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 our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements” and “Risk Factors” for a discussion of forward-looking statements and important factors that could cause actual results to differ materially from the results described in or implied by these forward-looking statements. Unless otherwise indicated or the context otherwise requires, references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section to ‘‘ZeroFox,’’ ‘‘we,’’ ‘‘us,’’ ‘‘our,’’ and other similar terms refer to ZeroFox Holdings, Inc. and its consolidated subsidiaries.
Overview
ZeroFox was formed through the merger of ZeroFox, Inc., ID Experts Holdings, Inc., and L&F Acquisition Corp (L&F) on August 3, 2022. ZeroFox, Inc. was founded in 2013 with the vision that the emergence and adoption of social media, mobile applications, and cloud computing by enterprises would fundamentally change the cybersecurity paradigm. Social media represents much more than a platform where individuals connect online. The adoption of social media revolutionized the way people communicate with each other and, subsequently, how enterprises and organizations enable communication among employees, customers, partners, and prospects. Mobile applications accelerated the digital transformation in which earlier versions of the web would need to become interactive and persist across multiple modern mediums. Furthermore, cloud computing’s continued evolution and adoption demonstrate how organizations are more comfortable with data residing beyond their traditional security perimeter outside of the historical boundaries of IT governance and control.
We provide customers with an innovative and comprehensive platform for external cybersecurity that protects organizations from threats outside the traditional corporate perimeter (our Platform). Our Platform protects our customers from threats to their organizations, brands, digital assets, and people. These threats include targeted phishing attacks, account takeovers, credential theft, data leakage, domain spoofing, and impersonations to name a few.
Our cloud-native platform combines protection, intelligence, adversary disruption, and response services into an integrated solution.
Our protection capabilities continuously monitor social, mobile, surface web, deep and dark web, email, and collaboration platforms and use artificial intelligence-powered analytics to identify threats. Our Platform processes millions of pieces of content, rich media, posts, messages, global intelligence, and threat actor activity across the digital landscape, including, without limitation, mobile app stores, social media sites, dark web forums, and discrete content sources. With the data we collect and process, we identify targeted phishing attacks, credential compromise, data exfiltration, brand hijacking, and executive and location threats across the public-facing surface web as well as the deep and dark web.
Our intelligence capabilities provide access to threat intelligence data as well as analysis and investigations provided by our threat intelligence experts.
Our adversary disruption capabilities enable the remediation of threats through automated takedowns of domains, impersonations, and malicious content, and facilitate the blocking of adversary infrastructure across various networks.
58
Our response services include breach response (notification, call center support, and identity protection) and incident response.
We sell subscriptions to our Platform to organizations of all sizes across multiple industries. We primarily sell subscriptions through our direct sales teams that leverage our global network of channel partners. A majority of our customers purchase subscription agreements with a term of one year. Our subscription agreements are generally priced on the number of assets protected and the desired levels of services. We generally recognize our subscription agreements ratably over the term of the agreement.
We also generate revenue from breach response services, incident response, investigative services, and training. Our breach response services can be priced on either a fixed price or variable price arrangement. A typical breach response arrangement includes breach notification services and a period of identity protection services. We recognize revenue for the breach notification services on completion of the notification and the identity protection on a ratable basis over the contract term, typically 15 months. Our incident response, investigative, and training services are generally priced on a fixed-fee basis and revenue is recognized as the services are performed.
COVID-19
The COVID-19 pandemic has further accelerated the movement toward a digital-first strategy for nearly every organization. Given unprecedented work from home arrangements and consumers’ increasing reliance on digital engagement for products and services, organizations and their security teams must implement new security strategies that protect against external threats to ensure trust and reduce risk. We believe that enterprises will face growing attacks on their public attack surface as modern IT infrastructure will be characterized by greater decentralization and collaboration that is dependent upon public networks.
We have shifted our approach from almost entirely in-person to a flexible work environment that is composed of in-person, hybrid in-person and remote, and fully remote. Our fully remote global team is supported and enabled for remote-only work. Our hybrid team has access to work in-person from designated offices and remote, and our in-person teams have designated offices they report to for work. The impact of the COVID-19 pandemic continues to rapidly evolve, and we will continue to monitor the situation and may take further actions that alter our business operations or that we determine are in the best interests of our employees, customers, partners, and other constituents. We do not know the full extent to which the COVID-19 pandemic may impact our business and our financial performance. For additional information related to risks related to the COVID-19 pandemic, see “Risk Factors—The COVID-19 pandemic could adversely affect our business, operating results, and financial condition" in the Final Prospectus.
Russian Invasion of Ukraine
We are monitoring and responding to the effects of the conflict in Ukraine and the associated sanctions and other restrictions. The full impact of the conflict on our business operations and financial performance remains uncertain and will depend on future developments, including the severity and duration of the conflict and its impact on regional and global economic conditions. We will continue to monitor the effects of the conflict and assess the related restrictions and other effects and pursue prudent decisions for our team members, customers, and business.
Recent Acquisitions
On April 21, 2023, we completed the acquisition of Lookingglass Cyber Solutions, Inc. (LookingGlass). The successful completion of the acquisition combined the innovative platforms of ZeroFox and LookingGlass, enabling our customers to build a robust security posture by providing world-class visibility into external attack surface assets and vulnerabilities.
59
Key Factors Affecting Performance
New Customer Acquisition
Our future growth depends in large part on our ability to acquire new customers. To attract new customers, we have invested, and will continue to invest, in our sales and marketing efforts. Many organizations have not yet adopted external cybersecurity solutions and our business and operating results will be affected by the rate at which organizations adopt our solutions. We believe our Platform addresses the evolving needs of organizations of all sizes and industries and coupled with our go-to-market strategy, presents significant opportunities for growth.
Investing in Growth
We intend to continue to invest in our business so that we can capitalize on our market opportunity. We intend to continue to invest in sales and marketing to grow our sales team, expand our brand recognition and optimize our channel partner network. We also intend to continue to invest in our research and development team to build additional functionality and enhance existing functionality in our Platform to extend our capabilities as our success is dependent on our ability to further our technological leadership. Additionally, we plan to evaluate strategic acquisitions of businesses and technologies to expand and enhance the functionality of our Platform.
Our investments in growth may adversely affect our operating results in the near term. However, we expect that these investments will contribute to our long-term growth and success.
If these investments do not lead to expected revenue growth, our operating losses may increase, we may not achieve profitability, and our growth rates may slow.
Retention and Expansion of Customers
Our ability to increase revenue depends in large part on our ability to retain our existing customers and grow the value of their subscriptions. We focus on increasing sales to our existing customers by increasing the number of protected assets and corresponding intelligence services delivered on and through our External Cybersecurity Platform. We intend to expand existing capabilities and launch new features which we believe will contribute to increased adoption by our growing base of customers. Our ability to expand within our customer base, particularly large enterprise and government customers, will depend on a number of factors, including platform performance, competitive offerings, pricing, overall changes in our customers’ spending levels, and the effectiveness of our efforts to help our customers realize the benefits of our Platform.
Key Business Metrics
We monitor the following key metrics to help us evaluate our business, identify trends affecting our business, formulate business plans and make strategic directions.
60
Subscription Customers
We believe that the size of our customer base is an indicator of our market adoption and that our net new customer additions are an indicator of the growth of our business. We focus our sales and marketing efforts on large enterprises and medium-sized businesses. We define a subscription customer as any entity that has entered into a distinct agreement for access to our Platform for which the term has not ended or with which we are continuing to provide service and negotiating a renewal contract that expired within 90 days of the applicable measurement date. We do not consider our channel partners as subscription customers, and we treat managed service security providers, who may purchase our products on behalf of multiple companies, as a single subscription customer. As of April 30, 2023, the Company had 1,251 subscription customers in 56 countries.
Annual Recurring Revenue ("ARR")
We believe that ARR is a key operating metric to measure our business as changes in ARR reflect our ability to acquire net new customers and to maintain, retain, and expand our relationships with our existing customers. We define ARR as the annualized contract value of all recurring revenue related to contracts in place at the end of the reporting date assuming any contract is renewed on its existing terms. We continue to include ARR from customers whose term has expired within 90 days of the applicable measurement date for which we are actively negotiating renewal. As of April 30, 2023, the Company had an ARR of $178.4 million.
Components of Our Results of Operations
Revenue
We generate revenue from subscription agreements and from services, which includes breach response services.
Subscription revenue includes access to our hosted platform for protection, intelligence, disruption, and response capabilities along with credit and identity protection services. The majority of our customers are invoiced annually in advance of their subscription term. Our subscription agreements are “stand ready” to permit platform access and provide our protection services over the contractual term. We recognize subscription revenue ratably over the term of the agreement.
Services revenue includes breach response, training, and investigative services. Our breach response services can be priced on either a fixed price or variable price arrangement. A typical breach response arrangement includes breach notification services and a period of identity protection services. We recognize revenue for the breach notification services on completion of the notification and the identity protection services on a ratable basis over the contract term, which is typically 15 months. Our training and investigative services are generally priced on a fixed-fee basis and revenue is recognized as the services are performed.
Cost of Revenue
Costs of subscription revenue consist primarily of third-party cloud infrastructure expenses; fees paid to data providers; personnel-related costs such as salaries, bonuses, benefits, and stock-based compensation associated with customer support; software and subscription services used to support our customers; amortization of our capitalized internal-use software; travel and related expenses; amortization of acquired technology; and allocated overhead costs. Our allocated overhead costs include depreciation and information technology expenses.
61
Cost of services revenue consist primarily of fees to outsourced service providers for credit monitoring; call center operation; notification mailing; insurance; personnel-related costs such as salaries, bonuses, benefits, and stock-based compensation associated with breach project management and delivery, intelligence services, and other services; travel and related expenses; amortization of acquired technology; and allocated overhead costs. Our allocated overhead costs include depreciation and information technology expenses.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel-related expenses, including salaries, bonuses, commissions, benefits, and stock-based compensation are the most significant components of each of these categories. Operating expenses also include allocated overhead costs.
