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Item 7. Management’s Discussion and Analysis

2024-02-01 compared with 2023-02-09 · 65 added, 51 removed, 191 unchanged (38% of the section changed)

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See the section of this Annual Report entitled “Forward-Looking Statements” for additional information.

The following discussion and analysis of our financial condition and results of operations discusses 2022 and 2021 items and year-over-year comparisons between 2022 and 2021.

The following discussion and analysis of our financial condition and results of operations includes 2023 and 2022 items and year-over-year comparisons between 2023 and 2022.

For discussion of 2021 items and year-over-year comparisons between 2022 and 2021, refer to Part II.

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We are a leading provider of cloud business management solutions for the real estate industry.

Our solutions are designed to enable our property manager customers to digitally transform their businesses, address critical business operations and deliver a better customer experience.

Our products assist our customers with an interconnected and growing network of stakeholders in their business ecosystems, including property owners, real estate investment managers, rental prospects, residents, and service providers, and provide key functionality related to critical transactions across the real estate lifecycle, including screening potential tenants, sending and receiving payments and even providing insurance-related risk mitigation services.

AppFolio’s intuitive interface, coupled with streamlined and automated workflows, make it easier for our customers to eliminate redundant and manual processes so they can deliver a great experience for their network of stakeholders while improving financial and operational performance.

Our solutions are designed to enable our property manager customers to digitally transform their businesses, address critical operations and deliver a better customer experience.

Our products assist our customers with an interconnected and growing network of stakeholders in their business ecosystems, including property owners, real estate investment managers, rental prospects, residents, and vendors, and provide key functionality related to critical transactions across the real estate lifecycle, including screening potential tenants, sending and receiving payments and providing insurance-related risk mitigation services.

AppFolio’s intuitive interface, streamlined workflows, and AI powered automation make it easier for our customers to eliminate redundant and manual processes so they can deliver a great experience for their network of stakeholders while improving financial and operational performance.

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 work environment to motivate and develop our valuable human capital.

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 work environment designed to motivate and develop our valuable human capital.

As we navigate the challenges of increased competition for talent, we continue to evolve our compensation and employee reward practices.

Key Business Metric

We monitor the key business metric set forth below to help us evaluate our business, identify trends affecting our business, formulate business plans, and make strategic decisions.

Property management units under management.

We believe that our ability to increase our number of property management units under management is an indicator of our market penetration, growth, and potential future business opportunities.

We believe that our ability to increase the number of property management units under management is an indicator of our market penetration, growth, and potential future business opportunities.

We define property management units under management as active or committed units under management at the period end date.

We had 8.2 million and 7.3 million property management units under management, as of December 31, 2023 and 2022, respectively.

We have historically experienced seasonality in our Value Added Services revenue, primarily in our tenant screening services, due to seasonally higher leasing activities in the second quarter which increases tenant screening transactions in that period.

We have historically experienced seasonality in our Value Added Services revenue, primarily in our tenant screening revenue, due to seasonally higher leasing activities in the second quarter, which increase tenant screening transactions in that period.

We generally experience decreased tenant screening revenue in the fourth quarter, when seasonally lower leasing activities occur.

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As a result of the seasonality of the rental lifecycle and the growth of our business, we have typically experienced a sequential increase in revenue in the first, second and third quarters and a sequential decline in revenue in the fourth quarter of each of our most recent fiscal years.

These seasonal factors could be heightened or lessened due to the impact of a change in macroeconomic factors that could impact tenant behavior or a change in the adoption rate of our other less seasonally impacted Value Added Services.

These seasonal factors could be heightened or lessened due to the impact of a change in macroeconomic factors that could impact tenant behavior or a change in our product portfolio mix or the adoption rate of our other less seasonally impacted Value Added Services.

Although these seasonal factors are common in the real estate industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance.

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We generally invoice for these other services in advance of the services being completed and recognize revenue in the period the service is rendered.

We generate revenue from the legacy customers of previously acquired businesses by providing services outside of our property management core solution platform.

