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, 2022 (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 elevated 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 maintaining and managing our billing systems; allocating time and resources required to manage our legal proceedings; liability for legal and other claims; or adhering 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; and ◦ Maintain favorable relationships with critical third-party vendors whose financial condition will not negatively impact the services they provide; -31- 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 and other catastrophic events outside of our control. Overview Consensus is a leading provider of secure information delivery services with a scalable Software-as-a-Service (“SaaS”) platform. Consensus serves approximately one million customers of all sizes, from enterprises to individuals, approximately 50 countries and multiple industry verticals including healthcare, government, 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’ 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 2022 and through the second quarter of 2023, 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. -32- 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 operations for the three and six months ended June 30, 2023 and 2022 (in thousands, except for percentages): Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Revenue ($ in thousands) Corporate $ 50,361 $ 48,867 $ 99,768 $ 95,386 Small office home office (“SoHo”) 42,429 42,228 84,459 85,007 92,790 91,095 184,227 180,393 Other revenues 2 20 19 20 Consolidated $ 92,792 $ 91,115 $ 184,246 $ 180,413 Average Revenue per Customer Account (“ARPA”) (1)(2) Corporate $ 316.55 $ 354.99 $ 316.15 $ 347.47 SoHo $ 15.69 $ 13.87 $ 15.39 $ 13.88 Consolidated $ 32.41 $ 28.64 $ 31.75 $ 28.19 Customer Accounts (in thousands) (1) Corporate 54 46 54 46 SoHo 889 1,002 889 1,002 Consolidated 943 1,048 943 1,048 Paid Adds (in thousands) (3) Corporate 3 4 6 7 SoHo 74 96 153 196 Consolidated 77 100 159 203 Monthly Churn % (4) Corporate 1.26 % 1.88 % 1.32 % 1.96 % SoHo 3.57 % 3.87 % 3.66 % 3.68 % Consolidated 3.44 % 3.79 % 3.54 % 3.61 % (1) Consensus customers are defined as paying Corporate and SoHo customer accounts. (2) Represents a monthly ARPA 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. -33- Critical Accounting 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 2022 Annual Report on Form 10-K filed with the SEC on March 31, 2023. During the six months ended June 30, 2023, there were no significant changes in our critical accounting policies and estimates. Results of Operations for the Three and Six Months Ended June 30, 2023 and 2022 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 June 30, Percentage Change Six Months Ended June 30, Percentage Change 2023 2022 2023 2022 Revenues $ 92,792 $ 91,115 2% $ 184,246 $ 180,413 2% Our revenues primarily consist of revenues from “fixed” customer subscription revenues and “variable” revenues generated from actual usage of our services. Revenues increased by $1.7 million or 2% over the prior comparable three month period. Our growth was primarily due to an increase of $1.5 million or 3% in our corporate business and an increase of $0.2 million or 1% in our SoHo business. Revenues increased by $3.8 million or 2% over the prior comparable six month period. Our growth was primarily due to an increase of $4.4 million or 5% in our corporate business; partially offset by an anticipated decline of $0.6 million or 1% in our SoHo business. Cost of Revenues (in thousands, except percentages) Three Months Ended June 30, Percentage Change Six Months Ended June 30, Percentage Change 2023 2022 2023 2022 Cost of revenues $17,246 $15,587 11% $34,754 $30,692 13% As a percent of revenue 19% 17% 19% 17% 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 months ended June 30, 2023 was primarily due to an increase of $1.1 million in personnel-related expenses and $0.4 million in depreciation associated with platform development costs compared to the prior comparable three month period. The increase in cost of revenues for the six months ended June 30, 2023 was primarily due to an increase of $2.3 million in personnel-related expenses and $1.4 million in depreciation associated with platform development costs compared to the prior comparable six month period. -34- Operating Expenses Sales and Marketing (in thousands, except percentages) Three Months Ended June 30, Percentage Change Six Months Ended June 30, Percentage Change 2023 2022 2023 2022 Sales and marketing $17,507 $16,394 7% $34,400 $32,224 7% As a percent of revenue 19% 18% 19% 18% 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 costs for the three months ended June 30, 2023 were $17.5 million (primarily consisting of $10.0 million of third-party advertising costs and $7.0 million of personnel costs) compared to the prior period of $16.4 million (primarily consisting of $10.3 million of third-party advertising costs and $5.9 million of personnel costs). The increase in sales and marketing expenses for the three months ended June 30, 2023 versus the prior comparable period was primarily due to increased personnel-related expenses, partially offset by a reduction of third-party advertising spend. Sales and marketing costs for the six