What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-09 compared with 2020-08-03 · 145 added, 132 removed, 257 unchanged (52% of the section changed)

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These statements involve numerous risks and uncertainties, including those related to the anticipated impact on our business from, and our response to, the COVID-19 pandemic.

Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in the section entitled “Risk Factors” in this Quarterly Report and in our Annual Report, as well as our other public filings with the SEC.

Annual Report, as well as our other public filings with the SEC.

Please also refer to the section of this Quarterly Report entitled "Cautionary Note Regarding Forward-Looking Statements" for additional information.

Our mission is to revolutionize vertical industry businesses by providing great software and services.

Today we offer industry-specific, cloud-based business software solutions, services and data analytics to the real estate market, which

represents approximately 90% of our revenue, and, to a lesser extent, to the legal market.

We offer industry-specific, cloud-based business software solutions, services and data analytics to our customers.

Although specific functionality varies by product, our core solutions address common business operations and interactions of our customers' businesses.

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This architecture leads to rich data sets that have a consistent schema across our customer base and enables us to deploy data-powered products and services for our customers.

Our real estate software solutions provide our property management customers (including third-party property managers and owner-operators who manage single- and multi-family residences, community associations, commercial properties, and student housing, as well as mixed real estate portfolios) with a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and other stakeholders, and a system of intelligence designed to leverage data to predict and optimize business workflows in order to enable superior customer experiences and increase efficiency across our customers' businesses.

Our legal software solutions enable law firms to administer their practice and manage their caseloads more efficiently by centralizing case details in a single system of record and system of engagement.

We have focused on growing our revenue by increasing the size of our customer base in the markets we serve, increasing the number of units under management, introducing new or expanded Value+ services, retaining customers, and increasing the adoption and utilization of our Value+ services by new and existing customers.

The significant majority of our customers in the real estate vertical use our property management solutions, which provide our property management customers, including third-party property managers and owner-operators who manage single- and multi-family residences, community associations, commercial properties, and student housing, as well as mixed real estate portfolios, with a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and other stakeholders, and a system of intelligence to leverage data to predict and optimize business workflows that enable superior customer experiences and increase efficiency across our customers' businesses.

We also provide software solutions to real estate investment managers.

We have focused on growing our revenue by providing cloud-based business software solutions, services and data analytics that are designed and developed with our customers’ industry-specific business needs in mind, increasing the size of our customer base in the markets we serve, increasing the number of units under management, introducing new or expanded Value+ services, retaining customers, and increasing the adoption and utilization of our Value+ services by new and existing customers.

We evaluate the success of our business during the periods presented based on factors such as the development and launch of new and innovative core functionality and Value+ services, enhancements to user experience, customer satisfaction, growth in our revenue and customer base, fluctuations in costs and operating expenses as a percentage of revenue, operating loss or income and cash flows from operating activities.

To date, we have experienced rapid revenue growth due to our investments in research and product development, sales and marketing, customer service and support, and infrastructure.

We intend to continue to invest in growth across our organization as we expand in our current and adjacent markets and into new verticals.

We intend to continue to invest in growth areas, organically and via acquisition, based on our market validation findings and customer feedback.

Over the long-term, these investments to grow our business are expected to continue to increase our costs and operating expenses on an absolute basis.

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We have managed, and plan to continue to manage, our business towards the achievement of long-term growth that we believe will positively impact long-term stockholder value, and not towards the realization of short-term financial or business metrics, or short-term stockholder value.

We have invested, and intend to continue to invest, in our business to capitalize on our market opportunity.

We have invested, and intend to continue to invest, in our business to capitalize on our market opportunity by working closely with our customers, prospects, partners and other industry participants to inform our product roadmap.

Accordingly, if opportunities arise that might cause us to sacrifice our performance with respect to short-term financial or business metrics, but that we believe are in the best interests of our stockholders in the long term, we will take those opportunities.

We believe our people are at the heart of our success and our customers’ success, and we have worked hard not only to attract and hire quality individuals but also to nurture and develop our valuable human resources.

We believe our people are at the heart of our success and our customers’ success, and we have worked hard not only to attract, hire and retain quality individuals but also to nurture and develop our valuable human resources.

The professionalism and dedication of our workforce to continue effectively developing and supporting our product and service offerings has persisted notwithstanding the current environment, and the morale and focus of our team, even while working remotely, remains high.

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Further, we have a limited history of remote work and the long-term impact on, and the resulting types of continuing investments necessary for, our employee base is uncertain.

As of June 30, 2020, we had approximately 1,370 employees, and we continue to consider our relationship with them to be very good.

As of September 30, 2020, we had approximately 1,420 employees, which includes 118 MyCase employees who were terminated in connection with the MyCase Transaction.

We continue to consider our relationship with our employees to be very good.

We also hire temporary employees and consultants, and believe we have a similarly strong relationship with them.

None of our employees is represented by a labor union or covered by a collective bargaining agreement.

We must continue to attract, retain and motivate highly qualified and motivated personnel across our organization to execute our growth plan and achieve our strategic objectives.

Our future growth depends, in part, upon our ability to continue to identify, attract and retain the necessary qualified personnel to support our growth plans and the continued service of our executive officers and other key employees.

If we fail to do so, our business and operating results may suffer.

Recent Developments

As previously disclosed, on September 30, 2020, the Company completed the divestiture of 100% of the issued and outstanding equity interests of MyCase, the former wholly owned subsidiary of the Company that provided legal practice and case management software solutions to our legal customers, to an affiliate of certain funds advised by Apax Partners LLP for $193.0 million.

