APPFOLIO INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and the related notes included elsewhere in this Quarterly Report and in our Annual Report. This discussion and analysis contains forward-looking statements that are based on our current expectations and reflect our plans, estimates and anticipated future financial performance. 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. Please also refer to the section of this Quarterly Report entitled "Cautionary Note Regarding Forward-Looking Statements" for additional information. Overview We provide innovative software, services and data analytics to the real estate industry. Our cloud-based solutions are used primarily by property managers, but also by numerous other constituencies in the property management business ecosystem. These other constituencies include property owners, rental prospects, tenants and service providers, whom we refer to collectively as "users". Although specific functionality varies by product, our core solutions are designed to enable our customers to digitally transform their businesses, address critical business operations and enable exceptional customer service. In addition to our core solutions, we offer an array of optional, but often business-critical, Value+ services that are designed to enhance, automate and streamline processes and workflows that are essential to our customers' businesses. Our Value+ services are generally available on an as-needed basis and enable our customers to adapt our offerings to their specific operational requirements. Our solutions and services are designed to be a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and users and a system of intelligence to leverage data to predict and optimize business workflows in order to enable exceptional customer experiences and increase efficiency across our customers' businesses. Our mobile-optimized software solutions are designed for use across multiple devices and operating systems. Our software solutions are offered as a service, are hosted using a modern cloud-based architecture, and, in part, use artificial intelligence technologies. This architecture leads to rich data sets that have a consistent schema across our customer and user base and enables us to deploy data-powered products and services for our customers and users. 22 Table of Contents In 2008, we introduced APM, a property management solution designed to address the unique operational and business requirements of property management companies and their business ecosystems. Recognizing that our customers and their business ecosystems would benefit from additional business critical services, we launched a series of Value+ services beginning in 2009. Our Value+ services are tailored to the specific workflows of property management businesses and generally fall into the categories of marketing and leasing, electronic payment services, business optimization and risk mitigation. In 2018, we introduced APM PLUS, a tier of APM designed for larger businesses with more complex needs. APM PLUS builds upon the functionality of APM and additionally offers data analytics, configurable workflows, and revenue management and optimization functionality for our customers. In April 2019, we launched AppFolio Investment Management, which is designed to enable real estate investment managers to better manage their investor relationships by increasing transparency and streamlining certain business processes. We do not separately break out customer information between APM, APM PLUS and AppFolio Investment Management at this time. APM and APM PLUS serve our property management customers, including third-party property managers and owner operators, who typically manage single- and multi-family residential properties, and others who manage community association, and commercial properties. Our solutions and services also serve other constituencies in the property management market, including property owners, rental prospects, tenants and service providers. Revenue generated from each customer varies based on the type of property, the number of units under management, and the level of adoption and utilization of Value+ services by the customer and users. Revenue per unit generated from each customer typically varies based on the type of property and the level of adoption and utilization of Value+ services by the customer and users. For example, revenue generated per community association unit, which represent a growing percentage of our overall units, is lower than revenue generated per residential unit given the unique and complex needs of the residential rental lifecycle and resulting impact on the adoption and utilization of V+ services. Property management customer count and property management units under management are presented in the table below. We define property management customers as those paying for a subscription to our core solutions. Quarter Ended September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2021 2020 Property manager customers 16,844 16,532 16,178 15,724 15,352 15,011 14,729 Property manager units under management (in millions) 6.04 5.82 5.62 5.36 5.12 4.94 4.80 To date, we have experienced rapid revenue growth due to strong relationships with our customers, as well as our investments in research and product development, sales and marketing, customer service and support, and infrastructure. 