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, 2023 (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, recent global conflicts, inflationary pressures, elevated interest rates, and the prospect of a U.S. federal government shutdown, 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. -22- 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 900 thousand customers of all sizes, from enterprises to individuals, across approximately 46 countries and multiple industry verticals including healthcare, government, financial services, law and education. Our top 10 customers represent approximately 8% of total revenues and approximately 75% of our Small office home office (“SoHo”) customer accounts are older than 2 years. 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 recent global conflicts, inflationary pressures, supply chain disruptions and challenges as well as labor market pressures. During fiscal year 2023 and through the first quarter of 2024, we have observed an increasingly competitive labor market. Increased employee turnover, changes in the availability of our employees 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. -23- Key Performance Metrics We use the following metrics to generally assess the operational and financial performance of our business, including the growth of our business, the value provided by customers to our business and our customer retention that provide insights that contribute to certain of our business planning decisions. We believe these financial measures are useful to investors both because (1) they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making and (2) they are used by our institutional investors and the analyst community to help them analyze the health of our business. The following table sets forth certain key performance metrics for our operations for the three months ended March 31, 2024 and 2023 (in thousands, except for percentages and Average Revenue per Customer Account): Three Months Ended March 31, 2024 2023 Revenue Corporate $ 51,390 $ 49,407 Small office home office (“SoHo”) 36,754 42,030 Total 88,144 91,437 Other revenues 2 17 Consolidated $ 88,146 $ 91,454 Average Revenue per Customer Account (“ARPA”) (1)(2) Corporate $ 316.07 $ 315.76 SoHo $ 14.95 $ 15.10 Consolidated $ 33.63 $ 31.09 Customer Accounts (1) Corporate 55 53 SoHo 808 914 Consolidated 863 967 Paid Adds (3) Corporate 4 3 SoHo 64 78 Consolidated 68 81 Monthly Churn % (4) Corporate 1.92 % 1.37 % SoHo 3.42 % 3.76 % Consolidated 3.32 % 3.63 % (1) Consensus customers are defined as paying Corporate and SoHo customer accounts. (2) Represents a monthly ARPA for the quarter, 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. 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 periods presented. -24- (4) Monthly churn is defined as Consensus paying customer accounts that cancelled 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. 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 2023 Annual Report on Form 10-K filed with the SEC on February 28, 2024. During the three months ended March 31, 2024, there were no significant changes in our critical accounting policies and estimates. Results of Operations for the Three Months Ended March 31, 2024 and 2023 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 2024 2023 Revenues $ 88,146 $ 91,454 (4)% Our revenues primarily consist of revenues from “fixed” customer subscription revenues and “variable” revenues generated from actual usage of our services. Revenues decreased by $3.3 million or 4% for the three months ended March 31, 2024 over the prior year comparable period. The decrease was due to a decline of $5.3 million or 13% in our SoHo business, partially offset by an increase of $2.0 million or 4% in our corporate business. Cost of Revenues (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2024 2023 Cost of revenues $17,048 $17,508 (3)% As a percent of revenue 19% 19% Cost of revenues is primarily comprised of costs associated with personnel costs, data transmission, online processing fees, network operations as well as capitalized software amortization and equipment depreciation. The decrease in cost of revenues for the three months ended March 31, 2024 over the prior year comparable period was primarily due to a decrease of $0.7 million in data transmission expense compared to the prior year comparable three month period. -25- Operating Expenses Sales and Marketing (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2024 2023 Sales and marketing $12,558 $16,893 (26)% As a percent of revenue 14% 18% Our sales and marketing costs consist primarily of personnel costs, internet-based advertising 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. The decrease in sales and marketing expenses of $4.3 million for the three months ended March 31, 2024 over the prior year comparable period was primarily due to a reduction in third party advertising spend of $4.7 million, predominantly in SoHo, partially offset by an increase of $0.3 million in personnel-related expenses due to continued investment in the corporate sales team. Research, Development and Engineering (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2024 2023 Research, development and engineering $1,905 $1,904 —% As a percent of revenue 2% 2% Our research, development and engineering costs consist primarily of personnel-related expenses. Research, development and engineering costs remained consistent for the three months ended March 31, 2024 compared to the prior year comparable period. General and Administrative (in thousands, except percentages) Three Months Ended March 31, Percentage Change 2024 2023 General and administrative $18,968 $21,152 (10)% As a percent of revenue 22% 23% Our general and administrative costs consist primarily of personnel-related expenses (inclusive of share-based compensation), professional fees, depreciation and amortization and bad debt expense. The decrease in general and administrative expenses for the three months ended March 31, 2024 over the prior year comparable period was primarily due to decreases of $1.2 million in professional fees and $1.0 million in personnel-related expenses. -26- 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 months ended March 31, 2024 and 2023 (in thousands): Three Months Ended March 31, 2024 2023 Cost of revenues $ 503 $ 296 Operating expenses: Sales and marketing 679 372 Research, development and engineering 95 40 General and administrative 3,173 4,432 Total $ 4,450 $ 5,140 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 March 31, 2024 and 2023 was $6.2 million and $12.6 million, respectively. The decrease between periods was