Red Violet, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (“Form 10-Q”). This Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), about our expectations, beliefs, or intentions regarding our business, financial condition, results of operations, strategies, or prospects. You can identify forward-looking statements by the fact that these statements do not relate strictly to historical or current matters. Rather, forward-looking statements relate to anticipated or expected events, activities, trends, or results as of the date they are made. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially from any future results expressed or implied by the forward-looking statements. Many factors could cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements, including the impact of the coronavirus (“Covid-19”) pandemic on our operating results. These factors include those contained in this Quarterly Report on Form 10-Q, as well as the disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 filed on March 10, 2021 (“Form 10-K”), and other filings we make with the Securities and Exchange Commission. We do not undertake any obligation to update forward-looking statements, except as required by law. We intend that all forward-looking statements be subject to the safe harbor provisions of PSLRA. These forward-looking statements are only predictions and reflect our views as of the date they are made with respect to future events and financial performance. To the extent that our business is negatively impacted due to a variety of factors, including the impact of Covid-19 on our operating results, we may implement longer-term cost reduction efforts in order to mitigate such impacts. References in this discussion and analysis to “we,” “us,” “our,” “red violet,” or the “Company,” refer to Red Violet, Inc. and its consolidated subsidiaries. Overview Red Violet, Inc. (“we,” “us,” “our,” “red violet,” or the “Company”), a Delaware corporation, is dedicated to making the world a safer place and reducing the cost of doing business. We build proprietary technologies and apply analytical capabilities to deliver identity intelligence. Our technology powers critical solutions, which empower organizations to operate with confidence. Our solutions enable the real-time identification and location of people, businesses, assets and their interrelationships. These solutions are used for purposes including risk mitigation, due diligence, fraud detection and prevention, regulatory compliance, and customer acquisition. Our intelligent platform, CORE TM , is purpose-built for the enterprise, yet flexible enough for organizations of all sizes, bringing clarity to massive datasets by transforming data into intelligence. We drive wokflow efficiency and enable organizations to make better data-driven decisions. Organizations are challenged by the structure, volume and disparity of data. Our platform and applications transform the way our customers interact with information, presenting connections and relevance of information otherwise unattainable, which drives actionable insights and better outcomes. Leveraging cloud-native proprietary technology and applying machine learning and advanced analytical capabilities, CORE provides essential solutions to public and private sector organizations through intuitive, easy-to-use analytical interfaces. With massive data assets consisting of public-record, proprietary and publicly-available data, our differentiated information and innovative platform and solutions deliver intelligence relating to all things identity – entities, relationships, affiliations, interactions, and events. Our solutions are used today to enable frictionless commerce, to ensure safety, and to reduce fraud and the concomitant expense borne by society. While our platform powers many diverse solutions for our customers, we presently market our solutions primarily through two brands, idiCORE™, our flagship product, and FOREWARN ® . idiCORE is a next-generation, investigative solution used to address a variety of organizational challenges including due diligence, risk mitigation, identity authentication and regulatory compliance, by financial services companies, insurance companies, healthcare companies, law enforcement and government, collections, law firms, retail, telecommunication companies, corporate security and investigative firms. FOREWARN is an app-based solution currently tailored for the real estate industry, providing instant knowledge prior to face-to-face engagement with a consumer, helping professionals identify and mitigate risk. As of March 31, 2021 and 2020, idiCORE had 5,902 and 5,326 billable customers and FOREWARN had 58,831 and 36,506 users, respectively. The Company defines a billable customer of idiCORE as a single entity that generated revenue during the last three months of the period. Billable customers are typically corporate organizations. In most cases, corporate organizations will have multiple users and/or departments purchasing our solutions, however, the Company counts the entire organization as a discrete customer. The Company defines a user of FOREWARN as a unique person that has a subscription to use the FOREWARN service as of the last day of the period. A unique person can only have one user account. 