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. -23- 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 825 thousand customers of all sizes, from enterprises to individuals, across approximately 45 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 74% 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, higher interest rates, supply chain disruptions and challenges as well as labor market pressures, all of which 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. -24- 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 and nine months ended September 30, 2024 and 2023 (in thousands, except for percentages and Average Revenue per Customer Account): Three Months Ended September 30, Nine Months Ended September 30, 2024 2023 2024 2023 Revenue Corporate $ 53,085 $ 50,430 $ 156,195 $ 150,198 Small office home office (“SoHo”) 34,664 40,129 107,197 124,588 Total 87,749 90,559 263,392 274,786 Other revenues 4 3 7 22 Consolidated $ 87,753 $ 90,562 $ 263,399 $ 274,808 Average Revenue per Customer Account (“ARPA”) (1)(2) Corporate $ 310.13 $ 312.45 $ 312.13 $ 314.92 SoHo $ 14.88 $ 15.31 $ 14.93 $ 15.37 Consolidated $ 35.09 $ 32.54 $ 34.31 $ 32.02 Customer Accounts (1) Corporate 58 54 58 54 SoHo 767 859 767 859 Consolidated 825 913 825 913 Paid Adds (3) Corporate 5 3 14 9 SoHo 64 64 187 217 Consolidated 69 67 201 226 Monthly Churn % (4) Corporate 2.61 % 1.49 % 2.27 % 1.38 % SoHo 3.38 % 3.49 % 3.40 % 3.61 % Consolidated 3.33 % 3.37 % 3.33 % 3.48 % (1) Consensus customers are defined as paying Corporate and SoHo customer accounts. (2) Represents a monthly ARPA for the quarter or year-to-date period, 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 a year-to-date basis is calculated by dividing revenue for the year-to-date period by the average customer base for the applicable period and dividing that amount by the respective period. 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. -25- (4) Monthly churn represents paid monthly SoHo and Corporate customer accounts that were cancelled during each month of the quarter or year-to-date period divided by the average number of customers during each month of the same quarter or year-to-date period (including the paid adds). The period measured is the quarter or year-to-date and expressed as a monthly churn rate over the respective 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 nine months ended September 30, 2024, there were no significant changes in our critical accounting policies and estimates. Results of Operations for the Three and Nine Months Ended September 30, 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 September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2024 2023 2024 2023 Revenues $ 87,753 $ 90,562 (3)% $ 263,399 $ 274,808 (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 $2.8 million or 3% for the three months ended September 30, 2024 over the prior year comparable period. The decrease was due to a decline of $5.5 million or 14% in our SoHo business, partially offset by an increase of $2.7 million or 5% in our corporate business. Revenues decreased by $11.4 million or 4% for the nine months ended September 30, 2024 over the prior year comparable period. The decrease was due to a decline of $17.4 million or 14% in our SoHo business, partially offset by an increase of $6.0 million or 4% in our corporate business. Cost of Revenues (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2024 2023 2024 2023 Cost of revenues $17,658 $16,853 5% $51,828 $51,607 —% As a percent of revenue 20% 19% 20% 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 increase in cost of revenues for the three months ended September 30, 2024 over the prior year comparable period was primarily due to increases of $0.9 million in depreciation associated with platform development costs and $0.8 million in network operations costs, partially offset by decreases of $0.3 million in data transmission expense, $0.2 million in personnel-related expenses and $0.2 million in online processing fees. -26- Cost of revenues for the nine months ended September 30, 2024 remained consistent with the prior year comparable period. Operating Expenses Sales and Marketing (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2024 2023 2024 2023 Sales and marketing $12,500 $15,319 (18)% $36,776 $49,719 (26)% As a percent of revenue 14% 17% 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 $2.8 million for the three months ended September 30, 2024 over the prior year comparable period was primarily due to a reduction in third party advertising spend of $2.7 million, predominantly in SoHo. The decrease in sales and marketing expenses of $12.9 million for the nine months ended September 30, 2024 over the prior year comparable period was primarily due to a reduction in third party advertising spend of $12.8 million, predominantly in SoHo. Research, Development and Engineering (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2024 2023 2024 2023 Research, development and engineering $2,034 $1,677 21% $5,582 $5,346 4% As a percent of revenue 2% 2% 2% 2% Our research, development and engineering costs consist primarily of personnel-related expenses. The increase in research, development and engineering for the three months ended September 30, 2024 over the prior year comparable period was primarily due to an increase of $0.3 million in personnel-related expenses. The increase in research, development and engineering for the nine months ended September 30, 2024 over the prior year comparable period was primarily due to increases of $0.1 million in personnel-related expenses and $0.1 million in computer related expense. General and Administrative (in thousands, except percentages) Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change 2024 2023 2024 2023 General and administrative $17,136 $17,798 (4)% $53,240 $56,382 (6)% As a percent of revenue 20% 20% 20% 21% 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 September 30, 2024 over the prior year comparable period was primarily due to decreases of $0.7 million in non-income related tax expenses. -27- The decrease in general and administrative expenses for the nine months ended September 30, 2024 over the prior year comparable period was primarily due to decreases of $1.5 million in personnel-related expenses and $1.4 million in professional fees. 