You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "will," "would" or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors", set forth in Part I, Item 1A of this Annual Report on Form 10-K and in our otherSEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview We provide precision-policing and security solutions for law enforcement and security personnel to help prevent and reduce gun violence and make cities, campuses and facilities safer. Our flagship public safety solution,ShotSpotter Respond (formerly ShotSpotter Flex), is the leading outdoor gunshot detection, location and alerting system. Our gunshot detection solutions are trusted by law enforcement agencies in over 110 cities as ofDecember 31, 2020 . Our patrol management software, ShotSpotter Connect (formerly ShotSpotter Missions), uses artificial intelligence-driven analysis to help strategically plan directed patrols and have consistent use of tactics to deter a broad set of crime types. Our security solutions, ShotSpotter SecureCampus and ShotSpotter SiteSecure, are designed to help law enforcement and security personnel serving universities, corporate campuses, big box retail, malls and key infrastructure or transportation centers mitigate risk and enhance security by notifying authorities of a potential outdoor gunfire incident, saving critical minutes for first responders to arrive. ShotSpotter Investigate™, adds case management to our expanding suite of precision policing technology solutions and provides agencies with a cloud-based investigative digital case folder and analytical and collaboration tools to improve case closure rates. In 2019, we created a new technology innovation unit,ShotSpotter Labs , to expand our efforts supporting innovative uses of our technology to help protect wildlife and the environment Our gunshot detection solutions consist of highly-specialized, cloud-based software integrated with proprietary, internet-enabled sensors designed to detect outdoor gunfire. The speed and accuracy of our gunfire alerts enable law enforcement and security personnel to consistently and quickly respond to shooting events including those unreported through 911, which can increase the chances of apprehending the shooter, providing timely aid to victims, and identifying witnesses before they scatter, as well as aid in evidentiary collection and serve as an overall deterrent. When a potential gunfire incident is detected by our sensors, our system precisely locates where the incident occurred and applies machine classification combined with human review to analyze and validate the incident. An alert containing a location on a map and critical information about the incident is sent directly to subscribing law enforcement or security personnel through any internet-connected computer and to iPhone or Android mobile devices. Our software sends validated gunfire data along with the audio of the triggering sound to our Incident Review Center ("IRC"), where our trained incident review specialists are on duty 24 hours a day, seven days a week, 365 days a year to screen and confirm actual gunfire incidents. Our trained incident review specialists can supplement alerts with additional tactical information, such as the potential presence of multiple shooters or the use of high-capacity weapons. Gunshot incidents reviewed by our IRC result in alerts typically sent within approximately 45 seconds of the receipt of the gunfire incident. 55
-------------------------------------------------------------------------------- We generate annual subscription revenues from the deployment ofShotSpotter Respond on a per-square-mile basis. Our security solutions,ShotSpotter SecureCampus and ShotSpotter SiteSecure, are typically sold on a subscription basis, each with a customized deployment plan. Our ShotSpotter Connect solution is also sold on a subscription basis. As ofDecember 31, 2020 , we had ShotSpotter Respond, ShotSpotter SecureCampus and ShotSpotter SiteSecure coverage areas under contract for 813 square miles, of which 779 square miles had gone live. Coverage areas under contract included over 100 cities and 12 campuses/sites acrossthe United States ,South Africa and theBahamas , including three of the ten largest cities inthe United States . Most of our revenues are attributable to customers based inthe United States . As a result of the COVID-19 pandemic, work-from-home and travel ban policies designed to protect the health of employees, and related government-mandated restrictions, our ability to deploy customer solutions sincemid-March 2020 has been adversely impacted. While this disruption is currently expected to be temporary, there is considerable uncertainty around the magnitude or duration. While we intend to continue to devote resources to increase sales of our ShotSpotter SecureCampus, ShotSpotter SiteSecure,ShotSpotter Labs and ShotSpotter Connect solutions, we expect that revenues from ourShotSpotter Respond solution will continue to comprise a substantial majority of our revenues for the foreseeable future.ShotSpotter Labs projects are generally conducted in coordination with a sponsoring charitable organization. These projects may or may not be revenue-producing. When they are revenue-producing, they will generally be sold on a cost-plus basis. As such,ShotSpotter Labs projects will normally produce gross margins significantly lower than our ShotSpotter Respond solutions. Additionally, in early 2020, we added new pricing programs for Tier 4 and 5 law enforcement agencies (those with fewer than 100 sworn officers) that allow them to contract for our gunshot detection solutions to cover a footprint of less than three square miles, using standardized coverage parameters, at a discounted annual subscription rate. Since our founding, 25 years ago,ShotSpotter has been and continues to be a purpose-led company. We are a mission-driven organization that is focused on improving public safety outcomes. We accomplish this by earning the trust of law enforcement and providing them solutions to help them better engage and strengthen the police-community relationships in fulfilling their sworn obligation equally to serve and protect all. Our inspiration comes from our principal founder, Dr.Bob Showen , who believes that the highest and best use of technology is to promote social good. We are committed to developing comprehensive, respectful, and engaged partnerships with law enforcement agencies, elected officials and communities focused on making a positive difference in the world. We enter into subscription agreements on a term basis that typically range from one to five years in duration, with the majority having a contract term of one year. Substantially all of our sales are to governmental agencies and universities, which often undertake a prolonged contract evaluation process that affects the size or the timing of our sales contracts and may likewise increase our customer acquisition costs. For a discussion of the risks associated with our sales cycle, see risks entitled "Our sales cycle can be unpredictable, time-consuming and costly, and our inability to successfully complete sales could harm our business" and "Because we generally recognize our subscription revenues ratably over the term of our contract with a customer, fluctuations in sales will not be fully reflected in our operating results until future periods" in Item 1A, Risk Factors, included in this Annual Report on Form 10-K. We rely on a limited number of suppliers and contract manufacturers to produce components of our solutions. We have no long-term contracts with these manufacturers and purchase from them on a purchase-order basis. Our outsourced manufacturers generally procure the components directly from third-party suppliers. Although we use a limited number of suppliers and contract manufacturers, we believe that we could find alternate suppliers or manufacturers if circumstances required us to do so, in part