Consensus Cloud Solutions, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Information In addition to historical information, we have also made forward-looking statements in this report. These statements are based on our estimates and assumptions and are subject to risks and uncertainties. Forward-looking statements include the information concerning our possible or assumed future results of operations. Forward-looking statements also include those preceded or followed by the words “expects,” “may,” “anticipates,” “believes,” “estimates,” “will” “hopes” or similar expressions. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those discussed below, the risk factors discussed in Part II, Item 1A - “Risk Factors” of this Quarterly Report on Form 10-Q (if any) and in Part I, Item 1A - “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021 (together, the “Risk Factors”), and the factors discussed in the section in this Quarterly Report on Form 10-Q entitled “Quantitative and Qualitative Disclosures About Market Risk.” Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the Risk Factors and the risk factors set forth in other documents we file from time to time with the SEC. Some factors that could cause actual results to differ materially from those anticipated in these forward-looking statements include, but are not limited to, our ability and intention to: ◦ Sustain growth or profitability, particularly in light of an uncertain U.S. or worldwide economy and the related impact on customer acquisition and retention rates, customer usage levels, and credit and debit card payment declines; ◦ Maintain and increase our customer base and average revenue per user; ◦ Generate sufficient cash flow to make interest and debt payments, reinvest in our business, and pursue desired activities and businesses plans while satisfying restrictive covenants relating to debt obligations; ◦ Acquire businesses on acceptable terms and successfully integrate and realize anticipated synergies from such acquisitions; ◦ Continue to expand our Cloud Fax businesses and operations internationally in the wake of numerous risks, including adverse currency fluctuations, difficulty in staffing and managing international operations, higher operating costs as a percentage of revenues, or the implementation of adverse regulations; ◦ Maintain our financial position, operating results and cash flows in the event that we incur new or unanticipated costs or tax liabilities, including those relating to federal and state income tax and indirect taxes, such as sales, value-added and telecommunication taxes; ◦ Accurately estimate the assumptions underlying our effective worldwide tax rate; ◦ Manage certain risks inherent to our business, such as costs associated with fraudulent activity, system failure or network security breach; effectively maintain and manage our billing systems; allocate time and resources required to manage our legal proceedings; or adhere to our internal controls and procedures; ◦ Compete with other similar providers with regard to price, service, and functionality; ◦ Cost-effectively procure, retain and deploy large quantities of fax numbers in desired locations in the United States and abroad; ◦ Achieve business and financial objectives in light of burdensome domestic and international telecommunications, internet or other regulations including data privacy, access, security, and retention; ◦ Successfully manage our growth, including but not limited to our operational and personnel-related resources, and integration of newly acquired businesses; ◦ Successfully adapt to technological changes and diversify services and related revenues at acceptable levels of financial return; ◦ Successfully develop and protect our intellectual property, both domestically and internationally, including our brands, patents, trademarks and domain names, and avoid infringing upon the proprietary rights of others; and ◦ Recruit and retain key personnel. ◦ Maintain favorable relationships with critical third-party vendors whose financial condition will not negatively impact the services they provide; and ◦ Manage certain risks inherent to our business, such as costs associated with fraudulent activity, system failure or security breach; effectively maintaining and managing our billing systems; time and resources required to manage our legal proceedings; liability for legal and other claims; or adhering to our internal controls and procedures. -30- In addition, other factors that could cause actual results to differ materially from those anticipated in these forward-looking statements or materially impact our financial results include the risks associated with new accounting pronouncements, as well as those associated with natural disasters, public health crises, pandemics including the COVID-19 outbreak and other catastrophic events outside of our control, including as to COVID-19 the scope and duration of the pandemic, actions taken by governmental authorities in response to the pandemic, and the direct and indirect impact of the pandemic on our customers, third parties and us. Overview On October 7, 2021, J2 Global, Inc. completed its previously