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, 2024 and 2023 (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2024 2023 2024 2023 Cost of revenues $ 465 $ 309 $ 1,449 $ 939 Operating expenses: Sales and marketing 592 375 1,856 1,134 Research, development and engineering 95 61 260 153 General and administrative 2,270 3,009 8,045 11,331 Total $ 3,422 $ 3,754 $ 11,610 $ 13,557 Non-Operating Income and Expenses Interest expense . Our interest expense is due to outstanding debt and is reduced by any capitalized interest. Interest expense was $9.8 million and $12.6 million for the three months ended September 30, 2024 and 2023, respectively, and $24.6 million and $38.0 million for the nine months ended September 30, 2024 and 2023, respectively. The decrease between periods was primarily due to the partial extinguishment of debt, resulting in a gain of $0.1 million and $6.7 million for the three and nine months ended September 30, 2024, respectively. Interest income. Our interest income is generated from interest earned on cash and cash equivalents. Interest income was $0.7 million and $1.5 million for the three months ended September 30, 2024 and 2023, respectively, and $2.2 million and $2.2 million for the nine months ended September 30, 2024 and 2023, respectively. Interest income for the three months ended September 30, 2024 decreased compared to the prior year comparable period as the Company decreased its investment in money market funds in order to repurchase long-term debt. Interest income for the nine months ended September 30, 2024 was consistent with the prior year comparable period. Other (expense) income, net . Our other (expense) income, net is generated primarily from foreign currency and miscellaneous items. Other (expense) income, net was $(2.1) million and $3.7 million for the three months ended September 30, 2024 and 2023, respectively, and $2.5 million and $3.4 million for the nine months ended September 30, 2024 and 2023, respectively. The change between periods was primarily attributable to exchange rate fluctuations on intercompany 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 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 was $6.1 million and $7.5 million for the three months ended September 30, 2024 and 2023, respectively, and $24.7 million and $18.9 million for the nine months ended September 30, 2024 and 2023, respectively. -28- Our effective tax rate was 22.5% and 23.9% for the three months ended September 30, 2024 and 2023, respectively, and 25.7% and 23.8% for the nine months ended September 30, 2024 and 2023, respectively. The decrease in our effective income tax rate for the three months ended September 30, 2024 was primarily due to the change in the geographical mix of income. The increase in our effective income tax rate for the nine months ended September 30, 2024 was primarily attributable to the change in the geographical mix of income, an increase in the valuation allowance and an increase in state taxes on foreign earnings not permanently reinvested. Liquidity and Capital Resources Cash and Cash Equivalents As of September 30, 2024, we had cash and cash equivalents of $54.6 million compared to $88.7 million as of 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 September 30, 2024, cash and cash equivalents held within domestic and foreign jurisdictions were $29.3 million and $25.3 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 September 30, 2024, no amount had 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 September 30, 2024, we had outstanding $618.2 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 $18.0 million, which had a weighted average remaining lease term of 5.9 years. As of September 30, 2024, our liability for uncertain tax positions was $11.9 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 September 30, 2024, the Company had retired an aggregate of $186.8 million in principal of its senior notes under this program. In connection with the Company’s Debt Repurchase Program (see Note 7 - Long-Term Debt), the Company paid $9.2 million, which includes accrued interest, to repurchase $9.1 million in principal of its senior notes subsequent to the period ended September 30, 2024. 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 -29- under this program. There were no shares repurchased during the three months ended September 30, 2024 under this program. During the three months ended September 30, 2023 the Company repurchased 152,399 shares under this program at an aggregate cost of $3.8 million, inclusive of excise tax of $0.1 million. During the nine months ended September 30, 2024 and 2023, the Company repurchased 42,962 and 490,953 shares, respectively, at an aggregate cost of $0.7 million and $15.1 million, respectively, inclusive of excise tax of zero and $0.1 million, respectively. Cumulatively as of September 30, 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 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 September 30, 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 3,489 shares and 2,412 shares, respectively. During the nine months ended September 30, 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 40,396 shares and 35,368 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 $110.6 million and $112.1 million for the nine months ended September 30, 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 decrease in our net cash provided by operating activities over the prior comparable period was primarily attributable to a decrease in our net working capital accounts of $3.4 million, partially offset by increased income of $1.9 million after excluding noncash items. Net cash used in investing activities was $25.5 million and $32.7 million for the nine months ended September 30, 2024 and 2023, respectively. For the nine months ended September 30, 2024, net cash used in investing activities consisted of capital expenditures associated with the purchase of property and equipment (including capitalized labor). The decrease in our net cash used in investing activities over the prior comparable period was primarily attributable to less cash used for investments and capital expenditures associated with the purchase of property and equipment (including capitalized labor). Net cash used in financing activities was $116.8 million and $14.1 million for the nine months ended September 30, 2024 and 2023, respectively. For the nine months ended September 30, 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 nine months ended September 30, 2023, net cash used in financing activities was primarily attributable to cash used to repurchase common stock. The change in net cash used in financing activities over the prior comparable period was primarily attributable to an increase in cash outflows related to the repurchase of our debt in the current period, which was absent in the prior period, partially offset by a decrease in the repurchases of the Company’s common stock.