because a significant portion of the components required by our solutions is available off the shelf. For a discussion of the risks associated with our limited number of suppliers, see risk entitled "We rely on a limited number of suppliers and contract manufacturers, and our proprietaryShotSpotter sensors are manufactured by a single contract manufacturer" in Item 1A, Risk Factors, included in this Annual Report on Form 10-K. We generated revenues of$45.7 million ,$40.8 million and$34.8 million for the years endedDecember 31, 2020 , 2019, and 2018, respectively, representing a year-over-year increases of 12% and 17%. For 2020, 2019, and 2018, revenues from ShotSpotter Respond represented approximately 94%, 96% and 97% of total revenues, respectively. Our two current largest customers, TheCity of Chicago andCity of New York each accounted for 18% 56 -------------------------------------------------------------------------------- and 15%, respectively, of our total revenues for the year endedDecember 31, 2020 . TheCity of Chicago and theCity of New York , each accounted for 20% and 14%, respectively, of our total revenues for the year endedDecember 31, 2019 . TheCity of Chicago and theCity of New York , each accounted for 22% and 15%, respectively, of our total revenues for the year endedDecember 31, 2018 . Substantially all of our revenues for the years endedDecember 31, 2020 , 2019, and 2018 were derived from customers withinthe United States (includingPuerto Rico and theU.S. Virgin Islands ). We had net income of$1.2 million for the year endedDecember 31, 2020 and had net income of$1.8 million for the year endedDecember 31, 2019 and a net loss of$2.7 million for the year endedDecember 31, 2018 . Our accumulated deficit was$94.4 million and$95.6 million as ofDecember 31, 2020 and 2019, respectively. During the years endedDecember 31, 2020 , 2019, and 2018, we went "live" on 49, 82 and 168 net new square miles of coverage, respectively. In each case, the increase in coverage was achieved through a combination of new customers and expansions with existing customers. During the year endedDecember 31, 2018 , 71 miles out of 168 miles were due to expansion from a single customer. In 2017, in connection with the cessation of our service toPuerto Rico and theU.S. Virgin Islands as a result of hurricane damage, we classified our contracts with them as expired, stopped recognizing revenues and accelerated the deferred revenues related to setup fees under these contracts.Puerto Rico returned as a customer in 2019 and added five new live miles in 2020, for a total of 21 miles live as ofDecember 31, 2020 .U.S. Virgin Islands also returned as a customer in 2020 with four live miles as ofDecember 31, 2020 . We have focused on rapidly growing our business and believe that its future growth is dependent on many factors, including our ability to increase our customer base, expand the coverage of our solutions among our existing customers, expand our international presence and increase sales of our security solutions. Our future growth will primarily depend on the market acceptance for outdoor gunshot detection solutions. Challenges we face in achieving this market acceptance and growing our business include our target customers having limited access to adequate funding sources, the fact that contracting with government entities can be complex, expensive and time-consuming, and the fact that our typical sales cycle is often very long, difficult to estimate accurately and can be costly. The extent to which certain of these challenges have increased as a result of the COVID-19 pandemic are summarized in the section below entitled "Impact of COVID-19 and Social Unrest on our Business." We expect international sales cycles to be even longer than our domestic sales cycles. To combat these challenges, we invest in research and development, increase awareness of our solutions, invest in new sales and marketing campaigns, often in different languages for international sales, and hire additional sales representatives to drive sales in order to continue to maintain our position as a market leader. In addition, we believe that entering into strategic partnerships with other service providers to cities and municipalities may offer an another potential avenue for expansion. We will also focus on expanding our business by introducing new products and services, such as ShotSpotter Connect, to existing customers and expanding coverage for our existing customers forShotSpotter Labs . We believe that developing and acquiring products for law enforcement in adjacent categories is a path for additional growth given our large and growing installed base of police departments who trustShotSpotter's products, support and way of doing business. The ability to cross-sell new products provides an opportunity to grow revenues per customer and lifetime value. Challenges we face in this area include ensuring our new products are reliable, integrated well with otherShotSpotter solutions and priced and serviced appropriately. In some cases, we will need to bring in new skill sets to properly develop, market, sell or service these new products depending on the categories they represent. Consistent with this strategy, we acquiredLEEDS, LLC inNovember 2020 to expand our ShotSpotter Investigate solution. With the addition of LEEDS,ShotSpotter will offer a more complete precision policing platform to enable intelligence-driven prevention, response to, and investigation of crime for local, state and federal agencies. ShotSpotter Investigate is expected to be our case management solution that helps automate investigative work and improve case clearance rates - addressing an inefficiency problem for many agencies that have had to rely on multiple disparate systems to work cases. ShotSpotter Investigate will be based on software currently developed and in use by LEEDS. Using the software, investigators benefit from a single digital case folder that includes all elements related to a case. Analytical and collaboration tools help investigators connect the dots and share information faster while reporting helps package cases for command staff and prosecutors. 57 -------------------------------------------------------------------------------- InOctober 2018 , we acquired the HunchLab technology and related assets that underline our ShotSpotter Connect solution. ShotSpotter Connect applies risk modeling and artificial intelligence to help forecast when and where crimes are likely to emerge and recommends specific patrols and tactics that can deter these events. The ShotSpotter Connect technology provides a proven, high-value, and complementary solution we can offer to our existing law enforcement customers. We believe this product helps to democratize the sharing of important intelligence with patrol officers who currently have limited direct access to crime analysts. With respect to international sales, we believe that we have the potential to expand our coverage within existing areas, and to pursue opportunities inLatin America and other regions of the world. By adding additional sales resources in strategic locations, we believe we will be better positioned to reach these markets. However, we recognize that we have limited international operational experience and currently operate in a limited number of regions outside ofthe United States . Operating successfully in international markets will require significant resources and management attention and will subject us to additional regulatory, economic and political risks. We may face additional challenges that may delay contract execution related to negotiating with governments in transition, the use of third-party integrations and consultants. Moreover, we anticipate that different political and regulatory considerations that vary across different jurisdictions could extend or make more difficult to predict the length of what is already a lengthy sales cycle.