Research and Development
Research and development expenses consist primarily of personnel costs for our research, product and engineering teams, including salaries, bonuses, benefits, and stock-based compensation. Research and development expenses also include software, subscription services, and third-party cloud infrastructure incurred in the design and development of our hosted platform as well as allocated overhead costs.
We expect research and development expenses to increase in absolute dollars as we continue to invest in our Platform and services. However, we anticipate research and development expenses to decrease as a percentage of our revenue over time. Our research and development expenses may fluctuate as a percentage of our revenue from period-to-period depending on the timing of these expenses and the capitalization of expenses that qualify as internal-use software.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel costs for our sales and marketing teams, including salaries, commissions, bonuses, benefits, and stock-based compensation. Sales and marketing expenses also include conferences, branding and other marketing events, software services, subscription services, travel and related expenses, amortization of acquired customer relationships, and allocated overhead costs. We capitalize and amortize sales commissions from the initial acquisition of a customer subscription agreement to sales and marketing expense over the estimated customer life. We capitalize and amortize sales commissions from breach service arrangements to sales and marketing expense over the service period. We capitalize and amortize commissions paid for the renewal of a customer’s subscription over the term of the renewal.
We expect sales and marketing expenses to increase in absolute dollars as we continue to invest in our sales and marketing organization to drive additional revenue, further penetrate our market, and expand our global customer base. However, we anticipate sales and marketing expenses to decrease as a percentage of our revenue over time. Our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period depending on the timing of these expenses.
General and Administrative
General and administrative expenses consist primarily of personnel costs for our executive, finance, legal, human resources, and information technology teams, including salaries, bonuses, benefits, and stock-based compensation. General and administrative expenses also include professional fees for external accounting, legal, and other advisory services, insurance, software and subscription services, travel and related expenses, facilities-related expenses, amortization of acquired trade names, and allocated overhead costs.
62
We expect to incur additional expenses as the result of operating as a public company, including costs related to additional reporting and compliance requirements applicable to a listed company and increased expenses for insurance, accounting, legal, and other services. We expect general and administrative expenses to increase in absolute dollars; however, we anticipate general and administrative expenses to decrease as a percentage of our revenue over time.
Goodwill Impairment
We record a goodwill impairment loss when, as a result of our annual test or interim test (if factors are present that require an interim test), the fair value of the Company's single reporting unit is below the carrying value of the Company's single reporting unit.
Interest Expense, net
Interest expense consists primarily of contractual interest expense, as well as amortization of debt discount and issuance costs related to our term loans and our Convertible Notes issued on August 3, 2022.
Change in fair value of purchase consideration liability
Purchase consideration liability consists of the fair value of the purchase consideration not yet finalized in the acquisition of LookingGlass. The change in the fair value of the purchase consideration liability is primarily driven by changes in the Company's public trading price.
Change in fair value of warrant liability
Warrant liability consists of the fair value of the Company's outstanding warrants issued to various holders. The change in the fair value of the warrant liability is primarily driven by changes in the Company's public trading price.
Change in fair value of sponsor earnout shares liability
Sponsor earnout shares liability consists of the fair value of the potentially issuable sponsor earnout shares. The change in the fair value of the sponsor earnout shares liability is primarily driven by changes in the Company's public trading price.
Other Income (Expense), Net
Other income (expense), net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates.
(Benefit from) Provision for Income Taxes
(Benefit from) provision for income taxes consists primarily of pre-tax losses and the reduction of deferred tax liabilities associated with the amortization of intangible assets with no tax basis acquired through the Business Combination. The provision also includes income taxes in foreign jurisdictions in which the Company operates.
63
Results of Operations
Results for the Three Months Ended April 30, 2023 (Successor) and the Three Months Ended April 30, 2022 (Predecessor)
This section describes the results of the Company for the three months ended April 30, 2023 and the Predecessor's results for the three months ended April 30, 2022 (the Quarter to Date Predecessor Period).
There is no comparative analysis between the periods presented in the Condensed Consolidated Statement of Comprehensive Loss as there is a lack of comparability between the periods presented. The Successor's results includes the consolidated results of the Company, including the results of its consolidated subsidiaries: ZeroFox, Inc., ID Experts Holdings, Inc., and Lookingglass Cyber Solutions, Inc. The prior periods presented include only the consolidated results of the Company's Predecessor, ZeroFox, Inc.
The following table sets forth our results of operations:
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Revenue |
|
|
|
|
|
|
|
Subscription |
|
$ |
18,223 |
|
|
|
$ |
12,778 |
|
Services |
|
|
27,311 |
|
|
|
|
813 |
|
Total revenue |
|
|
45,534 |
|
|
|
|
13,591 |
|
Cost of revenue |
|
|
|
|
|
|
|
Subscription (1) |
|
|
9,904 |
|
|
|
|
4,008 |
|
Services (1) |
|
|
20,716 |
|
|
|
|
241 |
|
Total cost of revenue |
|
|
30,620 |
|
|
|
|
4,249 |
|
Gross profit |
|
|
14,914 |
|
|
|
|
9,342 |
|
Operating expenses |
|
|
|
|
|
|
|
Research and development (1) |
|
|
6,417 |
|
|
|
|
3,961 |
|
Sales and marketing (1) |
|
|
19,389 |
|
|
|
|
8,534 |
|
General and administrative (1) |
|
|
10,407 |
|
|
|
|
4,946 |
|
Total operating expenses |
|
|
36,213 |
|
|
|
|
17,441 |
|
Loss from operations |
|
|
(21,299 |
) |
|
|
|
(8,099 |
) |
Interest expense, net |
|
|
(3,482 |
) |
|
|
|
(1,386 |
) |
Change in fair value of purchase consideration liability |
|
|
2,661 |
|
|
|
— |
|
Change in fair value of warrant liability |
|
|
(1,028 |
) |
|
|
|
(663 |
) |
Change in fair value of sponsor earnout shares |
|
|
2,100 |
|
|
|
— |
|
Loss before income taxes |
|
|
(21,048 |
) |
|
|
|
(10,148 |
) |
(Benefit from) provision for income taxes |
|
|
(3,069 |
) |
|
|
|
55 |
|
Net loss after tax |
|
$ |
(17,979 |
) |
|
|
$ |
(10,203 |
) |
(1) includes stock-based compensation expense as follows:
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Cost of revenue - subscription |
|
$ |
7 |
|
|
|
$ |
9 |
|
Cost of revenue - services |
|
|
6 |
|
|
|
|
1 |
|
Research and development |
|
|
168 |
|
|
|
|
55 |
|
Sales and marketing |
|
|
233 |
|
|
|
|
85 |
|
General and administrative |
|
|
685 |
|
|
|
|
224 |
|
Total stock-based compensation expense |
|
$ |
1,099 |
|
|
|
$ |
374 |
|
64
The following tables disclose the components of the Consolidated Statements of Comprehensive Loss as a percentage of revenue:
|
|
|
|
|
|
|
|
|
|
(as a percentage of total revenue) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Revenue |
|
|
|
|
|
|
|
Subscription |
|
|
40 |
% |
|
|
|
96 |
% |
Services |
|
|
60 |
% |
|
|
|
4 |
% |
Total revenue |
|
|
100 |
% |
|
|
|
100 |
% |
Cost of revenue |
|
|
|
|
|
|
|
Subscription (1) |
|
|
22 |
% |
|
|
|
29 |
% |
Services (1) |
|
|
45 |
% |
|
|
|
2 |
% |
Total cost of revenue |
|
|
67 |
% |
|
|
|
31 |
% |
Gross profit |
|
|
33 |
% |
|
|
|
69 |
% |
Operating expenses |
|
|
|
|
|
|
|
Research and development (1) |
|
|
14 |
% |
|
|
|
29 |
% |
Sales and marketing (1) |
|
|
43 |
% |
|
|
|
63 |
% |
General and administrative (1) |
|
|
23 |
% |
|
|
|
37 |
% |
Total operating expenses |
|
|
80 |
% |
|
|
|
129 |
% |
Loss from operations |
|
|
-47 |
% |
|
|
|
-60 |
% |
Interest expense, net |
|
|
-8 |
% |
|
|
|
-10 |
% |
Change in fair value of purchase consideration liability |
|
|
6 |
% |
|
|
|
0 |
% |
Change in fair value of warrant liability |
|
|
-2 |
% |
|
|
|
-5 |
% |
Change in fair value of sponsor earnout shares |
|
|
5 |
% |
|
|
|
0 |
% |
Loss before income taxes |
|
|
-46 |
% |
|
|
|
-75 |
% |
(Benefit from) provision for income taxes |
|
|
-7 |
% |
|
|
|
0 |
% |
Net loss after tax |
|
|
-39 |
% |
|
|
|
-75 |
% |
(1) includes stock-based compensation expense as follows:
|
|
|
|
|
|
|
|
|
|
(as a percentage of total revenue) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Cost of revenue - subscription |
|
|
0 |
% |
|
|
|
0 |
% |
Cost of revenue - services |
|
|
0 |
% |
|
|
|
0 |
% |
Research and development |
|
|
0 |
% |
|
|
|
0 |
% |
Sales and marketing |
|
|
1 |
% |
|
|
|
1 |
% |
General and administrative |
|
|
2 |
% |
|
|
|
2 |
% |
Total stock-based compensation expense |
|
|
3 |
% |
|
|
|
3 |
% |
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Subscription revenue |
|
$ |
18,223 |
|
|
|
$ |
12,778 |
|
Services revenue |
|
|
|
|
|
|
|
Breach |
|
|
26,150 |
|
|
|
|
— |
|
Other services |
|
|
1,161 |
|
|
|
|
813 |
|
Total services revenue |
|
|
27,311 |
|
|
|
|
813 |
|
Total |
|
$ |
45,534 |
|
|
|
$ |
13,591 |
|
Revenue was $45.5 million for the three months ended April 30, 2023, including $18.2 million for subscriptions and $27.3 million for services. Services revenue was primarily made up of breach response services of $26.1 million.