announced plans to separate into two leading publicly traded companies: one addressing healthcare interoperability and comprising the Cloud Fax business, which does business as Consensus Cloud Solutions, Inc. (“Consensus” or “the Company”), and one that will continue J2 Global’s strategy of building a leading internet platform focused on key verticals, including technology & gaming, shopping, health, cybersecurity and martech, which does business as Ziff Davis. We refer to the transactions that resulted in the separation of Consensus and Ziff Davis into two separate publicly traded companies as the “separation and distribution.” Following the separation and distribution, Consensus is a leading provider of secure information delivery services with a scalable Software-as-a-Service (“SaaS”) platform. Consensus serves more than one million customers of all sizes, from enterprises to individuals, across over 50 countries and multiple industry verticals including healthcare, financial services, law and education. Beginning as an online fax company over two decades ago, Consensus has evolved into a leading global provider of enterprise secure communication solutions. Consensus is well positioned to capitalize on advancements in how people and businesses share private documents and information. Its mission is to democratize secure information interchange across technologies and industries, and solve the healthcare interoperability challenge. Consensus’s communication and interoperability solutions enable its customers to securely and cooperatively access, exchange and use information across organizational, regional and national boundaries. The COVID-19 pandemic continues to have widespread, rapidly evolving and unpredictable impacts on global economies, inflation, supply chains, work force participation and wages, and has created significant volatility and disruption in financial markets. Our focus remains on promoting employee health and safety and serving our customers. During fiscal year 2021 and fiscal quarter 2022, we have observed an increasingly competitive labor market. Increased employee turnover, changes in the availability of our employees, including as a result of COVID-19-related absences, and labor shortages generally have resulted in, and could continue to result in, increased costs, and could adversely impact the efficiency of our operations. We continue to actively monitor the situation and will continue to adapt our business operations as necessary. For purposes of this management’s discussion and analysis of the results of operations and financial condition of Consensus (“MD&A”) section, we use the terms “the Company,” “we,” “us” and “our” to refer to Consensus. References in this MD&A section to “Parent” or “Parent Company” refer to Ziff Davis, Inc., collectively with its consolidated subsidiaries. -31- Key Performance Metrics We use the following metrics to evaluate our business, including the growth of our business, the value provided by customers to our business, and our customer retention. The following table sets forth certain key operating metrics for Consensus continuing operations for the three months ended March 31, 2022 and 2021 (in thousands, except for percentages): Three Months Ended March 31, 2022 2021 Revenue ($ in thousands) Corporate $ 46,519 $ 41,154 Small office home office (“SoHo”) 44,406 45,374 90,925 86,528 Other Revenues — 92 Consolidated $ 90,925 $ 86,620 Average Revenue per Customer Account (“ARPA) (1)(2) Corporate $ 339.94 $ 289.37 SoHo 14.41 14.16 Consolidated $ 28.25 $ 25.86 Customer Accounts (in thousands) (1) Corporate (5) 46 47 SoHo 1,027 1,068 Consolidated 1,073 1,115 Paid Adds (in thousands) (3) Corporate 4 3 SoHo 100 113 Consolidated 104 116 Monthly Churn % (4) Corporate 2.05 % 1.87 % SoHo 3.50 % 3.51 % Consolidated 3.44 % 3.45 % (1) Consensus customers are defined as paying Corporate and SoHo customer accounts. (2) Represents a monthly ARPA calculated for the quarter or year calculated as follows. Monthly ARPA on a quarterly basis is calculated using our standard convention of dividing revenue for the quarter by the average of the quarter’s beginning and ending customer base and dividing that amount by 3 months. Monthly ARPA on an annual basis is calculated by dividing revenue for the year by the average customer base for the applicable four quarters and dividing that amount by 12 months. We believe ARPA provides investors an understanding of the average monthly revenues we recognize per account associated within Consensus’ customer base. As ARPA varies based on fixed subscription fee and variable usage components, we believe it can serve as a measure by which investors can evaluate trends in the types of services, levels of services and the usage levels of those services across Consensus’ customers. (3) Paid Adds represents paying new Consensus customer accounts added during the annual period. (4) Monthly churn is defined as Consensus paying customer accounts that cancelled its services during the period divided by the average number of customers over the period. This measure is calculated monthly and expressed as an average over the applicable period. -32- Critical