gains in the three months ended June 30, 2021. The primary reason for the increase in foreign exchange losses was the strengthening of the U.S. dollar against the British pound, Euro, and Swiss franc. Interest Expense Three Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Interest expense $ 60 $ 80 $ (20) (25.0) % % of revenue 0.1 % 0.1 % Interest expense decreased by a nominal amount in the three months ended June 30, 2022 compared to the same period in 2021, primarily due to lower commitment fees on the letters of credit outstanding. Comparison of the Six Months Ended June 30, 2022 and 2021 Revenue Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Revenue Subscriptions $ 160,388 $ 120,712 $ 39,676 32.9 % Professional services 63,941 51,142 12,799 25.0 % Total revenue $ 224,329 $ 171,854 $ 52,475 30.5 % Total revenue increased $52.5 million, or 30.5%, in the six months ended June 30, 2022 compared to the same period in 2021 due to an increase in our subscriptions revenue of $39.7 million and an increase in our professional services revenue of $12.8 million. The increase in subscriptions revenue was driven largely by a $28.9 million increase in cloud subscription revenue, a $9.6 million increase in on-premises subscription revenue, and a $1.2 million increase in maintenance and support revenues. With respect to new versus existing customers, there was a $27.3 million increase in subscriptions revenue stemming from expanded deployments and corresponding sales of additional subscriptions to existing customers while $12.2 million of the increase was the result of sales of subscriptions to new customers. The remainder of the increase is attributable to revenue recognized from Lana Labs. The increase in professional services revenue was due primarily to a $13.9 million increase in sales to new customers, which was partially offset by a $1.1 million decrease in revenue from existing customers. Professional services revenue was also impacted by the level of usage of partners to perform professional services in the six months ended June 30, 2022 as compared to the same period in 2021. 36 Cost of Revenue Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Cost of revenue Subscriptions $ 16,751 $ 12,714 $ 4,037 31.8 % Professional services 47,563 36,650 10,913 29.8 % Total cost of revenue $ 64,314 $ 49,364 $ 14,950 30.3 % Subscriptions gross margin 89.6 % 89.5 % Professional services gross margin 25.6 % 28.3 % Total gross margin 71.3 % 71.3 % Cost of revenue increased $15.0 million, or 30.3%, in the six months ended June 30, 2022 compared to the same period in 2021, primarily due to a $9.9 million increase in professional services and product support personnel costs, a $2.5 million increase in hosting costs, a $1.1 million increase in overhead costs, a $0.8 million increase in contractor costs, and a $0.6 million increase in travel and entertainment expenses. Personnel costs increased due to an increase in professional services and product support personnel headcount of 17.0% from June 30, 2021 to June 30, 2022, coupled with a $0.7 million increase in stock-based compensation. Hosting costs increased as sales of our cloud offering increased in the six months ended June 30, 2022. The increase in overhead costs was due largely to an increase in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Contractor costs increased in the six months ended June 30, 2022 compared to the same period in 2021 due to an increase in the usage of subcontractors and consultants for professional services engagements. Subscriptions gross margin was 89.6% for the six months ended June 30, 2022, consistent with a margin of 89.5% in the same period in 2021. As sales of our cloud offering increased and became a larger proportion of our overall subscriptions revenue, hosting costs increased. However, this increase in hosting costs was offset by an increase in subscriptions revenue. Professional services gross margin decreased to 25.6% for the six months ended June 30, 2022 compared to 28.3% in the same period in 2021 due largely to higher personnel and human resources costs in the current year, partially offset by an increase in professional services revenue. Furthermore, fewer in-person professional services engagements and deployments during the six months ended June 30, 2021 as compared to the six months ended June 30, 2022 led to temporarily improved margins in the prior year. Based on the above offsetting factors, gross margin remained consistent at 71.3% for both the six months ended June 30, 2022 and June 30, 2021. Sales and Marketing Expense Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Sales and marketing $ 102,192 $ 76,504 $ 25,688 33.6 % % of revenue 45.6 % 44.5 % Sales and marketing expense increased $25.7 million, or 33.6%, in the six months ended June 30, 2022 compared to the same period in 2021, primarily due to a $15.0 million increase in sales and marketing personnel costs, a $6.3 million increase in overhead costs, and a $5.1 million increase in marketing costs, which were partially offset by a $0.7 million decrease in professional fees. Personnel costs increased due to an increase in sales and marketing personnel headcount of 19.2% from June 30, 2021 to June 30, 2022, increased sales commissions driven by our revenue growth, and a $1.7 million increase in stock-based compensation expense. Overhead costs increased due to increases in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Additionally, travel and entertainment expenses increased due to a higher number of in-person engagements and events relative to the prior year. Marketing costs increased due to an increase in the number of marketing events held during the six months ended June 30, 2022 as compared to the six months ended June 30, 2021, including spending on our annual user conference Appian World, which 37 resumed its in-person format in April 2022. Additionally, marketing costs increased