Revenue was $13.6 million for the three months ended April 30, 2022, including $12.8 million for subscriptions and $0.8 million for services.
Cost of Revenue, Gross Profit, and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Subscription cost of revenue |
|
$ |
9,904 |
|
|
|
$ |
4,008 |
|
Services cost of revenue |
|
|
20,716 |
|
|
|
|
241 |
|
Total cost of revenue |
|
|
30,620 |
|
|
|
|
4,249 |
|
|
|
|
|
|
|
|
|
Subscription gross profit |
|
|
8,319 |
|
|
|
|
8,770 |
|
Services gross profit |
|
|
6,595 |
|
|
|
|
572 |
|
Total gross profit |
|
$ |
14,914 |
|
|
|
$ |
9,342 |
|
|
|
|
|
|
|
|
|
Subscription gross margin |
|
|
46 |
% |
|
|
|
69 |
% |
Services gross margin |
|
|
24 |
% |
|
|
|
70 |
% |
Total gross margin |
|
|
33 |
% |
|
|
|
69 |
% |
65
Cost of revenue was $30.6 million for the three months ended April 30, 2023, including $9.9 million for subscription and $20.7 million for services. Cost of revenue for subscription was primarily made up of $3.4 million for salaries, benefits, and other compensation related costs for employees that support the subscription platforms; $4.8 million for amortization of acquired technology assets; and $1.2 million for acquired data and software. Cost of revenue for services was primarily made up of $16.8 million for acquired data, $1.7 million for amortization of deferred contract set up costs, and $1.3 million for salaries, benefits and other compensation related costs for employees that deliver the Company's professional service offerings.
Gross profit and gross profit margin for the three months ended April 30, 2023, were $14.9 million and 33%, respectively. Gross profit and gross profit margin for subscription for the three months ended April, 30, 2023, were $8.3 million and 46%, respectively. Gross profit and gross profit margin for services for the three months ended April 30, 2023, were $6.6 million and 24%, respectively.
Cost of revenue was $4.2 million for the three months ended April 30, 2022, including $4.0 million for subscription and $0.2 million for services. Cost of revenue for subscription was primarily made up of $2.7 million for salaries, benefits, and other compensation related costs for employees that support the subscription platforms and $0.7 million for acquired data and software. Cost of revenue for services was primarily made up of $0.2 million for salaries, benefits and other compensation related costs for employees that deliver the Company's service offerings.
Gross profit and gross profit margin for the three months ended April 30, 2022, were $9.3 million and 69%, respectively. Gross profit and gross profit margin for subscription for the Quarter to Date Predecessor Period, were $8.8 million and 69%, respectively. Gross profit and gross profit margin for services for the Quarter to Date Predecessor Period, were $0.5 million and 70%, respectively.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Research and development |
|
$ |
6,417 |
|
|
|
$ |
3,961 |
|
Research and Development cost was $6.4 million for the three months ended April 30, 2023. Research and Development cost was primarily made up of $5.2 million for salaries, benefits, and other compensation related costs for employees in software engineering and product development functions and $0.6 million for hosting, acquired software, and software services.
Research and Development cost was $4.0 million for the three months ended April 30, 2022. Research and Development cost was primarily made up of $3.5 million for salaries, benefits, and other compensation related costs for employees in software engineering and product development functions and $0.3 million for hosting, acquired software, and software services.
Sales and Marketing
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Sales and marketing |
|
$ |
19,389 |
|
|
|
$ |
8,534 |
|
Sales and Marketing cost was $19.4 million for the three months ended April 30, 2023. Sales and Marketing cost was primarily made up of $9.4 million for salaries, benefits, and other compensation related costs for employees in sales and marketing functions, $6.1 million for amortization of acquired customer relationships intangible assets, and $1.8 million for marketing programs and travel related expenses.
66
Sales and Marketing cost was $8.5 million for the three months ended April 30, 2022. Sales and Marketing cost was primarily made up of $5.9 million for salaries, benefits, and other compensation related costs for employees in sales and marketing functions, $0.7 million for amortization of acquired customer relationships intangible assets, and $1.0 million for marketing programs and travel related expenses.
General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
General and administrative |
|
$ |
10,407 |
|
|
|
$ |
4,946 |
|
General and Administrative cost was $10.4 million for the three months ended April 30, 2023. General and Administrative cost was primarily made up of $2.8 million for salaries, benefits, and other compensation related costs for employees primarily in executive leadership, finance, accounting human resources, legal, and corporate IT; $3.4 million for professional service fees, primarily legal and audit services; $0.9 million for amortization of acquired trade names intangible assets; $1.0 million for insurance; $0.7 million for stock-based compensation; and $0.6 million for rent and utilities.
General and Administrative cost was $5.0 million for the three months ended April 30, 2022. General and Administrative cost was primarily made up of $1.7 million for salaries, benefits, and other compensation related costs for employees primarily in executive leadership, finance, accounting human resources, legal, and corporate IT; $1.8 million for professional service fees, primarily legal and audit services; $0.3 for rent and related expenses; and $0.5 million for productivity tools utilized by employees.
Interest Expense, Net
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Interest expense, net |
|
$ |
3,482 |
|
|
|
$ |
1,386 |
|
Interest expense was $3.5 million for the three months ended April 30, 2023. Interest expense was primarily made up of $3.4 million for payment-in-kind interest at an annual rate of 8.75% on the Company's Convertible Notes.
Interest expense was $1.4 million for the three months ended April 30, 2022. Interest expense was primarily related to interest payments for the Predecessor's credit agreements with Stifel Bank and Orix Growth Capital, LLC.
Change in the Fair Market Value of Purchase Consideration Liability
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Change in fair value of purchase consideration liability |
|
$ |
2,661 |
|
|
|
$ |
— |
|
The change in the fair market value of the Purchase Consideration Liability represented a gain of $2.7 million for the three months ended April 30, 2023. The reduction in the fair market value of the Purchase Consideration liability was primarily driven by the reduction in the public trading price of the Company's Common Stock from April 21, 2023, to April 30, 2023.
There was no gain or loss recognized for change in fair market value of the Purchase Consideration liability for the three months ended April 30, 2022, as the liability was initially recognized as part of the completion of the LookingGlass Business Combination on April 21, 2023.
67
Change in the Fair Market Value of Warrants
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Change in fair value of warrant liability |
|
$ |
(1,028 |
) |
|
|
$ |
(663 |
) |
The change in fair market value of warrants represented a loss of $1.0 million for the three months ended April 30, 2023. The loss was due to the change in fair value of the Company's Public Warrants and Private Warrants. The warrant liability was recorded at a fair value of $2.6 million as of January 31, 2023. The Company recorded a mark to market adjustment of $1.7 million reducing the liability a fair value of $0.9 million as of April 30, 2023. The reduction in the fair value of the Company's warrant liability was driven by the reduction in the public trading price for the Company's Public Warrants from January 31, 2023, to April 30, 2023. The Company's Private Warrants are economically similar to the Public Warrants and as such, use the price of the Company's Public Warrants as an indicator of fair value. The gain on change in fair value was offset by $2.8 million loss on fair value of warrants that was recorded to adjust the settlement of warrants.
The change in fair market value of warrants represented a loss of $0.7 million for the three months ended April 30, 2022. The loss recognized during the three months ended April 30, 2022, reflected the increase in the estimated fair value of the Predecessor's Common Stock.
Change in the Fair Market Value of Sponsor Earnout Shares
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
Change in fair value of sponsor earnout shares |
|
$ |
2,100 |
|
|
|
$ |
— |
|
The change in the fair market value of the Sponsor Earnout Shares represented a gain of $2.1 million for the three months ended April 30, 2023. The reduction in the fair market value of the Sponsor Earnout Shares liability was primarily driven by the reduction in the public trading price of the Company's Common Stock from January 31, 2023, to April 30, 2023.
There was no gain or loss recognized for change in fair market value of the Sponsor Earnout Shares for the three months ended April 30, 2022, as the liability for the Sponsor Earnout Shares was initially recognized as part of the completion of the Business Combination on August 3, 2022.
Provision for Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
Successor |
|
|
|
Predecessor |
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
|
|
Three months ended
April 30, 2022 |
|
(Benefit from) provision for income taxes |
|
$ |
(3,069 |
) |
|
|
$ |
55 |
|
The benefit from income taxes was $3.1 million for the three months ended April 30, 2023. The benefit was primarily due to the impact of pre-tax losses and the reduction of deferred tax liabilities associated with the amortization of intangible assets with no tax basis acquired through the Business Combination.
The provision for income taxes was $0.1 million during the three months ended April 30, 2022. The provision was due to income taxes of the Predecessor's foreign subsidiaries. Due to the sustained net losses, the Predecessor had recorded a full valuation allowance against all its deferred tax assets during the three months ended April 30, 2022.
68
Critical Accounting Estimates
Our management’s discussion and analysis of financial condition and results of operations is based upon our financial statements and notes to our financial statements, which were prepared in accordance with US GAAP. The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Our management evaluates our estimates on an ongoing basis, including those related to the allowance for doubtful accounts, the carrying value and useful lives of long-lived assets, the fair value of financial instruments, the recognition and disclosure of contingent liabilities, income taxes, and stock-based compensation. We base our estimates and judgments on our historical experience, knowledge of factors affecting our business and our belief as to what could occur in the future considering available information and assumptions that are believed to be reasonable under the circumstances.
The accounting estimates we use in the preparation of our financial statements will change as new events occur, more experience is acquired, additional information is obtained, and our operating environment changes. Changes in estimates are made when circumstances warrant. Such changes in estimates and refinements in estimation methodologies are reflected in our reported results of operations and, if material, the effects of changes in estimates are disclosed in the notes to our financial statements. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these estimates.
The critical accounting estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
Revenue Recognition
Description
We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers. Revenue is recognized when a customer obtains control of promised services in an amount that reflects the consideration we expect to be entitled to receive in exchange for those services. In recognizing revenue, we apply the following five steps:
•Identify contracts with customers,
•Identify the performance obligations in the contract,
•Determine the transaction price,
•Allocate the transaction price to performance obligations in the contract, and
•Recognize revenue when or as performance obligations are satisfied.