In connection with the MyCase Transaction, our Credit Agreement was terminated and all obligations outstanding under the Term Loan and Revolving Facility, including all guarantees and security interests granted with respect to such obligations, were satisfied in full with proceeds from the sale and extinguished.

Real Estate Overview

In 2008, we entered the real estate market with our first product, AppFolio Property Manager ("APM"), a property management solution designed to address the unique operational and business requirements of property management companies.

In 2008, we entered the real estate vertical with our first product, AppFolio Property Manager ("APM"), a property management solution designed to address the unique operational and business requirements of property management companies.

Recognizing that our customers and their stakeholders would benefit from additional business critical services, we launched a series of Value+ services beginning in 2009.

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APM PLUS builds upon the core functionality of APM and also offers data analytics, configurable workflows, and revenue management and optimization functionality for our customers.

In January 2019, we acquired Dynasty, a provider of advanced artificial intelligence ("AI") solutions for the real estate market, and began offering an AI Leasing Assistant, which we refer to as "Lisa", as a Value+ service to our property management customers in mid-2019.

In January 2019, we acquired Dynasty Marketplace, Inc.

("Dynasty"), a provider of advanced artificial intelligence ("AI") solutions for the real estate vertical, and began offering an AI Leasing Assistant, which we refer to as "Lisa", as a Value+ service to our property management customers in mid-2019.

In April 2019, we launched AppFolio Investment Management, which enables real estate investment managers to better manage their investor relationships by increasing transparency and streamlining certain business processes.

Approximately 90% of our annual revenue is derived directly and indirectly from the software solutions, services and data analytics we offer to the real estate market.

The significant majority of our customers in the real estate market use our property management solutions.

The significant majority of our customers in the real estate vertical use our property management solutions.

We define our property management customer base as the number of customers subscribing to our property management core solutions.

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Quarter Ended

June 30, March 31, December 31, September 30, June 30, March 31,

September 30, June 30, March 31, December 31, September 30, June 30, March 31,

Property manager customers 15,352 15,011 14,729 14,385 14,034 13,737 13,409

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Legal Overview

We entered the legal market with the acquisition of MyCase Inc.

("MyCase") in 2012.

In 2013, we introduced website design and hosting services, our first Value+ service for our legal market customers, designed to assist smaller law firms and solo practitioners with the marketing of their practices, electronic storage of case information and communications.

In 2016, we launched electronic payments services for the legal market, which streamlined the billing and receivables process through MyCase.

We expanded our electronic payments services for our law firm customers in 2019 with support for in-office payments and recurring payment plans via credit card.

Our legal customers directly and indirectly account for approximately 10% of our annual revenue.

We define our legal customer base as the number of customers subscribing to MyCase core solutions, exclusive of free trial periods.

Legal customer count is summarized in the table below:

We entered the legal vertical with the acquisition of MyCase in 2012.

As stated above, on September 30, 2020, we exited the legal vertical upon the completion of our divestiture of 100% of the issued and outstanding equity interests of MyCase to an affiliate of certain funds advised by Apax Partners LLP, for $193.0 million.

As of September 30, 2020, our legal customers directly and indirectly accounted for approximately 10% of our annual revenue.

We do not expect there will be a material impact to our operating income as a result of the MyCase Transaction.

We formerly defined our legal customer base as the number of customers subscribed to MyCase core solutions, exclusive of free trial periods.

Our historical legal customer count is summarized in the table below for the periods presented therein:

Quarter Ended

June 30, March 31, December 31, September 30, June 30, March 31,

September 30, June 30, March 31, December 31, September 30, June 30, March 31,

Law firm customers 11,592 11,305 11,115 10,971 10,781 10,631 10,485

Trends and Uncertainties Related to the COVID-19 Pandemic

During early calendar year 2020, the novel coronavirus disease, referred to as COVID-19, spread globally, including to every state in the United States, and the World Health Organization has since declared COVID-19 a pandemic.

In response to the COVID-19 pandemic, many state, local, and foreign governments have put in place, and others in the future may put in place, travel restrictions, quarantines, "shelter-in-place" orders, and similar government orders and restrictions, in an attempt to control the spread and impact of the disease.

During early calendar year 2020, the novel coronavirus disease ("COVID-19") spread globally, including to every state in the United States.

The global pandemic has created and may continue to create significant uncertainty in a wide variety of industries and markets and has prompted many federal, state, local, and foreign governments to various orders and restrictions in an attempt to control the spread and mitigate the impact of the disease, which may reduce demand for our core solutions and/or Value+ services, impact the productivity of our workforce, reduce our access to capital, and harm our business and results of operations.

Such restrictions or orders, or the perception that such restrictions or orders could be implemented, have resulted in business closures, work stoppages, slowdowns and delays, work-from-home policies, travel restrictions and the cancellation or postponement of events.

These potential impacts are only amplified by the length of time they remain in place, as the cumulative effect upon our customers and their businesses may only exacerbate potential harm to our business and results of operations.

Beginning in March 2020, in an effort to protect our employees and comply with applicable government orders, we restricted non-essential employee travel and transitioned our employees to a remote work environment.

We currently expect our employees to continue working remotely at least through the end of the fiscal year.

We currently expect our employees to continue working remotely at least through the end of the first quarter of 2021.

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With all of that said, if the COVID-19 pandemic requires remote working conditions for a prolonged period of time, it could have an adverse impact on the productivity of our employees, which would harm our business and impede our ability to achieve our strategic plan.

For example, we expect our employees with younger children will need to respond to ongoing school closures and adapt to a distance learning environment for at least the first part of the school year.

For example, certain our employees with younger children have been required to respond to ongoing school closures and adapt to a distance learning environment, and may be required to continue to do so for the foreseeable future.