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 strategy. Over the long-term, these investments are expected to continue to increase our costs and operating expenses on an absolute basis. Many of these investments will occur in advance of our realization of revenue or any other benefit, which will make it difficult to determine if we are allocating our resources effectively and efficiently. We expect our operating margins will improve over the long-term, but this trend may be interrupted from time to time as a result of accelerated investment opportunities occurring in advance of realization of revenue. 23 Table of Contents We rely heavily on our talented team of employees to execute our growth plans and achieve our long-term strategic objectives. 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 retain talented individuals, but also to provide a challenging and rewarding environment to motivate and develop our valuable human capital. Beginning in March 2020, in an effort to protect our employees and comply with applicable government orders, we transitioned our employees to a remote work environment and restricted non-essential employee travel. Our workforce has continued to effectively develop and support our software and services offerings notwithstanding the current environment. We are slowly transitioning employees back to the workplace on a voluntary basis and have resumed limited employee business travel. Given the ongoing uncertainties surrounding COVID-19, we have pushed our return to office into 2022 and will continue to provide employees the option to work remotely until further notice. If the COVID-19 pandemic once again requires full remote working conditions or otherwise continues to slow our return to the workplace, it could have an adverse impact on the productivity of our employees as they navigate the challenges of daily life during a pandemic, which would harm our business and impede our ability to achieve our strategic objectives. We take the health and welfare of our people very seriously. We have encouraged, and will continue to encourage, safe practices designed to stem the infection and spread of COVID-19 within our workforce and beyond and to maintain the mental health and well-being of our employees. While the COVID-19 pandemic may have long-term effects on the nature of the office environment and remote working, which may present operational and workplace culture challenges that may adversely affect our business, we are committed to our employees returning to the workplace in the long-term. During the nine months ended September 30, 2020, we also provided software solutions and services to the legal industry via MyCase, a software solution primarily designed for small and mid-sized law firms. As previously disclosed, we completed our divestiture of MyCase, Inc. on September 30, 2020 (the "MyCase Transaction"). In connection with the MyCase Transaction, our credit facility was terminated and all obligations outstanding under our term and revolving loans, including all guarantees and security interests granted with respect to such obligations, were satisfied in full with proceeds from the sale and extinguished. For additional details, see Note 3, Divestitures of our Condensed Consolidated Financial Statements in this Quarterly Report. Key Components of Results of Operations Revenue Our core solutions and certain of our Value+ services are offered on a subscription basis. Our core solutions subscription fees vary by property type and are designed to scale to the size of our customers’ businesses. We recognize revenue for subscription-based services over time on a straight-line basis over the contract term beginning on the date that our service is made available. We generally invoice monthly or annually in advance of the subscription period. We also offer Value+ services, which are not covered by our subscription fees, on a per use basis. Usage-based fees are charged on a flat fee per transaction basis with no minimum usage commitments. We recognize revenue for usage-based services in the period the service is rendered. We generally invoice our usage-based services on a monthly basis or collect the fee at the time of service. A significant majority of our Value+ services revenue comes directly and indirectly from the use of our electronic payment services, tenant screening services, and insurance services. Usage-based fees are paid either by customers or by users. We charge our customers for on-boarding assistance to our core solutions and certain other non-reoccurring services. We generally invoice for these other services in advance of the services being completed and recognize revenue upon completion of the related service. We generate revenue from the standalone customers of previously acquired businesses such as WegoWise and Dynasty, by providing services outside of our property management core solution platform. Revenue derived from these services is