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, 2022 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission, or SEC, on February 16, 2023. 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, our future capital requirements, and our ability to meet our financial covenants under our Credit Agreement. 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 16, 2023 and in our other filings with the SEC. Forward-looking statements should not be relied on 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 software company that automates business processes. The Appian AI Process Platform includes everything you need to design, automate, and optimize even the most complex processes, from start to finish. The world's most innovative organizations trust Appian to improve their workflows, unify data, and optimize operations—resulting in better growth and superior customer experiences. 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 have 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, EY, Infosys, Wipro, and Deloitte, which allow them to refer customers to us in order to purchase subscriptions. Our partners then provide professional services directly to the customers using our platform. We intend to continue our focus on adding new customers with our strategic partners. In addition, over time we expect our 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 investment in professional services, including strategic partners building their practices around Appian, will drive increased adoption of our platform. Our customers primarily include financial services, government, life sciences, insurance, manufacturing, energy, healthcare, telecommunications, and transportation organizations. Generally, our sales team targets its efforts to 26 organizations with over 2,000 employees and $2 billion in annual revenue. Revenue from government agencies represented 21.1% and 20.6% of our total revenue for the three and nine months ended September 30, 2023, respectively, as compared to 21.2% and 19.2% of our total revenue for the three and nine months ended September 30, 2022, respectively. No single end-customer accounted for more than 10% of our total revenue in the three and nine months ended September 30, 2023 or 2022. We offer our platform globally. Our platform supports multiple languages to facilitate collaboration and address challenges in multinational organizations. In the three and nine months ended September 30, 2023, 35.3% and 35.6%, respectively, of our total revenue was generated from customers outside of the United States as compared to 31.3% and 33.2% in the three and nine months ended September 30, 2022, respectively. As of September 30, 2023, we operated in 16 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 which, with the exception of certain types 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 our platform, 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 or a legacy perpetual license 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 results in the expansion of our user base within an organization and a 27 corresponding increase in revenue. 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 customers realize value from our platform and to 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 lasting 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 nine months ended September 30, 2023 and 2022, 74.1% and 72.2% of our revenue, respectively, was derived from sales of subscriptions while the remaining 25.9% and 27.8%, 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 investing in our platform and infrastructure to continuously maximize their power and speed, meet the evolving needs of our customers, and take advantage of our market opportunity. In addition, we may 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 September 30, Nine Months Ended September 30, 2023 2022 % Change 2023 2022 % Change Cloud subscription revenue $ 77,247 $ 60,621 27.4 % $ 221,381 $ 171,083 29.4 % Cloud subscription revenue includes cloud subscriptions bundled with maintenance and support and hosting services. 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. 28 Cloud Subscription Revenue Retention Rate As of September 30, 2023 2022 Cloud subscription revenue retention rate 117 % 115 % 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 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. Revenue 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 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 teams, amortization of developed technology, 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. 29 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 providing services related to 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. 