months ended June 30, 2023 were $34.4 million (primarily consisting of $19.1 million of third-party advertising costs and $14.2 million of personnel costs) compared to the prior period of $32.2 million (primarily consisting of $20.4 million of third-party advertising costs and $11.5 million of personnel costs). The increase in sales and marketing expenses for the six months ended June 30, 2023 versus the prior comparable period was primarily due to increased personnel-related expenses, partially offset by a reduction of third-party advertising spend. Research, Development and Engineering (in thousands, except percentages) Three Months Ended June 30, Percentage Change Six Months Ended June 30, Percentage Change 2023 2022 2023 2022 Research, development and engineering $1,765 $2,741 (36)% $3,669 $5,077 (28)% As a percent of revenue 2% 3% 2% 3% Our research, development and engineering costs consist primarily of personnel-related expenses. The decrease in research, development and engineering costs for the three and six months ended June 30, 2023 versus the prior comparable period was primarily attributable to increased capitalization of personnel-related expenses due to our continued focus on internally developing our platform, products and solutions as well as a reduction in external development costs partially offset by an increase in personnel-related expenses. -35- General and Administrative (in thousands, except percentages) Three Months Ended June 30, Percentage Change Six Months Ended June 30, Percentage Change 2023 2022 2023 2022 General and administrative $17,432 $15,816 10% $38,584 $33,185 16% As a percent of revenue 19% 17% 21% 18% 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 expenses for the three months ended June 30, 2023 versus prior comparable period was primarily due to increased expenses of $1.8 million in bad debt expense, $0.5 million in computer equipment costs and $0.5 million in personnel-related expenses; partially offset by a $1.3 million reduction in professional fees and the absence of expenses of $0.4 million related to the registration of shares for sale held by Ziff Davis that were incurred in the second quarter of 2022. The increase in general and administrative expenses for the six months ended June 30, 2023 versus prior comparable period was primarily due to increased expenses of $3.2 million in bad debt expense, $1.2 million in personnel-related expenses and $0.9 million in professional fees primarily in connection with the year-end audit; partially offset by the absence of expenses of $0.4 million related to the registration of shares for sale held by Ziff Davis that were incurred in the second quarter of 2022. 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 six months ended June 30, 2023 and 2022 (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Cost of revenues $ 334 $ 216 $ 630 $ 439 Operating expenses: Sales and marketing 387 270 759 543 Research, development and engineering 52 340 92 696 General and administrative 3,890 4,097 8,322 8,648 Total $ 4,663 $ 4,923 $ 9,803 $ 10,326 Non-Operating Income and Expenses Interest expense . Our interest expense is due to outstanding debt and is reduced by any capitalized interest. Interest expense for the three months ended June 30, 2023 and 2022 was $12.8 million and $12.4 million, respectively. Interest expense for the six months ended June 30, 2023 and 2022 was $25.4 million and $25.6 million, respectively. Interest expense for both periods included interest expense on $805.0 million of debt associated with the 2026 and 2028 senior notes. Interest expense for the three and six months ended June 30, 2023 was reduced by $0.5 million and $1.0 million of capitalized interest, respectively, that did not occur during 2022. Interest income. Our interest income is generated from interest earned on cash and cash equivalents. Interest income was $0.7 million and zero for the three months ended June 30, 2023 and 2022, respectively. Interest income was $0.7 million and zero for the six months ended June 30, 2023 and 2022, respectively. Interest income was higher compared to the prior comparable periods due to investments in money market funds starting in 2023. -36- Other (expense) income, net . Our other (expense) income, net is generated primarily from miscellaneous items and gains or losses on currency exchange. Other (expense) income, net for the three months ended June 30, 2023 and 2022 was $0.6 million and $1.6 million, respectively. Other (expense) income, net for the six months ended June 30, 2023 and 2022 was $(0.3) million and $1.8 million, respectively. Changes in other (expense) income, net in three month period was driven by lower foreign exchange gains when compared to the prior comparable period. Changes in other (expense) income, net in six month period was driven by higher foreign exchange losses 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 June 30, 2023 and 2022 was $6.2 million and $7.9 million, respectively. Provision for income taxes for the six months ended June 30, 2023 and 2022 was $11.3 million and $14.9 million, respectively. The Company’s effective tax rate for the three months ended June 30, 2023 and 2022 was 22.7% and 26.4%, respectively. The Company’s effective tax rate for the six months ended June 30, 2023 and 2022 was 23.7% and 26.9%, respectively. The decrease in our effective income tax rate for the three and six months ended June 30, 2023 was primarily attributable to a reduction in nondeductible expenses, primarily consisting of sales tax penalties and the change in the geographical mix of income. 