14 We generate substantially all of our revenue from licensing our solutions. Customers access our solutions through a hosted environment using an online interface, batch processing, API and custom integrations. We recognize revenue from licensing fees (a) on a transactional basis determined by the customer’s usage, (b) via a monthly fee or (c) from a combination of both. Revenue pursuant to pricing contracts containing a monthly fee is recognized ratably over the contract period. Pricing contracts are generally annual contracts or longer, with auto renewal. Revenue from pricing contracts represented 80 % and 69 % of total revenue for the three months ended March 31, 202 1 and 20 20 , respectively . We endeavor to understand our customers’ needs at the moment of first engagement. We continuously engage with our customers and evaluate their usage of our solutions throughout their life cycle, to maximize utilization of our solutions and, hence, their productivity. Our go-to-market strategy leverages (a) an inside sales team that cultivates relationships, and ultimately closes business, with their end-user markets, (b) a strategic sales team that provides a more personal, face-to-face approach for major accounts within certain industries, and (c) distributors, resellers, and strategic partners that have a significant foothold in many of the industries that we have not historically served, as well as to further penetrate those industries that we do serve. We employ a “land and expand” approach. Our sales model generally begins with a free trial followed by an initial purchase on a transactional basis or minimum-committed monthly spend. As organizations derive benefits from our solutions, we are able to expand within organizations as additional use cases are presented across departments, divisions and geographic locations and customers become increasingly reliant on our solutions in their daily workflow. In order for us to continue to develop new products, grow our existing business and expand into additional markets, we must generate and sustain sufficient operating profits and cash flow in future periods. This will require us to generate additional sales from current products and new products currently under development. We continue to build out our sales organization to drive current products and to introduce new products into the marketplace. In December 2019, a novel strain of coronavirus, known as Covid-19, was reported in Wuhan, China and has since extensively impacted the global health and economic environment. In March 2020, the World Health Organization characterized Covid-19 as a pandemic. We have taken numerous steps, and will continue to take further actions as appropriate, to minimize the impact of the Covid-19 pandemic on our business, results of operations and financial performance. To ensure the health and well-being of our employees, beginning in March 2020, we instructed employees at our offices to work from home on a temporary basis. Starting in the second quarter of 2020, we implemented cost containment strategies across all areas of the organization, including continued curtailment of Company travel and partnering with suppliers, landlords and vendors for price concessions and payment deferrals during this interim period. As a result of preventative and protective actions taken by federal, state and local governments, including the implementation of stay-at-home orders and social distancing policies that resulted in significantly reduced commercial activity, and certain temporary government-imposed moratoria on collection customers’ activities, we experienced reduced transaction volume in the second and third quarters of 2020. Transaction volume returned to pre-Covid levels by the end of the third quarter 2020, except for collection customer volume. Collection customer transaction volume remained below pre-Covid levels during the first quarter of 2021, down $0.7 million, primarily attributable to our idiVERIFIED service, which is an ancillary collections market offering that is purely transactional and of a lower margin profile, for the three months ended March 31, 2021, compared to the three months ended March 31, 2020. We expect collection customer transaction volume, including that of our idiVERIFIED service, to return to pre-Covid levels in the second half of 2021. Beginning the second quarter of 2020, we took a proactive customer-centric approach working with customers who were impacted by Covid-19. Customers who had minimum contractual commitments and requested concessions because they were temporarily unable to meet their minimum contractual commitments as a result of Covid-19 were granted reductions, or eliminations where applicable, of minimums on a month-to-month basis. The end date of the