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, as well as by consultant utilization rates. Professional services gross margin is also impacted by the amount of services performed by subcontractors and partners as opposed to internal resources. In 2023, we expect professional services gross margin to be consistent with 2022; however, the margin remains subject to fluctuation based on the factors discussed above. 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 operating expense category include professional fees for third-party services such as contract labor, legal, software development resources, and consulting. In addition, operating expenses include allocated overhead costs, which are primarily comprised of facility costs, travel and entertainment expenditures, certain human resources costs (referral bonuses, training costs, and employee relations spending), office-related expenditures, and certain information technology costs (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 although at a more measured rate than prior years. 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 major 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, we 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, and allocated overhead costs. Our research and development efforts are focused on enhancing the capabilities, speed, and power of our software platform. In 2022, we opened a new product development center in India. Although 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, we believe our new product development center will result in cost savings over time. 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 teams 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, and bad debt expenses. In 2023, we expect our general and administrative expense to decrease in absolute dollars largely due to an anticipated decline in legal costs, partially offset by amortization expense associated with the judgment preservation insurance (see Note 12 to the Condensed Consolidated Financial Statements for further discussion). Other Non-Operating (Income) Expense Other (Income) Expense, Net Other (income) expense, net consists primarily of 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 interest on our debt, amortization of deferred financing fees, 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 (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Revenue Subscriptions $ 103,803 $ 86,520 $ 296,554 $ 246,908 Professional services 33,291 31,356 103,490 95,297 Total revenue 137,094 117,876 400,044 342,205 Cost of revenue Subscriptions (1) 11,265 9,313 32,492 26,065 Professional services (1) 24,804 24,447 76,515 72,011 Total cost of revenue 36,069 33,760 109,007 98,076 Gross profit 101,025 84,116 291,037 244,129 Operating expenses Sales and marketing (1) 55,667 54,912 181,338 157,104 Research and development (1) 37,135 37,623 118,502 101,401 General and administrative (1) 23,440 29,357 82,342 90,014 Total operating expenses 116,242 121,892 382,182 348,519 Operating loss (15,217) (37,776) (91,145) (104,390) Other non-operating expense Other expense (income), net 1,939 5,876 (4,637) 12,815 Interest expense 4,917 89 12,790 222 Total other non-operating expense 6,856 5,965 8,153 13,037 Loss before income taxes (22,073) (43,741) (99,298) (117,427) Income tax expense (benefit) 178 255 2,137 (924) Net loss $ (22,251) $ (43,996) $ (101,435) $ (116,503) (1) Stock-based compensation as a component of these line items is as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Cost of revenue Subscriptions $ 211 $ 284 $ 713 $ 712 Professional services 1,535 1,401 4,598 3,788 Operating expenses Sales and marketing 3,245 2,667 8,462 6,721 Research and development 2,930 3,454 9,466 8,831 General and administrative 3,090 3,530 9,976 7,375 Total stock-based compensation expense $ 11,011 $ 11,336 $ 33,215 $ 27,427 32 The following table sets forth our consolidated statements of operations data expressed as a percentage of total revenue: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Revenue Subscriptions 75.7 % 73.4 % 74.1 % 72.2 % Professional services 24.3 26.6 25.9 27.8 Total revenue 100.0 100.0 100.0 100.0 Cost of revenue Subscriptions 8.2 7.9 8.1 7.6 Professional services 18.1 20.7 19.1 21.0 Total cost of revenue 26.3 28.6 27.2 28.7 Gross profit 73.7 71.4 72.8 71.3 Operating expenses Sales and marketing 40.6 46.6 45.3 45.9 Research and development 27.1 31.9 29.6 29.6 General and administrative 17.1 24.9 20.6 26.3 Total operating expenses* 84.8 103.4 95.5 101.8 Operating loss (11.1) (32.0) (22.8) (30.5) Other non-operating expense Other expense (income), net 1.4 5.0 (1.2) 3.7 Interest expense 3.6 0.1 3.2 0.1 Total other