We generate revenue from legacy customers of previously acquired businesses by providing services outside of our property management core solution platform.

Revenue derived from these services is recorded in Other revenue .

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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, 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, and tax services), transaction costs related to sales of subsidiary businesses, regulatory fees, other corporate expenses, impairment of long-lived assets, and allocated shared and other costs.

In addition, general and administrative expense includes fees for third-party professional services (including audit, legal, compliance, and tax services), transaction costs related to sales of subsidiary businesses, regulatory fees or fines, other corporate expenses, impairment of long-lived assets, and allocated shared and other costs.

Depreciation and Amortization.

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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 Income, Net.

Other Income (Loss), Net.

Other income, net includes gain on sale of our equity-method investments, gains and losses associated with the sale of businesses and property and equipment, and income from certain post-closing transition services provided by us to MyCase, Inc.

during fiscal year 2021.

Interest Income (Expense), Net.

Interest Income, Net.

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 cash deposited in our bank accounts.

Interest expense includes interest paid on any outstanding borrowings during the year ended December 31, 2020.

Provision for Income Taxes.

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Total revenue $ 620,445 $ 471,883 $ 148,562 31 %

The increase in revenue for the year ended December 31, 2022, compared to the prior year, was primarily attributable to growth in our base of property management customers driving an increase in the number of property management units under management, and growth in users of our subscription and usage-based services.

During the year ended December 31, 2022, we experienced growth of 15% in the number of property management units under management resulting from 7% growth in the number of property management customers, compared to the prior year.

Our payment services experienced increased adoption during the comparative periods as residents, property managers, and owners transacted more business online.

The increase in revenue for the year ended December 31, 2023, compared to the prior year, was primarily attributable to an increase in the usage of our payments, tenant screening, and risk mitigation services.

During the year ended December 31, 2023, we experienced growth of 13% in the number of property management units under management compared to the prior year, which drove growth in users of our subscription and usage-based services.

Our payment services experienced increased usage during the comparative periods as residents, property managers, and owners transacted more business online.

In addition, we stopped waiving the eCheck (ACH) transaction fee beginning in the third quarter of 2023.

Our tenant screening and risk mitigation services usage also increased during the comparative periods in line with the increase in units under management.

A significant majority of our Value Added Services revenue comes from the use of our payment services, tenant screening services, and the risk mitigation services we make available to customers.

The decrease in other revenue is primarily attributable to the WegoWise Transaction during the year ended December 31, 2022.

For additional information regarding the WegoWise Transaction, refer to Note 3, Sale of Subsidiary Business, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

We expect total revenue for the year ending December 31, 2024 to increase compared to the year ended December 31, 2023 as we continue to add new customers and property management units under management, along with increased adoption and usage of our Value Added Services.

Cost of Revenue (Exclusive of Depreciation and Amortization)

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This increase was directly associated with the increased adoption and utilization of our Value Added Services.

Personnel-related costs, including performance-based compensation, necessary to support growth and key investments, increased $12.5 million for the year ended December 31, 2022, compared to the prior year.

Personnel-related costs, including stock-based and performance-based compensation, necessary to support growth and key investments, increased $9.6 million for the year ended December 31, 2023, compared to the prior year.

Included in the increase in personnel-related costs was $2.4 million of severance and related personnel costs associated with the workforce reduction in the third quarter of 2023.

For additional information, see Note 16, Workforce Reduction , of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

Allocated shared and other costs increased by $1.7 million for the year ended December 31, 2023, compared to the prior year, primarily related to platform infrastructure, software and other costs incurred in support of our overall growth.

As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) fluctuates primarily based on the mix of Value Added Services revenue in the period, given the varying percentage of revenue we pay to third-party service providers.

We expect cost of revenue (exclusive of depreciation and amortization) for the year ending December 31, 2023 to decrease as a percentage of revenue compared to the year ended December 31, 2022, as we expect to leverage headcount efficiencies to offset an increase in expenditures to third-party service providers related to the delivery of our Value Added Services.

