PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
S-1 DISCLOSURE BACKUP MEMORANDUM
CALDERWOOD & HARKNESS LLP 1 Market Street, Spear Tower, Suite 3600 San Francisco, California 94105
Matter: Lumos Analytics Inc. — Proposed Initial Public Offering of Class A Common Stock
Matter Number: 1008-00002
Prepared By: Audrey Zhou, Lead Associate, Capital Markets Group; Brendan Walsh, Working Associate, Capital Markets Group
Reviewed By: Robert Adeyemi, Responsible Partner, Capital Markets Group
Date: April 12, 2022 (updated through public filing of Form S-1/A (Amendment No. 1) on April 14, 2022)
Re: Documentation of Factual Basis and Legal Analysis Supporting Key Disclosure Positions in Registration Statement on Form S-1 (SEC File Number 333-264518; CIK 0001923847) — Maintained as Section 11 Backup File
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I. Purpose and Scope
This memorandum serves as the Section 11 backup file documenting the factual basis, source materials, and legal analysis supporting key disclosure positions in the Registration Statement on Form S-1 filed by Lumos Analytics Inc., a Delaware corporation ("Lumos," the "Company," or the "Issuer"), with the United States Securities and Exchange Commission (the "SEC" or the "Commission"). The Registration Statement was initially filed on January 28, 2022 (SEC File Number 333-264518; CIK 0001923847) and subsequently amended through the filing of Amendment No. 1 on Form S-1/A on April 14, 2022 (the "Registration Statement"). This memorandum has been updated through the date of that public filing.
The memorandum is prepared and maintained by Calderwood & Harkness LLP ("C&H" or the "Firm") in its capacity as issuer's counsel to Lumos in connection with the proposed initial public offering (the "IPO" or the "Offering") of shares of Class A Common Stock, par value $0.0001 per share, of the Company. The primary purpose of this memorandum is to support a reasonable investigation and due diligence defense under Section 11 of the Securities Act of 1933, as amended (the "Securities Act"), for Calderwood & Harkness LLP in its role as counsel to the Issuer. Section 11(b)(3)(A) of the Securities Act provides a defense to liability for any person who, after reasonable investigation, had reasonable ground to believe and did believe that the statements in the registration statement were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading. This memorandum, together with the underlying due diligence files maintained in the firm's document management system, constitutes the principal record of that reasonable investigation.
The memorandum covers the following principal disclosure areas, which were identified as requiring heightened analysis due to their materiality, complexity, or the nature of SEC Staff comments received during the review process:
(1) Risk factor disclosures (Item 105 of Regulation S-K);
(2) Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") (Item 303 of Regulation S-K), including the disclosure of non-GAAP financial measures and key performance metrics;
(3) Related-party transaction disclosures (Item 404 of Regulation S-K);
(4) Executive compensation disclosures (Item 402 of Regulation S-K, utilizing scaled disclosure available to the Company as an "emerging growth company" under the Jumpstart Our Business Startups Act (the "JOBS Act")); and
(5) Cheap stock analysis methodology, including the reconciliation of stock option exercise prices and 409A valuations to the proposed IPO price range.
This memorandum references the publicly filed Registration Statement on Form S-1/A (Amendment No. 1), filed with the SEC on April 14, 2022, in connection with the Company's proposed listing on the Nasdaq Global Select Market under the proposed ticker symbol "LMSA."
The Registration Statement covers a proposed offering of 16,441,176 shares of Class A Common Stock, consisting of (a) 12,941,176 primary shares to be issued and sold by the Company, and (b) 3,500,000 secondary shares to be sold by selling stockholders, comprised of 2,000,000 shares to be sold by Velthryn Venture Partners Fund IV, L.P. ("Velthryn") and 1,500,000 shares to be sold by Arclight Equity Group Fund VII, L.P. ("Arclight"). The preliminary price range set forth on the cover page of the prospectus included in the Registration Statement is $16.00 to $18.00 per share (the "Preliminary Price Range"), with a midpoint of $17.00 per share. Based on 12,941,176 primary shares offered at the midpoint price, the Company would receive gross proceeds of approximately $220,000,000 (before deducting underwriting discounts, commissions, and estimated offering expenses). Pinnacle Securities LLC is acting as lead bookrunning manager for the Offering.
All references in this memorandum to specific sections, pages, or disclosures of the Registration Statement are to the Registration Statement as filed in its Form S-1/A (Amendment No. 1) on April 14, 2022, unless otherwise indicated. Capitalized terms used but not otherwise defined in this memorandum have the meanings set forth in the Registration Statement.