non-operating expense 5.0 5.1 2.0 3.8 Loss before income taxes (16.1) (37.1) (24.8) (34.3) Income tax expense (benefit) 0.1 0.2 0.5 (0.3) Net loss (16.2) % (37.3) % (25.4) % (34.0) % * Totals may not foot due to rounding. Comparison of the Three Months Ended September 30, 2023 and 2022 Revenue Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Revenue Subscriptions $ 103,803 $ 86,520 $ 17,283 20.0 % Professional services 33,291 31,356 $ 1,935 6.2 % Total revenue $ 137,094 $ 117,876 $ 19,218 16.3 % Total revenue increased $19.2 million, or 16.3%, in the three months ended September 30, 2023 compared to the same period in 2022 due to an increase in our subscriptions revenue of $17.3 million and an increase in our professional services revenue of $1.9 million. The increase in subscriptions revenue was driven by a $16.6 million increase in cloud subscription revenue, a $0.4 million increase in maintenance and support revenue, and a $0.3 33 million increase in on-premises subscription revenue. With respect to new versus existing customers, there was a $6.8 million increase in subscriptions revenue stemming from sales of subscriptions to new customers, while the remaining $10.5 million of the increase was attributable to expanded deployments, price increases on renewals, and corresponding sales of additional subscriptions to existing customers. The increase in professional services revenue was due primarily to a $6.5 million increase in sales to new customers, which was partially offset by a $4.6 million decrease in revenue from existing customers. Cost of Revenue Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Cost of revenue Subscriptions $ 11,265 $ 9,313 $ 1,952 21.0 % Professional services 24,804 24,447 357 1.5 % Total cost of revenue $ 36,069 $ 33,760 $ 2,309 6.8 % Subscriptions gross margin 89.1 % 89.2 % Professional services gross margin 25.5 % 22.0 % Total gross margin 73.7 % 71.4 % Cost of revenue increased $2.3 million, or 6.8%, in the three months ended September 30, 2023 compared to the same period in 2022, primarily due to a $1.7 million increase in hosting costs and a $1.5 million increase in professional services and product support personnel costs. These increases were partially offset by a $0.5 million decrease in contractor costs and a $0.3 million decline in billable expenses. Hosting costs increased as sales of our cloud offering increased in the three months ended September 30, 2023. Personnel costs increased due to an increase in professional services and product support personnel headcount of 7.8% from September 30, 2022 to September 30, 2023 in addition to increased wages and fringe benefits and a $0.1 million increase in stock-based compensation expense. Contractor costs decreased as a result of a decline in the usage of subcontractors. Billable expenses decreased primarily as a result of lower travel and entertainment expenses stemming from fewer in-person engagements. Subscriptions gross margin was 89.1% for the three months ended September 30, 2023, consistent with a margin of 89.2% in the same period in 2022 due primarily to increased hosting costs as sales of our cloud offering increased. The increase in hosting costs was partially offset by an increase in subscriptions revenue during the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. Professional services gross margin increased to 25.5% for the three months ended September 30, 2023 compared to 22.0% in the same period in 2022 due largely to an increase in professional services revenue in the comparable periods coupled with a lower rate of professional services expense growth. Gross margin increased to 73.7% for the three months ended September 30, 2023 compared to 71.4% for the three months ended September 30, 2022, driven largely by the higher gross profit margin from professional services. Sales and Marketing Expense Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Sales and marketing $ 55,667 $ 54,912 $ 755 1.4 % % of revenue 40.6 % 46.6 % 34 Sales and marketing expense increased $0.8 million, or 1.4%, in the three months ended September 30, 2023 compared to the same period in 2022, primarily due to a $4.9 million increase in sales and marketing personnel costs. This increase was partially offset by a $3.4 million decrease in overhead costs and a $0.8 million decrease in marketing costs. Although sales and marketing personnel headcount fell 0.9% year over year, personnel costs increased due to increased wages and fringe benefits relative to the prior year, a $1.8 million increase in commissions expense due to increased sales, and a $0.6 million increase in stock-based compensation expense. Overhead costs decreased primarily due to the absence of non-recurring