Accounting Policies and Estimates In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements. Actual results could differ significantly from those estimates under different assumptions and conditions. Our critical accounting policies are described in our 2021 Annual Report on Form 10-K filed with the SEC on April 15, 2022. During the three months ended March 31, 2022, there were no significant changes in our critical accounting policies and estimates. Emerging Growth Company Status We are an emerging growth company, as defined in Section 3(a) of the Exchange Act, as amended by the JOBS Act. For as long as we are an emerging growth company, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002, or the “Sarbanes-Oxley Act,” reduced disclosure obligations regarding executive compensation in our periodic reports, proxy statements and registration statements and exemptions from the requirement of holding a nonbinding advisory vote on executive compensation, exemption from new or revised financial accounting. Results of Operations for the Three and Three Months Ended March 31, 2022 and 2021 The main strategic focus of our Consensus offerings is to enable our customers to securely and cooperatively access, exchange and use information across organizational, regional and national boundaries. As a result, we expect to continue to take steps to enhance our existing offerings and offer new services to continue to satisfy the evolving needs of our customers. We expect our business to primarily grow organically and inorganically through the use of capital for re-investment in the business and opportunistic acquisitions that expedite our product roadmap in the interoperability space should they arise. Revenues (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2022 2021 Revenues $ 90,925 $ 86,620 5% Our revenues primarily consist of revenues from “fixed” customer subscription revenues and “variable” revenues generated from actual usage of our services. We also generate an immaterial amount of Consensus revenues from intellectual property licensing. Revenues increased by $4.3 million or 5% over the prior comparable three month period. Our growth was primarily due to an increase $5.4 million or 13% in our corporate business (inclusive of $0.8 million due to the Summit acquisition); partially offset by a decline of $1.0 million or 2.1% in our SoHo business. Cost of Revenues (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2022 2021 Cost of revenue $ 15,104 $ 13,970 8% As a percent of revenue 17% 16% Cost of revenues is primarily comprised of costs associated with data transmission, network operations, customer service, software licenses for resale, online processing fees and equipment depreciation. -33- The increase in cost of revenues for the three months ended March 31, 2022 was primarily due to an increase in network operations and customer service expenses; partially offset by a decrease in data transmission costs. Operating Expenses Sales and Marketing. (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2022 2021 Sales and Marketing $ 15,830 $ 13,235 20% As a percent of revenue 17% 15% Our sales and marketing costs consist primarily of internet-based advertising, personnel costs and other business development-related expenses. Our internet-based advertising relationships consist primarily of fixed cost and performance-based (cost-per-impression, cost-per-click and cost-per-acquisition) advertising relationships with an array of online service providers. Our sales personnel consist of a combination of inside sales and outside sales professionals. Sales and marketing cost for the three months ended March 31, 2022 was $15.8 million (primarily consisting of $10.1 million of third-party advertising costs and $5.5 million of personnel costs) compared to the prior period of $13.2 million (primarily consisting of $8.5 million of third-party advertising costs and $4.6 million of personnel costs). The increase in sales and marketing expenses for the three months ended March 31, 2022 versus the prior comparable period was primarily due to increased advertising operations, sales and advertising and costs associated with the business acquired in the quarter. Research, Development and Engineering . (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2022 2021 Research, Development and Engineering $ 2,336 $ 1,676 39% As a percent of revenue 3% 2% Our research, development and engineering costs consist primarily of personnel-related expenses. The increase in research, development and engineering costs for the three months ended March 31, 2022 versus the prior comparable periods was primarily due to our continued focus on developing our platform, product and solutions primarily supporting our corporate revenue growth and incremental costs as a result of our Summit acquisition. During the three months ended March 31, 2022 and 2021, the Company capitalized internally developed software of $6.5 million and $3.3 million, respectively, which is recorded in property, plant and equipment on the Condensed Consolidated Balance Sheet. General and Administrative. (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2022 