II. Due Diligence Process Overview
II.A. Document Collection and Review
Calderwood & Harkness LLP issued a comprehensive due diligence request list (the "Due Diligence Request List") to Lumos management in November 2021, addressed to Naomi Feinberg, General Counsel and Corporate Secretary of the Company, and David Lau, Chief Financial Officer of the Company. The Due Diligence Request List was prepared in accordance with C&H's standard form for technology company initial public offerings, as modified to reflect the specific characteristics of the Company's business, regulatory environment, and corporate history. The request list was organized into the following principal categories:
(a) Corporate organization: certificates of incorporation, bylaws, board and stockholder minutes, subsidiary organizational documents, foreign qualifications, and good standing certificates;
(b) Capitalization: stock ledgers, stockholder records, option grant records and agreements, equity incentive plans, convertible instruments, warrants, capitalization tables, and 409A valuation reports;
(c) Material contracts: customer agreements, vendor agreements, partnership agreements, distribution agreements, licensing agreements, and any contracts with annual value in excess of $250,000 or with terms in excess of one year;
(d) intellectual property: patent portfolios, trademark registrations and applications, copyright registrations, trade secret protocols, IP assignment agreements, licenses granted and received, and open-source software usage;
(e) Employment matters: employment agreements with executive officers and key employees, offer letter templates, employee handbooks, non-competition and non-solicitation agreements, consulting agreements, employee benefit plans, and 401(k) plan documents;
(f) Litigation: pending and threatened litigation, arbitration proceedings, regulatory investigations, demand letters, consent decrees, and settlement agreements;
(g) Regulatory compliance: permits, licenses, regulatory filings, correspondence with regulators (banking regulators, state regulators, data protection authorities), compliance policies, and internal audit reports;
(h) Tax: federal and state income tax returns for the prior three years, tax opinions, transfer pricing documentation, and state and local tax compliance records;
(i) Insurance: directors' and officers' liability insurance, general commercial liability, errors and omissions, cyber liability, and key-person insurance policies;
(j) Real property: lease agreements, lease amendments, subleases, and any owned real property records;
(k) Related-party transactions: all agreements and transactions between the Company and any director, officer, 5% or greater stockholder, or immediate family member thereof;
(l) Environmental: environmental compliance reports, environmental site assessments, and any pending or threatened environmental claims or proceedings; and
(m) Financial information: audited financial statements for fiscal years 2019, 2020, and 2021; interim unaudited financial statements; budget and financial projections; accounts receivable aging; revenue recognition policies; and related accounting memoranda.
In response to the Due Diligence Request List, the Company established and maintained a virtual data room (the "Data Room") using Thackeray Solutions, to which C&H team members were granted access beginning in December 2021. The Data Room was organized in a folder structure corresponding to the categories of the Due Diligence Request List. The C&H team, led by Audrey Zhou and Brendan Walsh, with oversight from Robert Adeyemi, conducted a comprehensive review of all materials provided in the Data Room over the period from December 2021 through March 2022. A total of approximately 2,840 documents were uploaded to the Data Room by the Company, of which C&H reviewed each document and flagged approximately 480 documents for detailed legal analysis and potential relevance to S-1 disclosures.
Iterative follow-up document requests were issued by C&H to Naomi Feinberg and David Lau on a rolling basis through March 2022, as the due diligence review identified gaps in the documentary record or areas requiring additional documentation. Significant follow-up requests included requests for updated capitalization records, additional detail on customer concentration and annual recurring revenue metrics, executed copies of IP assignment agreements for key employees, and updated regulatory correspondence files. All follow-up requests and responses are documented in the matter files maintained in C&H's document management system under Matter Number 1008-00002.
II.B. Management Interviews and Verification Sessions
Calderwood & Harkness LLP conducted multiple interview and verification sessions with senior management of the Company throughout the due diligence process. These sessions served the dual purpose of (i) developing the factual basis for disclosure in the Registration Statement and (ii) verifying the accuracy and completeness of information provided by the Company in the Data Room and in draft disclosure documents. The following members of senior management participated in one or more due diligence sessions:
• Priya Subramanian, Chief Executive Officer and Co-Founder: Ms. Subramanian participated in sessions covering the Company's history, business strategy, competitive landscape, growth plans, regulatory environment, and the rationale for the dual-class stock structure. Ms. Subramanian also participated in the final bring-down due diligence session and signed the management representation letter.
• Marcus Henley, Chief Technology Officer and Co-Founder: Mr. Henley participated in sessions covering the Company's technology platform, product roadmap, intellectual property portfolio, research and development strategy, and infrastructure dependencies. Mr. Henley also provided detailed input on the competitive landscape section and the technology risk factors.
• David Lau, Chief Financial Officer: Mr. Lau participated in multiple sessions covering the Company's financial condition and results of operations, revenue recognition policies, key performance metrics (including ARR methodology), non-GAAP financial measures (including Adjusted EBITDA reconciliation), capitalization and dilution analysis, the Ashford National Bank credit facility, and liquidity and capital resources. Mr. Lau was the primary management contact for all financial data verification sessions and signed off on all financial data included in the Registration Statement.
• Naomi Feinberg, General Counsel and Corporate Secretary: Ms. Feinberg participated in sessions covering corporate organization, material contracts, regulatory compliance, litigation and contingencies, intellectual property, employment matters, related-party transactions, and corporate governance. Ms. Feinberg served as the primary coordinator for document collection and due diligence responses on behalf of the Company.
• Tomás Aguilar, Chief Revenue Officer: Mr. Aguilar participated in sessions covering the Company's customer base, revenue model, customer concentration, sales strategy, enterprise sales cycles, key customer relationships, and competitive dynamics. Mr. Aguilar provided detailed data supporting the customer concentration disclosure and the ARR bridge analysis.
Verification sessions on financial data, business metrics, customer concentration data, and forward-looking statements were conducted in accordance with C&H's standard verification protocols. Each verification session involved a line-by-line review of the relevant sections of the draft Registration Statement, with management confirming the accuracy of each factual assertion and identifying the source documentation supporting such assertion. Verification sessions were held on the following principal dates: January 10, 2022 (initial financial data verification); February 8, 2022 (business section and risk factor verification); March 14, 2022 (updated financial data and Q1 2022 preliminary data verification); and April 5, 2022 (final verification session covering Amendment No. 1 disclosures).
In addition, sessions were conducted with Meridian & Howe LLP, the Company's independent registered public accounting firm. Gregory Simmons, the engagement partner at Meridian & Howe, participated in discussions regarding the audited financial statements for fiscal years ended December 31, 2019, December 31, 2020, and December 31, 2021, as well as unaudited financial data for the first quarter ended March 31, 2022. Topics covered in the auditor sessions included revenue recognition policies, the application of ASC 606, stock-based compensation expense recognition under ASC 718, the accounting treatment of the Company's convertible preferred stock, critical accounting judgments, and the adequacy of internal controls over financial reporting. Meridian & Howe confirmed that the audited financial statements were prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and that no material audit adjustments were pending as of the date of the most recent audit report.