customer’s agreement was extended by one month for each month of the temporary concession. During the second quarter of 2020, we provided concessions to a total of 152 customers, representing a $342 thousand reduction in minimum committed spend. During the third quarter of 2020, we provided concessions to a total of 22 customers, representing a $94 thousand reduction in minimum committed spend. During the fourth quarter of 2020, we provided concessions to a total of 7 customers, representing a $32 thousand reduction in minimum committed spend. We continue to work with customers who have been impacted by Covid-19 and consider potential concessions on a case-by-case basis. We continue to take precautionary measures intended to minimize the risk of the Covid-19 pandemic to our employees, our customers, and the communities in which we operate. These measures may result in inefficiencies, delays and additional costs to our business. The Covid-19 pandemic and its impact on us and the economy has significantly limited our ability to forecast our future operating results, including our ability to predict revenue and expense levels, and plan for and model future operating results. We will continue to evaluate the nature and extent of the impact of the COVID-19 pandemic to our business. 15 To further support our liquidity, b eginning April 1, 2020, we elected, under Section 2302 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) , to defer payment of the employer portion of Social Security payroll tax. Under the CARES Act, employers can forgo timely payment of the employer portion of Social Security taxes that would otherwise be due from March 27, 2020 through December 31, 2020, without penalty or interest charges. Employers must pay 50% of the deferred amount by December 31, 2021, and the remainder by December 31, 2022. On May 5, 2020, we received funding under a promissory note dated May 5, 2020 evidencing an unsecured non-recourse loan in the principal amount of $2.2 million under the CARES Act (the “Loan”) . We submitted an application for forgiveness of the Loan in November 2020. We will continue to assess the CARES Act and other applicable government legislation aimed at assisting businesses during the Covid-19 pandemic. In accordance with best practices and guidance from the Centers for Disease Control and Prevention, we implemented protective safeguards, including daily temperature checks, mandatory wearing of masks, social distancing, plexiglass protective barriers, and an entire office HVAC UV-C system . We began our first phase of employees returning to the Boca Raton, Florida office in June 2020. By the end of the first quarter of 2021, nearly all of the Boca Raton office employees have returned to an in-office work environment. We will continue to assess the need and timing of additional employees returning to an in- office work environment . Given the dynamic nature of this health emergency, the full impact of the Covid-19 pandemic on our ongoing business, results of operations and overall financial performance cannot be reasonably estimated at this time . Critical Accounting Policies and Estimates Management’s d i scussion and ana l ysis of financial condition and results of oper a tions are based upon our condensed consolidated financial statement s , which have been prepared in accordance with acc o un t ing principles generally a c c e pted in the Unit e d St a tes (“G A AP”). The preparati o n of these financial statements requires us to make estimates and judgments that affect the reported amounts of ass e ts, li a bi l it i es, revenues and expenses, and r e lated disclosure of contingent a ssets and liabilities. On an ongo i ng basis, we evaluate our estimates, including those related to the allowance for doubtful accounts, useful lives of intangible ass e ts, recoverability of the carrying amounts of goodwill and intangible assets, share-based compensation and income tax provision. We base our e s timates on historical ex p e rience a n d on various other assumptions that are believed to be reason a ble under the circumstances, the results of which form the basis f or making judgments ab o ut the ca rrying valu e s of a s s e ts and l i abi l it i es t hat a r e not readily apparent from other sources. Actual results may differ from these est i ma t es under di f ferent assumptions or conditions. For additional information, please refer to our Form 10-K. There have been no material changes to Critical Accounting Policies and Estimates disclosed in our Form 10-K. Recently issued accounting standards See Note 1(b), “ Recently issued accounting standards,” in “Notes to Condensed Consolidated Financial Statements.” First Quarter Financial Results For the three months ended March 31, 2021 as compared to the three months ended March 31, 2020: • Total revenue increased 10% to $10.2 million. Platform revenue increased 21% to $9.8 million. Services revenue decreased 66% to $0.4 million. • Net loss narrowed 61% to $0.6 million. • Adjusted EBITDA increased 