We expect cost of revenue (exclusive of depreciation and amortization) for the year ending December 31, 2024, to decrease slightly as a percentage of revenue compared to the year ended December 31, 2023, as we continue to drive additional efficiencies.

Sales and Marketing

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Percentage of revenue 1.0 % 1.8 %

Sales and marketing expense for the year ended December 31, 2022 increased primarily due to increases in personnel-related costs, including performance-based compensation, necessary to support growth in the business of $23.9 million compared to the prior year.

Advertising and promotion costs increased by $2.1 million primarily due to increased advertising and promotion spending to support the growth and key investments in the business.

Allocated shared and other costs increased by $8.2 million year ended December 31, 2022 compared to the prior year, primarily related to software and other costs incurred in support of our overall growth.

Sales and marketing expense for the year ended December 31, 2023 was relatively flat compared to the prior year, reflecting a net increase in personnel-related costs, including stock-based and performance-based compensation, of $2.6 million, partially offset by a decrease in allocated shared and other costs of $1.9 million.

Included in the increase in personnel-related costs was $3.8 million of severance and related personnel costs associated with the workforce reduction in the third quarter of 2023.

For additional information, see Note 16, Workforce Reduction , of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

We expect sales and marketing expense for the year ending December 31, 2024 to decrease as a percentage of revenue compared to the year ended December 31, 2023, as we continue to leverage headcount efficiencies.

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Percentage of revenue 3.4 % 3.4 %

Research and product development expense for the year ended December 31, 2022 increased primarily due to an increase in personnel-related costs including performance-based compensation, net of capitalized software development costs, of $42.8 million, compared to the prior year.

Allocated shared and other costs increased by $2.3 million year ended December 31, 2022 compared to the prior year, primarily related to software and other costs incurred in support of our overall growth.

We expect research and product development expenses for the year ending December 31, 2023 to increase as a percentage of revenue compared to the year ended December 31, 2022, as we continue to invest in our research and product development organization to support our strategy to expand the use cases of our product capabilities to the larger customer segment.

Research and product development expense for the year ended December 31, 2023 increased primarily due to an increase in personnel-related costs, including stock-based and performance-based compensation, net of capitalized software development costs, of $37.7 million, compared to the prior year.

The increase in personnel-related costs was primarily due to headcount growth within our research and product development organization, higher salaries, and $3.4 million of severance and related personnel costs associated with the workforce reduction in the third quarter of 2023.

For additional information, see Note 16, Workforce Reduction, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

Allocated shared and other costs increased by $2.6 million year ended December 31, 2023 compared to the prior year, driven by costs supporting our overall growth.

We expect research and product development expenses for the year ending December 31, 2024 to decrease as a percentage of revenue compared to the year ended December 31, 2023, as we continue to leverage headcount efficiencies.

General and Administrative

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Percentage of revenue 3.5 % 2.9 %

General and administrative expense for the year ended December 31, 2022 increased primarily due to a net ROU and other lease-related asset impairment of $22.0 million.

Personnel-related costs, including performance-based compensation, increased $15.7 million for the year ended December 31, 2022, compared to the prior year.

Allocated shared and other costs increased $3.9 million for the year ended December 31, 2022, compared to the prior year, for professional fees, education and training, insurance, software and other costs to support our growth.

Additionally, offsetting general and administrative expense for the year ended December 31, 2021 was a $1.9 million insurance recovery related to our previously disclosed settlement with the Federal Trade Commission (the "FTC").

Excluding the impairment charge, we expect general and administrative expenses for the year ending December 31, 2023 to remain flat as a percentage of revenue compared to the year ended December 31, 2022.

General and administrative expense for the year ended December 31, 2023 decreased compared to the same period in the prior year primarily due to lease-related asset impairment charges of $22.0 million recognized in the year ended December 31, 2022 that did not recur in 2023.

In addition, there was a decrease of $4.3 million due to gains related to lease modifications for the year ended December 31, 2023, compared to the prior year.