II.C. Third-Party Confirmation
In connection with its due diligence investigation, C&H reviewed and relied upon the following third-party materials and confirmations:
Auditor Reports. C&H reviewed the independent auditor's reports issued by Meridian & Howe LLP for each of fiscal year 2019, fiscal year 2020, and fiscal year 2021. Each report contained an unqualified opinion on the Company's consolidated financial statements. C&H also reviewed the management representation letters provided by the Company to Meridian & Howe in connection with each annual audit. No material weaknesses in internal control over financial reporting were identified by Meridian & Howe in any of the audit periods, although the Company disclosed one significant deficiency related to the timely reconciliation of deferred revenue accounts, which was remediated during fiscal year 2021.
Material Contracts. C&H conducted a detailed review of the following material contracts, each of which is filed as an exhibit to the Registration Statement or described in the "Business" or "MD&A" sections of the prospectus:
(i) Brindoval Data Centers LLC Master Cloud Services Agreement, dated January 15, 2021, providing for the Company's primary cloud infrastructure hosting services, with a five-year initial term and an annual minimum commitment of $8.2 million;
(ii) Nordwell Financial Technologies Inc. Strategic Partnership Agreement, dated March 30, 2021, providing for co-development of integrated compliance analytics solutions and mutual distribution rights, with a three-year initial term and automatic renewal provisions; and
(iii) Ashford National Bank Revolving Credit Facility Agreement, dated June 1, 2021, providing for a $50 million revolving credit commitment at an interest rate of the Secured Overnight Financing Rate ("SOFR") plus 275 basis points, with a maturity date of June 1, 2024 and customary financial covenants.
Each of these agreements was reviewed in full by C&H, and key terms were summarized and verified against the corresponding disclosure in the Registration Statement. No material inconsistencies were identified between the contractual terms and the S-1 disclosure.
intellectual Property Review. C&H reviewed records obtained from the United States Patent and Trademark Office ("USPTO") confirming the Company's intellectual property portfolio, consisting of fourteen (14) issued U.S. utility patents, seven (7) pending U.S. utility patent applications, and registered trademarks for the marks "Lumos," "Lumos AI," "LumosIQ," and "FraudLens." Patent and trademark assignment records were reviewed to confirm that all intellectual property was properly assigned to the Company. C&H also reviewed the Company's standard form of invention assignment and confidentiality agreement used with employees and contractors to confirm that the Company's IP assignment practices were consistent with the disclosures in the Registration Statement.
II.D. SEC Comment Letter Process
The Registration Statement on Form S-1 was initially filed with the SEC on January 28, 2022. The following summarizes the comment letter process with the SEC Division of Corporation Finance:
First Comment Letter. The SEC Staff issued its initial comment letter on February 14, 2022, containing forty-two (42) comments. The comments addressed a broad range of disclosure topics, including but not limited to: (i) the specificity of risk factor disclosures (the Staff requested that certain generic risk factors be revised to include company-specific quantitative data); (ii) the non-GAAP nature of the Company's ARR metric and the need for disclosure of calculation methodology and limitations; (iii) the trending analysis in the MD&A section and the need for additional discussion of revenue growth deceleration; (iv) the cheap stock issue, including requests for detailed disclosure of grant date fair values, a waterfall reconciliation from the most recent 409A valuation to the midpoint of the preliminary price range, and qualitative and quantitative factors explaining the difference; (v) the adequacy of the Adjusted EBITDA reconciliation and related cautionary language; and (vi) various comments regarding the description of the Company's business, competitive landscape, and regulatory environment.
C&H prepared the response letter in collaboration with Lumos management and Meridian & Howe LLP. The response was filed with the SEC on March 4, 2022. The response addressed each of the forty-two comments individually, providing revised disclosure language where appropriate and supplemental explanations where no changes to the filing were deemed necessary. The revised Registration Statement incorporating the responsive changes was filed concurrently with the response letter.
Second Comment Letter. The SEC Staff issued a follow-up comment letter on March 18, 2022, containing twelve (12) comments. The second-round comments were more narrowly focused and addressed: (i) the customer concentration quantification (the Staff requested that the Company quantify the percentage of ARR attributable to its top ten customers); (ii) additional specificity regarding stock-based compensation expense recognition in connection with the cheap stock analysis; (iii) clarifications to the capitalization and dilution tables; and (iv) minor revisions to the description of the Company's regulatory environment. C&H prepared the response letter, which was filed on March 28, 2022, together with a further revised Registration Statement.
Clearance. The SEC Staff declared that it had no further comments on April 8, 2022. The Company filed the Form S-1/A (Amendment No. 1) on April 14, 2022, incorporating all revisions made in response to the two rounds of SEC comments and reflecting updated financial data and the Preliminary Price Range.
Each response to the SEC comment letters integrated the responsive changes into the revised disclosure in the Registration Statement. The backup documentation supporting each comment response is maintained separately in the C&H matter files and is cross-referenced in Appendix C to this memorandum.
III. Risk Factor Disclosures
III.A. Overview of Risk Factor Framework
The risk factor disclosures in the Registration Statement are governed by Item 105 of Regulation S-K, which requires disclosure of the material factors that make an investment in the registrant speculative or risky. Effective November 9, 2020, the SEC amended Item 105 to require that risk factors be organized under relevant headings and that each risk factor adequately describe the ways in which the risk affects the particular registrant, rather than presenting risks generically. Risk factors are to be organized by relative importance within each category, with the most significant risks appearing first.