Key Business Metrics
We focus on four key business metrics, primarily driven by ShotSpotter Respond, in order to measure our operational performance and inform strategic decisions. Revenue retention rate, sales and marketing spend per$1.00 of new annualized contract value and net new "go-live" square miles are each calculated annually. Net new "go-live" cities is calculated on a quarterly basis. All of these metrics are delivered using internal data and may be calculated in a manner different than similar metrics used by other companies. Year Ended December 31, 2020 2019 2018 (in thousands) Revenue retention rate 107 % 111 % 139 % Sales and marketing spend per$1.00 of new annualized contract value$ 0.51 $ 0.43 $ 0.30 Net new "go-live" square miles 49 82 168 Net new "go-live" cities 10 6 10 Revenue Retention Rate We calculate our revenue retention rate annually by dividing the (a) total revenues for such year from those customers who were customers during the corresponding prior year by (b) the total revenues from all customers in the corresponding prior year. For the purposes of calculating our revenue retention rate, we count as customers all entities with which we had contracts in the applicable year. Revenue retention rate for any given period does not include revenues attributable to customers first acquired during such period. We focus on our revenue retention rate because we believe that this metric provides insight into revenues related to and retention of existing customers. If our revenue retention rate for a year exceeds 100%, as it did in the years presented above, this indicates a low churn and means that the revenues retained during the year, including from customer expansions, more than offset the revenues that we lost from customers that did not renew their contracts during the year. As further evidence of our low churn, since transitioning our public safety business to the ShotSpotter Respond model in 2011, we have added over 80 new ShotSpotter Respond customers, but only 13 customers have terminated service, two of which were terminated due to hurricane damage. One of the two customers who terminated due to hurricane damage subsequently returned as a customer. Our revenue retention rate in 2018 reflects a large expansion deployment by our largest customer,Chicago , without which the revenue retention rate for that year would have been 118%. 58
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Sales and Marketing Spend per
We calculate sales and marketing spend annually as the total sales and marketing expense during a year divided by the first 12 months of contract value for contracts entered into during the same year. We use this metric to measure the efficiency of our sales and marketing efforts in acquiring customers, renewing customer contracts and expanding their coverage areas.
Net new "go-live" square miles represent the square miles covered by deployments of our gunshot detection solutions that were formally approved by customers during the year, both from initial and expanded customer deployments, net of square miles that ceased to be "live" during the year due to customer cancellations. New square miles include deployed square miles that may have been sold, or booked, in prior years. We focus on net new "go-live" square miles as a key business metric to measure our operational performance and inform strategic decisions.Net New "Go-Live " Cities Net new "go-live" cities represent the number of cities covered by deployments of our gunshot detection solutions that were formally approved by customers during the year, both from initial and expanded customer deployments, net of cities that ceased to be "live" during the year due to customer cancellations. New cities include deployed coverage areas that may have been sold, or booked, in a prior period. We focus on net new "go-live" cities as a key business metric to measure our operational performance and market penetration
Impact of COVID-19 and Social Unrest on our Business
The COVID-19 pandemic resulted in a substantial curtailment of business activities worldwide and caused ongoing economic uncertainty, both inthe United States and many countries abroad. In connection with efforts to contain the spread of COVID-19, many companies and state, local and foreign governments imposed restrictions, including shelter-in-place orders and travel bans that were in effect for most or all of 2020. These factors have negatively impacted our operations and results of operations for 2020. While some of these companies and jurisdictions have relaxed or ended such restrictions, some restrictions remain and others may be put back in place after having been lifted. We expect that the evolving COVID-19 pandemic, associated travel restrictions and social distancing requirements will continue to have an adverse impact on our results of operations. While the ultimate economic impact of the COVID-19 pandemic is highly uncertain, we expect that our business and results of operations, including our revenues, earnings and cash flows from operations, may continue to be adversely impacted in 2021, potentially as a result of: • Delays in our ability to deploy new "go-live" miles attributable to company policies or customer policies designed to protect employee health and comply with government restrictions;
• Greater funding challenges for our customer base, which may adversely
affect customer contract renewals, expansion of existing customer deployments or new customer sales;
• Possible disruption to our supply chain caused by distribution and other
logistical issues, which may further delay our ability to deploy new go-live miles; and
• Potential decrease in productivity of our employees or these of our
customers or suppliers due to travel bans or restrictions, work-from-home
or shelter-in-place policies and orders.
