Consensus Cloud Solutions, Inc. 10-Q/A

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, inflationary pressures and increasing interest rates, 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 business 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 risks from our international operations, including risks associated with currency fluctuations and foreign exchange controls and adverse changes in global financial markets; ◦ 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; ◦ 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. -43- 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 global economy continues to be impacted by macroeconomic uncertainty and volatility resulting from the COVID-19 pandemic, Russia’s invasion of Ukraine, inflationary pressures, supply chain disruptions and challenges and labor market pressures. During fiscal year 2021 and through the third quarter of 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 “Former Parent” or “Former Parent Company” refers to Ziff Davis, Inc., collectively with its consolidated subsidiaries. -44- 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 our continuing operations for the three and nine months ended September 30, 2022 and 2021 (in thousands, except for percentages): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Revenue ($ in thousands) (As Restated) (As Restated) Corporate $ 48,974 $ 43,175 $ 144,360 $ 126,290 Small office home office (“SoHo”) 42,801 45,931 127,808 137,095 91,775 89,106 272,168 263,385 Other Revenues 2 92 22 275 Consolidated $ 91,777 $ 89,198 $ 272,190 $ 263,660 Average Revenue per Customer Account (“ARPA) (1)(2) Corporate $ 348.94 $ 314.69 $ 347.96 $ 300.83 SoHo 14.41 14.34 14.06 14.25 Consolidated $ 29.51 $ 26.67 $ 28.63 $ 26.24 Customer Accounts (in thousands) (1) Corporate 47 45 47 45 SoHo 978 1,064 978 1,064 Consolidated 1,025 1,109 1,025 1,109 Paid Adds (in thousands) (3) Corporate 4 3 11 10 SoHo 86 98 283 321 Consolidated 90 101 294 331 Monthly Churn % (4) Corporate 1.71 % 3.20 % 1.88 % 2.74 % SoHo 3.60 % 3.21 % 3.66 % 3.31 % Consolidated 3.51 % 3.21 % 3.58 % 3.28 % (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. -45- 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 nine months ended September 30, 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, exemptions from the requirement of holding a nonbinding advisory vote on executive compensation, and exemption from new or revised financial accounting. As of December 31, 2022, we will no longer be an emerging growth company as defined in Section 3(a) of the Exchange Act, as we will be a large accelerated filer. Results of Operations for the Three and Nine Months Ended September 30, 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 September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2022 (1) 2021 2022 (1) 2021 Revenues $ 91,777 $ 89,198 3% $ 272,190 $ 263,660 3% (1) As Restated Our revenues primarily consist of revenues from “fixed” customer subscription revenues and “variable” revenues generated from actual usage of our services. Revenues increased by $2.6 million or 3% over the prior comparable three month period. Our growth was primarily due to an increase of $5.8 million or 13% in our corporate business (inclusive of $1.9 million due to the Summit acquisition); partially offset by a decline of $3.1 million or 7% in our SoHo business. Revenues increased by $8.5 million or 3% over the prior comparable nine month period. Our growth was primarily due to an increase of $18.1 million or 14% in our corporate business (inclusive of $5.3 million due to the Summit acquisition); partially offset by a decline of $9.3 million or 7% in our SoHo business. -46- Cost of Revenues (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2022 2021 2022 2021 Cost of revenue $15,419 $14,604 6% $46,111 $43,128 7% As a percent of revenue 17% 16% 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. The increase in cost of revenues for the three and nine months ended September 30, 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 September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2022 2021 2022 2021 Sales and marketing $16,626 $13,115 27% $48,850 $40,031 22% As a percent of revenue 18% 15% 18% 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 September 30, 2022 was $16.6 million (primarily consisting of $10.3 million of third-party advertising costs and $6.0 million of personnel costs) compared to the prior period of $13.1 million (primarily consisting of $8.2 million of third-party advertising costs and $4.8 million of personnel costs). The increase in sales and marketing expenses for the three months ended September 30, 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 current year. Sales and marketing cost for the nine months ended September 30, 2022 was $48.9 million (primarily consisting of $30.7 million of third-party advertising costs and $17.3 million of personnel costs) compared to the prior period of $40.0 million (primarily consisting of $25.5 million of third-party advertising costs and $14.2 