In connection with the preparation of the Registration Statement, C&H worked with Lumos management to identify, draft, and refine the risk factor disclosures over the course of multiple drafting sessions. The initial risk factor section was prepared in December 2021 and was subsequently revised in response to management comments, internal C&H review, and, most significantly, the SEC Staff's comments in the first-round comment letter. The SEC Staff's comments on the risk factors principally addressed the need for greater specificity and company-specific quantitative data in several risk factor disclosures that the Staff viewed as overly generic in the initial filing. In response, C&H and management revised the risk factors to include specific financial data points, customer concentration metrics, and quantified descriptions of contractual commitments and regulatory obligations.
The final risk factor section of the Registration Statement, as set forth in Amendment No. 1, is organized into the following categories: (i) risks related to the Company's business and operations; (ii) risks related to the Company's financial condition; (iii) risks related to the regulatory environment; (iv) risks related to the Company's intellectual property; (v) risks related to the Company's dual-class capital structure; and (vi) risks related to the Offering and ownership of the Company's Class A Common Stock. The following subsections document the factual basis, source materials, and disclosure positions for the most significant risk factors within each category.
III.B. History of Net Losses / Path to Profitability
Factual Basis. The Company has incurred net losses in each year since its inception in 2016. For fiscal year ended December 31, 2021, the Company reported a net loss of $(41.2) million. For the same period, the Company reported Adjusted EBITDA of $(18.7) million. For the quarter ended March 31, 2022 (unaudited), the Company reported a net loss of $(13.8) million. These losses have been driven primarily by the Company's significant investments in research and development, sales and marketing, and general and administrative infrastructure necessary to support the Company's growth.
As of December 31, 2021, the Company had cash and cash equivalents of $94.3 million, representing the Company's primary source of liquidity. In addition, the Company has access to a $50 million revolving credit facility with Ashford National Bank, of which approximately $15 million was drawn as of March 31, 2022, leaving approximately $35 million of available borrowing capacity.
The Company's accumulated deficit as of December 31, 2021 was approximately $(126.8) million. There can be no assurance that the Company will achieve profitability in any future period, and the Company expects to continue to incur significant expenses in connection with its continued investment in product development, expansion of its sales and marketing organization, and general corporate infrastructure.
Disclosure Position. The risk factor disclosure states that the Company has incurred net losses since inception and may not achieve or sustain profitability. The disclosure further notes that the Company expects to continue to invest heavily in research and development and sales and marketing, which may result in continued net losses for the foreseeable future. The disclosure identifies the key factors that could affect the Company's path to profitability, including the rate of revenue growth, the Company's ability to manage operating expenses, and the timing and magnitude of the Company's capital expenditures.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) audited financial statements for fiscal years 2019, 2020, and 2021, as prepared by the Company and audited by Meridian & Howe LLP; (ii) unaudited interim financial statements for the quarter ended March 31, 2022; (iii) management representations provided by David Lau, CFO, during the financial data verification sessions; and (iv) the Ashford National Bank Revolving Credit Facility Agreement.
III.C. Customer Concentration Risk
Factual Basis. As of December 31, 2021, the Company had approximately 340 enterprise customers globally, with annual recurring revenue ("ARR") of $206.8 million. As of March 31, 2022, ARR had grown to $219.5 million. The Company's platform processes over two billion transactions per month on behalf of its customer base. The Company's top ten customers, by ARR, represented approximately 34% of total ARR as of December 31, 2021. No single customer individually represented more than 8% of total ARR as of that date.
This customer concentration metric was the subject of a specific comment in the SEC's second-round comment letter, dated March 18, 2022. The Staff requested that the Company quantify the percentage of ARR attributable to its top customers and disclose the potential impact of the loss of any significant customer on the Company's revenue and results of operations. In response, C&H and management incorporated the 34% figure into the risk factor disclosure. The figure was confirmed by management through a review of the Company's customer-level ARR data and was verified against accounts receivable aging reports provided by David Lau.
Disclosure Position. The risk factor disclosure states that the loss of any one or more of the Company's significant customers, or a material reduction in the scope or value of such customers' subscriptions, could materially and adversely affect the Company's revenue, results of operations, and financial condition. The disclosure further notes that the Company's enterprise customers typically enter into subscription contracts with initial terms of one to three years and that there can be no assurance that customers will renew their subscriptions at the same or higher levels, or at all. The disclosure identifies specific risk factors, including competitive alternatives, customer budget constraints, changes in customer strategic priorities, and the risk that customers may elect to develop internal solutions.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) management's ARR calculation and customer-level ARR data, as provided by David Lau and Tomás Aguilar; (ii) accounts receivable aging reports as of December 31, 2021 and March 31, 2022; (iii) customer contract files reviewed in the Data Room; and (iv) management representations from the verification sessions conducted with Tomás Aguilar regarding customer concentration, renewal rates, and the competitive environment for enterprise customers.
III.D. Dual-Class Stock Structure
Factual Basis. The Company's Amended and Restated Certificate of Incorporation, to be filed in connection with the completion of the IPO, establishes a dual-class capital structure consisting of Class A Common Stock and Class B Common Stock. Each share of Class A Common Stock is entitled to one (1) vote per share. Each share of Class B Common Stock is entitled to ten (10) votes per share. Class A Common Stock is the class of stock being offered to the public in the IPO. Class B Common Stock is held exclusively by the Company's co-founders and is not being offered or sold in the IPO.
As of immediately following the completion of the IPO (assuming no exercise of the underwriters' over-allotment option), the following shares of Class B Common Stock will be outstanding:
• Priya Subramanian: 16,500,000 shares of Class B Common Stock, representing 165,000,000 votes;
• Marcus Henley: 12,000,000 shares of Class B Common Stock, representing 120,000,000 votes.
In the aggregate, the co-founders will hold 28,500,000 shares of Class B Common Stock, representing a total of 285,000,000 votes. Based on the total voting power of all shares of common stock outstanding immediately following the IPO, the co-founders are expected to hold approximately 73.5% of the total combined voting power of all outstanding shares of common stock.