recorded in Other revenue. Costs and Operating Expenses Cost of Revenue. Many of our Value+ services are facilitated by third-party service providers. Cost of revenue includes the fees paid to these third-party service providers (including legal fees and costs associated with the delivery and provision of those services, as well as loss reserves and other costs associated with our legal liability to landlord insurance services), which vary both in cost and as a percent of revenue for each Value+ service offering, personnel-related costs for our employees focused on customer service and the support of our operations (including salaries, performance-based compensation, benefits, and stock-based compensation), platform infrastructure costs (such as data center operations and hosting-related costs), payment processing fees and allocated shared costs. Cost of revenue excludes depreciation of property and equipment, and amortization of capitalized software development costs and intangible assets. Sales and Marketing. Sales and marketing expense consists of personnel-related costs for our employees focused on sales and marketing (including salaries, sales commissions, performance-based compensation, benefits, and stock-based compensation), costs associated with sales and marketing activities, and allocated shared and other costs. Marketing activities include advertising, online lead generation, lead nurturing, customer and industry events, and the creation of industry-related 24 Table of Contents content and collateral. Sales commissions and other incremental costs to acquire customers and grow adoption and utilization of our Value+ services by our new and existing customers are deferred and then amortized on a straight-line basis over a period of benefit, which we have determined to be three years. We focus our sales and marketing efforts on generating awareness of our software solutions, creating sales leads, establishing and promoting our brands, and cultivating an educated community of successful and vocal customers. Research and Product Development. Research and product development expense consists of personnel-related costs for our employees focused on research and product development (including salaries, performance-based compensation, benefits, and stock-based compensation), fees for third-party development resources, and allocated shared and other 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. We capitalize our software development costs which meet the criteria for capitalization. Amortization of capitalized software development costs is included in depreciation and amortization expense. General and Administrative. General and administrative expense consists of personnel-related costs for employees in our executive, finance, information technology, human resources, legal, compliance, corporate development and administrative organizations (including salaries, a majority of total performance-based cash compensation, benefits, and stock-based compensation). In addition, general and administrative expense includes fees for third-party professional services (including audit, legal, compliance, tax, and consulting services), transaction costs related to business combinations and divestitures, regulatory fines and penalties, other corporate expenses, and allocated shared costs. Depreciation and Amortization. Depreciation and amortization expense includes depreciation of property and equipment, amortization of capitalized software development costs, and amortization of intangible assets. We depreciate or amortize property and equipment, software development costs, and intangible assets over their expected useful lives on a straight-line basis, which approximates the pattern in which the economic benefits of the assets are consumed. Other (Loss) Income, Net. Other (loss) income, net includes gains and losses associated with the sale of property, equipment and investment securities, as well as income from certain post-closing transition services provided by us to MyCase in connection with the MyCase Transaction. Interest Income (Expense), Net. Interest expense includes interest paid on any outstanding borrowings. 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) Provision for Income Taxes. ( Benefit from) Provision for income taxes consists of federal and state income taxes in the United States. 25 Table of Contents Results of Operations The following table sets forth our results of operations for the periods presented in dollars (in thousands) and as a percentage of revenue: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Amount % Amount % Amount % Amount % Consolidated Statements of Operations Data: Revenue $ 95,809 100.0 % $ 84,086 100.0 % $ 263,770 100.0 % $ 237,624 100.0 % Costs and operating expenses: Cost of revenue (exclusive of depreciation and amortization) (1) 38,730 40.4 32,752 39.0 104,847 39.7 89,124 37.5 Sales and marketing (1) 19,362 20.2 14,894 17.7 53,255 20.2 43,117 18.1 Research and product development (1) 16,500 17.2 13,454 16.0 46,389 17.6 36,794 15.5 General and administrative (1) 13,404 14.0 12,946 15.4 40,971 15.5 36,303 15.3 Depreciation and amortization 7,826 8.2 6,680 7.9 