million of personnel costs). The increase in sales and marketing expenses for the nine months ended September 30, 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 current year. -47- Research, Development and Engineering (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2022 2021 2022 2021 Research, development and engineering $3,236 $2,019 60% $8,313 $5,635 48% As a percent of revenue 4% 2% 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 and nine months ended September 30, 2022 versus the prior comparable periods was primarily due to our continued focus on developing our platform, products and solutions primarily supporting our corporate revenue growth and incremental costs as a result of our Summit acquisition. General and Administrative (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2022 (1) 2021 2022 (1) 2021 General and administrative $23,839 $8,237 189% $57,024 $20,262 181% As a percent of revenue 26% 9% 21% 8% (1) As Restated 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. The increase in general and administrative expense for the three months ended September 30, 2022 versus prior comparable period was primarily due to $7.8 million in non-income tax related expenses. In addition, increased expenses related to operating as a standalone public company, included increases of $7.1 million in salary and benefits (inclusive of $3.8 million of share-based compensation) and $2.2 million in professional fees partially offset by a $2.8 million reduction in bad debt expense. The increase in general and administrative expense for the nine months ended September 30, 2022 versus prior comparable period was primarily due to increased expenses related to operating as a standalone public company, including increases of $23.1 million in salary and benefits (inclusive of $12.1 million of share-based compensation), $8.5 million in non-income tax related expense, $5.3 million in professional fees, $2.3 million in computer and related expenses, $1.5 million insurance expenses, $1.0 million in depreciation and amortization expense partially offset by a $5.6 million reduction in bad debt expense. -48- 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 nine months ended September 30, 2022 and 2021 (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 (1) 2021 2022 (1) 2021 Cost of revenues $ 219 $ 37 $ 658 $ 136 Operating expenses: Sales and marketing 269 93 812 281 Research, development and engineering 390 99 1,086 300 General and administrative 3,878 123 12,526 399 Continuing operations 4,756 352 15,082 1,116 Loss from discontinued operations — 1,099 — 3,254 Total $ 4,756 $ 1,451 $ 15,082 $ 4,370 (1) As Restated Non-Operating Income and Expenses Interest expense . Our interest expense is due to outstanding debt. Interest expense for the three months ended September 30, 2022 and 2021 was $13.9 million and $0.1 million, respectively. Interest expense for the nine months ended September 30, 2022 and 2021 was $39.6 million and $0.6 million, respectively. Interest expense for the three and nine months ended September 30, 2022 included interest expense on $805.0 million of debt associated with the 2026 and 2028 senior notes, which were entered into in October 2021, and as such there was no interest expense related to these facilities in prior comparable periods. 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 September 30, 2022 and 2021 was $3.0 million and $1.6 million, respectively. Other income, net for the nine months ended September 30, 2022 and 2021 was $4.7 million and $1.8 million. Changes in Other income, net in both periods were driven by higher foreign exchange gains when compared to the prior comparable periods. 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 September 30, 2022 and 2021 was $6.3 million and $11.5 million, respectively. Provision for income taxes for the nine months ended September 30, 2022 and 2021 was $21.3 million and $36.6 million, respectively. The Company’s effective tax rate for the three months ended September 30, 2022 and 2021 was 29.2% and 21.9%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2022 and 2021 was 27.6% and 23.5%, respectively. The increase in our effective income tax rate for the three and nine months ended September 30, 2022 was primarily attributable to an increase in tax expense due to certain expenses 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 challenged, and this may have a significant impact on our effective tax rate if our tax reserves are insufficient. -49- Liquidity and Capital Resources Cash and Cash Equivalents At September 30, 2022, we had cash and cash equivalents of $103.7 million compared to $66.8 million at December 31, 2021. The increase in cash and cash equivalents resulted primarily from cash provided by operations; partially offset by cash used in a business and asset acquisition, purchases of property and equipment (including capitalized labor), the repurchase of common stock, and the surrendering of shares to cover employee income tax related to the release of equity awards. As of September 