Further, we have a limited history of remote work and the long-term impact on, and the resulting types of continuing investments necessary for, our employee base is uncertain.

We began fiscal year 2020 with healthy demand for our products and services, many of which are designed to enable our customers to manage their businesses virtually.

During the three and six months ended June 30, 2020, we experienced some variability in demand for certain Value+ services after government restrictions were implemented.

During the three and nine months ended September 30, 2020, we experienced some variability in demand for certain Value+ services after government restrictions were implemented.

We expect demand variability for our products and services could continue as a result of the COVID-19 pandemic, although it is presently unclear whether the cumulative impacts will be positive or negative.

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These efforts include increasing our cash position and eliminating, reducing, or deferring non-essential expenditures, as well as complying with local and state government recommendations to protect our workforce.

Our reported results for the three and six months ended June 30, 2020 may not be reflective of current market conditions, or of our results for any future periods, which may be negatively impacted by the COVID-19 pandemic to a greater extent than the reported period.

Our reported results for the three and nine months ended September 30, 2020 may not be reflective of current market conditions, or of our results for any future periods, which may be negatively impacted by the COVID-19 pandemic to a greater extent than the reported period.

The impact of the COVID-19 pandemic may also exacerbate other risks discussed in this Quarterly Report.

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Research and Product Development.

Research and product development expense consists of personnel-related costs (including salaries, performance-based compensation, benefits, and stock-based compensation) for our employees focused on research and product development, fees for third-party development resources, and allocated shared costs.

Research and product development expense consists of personnel-related costs (including salaries, performance-based compensation, benefits, and stock-based compensation) for our employees focused on

research and product development, fees for third-party development resources, and allocated shared costs.

Our research and product development efforts are focused on enhancing functionality and the ease of use of our existing software solutions by adding new core functionality, Value+ services and other improvements, as well as developing new products and services for new and existing markets.

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Finally, as we expand our facilities footprint and increase our base of employees, we expect to have increased property and equipment expenditures and incremental depreciation expense.

Other Income (Expense), Net.

Other income (expense), net includes gains and losses associated with the sale of businesses, property and equipment and investment securities.

Interest Expense, Net .

Interest expense includes interest paid on outstanding borrowings under our Credit Agreement.

Interest expense includes interest paid on outstanding borrowings under our former Credit Agreement.

Interest income includes interest earned on investment securities, amortization and accretion of the premium and discounts paid from the purchase of investment securities, and interest earned on notes receivable and on cash deposited in our bank accounts.

Benefit from Income Taxes.

Benefit from income taxes consists of federal and state income taxes in the United States.

Provision for (Benefit from) Income Taxes.

Provision for (benefit from) income taxes consists of federal and state income taxes in the United States.

Results of Operations

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Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2020 2019 2020 2019

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Interest expense, net (853) (1.0) (400) (0.6) (1,909) (0.8) (1,324) (0.7)

Income before benefit from income taxes 5,773 7.1 1,813 2.8 8,131 5.3 1,257 1.0

Benefit from income taxes (13,484) (16.6) (21,338) (33.5) (13,109) (8.5) (25,619) (21.2)

Income before provision for (benefit from) income taxes 190,254 226.3 3,723 5.5 198,385 83.5 4,980 2.6

Provision for (benefit from) income taxes 52,578 62.5 (1,255) (1.8) 39,469 16.6 (26,874) (14.2)

Net income $ 137,676 163.7 % $ 4,978 7.3 % $ 158,916 66.9 % $ 31,854 16.9 %

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Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2020 2019 2020 2019

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Total stock-based compensation expense $ 3,096 $ 2,192 $ 6,808 $ 5,431

Comparison of the Three and Six Months Ended June 30, 2020 and 2019

Comparison of the Three and Nine Months Ended September 30, 2020 and 2019

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Total revenue $ 84,086 $ 67,935 $ 16,151 24 % $ 237,624 $ 188,650 $ 48,974 26 %

For the three and six months ended June 30, 2020 and 2019, we derived the significant majority of our revenue directly and indirectly from the software solutions, services and data analytics we offer to our real estate market customers, most notably from our property management solutions.

For the three and nine months ended September 30, 2020 and 2019, we derived approximately 90% of our revenue directly and indirectly from the software solutions, services and data analytics we offer to our real estate vertical customers, most notably from our property management solutions.

The majority of our revenue is derived from our property management core solutions and Value+ services utilized by property managers, residents, applicants and owners.

The increase in core solutions and Value+ services revenue was mainly attributable to a growing base of property management customers and additional residents, applicants and owners utilizing our Value+ services.

During the comparative three and six months ended June 30, 2020, we experienced growth of 17% and 18%, respectively, in the average number of property management units under management resulting from 10% growth in the average number of property management customers during the same periods.

In addition, the increase in core solutions revenue was also attributable to growth of 6% and 7%, respectively, in the average number of law firm customers coupled with a core solutions price increase rolled out during the period.

During the comparative three and nine months ended September 30, 2020, we experienced growth of 16% and 17%, respectively, in the average number of property management units under management resulting from 9% and 10% growth, respectively, in the average number of property management customers during the same periods.

In addition, the increase in core solutions revenue was also attributable to growth of 7% in the average number of law firm customers coupled with a core solutions price increase rolled out during the period.

A significant majority of our Value+ services revenue comes directly and indirectly from our customers' use of our electronic payment services, tenant screening services, and insurance services.

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During the comparative periods, we also introduced new Value+ services and expanded the functionality of others, which resulted in incremental revenue.