66% to $2.9 million. • Gross profit increased 21% to $6.3 million. Gross margin increased to 61% from 55%. • Adjusted gross profit increased 24% to $7.5 million. Adjusted gross margin increased to 73% from 65%. • Generated $1.2 million in cash from operating activities in the first quarter. • Cash and cash equivalents were $12.9 million as of March 31, 2021. First Quarter and Recent Business Highlights • Revenue attributable to customer contracts reached a record 80%. Customer contracts are generally annual contracts or longer with auto renewal. • Added over 170 new customers to idiCORE™ during the first quarter, ending the quarter with 5,902 customers. • Added over 10,400 users to FOREWARN ® during the first quarter, ending the quarter with 58,831 users. Over 140 REALTOR ® Associations throughout the U.S. are now contracted to use FOREWARN. • Added two seasoned business development leaders with deep industry knowledge across multiple verticals we serve today. 16 Platform revenue consists of both contractual and transactional revenue generated from our technology platform, CORE. It includes all revenue generated through our idiCORE and FOREWARN solutions. The cost of platform revenue, which consists primarily of data acquisition costs, remains relatively fixed irrespective of revenue generation. Services revenue consists of revenue generated from our idiVERIFIED service , which is an ancillary collections market offering that is purely transactional and of a lower margin profile . The cost of services revenue, which consists primarily of third-party servicer costs, is variable. Use and Reconciliation of Non-GAAP Financial Measures Management evaluates the financial performance of our business on a variety of key indicators, including non-GAAP metrics of adjusted EBITDA, adjusted gross profit and adjusted gross margin. Adjusted EBITDA is a financial measure equal to net loss, the most directly comparable financial measure based on GAAP, excluding interest expense (income), net, depreciation and amortization, share-based compensation expense, litigation costs and write-off of long-lived assets and others, as noted in the tables below. We define adjusted gross profit as revenue less cost of revenue (exclusive of depreciation and amortization), and adjusted gross margin as adjusted gross profit as a percentage of revenue. Three Months Ended March 31, (In thousands) 2021 2020 Net loss $ (578 ) $ (1,481 ) Interest expense (income), net 5 (31 ) Depreciation and amortization 1,258 910 Share-based compensation expense 2,046 2,221 Litigation costs 120 - Write-off of long-lived assets and others 20 111 Adjusted EBITDA $ 2,871 $ 1,730 The following is a reconciliation of gross profit, the most directly comparable GAAP financial measure, to adjusted gross profit: Three Months Ended March 31, (In thousands) 2021 2020 Revenue $ 10,217 $ 9,300 Cost of revenue (exclusive of depreciation and amortization) (2,761 ) (3,292 ) Depreciation and amortization of intangible assets (1,203 ) (850 ) Gross profit 6,253 5,158 Depreciation and amortization of intangible assets 1,203 850 Adjusted gross profit $ 7,456 $ 6,008 Gross margin 61 % 55 % Adjusted gross margin 73 % 65 % In order to assist readers of our condensed consolidated financial statements in understanding the operating results that management uses to evaluate the business and for financial planning purposes, we present non-GAAP measures of adjusted EBITDA, adjusted gross profit and adjusted gross margin as supplemental measures of our operating performance. We believe they provide useful information to our investors as they eliminate the impact of certain items that we do not consider indicative of our cash operations and ongoing operating performance. In addition, we use them as an integral part of our internal reporting to measure the performance and operating strength of our business. We believe adjusted EBITDA, adjusted gross profit and adjusted gross margin are relevant and provide useful information frequently used by securities analysts, investors and other interested parties in their evaluation of the operating performance of companies similar to ours and are indicators of the operational strength of our business. We believe adjusted EBITDA eliminates the uneven effect of considerable amounts of non-cash depreciation and amortization, share-based compensation expense and the impact of other non-recurring items, providing useful comparisons versus prior periods or forecasts. Our adjusted gross profit is a measure used by management in evaluating the business’s current operating performance by excluding the impact of prior historical costs of assets that are expensed systematically and allocated over the estimated useful lives of the assets, which may not be indicative of the current operating activity. Our adjusted gross profit is calculated by using revenue, less cost of revenue (exclusive of depreciation and amortization). We believe adjusted gross profit provides useful information to our investors by eliminating the impact of non-cash depreciation and amortization, and specifically the amortization of software developed for internal use, providing a baseline of our core operating results that allow for analyzing trends in our underlying business consistently over multiple periods. Adjusted gross margin is calculated as adjusted gross profit as a percentage of revenue. 