2021 General and Administrative $ 18,806 $ 6,048 211% As a percent of revenue 21% 7% Our general and administrative costs consist primarily of personnel-related expenses, depreciation and amortization, share-based compensation expense, bad debt expense, professional fees and insurance costs. -34- The increase in general and administrative expense for the three months ended March 31, 2022 versus prior comparable period was primarily due to operating as a standalone public company. The increase in costs was primarily attributable to $8.1 million in salary and benefits (inclusive of $4.4 million of share-based compensation), $1.1 million in professional fees, $0.8 million in depreciation and amortization and $0.7 million in Wayfair Sales Tax expense. Share-Based Compensation The following table represents share-based compensation expense included in cost of revenues and operating expenses in the accompanying condensed consolidated statements of income for the three and three months ended March 31, 2022 and 2021 (in thousands): Three Months Ended March 31, 2022 2021 Cost of revenues $ 223 $ 50 Operating expenses: Sales and marketing 273 95 Research, development and engineering 356 102 General and administrative 4,361 136 Continuing Operations 5,213 383 Income from discontinued operations — 1,108 Total $ 5,213 $ 1,491 Non-Operating Income and Expenses Interest expense . Our interest expense is generated primarily from interest expense due on outstanding debt. Interest expense for the three months ended March 31, 2022 and 2021 was $13.3 million and $0.2 million, respectively. Interest expense increased over the prior comparable period due to three months of interest expense on $805.0 million of debt associated with the 2026 and 2028 senior notes in the current period which was not present in the prior comparable period. Interest income . Our interest income is generated by interest income earned on cash and cash equivalents. Interest income for the three months ended March 31, 2022 and 2021 was zero and $9.0 thousand, respectively. Changes in interest income was immaterial when compared to the prior comparable period. Other income, net . Our other income, net is generated primarily from miscellaneous items and gains or losses on currency exchange. Other income, net for the three months ended March 31, 2022 and 2021 was $0.2 million and $0.4 million, respectively. Changes in Other income, net was immaterial when compared to the prior comparable period. Income Taxes Our effective tax rate is based on pre-tax income, statutory tax rates, tax regulations (including those related to transfer pricing) and different tax rates in the various jurisdictions in which we operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefits and costs we expect to realize. When necessary, we establish valuation allowances to reduce our deferred tax assets to an amount that will more likely than not be realized. Provision for income taxes for the three months ended March 31, 2022 and 2021 amounted to $7.0 million and $12.6 million, respectively. Our effective tax rate for the three months ended March 31, 2022 and 2021 was 27.4% and 24.3%, respectively. The increase in our effective income tax rate for the three months ended March 31, 2022 was primarily attributable to an increase in tax expense due to certain compensation not being deductible for tax purposes. Significant judgment is required in determining our provision for income taxes and in evaluating our tax positions on a worldwide basis. We believe our tax positions, including intercompany transfer pricing policies, are consistent with the tax laws in the jurisdictions in which we conduct our business. Certain of these tax positions have in the past been, and are currently being, challenged, and this may have a significant impact on our effective tax rate if our tax reserves are insufficient. -35- Liquidity and Capital Resources Cash and Cash Equivalents At March 31, 2022, we had cash and cash equivalents of $93.9 million compared to $66.8 million at December 31, 2021. The increase in cash and cash equivalents resulted primarily from cash provided from operations; partially offset by cash used in a business and asset acquisition, purchases of property and equipment (including capitalized labor) and the surrendering of shares to cover employee income tax related to the release of equity awards. As of March 31, 2022, cash and cash equivalents held within domestic and foreign jurisdictions were $59.1 million and $34.8 million, respectively. On March 4, 2022, the Company entered into a Credit Agreement with certain lenders from time to time party thereto (collectively, the “Lenders”) and MUFG Union Bank, N.A., as administrative agent, collateral agent and sole lead arranger for the Lenders (the “Agent”). Pursuant to the Credit Agreement, the Lenders have provided Consensus with a revolving credit facility of $25 million (the “Credit Facility”). The final maturity of the Credit Facility will occur on March 4, 2027. As of March 31, 2022, no amount has been drawn down on the Credit Facility. We currently anticipate that our existing cash and cash equivalents and cash generated from