The increase in Other revenue was primarily attributable to increases in revenue from our acquisitions of WegoWise and Dynasty, onboarding fees driven by growth in the number of property management customers, and fees associated with our property management customers upgrading to a new website hosting platform.

The decrease in Other revenue for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily attributable to a decrease in fees associated with our property management customers upgrading to a new website hosting platform, partially offset by increases in revenue from WegoWise and Dynasty.

The increase in Other revenue for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily attributable to increases in revenue from WegoWise and Dynasty.

Cost of Revenue (Exclusive of Depreciation and Amortization)

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Percentage of revenue 39.0 % 38.2 % 37.5 % 39.9 %

The increase in cost of revenue (exclusive of depreciation and amortization) for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, was primarily attributable to increased costs associated with servicing the incremental $17.4 million in revenue over the same period, partially offset by third party service provider incentives earned of $2.0 million.

For the three months ended June 30, 2020, expenditures to third-party service providers related to the delivery of our Value+ services increased $2.3 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $12.5 million increase in Value+ services revenue.

Offsetting this volume increase was $2.0 million of annual maximum incentives earned during the period from third-party service providers related to programs intended to increase adoption and utilization of online payments and favorable trends in loss reserves in our insurance services business.

The increase in cost of revenue (exclusive of depreciation and amortization) for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, was primarily attributable to increased costs associated with servicing the incremental $16.2 million in revenue over the same period.

For the three months ended September 30, 2020, expenditures to third-party service providers related to the delivery of our Value+ services increased $4.0 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $11.7 million increase in Value+ services revenue.

Personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business, increased $2.2 million.

Allocated and other costs increased by $0.1 million primarily driven by an increase in platform infrastructure, payment processing and other costs associated with the delivery and provision of our Value+ services, partially

offset by a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in cost of revenue (exclusive of depreciation and amortization) for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, was primarily attributable to increased costs associated with servicing the incremental $32.8 million in revenue over the same period, partially offset by third-party service provider incentives earned of $2.1 million.

For the six months ended June 30, 2020, expenditures to third-party service providers related to the delivery of our Value+ services increased $5.8 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $23.0 million increase in Value+ services revenue.

Allocated and other costs increased by $0.6 million primarily driven by an increase in platform infrastructure, payment processing and other costs associated with the delivery and provision of our Value+ services, partially offset by a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in cost of revenue (exclusive of depreciation and amortization) for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, was primarily attributable to increased costs associated with servicing the incremental $49.0 million in revenue over the same period, partially offset by third-party service provider incentives earned of $2.1 million.

For the nine months ended September 30, 2020, expenditures to third-party service providers related to the delivery of our Value+ services increased $7.7 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $34.7 million increase in Value+ services revenue.

Partially offsetting this volume increase was $2.1 million of annual maximum incentives earned during the period from third-party service providers related to programs intended to increase adoption and utilization of online payments and favorable trends in loss reserves in our insurance services business.

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As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) fluctuates primarily based on the mix and prices of Value+ services utilized during the period, and investments made in advance of expected revenue generation.

Excluding the third-party service provider incentives earned during the period, as a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) decreased to 36.4% from 39.5% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, and to 38.1% from 40.8% for the six months ended June 30, 2020 compared to the six months ended June 30, 2019.

This improvement in cost as a percentage of revenue was primarily driven by the mix of Value+ services revenue with varying underlying costs and our ability to increase revenue with a more moderate increase in personnel-related costs.

Excluding the third-party service provider incentives earned during the period, as a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) increased to 39.0% from 38.2% for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, and decreased to 38.4% from 39.9% for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

These fluctuations in cost as a percentage of revenue were primarily driven by the mix of Value+ services revenue with varying underlying costs.

Sales and Marketing

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Percentage of revenue 17.7 % 18.6 % 18.1 % 19.7 %

The increase in sales and marketing expense for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, was primarily due to a $2.0 million increase in personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business.

As a result of the COVID-19 pandemic, advertising and promotion costs decreased by $0.7 million primarily due to the cancellation or postponement of in-person events and the reduction of online marketing spend.

The increase in sales and marketing expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, was primarily due to a $1.6 million increase in personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business.

Advertising and promotion costs increased by $1.1 million due to increased online advertising and virtual marketing events aimed at increasing revenue and supporting growth in the business.

In addition, there was a decrease in allocated and other costs of $0.4 million related to a reduction of workplace-related expenses, the elimination of event-related travel from cancelled or postponed events and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The investment we make in sales and marketing is key to acquiring new customers, expanding the adoption and utilization of Value+ services, and growing revenue over time.

Notwithstanding these decreases, we intend to continue to invest in sales and marketing to increase our customer base and increase the adoption and utilization of Value+ services over time.

The increase in sales and marketing expense for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, was primarily due to a $4.5 million increase in personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business.

As a result of the COVID-19 pandemic, advertising and promotion costs decreased by $0.3 million primarily due to the cancellation or postponement of in-person events and the reduction of online marketing spend.

We intend to continue to invest in sales and marketing to increase our customer base and increase the adoption and utilization of Value+ services over time.

The increase in sales and marketing expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, was primarily due to a $6.1 million increase in personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business.

Advertising and promotion costs increased by $0.9 million due to increased online advertising and virtual marketing events aimed at increasing revenue and supporting growth in the business.

In addition, there was a decrease in allocated and other costs of $0.9 million related to a reduction of workplace-related expenses, the elimination of event-related travel from cancelled or postponed events and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

As a percentage of revenue, sales and marketing expense decreased to 16.9% from 20.8% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019 and 18.4% from 20.3% for the six months ended June 30, 2020 compared to the six months ended June 30, 2019.