We may be adversely affected by social unrest, protests against racial inequality, protests against police brutality and movements such as "Defund the Police". These events may directly or indirectly affect police agency budgets and funding available to current and potential customers. Participants in these events may also attempt to create the perception that our solutions are contributing to the perceived problems, which may adversely affect us, our business and results of operations, including our revenues, earnings and cash flows from operations. 59
-------------------------------------------------------------------------------- It is currently not possible to predict the magnitude or duration of the COVID-19 pandemic's impact on our business or the future impact of the recent, ongoing and possible future unrest. The extent to which these events impact our business will depend on numerous evolving factors that we may not be able to control or accurately predict, including without limitation: • the duration and scope of the challenges created by pandemic or by ongoing social unrest; • governmental, business and individuals' actions that have been and continue to be taken in response to these events;
• the impact of the pandemic and social unrest on economic activity and
actions taken in response; • the effect on our customers and demand for our products and services;
• our ability to continue to sell our products and services, including as a
result of travel restrictions and people working from home, or restrictions on access to our potential customers; • the ability of our customers to pay for our products and services;
• any closures of our facilities and the facilities of our customers and
suppliers; and
• the degree to which our employees or those of our customers or suppliers
become ill with COVID-19.
Components of Results of Operations
Presentation of Financial Statements
Our consolidated financial statements include the accounts of our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Revenues Through 2020, we derived substantially all of our revenues from subscription services. We recognize subscription fees ratably, on a straight-line basis, over the term of the subscription, which for new customers is typically initially one to three years. Customer contracts include one-time set-up fees for the set-up of our sensors in the customer's coverage areas, training and third-party integration licenses. If the set-up fees are deemed to be a material right, they are recognized ratably over three to five years. Training and third-party integration license fees are recognized upon delivery. For ShotSpotter Respond, we generally invoice customers for 50% of the total contract value when the contract is fully executed and for the remaining 50% when the subscription service is operational and ready to go live - that is, when the customer has acknowledged the completion of all the deliverables in the signed customer acceptance form. All fees billed in advance of services being delivered are recorded as deferred revenue. The timing of when new miles go live can be uncertain and, as a result, can have a significant impact on the levels of revenues and deferred revenue from quarter to quarter. For ourShotSpotter Respond solution, our pricing model is based on a per-square-mile basis. For ShotSpotter SecureCampus and ShotSpotter SiteSecure, our pricing model is on a customized-site basis. For our ShotSpotter Connect solution, pricing is currently customized, generally tied to the number of sworn police officers in a particular city. We may also offer discounts or other incentives in conjunction with sales of ShotSpotter Connect in an effort to introduce the product to new or existing customers and accelerate sales. As a result of our process for invoicing contracts and renewals upon execution, our cash flow from operations and accounts receivable can fluctuate due to timing of contract execution and timing of deployment. We generally invoice subscription service renewals for 100% of the total contract value when the renewal contract is executed. Renewal fees are recognized ratably over the term of the renewal, which is typically one year. While most of our customers elect to renew their agreements, in some cases, they may not be able to obtain the 60
-------------------------------------------------------------------------------- proper approvals or funding to complete the renewal prior to expiration. For these customers, we stop recognizing subscription revenues at the end of the current contract term, even though we may continue to provide services for a period of time until the renewal process is completed. Once the renewal is complete, we then recognize subscription revenues for the period between the expiration of the term of the agreement and the completion of the renewal process in the month in which the renewal is executed. If a customer declines to renew its subscription prior to the end of the contract term, then the remaining setup fees are immediately recognized.
It is likely that international deployments may have different payment and billing terms due to their local laws, restrictions or other customary terms and conditions.
With the acquisition of CrimeCenter, the Company also generates revenues from the sale of a software license and related maintenance and support services to its proprietary software technology and professional software development services to a single customer, through a sales channel intermediary. The sales channel intermediary contract includes an annual, renewable subscription for software and related maintenance and support services. The contract also provides for the procurement of professional services, such as for software development and testing for product feature enhancements, by executing supplementary work orders. We anticipate that, due to the ongoing COVID-19 pandemic, our customers may be facing budget shortfalls due to the increased expenditures our customers have had to endure to address the pandemic, as well as the anticipated significant tax revenue declines resulting from the economic impact that the pandemic has rapidly generated in 2020, the duration of which is unknown.
Costs
Costs include the cost of revenues. Cost of revenues primarily includes depreciation expense associated with capitalized customer acoustic sensor networks, communication expenses, costs related to hosting our service applications, costs related to operating our IRC, providing remote and on-site customer support and maintenance and forensic services, providing customer training and onboarding services, certain personnel and related costs of operations, stock-based compensation and allocated overheads, which includes information technology, facility and equipment depreciation costs. Impairment of property and equipment is primarily attributable to our write-off of the remaining book value of sensor networks related to customers lost during the year endedDecember 31, 2020 and our write-off of the remaining book value of indoor sensor inventory and indoor sensor networks installed in certain security customers during the year endedDecember 31, 2018 . We will have to upgrade our sensors that use third-generation ("3G") cellular communications to the fourth-generation Long-Term Evolution wireless technology, which will increase our cost of revenues. Originally, we had expected to start incurring these upgrade costs in 2021 through 2022. We have begun plans to replace sensors in certain geographic areas starting in the second half of 2020 in order to optimize personnel utilization. Accelerated bandwidth changes by our carriers may require us to continue to accelerate the upgrade of our 3G sensors prior to 2022, which would accelerate the costs associated with the upgrade, which are estimated to be approximately$5.0 million in total. We may re-use and re-deploy the old 3G sensors that have a remaining serviceable life where it makes sense to do so. As we upgrade our sensors, cost of revenues may increase as a percentage of revenues. In the near term, we expect our cost of revenues to increase in absolute dollars as our installed base increases, although certain of our costs of revenues are fixed and do not need to increase commensurate with increases in revenues. In addition, depreciation expense associated with deployed equipment is recognized over the first five years from the go-live date, while equipment sometimes remains operational beyond that period, reducing our cost of revenues. We also expect cost of revenues to increase in absolute dollars as we continue to invest in our customer success capabilities to drive growth and value for our customers. 61
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Operating Expenses
Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Salaries, bonuses, stock-based compensation expense and other personnel costs are the most significant components of each of these expense categories. We include stock-based compensation expense incurred in connection with the grant of stock options and restricted stock units in the applicable operating expense category based on the equity award recipient's functional area. We are focused on executing on our growth strategy. As a result, in the near term we expect our total operating expenses to increase in absolute dollars as we incur additional expenses due to growth. Although our operating expenses will fluctuate, we expect that over time, they will generally decrease as a percentage of revenues.