Judgments and Uncertainties
We apply judgment in determining the customer’s ability and intent to pay, including the customer’s historical payment experience or credit and financial information pertaining to the customer.
Our contracts may contain multiple performance obligations which are accounted for separately if they are capable of being distinct or are distinct in the context of the contract. Contracts with multiple performance obligations require an allocation of the transaction price to each performance obligation based on the stand-alone selling price (SSP) of each performance obligation, using the relative selling price method of allocation. We apply judgment in determining SSP for our performance obligations utilizing our observable standalone sales, sales of bundled items when standalone sales are not available, and our overall pricing methodology. Relative changes in SSP estimates between performance obligations which have different patterns of recognition, point-in-time versus over time, can impact the amount of revenue we recognize in a period.
69
Subscription revenue: Subscription revenue consists of revenue from subscriptions to access our Platform together with related data and support service offerings. Revenue is recognized over time on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Customers have the option to purchase additional subscription and support services at a stated price. These options do not represent an additional performance obligation that would require an allocation of the transaction price.
Services revenue, breach services: The typical breach services arrangement includes three performance obligations: notification, identity protection services enrollment call center, and identity protection services. The notification and identity protection services are considered distinct performance obligations. Revenue is allocated to the notification and identity protection services based on the SSP of each, using the relative selling price method of allocation. We apply judgment in determining SSP for our performance obligations utilizing our observable standalone sales, sales of bundled items when standalone sales are not available, and our overall pricing methodology. Revenue for the notification performance obligation is recognized when the notifications are sent and the identity protection service is recognized over the service period, which is typically 15 months. At inception of the contract, there is an element of variable consideration related to our estimate of the enrollment in the identify protection services call center as the actual amount is unknown until completion of the call center term.
Services revenue, all other: All of our services are considered distinct performance obligations when sold on a stand-alone basis. Revenue is generally recognized at the point in time when the professional service is delivered.
Sensitivity of Estimate to Change
We do not expect relative SSP estimates to change materially period to period.
Services revenue accounted for 60% of total revenue for the three months ended April 30, 2023. Most breach services arrangements include performance obligations satisfied at both a point-in-time and over time. An assumed 10% relative shift in SSP estimates to point-in-time performance obligations versus over time would not cause a material increase in revenue for the three months ended April 30, 2023.
Subscription revenue accounted for 40% of total revenue for the three months ended April 30, 2023. Some customer arrangements include both subscription performance obligations that are satisfied over time and service-related performance obligations that are satisfied at a point-in-time. An assumed 10% relative shift in SSP estimates to point-in-time performance obligations versus over time would not cause a material increase in revenue for the three months ended April 30, 2023.
Deferred Contract Acquisition Costs
Description
Contract acquisition costs are related to sales commissions earned, which represent incremental costs to obtain a contract. We amortize the initial commissions over the longer of the customer relationship or over the same period as the initial revenue arrangement to which these costs relate.
Judgments and Uncertainties
The critical accounting estimate for deferred contract acquisition costs is the amortizable life of the asset. We have estimated the period of benefit for new customer relationships to be 3 years. Management monitors trends in customer attrition and the typical term of service arrangements to determine if the estimated amortizable life estimate should be updated.
70
Sensitivity of Estimate to Change
We do not expect the useful life estimate to deviate materially period to period. The decrease to amortization expense for the three months ended April 30, 2023, for a change of one year to the estimated life of our customer relationships would be approximately $0.6 million.
Stock-Based Compensation
Description
We account for stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation. ASC 718 requires that the cost of awards of equity instruments offered in exchange for employee services, including employee stock options and restricted stock unit awards (RSUs), is measured based on the grant-date fair value of the award. We determine the fair value of options granted using the Black-Scholes model, which requires the input of subjective assumptions. We recognize the fair value of stock option awards, net of estimated forfeitures, over the period which an employee is required to provide service in exchange for the award, generally the vesting period. The fair value of RSUs is based on the closing price of our Common Stock on the date of grant. We recognize the fair value of RSUs, net of estimated forfeitures, as expense over the requisite service period of the awards.
Judgments and Uncertainties
The critical accounting estimates related to stock-based compensation are the assumptions utilized in the Black-Scholes valuation model and our estimate of award forfeitures.
The assumptions used by management in the Black-Scholes model are as follows:
•Fair value of common stock: our Common Stock is publicly traded under the ticker "ZFOX". We use the closing price of our Common Stock on the date of grant.
•Expected term: the expected term represents the period of time that options granted are expected to remain unexercised. We calculate the expected term using the simplified method, which equals the midpoint of the options’ vesting term and contractual period.
•Expected Volatility: as our Common Stock has been publicly traded only for a short time, we estimate the expected volatility based on historical volatilities of comparable public traded companies. The Company expects to continue to use this methodology until such time as the Company’s Common Stock has a sufficient amount of historical data to reasonably calculate the volatility of the Company’s Stock.
•Risk-free interest rate: we use the U.S. Treasury yield for a period that corresponds to the expected term of the award.
•Dividend yield: we do not currently issue dividends and do not expect to issue dividends in the foreseeable future. Accordingly, our dividend yield is zero.
•Forfeiture rate: we estimates the rate of option forfeiture by monitoring the rate of employee turnover and average tenure at separation of employment.
Sensitivity of Estimate to Change
These estimates involve inherent uncertainties and the application of management’s judgement. If the Company had made different assumptions, the Company’s stock-based compensation expense and its net loss could have been materially different.
71
An increase in risk-free interest rate will reduce the estimated fair value of a stock option grant, while a decrease in these factors will have an opposite effect.
A decrease in volatility and expected term will decrease the estimated fair value of a stock option grant, while an increase in these factors will have an opposite effect. The Company utilizes a consistent group of peer companies unless one or more of those companies cease to be publicly traded or are no longer similar to the Company’s business. In cases where a peer group company is no longer able to be used, the Company identifies a replacement peer company for its volatility calculation. Once the Company's Common Stock has a sufficient, representative trading history on which to base a volatility factor estimate, we will change to an estimate based on the Company's Common Stock. We do not expect to change the volatility estimation methodology in the next twelve months. When we do change the method, it will apply to new stock-based awards on a prospective basis.
The Company does not expect to change the dividend yield assumption in the near future.
A decrease in the Company’s estimate of option forfeiture will increase the amount of stock option expense recognized in a period while an increase will have the opposite effect.
Business Combinations
Description
We account for the acquisition of a business using the acquisition method of accounting, which requires us to estimate the fair values of the tangible and intangible assets acquired and liabilities assumed. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets such as identified acquired technology and customer relationships. We generally determine the fair value of acquired technology using the relief from royalty method. We determine the fair value of customer relationships using the multi-period excess earnings method, a form of the income approach.
Significant changes in assumptions and estimates subsequent to completing the allocation of the purchase price to the assets and liabilities acquired, as well as differences in actual and estimated results, could result in material impacts to our financial results. Additional information related to the acquisition date fair value of acquired assets and liabilities obtained during the allocation period, not to exceed one year, may result in changes to the recorded values of acquired assets and liabilities, resulting in an offsetting adjustment to the goodwill associated with the business acquired.
Judgments and Uncertainties
Estimates in valuing identifiable intangible assets include, but are not limited to, the selection of valuation methodologies, future expected cash flows, discount rates, and useful lives. Our estimate of fair value is based on assumptions we believe to be reasonable, but which are inherently uncertain and, as a result, actual results may differ from estimates.
Sensitivity of Estimate to Change
Additional information related to the acquisition date fair value of acquired assets and liabilities obtained during the measurement period, not to exceed one year, may result in changes to the recorded values of acquired assets and liabilities. Offsetting adjustments are recorded to goodwill. Any adjustments made after the measurement period will be reflected in the Consolidated Statements of Operations.
The impact to our financial statements for a change of one year to the estimated lives our acquired intangible assets would be approximately $2.3 million for the three months ended April 30, 2023.
72
Goodwill
Description
The excess of the fair value of purchase consideration over the values of the identifiable assets acquired and liabilities assumed is recorded as goodwill. We perform our annual goodwill impairment assessment on November 1, or when an assessment of qualitative factors indicates an impairment may have occurred. The qualitative assessment includes an evaluation of events and circumstances including long-term growth projections, profitability, industry, and market and macroeconomic conditions. The quantitative assessment includes an analysis that compares the fair value of a reporting unit to its carrying value, including goodwill recorded by the reporting unit.
Judgments and Uncertainties
Management applies judgement to determine the number of reporting units and if circumstances or events indicate if an impairment may exist. We have determined that the Company operates as a single reporting unit. As such, we perform the impairment assessment for goodwill at the enterprise level.
We determine the fair value of our reporting unit using a combination of the income and market approaches. The results from each of these approaches are weighted appropriately taking into account the relevance and availability of data at the time we perform the valuation. The estimate of the fair value of the related reporting unit includes several judgments, each with inherent uncertainties such as projections of revenue growth rates, gross margin, and projected future cash flows of the reporting unit and the discount rate applied to those projected future cash flows.
The discount rate used in the income approach is based on our weighted-average cost of capital and may be adjusted for the relevant risks associated with business-specific characteristics and any uncertainty related to the reporting unit's ability to execute on the projected future cash flows. Under the market approach, the fair value is determined using certain financial metrics of publicly traded companies and historically completed transactions of comparable businesses. The selection of comparable businesses requires judgment and is based on the markets in which we operate giving consideration to, among other things, risk profiles, size, and geography. The market approach may also be limited in instances where there is a lack of recently executed transactions of comparable businesses.
Determining the fair value of our reporting unit requires judgment and the use of significant estimates and assumptions. Given the current competitive and macroeconomic environment and the uncertainties regarding the related impact on the business, there can be no assurance that the estimates and assumptions made for purposes of the Company’s interim and annual goodwill impairment tests will prove to be accurate predictions of the future. If the Company’s assumptions are not realized, the Company may record additional goodwill impairment charges in the future. It is not possible at this time to determine if any such future impairment charge would result or whether such charge would be material.