due to an increase in spending on advertising campaigns. Professional fees decreased due to a decrease in the use of third-party sales and marketing consultants for certain initiatives. Research and Development Expense Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Research and development $ 63,778 $ 44,552 $ 19,226 43.2 % % of revenue 28.4 % 25.9 % Research and development expense increased $19.2 million, or 43.2%, in the six months ended June 30, 2022 compared to the same period in 2021, primarily due to a $15.8 million increase in research and development personnel costs, a $2.5 million increase in overhead costs, and a $0.8 million increase in professional fees. Personnel costs increased due to an increase in research and development personnel headcount of 32.2% from June 30, 2021 to June 30, 2022, coupled with a $3.3 million increase in stock-based compensation expense. Overhead costs increased due to increases in certain allocated costs tied directly to our growth such as spending for offices, human resources costs, and information technology infrastructure. Professional fees increased due to an increase in consulting fees stemming from higher usage of external resources to assist in our platform development efforts. General and Administrative Expense Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) General and administrative expense $ 60,658 $ 36,500 $ 24,158 66.2 % % of revenue 27.0 % 21.2 % General and administrative expense increased $24.2 million, or 66.2%, in the six months ended June 30, 2022 compared to the same period in 2021, primarily due to a $16.9 million increase in professional fees, a $6.0 million increase in overhead costs, and a $1.2 million increase in general and administrative personnel costs. Professional fees increased due to higher legal fees incurred in connection with two separate lawsuits, one involving an effort to enforce our intellectual property and one involving reciprocal false advertising and related claims with a competitor. Refer to Item 1. Legal Proceedings, within Part II of this Form 10-Q for further information. Overhead costs increased primarily due to an increase in certain allocated costs tied to our growth such as insurance premiums, information technology spending, human resources costs, and office-related expenses. Personnel costs increased due to an increase in general and administrative personnel headcount of 27.4% from June 30, 2021 to June 30, 2022. This increase was partially offset by a $2.2 million decrease in stock-based compensation, driven by the accelerated recognition of expense pursuant to the vesting of the 2019 CEO grant during the six months ended June 30, 2021. Other Non-Operating Expense, Net Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Other expense, net $ 6,940 $ 1,812 $ 5,128 *** % of revenue 3.1 % 1.1 % *** Indicates a percentage that is not meaningful. Other expense, net was $6.9 million in the six months ended June 30, 2022 compared to other expense, net of $1.8 million in the six months ended June 30, 2021. This change was primarily due to $8.4 million in foreign exchange losses in the six 38 months ended June 30, 2022 as compared to $2.0 million in foreign exchange losses in the six months ended June 30, 2021. The primary reason for the increase in foreign exchange losses was the strengthening of the U.S. dollar against the British pound, Euro, and Swiss franc. Interest Expense Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Interest expense $ 134 $ 161 $ (27) (16.8) % % of revenue 0.1 % 0.1 % Interest expense decreased by a nominal amount in the six months ended June 30, 2022 compared to the same period in 2021, primarily due to lower commitment fees on the letters of credit outstanding. Liquidity and Capital Resources The following table presents selected financial information and statistics pertaining to liquidity and capital resources as of June 30, 2022 and December 31, 2021: As of June 30, 2022 December 31, 2021 Cash and cash equivalents $ 76,185 $ 100,796 Short-term investments and marketable securities 59,748 55,179 Property and equipment, net 38,539 36,913 Long-term investments 2,022 12,044 Working capital* 102,338 121,752 * Defined as current assets net of current liabilities, excluding the current portion of restricted cash As of June 30, 2022, we had $76.2 million of cash and cash equivalents and $59.7 million of short-term investments and marketable securities. We believe our existing cash and cash equivalents and short-term investments and marketable securities, together with any positive cash flows from operations and available borrowings under our line of credit, will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. We expect future sources of funds to consist primarily of cash generated from sales of subscriptions and the related professional services. We may also elect to raise additional sources of funding through draws on our existing line of credit, entering into new debt financing arrangements, or conducting additional public offerings. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and functions as well as platform enhancements and professional services offerings, and the level of market acceptance of our applications. In the event additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. To the extent existing cash and cash equivalents, short-term investments and cash from operations are not sufficient to fund future activities, we may need to raise additional funds. We may seek to raise additional funds through equity, equity-linked, or debt financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness may have rights that are senior to holders of our equity securities and could contain covenants that restrict operations. Any additional equity financing may be dilutive to our existing stockholders. We recently have, and in the future may enter into, investments in or acquisitions of complementary businesses, products, or technologies, which could also require us to seek additional equity financing, incur indebtedness, or use cash resources. We have no present binding agreements or commitments to enter into any such acquisitions. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected. 39 Sources of Funds Since becoming a public company in 2017, we have financed our operations in large part with equity financing arrangements, including net proceeds of $77.8 million from our initial public offering in May 2017, net proceeds of $57.8 million from our underwritten public offering in August 2018, net proceeds of $101.3 million from our underwritten public offering in September 2019, and net proceeds of $107.9 million from our underwritten public offering in June 2020. In addition, we have financed our operations through sales of subscriptions and professional services. We have a $20.0 million revolving line of credit with a lender that matures in November 2025. In January 2022, we executed the second loan modification agreement to increase the aggregate amount of funds our foreign subsidiaries are allowed to maintain outside of the United States. We were in compliance with all covenants as of June 30, 2022. As of June 30, 2022, we had no outstanding borrowings under this revolving line of credit, and we had outstanding letters of credit totaling $11.0 million in connection with securing our leased office space. Uses of Funds Our current principal uses of cash are funding operations and other working capital requirements. Historically, we have also utilized cash to pay for the acquisition of businesses that were complementary to ours, and we may pursue similar opportunities in the future. Over the past several years, revenue has increased significantly from year to year and, as a result, cash flows from customer collections have also grown. However, as we continue to invest in growing our business, operating expenses have also increased. Outside of cash used in operations, other uses of cash in 2022 to date have included capital expenditures related to the expansion of our headquarters. Non-operating cash uses in the prior year through June 30, 2021 also consisted primarily of modest capital expenditures. Furthermore, in 2021 we executed a non-cancellable cloud hosting arrangement with Amazon Web Services that contains provisions for minimum purchase commitments. Purchase commitments under the agreement total $131.0 million over five years, including $22.0 million in the first year, $25.0 million in the second year, and $28.0 million in each of the third, fourth, and fifth years. The timing of payments under the agreement may vary, and the total amount of payments may exceed the minimum depending on the volume of services utilized. Spending under this agreement for the six months ended June 30, 2022 totaled $15.9 million. Historical Cash Flows Six Months Ended June 30, 2022 2021 $ Change % Change (dollars in thousands) Beginning cash, cash equivalents, and restricted cash $ 103,960 $ 112,462 $ (8,502) (7.6) % Operating activities: Net loss (72,508) (37,412) (35,096) 93.8 Stock-based compensation and other non-cash adjustments 18,361 14,910 3,451 23.1 Changes in working capital 3,886 13,129 (9,243) (70.4) Net cash used by operating activities (50,261) (9,373) (40,888) *** Investing activities: Net cash provided by investing activities 574 26,577 (26,003) (97.8) Financing activities: Net cash provided by financing activities 25,030 2,089 22,941 *** Effect of exchange rates (205) (476) 271 (56.9) Net change in cash (24,862) 18,817 (43,679) *** Ending cash, cash equivalents, and restricted cash $ 79,098 $ 131,279 (52,181) (39.7) *** Indicates a percentage that is not meaningful. 40 Operating Activities Net cash used by operating activities was $50.3 million for the six months ended June 30, 2022 as compared to $9.4 million used by operating activities for the six months ended June 30, 2021. The increase in net cash used by operating activities was primarily due to a $35.1 million increase in net losses, most notably driven by the increase in operating expenses as discussed above. In addition, the increase in cash used by operating activities for the six months ended June 30, 2022 was attributed to a decline in cash flows from working capital of $9.2 million. This change from working capital is comprised primarily of a $7.7 million decrease in accrued compensation and related benefits and a $5.6 million increase in prepaid expenses and other assets was driven by higher prepayments under the AWS cloud hosting arrangement. Investing Activities Net cash provided by investing activities was $0.6 million for the six months ended June 30, 2022 as compared to $26.6 million provided by investing activities for the six months ended June 30, 2021. The decrease in net cash provided by investing activities was primarily due to $31.2 million in purchases of investments for the six months ended June 30, 2022 and a $3.7 million increase in capital expenditures year over year, partially offset by an $8.9 million increase in proceeds from the sale of investments. Financing Activities Net cash provided by financing activities was $25.0 million for the six months ended June 30, 2022 as compared to $2.1 million provided by financing activities for the six months ended June 30, 2021. The increase in net cash provided by financing activities was primarily due to $23.8 million in proceeds received from the exercise of the 2019 CEO stock option during the six months ended June 30, 2022. Critical Accounting Estimates There have been no material changes in our critical accounting policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022. We are not aware of any specific events or circumstances that would require us to update our estimates, assumptions, and judgments. Recent Accounting Pronouncements See Note 2 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements. 41