Sales and Marketing
Sales and marketing expenses primarily consist of personnel-related costs attributable to our sales and marketing personnel, commissions earned by our sales personnel and third party agencies, marketing expenses for trade shows, conferences and conventions, consulting fees, travel and facility-related costs, amortization of customer relationship assets acquired from business combinations and allocated overhead. During the duration of the COVID-19 pandemic and associated shelter-in-place orders, work-from-home policies and travel bans, our sales and marketing expense has decreased and is expected to remain relatively flat as the pandemic continues. Thereafter, in the near term, we expect our sales and marketing expenses to increase in absolute dollars primarily due to planned growth in our sales and marketing organization. This growth may include adding sales and/or marketing personnel and expanding our marketing activities to continue to generate additional leads. Sales and marketing expense may fluctuate from quarter to quarter based on the timing of commission expense, marketing campaigns and tradeshows.
Research and Development
Research and development expenses primarily consist of personnel-related costs attributable to our research and development personnel, consulting fees and allocated overhead. We have devoted our product development efforts primarily to develop new lower-cost sensor hardware, develop new features including a mobile application, improve functionality of our solutions and adapt to new technologies or changes to existing technologies. We are investing in engineering resources to support further development of ShotSpotter Connect and ShotSpotter Investigate. The focus of this effort will be in the areas of data science modeling, user experience, core application functionality and backend infrastructure improvements, including integration ofShotSpotter gunshot data to enhance forecasting of gun violence. We are also investing research and development resources in conjunction with ourShotSpotter Labs projects and initiatives. The initial focus of these efforts is to develop innovative sensor applications as well as to test and expand the functionality of our outdoor sensors in challenging environmental conditions.
In the near term, we expect our research and development expenses to increase in absolute dollars as we increase our research and development headcount to further strengthen our software and invest in the development of our service.
We will continue to invest in research and development to leverage our large and growing database of acoustic events, which includes those from both gunfire and non-gunfire. We also intend to leverage third-party AI and our own evolving cognitive and analytical applications to improve the efficiency of our solutions. Certain of these applications and outputs may expand the platform of services that we will be able to offer our customers. 62
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General and Administrative
General and administrative expenses primarily consist of personnel-related costs attributable to our executive, finance, and administrative personnel, legal, accounting and other professional services fees, other corporate expenses and allocated overhead.
In the near term, we expect our general and administrative expenses to increase significantly in absolute dollars as we grow our business, support our operations as a public company and increase our headcount.
Other Income (Expense), Net
Other income (expense), net, consisted primarily of interest income and local and franchise tax expenses.
Income Taxes
Our income taxes are based on the amount of our taxable income and enacted federal, state and foreign tax rates, adjusted for allowable credits, deductions and the valuations allowance against deferred tax assets, as applicable.
We continually monitor all positive and negative evidence regarding the realization of our deferred tax assets and may record assets when it becomes more likely than not, than they will be realized, which may impact the expense or benefit from income taxes.
Results of Operations
The following table sets forth our consolidated statements of operations data
for the years ended
As a % of As a % of Change 2020 Revenues 2019 Revenues $ % Revenues$ 45,734 100 %$ 40,752 100 %$ 4,982 12 % Costs Cost of revenues 18,525 41 % 16,409 40 % 2,116 13 % Impairment of property and equipment 234 - - - 234 - Total costs 18,759 41 % 16,409 40 % 2,350 14 % Gross profit 26,975 59 % 24,343 60 % 2,632 11 % Operating expenses: Sales and marketing 10,328 23 % 9,989 25 % 339 3 % Research and development 5,614 12 % 5,344 13 % 270 5 % General and administrative 9,740 21 % 7,415 18 % 2,325 31 % Total operating expenses 25,682 56 % 22,748 56 % 2,934 13 % Income from operations 1,293 3 % 1,595 4 % (302 ) (19 %) Other expense, net (158 ) - 162 - (320 ) (198 %) Benefit from income taxes 90 - 41 - 49 120 % Net income$ 1,225 3 %$ 1,798 4 %$ (573 ) (32 %) Revenues The increase of$5.0 million was primarily attributable to new customers and expansions of existing customer coverage areas, LEEDS' revenue contribution for a partial quarter, partially offset by a normal rate of customer attrition. We went live with 49 net new square miles during the year endedDecember 31, 2020 .
Gross margin remained relatively consistent with prior year as a result of revenue growth offset by the increase in our investment in the customer success organization.