operations will be sufficient to meet our anticipated needs for working capital, capital expenditures and stock repurchases, if any, for at least the next 12 months. Common Stock Repurchase Program On March 1, 2022, the Company’s Board of Directors approved a share buyback program. Under this program, the Company may purchase in the public market or in off-market transactions up to $100.0 million worth of the Company’s common stock through February 2025. The timing and amounts of purchases will be determined by the Company, depending on market conditions and other factors it deems relevant. During Q1 2022, the Company entered into Rule 10b-18 and Rule 10b5-1 trading plans and during the three months ended March 31, 2022, the Company repurchased zero shares under these program. Periodically, participants in the Consensus’ Equity Incentive Plan surrender to the Company shares of the Company’s stock to satisfy tax withholding obligations arising upon the vesting of restricted stock. During the three months ended March 31, 2022, participants surrendered to the Company 19,922 shares from plan participants for this purpose at an aggregate cost of $1.2 million. Cash Flows The prior period includes cash flows from discontinued operations of the non-Consensus business, accordingly does not lend itself to a quarter-over-quarter analysis. Our primary sources of liquidity are cash flows generated from operations, together with cash and cash equivalents. Net cash provided by operating activities was $49.9 million and $59.9 million for the three months ended March 31, 2022 and 2021, respectively. Our operating cash flows resulted primarily from cash received from our customers offset by cash payments we made to third parties for their services and employee compensation. The decrease in our net cash provided by operating activities in 2022 compared to 2021 was attributable to decreased income after considering noncash items; partially offset by cash inflows from accounts payable and accrued expenses, other long-term liabilities,income taxes, accounts receivable and prepaid expenses. Our cash and cash equivalents were $93.9 million and $66.8 million at March 31, 2022 and December 31, 2021, respectively. Net cash used in investing activities was $20.8 million and $1.5 million for the three months ended March 31, 2022 and 2021, respectively. For the three months ended March 31, 2022 and 2021, net cash used in investing activities was primarily due to business and asset acquisitions and capital expenditures associated with the purchase of property and equipment (including capitalized labor); partially offset by proceeds from the sale of businesses. The increase in our net cash used in investing activities in 2022 compared to 2021 was primarily due to additional cash used for business and asset acquisitions; partially offset by proceeds from the sale of businesses. Net cash (used in) provided by financing activities was $(1.4) million and $10.6 million for the three months ended March 31, 2022 and 2021, respectively. For the three months ended March 31, 2022 and 2021, net cash provided by financing activities was primarily due to contributions from the former parent, Ziff Davis; partially offset by deferred payments for acquisitions and the the surrendering of shares to cover employee income tax related to the release of equity awards. The -36- change in net cash (used in) provided by financing activities in 2022 compared to 2021 was primarily attributable to decreased contributions from the former parent; partially offset by deferred payments for business acquisitions in the prior period; partially offset by the surrendering of shares to cover employee income tax related to the release of equity awards. Contractual Obligations and Commitments The following table summarizes our contractual obligations and commitments as of March 31, 2022: Payment Due by Period (in thousands) Contractual Obligations 2022 2023 2024 2025 2026 Thereafter Total Long-term debt - principal (a) $ — $ — $ — $ — $ 305,000 $ 500,000 $ 805,000 Long-term debt - interest (b) 50,800 50,800 50,800 50,800 50,800 65,000 319,000 Operating leases (c) 2,082 2,602 2,561 2,389 2,461 10,697 22,792 Telecom services and co-location facilities (d) 810 251 5 — — — 1,066 Holdback payment (e) — 750 750 — — — 1,500 Other (f) 315 — — — — — 315 Total $ 54,007 $ 54,403 $ 54,116 $ 53,189 $ 358,261 $ 575,697 $ 1,149,673 (a) These amounts represent principal on long-term debt. (b) These amounts represent interest on long-term debt. (c) These amounts represent undiscounted future minimum rental commitments under noncancellable operating leases. (d) These amounts represent service commitments to various telecommunication providers. (e) These amounts represent the holdback amounts in connection with certain business acquisitions. (f) These amounts represent certain consulting and Board of Directors fee arrangements. As of March 31, 2022, our liability for uncertain tax positions was $4.8 million. The future payments related to uncertain tax positions have not been presented in the table above due to the uncertainty of the amounts and timing of cash settlement with the taxing authorities.