17 Adjusted EBITDA, adjusted gross profit and adjusted gross margin are not intended to be performance measures that should be regarded as an alternative to, or more meaningful than, financial measures presented in accordance with GAAP. The way we measure adjusted EBITDA, adjusted gross profit and adjusted gross margin may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements . Results of Operations Three months ended March 31, 2021 compared to three months ended March 31, 2020 Revenue . Revenue increased $0.9 million or 10% to $10.2 million for the three months ended March 31, 2021 from $9.3 million for the three months ended March 31, 2020. This increase was driven by strong growth in usage from existing customers, with base revenue from existing customers increasing $0.7 million or 11%, and growth revenue from existing customers increasing $0.6 million or 51%. This growth was partially offset by a decrease in revenue from new customers of $0.4 million or 32%. As a result of certain Covid-19 related government mandated collections moratoria remaining in place during the period, collection customer volume was down $0.7 million for the three months ended March 31, 2021. This was primarily attributable to our idiVERIFIED service, which is an ancillary collections market offering that is purely transactional and of a lower margin profile. We expect collection customer transaction volume, including that of our idiVERIFIED service, to return to pre-Covid levels in the second half of 2021. Our idiCORE billable customer base grew from 5,326 customers as of March 31, 2020 to 5,902 customers as of March 31, 2021, and our FOREWARN user base grew from 36,506 users to 58,831 users during that same period. Revenue from new customers represents the total monthly revenue generated from new customers in a given period. A customer is defined as a new customer during the first six months of revenue generation. Base revenue from existing customers represents the total monthly revenue generated from existing customers in a given period that does not exceed the customers' trailing six-month average revenue. A customer is defined as an existing customer six months after their initial month of revenue. Growth revenue from existing customers represents the total monthly revenue generated from existing customers in a given period in excess of the customers' trailing six-month average revenue. Cost of revenue (exclusive of depreciation and amortization) . Cost of revenue decreased $0.5 million or 16% to $2.8 million for the three months ended March 31, 2021 from $3.3 million for the three months ended March 31, 2020. Our cost of revenue primarily includes data acquisition costs. Data acquisition costs consist primarily of the costs to acquire data either on a transactional basis or through flat-fee data licensing agreements, including unlimited usage agreements. The decrease in cost of revenue was primarily attributable to the decrease in transactional based data acquisition costs associated with the reduction in our idiVERIFIED services revenue. We continue to enhance the breadth and depth of our data through the addition and expansion of relationships with key data suppliers, including our largest data supplier, which accounted for approximately 45% of our total data acquisition costs for the three months ended March 31, 2021 compared to approximately 39% for the three months ended March 31, 2020. Other cost of revenue items include expenses related to third-party infrastructure fees. As the construct of our data costs is primarily a flat-fee, unlimited usage model, the cost of revenue as a percentage of revenue decreased to 27% for the three months ended March 31, 2021 from 35% for the three months ended March 31, 2020. We expect that cost of revenue as a percentage of revenue will continue to decrease over the coming years as our revenue increases. Historically, at scale, the industry business model’s cost of revenue will trend between 15% and 30% as a percentage of revenue. Sales and marketing expenses . Sales and marketing expenses remained consistent at $2.2 million for the three months ended March 31, 2021 and 2020. Sales and marketing expenses consist of salaries and benefits, advertising and marketing, travel expenses, and share-based compensation expense, incurred by our sales team, and provision for bad debts. General and administrative expenses . General and administrative expenses increased $0.2 million or 3% to $4.6 million for the three months ended March 31, 2021 from $4.4 million for the three months ended March 31, 2020. For the three months ended March 31, 2021 and 2020, our general and administrative expenses consisted