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Costs
The increase of$2.4 million was due primarily to a$2.0 million increase in overall personnel-related costs. including a partial quarter of costs related to LEEDS. The increase also includes a reallocation of certain resources as we formalized our customer success organization. There was also a$0.4 million increase in depreciation expense, a$0.2 million increase in repairs and maintenance costs, as well as a$0.2 million write-off related to sensor assets due to customer attrition. These increases are partially offset by a$0.4 million decrease in costs related toShotSpotter Labs projects, for which revenues and costs vary from quarter to quarter depending on the phase of the projects. Operating Expenses Sales and Marketing Expense The increase in sales and marketing expense of$0.3 million was primarily due to a$0.8 million increase in personnel costs, and$0.3 million increase in other costs including commissions expense and amortization of the customer relationship intangible asset related to LEEDS, partially offset by$0.8 million decrease in travel costs due to limited travel during the COVID-19 pandemic.
Research and Development Expense
The increase in research and development expense of$0.3 million was primarily due to an increase in personnel andLEEDS related expenses offset by a reduction in outside consulting fees.
General and Administrative Expense
The increase of$2.3 million was due primarily to a$1.0 million increase in personnel costs,$0.6 million increase in acquisition related expenses,$0.4 million increase in legal and professional fees and$0.3 million increase in insurance costs.
Other Income (Expense), Net
The decrease of
Income Taxes
Our income taxes are based on the amount of our taxable income and enacted federal, state and foreign tax rates, adjusted for allowable credits, deductions and the valuations allowance against deferred tax assets, as applicable. For the years endedDecember 31, 2020 and 2019, our provision for income taxes consisted of a benefit (provision) for foreign income taxes only. We continually monitor all positive and negative evidence regarding the realization of our deferred tax assets and may record assets when it becomes more likely than not, than they will be realized, which may impact the expense or benefit from income taxes. 64
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Comparison of Years Ended
The following table sets forth our consolidated statements of operations data
for the years ended
As a % of As a % of Change 2019 Revenues 2018 Revenues $ % Revenues$ 40,752 100 %$ 34,753 100 %$ 5,999 17 % Costs Cost of revenues 16,409 40 % 14,846 43 % 1,563 11 % Impairment of property and equipment - - 686 2 % (686 ) (100 %) Total costs 16,409 40 % 15,532 45 % 877 6 % Gross profit 24,343 60 % 19,221 55 % 5,122 27 % Operating expenses: Sales and marketing 9,989 25 % 8,377 24 % 1,612 19 % Research and development 5,344 13 % 4,987 14 % 357 7 % General and administrative 7,415 18 % 8,425 24 % (1,010 ) (12 %) Total operating expenses 22,748 56 % 21,789 63 % 959 4 % Income (loss) from operations 1,595 4 % (2,568 ) (7 %) 4,163 (162 %) Other income (expense), net 162 - (170 ) (1 %) 332 (195 %) Benefit from income taxes 41 - 13 - 28 215 % Net income (loss)$ 1,798 4 %$ (2,725 ) (8 %)$ 4,523 (166 %) Revenues The increase of$6.0 million in revenues was primarily attributable to$2.3 million of new customer deployments that went live during 2019,$0.8 million from expansions of existing customer coverage areas that went live during 2019, and$4.4 million related primarily to customer deployments that went live in 2018 and for which we recognized a full year of revenues in 2019. These increases were partially offset by lost customers and the timing of renewals from certain customers resulting in deferred revenues. We went live with 82 net new square miles in 2019. Costs The increase in costs of$0.9 million was due primarily to a$1.2 million increase in overhead expenses resulting from an increase in employee headcount, a$0.9 million increase in depreciation expense associated with new customer deployment and expansions in existing customer coverage area, and a$0.1 million increase in software amortization, offset by a$0.6 million decrease in operating costs, which includes costs incurred in providing remote and on-site customer support and maintenance services, infrastructure hosting for our service application and costs related to operating our IRC and$0.7 million in impairment charges taken in 2018 that were not repeated in 2019. During 2018, we recognized impairment expense of$0.7 million for the impairment of property and equipment primarily related to the remaining book value of indoor sensor inventory and indoor sensor networks installed at certain security customers.
Gross margin for 2019 increased five percentage points from gross margin for 2018 because certain costs of revenues are fixed and did not increase commensurate with the increase in subscription revenues.
Operating Expenses
Sales and Marketing Expense
The increase in sales and marketing expense of$1.6 million was primarily due to a$1.3 million increase in personnel expense resulting from increased headcount, and a$0.3 million increase in consulting and travel expenses associated with the growth of our sales and marketing organization. 65
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Research and Development Expense
The increase in research and development expense of
General and Administrative Expense
The decrease in general and administrative expense of$1.0 million was primarily due to a$1.5 million decrease in legal expenses resulting from litigation that settled in 2018 and our HunchLab acquisition in 2018, partially offset by$0.5 million increase in personnel and consulting expenses during the year endedDecember 31, 2019 .
Other Income (Expense), Net
The increase in other income (expense), net of$0.3 million was due to a$0.4 million increase in interest income partially offset by a decrease in local and state income taxes. Income Taxes Our income taxes are based on the amount of our taxable income and enacted federal, state and foreign tax rates, adjusted for allowable credits, deductions and the valuations allowance against deferred tax assets, as applicable. For the years endedDecember 31, 2019 and 2018, our provision for income taxes consisted of a benefit (provision) for foreign income taxes only.
Liquidity and Capital Resources
Sources of Funds
Our operations have been financed primarily through net proceeds from the sale of equity, debt financing arrangements and cash from operating activities. Our principal source of liquidity is cash and cash equivalents totaling$16.0 million as ofDecember 31, 2020 . We also have a$20.0 million credit facility, of which no amounts were outstanding as ofDecember 31, 2020 .