22,844 8.7 19,751 8.3 Total costs and operating expenses 95,822 100.0 80,726 96.0 268,306 101.7 225,089 94.7 (Loss) income from operations (13) — 3,360 4.0 (4,536) (1.7) 12,535 5.3 Other (loss) income, net (353) (0.4) 187,747 223.3 705 0.3 187,759 79.0 Interest income (expense), net 65 0.1 (853) (1.0) 173 0.1 (1,909) (0.8) (Loss) income before (benefit from) provision for income taxes (301) (0.3) 190,254 226.3 (3,658) (1.4) 198,385 83.5 (Benefit from) provision for income taxes (160) (0.2) 52,578 62.5 (6,017) (2.3) 39,469 16.6 Net (loss) income $ (141) (0.1) % $ 137,676 163.7 % $ 2,359 0.9 % $ 158,916 66.9 % (1) Includes stock-based compensation expense as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Stock-based compensation expense included in costs and operating expenses: Cost of revenue (exclusive of depreciation and amortization) $ 575 $ 452 $ 1,509 $ 1,098 Sales and marketing 738 367 1,587 1,069 Research and product development 1,451 474 3,522 1,348 General and administrative 1,299 1,803 3,435 3,293 Total stock-based compensation expense $ 4,063 $ 3,096 $ 10,053 $ 6,808 26 Table of Contents Comparison of the Three and Nine Months Ended September 30, 2021 and 2020 Revenue Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Core solutions $ 26,920 $ 27,117 $ (197) (1) % $ 76,457 $ 78,080 $ (1,623) (2) % Value+ services 65,578 53,392 12,186 23 % 177,535 149,122 28,413 19 % Other 3,311 3,577 (266) (7) % 9,778 10,422 (644) (6) % Total revenue $ 95,809 $ 84,086 $ 11,723 14 % $ 263,770 $ 237,624 $ 26,146 11 % Revenue for the three months ended September 30, 2021 and 2020, was $95.8 million and $84.1 million, respectively, an increase of $11.7 million, or 14%. This increase was primarily attributable to the growth in the number of property management customers and units under management utilizing our software and services. Revenue in 2020 includes $9.5 million attributable to our legacy legal vertical. Excluding this amount, revenue derived from our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 and 2020 increased $21.2 million, or 28%. Revenue for the nine months ended September 30, 2021 and 2020, was $263.8 million and $237.6 million, respectively, an increase of $26.1 million, or 11%. This increase was primarily attributable to the growth in the number of property management customers and units under management utilizing our software and services. Revenue in 2020 includes $25.3 million attributable to our legacy legal vertical. Excluding this amount, revenue derived from our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 increased $51.5 million, or 24%. Core solutions revenue derived from our real estate vertical for the three months ended September 30, 2021 and 2020 was $26.9 million and $22.0 million, respectively, an increase of $4.9 million or 23%. Core solutions revenue derived from our real estate vertical for the nine months ended September 30, 2021 and 2020 was $76.5 million and $63.7 million, respectively, an increase of $12.8 million or 20%. Value+ services revenue derived from our real estate vertical for the three months ended September 30, 2021 and 2020 was $65.6 million and $49.1 million, respectively, an increase of $16.5 million or 34%. Value+ services revenue derived from our real estate vertical for the nine months ended September 30, 2021 and 2020 was $177.5 million and $138.2 million, respectively, an increase of $39.3 million or 28%. These increases in core solutions and Value+ services revenue for the three and nine months ended September 30, 2021 and 2020 were mainly attributable to growth in our base of property management customers and growth in users of our subscription and usage-based services. During the three and nine month periods we experienced growth of 18% and 17%, respectively, in the average number of property management units under management resulting from 10% growth in the average number of property management customers during each of the periods. Our electronic payment services experienced increased demand during the comparative periods as residents, property managers, owners and customers transacted more business online. Our tenant screening and insurance services usage also increased during the comparative periods in line with the increase in units under management. A significant majority of our Value+ services revenue comes directly and indirectly from the use of our electronic payment services, tenant screening services, and the insurance services we make available to customers. 