primarily due to the partial extinguishment of debt in the first quarter of 2024, resulting in a gain of $4.9 million. Interest income. Our interest income is generated from interest earned on cash and cash equivalents. Interest income was $0.9 million and zero for the three months ended March 31, 2024 and 2023, respectively. Interest income was higher in 2024 compared to the prior year comparable period due to investments in money market funds that began in the second quarter of 2023. Other income (expense), net . Our other income (expense), net is generated primarily from foreign currency and miscellaneous items. Other income (expense), net for the three months ended March 31, 2024 and 2023 was $3.9 million and $(0.8) million, respectively. The change between periods was primarily attributable to exchange rate fluctuations on inter-company balances between periods in foreign subsidiaries that were in functional currencies other than the U.S. Dollar. Income Taxes 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. 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 basis 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. The provision for income taxes for the three months ended March 31, 2024 and 2023 was $9.9 million and $5.1 million, respectively. The Company’s effective tax rate for the three months ended March 31, 2024 and 2023 was 27.3% and 24.9%, respectively. The increase in our effective income tax rate for the three months ended March 31, 2024 was primarily attributable to the change in the geographical mix of income and an increase in the valuation allowance. -27- Liquidity and Capital Resources Cash and Cash Equivalents At March 31, 2024, we had cash and cash equivalents of $61.5 million compared to $88.7 million at December 31, 2023. The decrease in cash and cash equivalents resulted primarily from cash used for debt repurchases, capitalized expenditures and common stock repurchases, partially offset by cash provided by operations. As of March 31, 2024, cash and cash equivalents held within domestic and foreign jurisdictions were $33.0 million and $28.5 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 March 31, 2024, 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 March 31, 2024, we had outstanding $679.0 million in aggregate principal amount of indebtedness (see Note 7 - Long-Term Debt of the Notes to the Condensed Consolidated Financial Statements) and total minimum lease payments of $18.2 million, which had a weighted average remaining lease term of 6.5 years. As of March 31, 2024, our liability for uncertain tax positions was $10.5 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. We currently anticipate that our existing cash and cash equivalents and cash generated from operations will be sufficient to fund our anticipated needs for working capital, capital expenditures, stock and debt repurchases, if any, for at least the next 12 months and the foreseeable future. Debt Repurchase Program On November 9, 2023, the Board of Directors approved a debt repurchase program, pursuant to which Consensus may reduce, through redemptions, open market purchases, tender offers, privately negotiated purchases or other retirements, a combination of the outstanding principal balance of the 2026 Senior Notes and 2028 Senior Notes (“Debt Repurchase Program”). The authorization permits an aggregate principal amount reduction of up to $300.0 million and expires on November 9, 2026. The timing and amounts of purchases will be determined by the Company, depending on market conditions and other factors it deems relevant. Any gains or losses on extinguishment of debt are recognized in interest expense on the Condensed Consolidated Statements of Income. As of March 31, 2024 the Company has retired an aggregate of $126.0 million in principal of its senior notes under this program. 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 March 31, 2024 and 2023, the Company repurchased 42,962 and 270,192 shares, respectively, at an aggregate cost of $0.7 million and $9.2 million, respectively, under this program, inclusive of excise tax of zero in both periods. Cumulatively as of March 31, 2024, 1,071,624 shares have been repurchased under this program at an aggregate cost of $32.0 million (inclusive of excise tax of $0.2 million). The excise tax is assessed at 1% of the fair market value of net stock repurchases after December 31, 2022. Vested Restricted Stock 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 -28- 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 months ended March 31, 2024 and 2023, the Company withheld shares on its vested restricted stock units and restricted stock awards relating to its share-based compensation plans of 15,340 shares and 11,418 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 $44.7 million and $38.0 million for the three months ended March 31, 2024 and 2023, 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 increase in our net cash provided by operating activities in 2024 compared to 2023 was primarily attributable to increased income after excluding noncash items. In addition, contributing to the increase in cash provided by operating activities, there was an increase in income tax payable in 2024 compared to 2023, and less of an increase in accounts receivable in 2024 compared to 2023. These sources of cash flow were partially offset by a lower increase in accounts payable and accrued expenses in 2024 compared to 2023. Net cash used in investing activities was $8.9 million and $12.5 million for the three months ended March 31, 2024 and 2023, respectively. For the three months ended March 31, 2024, net cash used in investing activities consisted of capital expenditures associated with the purchase of property and equipment (including capitalized labor). Capital expenditures remained consistent from 2023 to 2024, however in 2023 the Company purchased an investment, which increased the net cash used in investing activities in 2023. Net cash used in financing activities was $58.8 million and $9.6 million for the three months ended March 31, 2024 and 2023, respectively. For the three months ended March 31, 2024, net cash used in financing activities was primarily attributable to cash outlays the Company used to repurchase a portion of its outstanding senior notes debt facilities. For the three months ended March 31, 2023, net cash used in financing activities was primarily attributable to cash used to repurchase common stock. For the three months ended March 31, 2024 and 2023, net cash used in financing activities also included the payment of employee income tax obligations related to the net settlement of equity awards.