primarily of employee salaries and benefits of $1.5 million and $1.2 million, share-based compensation expense of $1.9 million and $2.1 million, and professional fees of $0.7 million and $0.6 million, respectively. Depreciation and amortization . Depreciation and amortization expenses increased $0.4 million or 38% to $1.3 million for the three months ended March 31, 2021 from $0.9 million for the three months ended March 31, 2020. The increase in depreciation and amortization for the three months ended March 31, 2021 resulted primarily from the amortization of software developed for internal use that became ready for its intended use after March 31, 2020. Loss before income taxes . L oss before income taxes narrowed $0.9 million or 61% to $0.6 million for the three months ended March 31, 2021 from $1.5 million for the three months ended March 31, 2020. The decrease in loss before income taxes was primarily attributable to the increase in revenue, decrease in our cost of revenue as a percentage of revenue, and decrease in share-based compensation expense, which was partially offset by the increase in employee salaries and benefits and sales commission of $0.5 million, and depreciation and amortization of $0.4 million. 18 Income taxes . Income tax expense of $0 was recognized for the three months ended March 31, 2021 and 2020 . A full valuation allowance on the deferred tax assets was recognized as of March 31, 2021 and 2020 . See Note 6 , “Income Taxes,” included in “Notes to Condensed Consolidated Financial Statements,” for details . Net loss . Net loss narrowed $0.9 million or 61% to $0.6 million for the three months ended March 31, 2021 from $1.5 million for the three months ended March 31, 2020, as a result of the foregoing . Effect of Inflation The rates of inflation experienced in recent years have had no material impact on our financial statements. We attempt to recover increased costs by increasing prices for our services, to the extent permitted by contracts and competition. Liquidity and Capital Resources Cash flows provided by operating activities . For the three months ended March 31, 2021, net cash provided by operating activities was $1.2 million, primarily the result of the net loss of $0.6 million, adjusted for certain non-cash items (consisting of share-based compensation expense, depreciation and amortization, write-off of long-lived assets, provision for bad debts, and noncash lease expenses) totaling $3.5 million, and the cash used as a result of changes in assets and liabilities of $1.7 million, primarily the result of the increase in accounts receivable and prepaid expenses and other current assets, and the decrease in accounts payable, accrued expenses and other current liabilities and operating lease liabilities. For the three months ended March 31, 2020, net cash provided by operating activities was $1.2 million, primarily the result of the net loss of $1.5 million, adjusted for certain non-cash items, as mentioned above, totaling $3.4 million, and the cash used as a result of changes in assets and liabilities of $0.7 million, primarily the result of the increase in prepaid expenses and other current assets, and the decrease in accrued expenses and other current liabilities and operating lease liabilities. Cash flows used in investing activities . For the three months ended March 31, 2021 and 2020, net cash used in investing activities was $1.3 million and $1.6 million, respectively, primarily as a result of capitalized costs included in intangible assets. As of March 31, 2021, we had material commitments under certain data licensing agreements of $8.7 million. We anticipate funding our operations using available cash and cash flow generated from operations within the next twelve months. We reported net loss of $0.6 million and $1.5 million for the three months ended March 31, 2021 and 2020, respectively. As of March 31, 2021, we had a total shareholders’ equity balance of $45.2 million. As of March 31, 2021, we had cash and cash equivalents of approximately $12.9 million. Based on projections of growth in revenue and operating results in the next twelve months, and the available cash and cash equivalents held by us, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. We further believe that our financial resources will allow us to manage the impact of Covid-19 on the Company's business operations for the foreseeable future. However, subject to revenue growth, our ability to generate positive cash flow, and the potential impact of Covid-19, we may have to raise capital through the issuance of additional equity and/or debt, which, if we are able to obtain, could have the effect of diluting stockholders. Any equity or debt financings, if available at all, may be on terms which are not favorable to us. Off-Balance Sheet Arrangements As of March 31, 2021, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As a smaller reporting company as defined in Rule 12b-2 of the Exchange Act, we are not required to include information required by this item. 19