expenditures for an internal sales and marketing event that occurred in the third quarter of the prior year and a decrease in certain allocated costs (primarily IT spending). Marketing costs decreased primarily due to a decrease in advertising expense stemming from a decrease in the number of advertising campaigns launched in the three months ended September 30, 2023 relative to the three months ended September 30, 2022. Research and Development Expense Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Research and development $ 37,135 $ 37,623 $ (488) (1.3) % % of revenue 27.1 % 31.9 % Research and development expense decreased $0.5 million, or 1.3%, in the three months ended September 30, 2023 compared to the same period in 2022, primarily due to a $0.4 million decrease in professional fees. Professional fees decreased due to a decline in consulting fees stemming from a lower usage of external resources to assist in our platform development efforts relative to the prior year. General and Administrative Expense Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) General and administrative expense $ 23,440 $ 29,357 $ (5,917) (20.2) % % of revenue 17.1 % 24.9 % General and administrative expense decreased $5.9 million, or 20.2%, in the three months ended September 30, 2023 compared to the same period in 2022 primarily due to a $7.2 million decrease in professional fees and a $0.4 million decrease in general and administrative personnel costs. These decreases were partially offset by a $1.7 million increase in overhead costs. Professional fees decreased due to a $7.6 million decline in legal fees incurred relative to the three months ended September 30, 2022. Personnel costs decreased due to a decrease in general and administrative personnel headcount of 4.3% from September 30, 2022 to September 30, 2023 and a $0.4 million decrease in stock-based compensation expense. Overhead costs increased primarily due to amortization expense related to our judgment preservation insurance policy. 35 Other Non-Operating Expense, Net Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Other expense, net $ 1,939 $ 5,876 $ (3,937) (67.0) % % of revenue 1.4 % 5.0 % *** Indicates a percentage that is not meaningful. Other expense, net was $1.9 million in the three months ended September 30, 2023 compared to other expense, net of $5.9 million in the three months ended September 30, 2022. This change was primarily due to $4.3 million in foreign exchange losses in the three months ended September 30, 2023 as compared to $6.1 million in foreign exchange losses in the three months ended September 30, 2022. In addition, there was a $2.1 million increase in interest income in the three months ended September 30, 2023 relative to the prior year stemming from increased investments. Interest Expense Three Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Interest expense $ 4,917 $ 89 $ 4,828 *** % of revenue 3.6 % 0.1 % *** Indicates a percentage that is not meaningful. Interest expense increased $4.8 million in the three months ended September 30, 2023 as compared to the corresponding period in 2022 primarily due to interest expense incurred on the new credit facility borrowings that we entered into during the fourth quarter of 2022. Comparison of the Nine Months Ended September 30, 2023 and 2022 Revenue Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Revenue Subscriptions $ 296,554 $ 246,908 $ 49,646 20.1 % Professional services 103,490 95,297 8,193 8.6 % Total revenue $ 400,044 $ 342,205 $ 57,839 16.9 % Total revenue increased $57.8 million, or 16.9%, in the nine months ended September 30, 2023 compared to the same period in 2022 due to an increase in our subscriptions revenue of $49.6 million and an increase in our professional services revenue of $8.2 million. The increase in subscriptions revenue was driven by a $50.3 million increase in cloud subscription revenue and a $1.7 million increase in maintenance and support revenue, both of which were partially offset by a $2.4 million decrease in on-premises subscription revenue. With respect to new versus existing customers, there was a $17.1 million increase in subscriptions revenue stemming from sales of 36 subscriptions to new customers along with a $32.6 million increase attributable to expanded deployments, price increases on renewals, and corresponding sales of additional subscriptions to existing customers. The increase in professional services revenue was due primarily to a $16.7 million increase in sales to new customers, which was partially offset by an $8.5 million decrease in revenue from existing customers. Cost of Revenue Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Cost of revenue Subscriptions $ 32,492 $ 26,065 $ 6,427 24.7 % Professional services 76,515 72,011 4,504 6.3 % Total cost of revenue $ 109,007 $ 98,076 $ 10,931 11.1 % Subscriptions gross margin 89.0 % 89.4 % Professional services gross margin 26.1 % 24.4 % Total gross margin 72.8 % 71.3 % Cost of revenue increased $10.9 million, or 11.1%, in the nine months ended September 30, 2023 compared to the same period in 2022, primarily due to a $6.2 million increase in professional services and product support personnel costs and a $4.8 million increase in hosting costs. Personnel costs increased due to an increase in professional services and product support personnel headcount of 7.8% from September 30, 2022 to September 30, 2023 in addition to increased wages and fringe benefits and a $0.8 million increase in stock-based compensation expense. Hosting costs increased as sales of our cloud offering increased in the nine months ended September 30, 2023. Subscriptions gross margin decreased to 89.0% for the nine months ended September 30, 2023 as compared to 89.4% for the nine months ended September 30, 2022 as an increase in subscriptions revenue was offset by an increase in hosting costs. Professional services gross margin increased to 26.1% for the nine months ended September 30, 2023 compared to 24.4% in the same period in 2022 due largely to the aforementioned increase in professional services revenue, which was partially offset by higher personnel costs. Gross margin rose to 72.8% for the nine months ended September 30, 2023 compared to 71.3% for the nine months ended September 30, 2022 driven largely by the higher gross margin from professional services. Sales and Marketing Expense Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Sales and marketing $ 181,338 $ 157,104 $ 24,234 15.4 % % of revenue 45.3 % 45.9 % Sales and marketing expense increased $24.2 million, or 15.4%, in the nine months ended September 30, 2023 compared to the same period in 2022, primarily due to a $27.7 million increase in sales and marketing personnel costs which was partially offset by a $3.3 million decrease in marketing costs. Although sales and marketing personnel headcount fell 0.9% year over year, personnel costs increased due to increased wages and fringe benefits relative to the prior year, a $7.1 million increase in commissions expense due to increased sales, a $5.2 million increase in severance costs, and a $1.7 million increase in stock-based compensation expense. Marketing costs decreased primarily due to a decrease in advertising expense stemming from a decrease in the number of 37 advertising campaigns launched in the nine months ended September 30, 2023 relative to the nine months ended September 30, 2022, which was partially offset by an increase in the cost of marketing events. Research and Development Expense Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Research and development $ 118,502 $ 101,401 $ 17,101 16.9 % % of revenue 29.6 % 29.6 % Research and development expense increased $17.1 million, or 16.9%, in the nine months ended September 30, 2023 compared to the same period in 2022, primarily due to a $17.8 million increase in research and development personnel costs. This increase was partially offset by a $0.5 million decrease in professional fees. Personnel costs increased due to an increase in research and development personnel headcount of 9.1% from September 30, 2022 to September 30, 2023 in addition to increased wages and fringe benefits coupled with a $0.6 million increase in stock-based compensation expense and a $1.2 million increase in severance costs. Professional fees decreased due to a decrease in consulting fees stemming from a lower usage of external resources to assist in our platform development efforts relative to the prior year. General and Administrative Expense Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) General and administrative expense $ 82,342 $ 90,014 $ (7,672) (8.5) % % of revenue 20.6 % 26.3 % General and administrative expense decreased $7.7 million, or 8.5%, in the nine months ended September 30, 2023 compared to the same period in 2022 primarily due to a $21.0 million decrease in professional fees. This decrease was partially offset by a $9.6 million increase in general and administrative personnel costs and a $3.7 million increase in allocated overhead costs. Professional fees decreased due to a $23.7 million decline in legal fees incurred relative to the nine months ended September 30, 2022, which was partially offset by a $1.8 million increase in consulting fees. Although general and administrative personnel headcount fell 4.3% year over year, personnel costs increased due to increased wages and fringe benefits relative to the prior year and a $2.6 million increase in stock-based compensation expense. Overhead costs increased primarily due to an increase in lease expense resulting from an expansion of our corporate headquarters, and amortization expense related to our judgment preservation insurance policy. Other Non-Operating (Income) Expense, Net Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Other (income) expense, net $ (4,637) $ 12,815 $ (17,452) *** % of revenue (1.2) % 3.7 % *** Indicates a percentage that is not meaningful. 