Sensitivity of Estimate to Change
As of October 31, 2022, the Company concluded that it was more likely than not that the estimated fair value of its reporting unit was less than its carrying value. Accordingly, in connection with its annual test as of November 1, 2022, the Company completed an interim goodwill impairment assessment. Based on our quantitative assessment the Company determined the fair value of the Company's single reporting unit as of October 31, 2022, was $675.0 million. As this amount was less than the reporting unit's carrying value of $1,373.7 million, we recorded a goodwill impairment charge of $698.7 million.
73
Liquidity and Capital Resources
We have financed operations primarily through the sale of equity securities, borrowings under various security and loan agreements, and payments from customers. Our operating losses have been significant, as reflected in our accumulated deficit of $772.7 million as of April 30, 2023. We expect to continue to incur operating losses in the near term.
Cash and cash equivalents were $28.3 million on April 30, 2023. We believe that our existing cash and cash equivalents will be sufficient to fund our operating and capital expenditure requirements for at least the next twelve months.
Additional future sources of liquidity may come from the issuance of additional debt, exercise of warrants, and/or the issuance of new shares of Common Stock. In the case of additional debt, we are permitted by the indenture governing the Convertible Notes to issue no more than $50.0 million of senior debt. If we raise funds by issuing debt securities, such debt securities would have rights, preferences and privileges senior to those of holders of our Common Stock. The terms of debt securities or borrowings could impose significant restrictions on our operations. For warrants, the Company will receive the proceeds from the cash exercise of any warrants. The aggregate proceeds of the exercise of all outstanding warrants, assuming cash exercise, would be $186.6 million. We believe the likelihood that warrant holders will exercise their warrants, and therefore the amount of cash proceeds that we would receive, is dependent upon the market price of our Common Stock. On June 6, 2023, the last reported sales price of our Common Stock on the Nasdaq Global Market was $1.19 per share. If the market price for our Common Stock is less than $11.50 per share, we believe the warrant holders will be unlikely to exercise their warrants. We may issue additional shares of our Common Stock or other equity securities of equal or senior rank in the future for investment or operational purposes. If we issue additional shares of Common Stock, dilution to our public shareholders may occur and the market price for our Common Stock may decrease and/or become more volatile. The amount, timing, and mix (be it debt or equity) of future amounts of liquidity will depend upon the judgment of management, the market price of our Common Stock, and prevailing interest rates, among other factors.
Future capital requirements will depend on many factors including, but not limited to, cash collected from customers, additional borrowing, acceleration of sales and marketing costs to facilitate revenue expansion, and the continued adoption of our subscription products. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, financial condition and results of operations would be harmed. To support the growth of our business, we may need to incur additional indebtedness under our existing loan agreement or seek capital through new equity or debt financing, which sources of additional capital may not be available to us on acceptable terms or at all.
Cash Flows
The following table presents a summary of our cash flows:
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Cash, cash equivalents, and restricted cash at beginning of period |
|
$ |
47,649 |
|
Net cash used in operating activities |
|
|
(17,917 |
) |
Net cash used in investing activities |
|
|
(8,201 |
) |
Net cash provided by financing activities |
|
|
7,346 |
|
Foreign exchange translation adjustments |
|
|
25 |
|
Cash, cash equivalents, and restricted cash at end of period |
|
$ |
28,902 |
|
74
Operating Activities
Our largest source of cash is payments from customers. Our primary uses of cash stem from personnel-related expense, third-party hosting expense, data source expense, and overhead expense, which is primarily comprised of IT support, facilities, and insurance expense. Cash used in operating activities primarily consists of our net losses from operations adjusted for non-cash expenses, including stock-based compensation expense, depreciation and amortization expense, goodwill impairment charges, and changes in period operating assets and liabilities.
Cash used in operating activities was $(17.9) million for the three months ended April 30, 2023. The cash used in operating activities consisted of our net loss of $(18.0) million adjusted by non-cash reconciling items of $8.2 million and net cash outflows of from changes in operating assets and liabilities of $(9.8) million, primarily due to an increase in accounts receivable of $(13.4) million, a decrease in operating lease liabilities of $(0.3) million, partially offset by an increase in accounts payable, accrued compensation, accrued expenses and other current liabilities of $3.0 million, a decrease in prepaid expenses and other assets of $1.7 million, and an increase in deferred revenue $0.8 million.
Investing Activities
Cash used in investing activities was $(8.2) million for the three months ended April 30, 2023. The cash used in investing activities primarily consisted of the net purchase price paid to complete the acquisition of LookingGlass of $(7.9) million.
Financing Activities
Cash provided by financing activities was $7.3 million for the three months ended April 30, 2023. The cash provided by financing activities primarily consisted of proceeds from the issuance of debt of $7.5 million of additional borrowings from Stifel.
Debt Obligations
The following table presents a summary of our debt obligations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of April 30, 2023 |
|
(dollars in thousands) |
|
Stated
Interest Rate |
|
Gross
Balance |
|
|
Unamortized
Debt Discount |
|
|
Unamortized
Deferred
Debt Issuance
Costs |
|
|
Net
Carrying
Value |
|
Stifel Bank |
|
9.00% |
|
$ |
22,500 |
|
|
$ |
(125 |
) |
|
$ |
— |
|
|
$ |
22,375 |
|
InfoArmor |
|
5.50% |
|
|
2,109 |
|
|
|
— |
|
|
|
— |
|
|
|
2,109 |
|
Convertible notes |
|
7.00% Cash / 8.75% PIK |
|
|
159,949 |
|
|
|
— |
|
|
|
(114 |
) |
|
|
159,835 |
|
Alsop Louie Convertible Note |
|
6.00% |
|
|
3,333 |
|
|
|
— |
|
|
|
— |
|
|
|
3,333 |
|
|
|
|
|
$ |
187,891 |
|
|
$ |
(125 |
) |
|
$ |
(114 |
) |
|
$ |
187,652 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current portion of long-term debt |
$ |
938 |
|
|
|
|
|
|
|
|
|
|
|
Long-term debt |
|
186,714 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
187,652 |
|
75
Material Cash Requirements
Our material cash requirements are associated with repayment of debt and obligations associated with non-cancelable contracts for the purchase of goods and third-party services and operating leases. We expect to satisfy these cash requirements through the cash available on our balance sheet.
The following table summarizes current and long-term material cash requirements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of April 30, 2023 |
|
(dollars in thousands) |
|
Thereafter |
|
|
Less than 1 year |
|
|
1-3 years |
|
|
3-5 years |
|
|
Total |
|
Operating leases (1) |
|
$ |
- |
|
|
$ |
1,176 |
|
|
$ |
1,953 |
|
|
$ |
492 |
|
|
$ |
3,621 |
|
Purchase commitments (2) |
|
|
- |
|
|
|
12,714 |
|
|
|
168 |
|
|
— |
|
|
|
12,882 |
|
Debt repayments |
|
|
- |
|
|
|
938 |
|
|
|
186,953 |
|
|
— |
|
|
|
187,891 |
|
Total |
|
$ |
- |
|
|
$ |
14,828 |
|
|
$ |
189,074 |
|
|
$ |
492 |
|
|
$ |
204,394 |
|
(1) Relates to our office facilities.
(2) Relates to our non-cancelable purchase commitments to purchase products and services entered into in the normal course of business.
Non-GAAP Financial Measures
In addition to our results determined in accordance with US GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance by excluding certain items that may not be indicative of our business, results of operations, or outlook. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool, and should not be considered in isolation or as a substitute for financial information presented in accordance with US GAAP.
Other companies, including companies in our industry, may calculate similarly titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. In particular, free cash flow is not a substitute for cash used in operating activities. Additionally, the utility of free cash flow as a measure of our liquidity is limited as it does not represent the total increase or decrease in our cash balance for a given period.
Below, we have provided a reconciliation for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures and not rely on any single financial measure to evaluate our business.
Non-GAAP Gross Profit and Non-GAAP Gross Margin
We believe non-GAAP gross profit and non-GAAP gross margin provide our management and investors consistency and comparability with our past financial performance and facilitate period-to-period comparisons of operations, as these measures eliminate the effects of certain variables unrelated to our overall operating performance.
Non-GAAP Gross Profit and Non-GAAP Gross Margin
We define non-GAAP gross profit and non-GAAP gross margin as US GAAP gross profit and US GAAP gross margin, respectively, excluding stock-based compensation expense and amortization of acquired intangible assets.
76
The following table provides a reconciliation of our US GAAP gross profit to our non-GAAP gross profit and of our US GAAP gross margin to our non-GAAP gross margin:
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Revenue |
|
$ |
45,534 |
|
Gross profit |
|
|
14,914 |
|
Add: Stock-based compensation expense |
|
|
13 |
|
Add: Amortization of acquired intangible assets |
|
|
4,799 |
|
Non-GAAP gross profit |
|
$ |
19,726 |
|
Gross margin |
|
|
33 |
% |
Non-GAAP gross margin |
|
|
43 |
% |
Subscription Non-GAAP Gross Profit and Non-GAAP Gross Margin
We define subscription non-GAAP gross profit and subscription non-GAAP gross margin as US GAAP subscription gross profit and US GAAP subscription gross margin, respectively, excluding stock-based compensation expense and amortization of acquired intangible assets.
The following table provides a reconciliation of our US GAAP subscription gross profit to our non-GAAP subscription gross profit and of our US GAAP subscription gross margin to our non-GAAP subscription gross margin:
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Subscription revenue |
|
$ |
18,223 |
|
Subscription gross profit |
|
|
8,319 |
|
Add: Stock-based compensation expense |
|
|
7 |
|
Add: Amortization of acquired intangible assets |
|
|
4,799 |
|
Non-GAAP subscription gross profit |
|
$ |
13,125 |
|
Subscription gross margin |
|
|
46 |
% |
Non-GAAP subscription gross margin |
|
|
72 |
% |
Services Non-GAAP Gross Profit and Non-GAAP Gross Margin
We define services non-GAAP gross profit and services non-GAAP gross margin as US GAAP services gross profit and US GAAP services gross margin, respectively, excluding stock-based compensation expense. There is no amortization of intangible assets expenses recorded in services US GAAP gross profit and therefore, no exclusion is necessary.