This was partially offset by an increase in personnel-related costs, including stock-based and performance-based compensation, in the year ended December 31, 2023 of $17.2 million compared to the prior year.

The increase in personnel-related costs for the year ended December 31, 2023 was driven primarily by the separation costs associated with our former Chief Executive Officer's Separation Agreement of $14.9 million and the severance related costs associated with the workforce reduction in the third quarter of 2023 of $2.5 million.

For further information, see Note 8, Accrued Employee Expenses , and Note 16, Workforce Reduction , of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

For the year ended December 31, 2023, stock-based compensation increased due to additional grants to current and new employees and incremental expense associated with the workforce reduction in the third quarter of 2023.

We expect general and administrative expenses for the year ending December 31, 2024 to decrease as a percentage of revenue compared to the year ended December 31, 2023, as we continue to leverage headcount efficiencies.

Depreciation and Amortization

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Percentage of revenue 4.7 % 7.0 %

Depreciation and amortization expense for the year ended December 31, 2022 increased, compared to the prior year, primarily due to increased amortization expense associated with accumulated capitalized software development balances.

Depreciation and amortization expense for the year ended December 31, 2023 decreased, compared to the prior year, primarily due to decreased amortization expense associated with capitalized software development and intangible balances.

We expect depreciation and amortization expenses for the year ending December 31, 2024 to decrease as a percentage of revenue compared to the year ended December 31, 2023 due to a decrease in amortization of accumulated capitalized software development balances.

Interest Income, Net

Year Ended December 31, Change

2023 2022 Amount %

Interest income, net $ 7,031 $ 1,184 $ 5,847 494 %

Percentage of revenue 1.1 % 0.3 %

Interest income for the year ended December 31, 2023 increased, compared to the prior year, primarily due to higher interest rates.

Other Income, net

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Percentage of revenue — % 0.9 %

Other income, net for the year ended December 31, 2022 decreased, compared to the prior year, primarily due to a gain of $12.8 million related to the sale of our investment in SecureDocs during the year ended December 31, 2021.

The decrease was offset by a gain of $4.2 million associated with the WegoWise Transaction during the year ended December 31, 2022.

For additional information regarding the WegoWise Transaction, refer to Note 3, Sale of Subsidiary Businesses .

Other income, net for the year ended December 31, 2023 decreased, compared to the prior year, primarily due to a gain of $4.2 million associated with the WegoWise Transaction during the year ended December 31, 2022.

For further information, see Note 3, Sale of Subsidiary Business, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

Provision for Income Taxes

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(dollars in thousands)

Income (loss) before provision for income taxes $ 7,997 $ (66,717) $ 74,714 (112) %

Provision for income taxes

Percentage of revenue 0.3 % 0.2 %

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

federal statutory rate of 21% differs primarily due to change in valuation allowance against deferred taxes and non-deductible expenses, partially offset by state income taxes and tax benefits associated with stock-based compensation expense and research and development tax credits.

$ 5,295 $ 1,402 $ 3,893 278 %

Effective tax rate 66.2 % (2.1) %

The increase in our effective tax rate for the year ended December 31, 2023, as compared to the prior year, is primarily due to the significant increase in our pre-tax income, change in valuation allowance against deferred tax assets, higher non-deductible officers’ compensation, partially offset by higher tax benefits from stock-based compensation and research and development credits.

Liquidity and Capital Resources

Our principal sources of liquidity continue to be cash, cash equivalents, and investment securities, as well as cash flows generated from our operations.

At December 31, 2022, our cash and cash equivalents and investment securities had an aggregate balance of $185.2 million.

As of December 31, 2023, our cash and cash equivalents and investment securities had an aggregate balance of $211.7 million.

We have financed our operations primarily through cash generated from operations.

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Net cash used in financing activities (25,961) (6,163)

Net increase (decrease) in cash and cash equivalents $ 12,736 $ (82,416)

Net (decrease) increase in cash and cash equivalents

$ (21,260) $ 12,736

Cash Provided by Operating Activities

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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.