38 Other income, net was $4.6 million in the nine months ended September 30, 2023 compared to other expense, net of $12.8 million in the nine months ended September 30, 2022. This change was primarily due to $2.4 million in foreign exchange losses in the nine months ended September 30, 2023 as compared to $14.5 million in foreign exchange losses in the nine months ended September 30, 2022. In addition, there was a $6.6 million increase in interest income in the nine months ended September 30, 2023 relative to the prior year stemming from increased investments. Interest Expense Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Interest expense $ 12,790 $ 222 $ 12,568 *** % of revenue 3.2 % 0.1 % *** Indicates a percentage that is not meaningful. Interest expense increased $12.8 million in the nine months ended September 30, 2023 as compared to the corresponding period in 2022 primarily due to interest expense incurred on the new credit facility borrowings that we entered into during the fourth quarter of 2022. Non-GAAP Financial Measures To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial performance measures. We use these non-GAAP financial performance measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. Management believes these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain expenses that may not be indicative of our recurring core business operating results. We believe both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparisons to historical performance as well as comparisons to competitors’ operating results. We believe these non-GAAP financial measures are useful to investors both because (1) they allow for greater transparency with respect to measures used by management in its financial and operational decision-making and (2) they are used by institutional investors and the analyst community to help them analyze the health of our business. Our non-GAAP financial performance measures include non-GAAP net loss, non-GAAP net loss per share, and non-GAAP operating loss. These non-GAAP financial performance measures exclude the effect of stock-based compensation expense, certain litigation-related expenses consisting of legal and other professional fees associated with the Pegasystems cases (net of insurance reimbursements), amortization of the judgment preservation insurance (“JPI”) policy and severance costs related to involuntary reductions in our workforce. While some of these items may be recurring in nature and should not be disregarded in the evaluation of our earnings performance, it is useful to exclude such items when analyzing current results and trends compared to other periods as these items can vary significantly from period to period depending on specific underlying transactions or events that may occur. Therefore, while we may incur or recognize these types of expenses in the future, we believe removing these items for purposes of calculating the non-GAAP financial measures provides investors with a more focused presentation of our ongoing operating performance. We also discuss adjusted EBITDA, a non-GAAP financial performance measure we believe offers a useful view of the overall operation of our business. We define adjusted EBITDA as net loss before (1) other non-operating (income) expenses, net, (2) interest expense, (3) income tax expense (benefit), (4) depreciation expense and amortization of intangible assets, (5) stock-based compensation expense, (6) litigation expenses (net of insurance reimbursements) directly associated with the Pegasystems cases, (7) JPI amortization, and (8) severance costs. The most directly comparable GAAP financial measure to adjusted EBITDA is net loss. Users should consider the 39 limitations of using adjusted EBITDA, including the fact this measure does not provide a complete measure of our operating performance. Adjusted EBITDA is not intended to purport to be an alternative to net loss as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. The presentation of these non-GAAP financial measures is not intended to be considered in isolation from, as a substitute for, or superior to the financial information prepared and presented in accordance with GAAP, and our