This leverage in cost as a percentage of revenue was primarily driven by the reduction of advertising and promotion, event related travel and other non-essential expenditures as a result of the

COVID-19 pandemic.

As a percentage of revenue, sales and marketing expense decreased to 17.7% from 18.6% for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 and 18.1% from 19.7% for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

This leverage in cost as a percentage of revenue was primarily driven by the reduction of event related travel and other non-essential expenditures as a result of the COVID-19 pandemic.

Notwithstanding the leverage in cost as a percentage of revenue, we intend to continue to invest in sales and marketing to increase our customer base and increase the adoption and utilization of Value+ services over time.

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Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Percentage of revenue 16.0 % 15.6 % 15.5 % 15.1 %

The increase in research and product development expense for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, was the result of an increase in personnel-related costs, net of capitalized software development costs, of $3.3 million due to investments in headcount growth within our research and product development organization.

This increase was partially offset by a decrease in allocated and other costs of $0.5 million related to a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in research and product development expense for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, was the result of an increase in personnel-related costs, net of capitalized software development costs, of $5.6 million due to investments in headcount growth within our research and product development organization.

This increase was partially offset by a decrease in allocated and other costs of $0.1 million related to a reduction of workplace related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in research and product development expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, was the result of an increase in personnel-related costs, net of capitalized software development costs, of $3.7 million due to investments in headcount growth within our research and product development organization.

This increase was partially offset by a decrease in allocated and other costs of $0.8 million primarily related to a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in research and product development expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, was the result of an increase in personnel-related costs, net of capitalized software development costs, of $9.3 million due to investments in headcount growth within our research and product development organization.

This increase was partially offset by a decrease in allocated and other costs of $0.9 million primarily related to a reduction of workplace related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

General and Administrative

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Percentage of revenue 15.4 % 13.2 % 15.3 % 13.4 %

The increase in general and administrative expense for the three months ended June 30, 2020 compared to the three months ended June 30, 2019 was primarily due to a $4.3 million expense recorded during the current period, which we believe is a reasonable estimate of the probable loss associated with the FTC Investigation based on information currently available to us.

For additional information regarding the FTC Investigation and related matters, refer to Note 9, Commitments and Contingencies , of our Condensed Consolidated Financial Statements.

In addition, personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business, increased $2.6 million.

This increase was partially offset by a decrease in allocated and other costs of $0.3 million related to a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in general and administrative expense for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, was primarily due to a $4.3 million expense recorded during the current period related to the probable loss associated with the FTC Investigation.

In addition, personnel-related costs, including performance-based compensation, necessary to support growth and key investments in the business, increased $3.3 million.

This increase was partially offset by a decrease in allocated and other costs of $0.7 million related to a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

The increase in general and administrative expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily due to a $1.8 million increase in personnel-related costs, including performance-based compensation, due to investments in headcount growth within our general and administrative organizations.

In addition, there was an increase in professional services fees and other costs of $2.3 million related to the MyCase Transaction.

The increase in general and administrative expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, was primarily due to a $5.0 million increase in personnel-related costs, including performance-based compensation, due to investments in headcount growth within our general and administrative organizations.

In addition, there was a $4.3 million expense recorded during the current period related to the probable loss associated with the FTC Investigation.

There was also an increase in professional services fees and other costs of $2.3 million related to the MyCase Transaction.

Allocated and other costs decreased $0.7 million primarily due to a reduction of workplace-related expenses and the reduction of other non-essential expenditures in response to the impact of the COVID-19 pandemic.

We expect stock-based compensation expense will continue to decrease for certain executives in light of our adoption of the Long-Term Cash Bonus Plan in 2018.

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Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

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Percentage of revenue 7.9 % 8.4 % 8.3 % 8.6 %

The increase in depreciation and amortization expense for the three and six months ended June 30, 2020 compared to the three and six months ended June 30, 2019, was primarily due to increased amortization expense associated with higher accumulated capitalized software development balances.

Benefit from Income Taxes

The increase in depreciation and amortization expense for the three and nine months ended September 30, 2020 compared to the three and nine months ended September 30, 2019, was primarily due to increased amortization expense associated with higher accumulated capitalized software development balances.

Other Income (Expense), net

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

(dollars in thousands)

Benefit from income taxes $ (13,484) $ (21,338) $ 7,854 (37) % $ (13,109) $ (25,619) $ 12,510 (49) %

Other income (expense), net $ 187,747 $ (11) $ 187,758 n/a $ 187,759 $ (68) $ 187,827 n/a

Percentage of revenue 223.3 % — % 79.0 % — %

The increase in other income (expense), net for the three and nine months ended September 30, 2020 compared to the three and nine months ended September 30, 2019, was primarily due to the gain of $187.6 million associated with the MyCase Transaction.

We expect to recognize additional other income beginning in the fourth quarter of 2020 relating to income from certain post-closing transition services to be provided by the Company to MyCase.

Provision for (Benefit from) Income Taxes

Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2020 2019 Amount % 2020 2019 Amount %

(dollars in thousands)

Provision for (benefit from) income taxes $ 52,578 $ (1,255) $ 53,833 (4,289) % $ 39,469 $ (26,874) $ 66,343 (247) %

Percentage of revenue 62.5 % (1.8) % 16.6 % (14.2) %

We calculate our provision for income taxes on a quarterly basis by applying an estimated annual effective tax rate to income from operations and by calculating the tax effect of discrete items recognized during the quarter.

For the three and six months ended June 30, 2020, we recorded income tax benefit of $13.5 million and $13.1 million, respectively.

For the three and nine months ended September 30, 2020, we recorded income tax expense of $52.6 million and $39.5 million, respectively.