27 Table of Contents Cost of Revenue (Exclusive of Depreciation and Amortization) Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Cost of revenue (exclusive of depreciation and amortization) $ 38,730 $ 32,752 $ 5,978 18 % $ 104,847 $ 89,124 $ 15,723 18 % Percentage of revenue 40.4 % 39.0 % 39.7 % 37.5 % Cost of revenue (exclusive of depreciation and amortization) related to our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 and 2020 was $38.7 million and $29.3 million, respectively, an increase of $9.4 million, or 32%. This increase was primarily attributable to increased costs associated with servicing the incremental $21.2 million in revenue over the same period. The remaining cost of revenue in 2020 was attributed to our legacy legal vertical. For the three months ended September 30, 2021 and 2020, expenditures to third-party service providers related to the delivery of our Value+ services to the real estate vertical increased $5.8 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $16.5 million increase in Value+ services revenue to the real estate vertical. Personnel-related costs, including performance-based compensation, necessary to support growth and key investments, increased $2.3 million. Allocated shared and other costs increased by $1.3 million primarily driven by increases in software, payment processing and other costs incurred in support of our overall growth. Cost of revenue (exclusive of depreciation and amortization) related to our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 was $104.7 million and $80.0 million, respectively, an increase of $24.7 million, or 31%. This increase was primarily attributable to increased costs associated with servicing the incremental $51.5 million in revenue over the same period. The remaining cost of revenue was attributed to our legacy legal vertical and such costs for 2021 were reimbursed through our ongoing Transition Services Agreement and recorded in Other (loss) income, net . For the nine months ended September 30, 2021 and 2020, expenditures to third-party service providers related to the delivery of our Value+ services to the real estate vertical increased $15.2 million, which was directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the $39.3 million increase in Value+ services revenue to the real estate vertical. Personnel-related costs, including performance-based compensation, necessary to support growth and key investments, increased $7.1 million. Allocated shared and other costs increased by $2.4 million primarily driven by a $2.8 million increase in software, payment processing and other costs incurred in support of our overall growth, partially offset by a $0.4 million reduction of expenses attributed to a decrease in workplace-related and other expenditures in response to the impact of the COVID-19 pandemic. As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) fluctuates primarily based on the mix of Value+ services revenue in the period, given the varying percentage of revenue we pay to third-party service providers, and investments made in advance of expected revenue generation. For the three months ended September 30, 2021, cost of revenue (exclusive of depreciation and amortization), as a percentage of revenue, increased to 40.4% from 39.3% for the three months ended September 30, 2020, and increased to 39.7% from 37.7% for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. 28 Table of Contents Sales and Marketing Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Sales and marketing $ 19,362 $ 14,894 $ 4,468 30 % $ 53,255 $ 43,117 $ 10,138 24 % Percentage of revenue 20.2 % 17.7 % 20.2 % 18.1 % Sales and marketing expense related to our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 and 2020 was $19.4 million and $13.1 million, respectively, an increase of $6.3 million, or 48%. This increase was primarily due to a $3.6 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 $2.0 million due in part from lower spending in 2020 from the cancellation or postponement of in person events and the reduction of online marketing spend, as well as increased advertising and promotion spending in 2021 to support the growth and key investments in the business in 2021 and beyond. In addition, there was an increase in allocated shared and other costs of $0.8 million primarily driven by increases in software and other costs incurred in support of our overall growth. The remaining sales and marketing expense in 2020 was attributed to our legacy legal vertical. Sales and marketing expense related to our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 was $53.1 million and $37.3 million, respectively, an increase of $15.8 million, or 42%. This increase was primarily due to an $8.5 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 $6.2 million due in part to lower spending in 2020 due to the cancellation or postponement of in person events and the reduction of online marketing spend, as well as increased advertising and promotion spending in 2021 to support the growth and key investments in the business in 2021 and beyond. In addition, there was an increase in allocated shared and other costs of $1.1 million primarily related to software and other costs incurred in support of our overall growth. The remaining sales and marketing expense was attributed to our legacy legal vertical and such costs for 2021 were reimbursed through our ongoing Transition Services Agreement and recorded in Other (loss) income, net . As a percentage of revenue, sales and marketing expense increased to 20.2% from 17.6% for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 and increased to 20.1% from 17.6% for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The increase for the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020 was due in part to lower advertising and promotion costs in 2020 as