non-GAAP measures may be different from non-GAAP measures used by other companies. The following tables reconcile our non-GAAP measures to their nearest comparable GAAP measures (in thousands, except per share data): GAAP Measure Stock-Based Compensation Litigation Expenses JPI Amortization Severance Costs Non-GAAP Measure Three Months Ended September 30, 2023 Subscriptions cost of revenue $ 11,265 $ (211) $ — $ — $ — $ 11,054 Professional services cost of revenue 24,804 (1,535) — — — 23,269 Total cost of revenue 36,069 (1,746) — — — 34,323 Total operating expense 116,242 (9,265) 4,961 (1,485) — 110,453 Operating loss (15,217) 11,011 (4,961) 1,485 — (7,682) Income tax expense 178 88 — — — 266 Net loss (22,251) 11,099 (4,961) 1,485 — (14,628) Net loss per share, basic and diluted $ (0.30) $ 0.15 $ (0.07) $ 0.02 $ — $ (0.20) Nine Months Ended September 30, 2023 Subscriptions cost of revenue $ 32,492 $ (713) $ — $ — $ (30) $ 31,749 Professional services cost of revenue 76,515 (4,598) — — (158) 71,759 Total cost of revenue 109,007 (5,311) — — (188) 103,508 Total operating expense 382,182 (27,904) 2,772 (1,485) (6,111) 349,454 Operating loss (91,145) 33,215 (2,772) 1,485 6,299 (52,918) Income tax expense 2,137 731 — — 139 3,007 Net loss (101,435) 33,946 (2,772) 1,485 6,438 (62,338) Net loss per share, basic and diluted $ (1.39) $ 0.46 $ (0.04) $ 0.02 $ 0.09 $ (0.86) 40 GAAP Measure Stock-Based Compensation Litigation Expenses Non-GAAP Measure Three Months Ended September 30, 2022 Subscriptions cost of revenue $ 9,313 $ (284) $ — $ 9,029 Professional services cost of revenue 24,447 (1,401) — 23,046 Total cost of revenue 33,760 (1,685) — 32,075 Total operating expense 121,892 (9,651) (1,810) 110,431 Operating loss (37,776) 11,336 1,810 (24,630) Net loss (43,996) 11,336 1,810 (30,850) Net loss per share, basic and diluted $ (0.61) $ 0.16 $ 0.02 $ (0.43) Nine Months Ended September 30, 2022 Subscriptions cost of revenue $ 26,065 $ (712) $ — $ 25,353 Professional services cost of revenue 72,011 (3,788) — 68,223 Total cost of revenue 98,076 (4,500) — 93,576 Total operating expense 348,519 (22,927) (20,432) 305,160 Operating loss (104,390) 27,427 20,432 (56,531) Net loss (116,503) 27,427 20,432 (68,644) Net loss per share, basic and diluted $ (1.61) $ 0.38 $ 0.28 $ (0.95) The following table reconciles GAAP net loss to adjusted EBITDA for the three and nine months ended September 30, 2023 and 2022 (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 GAAP net loss $ (22,251) $ (43,996) $ (101,435) $ (116,503) Other expense (income), net 1,939 5,876 (4,637) 12,815 Interest expense 4,917 89 12,790 222 Income tax expense (benefit) 178 255 2,137 (924) Depreciation and amortization of intangibles 2,340 1,759 7,046 5,332 Stock-based compensation expense 11,011 11,336 33,215 27,427 Litigation expenses (4,961) 1,810 (2,772) 20,432 JPI amortization 1,485 — 1,485 — Severance costs — — 6,299 — Adjusted EBITDA $ (5,342) $ (22,871) $ (45,872) $ (51,199) 41 Liquidity and Capital Resources The following table presents selected financial information and statistics pertaining to liquidity and capital resources as of September 30, 2023 and December 31, 2022: As of September 30, 2023 December 31, 2022 Cash and cash equivalents $ 130,761 $ 148,132 Short-term investments and marketable securities 38,726 47,863 Property and equipment, net 42,444 41,855 Working capital* 62,120 149,996 * Defined as current assets net of current liabilities, excluding the current portion of restricted cash. 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 twelve months. We have in the past, and may in the future 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. Sources of Funds We have historically financed our operations in large part with equity financing arrangements. Through September 30, 2023, we have completed four public offerings and received net proceeds of $344.8 million. Outside of equity offerings, we have financed our operations through sales of subscriptions and professional services. To further help strengthen our financial position and support our growth initiatives, in November 2022 we entered into a Senior Secured Credit Facilities Credit Agreement, or the Credit Agreement, which provides for a five-year term loan facility in an aggregate principal amount of $150.0 million and, in addition, up to $75.0 million for a revolving credit facility, including a letter of credit sub-facility in the aggregate availability amount of $15.0 million and a swingline sub-facility in the aggregate availability amount of $10.0 million (as a sublimit of the revolving loan facility). The Credit Agreement matures on November 3, 2027. We will use the proceeds from the $150.0 million term loan to fund the continued growth of our business and support our working capital requirements. We were in compliance with all covenants as of September 30, 2023. We believe, based on our current financial forecasts and trends, that we will remain compliant with all covenants for the foreseeable future. As of September 30, 2023, we had used borrowing capacity of $62.0 million under our $75.0 million revolving credit facility, and we had outstanding letters of credit totaling $11.9 million in connection with securing our leased office space. 