The Amended and Restated Certificate of Incorporation includes a sunset provision, pursuant to which each share of Class B Common Stock will automatically convert into one share of Class A Common Stock upon the earliest of: (i) the seventh (7th) anniversary of the date of the completion of the IPO; (ii) the date on which such share is transferred to any person other than a "Permitted Transferee" (as defined in the Amended and Restated Certificate of Incorporation, which includes transfers to the other co-founder, to certain family trusts, and to entities wholly owned and controlled by the transferring co-founder); and (iii) the date on which the co-founders, collectively, cease to beneficially own at least ten percent (10%) of the total number of outstanding shares of all classes of common stock.
Disclosure Position. The risk factor disclosure states that the concentrated voting control of the co-founders may: (a) deter or prevent a change in control of the Company, including transactions in which stockholders might otherwise receive a premium for their shares; (b) limit the ability of other stockholders to influence corporate matters, including the election and removal of directors, amendments to the Company's organizational documents, and the approval of significant corporate transactions; (c) result in management entrenchment and reduce the Company's accountability to stockholders generally; and (d) affect the trading price of the Class A Common Stock and the Company's eligibility for inclusion in certain stock indices, including the S&P 500, which may consider a company's governance structure in making index inclusion decisions.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) the draft Amended and Restated Certificate of Incorporation, reviewed in its final form; (ii) the capitalization table prepared by David Lau and verified by C&H; (iii) board resolutions approving the dual-class structure; and (iv) the Investor Rights Agreement, insofar as it addresses the interaction of the dual-class structure with investor consent rights.
III.E. Regulatory Risk in Financial Services / Fintech
Factual Basis. The Company provides analytics software solutions to financial institutions and fintech companies for transaction monitoring, fraud detection, regulatory reporting, and predictive risk modeling. As such, the Company operates in a regulatory environment that encompasses federal and state banking regulations, data privacy and data protection laws (including, without limitation, the California Consumer Privacy Act, the EU General Data Protection Regulation, and the Gramm-Leach-Bliley Act), anti-money laundering regulations (including the Bank Secrecy Act and the USA PATRIOT Act), and various international data transfer restrictions. While the Company is not itself a financial institution or money services business, many of its customers are regulated entities that are subject to examination by banking regulators, and the Company's products are used by those customers in connection with their regulatory compliance obligations.
Changes in the regulatory environment — including the adoption of new regulations, the amendment or reinterpretation of existing regulations, or more aggressive enforcement of existing regulatory requirements — could require the Company to make significant modifications to its products, increase the Company's compliance costs, or reduce demand for the Company's products if customers determine that the Company's solutions are insufficient to satisfy their regulatory obligations. In addition, the Company's products incorporate machine learning algorithms that make automated decisions or recommendations, which may come under increasing regulatory scrutiny as governments consider regulations governing the use of artificial intelligence in financial services.
Disclosure Position. The risk factor disclosure describes the regulatory environment in which the Company operates and identifies the specific regulatory regimes that are most relevant to the Company's business. The disclosure further states that changes in regulatory requirements could require significant product modifications, increase the Company's compliance costs, limit the Company's ability to introduce new products or features, or reduce demand for the Company's existing products and services. The disclosure also notes the emerging regulatory landscape for artificial intelligence and machine learning technologies.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) management interviews conducted with Tomás Aguilar, Chief Revenue Officer, and Naomi Feinberg, General Counsel, regarding the regulatory environment and the Company's compliance posture; (ii) regulatory compliance files maintained in the Data Room, including the Company's internal compliance policies and procedures; and (iii) public regulatory guidance and rulemaking activity reviewed by C&H as part of its legal analysis.
III.F. Competition from Larger Enterprise Software Providers
Factual Basis. The Company operates in a competitive market for analytics, fraud detection, and regulatory compliance software solutions for the financial services industry. The Company's competitive landscape includes established enterprise technology companies with significantly greater financial, technical, marketing, and sales resources than the Company, as well as emerging fintech platforms that may develop competing solutions. Specific categories of competitors identified by management include: (i) large enterprise software companies with existing relationships with financial institutions; (ii) established fraud detection and risk management solution providers; (iii) fintech companies developing point solutions for specific compliance or fraud detection use cases; and (iv) internal technology teams at financial institutions that may develop proprietary solutions.
Disclosure Position. The risk factor disclosure states that the Company faces competition from companies with greater financial, technical, and marketing resources, and that such competitors could develop products that are superior to the Company's products or that are available at lower prices. The disclosure further notes that competition could intensify as a result of industry consolidation, new market entrants, or existing competitors expanding their product offerings. The risk factor also identifies the potential for customers to develop internal solutions as an alternative to purchasing third-party software.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) management representations provided during interviews with Priya Subramanian, Marcus Henley, and Tomás Aguilar; (ii) investor presentation materials prepared by the Company in connection with the Series C and Series D financing rounds, which included competitive landscape analyses; and (iii) competitive analysis materials maintained by the Company in the ordinary course of business, copies of which were reviewed in the Data Room.
III.G. Market Conditions and Macroeconomic Uncertainty
Factual Basis. The broader technology sector experienced significant market volatility during the first half of 2022, with the Nasdaq Composite Index declining approximately 12% during the month of April 2022 alone, reflecting investor concerns regarding rising interest rates, inflationary pressures, geopolitical instability, and a reassessment of technology company valuations. These market conditions created heightened uncertainty regarding the timing and pricing of new technology company initial public offerings and the trading performance of recently listed technology companies.
Disclosure Position. The risk factor disclosure states that adverse market conditions, macroeconomic uncertainty, and geopolitical risks may affect customer spending on technology solutions, the Company's access to capital markets, and the Company's ability to execute its growth strategy. The disclosure further notes that deteriorating market conditions could adversely affect the market price of the Company's Class A Common Stock following the IPO and could result in increased volatility in the Company's stock price.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) publicly available market data regarding the performance of technology sector indices and comparable company stock prices; and (ii) management discussions regarding the potential impact of market conditions on the Company's business and on the timing and execution of the IPO.