The following table provides a reconciliation of our US GAAP services gross profit to our non-GAAP services gross profit and of our US GAAP services gross margin to our non-GAAP services gross margin:
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Services revenue |
|
$ |
27,311 |
|
Services gross profit |
|
|
6,595 |
|
Add: Stock-based compensation expense |
|
|
6 |
|
Non-GAAP services gross profit |
|
$ |
6,601 |
|
Services gross margin |
|
|
24 |
% |
Non-GAAP services gross margin |
|
|
24 |
% |
Non-GAAP Loss from Operations
We define non-GAAP loss from operations as US GAAP net loss from operations, excluding stock-based compensation expense, amortization of acquired intangible assets, costs incurred for the Business Combination, and goodwill impairment charges. We believe non-GAAP loss from operations provides our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations as these measures eliminate the effects of certain variables unrelated to our overall operating performance.
77
The following table provides a reconciliation of our US GAAP net loss from operations to our non-GAAP loss from operations:
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Loss from operations |
|
$ |
(21,299 |
) |
Add: Stock-based compensation expense |
|
|
1,099 |
|
Add: Amortization of acquired intangible assets |
|
|
11,766 |
|
Non-GAAP loss from operations |
|
$ |
(8,434 |
) |
Free Cash Flow
We define free cash flow as net cash used in operating activities less purchases of property and equipment and capitalized internal-use software. We believe that free cash flow is a useful indicator of liquidity that provides meaningful information to management and investors about the amount of cash provided by our operating activities that is available to be used for other strategic initiatives or consumed by our operating activities that impact our liquidity. Free cash flow does not represent the total increase or decrease in our cash balance for a given period and does not reflect our future contractual commitments. In addition, other companies may calculate free cash flow differently or not at all, which reduces the usefulness of free cash flow as a tool for comparison.
The following table presents a reconciliation of net cash used in operating activities to free cash flow:
|
|
|
|
|
(dollars in thousands) |
|
Three months ended
April 30, 2023 |
|
Net cash used in operating activities |
|
$ |
(17,917 |
) |
Less: Purchases of property and equipment |
|
|
(255 |
) |
Less: Capitalized software |
|
|
(54 |
) |
Free cash flow |
|
$ |
(18,226 |
) |
78
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF ID EXPERTS HOLDINGS, INC.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements” and “Risk Factors” for a discussion of forward-looking statements and important factors that could cause actual results to differ materially from the results described in or implied by these forward-looking statements. Unless otherwise indicated or the context otherwise requires, references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section to ‘‘IDX,’’ ‘‘we,’’ ‘‘us,’’ ‘‘our,’’ and other similar terms refer to ID Experts Holdings, Inc. and its subsidiary.
Overview
IDX was founded in 2003 with a mission to address the growing threat from data breaches and resulting identity theft and fraud. IDX created a software and services platform to help protect individuals from data breaches and resulting identity crime and to remediate the negative effects of such breaches.
As organizations began to experience cybersecurity breaches of growing frequency and severity, IDX expanded its offerings by providing organizations with data breach response services that leveraged IDX’s identity protection offerings for individuals. As new laws and regulations were passed that required breach notification and protections for affected individuals, the IDX business grew to serve both governmental and commercial entities of varied sizes.
The Business
IDX believes it has a leading position in the United States by revenue as a provider of data breach response services, and associated identity and privacy protection services, to both government and commercial entities. IDX acquires new customers for its data breach services through cyber insurers and their approved privacy attorneys. IDX services are often pre-approved through direct relationships with organizations that have entered into master services agreements (MSA) for current and future services, as well as through government channels as a result of approved listings with the General Services Administration (GSA) for federal agencies and the National Association of State Procurement Officials (NASPO) for state and local agencies.
IDX provides identity and privacy protection services through its proprietary, cloud-native platform for the protection of individuals impacted by data breaches, as well as through other channels, for proactively addressing the risks associated with privacy and identity risks to the affected individuals and the breached organization. The IDX platform was designed to improve scalability and usability, while concurrently supporting rapid development of new capabilities, and compliance with increasingly rigorous security standards based on the National Institute of Standards and Technology (NIST) Special Publication 800-53 Rev 4. Typically, IDX evaluates its own security controls, and in some cases contracts testing to third parties as part of yearly FISMA security risk assessments, HIPAA security risk analysis for business associates, and SOC 2 type 2 certifications.
IDX has a substantial customer base for data breach services in the public sector. The largest component of revenue from the public sector results from a multiyear contract with the U.S. Office of Personnel Management (OPM), described below.
79
In 2015, OPM and the Department of Defense (DoD) awarded IDX a three-year, $330 million contract to provide identity protection and breach response services covering approximately 21.5 million current and former federal employees and contractors that were affected by the OPM data breach of background investigation records (OPM Contract). IDX believes winning this award resulted in further market validation, increased visibility, and enhanced reputation for IDX as a leading data breach response provider in the United States by revenue. Earning this award required IDX to comply with rigorous government security standards. IDX’s compliance performance combined with receiving “very good” and “excellent” Contractor Performance Assessment Reports (CPAR) ratings leave the IDX data breach response business well positioned to address large-scale data breaches.
IDX won a rebid of the contract with OPM and the DoD in 2018. The new contract is worth at least $460 million, assuming all option periods and the extension period are exercised, for the period ending June 30, 2024. The scope of the new contract is for IDX to provide identity protection services for certain employees and prospective employees of the U.S. Government affected by a breach of OPM systems. IDX believes the OPM Contract was and remains as of August 3, 2022, the largest data breach response arrangement in the history of such contracts in the United States. The award of this contract to IDX cemented it as a leading provider in the United States by revenue of data breach response services to both governmental and commercial entities. In addition, IDX is listed on the General Services Administration (GSA) SIN 520.20 for Data Breach Response and Identity Protection Services facilitating data breach response contracts with numerous other government agencies. A SIN is a Special Item Number that identifies products and services that GSA contract holders offer to government buyers. IDX benefits from having a SIN with GSA as it allows IDX to participate in more bid opportunities for providing Data Breach Response and Identity Protection Services.
The OPM Contract is structured as a Base Period from July 1, 2019, to June 30, 2020, followed by a series of options as follows: Option Period I from July 1, 2020, to June 30, 2021; Option Period II from July 1, 2021, to June 30, 2022; Option Period III from July 1, 2022, to June 30, 2023; and Option Period IV from July 1, 2023, to December 31, 2023. OPM has an option to extend the OPM Contract from January 1, 2024, to June 30, 2024, as well as an option to add a transition-out period beyond June 30, 2024. OPM has exercised Option Period I, Option Period II, and Option Period III. IDX plans to pursue the rebid of the OPM Contract in 2024 for an extension through 2027. For more information, see a copy of the OPM Contract incorporated by reference as an exhibit to the ZeroFox Holdings, Inc., Annual Report on Form 10-K, filed with the Securities and Exchange Commission (SEC) on March 30, 2023.
IDX generates the largest component of its commercial revenue from organizations that require response services for data breach incidents. The response services typically include notifications to individuals impacted by the breach; call center support; a customized webpage for providing information, privacy and identity protection software, and additional services to the affected population. In addition to revenue from data breach incident response services, IDX also provides identity and privacy services on a subscription basis to organizations, which they can offer as a benefit for their employees or customers.
80
Impact of COVID-19 On the Business
IDX operates in geographic locations that have been impacted by COVID-19. The pandemic has affected, and could further affect, IDX’s operations and the operations of its customers as a result of various factors, including but not limited to quarantines, local, state, and federal government public health orders, facility and business closures, and travel and logistics restrictions. IDX anticipates governments and businesses will likely take additional actions or extend existing actions to respond to the risks of the COVID-19 pandemic. IDX continues to actively monitor the impacts and potential impacts of the COVID-19 pandemic on IDX’s customers, supply chain, and operations. For further information, please see “Risk Factors—The COVID-19 pandemic could adversely affect our business, operating results, and financial condition” in the ZeroFox Holdings, Inc., Annual Report on Form 10-K, filed with the SEC on March 30, 2023.
IDX instituted a global work-from-home policy in March 2020 and to-date have not experienced significant disruptions as a result. IDX has not requested relief under the Coronavirus Aid, Relief, and Economic Security Act, and it therefore had no effect on its financial statements.
81
Key Factors Affecting Performance
New customer acquisition
IDX believes that its future growth depends in part on its ability to acquire new customers for its data breach services and identity protection membership services to its strategic partners’ members, employer groups’ employees, and individual customers. IDX has sourced a significant proportion of new data breach services customers as a result of relationships with cyber insurers. IDX makes on-going investments in developing and maintaining these relationships, as well as relationships with privacy attorneys that represent many of their cyber insurers. Additionally, IDX invests in direct marketing to prospective customers for data breach services, as well as IDX’s identity and privacy membership services for employee benefits and strategic partner customer protection.
Customer Retention
IDX’s revenue growth is fostered by its ability to retain customers that have an ongoing need for data breach response services. IDX maintains its relationship with its customers after the conclusion of the data breach response by cross-selling membership services to its customers affected stakeholders, which are typically our customers’ employees or their own customers. IDX has multi-year contracts with some government entities, including the OPM Contract. The possible retention and renewal of the OPM Contract may also be a factor in maintaining revenue growth.
Investing in Business Growth
IDX also invests in initiatives to support the growth of its business. IDX’s research and development organization, composed of employees and contractors, uses an agile development philosophy in an effort to enhance its existing identity and privacy platform while adding new features and products, usability enhancements, customer integrations and APIs, and security certifications. IDX’s sales and marketing teams invest in business growth through channel expansion with dedicated sales teams and associated marketing demand generation programs.