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. Liquidity and Capital Resources Cash and Cash Equivalents At June 30, 2023, we had cash and cash equivalents of $112.0 million compared to $94.2 million at December 31, 2022. The increase in cash and cash equivalents resulted primarily from cash provided by operations; partially offset by cash used in the repurchase of commons stock, purchases of property and equipment (including capitalized labor) and the purchase of investments. As of June 30, 2023, cash and cash equivalents held within domestic and foreign jurisdictions were $35.2 million and $76.8 million, respectively. Credit Agreement 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 revolving credit facility of $25.0 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 June 30, 2023, no amount has been drawn down on the Credit Facility. Material Cash Requirements Our long-term contractual obligations generally include our debt and related interest payments, noncancellable operating leases as well as other commitments. As of June 30, 2023, we had outstanding $805.0 million in aggregate principal amount of indebtedness (see Note 6 - Debt of the Notes to the Condensed Consolidated Financial Statements). As of June 30, 2023, our total minimum lease payments are $20.1 million (see Note 7 - Leases of the Notes to the Condensed Consolidated Financial Statements). As of June 30, 2023, our liability for uncertain tax positions was $8.2 million. Due to uncertainties in the timing of the amounts and timing of cash settlement with the taxing authorities we are unable to make a reasonably reliable estimate of the timing of payments. -37- 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 and the foreseeable future. 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 months ended June 30, 2023 and 2022, the Company repurchased 68,362 and 189,114, respectively, shares under this program. During the six months ended June 30, 2023 and 2022, the Company repurchased 338,554 and 189,114 shares, respectively, under this program. Cumulatively as of June 30, 2023, 527,668 shares have been repurchased at an aggregate cost of $18.9 million (inclusive of excise tax of $0.1 million). The excise tax is assessed at 1% of the fair market value of net stock repurchases after December 31, 2022. 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 six months ended June 30, 2023 the Company withheld shares on its vested restricted stock units and restricted stock awards relating to its share-based compensation plans of 21,538 and 32,956 shares, respectively. During the three and six months ended June 30, 2022 the Company withheld shares on its vested restricted stock units and restricted stock awards relating to its share-based compensation plans of 7,897 and 27,819 shares, respectively. Cash Flows Our primary sources of liquidity are cash flows generated from operations, together with cash and cash equivalents. Net cash provided by operating activities was $52.1 million and $52.2 million for the six months ended June 30, 2023 and 2022, 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. Net cash provided by operating activities was consistent period over period, however the net cash provided by operating activities in 2023 included a larger decrease in accounts payable and accrued expenses and a larger increase in accounts receivable in 2023, as well as a decrease in deferred revenue in 2023 compared to an increase in deferred revenue in 2022. Largely offsetting these items were increases in the provision for doubtful accounts and deferred income taxes, net in 2023. Net cash used in investing activities was $22.7 million and $29.1 million for the six months ended June 30, 2023 and 2022, respectively. For the six months ended June 30, 2023, net cash used in investing activities was primarily attributed to capital expenditures associated with the purchase of property and equipment (including capitalized labor) and the purchase of investments. For the six months ended June 30, 2022, 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). The decrease in our net cash used in investing activities in 2023 compared to 2022 was due to a lower cash outlay related to the purchase of investments in 2023, compared to a higher cash outlay associated with a business acquisition in 2022, partially offset by an increase in capital expenditures associated with the purchase of property and equipment (including capitalized labor) in 2023. Net cash used in financing activities was $11.5 million and $8.8 million for the six months ended June 30, 2023 and 2022, respectively. For the six months ended June 30, 2023 and 2022, net cash used in financing activities was primarily due to the repurchase of common stock and the payment of employee income tax obligations related to the net settlement of equity awards. The change in net cash used in financing activities in 2023 compared to 2022 was primarily attributable to an increase in cash outflows related to the repurchase of common stock in 2023 compared to 2022. -38-