III.H. Infrastructure Dependency Risk
Factual Basis. The Company relies on third-party cloud infrastructure services provided by Brindoval Data Centers LLC ("Brindoval") for the hosting, storage, and processing of substantially all of its customer-facing platform operations. The Master Cloud Services Agreement between the Company and Brindoval, dated January 15, 2021, has a five-year initial term (expiring January 14, 2026) and requires the Company to maintain an annual minimum commitment of $8.2 million for cloud computing, storage, and data transfer services. The agreement includes service level commitments from Brindoval, with financial credits for downtime exceeding specified thresholds, but does not guarantee uninterrupted service.
Disclosure Position. The risk factor disclosure states that the Company's reliance on third-party cloud infrastructure means that service interruptions, security breaches, or performance degradation at Brindoval's facilities could materially impact the availability, performance, and reliability of the Company's platform. The disclosure further notes that the Company's annual minimum commitment of $8.2 million represents a significant fixed cost that the Company is obligated to pay regardless of actual usage, and that any transition to an alternative infrastructure provider would involve significant cost, time, and operational risk.
Source Documents. The factual basis for this risk factor is supported by the following source documents: (i) the Brindoval Data Centers LLC Master Cloud Services Agreement, reviewed in full by C&H; (ii) management representations from Marcus Henley, CTO, regarding the Company's infrastructure architecture and disaster recovery capabilities; and (iii) the Company's internal business continuity and disaster recovery plans, copies of which were reviewed in the Data Room.
IV. Management's Discussion and Analysis (MD&A) — Disclosure of Operating Trends
IV.A. Revenue Growth and Key Performance Metrics
Factual Basis. The Company's revenue has grown significantly since inception, reflecting increasing adoption of the Company's platform by enterprise customers in the financial services industry. The Company's total revenue for the periods presented in the Registration Statement was as follows:
Annual recurring revenue ("ARR") as of December 31, 2021 was $206.8 million, growing to $219.5 million as of March 31, 2022, representing growth of approximately 6.1% during the quarter and providing an annualized growth rate that management viewed as consistent with the Company's forward trajectory, though modestly below the fiscal year 2021 growth rate.
The deceleration from a 58% annual revenue growth rate in fiscal year 2021 to a 40% year-over-year quarterly growth rate in Q1 2022 was the subject of detailed discussion during the C&H verification sessions with David Lau and Priya Subramanian. Management attributed this deceleration to several factors: (i) the Company's larger revenue base, which inherently requires larger absolute dollar increments to maintain the same percentage growth rate; (ii) longer enterprise sales cycles, particularly for the Company's larger and more complex implementations; and (iii) the timing of certain contract renewals and expansions, which management expected to close in Q2 2022 rather than Q1 2022. Management emphasized that the deceleration did not reflect a deterioration in demand or competitive position, a view that was supported by the Company's growing pipeline data and the increase in ARR during the quarter.
The SEC Staff's first-round comment letter requested more robust trending analysis in the MD&A section, including sequential quarterly growth rates and an ARR bridge analysis that would provide investors with greater visibility into the components of the Company's revenue growth. In response, C&H and management expanded the MD&A disclosure to include a discussion of sequential quarterly growth rates for the four quarters of fiscal year 2021 and Q1 2022, as well as a narrative ARR bridge analysis showing the contributions of new customer additions, expansion of existing customer subscriptions, and customer churn to the overall change in ARR during the period.
Source Documents. The factual basis for the revenue growth and key performance metrics disclosure is supported by the following source documents: (i) audited financial statements for fiscal years 2019, 2020, and 2021, as prepared by the Company and audited by Meridian & Howe LLP; (ii) unaudited interim financial statements for Q1 2022; (iii) management certification letters provided by David Lau confirming the accuracy of the financial data incorporated into the Registration Statement; and (iv) the CFO verification session notes maintained in the C&H matter files.
IV.B. ARR Methodology Disclosure
The SEC Staff's first-round comment letter included a comment specifically addressing the Company's use of the annual recurring revenue metric in the Registration Statement. The Staff noted that ARR is a non-GAAP financial measure and requested that the Company provide: (i) a clear definition of ARR, including the specific components that are included and excluded from the calculation; (ii) a discussion of the limitations of ARR as a measure of the Company's financial performance; and (iii) a reconciliation or other explanatory disclosure enabling investors to understand the relationship between ARR and revenue as reported in accordance with GAAP.
In response, C&H worked with David Lau to develop the following definition of ARR for inclusion in the Registration Statement:
"Annual recurring revenue, or ARR, represents the annualized value of all active subscription contracts as of the measurement date, calculated by multiplying the monthly recurring revenue from each active subscription contract by twelve. ARR excludes (i) one-time professional services fees, (ii) usage-based overage fees that are billed in excess of contractual subscription commitments, and (iii) any revenue recognized in connection with contracts that have been terminated or that are in a notice period. ARR is a forward-looking operational metric and is not a substitute for revenue calculated in accordance with GAAP."
The disclosure further includes a reconciliation footnote explaining the principal differences between ARR and GAAP revenue for the periods presented, including the impact of (a) the timing of revenue recognition under ASC 606 relative to the annualization methodology used in ARR, (b) the inclusion of professional services revenue in GAAP revenue but not in ARR, and (c) the treatment of multi-year contracts with varying annual fee structures. The disclosure also includes cautionary language noting that ARR should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP.