IDX also invests in the growth of its business with government entities by building relationships with consultants experienced in the government procurement process and maintenance of its listings on relevant GSA schedules, as well as by investing in relationships with key government agency stakeholders and congressional representatives. IDX from time to time will work with consultants who specialize in government contract bidding strategies, provide advice on optimal maintenance and use of the U.S. Government GSA schedule, and provide strategic, relationship-building, and legislative affairs services with members of Congress and their staffs.
Key Business Metrics
IDX monitors the following key metrics to measure performance, identify trends, formulate business plans, and make strategic decisions.
82
Breach Revenue, Membership Services, and Total Revenue
The tables below present IDX’s key performance indicators for the periods indicated (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2022 |
|
Breach revenue (1) |
|
|
$ |
26,367 |
|
Membership services (1) |
|
|
|
1,107 |
|
Total revenue |
|
|
$ |
27,474 |
|
Breach customers (2) |
|
|
|
1,042 |
|
Membership customers (2) |
|
|
|
174 |
|
|
|
|
|
|
|
|
|
|
|
(1) IDX defines breach revenue as revenue related to breach contracts, which typically have a term of 15 months (three-month call center period followed by 12 months of identity protection services) and are non-recurring. IDX defines membership services as recurring monthly and yearly ongoing identity and privacy services provided to strategic partners’ members and employer groups’ employees and retail customers. |
|
(2) IDX defines a breach customer as an agency or organization from which it has recognized breach revenue in a reporting period. IDX defines membership customers, in this instance, as strategic partners and employer groups receiving membership services (non-breach and non-retail customers). |
|
Components of Results from Operations
Revenue
IDX recognizes revenue when control of the promised goods or services is transferred to its customers, in an amount that reflects the consideration IDX expects to be entitled to in exchange for its goods or services. For arrangements with multiple performance obligations, IDX allocates revenue to each performance obligation on a relative fair value basis based on management’s estimate of Stand-Alone Selling Price (SSP).
IDX’s breach services revenue consists of contracts with various combinations of notification, project management, communication services, and ongoing identity protection services. Performance periods generally range from one to three years. Payment terms are generally either thirty or sixty days throughout the term. Contracts do not contain significant financing components. IDX’s breach services contracts are structured as either fixed price or variable price. In fixed price contracts, IDX charges customers a fixed total price or fixed per-impacted individual price for the total package of services. For variable price breach services contracts, IDX charges the breach communications component, which includes notifications and call center support, at a fixed total fee and charges for ongoing identity protection services as incurred using a fixed price per enrollment. Refunds and related reserves have been insignificant historically.
IDX provides identity and privacy protection services memberships through its employer groups and strategic partners as well as directly to individual end-users through its website. Membership services consist of multiple bundled identity and privacy product offerings which provide members with ongoing identity protection services. For membership services, IDX recognizes revenue ratably over the service period, which is typically one year. Payments from employer groups and strategic partners are generally collected monthly and payments from end-users are collected up front.
IDX evaluates arrangements with governmental entities containing “fiscal funding” or “termination for convenience” provisions, when such provisions are required by law, to determine the probability of possible cancellation. IDX considers multiple factors including its history with the government entity in similar transactions and the budgeting and approval processes undertaken by the governmental entity. If IDX determines upon execution of these arrangements that the likelihood of cancellation is remote, it recognizes revenue for such arrangements once all relevant criteria have been met. If IDX cannot make such a determination, it recognizes revenue upon the earlier of cash receipt or approval of the applicable funding provision by the governmental entity for such arrangements.
83
Cost of Revenue
Cost of revenue consists of fees to outsourced service providers for credit monitoring, call center operation, notification mailing, insurance, other miscellaneous services, and internal labor costs. IDX expenses notification costs as fulfillment costs and recognizes those notification costs at a point in time. IDX capitalizes call center costs and amortizes the call center costs over time. IDX generally recognizes sales commissions, which are incremental costs to obtain contracts, ratably over the contractual period of the applicable agreement. IDX presents notification and call center costs within capitalized contract costs and recognizes the costs over the combined service and membership terms. IDX expenses the remainder of cost of services as incurred.
Gross Profit
Gross profit, calculated as total revenue less total cost of services, is affected by several factors including the timing of breach incidents; renewals from existing customers; costs associated with fulfilling contracts such as notification, call center, and monitoring costs; the extent to which IDX expands its customer support organization; and the extent to which IDX can negotiate any preferential pricing from its vendors. IDX’s services revenue and gross profit may fluctuate over time because of these factors.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee compensation and related expenses, including salaries, bonuses, and benefits for IDX’s sales and marketing employees; sales commissions that are recognized as expenses over the period of benefit; marketing programs; travel and entertainment expenses; and allocated overhead costs. IDX capitalizes its sales commissions and recognizes them as expenses over the estimated period of benefit.
General and Administrative
General and administrative costs consist primarily of salaries, stock-based compensation expenses, and benefits for personnel involved in IDX’s executive, finance, legal, human resources, and administrative functions; third-party services and fees; and overhead expenses. IDX expects that general and administrative expenses will increase in absolute dollars as IDX hires additional personnel and enhances its systems, processes, and controls to support the growth in IDX’s business as well as increased compliance and reporting requirements as a public company.
Research and Development
Research and development expenses consist primarily of personnel costs and contractor fees related to the bundling of other third-party software products that are offered as one combined package within IDX’s product offerings. Personnel costs include salaries, bonuses, stock-based compensation, and related employer-paid payroll taxes, as well as an allocation of facilities, benefits, and information technology costs. IDX expenses research and development costs as incurred.
Interest and Other Expense
Interest and other expense consist primarily of term loan interest expense and the amortization of warrant and loan fees, which are recorded as a reduction to debt on the IDX Consolidated Balance Sheets.
84
Income Tax Expense (Benefit)
Income tax expense (benefit) consists of federal and state income taxes in the United States. IDX maintains a partial valuation allowance on its state net operating losses.
Results of Operations
Three months ended March 31, 2022
This section describes the results of IDX for the three months ended March 31, 2022.
The following table sets forth the IDX Consolidated Statement of Income in dollar amounts and as a percentage of total revenue for each period presented (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2022 |
|
|
|
|
|
|
Percentage of Revenue |
|
Revenue |
|
$ |
27,474 |
|
|
|
100 |
% |
Cost of revenue |
|
|
21,265 |
|
|
|
77 |
% |
Gross profit |
|
|
6,209 |
|
|
|
23 |
% |
Operating expenses: |
|
|
|
|
|
|
Research and development |
|
|
1,450 |
|
|
|
6 |
% |
Sales and marketing |
|
|
1,896 |
|
|
|
7 |
% |
General and administrative |
|
|
2,823 |
|
|
|
10 |
% |
Total operating expenses |
|
|
6,169 |
|
|
|
23 |
% |
Income from operations |
|
|
40 |
|
|
|
0 |
% |
Total other expense |
|
|
392 |
|
|
|
1 |
% |
Loss before income taxes |
|
|
(352 |
) |
|
|
-1 |
% |
Income tax benefit |
|
|
(94 |
) |
|
|
0 |
% |
Net loss after tax |
|
$ |
(258 |
) |
|
|
-1 |
% |
Revenue
Revenue was $27.5 million for the three months ended March 31, 2022.
Cost of Revenue
Cost of revenue was $21.3 million for the three months ended March 31, 2022.
Gross Profit
Gross profit and gross profit margin for the three months ended March 31, 2022, were $6.2 million and 23%, respectively.
Operating Expenses
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Three Months Ended March 31, 2022 |
|
Research and development |
|
|
|
|
|
$ |
1,450 |
|
Sales and marketing |
|
|
|
|
|
|
1,896 |
|
General and administrative |
|
|
|
|
|
|
2,823 |
|
Total operating expenses |
|
|
|
|
|
$ |
6,169 |
|
Research and Development
Research and development cost was $1.5 million for the three months ended March 31, 2022.
Sales and Marketing
Sales and marketing cost was $1.9 million for the three months ended March 31, 2022.
85
General and Administrative
General and administrative cost was $2.8 million for the three months ended March 31, 2022.
Total Other Expense
Total other expense was $0.4 million for the three months ended March 31, 2022.
Provision for Income Taxes
Income tax benefit was $0.1 million for the three months ended March 31, 2022.
Cash Flows
The following table summarizes IDX’s cash flows for the periods indicated:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Three Months Ended March 31, 2022 |
|
Net cash used in operating activities |
|
|
|
|
|
$ |
(2,255 |
) |
Net cash used in investing activities |
|
|
|
|
|
|
(36 |
) |
Net cash provided by financing activities |
|
|
|
|
|
$ |
2 |
|
Operating Activities
Cash used in operating activities was $(2.3) million for the three months ended March 31, 2022. The cash used in operating activities consisted of our net loss of $(0.3) million adjusted by non-cash reconciling items of $0.3 million and net cash outflows of from changes in operating assets and liabilities of $(2.3) million, primarily due to an increase in accounts receivable of $(1.1) million, an increase in prepaid expenses and other assets of $(0.4) million, a decrease in accrued compensation, accrued expenses and other current liabilities of $(0.8) million partially offset by an increase in accounts payable of $0.2 million, and deferred revenue of $0.1 million.
Investing Activities
Cash used in investing activities was $(0.04) million for the three months ended March 31, 2022. These cash outflows were for purchases of property and equipment.
Financing Activities
Cash provided by financing activities was $0.01 million for the three months ended March 31, 2022. These cash inflows were from exercises of stock options.
Contractual Obligations
IDX has entered a non-cancelable purchase commitment of $16.2 million related to three months of outsourced credit and other monitoring services provided to IDX’s largest customer as of March 31, 2022.