In
We believe our existing cash and cash equivalent balances, our available credit facility and cash flow from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenues growth, the timing and extent of spending on sales and marketing, the expansion of sales and marketing activities, the timing of new product introductions, market acceptance of our products and overall economic conditions. We may also seek additional capital to fund our operations, including through the sale of equity or debt financings. To the extent that we raise additional capital through the future sale of equity, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our existing common stockholders. The incurrence of debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.
Use of Funds
Our historical uses of cash have primarily consisted of cash used for operating activities, such as expansion of our sales and marketing operations, research and development activities and other working capital needs, and cash used in investing activities, such as property and equipment expenditures to install infrastructure in customer cities in order to deliver our solutions. 66 -------------------------------------------------------------------------------- OnNovember 24, 2020 , we completed the acquisition ofLEEDS, LLC for a purchase consideration of$21.6 million in cash, subject to working capital adjustments, and the issuance of 63,901 shares ofShotSpotter common stock worth$2.0 million . The purchase consideration also included a contingent earnout payable for up to$5.0 million based onLEEDS' revenues generated during 2021 and 2022. OnOctober 3, 2018 , we acquired certain technology, referred to as HunchLab, and related assets fromAzavea Inc. The purchase consideration totaled$2.5 million , consisting of$1.7 million in cash and a contingent earnout payable in cash for up to$750,000 based on HunchLab's revenues generated over the three-year period following the acquisition date. InJanuary 2020 , we paid$0.3 million based on revenues generated over the first year of the contingent earnout period. InFebruary 2021 , subsequent toDecember 31, 2020 , we paid the remaining$0.4 million of the contingent earnout based on revenues generated over the second year of the contingent earnout period.
Stock Repurchase Program
InMay 2019 , we announced that our Board of Directors had approved a stock repurchase program for up to$15 million of our common stock. The shares may be repurchased from time to time in open market transactions, in privately negotiated transactions or by other methods in accordance with federal securities laws. The actual timing, number and value of shares repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including the market price of our common stock, general market and economic conditions and applicable legal requirements. The stock repurchase program does not obligate us to purchase any particular amount of common stock and may be suspended or discontinued at any time. During the year endedDecember 31, 2020 , we repurchased 74,520 shares of its common stock at an average price of$21.65 per share for$1.6 million . The repurchases were made in open market transactions using cash on hand, and all of the shares repurchased were retired.
Credit Facility
OnSeptember 27, 2018 , we entered into the Umpqua Credit Agreement. InAugust 2020 , we entered into an amendment to our credit facility to increase the size of our available loan facility from$10.0 million to$20.0 million , which allows us to borrow up to$20.0 million under a revolving loan facility. We intend to use the revolving loan facility for general working capital purposes.
Cash Flows
Comparison of Years Ended
The following table presents a summary of our cash flows for the years ended
Year Ended December 31, 2020 2019 2018 (in thousands) Net cash provided by (used in): Operating activities$ 11,209 $ 13,692 $ (1,386 ) Investing activities (18,758 ) (4,909 ) (10,203 ) Financing activities (956 ) 5,482 2,437
Net change in cash and cash equivalents
As of
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Operating Activities
Our net income (loss) and cash flows provided by operating activities are significantly influenced by our increase in headcount to support our growth, increase in legal, outside services fees, and sales and marketing expenses, and our ability to bill and collect in a timely manner.
Operating activities provided
The net cash provided by operating activities in the year endedDecember 31, 2020 was primarily driven by collections of accounts receivable driven by new customer contracts and expansions of existing customer coverage. The net cash provided by operating activities in the year endedDecember 31, 2019 was primarily driven by increased collections of accounts receivable driven by new customer contracts and expansions of existing customer coverage.
The use of cash for 2018 was primarily driven by changes in accounts receivable
and our net loss of
Investing Activities
Our investing activities consist primarily of capital expenditures to install our solutions in customer coverage areas, purchases of property and equipment, and investments in intangible assets and business acquisitions. Investing activities used$18.8 million ,$4.9 million , and$10.2 million in the years endedDecember 31, 2020 , 2019 and 2018, respectively. We completed our acquisition ofLEEDS, LLC for approximately$14.6 million in cash, net of$7.0 million cash acquired at closing during the year endedDecember 31, 2020 . We completed our acquisition of the HunchLab assets for approximately$1.7 million in cash at closing during the year endedDecember 31, 2018 . The remaining use of cash was primarily for property and equipment expenditures to install our solutions in customer coverage areas.
Financing Activities
Cash generated by financing activities includes proceeds from our secondary offering, net proceeds from the exercise of stock options and warrants, proceeds from the employee stock purchase plan, offset by payment for repurchases of our common stock, payment of indebtedness, and debt issuance and financing costs. Financing activities used$1.0 million in cash during the year endedDecember 31, 2020 from$1.6 million in payments for repurchases of our common stock and$0.3 million payment for HunchLab's contingent consideration, partially offset by$0.7 million proceeds from ESPP purchase and$0.3 million in proceeds from the exercise of options and warrants. Financing activities provided$5.5 million in cash during the year endedDecember 31, 2019 from$10.8 million in net proceeds from the issuance of common stock upon our secondary offering,$0.9 million proceeds from ESPP purchase and$0.5 million in proceeds from the exercise of options and warrants, partially offset by$6.7 million in payments for repurchases of our common stock. Financing activities provided$2.4 million in the year endedDecember 31, 2018 , primarily from$1.5 million from the exercise of stock options and warrants, and$0.9 million proceeds from employee stock purchase plan.