Source Documents. The factual basis for the ARR methodology disclosure is supported by the following source documents: (i) management's ARR calculation methodology memo, prepared by David Lau and reviewed by C&H; (ii) CFO representations regarding the ARR calculation, including the specific inclusion and exclusion criteria; and (iii) the verification session notes documenting C&H's review of the ARR methodology with David Lau.
IV.C. Gross Margin Analysis
Factual Basis. The Company's gross margin for fiscal year 2021 was 72.3%, reflecting the Company's subscription-based revenue model and the scalability of its platform architecture. Gross margin for fiscal year 2020 was 68.9%, reflecting the impact of the Company's early investment in cloud infrastructure capacity in advance of customer demand. The improvement in gross margin from fiscal year 2020 to fiscal year 2021 was driven primarily by increased revenue relative to the Company's fixed and semi-fixed cost of revenue, including the $8.2 million annual minimum commitment under the Brindoval Master Cloud Services Agreement.
The MD&A disclosure discusses the key drivers of gross margin performance, including: (i) the inherent scalability of the Company's software platform, which allows incremental revenue to be generated at relatively low incremental cost; (ii) the Company's subscription-based pricing model, which provides predictable recurring revenue; and (iii) the Company's investment in platform efficiency and automation, which has reduced the per-unit cost of processing transactions on the platform. The disclosure also identifies potential headwinds to gross margin, including: (a) the fixed nature of the $8.2 million annual minimum commitment under the Brindoval agreement, which represents a significant component of cost of revenue; (b) potential increases in cloud infrastructure costs as the Company scales its platform to process increasing transaction volumes; and (c) the potential need to increase the Company's data center and infrastructure capacity to support growth.
Source Documents. The factual basis for the gross margin analysis is supported by the following source documents: (i) audited financial statements for fiscal years 2020 and 2021; (ii) the cost accounting analysis provided by David Lau, which itemized the components of cost of revenue and their respective growth rates; and (iii) the Brindoval Master Cloud Services Agreement, which sets forth the terms of the annual minimum commitment.
IV.D. Non-GAAP Financial Measures — Adjusted EBITDA
Factual Basis. For fiscal year 2021, the Company reported Adjusted EBITDA of $(18.7) million, compared to a GAAP net loss of $(41.2) million. The reconciliation of GAAP net loss to Adjusted EBITDA for fiscal year 2021 is as follows:
The Company defines Adjusted EBITDA as net loss, adjusted to exclude stock-based compensation expense, depreciation and amortization expense, interest expense (net of interest income), income tax expense (benefit), and certain other non-recurring charges. The "other non-recurring items" category for fiscal year 2021 consisted of: (i) $1.4 million of IPO preparation costs, including legal, accounting, and consulting fees incurred in connection with the Company's preparations for the offering; (ii) $0.9 million of costs associated with a corporate restructuring initiative undertaken in Q3 2021; and (iii) $0.7 million of other one-time items, including settlement of a pre-litigation commercial dispute with a former vendor.
The SEC Staff's first-round comment letter required that the Company provide a clear tabular reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure (net loss) and include appropriate cautionary language regarding the limitations of non-GAAP financial measures. The SEC Staff also requested that the Company identify each component of the "other non-recurring items" add-back and explain why each such item was considered non-recurring. In response, C&H and management revised the Adjusted EBITDA disclosure to include: (i) a tabular reconciliation for each period presented (fiscal years 2020 and 2021, and Q1 2021 and Q1 2022); (ii) a line-item description of each component of the "other non-recurring items" add-back; and (iii) cautionary language stating that Adjusted EBITDA is a supplemental measure of operating performance that is not calculated in accordance with GAAP, that it should not be considered in isolation from or as a substitute for GAAP net loss, and that the Company's definition of Adjusted EBITDA may differ from the definitions used by other companies.
Disclosure Position. Adjusted EBITDA is presented in the Registration Statement as a supplemental measure of the Company's operating performance that management believes is useful to investors in evaluating the Company's core operating results. The limitations of this measure are clearly stated, and the tabular reconciliation to GAAP net loss is presented prominently in the MD&A section.
Source Documents. The factual basis for the Adjusted EBITDA disclosure is supported by the following source documents: (i) management's Adjusted EBITDA reconciliation, prepared by David Lau; (ii) Meridian & Howe LLP's review of the reconciliation methodology, confirming that the underlying GAAP figures are consistent with the audited financial statements; (iii) supporting documentation for each non-recurring item add-back, including invoices, settlement agreements, and internal approvals for the restructuring initiative; and (iv) the SEC Staff comment letter and C&H's response.
IV.E. Liquidity and Capital Resources
Factual Basis. As of December 31, 2021, the Company's principal sources of liquidity consisted of: (i) cash and cash equivalents of $94.3 million; and (ii) the Ashford National Bank revolving credit facility with a total commitment of $50 million, of which approximately $15 million was drawn as of March 31, 2022 and approximately $35 million remained available for future borrowings (subject to the satisfaction of customary borrowing conditions and financial covenants). The revolving credit facility bears interest at a rate of SOFR plus 275 basis points and matures on June 1, 2024.
The anticipated net proceeds to the Company from the IPO are estimated at approximately $200.9 million, calculated as follows:
The Company's intended use of the net proceeds from the offering is for general corporate purposes, including working capital, continued investment in research and development, expansion of the Company's sales and marketing organization, and potential strategic acquisitions, partnerships, or investments in complementary businesses or technologies. The Company has not allocated the net proceeds to any specific purpose and retains broad discretion in the application of net proceeds. The Company does not currently have any agreements, commitments, or understandings with respect to any material acquisitions.
Source Documents. The factual basis for the liquidity and capital resources disclosure is supported by the following source documents: (i) the audited balance sheet as of December 31, 2021; (ii) the Ashford National Bank Revolving Credit Facility Agreement, reviewed in full; (iii) management representations provided by David Lau regarding the use of proceeds, confirmed during the verification session; and (iv) the underwriting agreement terms as agreed between the Company and Pinnacle Securities LLC.