a result of fewer events and lower online marketing spend, as well as increased spend in 2021 to support the growth of the business. Research and Product Development Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Research and product development $ 16,500 $ 13,454 $ 3,046 23 % $ 46,389 $ 36,794 $ 9,595 26 % Percentage of revenue 17.2 % 16.0 % 17.6 % 15.5 % Research and product development expense related to our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 and 2020 was $16.5 million and $11.7 million, respectively, an increase of $4.8 million, or 41%. This increase was the result of an increase in personnel-related costs, including performance based compensation, net of capitalized software development costs, of $4.1 million due to investments in headcount growth within our research and product development organization. Allocated shared and other costs increased by $0.7 million primarily related to software and other costs to support our overall growth. The remaining research and development expense for 2020 was attributed to our legacy legal vertical. 29 Table of Contents Research and product development expense related to our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 was $46.3 million and $32.3 million, respectively, an increase of $14.0 million, or 43%. This increase was the result of an increase in personnel-related costs, including performance based compensation, net of capitalized software development costs, of $13.3 million due to investments in headcount growth within our research and product development organization. Allocated shared and other costs increased $0.7 million primarily related to software and other costs to support our overall growth. The remaining research and development expense was attributed to our legacy legal vertical and such costs for 2021 were reimbursed through our ongoing Transition Services Agreement and recorded in Other (loss) income, net . 30 Table of Contents General and Administrative Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) General and administrative $ 13,404 $ 12,946 $ 458 4 % $ 40,971 $ 36,303 $ 4,668 13 % Percentage of revenue 14.0 % 15.4 % 15.5 % 15.3 % General and administrative expense related to our software and solutions offered to the real estate vertical and general corporate overhead expenses for the three months ended September 30, 2021 and 2020 was $13.4 million and $12.0 million, respectively, an increase of $1.4 million, or 12%. The increase in general and administrative expense was primarily due to an increase of $1.9 million in personnel related costs due to investments in headcount growth within our general and administrative organizations, a $1.3 million increase in connection with long-term executive cash incentive plans for certain executives, including certain of our named executive officers, and a $1.1 million increase in allocated shared and other costs to support our overall growth. We expect to incur additional expense in future periods under the long-term executive cash incentive plans throughout the remaining service periods. These increases were offset by a $1.9 million insurance recovery related to our previously disclosed settlement with the Federal Trade Commission (the "FTC") and a $1.0 million decrease in legal fees related to the MyCase Transaction. The remaining general and administrative expense for 2020 was attributed to our legacy legal vertical. General and administrative expense related to our software and solutions offered to the real estate vertical and general corporate overhead expenses for the nine months ended September 30, 2021 and 2020 was $41.0 million and $35.0 million, respectively, an increase of $6.0 million, or 17%. The increase in general and administrative expense was primarily due to a $7.1 million increase in personnel-related costs for investments in headcount, a $2.0 million expense in connection with long-term executive cash incentive plans for certain executives, $1.0 million expense related to severances, and an increase of $3.0 million in allocated shared and other costs for professional fees, education and training, insurance, software and other costs to support our overall growth. These increases were offset by a $1.9 million insurance recovery received during the nine months ended September 30, 2021 and a decrease in legal costs of $5.3 million related to our $4.3 million settlement with the FTC and a decrease in legal fees of $1.0 million related to the MyCase transaction during the nine months ended September 30, 2020. The remaining general and administrative expense for 2020 was attributed to our legacy legal vertical and such costs for 2021 were reimbursed through our ongoing Transition Services Agreement and recorded in Other (loss) income, net . Depreciation and Amortization Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Depreciation and amortization $ 7,826 $ 6,680 $ 1,146 17 % $ 22,844 $ 19,751 $ 3,093 16 % Percentage of revenue 8.2 % 7.9 % 8.7 % 8.3 % Depreciation and amortization expense related to our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 and 2020 was $7.8 million and $6.2 million, respectively, an increase of $1.6 million, or 26%. Depreciation