The following table summarizes IDX’s contractual obligations and commitments as of March 31, 2022, (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
Less than 1 year |
|
|
1-3 years |
|
Operating leases |
|
|
|
$ |
596 |
|
|
$ |
498 |
|
|
$ |
98 |
|
Purchase commitments |
|
|
|
|
16,207 |
|
|
|
16,207 |
|
|
— |
|
Total |
|
|
|
$ |
16,803 |
|
|
$ |
16,705 |
|
|
$ |
98 |
|
86
Off-Balance Sheet Arrangements
Leases
Rental payments under operating leases are recognized on a straight-line basis over the term of the lease including any periods of free rent. Rental expense for operating leases was $0.1 million for the three months ended March 31, 2022.
IDX executed the Fifth Amendment to the office lease on October 9, 2020. This amendment was for two years and two months commencing on January 1, 2021, and ending February 28, 2023. IDX’s landlord provided an abatement for January 1, 2021, through February 28, 2021, as part of its lease renewal.
Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of March 31, 2022, are (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases |
|
Fiscal Year: |
|
|
|
|
|
|
2022 (remaining quarters) |
|
|
|
|
$ |
399 |
|
2023 |
|
|
|
|
$ |
149 |
|
2024 |
|
|
|
|
$ |
48 |
|
Total minimum lease payments |
|
|
|
|
$ |
596 |
|
Critical Accounting Policies and Estimates
IDX’s financial statements are prepared in accordance with US GAAP. The preparation of these financial statements requires IDX to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, as well as related disclosures. IDX evaluates its estimates and assumptions on an ongoing basis. Estimates are based on historical experience and various other assumptions that IDX believes to be reasonable under the circumstances. Actual results could differ from these estimates. The critical accounting policies, assumptions, and judgements that IDX believes have the most significant impact on the IDX Consolidated Financial Statements are described below.
Revenue Recognition
Revenue is derived from sales of breach response services and identity and privacy protection services. IDX satisfies performance obligations to recognize revenue for two performance obligations, one at a point in time and the other ratably over the expected term with the customer.
Revenue is recognized when all of the following criteria are met:
Identification of the contract, or contracts, with a customer—A contract with a customer to account for exists when (i) IDX enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services, (ii) the contract has commercial substance and the parties are committed to perform, and (iii) IDX determines that collection of substantially all consideration to which it will be entitled in exchange for goods or services that will be transferred is probable based on the customer’s intent and ability to pay the promised consideration.
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Identification of the performance obligations in the contract—Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, IDX applies judgment to determine whether promised goods or services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised goods or services are accounted for as a combined performance obligation.
Determination of the transaction price—The transaction price is determined based on the consideration to which IDX will be entitled in exchange for transferring goods or services to the customer.
Allocation of the transaction price to the performance obligations in the contract—IDX allocates the transaction price to each performance obligation based on the amount of consideration expected to be received in exchange for transferring goods and services to the customer. IDX allocates the transaction price by using an estimated selling price for services provided to determine which portion of its contracts’ total transaction price should be recognized at a point-in-time and which portion should be recognized over-time. If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation on a relative standalone selling price based on the observable selling price of products and services.
Recognition of revenue when, or as, IDX satisfies performance obligations—IDX satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at or over the time the related performance obligation is satisfied by transferring a promised good or service to a customer.
Significant Judgments
Significant judgments and estimates are required under Topic 606. Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic 606 for IDX’s arrangements may be dependent on contract-specific terms and may vary in some instances. IDX’s contracts with customers often include promises to transfer multiple services, including project management services, notification services, call center services, and identity protection services. Determining whether services are distinct performance obligations that should be accounted for separately requires significant judgment.
IDX is required to estimate the total consideration expected to be received from contracts with customers, including any variable consideration. Once the estimated transaction price is established, amounts are allocated to performance obligations on a relative SSP basis. IDX’s breach business derives revenue from two main performance obligations: (i) notification and (ii) combined call center and identity protection services, described further in Note 2 in IDX’s notes to the IDX Condensed Consolidated Financial Statements included in this Quarterly Report.
At contract inception, IDX assesses the products and services promised in the contract to identify each performance obligation and evaluate whether the performance obligations are capable of being distinct and are distinct within the context of the contract. Performance obligations that are not both capable of being distinct and distinct within the context of the contract are combined and treated as a single performance obligation in determining the allocation and recognition of revenue. Determining whether products and services are considered distinct performance obligations requires significant judgment. In determining whether products and services are considered distinct performance obligations, IDX assesses whether the customer can benefit from the products and services on their own or together with other readily available resources and whether our promise to transfer the product or service to the customer is separately identifiable from other promises in the contract.
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Judgment is required to determine the SSP for each distinct performance obligation. IDX rarely sells its individual breach services on a standalone basis, and accordingly, IDX is required to estimate the range of SSPs for each performance obligation. In instances where the SSP is not directly observable because IDX does not sell the service separately, IDX reviews information that includes historical discounting practices, market conditions, cost-plus analysis, and other observable inputs to determine an appropriate SSP. IDX typically has more than one SSP for individual performance obligations due to the stratification of those items by classes of customers, size of breach, and other circumstances. In these instances, IDX may use other available information such as service inclusions or exclusions, customizations to notifications, or varying lengths of call center or identity protection services in determining the SSP.
If a group of agreements are so closely related to each other that they are, in effect, part of a single arrangement, such agreements are deemed to be one arrangement for revenue recognition purposes. IDX exercises judgment to evaluate the relevant facts and circumstances in determining whether the separate agreements should be accounted for separately or as, in substance, a single arrangement. IDX’s judgments about whether a group of contracts comprises a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of IDX’s operations for the periods involved.
Generally, IDX has not experienced significant returns or refunds to customers. IDX’s estimates related to revenue recognition may require significant judgment and the change in these estimates could have an effect on IDX’s results of operations during the periods involved.
Contract Balances
The timing of revenue recognition may differ from the timing of invoicing to customers and these timing differences result in receivables, contract assets, or contract liabilities (deferred revenue) on the IDX Consolidated Balance Sheets. IDX records a contract asset when revenue is recognized prior to invoicing and records a deferred revenue liability when revenue is expected to be recognized subsequent to invoicing. For IDX’s breach services agreements, customers are typically invoiced at the beginning of the arrangement for the entire contract. When the breach agreement includes variable components related to as-incurred identity protection services, customers are invoiced monthly for the duration of the enrollment or call center period. Large contracts are typically billed 50% upfront and due upon receipt with the remaining 50% invoiced subsequently with net 30 terms.
Contract assets are presented as other receivables within the IDX Consolidated Balance Sheets and primarily relate to IDX’s rights to consideration for work completed but not billed on service contracts. Contract assets are transferred to receivables when IDX invoices the customer. Contract liabilities are presented as deferred revenue and relate to payments received for services that are yet to be recognized in revenue.
During the three months ended March 31, 2022, the Company recognized $2.5 million of revenue that was included in deferred revenue at the end of the preceding year. All other deferred revenue activity is due to the timing of invoices in relation to the timing of revenue, as described above. The Company expects to recognize as revenue approximately 69% of its March 31, 2022, deferred revenue balance in the remaining quarters of 2022, 11% in the three months ended March 31, 2023, and the remainder thereafter.
In instances where the timing of revenue recognition differs from that of invoicing, IDX has determined that its contracts do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing IDX’s services, not to facilitate financing arrangements.
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Government Contracts
IDX evaluates arrangements with governmental entities containing “fiscal funding” or “termination for convenience” provisions, when such provisions are required by law, to determine the probability of possible cancellation. IDX considers multiple factors, including the history with the customer in similar transactions and budgeting and approval processes undertaken by the governmental entity. If IDX determines upon execution of these arrangements that the likelihood of cancellation is remote, it then recognizes revenue for such arrangements once all relevant criteria have been met. If such a determination cannot be made, revenue is recognized upon the earlier of cash receipt or approval of the applicable funding provision by the governmental entity for such arrangements.
Contract Costs
IDX capitalizes costs to obtain a contract or fulfill a contract. These costs are recorded as capitalized contract costs on the IDX Consolidated Balance Sheets. Costs to obtain a contract for a new customer are amortized on a straight-line basis over the estimated period of benefit. IDX determines the estimated period of benefit by taking into consideration the contractual term. IDX periodically reviews the carrying amount of the capitalized contract costs to determine whether events or changes in circumstances have occurred that could affect the period of benefit. Amortization expense associated with costs to fulfill a contract is recorded to cost of services on the IDX Consolidated Statements of Income, and amortization expense associated with costs to obtain a contract (sales commissions) is recorded to sales and marketing expense.
All notification costs are being expensed as fulfillment costs and recognized at a point in time. Call center costs are being capitalized and amortized over time. Sales commissions, which are incremental costs to obtain contracts, are recognized ratably over the contractual period of the applicable agreement.
Income Taxes
IDX provides for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax effect of differences between recorded assets and liabilities and their respective tax basis along with operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the rate change becomes effective. IDX recognizes the effect of income tax positions only if those positions are more likely than not of being sustained in the event of a tax audit.
Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest related to unrecognized tax benefits in interest expense. Penalties and interest of $0.1 million have been accrued to expense as of March 31, 2022, and are discussed further in Note 6 Income Taxes in the notes to the consolidated financial statements.
Deferred tax assets are reduced by a valuation allowance when, in management’s opinion, it is more likely than not that some portion or all the deferred tax assets will not be realized. IDX considers the future reversal of existing taxable temporary differences, taxable income in prior carryback years, projected future taxable income, and tax planning strategies in making this assessment. IDX’s valuation allowance is based on all available positive and negative evidence, including its recent financial operations, evaluation of positive and negative evidence with respect to certain specific deferred tax assets (including evaluating sources of future taxable income) to support the realization of the deferred tax assets.
The Company’s income tax returns are generally subject to examination by taxing authorities for a period of three years from the date they are filed. Tax authorities may have the ability to review and adjust net operating loss or tax credit carryforwards that were generated prior to these periods if utilized in an open tax year. As of March 31, 2022, the Company’s income tax returns for the years ended December 31, 2016,
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through 2021 are subject to examination by the Internal Revenue Service and applicable state and local taxing authorities.