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 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 product. 42 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 2023 to date have included capital expenditures related to the expansion of our headquarters, repayments of existing debt, and purchases of investments. In addition, on September 1, 2023, we entered into a Judgment Preservation Insurance (“JPI”) policy in connection with our $2.036 billion judgment against Pegasystems (see Note 12 to the condensed consolidated financial statements for additional details). The total cost of the policy was $57.3 million, which we paid with operating cash on hand. Furthermore, we have a non-cancellable cloud hosting arrangement with Amazon Web Services that contains provisions for minimum purchase commitments. Specifically, purchase commitments under the agreement total $131.0 million over five years. The agreement, which started in July 2021 and is now in its third year as of September 30, 2023, contains minimum spending requirements of $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 three and nine months ended September 30, 2023, totaled $9.3 million and $27.8 million, respectively. Spending under this agreement for the three and nine months ended September 30, 2022 totaled $9.0 million and $24.8 million, respectively. We expect to meet our minimum purchase commitments for the remainder of the contract term. Historical Cash Flows Nine Months Ended September 30, 2023 2022 $ Change % Change (dollars in thousands) Beginning cash, cash equivalents, and restricted cash $ 150,381 $ 103,960 $ 46,421 44.7 % Operating activities: Net loss (101,435) (116,503) 15,068 (12.9) Stock-based compensation and other non-cash adjustments 40,485 31,771 8,714 27.4 Changes in working capital (41,248) (9,226) (32,022) *** Net cash used by operating activities (102,198) (93,958) (8,240) 8.8 Investing activities: Net cash provided by investing activities 869 20,342 (19,473) (95.7) Financing activities: Net cash provided by financing activities 82,388 25,205 57,183 *** Effect of exchange rates (679) (1,694) 1,015 (59.9) Net change (19,620) (50,105) 30,485 (60.8) Ending cash, cash equivalents, and restricted cash $ 130,761 $ 53,855 $ 76,906 *** *** Indicates a percentage that is not meaningful. Operating Activities 43 Net cash used by operating activities was $102.2 million for the nine months ended September 30, 2023 as compared to $94.0 million used by operating activities for the nine months ended September 30, 2022. The increase in net cash used by operating activities was due to the $57.3 million payment for our JPI policy. This increase was mostly offset by a decline in legal fees and stronger collections from accounts receivable across the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. Investing Activities Net cash provided by investing activities was $0.9 million for the nine months ended September 30, 2023 as compared to $20.3 million in net cash provided by investing activities for the nine months ended September 30, 2022. This change was primarily driven by a $22.2 million increase in purchases of investments and a $2.4 million increase in capital expenditures, both of which were partially offset by a $5.2 million increase in proceeds from the sale of investments. Financing Activities Net cash provided by financing activities was $82.4 million for the nine months ended September 30, 2023 as compared to $25.2 million of net cash provided by financing activities for the nine months ended September 30, 2022. The increase in net cash provided by financing activities was primarily due to a $92.0 million increase in proceeds from borrowings during the nine months ended September 30, 2023. This increase was partially offset by a $24.5 million decrease in proceeds received from the exercise of stock options, a $7.2 million increase in payments for employee tax withholdings associated with the net settlement of stock awards, and a $2.6 million increase in debt repayments. 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, 2022, filed with the SEC on February 16, 2023. 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. 44