Off-Balance Sheet Arrangements
As ofDecember 31, 2020 , we did not have any relationships, material commitments or obligations with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements. We do not engage in off-balance 68
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sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP"). The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of revenues, assets, liabilities, costs and expenses. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates. Our most critical accounting policies are summarized below. See Note 3, Basis of Presentation and Summary of Significant Accounting Policies, to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a description of our other significant accounting policies.
Revenue Recognition
Revenue Recognition - Gunshot Detection Services
We generate substantially all of our revenues from the sale of gunshot detection subscription services, in which gunshot data generated by company-owned sensors and software is sold to customers through a cloud-based hosting application for a specified contract period. Typically, the initial contract period is one to five years in length. The subscription contract is generally noncancelable without cause. Generally, these service arrangements do not provide the customer with the right to take possession of the hardware or software supporting the subscription service at any time. A small portion of our revenues are generated from the delivery of setup services to install company-owned sensors in the customer's coverage area and other services including training and license to integrate with third-party applications. We generally invoice customers for 50% of the total contract value when the contract is fully executed and for the remaining 50% when the subscription service is operational and ready to go live - that is, when the customer has acknowledged the completion of all the deliverables in the signed customer acceptance form. We generally invoice subscription service renewals for 100% of the total contract value when the renewal contract is executed. For the public safety solution, the pricing model is based on a per-square-mile basis. For security solutions, the pricing model is on a customized-site basis. As a result of the process for invoicing contracts and renewals upon execution, cash flows from operations and accounts receivable can fluctuate due to timing of contract execution and timing of deployment. We recognize revenues upon the satisfaction of performance obligations. At contract inception, we assess the services promised in our contracts with customers and identify a performance obligation for each promise to transfer to the customer a good or service (or bundle of services) that is distinct. To identify the performance obligations, we consider all of the services promised in the contract regardless of whether they are explicitly stated or are implied by customary business practices. We determined that the subscription services, training, and licenses to integrate with third-party applications are each distinct services that represent separate performance obligations. The setup activities are not distinct from the subscription service and are combined into the subscription service performance obligation. However, setup fees may provide a material right to the customer that has influence over the customers' decision to renew. All setup fees are assessed on a quantitative and qualitative basis to determine whether they represent a distinct performance obligation. The total contract value is allocated to each performance obligation identified based on the standalone selling price of the service. Discounts are allocated pro-rata to the identified performance obligations. For contracts that have an original duration of one year or less, we use the practical expedient applicable to such contracts and do not consider the time value of money. Revenues from subscription services are recognized ratably, on a straight-line basis, over the term of the subscription. Revenues from material rights are recognized ratably over the period in which they are determined to provide a material right to the customer, which is generally three years. Revenues from training and licenses to integrate with third-party applications are recognized upon delivery which generally occurs when the subscription service is operational and ready to go live. 69 -------------------------------------------------------------------------------- Subscription renewal fees are recognized ratably over the term of the renewal, which is typically one year. While most customers elect to renew their agreements, in some cases, they may not be able to obtain the proper approvals or funding to complete the renewal prior to expiration. For these customers, we stop recognizing subscription revenues at the end of the current contract term, even though services may continue to be provided for a period of time until the renewal process is completed. Once the renewal is complete, we recognize subscription revenues for the period between the expiration of the term of the agreement and the completion of the renewal process in the month in which the renewal is executed. If a customer declines to renew its subscription, then the remaining fees from material rights, if any, are immediately recognized.
Revenue Recognition - Software License, Maintenance and Support, and Professional Services
With the acquisition ofLEEDS , we also generate revenues from the sale of (i) a software license and related maintenance and support services to its proprietary software technology and (ii) professional software development services to a single customer, through a sales channel intermediary. We have been serving this customer for more than ten years. The sales channel intermediary contract includes an annual, renewable subscription for software and related maintenance and support services. The contract also provides for the procurement of professional services, such as for software development and testing for product feature enhancements, by executing supplementary work orders We recognize revenue from the license of its software license and related maintenance and support services revenues upon the satisfaction of performance obligations. We determined that the term-based software license should be combined with the maintenance and support services as a single performance obligation. The nature of the maintenance and support services, inclusive of our obligation to provide additional, unspecified software functionality over the license term, in allowing this single customer to be flexible in utilizing the customized software to respond to the changing regulatory environment, are critical to the customer's ability to derive benefit and value from the license. Contractually, we provide continuous access to the software, maintenance and support services, helpdesk and technical support over the contract term, hence a time-elapsed method is used to recognize revenue. Revenues from the software license and maintenance and support services are recognized ratably over the term of the contract because our obligation to provide the license and related support services is uniform over the license term. We generally invoice for these services on a monthly basis in arrears. Stock-Based Compensation - We recognize stock-based compensation expense for stock-based compensation awards granted to our employees, directors, and consultants that can be settled in shares of our common stock. Compensation expense for stock-based compensation awards granted is based on the grant date fair value estimate for each award as determined by our board of directors. We recognize these compensation costs on a straight-line basis over the requisite service period of the award.
Restricted stock unit awards are valued using the last reported stock price on the date of grant.
We estimate the fair value of stock option awards at the date of grant using the Black-Scholes option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and are freely transferable. The fair values generated by the model may not be indicative of the actual fair values of our awards as it does not consider other factors important to those stock-based payment awards, such as continued employment, periodic vesting requirements and limited transferability. Business Acquisition - We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing such intangible assets include, but not limited to, future expected cash flows from customer relationships and developed technology; and discount rates.Goodwill -Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (October 1 ) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying 70
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value. The Company has concluded there is only one reporting unit for purposes of performing the goodwill impairment test. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, and may include estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment. We performed our annual test for goodwill impairment as ofOctober 1, 2020 and concluded that no impairment charge was necessary.
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