The tax provision for the three months ended September 30, 2020 includes a discrete tax expense of $47.9 million relating to the MyCase Transaction which includes $48.9 million of current tax expense less a $1.0 million benefit from the reversal of deferred tax liabilities.

The effective tax rate as compared to the U.S.

federal statutory rate of 21% differs primarily due to the significance of the benefits associated with stock-based compensation expense and research and development tax credits in relation to the forecasted pre-tax results for the year.

For the three and six months ended June 30, 2019, we recorded an income tax benefit of $21.3 million and $25.6 million, respectively.

For the three and nine months ended September 30, 2019, we recorded an income tax benefit of $1.3 million and $26.9 million, respectively.

The tax benefits recorded were primarily due to the release of the valuation allowance during the second quarter of 2019.

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Cash and Cash Equivalents

As of June 30, 2020, our principal sources of liquidity were cash and cash equivalents and investment securities, which had an aggregate balance of $80.2 million.

During the six months ended June 30, 2020, we increased cash and cash equivalents by borrowing $49.0 million of the $50.0 million available under our Revolving Facility.

Our available cash is subject to our ongoing compliance with the financial covenants set forth in the Credit Agreement.

For additional information regarding the Credit Agreement, refer to Note 8, Long-Term Debt, of our Condensed Consolidated Financial Statements.

As of September 30, 2020, our principal sources of liquidity were cash and cash equivalents and investment securities, which had an aggregate balance of $181.9 million.

During the nine months ended September 30, 2020, our cash and cash equivalents increased primarily as a result of the proceeds from the MyCase Transaction.

Working Capital

As of June 30, 2020, we had working capital of $55.4 million, compared to working capital of $14.3 million as of December 31, 2019.

The increase in our working capital was primarily due to an increase in cash and cash equivalents as a result of our borrowing under the Revolving Facility, a decrease in other current liabilities due to the payment of contingent consideration related to the Dynasty acquisition, and an increase in accounts receivable primarily driven by increased usage of our Value+ services.

The increase in our working capital was partially offset by a decrease in investment securities-current and increases in accrued expenses, accounts payable and accrued employee expenses.

Revolving Facility

As of June 30, 2020, we had a $50.0 million Revolving Facility under the terms of the Credit Agreement with $1.0 million remaining available to borrow.

During the six months ended June 30, 2020, we borrowed $49.0 million under our Revolving Facility to provide additional liquidity in light of the uncertainty caused by the COVID-19 pandemic.

For additional information regarding the Credit Agreement, refer to Note 8, Long-Term Debt, of our Condensed Consolidated Financial Statements.

As of September 30, 2020, we had working capital of $145.7 million, compared to working capital of $14.3 million as of December 31, 2019.

The increase in our working capital was primarily due to an increase in cash and cash equivalents as a result of the net proceeds from the MyCase Transaction, an increase in investment securities-current, a decrease in other current liabilities due to the payment of contingent consideration related to the Dynasty acquisition, a decrease in deferred revenue, and an increase in accounts receivable primarily driven by increased usage of our Value+ services.

The increase in our working capital was partially offset by an increase in income taxes payable related to the MyCase Transaction, and increases in accrued expenses, accounts payable and accrued employee expenses.

Liquidity Requirements

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Capital Requirements

Our future capital requirements will depend on many factors, including continued market acceptance of our software solutions, change in the number of our customers, adoption and utilization of our Value+ services by new and existing customers, the timing and extent of the introduction of new core functionality, products and Value+ services, the timing and extent of our expansion into adjacent or new markets, the timing and extent of our investments across our organization, and the impact of the COVID-19 pandemic on the customers we serve and on our business.

Our future capital requirements will depend on many factors, including continued market acceptance of our software solutions, changes in the number of our customers, adoption and utilization of our Value+ services by new and existing customers, the timing and extent of the introduction of new core functionality, products and Value+ services, the timing and extent of our expansion into adjacent or new markets, the timing and extent of our investments across our organization, and the impact of the COVID-19 pandemic on the customers we serve and on our business.

In addition, we have in the past entered into, and may in the future enter into, arrangements to acquire or invest in new technologies or markets adjacent to those we serve today or entirely new verticals.

Furthermore, our Board of Directors has authorized our management to repurchase up to $100.0 million of shares of our Class A common stock from time to time.

To date, we have repurchased $4.2 million of our Class A common stock under the Program.

To date, we have repurchased $4.2 million of our Class A common stock under the Share Repurchase Program.

For additional information regarding our share repurchase program, refer to Note 10, Share Repurchase Program, of our Condensed Consolidated Financial Statements.

The following table summarizes our cash flows for the periods indicated (in thousands):

Six Months Ended

Nine Months Ended

September 30,

Net cash provided by operating activities $ 45,216 $ 23,413

Net cash used in investing activities (18,712) (60,777)

Net cash provided by (used in) financing activities 28,840 (5,597)

Net cash provided by (used in) investing activities 152,542 (70,728)

Net cash used in financing activities (69,541) (6,639)

Net increase (decrease) in cash, cash equivalents and restricted cash $ 128,217 $ (53,954)

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Our primary uses of cash from operating activities are for personnel-related expenditures and third-party costs incurred to support the delivery of our software solutions.

For the six months ended June 30, 2020, net cash provided by operating activities was $27.4 million resulting from net income of $21.2 million, adjusted by non-cash charges of $5.7 million and a net increase in our operating assets and liabilities of $0.4 million.

For the nine months ended September 30, 2020, net cash provided by operating activities was $45.2 million resulting from net income of $158.9 million, adjusted by the gain on the sale of MyCase of $187.6 million, non-cash charges of $52.6 million and a net increase in our operating assets and liabilities of $21.3 million.