and amortization expense related to our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 was $22.8 million and $18.0 million, respectively, an increase of $4.8 million, or 27%. These increases in depreciation and amortization expense were primarily due to increased amortization expense associated with higher accumulated capitalized software development balances. The remaining depreciation and amortization expense for 2020 was attributed to our legacy legal vertical. Other (Loss) Income, net Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) Other (loss) income, net $ (353) $ 187,747 $ (188,100) * $ 705 $ 187,759 $ (187,054) * Percentage of revenue (0.4) % 223.3 % 0.3 % 79.0 % 31 Table of Contents *Percentage change not meaningful Other loss, net related to our software and solutions offered to the real estate vertical for the three months ended September 30, 2021 was $0.4 million compared to other income of $187.7 million for the three months ended September 30, 2020, a decrease of $188.1 million. The decrease in other (loss) income, net was primarily due to the gain of $187.6 million associated with the MyCase Transaction in September 2020. Other income, net related to our software and solutions offered to the real estate vertical for the nine months ended September 30, 2021 and 2020 was $0.7 million and $187.8 million, respectively, a decrease of $187.1 million. The decrease in other income, net was primarily due to the gain of $187.6 million associated with the MyCase Transaction in September 2020. The decrease was offset by $0.7 million in other income recorded during the nine months ended September 30, 2021 related to certain post-closing transition services provided to MyCase, and $0.4 million in other income recorded during the nine months ended September 30, 2021 related to post-closing adjustments to the sales price of MyCase. (Benefit from) Provision for Income Taxes Three Months Ended September 30, Change Nine Months Ended September 30, Change 2021 2020 Amount % 2021 2020 Amount % (dollars in thousands) (Benefit from) provision for income taxes $ (160) $ 52,578 $ (52,738) * $ (6,017) $ 39,469 $ (45,486) * Percentage of revenue (0.2) % 62.5 % (2.3) % 16.6 % *Percentage not meaningful We calculate our (benefit from) 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 nine months ended September 30, 2021, we recorded an income tax benefit of $0.2 million and $6.0 million, respectively. 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 nine months ended September 30, 2020 we recorded an 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. Liquidity and Capital Resources Our principal sources of liquidity continue to be comprised of our cash, cash equivalents, investment securities, as well as cash flows generated from our operations. As of September 30, 2021, our cash, cash equivalents, and investment securities had an aggregate balance of $169.8 million. We have financed our operations primarily through cash generated from operations. We believe that our existing cash and cash equivalents, investment securities, and cash generated from operating activities will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. 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 Share Repurchase Program. For additional information regarding our share repurchase program, refer to Note 10, Share Repurchase Program, of our Condensed Consolidated Financial Statements. 32 Table of Contents Cash Flows The following table summarizes our cash flows for the periods indicated (in thousands): Nine Months Ended September 30, 2021 2020 Net cash provided by operating activities $ 26,459 $ 45,216 Net cash (used in) provided by investing activities (73,766) 152,542 Net cash used in financing activities (8,512) (69,541) Net (decrease) increase in cash, cash equivalents and restricted cash $ (55,819) $ 128,217 Cash Provided by Operating Activities Our primary source of operating cash inflows is cash collected from our customers in connection with their use of our core solutions and Value+ services. 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 nine months ended September 30, 2021, net cash provided by operating activities was $26.5 million resulting from income of $2.4 million, non-cash charges of $28.5 million and a net decrease in our operating assets and liabilities of $4.4 million. The non-cash charges primarily consist of $22.8 million of depreciation and amortization costs, stock-based compensation expense of $10.1 million, a decrease in deferred taxes of $6.4 million, and $2.3 million of amortization of operating lease right-of-use ("ROU") assets. The net decrease in our operating assets and liabilities was mostly attributable to an $8.9 million decrease in income taxes payable primarily driven by income taxes paid due to the MyCase Transaction, a $3.6 million increase in prepaid expenses and other current assets primarily attributable to a $1.9 million insurance recovery received related to our previously disclosed settlement with the FTC, and an increase in prepaid expenses to support our overall growth, a $1.4 million decrease in accrued expenses which was primarily due to a $4.3 million