30, 2022, cash and cash equivalents held within domestic and foreign jurisdictions were $51.1 million and $52.6 million, respectively. On March 4, 2022, the Company entered into a Credit Agreement with certain lenders party thereto (collectively, the “Lenders”) and MUFG Union Bank, N.A., as agent (the “Agent”). Pursuant to the Credit Agreement, the Lenders have provided Consensus with a senior secured revolving credit facility of $25 million (the “Credit Facility”) with an option held by the Company to obtain an additional commitment of up to a maximum of $25.0 million.. The final maturity of the Credit Facility will occur on March 4, 2027. As of September 30, 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. The Company entered into Rule 10b-18 and Rule 10b5-1 trading plans and during the three and nine months ended September 30, 2022, the Company repurchased zero and 189,114, respectively, shares under this program. At the time of certain vesting events related to restricted stock units or restricted stock awards that are held by participants in Consensus’ Equity Incentive Plan, a portion of the awards subject to vesting are withheld by the Company to satisfy the employees’ tax withholding obligations that arise upon the vesting of restricted stock. As a result, the number of shares issued upon vesting for these awards is net of the statutory withholding requirements that the Company pays on behalf of its employees. Although shares withheld are not issued, they are treated as common share repurchases in the Company’s condensed consolidated financial statements, as they reduce the number of shares that would have been issued upon vesting. These shares do not count against the authorized capacity under the Company’s share repurchase program described above. During the three and nine months ended September 30, 2022 the Company withheld shares on its vested restricted stock units relating to its share-based compensation plans of 1,906 and 29,725 shares, respectively. Cash Flows The prior period includes cash flows from discontinued operations of the non-Consensus business. As a result, the prior period is not comparable. Our primary sources of liquidity are cash flows generated from operations, together with cash and cash equivalents. Net cash provided by operating activities was $89.3 million and $196.4 million for the nine months ended September 30, 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, an increase in accounts receivable, and a decrease in other liabilities; partially offset by increases in accounts payable and accrued expenses and our liability for uncertain tax positions, as well as changes in prepaid expenses and other current assets, income tax payable and operating lease liabilities in the prior year period that were lower in the current year period. Our cash and cash equivalents were $103.7 million and $66.8 million at September 30, 2022 and December 31, 2021, respectively. Net cash used in investing activities was $34.3 million and $37.8 million for the nine months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 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 non-fax businesses in 2021. The decrease -50- in our net cash used in investing activities in 2022 compared to 2021 was primarily due to a decrease in cash outlays associated with business acquisitions and capital expenditures; partially offset by proceeds from the sale of non-fax businesses in 2021. Net cash (used in) provided by financing activities was $(8.9) million and $14.4 million for the nine months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022 and 2021, net cash (used in) provided by financing activities was primarily due to contributions from the Former Parent; partially offset by the repurchase of common stock, deferred payments for acquisitions and the surrendering of shares to cover employee income tax related to the release of equity awards. The change in net cash (used in) provided by financing activities in 2022 compared to 2021 was primarily attributable to cash inflows related to contributions from the Former Parent that occurred in 2021, partially offset by deferred payments for acquisitions in 2021; compared to cash outflows related to the repurchase of common stock and shares withheld to cover employee income taxes in 2022. Contractual Obligations and Commitments The following table summarizes our contractual obligations and commitments as of September 30, 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) 25,470 50,800 50,939 50,800 50,800 65,089 293,898 Operating leases (c) 1,169 2,602 2,561 2,389 2,461 10,697 21,879 Telecom services and co-location facilities (d) 151 278 14 1 — — 444 Other (e) 210 375 — — — — 585 Total $ 27,000 $ 54,055 $ 53,514 $ 53,190 $ 358,261 $ 575,786 $ 1,121,806 (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 certain agreements associated with the Summit acquisition and Board of Directors fee arrangements. As of September 30, 2022, our liability for uncertain tax positions was $7.0 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.