The non-cash charges primarily consist of an increase in deferred taxes of $22.9 million, $19.8 million of depreciation and amortization costs, stock-based compensation expense of $6.8 million, and $3.0 million of amortization of operating lease right-of-use assets.

The net increase in our operating assets and liabilities was mostly attributable to a $5.1 million increase in accounts receivable primarily driven by growth of our Value+ services, partially offset by a $4.5 million increase in accrued expenses which was primarily due to a $4.3 million accrual recorded during the current period related to our reasonable estimate of the probable loss associated with the FTC Investigation, a $0.7 million increase in accrued employee expenses primarily due to an increase in accrued paid time off and partially offset by a decrease in accrued performance-based cash compensation and a $0.5 million increase in deferred revenue driven by growth in the number of customers invoiced during the period.

For the six months ended June 30, 2019, cash provided by operating activities was $11.8 million resulting from net income of $26.9 million, adjusted by non-cash charges of $9.9 million and a net decrease in our operating assets and liabilities of $5.2 million.

The non-cash charges primarily consist of a one-time benefit of $25.6 million related to the release of the valuation allowance for our deferred tax assets, offset by $10.5 million of depreciation and amortization of our property and equipment and capitalized software development costs, $3.2 million of stock-based compensation and $1.9 million of amortization of operating lease right-of-use assets.

The net decrease in our operating assets and liabilities was mostly attributable to an increase of $5.2 million in prepaid expenses and other current assets, $2.7 million increase in accounts receivable primarily driven by growth in our Value+ services and a $1.8 million decrease in operating lease liabilities.

The decrease in our operating assets and liabilities was partially offset by a $1.3 million decrease in other long-term assets, a $1.4 million increase in accrued expenses and a $0.7 million increase in accrued employee expenses.

Cash Used in Investing Activities

Cash used in investing activities is generally comprised of purchases, maturities and sales of investment securities, purchases of property and equipment, additions to capitalized software development, and cash paid for business acquisitions.

For the six months ended June 30, 2020, investing activities used $18.7 million in cash primarily due to capital expenditures of $14.3 million to purchase property and equipment for the continued growth and expansion of our business, purchases of investment securities of $13.4 million, and capitalized software development costs of $12.7 million for the continued investment in our software development.

These uses of cash were partially offset by sales and maturities of investment securities of $13.9 million and $7.8 million, respectively.

For the six months ended June 30, 2019, investing activities used $60.8 million in cash primarily due to $54.0 million used to acquire Dynasty, as well as capitalized software development costs of $9.4 million for the continued investment in our software development, and capital expenditures of $2.4 million to purchase property and equipment for the continued growth and expansion of our business.

The net increase in our operating assets and liabilities was mostly attributable to a $16.5 million increase in other liabilities primarily driven by income taxes payable due to the MyCase Transaction, a $5.9 million increase in accrued expenses which was primarily due to a $4.3 million accrual recorded during the current period related to our reasonable estimate of the probable loss associated with the FTC Investigation, a $1.9 million increase in accrued employee expenses primarily due to an increase in accrued paid time off, and a $0.8 million increase in deferred revenue driven by growth in the number of customers invoiced during the period.

These increases were partially offset by a $2.2 million increase in accounts receivable primarily driven by growth of our Value+ services, a $1.1 million decrease in operating lease liabilities, and a $0.9 million increase in prepaid expenses and other current assets.

For the nine months ended September 30, 2019, net cash provided by operating activities was $23.4 million resulting from net income of $31.9 million, adjusted by non-cash charges of $2.3 million and a net decrease in our operating assets and liabilities of $6.2 million.

The non-cash charges primarily consist of a one-time benefit of $27.0 million related to the release of the valuation allowance for our deferred tax assets, offset by $16.2 million of depreciation and amortization of our property and equipment and capitalized software development costs, $5.4 million of stock-based compensation and $3.0 million of amortization of operating lease right-of-use ("ROU") assets in accordance with ASU 2016-02.

The net decrease in our operating assets and liabilities was mostly attributable to an increase of $4.4 million in prepaid expenses and other current assets, a $2.9 million decrease in operating lease liabilities, and a $2.8 million increase in accounts receivable primarily driven by growth of our Value+ services.

The decrease in our operating assets and liabilities was partially offset by a $1.1 million decrease in other assets, a $1.0 million increase in deferred revenue, a $1.0 million increase in other liabilities, and a $0.5 million increase in accrued employee expenses.

Cash Provided by (Used in) Investing Activities

Cash provided by (used in) investing activities is generally comprised of proceeds from divestitures, purchases, maturities and sales of investment securities, purchases of property and equipment, additions to capitalized software development, and cash paid for business acquisitions.

For the nine months ended September 30, 2020, investing activities provided $152.5 million in cash primarily due to net proceeds from the MyCase Transaction of $191.4 million and the sales and maturities of investment securities of $13.9 million and $13.3 million, respectively.

These sources of cash were partially offset by purchases of investment securities of $29.9 million, capitalized software development costs of $19.7 million, and capital expenditures of $16.6 million to purchase property and equipment for the continued growth and expansion of our business.

For the nine months ended September 30, 2019, investing activities used $70.7 million in cash primarily due to $54.0 million used to acquire Dynasty, as well as capitalized software development costs of $15.7 million for the continued investment in our software development, purchases of investment securities of $10.7 million, and capital expenditures of $4.1 million to purchase property and equipment for the continued growth and expansion of our business.

These uses were partially offset by sales and maturities of investment securities of $2.8 million and $11.0 million, respectively.