Net cash provided by operating activities was $25.4 million for the year ended December 31, 2022 compared to net cash provided by operating activities of $35.4 million for the year ended December 31, 2021.

The net decrease in cash provided by operating activities was primarily due to an increase in employee related costs and the settlement of accounts payable offset by an increase in cash collections from customers due to higher revenue growth and a decrease in income taxes paid related to the sale of MyCase, Inc.

during the year ended December 31, 2021.

The net increase in cash provided by operating activities for the year ended December 31, 2023, compared to the prior year, was primarily due to a higher increase in cash collections from customers relative to the increase in operating expenditures, partially offset by the payment of separation costs related to our former Chief Executive Officer's Separation Agreement and the severance costs associated with the workforce reduction during the year ended December 31, 2023.

For additional information, see Note 16, Workforce Reduction , of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

Cash Used in Investing Activities

Cash used in investing activities is generally composed of purchases of investment securities, maturities and sales of investment securities, purchases of property and equipment, and additions to capitalized software development.

Net cash used in investing activities for the year ended December 31, 2022 was $6.5 million compared to $110.5 million for the year ended December 31, 2021.

The net decrease in cash used in investing activities was primarily due to decreases in purchases of available-for-sale investment securities and capitalization of software development costs, offset by a decrease in proceeds from sales of available-for-sale investment securities and decrease in proceeds from sales of business and equity method investments.

The net increase in cash used in investing activities for the year ended December 31, 2023, compared to the prior year, was primarily due to higher purchases of available-for-sale investment securities.

Cash Used in Financing Activities

Cash used in financing activities is generally composed of net share settlements for employee tax withholdings associated with the vesting of equity awards offset by proceeds from the exercise of stock options.

Net cash used in financing activities for the year ended December 31, 2022 was $6.2 million compared to $7.3 million for the year ended December 31, 2021.

The decrease in cash used in financing activities was primarily due to an increase in proceeds from stock option exercises.

The net increase in cash used in financing activities for the year ended December 31, 2023, compared to the prior year, was primarily due to an increase in net share settlements for employee tax withholdings associated with the vesting of equity awards.

Off-Balance Sheet Arrangements

At December 31, 2022, we did not have any off-balance sheet arrangements.

As of December 31, 2023, we did not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

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We account for individual performance obligations separately if they are distinct.

The performance obligations for these contracts include access and use of our core solutions, implementation services, and customer support.

The performance obligations for

these contracts include access and use of our core solutions, implementation services, and customer support.

Access and use of our core solutions and implementation services are considered distinct.

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For ROU and other lease-related assets, such circumstances would include subleases that do not fully recover the costs of the associated leases or a decision to abandon the use of all or part of a leased asset.

We recorded a net impairment of $22.0 million consisting of $17.6 million related to ROU assets and $4.4 million related to property and equipment associated with our leased office spaces as described further in Note 9, Leases.

Significant judgment and estimates are required in assessing impairment of long-lived assets, including identifying whether events or changes in circumstances require an impairment assessment, estimating future cash flows, uncertainty associated with the time period it will take to obtain a sublessee, the anticipated sublease income and determining appropriate discount rates.

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In evaluating the need for a valuation allowance, we consider the weighting of all available positive and negative evidence, which includes, among other things, the nature, frequency and severity of current and cumulative taxable income or losses, future projections of profitability, and the duration of statutory carryforward periods.

We give significant weight to objectively verified evidence, such as historical cumulative losses, in our overall assessment.

Judgment is required to measure the amount of tax benefits that can be recognized associated with uncertain tax positions.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.

We recognize interest and penalties accrued with respect to uncertain tax positions, if any, in our provision for income taxes in the Consolidated Statements of Operations.

We recognize interest and

penalties accrued with respect to uncertain tax positions, if any, in our provision for income taxes in the Consolidated Statements of Operations.

Recent Accounting Pronouncements

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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-K

Item 7. Management’s Discussion and Analysis