IV.F. Critical Accounting Policies
The MD&A section of the Registration Statement includes disclosure of the Company's critical accounting policies and estimates, which are those accounting policies that require significant management judgment and that could have a material impact on the Company's financial statements if different assumptions or estimates were used. The following critical accounting policies are disclosed:
Revenue Recognition (ASC 606). The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customers. The Company's revenue is derived primarily from subscription arrangements for access to its software platform, which are typically structured as time-based licenses with terms of one to three years. Revenue from subscription arrangements is recognized ratably over the term of the subscription period. The Company also generates revenue from professional services engagements, including implementation, integration, and training services, which are typically performed on a time-and-materials or fixed-fee basis and are recognized as the services are performed. For multi-element arrangements that include both subscription and professional services components, the Company allocates the total transaction price among the performance obligations based on their relative standalone selling prices. The disclosure discusses the key judgments required in applying ASC 606, including the identification of performance obligations, the determination of standalone selling prices, and the timing of revenue recognition.
Stock-Based Compensation. The Company accounts for stock-based compensation in accordance with ASC 718, Compensation — Stock Compensation. Stock-based compensation expense is measured based on the fair value of the equity award at the date of grant. For stock options, the Company uses the Black-Drubeck option-pricing model to estimate the fair value of each option grant, utilizing the following key assumptions: expected term, expected volatility (based on the historical volatility of comparable public companies), risk-free interest rate, and expected dividend yield. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period of the award, net of estimated forfeitures. The disclosure discusses the sensitivity of the compensation expense calculation to changes in the key assumptions, particularly expected volatility and expected term.
Capitalization of Internal-Use Software Development Costs. The Company capitalizes certain costs incurred in connection with the development of software for internal use, in accordance with ASC 350-40, Intangibles — Goodwill and Other — Internal-Use Software. Costs incurred during the application development stage are capitalized, while costs incurred during the preliminary project stage and post-implementation stage are expensed as incurred. Capitalized software development costs are amortized on a straight-line basis over the estimated useful life of the software, generally three to five years. The disclosure discusses the key judgments required in determining which costs qualify for capitalization and in estimating the useful life of the developed software.
Source Documents. The factual basis for the critical accounting policies disclosure is supported by the following source documents: (i) Meridian & Howe LLP audit work papers, which were reviewed by C&H (but are not attached to this memorandum due to their proprietary nature); (ii) accounting policy memoranda prepared by the Company's finance team and reviewed by Meridian & Howe; and (iii) management representations provided by David Lau during the verification sessions.
V. Related-Party Transaction Disclosures
V.A. Disclosure Framework
The related-party transaction disclosures in the Registration Statement are governed by Item 404 of Regulation S-K, which requires disclosure of any transaction since the beginning of the registrant's last fiscal year (or any currently proposed transaction) in which: (i) the amount involved exceeds $120,000; (ii) the registrant is a participant; and (iii) any related person has or will have a direct or indirect material interest. "Related persons" include directors, executive officers, holders of more than 5% of any class of the registrant's voting securities, and the immediate family members of any such person. In addition to Item 404, the Company is subject to Nasdaq listing standards regarding related-party transactions, which require that the Audit Committee or another independent body of the Board of Directors review and approve all related-party transactions.
C&H reviewed all transactions disclosed in the Registration Statement under Item 404 and confirmed that each disclosed transaction was reviewed and approved by the Board of Directors and, where applicable, by the Audit Committee. The Company has adopted a written related-party transactions policy, which was reviewed by C&H and is summarized in the Registration Statement. Under this policy, the Audit Committee is responsible for reviewing and approving (or ratifying) all transactions involving a related person in which the amount involved exceeds $120,000. The policy requires consideration of the terms of the transaction, the related person's interest in the transaction, and whether the transaction is on terms at least as favorable to the Company as those available from unrelated third parties.
V.B. Investor Rights Agreement
Parties. The Investor Rights Agreement, dated as of the Series D closing (August 24, 2020, as amended), is among Lumos Analytics Inc., Velthryn Venture Partners Fund IV, L.P. ("Velthryn"), Arclight Equity Group Fund VII, L.P. ("Arclight"), and Ridgeline Capital Partners Fund II, L.P. ("Ridgeline"). As of the date of the Registration Statement, the ownership positions of these investors on a fully diluted basis are as follows:
Registration Rights. The Investor Rights Agreement provides the following registration rights:
(a) Demand Registration Rights. Each of Velthryn and Arclight has the right to demand that the Company file a registration statement on Form S-1 (or Form S-3, when available) covering the resale of registrable securities held by such investor, subject to customary limitations on the number of demand registrations (two demands per investor) and minimum thresholds (shares having an aggregate market value of at least $25 million at the time of the demand).
(b) Piggyback Registration Rights. Each of Velthryn, Arclight, and Ridgeline has piggyback registration rights entitling it to include its registrable securities in any registration statement filed by the Company (other than certain excluded registrations), subject to customary cutback provisions in the event that the managing underwriter determines that the inclusion of additional shares would adversely affect the marketing of the offering.
(c) Form S-3 Shelf Registration Rights. Following the Company's eligibility to use Form S-3 for secondary offerings, each of Velthryn, Arclight, and Ridgeline has the right to request that the Company file and maintain a shelf registration statement on Form S-3 covering the resale of such investor's registrable securities.
Board Designation Rights. The Investor Rights Agreement provides for the following board designation rights:
• Velthryn has the right to designate one member of the Board of Directors for so long as Velthryn holds at least 10% of the Company's outstanding capital stock. The current Velthryn designee is Jonathan Tsai.
• Arclight has the right to designate one member of the Board of Directors for so long as Arclight holds at least 10% of t