legal expense accrued during the nine months ended September 30, 2020 and paid in the three months ended March 31, 2021 related to our settlement with the FTC, and a $1.4 million increase in accounts receivable primarily driven by growth of our Value+ services. These decreases were partially offset by a $6.3 million increase in accrued employee expenses-current primarily due to an increase in other short-term accrued management bonuses, an increase in payroll expense based on the number of days accrued, and an increase in accrued paid time off, a $2.0 million increase in operating lease liabilities, a $1.4 million increase in accounts payable, and a $2.1 million increase in accrued employee expenses-noncurrent due to an increase in accrued long-term management bonuses made in connection with long-term executive cash incentive plans for certain executives. 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 $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. Cash (Used in) Provided by Investing Activities Cash (used in) provided by investing activities is generally comprised of purchases of investment securities, maturities and sales of investment securities, purchases of property and equipment, and additions to capitalized software development. For the nine months ended September 30, 2021, investing activities used $73.8 million in cash primarily due to purchases of investment securities of $167.0 million, capitalized software development costs of $18.5 million, and capital expenditures of $5.2 million to purchase property and equipment for the continued growth and expansion of our business. These uses of cash were partially offset by sales and maturities of investment securities of $43.2 million and $73.8 million, respectively. 33 Table of Contents 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. 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, activities associated with our former credit facility, which was terminated in connection with the divestiture of MyCase Inc. (For additional details, refer to Note 3, Divestitures ), and activities related to the repurchase of our Class A common stock. For the nine months ended September 30, 2021, financing activities used $8.5 million in cash primarily as a result of net share settlements for employee tax withholdings associated with the vesting of RSUs of $9.3 million, offset by proceeds from stock option exercises of $0.8 million. 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. Contractual Obligations and Other Commitments There have been no material changes to our contractual obligations and other commitments as disclosed in our Annual Report. Off-Balance Sheet Arrangements As of September 30, 2021, we did not have any off-balance sheet arrangements. Critical Accounting Policies and Estimates Our Condensed Consolidated Financial Statements and the related notes are prepared in accordance with accounting principles generally accepted in the United States. The preparation of our Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting period. There have been no changes to our critical accounting policies and estimates described in our Annual Report that have had a material impact on our Condensed Consolidated Financial Statements and related notes. Recent Accounting Pronouncements For information regarding recent accounting pronouncements, refer to Note 2, Summary of Significant Accounting Policies , of our Condensed Consolidated Financial Statements. 34 Table of Contents Item 3. Qualitative and Quantitative Disclosure about Market Risk Interest Rate Risk Investment Securities As of September 30, 2021, we had cash and cash equivalents of $84.4 million consisting of bank deposits, money market funds, and treasury securities, and $85.3 million of investment securities consisting of United States government agency securities, corporate bonds, and treasury securities. The primary objective of investing in securities is to support our liquidity and capital needs. We did not purchase these investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. Our investment securities are exposed to market risk due to interest rate fluctuations. While fluctuations in interest rates do not impact our interest income from our investment securities as all of these securities have fixed interest rates, changes in interest rates may impact the fair value of the investment securities. 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 September 30, 2021, a hypothetical 100 basis point decrease in interest rates would not have resulted in material change in the fair value of our investment securities and a hypothetical 100 basis point increase in interest rates would have resulted in a decrease in the fair value of our investment securities of approximately $0.4 million. This estimate is based on a sensitivity model which measures an instant change in interest rates by 100 basis points at September 30, 2021. Inflation Risk We have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in inflation rates. Foreign Currency Risk We have not been exposed to, nor do we anticipate being exposed to, material risks relating to foreign currency exchange rate fluctuations.