Cash Provided by (Used in) Financing Activities

Cash provided by (used in) financing activities is generally comprised of proceeds from the exercise of stock options, net share settlements for employee tax withholdings associated with the vesting of RSUs, the payment of contingent consideration under acquisition arrangements, activities associated with our Credit Facility, and activities related to the repurchase of our Class A common stock.

For the six months ended June 30, 2020, financing activities provided $28.8 million in cash primarily as a result of proceeds from the Revolving Facility of $50.2 million, partially offset by net share settlements for employee tax withholdings associated with the vesting of RSUs of $9.7 million, payment of contingent consideration related to the Dynasty acquisition of $6.0 million, the repurchase of outstanding shares of Class A common stock in the amount of $4.2 million, and principal payments on debt of $1.8 million.

For the six months ended June 30, 2019, financing activities used $5.6 million in cash primarily as a result of net share settlements for employee tax withholdings associated with the vesting of RSUs of $4.8 million, as well as principal payments on debt of $1.8 million, and payments of debt issuance costs of $0.4 million, partially offset by proceeds from issuance of debt of $1.2 million and proceeds from stock option exercises of $0.2 million.

Cash Used in Financing Activities

Cash used in financing activities is generally comprised of proceeds from the exercise of stock options, net share settlements for employee tax withholdings associated with the vesting of RSUs, the payment of contingent consideration under acquisition arrangements, activities associated with our former Credit Facility, and activities related to the repurchase of our Class A common stock.

For the nine months ended September 30, 2020, financing activities used $69.5 million in cash primarily as a result of the payment of all outstanding amounts due under the Credit Facility of $99.6 million, net share settlements for employee tax withholdings associated with the vesting of RSUs of $11.0 million, payment of contingent consideration related to the Dynasty acquisition of $6.0 million, and the repurchase of outstanding shares of Class A common stock in the amount of $4.2 million.

These uses of cash were partially offset by net proceeds from the Revolving Facility of $50.8 million.

For the nine months ended September 30, 2019, financing activities used $6.6 million in cash primarily as a result of net share settlements for employee tax withholdings associated with the vesting of RSUs of $5.5 million, as well as principal payments on debt of $2.6 million, and payments of debt issuance costs of $0.4 million, partially offset by proceeds from issuance of debt of $1.7 million and proceeds from stock option exercises of $0.3 million.

Contractual Obligations and Other Commitments

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Off-Balance Sheet Arrangements

As of June 30, 2020, we did not have any off-balance sheet arrangements.

As of September 30, 2020, we did not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

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While we considered the effects of COVID-19 in our estimates and assumptions, due to the current level of uncertainty over the economic and operational impacts of COVID-19 on our business, there may be other judgments and assumptions that were not currently considered.

Such judgments and assumptions could result in a meaningful impact to our

financial statements in future periods.

Such judgments and assumptions could result in a meaningful impact to our financial statements in future periods.

Actual results could differ from those estimates and any such differences may have a material impact on our financial statements.

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Short-Term Investments

As of June 30, 2020, we had cash and cash equivalents of $53.3 million consisting of bank deposits, money market funds, and treasury securities, and $26.9 million of investment securities consisting of treasury securities, United States government agency securities and corporate bonds.

As of September 30, 2020, we had cash and cash equivalents of $144.0 million consisting of bank deposits, money market funds, and treasury securities, and $37.8 million of investment securities consisting of treasury securities, United States government agency securities and corporate bonds.

The primary objective of our investment policy is to invest in securities to support our liquidity and capital needs.

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Since our investment securities are held as available for sale, all changes in fair value impact our other comprehensive income unless an investment security is considered impaired in which case changes in fair value are reported in other expense.

As of June 30, 2020 a hypothetical 100 basis point change in interest rates would not have resulted in a material change in the fair value of our investment securities.

This estimate is based on a sensitivity model which measured an instant change in interest rates by 100 basis points as of June 30, 2020.

As of September 30, 2020 a hypothetical 100 basis point change in interest rates would not have resulted in a material change in the fair value of our investment securities.

This estimate is based on a sensitivity model which measured an instant change in interest rates by 100 basis points as of September 30, 2020.

Credit Facility

We are exposed to interest rate risk as a result of our Credit Facility.

Outstanding borrowings under the Credit Facility accrue interest as described in Note 8, Long-Term Debt, of our Condensed Consolidated Financial Statements.

Our borrowings under the Credit Facility are subject to interest rate fluctuations, which could have a material impact on our cash flows and results of operations depending on the magnitude of the fluctuations and the outstanding borrowings.

We were exposed to interest rate risk as a result of our Credit Facility prior to its termination.

Outstanding borrowings under the Credit Facility accrued interest as described in Note 8, Long-Term Debt, of our Condensed Consolidated Financial Statements.

Our borrowings under the Credit Facility were subject to interest rate fluctuations, which could have had a material impact on our cash flows and results of operations depending on the magnitude of the fluctuations and the outstanding borrowings.

In order to determine the potential impact of changes in interest rates on our cash flows and result of operations, we performed a sensitivity analysis.

A hypothetical 100 basis point increase in interest rates during the period ended June 30, 2020 would not have had a material impact on our cash flows or results of operations.

A hypothetical 100 basis point increase in interest rates during the period ended September 30, 2020 would not have had a material impact on our cash flows or results of operations.

In connection with the MyCase Transaction, and as required by the terms of the Credit Agreement, the Credit Agreement was terminated and all obligations outstanding under the Term Loan and Revolving Facility thereunder, including all guarantees and security interests granted with respect to such obligations, were satisfied in full with proceeds from the MyCase Transaction and extinguished.

Inflation Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis