10-Q 1 appf3311910-q.htm 10-Q Document

 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019.
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.

Commission File Number 001-37468
AppFolio, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
26-0359894
(State of incorporation or organization)
 
(I.R.S. Employer Identification No.)
50 Castilian Drive
Santa Barbara, California
 
93117
(Address of principal executive offices)
 
(Zip Code)
 (805) 364-6093
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
x
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
o
 
 
 
 
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x




Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Class A Common Stock, $0.0001 par value
APPF
NASDAQ Global Market

As of April 25, 2019, the number of shares of the registrant’s Class A common stock outstanding was 15,944,323 and the number of shares of the registrant’s Class B common stock outstanding was 18,061,471.



TABLE OF CONTENTS
 
Section
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2019 (this "Quarterly Report"), includes “forward-looking statements” within the meaning of 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"), which statements are subject to considerable risks and uncertainties. Forward-looking statements include all statements that are not statements of historical facts contained in this Quarterly Report and can be identified by words such as “anticipates,” “believes,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts, “projects,” “should,” “could,” “will,” “would” or similar expressions and the negatives of those expressions. Forward-looking statements also include the assumptions underlying or relating to such statements. In particular, forward-looking statements contained in this Quarterly Report relate to, among other things, our future or assumed financial condition, results of operations and liquidity, business forecasts and plans, certain trends affecting our business and industry, capital needs and financing plans, capital resource allocation plans, potential repurchase of our shares, research and product development plans, future products and Value+ services, growth in the size of our business and number of customers, strategic plans and objectives, the impact of acquisitions and investments, changes in the competitive environment, the outcome of legal proceedings or regulatory matters, and the application of accounting guidance. We caution you that the foregoing list may not include all of the forward-looking statements made in this Quarterly Report.

Our forward-looking statements are based on our management’s current beliefs, assumptions and expectations about future events and trends, which affect or may affect our business, strategy, operations or financial performance. Although we believe these forward-looking statements are based upon reasonable assumptions, they are subject to numerous known and unknown risks and uncertainties and are made in light of information currently available to us. Our actual financial condition and results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Quarterly Report and in the section entitled "Risk Factors" of this Quarterly Report and in our Annual Report on form 10-K for the fiscal year ended December 31, 2018 (our "Annual Report"), as well as in the other reports we file with the Securities and Exchange Commission (the "SEC"). You should read this Quarterly Report, and the other documents that we have filed with the SEC, with the understanding that our actual future results may be materially different from the results expressed or implied by these forward-looking statements.

Moreover, we operate in an evolving environment. New risks and uncertainties emerge from time to time and it is not possible for our management to predict all risks and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual future results to be materially different from those expressed or implied by any forward-looking statements.

Forward-looking statements speak only as of the date they were made, and, except to the extent required by law or the rules of the NASDAQ Global Market, we undertake no obligation to update or review any forward-looking statement because of new information, future events or other factors.

We qualify all of our forward-looking statements by these cautionary statements.


1


PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements

APPFOLIO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except par values)
 
 
 
March 31,
2019
 
December 31,
2018
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
16,783

 
$
74,076

Investment securities—current
 
17,712

 
16,631

Accounts receivable, net
 
7,966

 
5,516

Prepaid expenses and other current assets
 
15,086

 
11,775

Total current assets
 
57,547

 
107,998

Investment securities—noncurrent
 
6,300

 
11,256

Property and equipment, net
 
7,169

 
6,871

Operating lease right-of-use assets
 
16,004

 

Capitalized software, net
 
22,396

 
20,485

Goodwill
 
57,496

 
15,548

Intangible assets, net
 
26,644

 
5,895

Other long-term assets
 
7,026

 
7,688

Total assets
 
$
200,582

 
$
175,741

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
1,557

 
$
1,481

Accrued employee expenses
 
10,795

 
12,377

Accrued expenses
 
9,450

 
8,281

Deferred revenue
 
4,045

 
3,414

Other current liabilities
 
11,099

 
1,447

Long-term debt, net—current portion
 
1,213

 
1,213

Total current liabilities
 
38,159

 
28,213

Operating lease liabilities
 
19,064

 

Long-term debt, net
 
48,290

 
48,602

Other long-term liabilities
 
14

 
7,080

Total liabilities
 
105,527

 
83,895

Commitments and contingencies (Note 9)
 

 

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.0001 par value, 25,000 authorized and no shares issued and outstanding at March 31, 2019 and December 31, 2018
 

 

Class A common stock, $0.0001 par value, 250,000 shares authorized at March 31, 2019 and December 31, 2018; issued - 16,269 and 16,159, shares at March 31, 2019 and December 31, 2018; outstanding - 15,899 and 15,789 shares at March 31, 2019 and December 31, 2018, respectively;
 
2

 
2

Class B common stock, $0.0001 par value, 50,000 shares authorized at March 31, 2019 and December 31, 2018; 18,071 and 18,109 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively;
 
2

 
2

Additional paid-in capital
 
157,253

 
157,898

Accumulated other comprehensive loss
 
(49
)
 
(178
)
Treasury stock, at cost, 370 Class A shares at March 31, 2019 and December 31, 2018
 
(21,562
)
 
(21,562
)
Accumulated deficit
 
(40,591
)
 
(44,316
)
Total stockholders’ equity
 
95,055

 
91,846

Total liabilities and stockholders’ equity
 
$
200,582

 
$
175,741

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

2


APPFOLIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share amounts)
 
 
Three Months Ended
March 31,
 
2019
 
2018
Revenue
$
57,091

 
$
42,340

Costs and operating expenses:
 
 
 
Cost of revenue (exclusive of depreciation and amortization)
24,181

 
16,613

Sales and marketing
11,219

 
7,405

Research and product development
8,481

 
5,333

General and administrative
8,192

 
5,316

Depreciation and amortization
5,076

 
3,500

Total costs and operating expenses
57,149

 
38,167

Income (loss) from operations
(58
)
 
4,173

Other expense, net
(1
)
 
(3
)
Interest income (expense), net
(497
)
 
176

Income (loss) before provision for (benefit from) income taxes
(556
)
 
4,346

Provision for (benefit from) income taxes
(4,281
)
 
26

Net income
$
3,725

 
$
4,320

 
 
 
 
Net income per common share:
 
 
 
Basic
$
0.11

 
$
0.13

Diluted
$
0.11

 
$
0.12

Weighted average common shares outstanding:
 
 
 
Basic
33,913

 
34,070

Diluted
35,342

 
35,300

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.


3



APPFOLIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)


 
Three Months Ended
March 31,
 
2019
 
2018
Net income
$
3,725

 
$
4,320

Other comprehensive income (loss):
 
 
 
    Changes in unrealized gains (losses) on investment securities
129

 
(148
)
Comprehensive income
$
3,854

 
$
4,172

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.


4



APPFOLIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(in thousands)

 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
Other
 
 
 
 
 
 
 
Common Stock
 
Common Stock
 
Paid-in
 
Comprehensive
 
Treasury
 
Accumulated
 
 
 
Class A
 
Class B
 
Capital
 
Loss
 
Stock
 
Deficit
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
14,879

 
$
1

 
19,102

 
$
3

 
$
152,531

 
$
(209
)
 
$

 
$
(67,247
)
 
$
85,079

Exercise of stock options
98

 

 

 

 
470

 

 

 

 
470

Stock-based compensation

 

 

 

 
1,495

 

 

 

 
1,495

Vesting of restricted stock units, net of shares withheld for taxes
68

 

 

 

 
(1,650
)
 

 

 

 
(1,650
)
Vesting of early exercised shares

 

 

 

 
9

 

 

 

 
9

Conversion of Class B stock to Class A stock
47

 

 
(47
)
 

 

 

 

 

 

Other comprehensive loss

 

 

 

 

 
(148
)
 

 

 
(148
)
Cumulative-effect adjustment resulting from adoption of ASU 2014-09

 

 

 

 

 

 

 
2,964

 
2,964

Net income

 

 

 

 

 

 

 
4,320

 
4,320

Balance at March 31, 2018
15,092

 
$
1

 
19,055

 
$
3

 
$
152,855

 
$
(357
)
 
$

 
$
(59,963
)
 
$
92,539

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
Other
 
 
 
 
 
 
 
Common Stock
 
Common Stock
 
Paid-in
 
Comprehensive
 
Treasury
 
Accumulated
 
 
 
Class A
 
Class B
 
Capital
 
Loss
 
Stock
 
Deficit
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
15,789

 
$
2

 
18,109

 
$
2

 
$
157,898

 
$
(178
)
 
$
(21,562
)
 
$
(44,316
)
 
$
91,846

Exercise of stock options
14

 

 

 

 
90

 

 

 

 
90

Stock-based compensation

 

 

 

 
1,831

 

 

 

 
1,831

Vesting of restricted stock units, net of shares withheld for taxes
58

 

 

 

 
(2,572
)
 

 

 

 
(2,572
)
Vesting of early exercised shares

 

 

 

 
6

 

 

 

 
6

Conversion of Class B stock to Class A stock
38

 

 
(38
)
 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 
129

 

 

 
129

Net income

 

 

 

 

 

 

 
3,725

 
3,725

Balance at March 31, 2019
15,899

 
$
2

 
18,071

 
$
2

 
$
157,253

 
$
(49
)
 
$
(21,562
)
 
$
(40,591
)
 
$
95,055

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.


5


APPFOLIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 
 
 
Three Months Ended
March 31,
 
2019
 
2018
Cash from operating activities
 
 
 
Net income
$
3,725

 
$
4,320

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,076

 
3,500

Stock-based compensation
1,552

 
1,318

Deferred income taxes
(4,281
)
 

Other
27

 
79

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(2,051
)
 
(1,148
)
Prepaid expenses and other current assets
(3,340
)
 
441

Other long-term assets
1,365

 
(766
)
Accounts payable
100

 
415

Accrued employee expenses
(2,867
)
 
(3,842
)
Accrued expenses
1,580

 
611

Deferred revenue
268

 
(1,334
)
Other long-term liabilities
(859
)
 
(252
)
Net cash provided by operating activities
295

 
3,342

Cash from investing activities
 
 
 
Purchases of property and equipment
(1,030
)
 
(263
)
Additions to capitalized software
(4,658
)
 
(2,936
)
Purchases of investment securities

 
(15,573
)
Sales of investment securities
1,750

 
5

Maturities of investment securities
2,250

 
8,296

Acquisition, net of cash acquired
(54,004
)
 

Net cash used in investing activities
(55,692
)
 
(10,471
)
Cash from financing activities
 
 
 
Proceeds from stock option exercises
90

 
470

Tax withholding for net share settlement
(1,315
)
 
(901
)
Proceeds from issuance of debt
597

 
32

Principal payments on debt
(909
)
 
(32
)
Payment of debt issuance costs
(360
)
 

Net cash used in financing activities
(1,897
)
 
(431
)
Net decrease in cash, cash equivalents and restricted cash
(57,294
)
 
(7,560
)
Cash, cash equivalents and restricted cash
 
 
 
Beginning of period
74,506

 
16,537

End of period
$
17,212

 
$
8,977

 
 
 
 

6


APPFOLIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 
 
 
Three Months Ended
March 31,
 
2019
 
2018
Noncash investing and financing activities
 
 
 
Purchases of property and equipment included in accounts payable and accrued expenses
$
445

 
$
114

Additions of capitalized software included in accrued and accrued employee expenses
391

 
243

Stock-based compensation capitalized for software development
338

 
235

Tax withholding for net share settlement included in accrued employee expenses
1,258

 
749

Purchase consideration for acquisitions included in other current liabilities
6,000

 


The following table presents a reconciliation of cash, cash equivalents and restricted cash reported within the Condensed Consolidated Balance Sheets to the total of the same such amounts shown above (in thousands):
 
March 31,
 
2019
 
2018
Cash and cash equivalents
$
16,783

 
$
8,549

Restricted cash included in other assets
429

 
428

Total cash, cash equivalents and restricted cash
$
17,212

 
$
8,977


The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

7


APPFOLIO, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
1. Nature of Business
AppFolio, Inc. (“we,” "us" or "our") provides industry-specific, cloud-based business software solutions, services and data analytics to the real estate market, which comprises a significant majority of our revenue, and, to a lesser extent, to the legal market. Our mission is to revolutionize vertical industry businesses by providing great software and services. We believe we accomplish this mission by providing our customers with a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and other stakeholders, and a system of intelligence designed to leverage data to predict and optimize business workflows in order to enable superior customer experiences and increase efficiency across our customers' businesses. Customers in our real estate market directly and indirectly account for more than 90% of our annual revenue. Real estate customers include third-party property managers, owner-operators and real estate investment managers who manage and/or invest in single- and multi-family residences, commercial properties, community associations, student housing, as well as mixed real estate portfolios. Our legal customers are typically small law firms that directly and indirectly account for less than 10% of our annual revenue.

Recent Developments

Acquisition of Dynasty Marketplace, Inc.

On January 7, 2019, we completed the acquisition of Dynasty Marketplace, Inc. ("Dynasty"),  a provider of advanced artificial intelligence ("AI") solutions for the real estate market. Dynasty offers advanced conversational AI solutions that automate leasing communications, replace manual tasks and help customers grow their portfolios. Dynasty’s technology is designed to enable operational efficiency in the leasing process including consistent prospect experience, lead conversion, and improved market insights. For additional information regarding this acquisition, refer to Note 3, Business Combinations.
2. Summary of Significant Accounting Policies
Basis of Presentation and Significant Accounting Policies
The accompanying unaudited Condensed Consolidated Financial Statements were prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information and disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted. Accordingly, these Condensed Consolidated Financial Statements should be read in conjunction with our audited consolidated financial statements and the related notes included in our Annual Report filed with the Securities and Exchange Commission ("SEC") on February 28, 2019. The year-end condensed balance sheet was derived from our audited consolidated financial statements. Our unaudited interim Condensed Consolidated Financial Statements include, in the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair statement of the Condensed Consolidated Financial Statements. The operating results for the three months ended March 31, 2019 are not necessarily indicative of the results expected for the full year ending December 31, 2019.
Changes in Accounting Policies
On January 1, 2019, we adopted Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") No. 2016-02, Leases (as amended, "ASU 2016-02" or the "new lease standard"), and have revised certain related accounting policies as follows:
Leases
We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities on our Condensed Consolidated Balance Sheets. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As none of our leases provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU assets also include any lease payments made and excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.

Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. We have lease arrangements with lease and non-lease components, which are generally accounted for as a single lease component. Leases with

8


an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. On an ongoing basis, management evaluates its estimates based on historical data and experience, as well as various other factors that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.
Net Income per Common Share
The net income per common share was the same for shares of our Class A and Class B common stock because they are entitled to the same liquidation and dividend rights and are therefore combined in the table below. The following table presents a reconciliation of our weighted average number of shares of our Class A and Class B common stock used to compute net income per common share (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Weighted average common shares outstanding
 
33,918

 
34,085

Less: Weighted average unvested restricted shares subject to repurchase
 
5

 
15

Weighted average common shares outstanding; basic
 
33,913

 
34,070

Plus: Weighted average options, restricted stock units and restricted shares used to compute diluted net income per common share
 
1,429

 
1,230

Weighted average common shares outstanding; diluted
 
35,342

 
35,300

For the three months ended March 31, 2019 and 2018, an aggregate of approximately 362,000 and 607,000 shares, respectively, underlying performance based options ("PSOs") and performance based restricted stock units ("PSUs"), are not included in the computations of diluted and anti-dilutive shares as they are considered contingently issuable upon the satisfaction of pre-defined performance measures and their respective performance measures have not been met.
The following table presents the number of anti-dilutive common shares excluded from the calculation of weighted average number of shares used to compute diluted net income per common share for the three months ended March 31, 2019 and 2018 (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Unvested restricted stock units
 
24

 
16

Contingent restricted stock units(1)
 

 
6

Total shares excluded from diluted net income per common share
 
24

 
22

(1) The reported shares are based on fixed price restricted stock unit (“RSU”) commitments for which the number of shares was not determined at the grant date. For the purposes of this table, the number of shares has been determined by dividing the fixed price commitment to issue shares in the future by the closing price of our common stock as of the applicable reporting period date.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, which requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements ("ASU 2018-11"). Among other things, ASU 2018-11 provides administrative relief by allowing entities to implement the lease standard on a modified retrospective basis (the "Optional Transition Method"). Effectively, the Optional

9


Transition Method permits us to adopt the lease standard through a cumulative effect adjustment to our opening balance sheet as of January 1, 2019, and report under the new lease standard on a post-adoption basis.

We adopted ASU 2016-02 effective January 1, 2019 using the Optional Transition Method. We elected the package of practical expedients permitted under the transition guidance, which allows us to carry forward our historical lease classification, our assessment of whether a contract is or contains a lease, and our initial direct costs for any leases that existed prior to adoption of the lease new standard. We also elected to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the Consolidated Statements of Operations on a straight-line basis over the lease term. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. We updated our accounting policies, processes, internal controls and information systems that were required to meet the new lease standard's reporting and disclosure requirements.

The adoption of ASU 2016-02 had a material impact on our Condensed Consolidated Balance Sheets, but did not have an impact on our Condensed Consolidated Statements of Operations or our Condensed Consolidated Statements of Cash Flows. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases. We also reclassified prepaid and deferred rent to the ROU asset balance as of January 1, 2019.

The cumulative effect of the changes made to our Condensed Consolidated Balance Sheet at January 1, 2019 for the adoption of the new lease standard was as follows (in thousands):
 
Balance at
December 31, 2018
 
Adjustments
 
Balance at
January 1, 2019
Assets
 
 
 
 
 
Prepaid expenses and other current assets
$
11,775

 
$
(317
)
 
$
11,458

Operating lease right-of-use assets

 
16,945

 
16,945

 
 
 
 
 


Liabilities and Stockholders’ Equity
 
 
 
 
 
Other current liabilities
$
1,447

 
$
3,493

 
$
4,940

Operating lease liabilities

 
20,056

 
20,056

Other long-term liabilities
7,080

 
(6,921
)
 
159


In March 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”). ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium. Specifically, ASU 2017-08 requires the premium to be amortized to the earliest call date. ASU 2017-08 does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment made directly to retained earnings at the beginning of the period of adoption. The adoption of this guidance did not have a material impact on our financial condition, results of operations, cash flows or disclosures. 
In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"). This amendment expands the scope of Topic 718, Compensation—Stock Compensation (which only included share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. The adoption of this guidance did not have a material impact on our financial condition, results of operations, cash flows or disclosures.
Recent Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which amends the current accounting guidance and requires the measurement of all expected losses based on historical experience, current conditions and reasonable and supportable forecasts. This guidance amends the accounting for credit losses for available-for-sale investment securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period after December 15, 2018. We are currently evaluating the effect of the adoption of ASU 2016-13 on our Consolidated Financial Statements. The effect will largely depend on the composition and credit quality of our investment portfolio and the economic conditions at the time of adoption.


10


In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, a series of amendments which align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. For public business entities, the amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. We have not yet determined the effect of this guidance on our financial condition, results of operations, cash flows or disclosures.
3. Business Combinations
Acquisition of Dynasty

On January 7, 2019, we acquired 100% of the voting equity interest of Dynasty, a provider of advanced artificial intelligence ("AI") solutions for the real estate market. Dynasty offers advanced conversational AI solutions that automate leasing communications, replace manual tasks and help customers grow their portfolios. Dynasty’s technology is designed to enable operational efficiency in the leasing process including consistent prospect experience, lead conversion, and improved market insights.

The total purchase consideration was $60.2 million, subject to certain adjustments, of which $6.0 million (the "Holdback Amount") was retained by the Company to satisfy any such adjustments, including without limitation certain indemnification claims. The balance of the Holdback Amount, less any amount retained (the “Retained Amount”) with respect to any unresolved indemnification claims (each, an “Unresolved Claim”), will be released to the stockholders of Dynasty, within three business days after the one-year anniversary of the Closing Date (the “Holdback Release Date”). If an Unresolved Claim is finally resolved after the Holdback Release Date, then, within three business days after the final resolution of such Unresolved Claim, the balance of the Retained Amount after satisfying such Unresolved Claim, less any amounts associated with all remaining Unresolved Claims, will be released to the Stockholders. The Holdback Amount is recorded in other current liabilities on the Condensed Consolidated Balance Sheet as of March 31, 2019.

The transaction was accounted for using the acquisition method, and as a result, assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. We are in the process of finalizing the valuation of the assets. The following table summarizes the preliminary purchase price allocation (in thousands) as well as the estimated useful lives of the acquired intangible assets over which they are amortized on a straight-line basis, as this approximates the pattern in which economic benefits are consumed:


11


 
 
Amount
(in thousands)
 
Estimated Useful Life (in years)
Total current assets
 
$
305

 
 
Identified intangible assets:
 
 
 
 
Technology
 
7,450

 
4.0
Database
 
4,710

 
10.0
Customer relationships
 
1,110

 
5.0
Backlog
 
100

 
1.0
Trademark & trade name
 
1,390

 
10.0
Non-compete agreement
 
7,340

 
5.0
Total intangible assets subject to amortization
 
22,100

 
6.0
Goodwill
 
41,948

 
Indefinite
Other noncurrent assets
 
35

 
 
Total assets acquired
 
64,388

 
 
 
 
 
 
 
Accrued and other liabilities
 
48

 
 
Deferred tax liability, net
 
4,109

 
 
Total liabilities assumed
 
4,157

 
 
Purchase consideration
 
$
60,231

 
 

Goodwill is mainly attributable to synergies expected from the acquisition and assembled workforce and is non-deductible for U.S. federal income tax purposes.

We incurred a total of $291,000 in transaction costs related to the acquisition and expensed all transaction costs incurred during the period in which such service was received. The results of operations of Dynasty since the acquisition are included in our Condensed Consolidated Statements of Operations for the three months ended March 31, 2019. Revenue and net loss attributable to Dynasty, in the period from the acquisition date of January 7, 2019 through March 31, 2019, was $0.5 million and $1.9 million, respectively.
Acquisition of WegoWise

On August 31, 2018, we completed the acquisition of substantially all of the assets of WegoWise, Inc. ("WegoWise"), a provider of cloud-based utility analytics software solutions serving the real estate market. The WegoWise platform empowers building owners and third-party property managers to better manage operating and capital expenditures relating to utilities, and we expect that the acquisition will provide enhanced functionality to our real estate customers over time, such as a future utility analytics and management Value+ services.

The consideration paid in cash for the assets was $14.4 million, of which $2.0 million will be held in escrow for 12 months to satisfy WegoWise’s indemnity obligations.

The transaction was accounted for using the acquisition method, and as a result, assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The following table summarizes the final purchase price allocation (in thousands) as well as the estimated useful lives of the acquired intangible assets over which they are amortized on a straight-line basis, as this approximates the pattern in which economic benefits are consumed:


12


 
Amount
(in thousands)
 
Estimated Useful Life (in years)
Net tangible assets
$
270

 
 
Identified intangible assets:
 
 
 
Customer relationships
1,170

 
5.0
Database
3,620

 
10.0
Trademark and trade name
370

 
10.0
Non-compete agreement
60

 
5.0
Backlog
140

 
1.0
Total intangible assets subject to amortization
5,360

 
8.6
Goodwill
8,811

 
Indefinite
Purchase consideration, paid in cash
$
14,441

 
 

Goodwill is mainly attributable to synergies expected from the acquisition and assembled workforce and is deductible for U.S. federal income tax purposes.

We incurred a total of $240,000 in transaction costs related to the acquisition and expensed all transaction costs incurred during the period in which such service was received.
Pro Forma Results of Acquisitions

The following unaudited pro forma information has been prepared for illustrative purposes only, and assumes that the aforementioned Dynasty and WegoWise acquisitions occurred on January 1, 2018 and January 1, 2017, respectively, and includes pro forma adjustments related to the amortization of acquired intangible assets, elimination of historical interest and amortization expense, income taxes, compensation arrangements, and the transaction costs incurred. The unaudited pro forma results have been prepared based on estimates and assumptions, which we believe are reasonable; however, they are not necessarily indicative of the consolidated results of operations had the acquisitions occurred at the beginning of the periods presented, or of future results of operations. The unaudited pro forma results are as follows (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Revenue
 
$
57,126

 
$
43,058

Net income (loss)
 
$
(546
)
 
$
4,798

 
 
 
 
 
Net income (loss) per common share:
 
 
 
 
Basic
 
$
(0.02
)
 
$
0.14

Diluted
 
$
(0.02
)
 
$
0.14

 

13


4. Investment Securities and Fair Value Measurements
Investment Securities
Investment securities classified as available-for-sale consisted of the following at March 31, 2019 and December 31, 2018 (in thousands):
 
March 31, 2019
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Corporate bonds
$
19,711

 
$
19

 
$
(66
)
 
$
19,664

Agency securities
4,350

 
8

 
(10
)
 
4,348

Total available-for-sale investment securities
$
24,061

 
$
27

 
$
(76
)
 
$
24,012

 
December 31, 2018
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Corporate bonds
$
23,720

 
$

 
$
(163
)
 
$
23,557

Agency securities
4,345

 
4

 
(19
)
 
4,330

Total available-for-sale investment securities
$
28,065

 
$
4

 
$
(182
)
 
$
27,887

At March 31, 2019, the unrealized losses on investment securities which have been in a net loss position for 12 months or greater were not material. These unrealized losses are considered temporary and there were no impairments considered to be "other-than-temporary" based on our evaluation of available evidence, which includes our intent to hold these investments to maturity or until a recovery of the cost basis.
At March 31, 2019 and December 31, 2018, the contractual maturities of our investments did not exceed 36 months. The fair values of available-for-sale investment securities, by remaining contractual maturity, are as follows (in thousands):
 
March 31, 2019
 
December 31, 2018
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
17,761

 
$
17,712

 
$
16,738

 
$
16,631

Due after one year through three years
6,300

 
6,300

 
11,327

 
11,256

Total available-for-sale investment securities
$
24,061

 
$
24,012

 
$
28,065

 
$
27,887


14


During the three months ended March 31, 2019 and 2018, we had sales and maturities (which include calls) of investment securities, as follows (in thousands):
 
Three Months Ended March 31, 2019
 
Gross Realized Gains
 
Gross Realized Losses
 
Gross Proceeds from Sales
 
Gross Proceeds from Maturities
Corporate bonds
$

 
$
(1
)
 
$
1,750

 
$
2,250

 
Three Months Ended March 31, 2018
 
Gross Realized Gains
 
Gross Realized Losses
 
Gross Proceeds from Sales
 
Gross Proceeds from Maturities
Corporate bonds
$

 
$

 
$

 
$
6,300

Agency securities

 

 

 
1,000

Certificates of deposit

 

 

 
996

Treasury securities

 

 
5

 


$

 
$

 
$
5

 
$
8,296

Interest income, net of the amortization and accretion of the premium and discount was $0.2 million for the three months ended March 31, 2019 and 2018.
Fair Value Measurements
Recurring Fair Value Measurements
Financial assets and financial liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following tables summarize our financial assets measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018 by level within the fair value hierarchy (in thousands):
 
March 31, 2019

Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
2,617

 
$

 
$

 
$
2,617

Available-for-sale investment securities:
 
 
 
 
 
 
 
Corporate bonds

 
19,664

 

 
19,664

Agency securities

 
4,348

 

 
4,348

Total
$
2,617

 
$
24,012

 
$

 
$
26,629

 
December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
10,694

 
$

 
$

 
$
10,694

Available-for-sale investment securities:
 
 
 
 
 
 
 
Corporate bonds

 
23,557

 

 
23,557

Agency securities

 
4,330

 

 
4,330

Total
$
10,694

 
$
27,887

 
$

 
$
38,581

The carrying amounts of cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the short maturity of these items.



15


The estimated fair value of the Term Loan approximates its carrying value due to the variable interest rates. We consider the fair value of the Term Loan to be a Level 2 measurement as the Term Loan is not actively traded. We carry the Term Loan at face value less the unamortized discount on our Consolidated Balance Sheets. Refer to Note 8, Long-term Debt of our Condensed Consolidated Financial Statements for more information about the Term Loan.
There were no changes to our valuation techniques used to measure financial asset and financial liability fair values on a recurring basis during the three months ended March 31, 2019. The valuation techniques for the financial assets in the tables above are as follows:
Cash Equivalents
As of March 31, 2019 and December 31, 2018, cash equivalents include cash invested in money market funds. Fair value is based on market prices for identical assets.
Available-for-Sale Investment Securities
Our Level 2 securities were priced by a pricing vendor. The pricing vendor utilizes the most recent observable market information in pricing these securities or, if specific prices are not available for these securities, use of other observable inputs like market transactions involving comparable securities. The fair value of our certificates of deposit is based on market prices for identical assets.
Non-Recurring Fair Value Measurements
Certain assets, including goodwill, intangible assets and our note receivable with SecureDocs, are also subject to measurement at fair value on a non-recurring basis using Level 3 measurement, but only when they are deemed to be impaired as a result of an impairment review. For the three months ended March 31, 2019 and 2018, no impairments were identified on those assets required to be measured at fair value on a non-recurring basis.
5. Internal-Use Software Development Costs
Internal-use software development costs as of March 31, 2019 and December 31, 2018 were as follows (in thousands):
 
 
March 31,
2019
 
December 31,
2018
Internal use software development costs, gross
 
$
63,189

 
$
58,237

Less: Accumulated amortization
 
(40,793
)
 
(37,752
)
Internal use software development costs, net
 
$
22,396

 
$
20,485


Capitalized software development costs for the three months ended March 31, 2019 and 2018 were $5.0 million and $3.0 million, respectively. Amortization expense with respect to software development costs totaled $3.0 million and $2.6 million for the three months ended March 31, 2019 and 2018, respectively.

Future amortization expense with respect to capitalized software development costs as of March 31, 2019 is estimated as follows (in thousands):
Years Ending December 31,
2019
 
$
8,847

2020
 
8,498

2021
 
4,603

2022
 
448

    Total amortization expense
 
$
22,396


16


6. Intangible Assets and Goodwill
Intangible assets consisted of the following as of March 31, 2019 and December 31, 2018 (in thousands):
 
 
March 31, 2019
 
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net Carrying
Value
 
Weighted
Average Useful
Life in Years
Customer relationships
 
$
3,070

 
$
(870
)
 
$
2,200

 
5.0
Database
 
8,330

 
(329
)
 
8,001

 
10.0
Technology
 
12,261

 
(5,006
)
 
7,255

 
5.0
Trademarks and trade names
 
2,690

 
(706
)
 
1,984

 
10.0
Partner relationships
 
680

 
(680
)
 

 
3.0
Non-compete agreements
 
7,440

 
(414
)
 
7,026

 
5.0
Domain names
 
273

 
(273
)
 

 
5.0
Patents
 
285

 
(240
)
 
45

 
5.0
Backlog
 
240

 
(107
)
 
133

 
1.0
 
 
$
35,269

 
$
(8,625
)
 
$
26,644

 
6.4

 
 
December 31, 2018
 
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net Carrying
Value
 
Weighted Average Useful Life in Years
Customer relationships
 
$
1,960

 
$
(728
)
 
$
1,232

 
5.0
Database
 
3,620

 
(121
)
 
3,499

 
10.0
Technology
 
4,811

 
(4,506
)
 
305

 
8.0
Trademarks & trade names
 
1,300

 
(642
)
 
658

 
9.0
Partner relationships
 
680

 
(680
)
 

 
3.0
Non-compete agreements
 
100

 
(44
)
 
56

 
4.0
Domain names
 
273

 
(273
)
 

 
5.0
Patents
 
285

 
(233
)
 
52

 
5.0
Backlog
 
140

 
(47
)
 
93

 
1.0
 
 
$
13,169

 
$
(7,274
)
 
$
5,895

 
7.0
Amortization expense with respect to intangible assets for the three months ended March 31, 2019 and 2018 was $1.4 million and $0.3 million, respectively.
Future amortization expense with respect to intangible assets as of March 31, 2019 is estimated as follows (in thousands):
Years Ending December 31,
2019
 
$
4,003

2020
 
5,066

2021
 
4,931

2022
 
4,869

2023
 
2,863

Thereafter
 
4,912

    Total amortization expense
 
$
26,644


Our goodwill balance is solely attributable to acquisitions. There have been no impairment charges recorded against goodwill. Goodwill recorded during the three months ended March 31, 2019 related to the acquisition of Dynasty was allocated

17


to our one operating segment. The change in the carrying amount of goodwill is as follows (in thousands):
Goodwill at December 31, 2018
 
$
15,548

Goodwill from acquisition of Dynasty
 
41,948

Goodwill at March 31, 2019
 
$
57,496

7. Leases

We have operating leases for our corporate offices and data centers. Our leases have remaining lease terms ranging from one to nine years, with various term extensions available. Our lease agreements do not contain any residual value guarantees or material restrictive covenants. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. The total lease cost associated with our operating leases for the three months ended March 31, 2019 was $1.2 million.

Lease-related assets and liabilities were as follows at March 31, 2019 (in thousands):
Assets
 
Operating lease right-of-use assets
$
16,004

 
 
Liabilities
 
Other current liabilities
$
4,013

Operating lease liabilities
19,064

Total lease liabilities
$
23,077

 
 
Weighted-average remaining lease term (years)
6.6

Weighted-average discount rate
4.1
%

Supplemental cash flow information related to leases was as follows for the three months ended March 31, 2019 (in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
 
Operating cash flows from operating leases
$
970



Future minimum lease payments under non-cancellable leases as of March 31, 2019 were as follows (in thousands):
Years ending December 31,
 
2019
$
3,677

2020
5,171

2021
4,048

2022
2,717

2023
2,053

Thereafter
9,128

Total future minimum lease payments
26,794

Less: imputed interest
(3,717
)
Total
$
23,077



18


A summary of our future minimum payments for obligations under non-cancellable operating leases as of December 31, 2018 was as follows (in thousands):
Years Ending December 31,
 
2019
$
4,211

2020
4,889

2021
4,038

2022
2,717

2023
2,053

Thereafter
9,128

Total lease commitments
$
27,036



At March 31, 2019 we have additional leases that have not yet commenced with a total commitment of $0.7 million. These leases will commence in 2019 with lease terms of two to three years.

On January 22, 2019, we signed a new sublease for approximately 10,500 square feet of office space located at 130 Castilian Drive, Santa Barbara, California. The sublease is for 32 months commencing on April 1, 2019 and ending on February 28, 2021. The total commitment under this sublease is $0.45 million.
    
On January 28, 2019, we signed an amendment to our existing lease at 9201 Spectrum Center Boulevard in San Diego, California which increased the square footage leased by approximately 4,500 square feet. The total commitment under this lease extension is $0.7 million. All other terms and conditions from the original lease remain the same.     

On April 1, 2019, we signed a new lease with Rose Studios, LLC to lease approximately 5,000 square feet of office space located at 215-221 Rose Avenue, Venice, California. The lease is for a five-year term commencing August 1, 2019 and ending on July 31, 2024. The total commitment under this lease is $2.0 million.
8. Long-Term Debt
The following is a summary of our long-term debt at March 31, 2019 (in thousands):
Principal amounts due under term loan
 
$
49,688

Less: Debt financing costs
 
(185
)
Long-term debt, net of unamortized debt financing costs
 
49,503

Less: Current portion of long-term debt
 
(1,213
)
Total long-term debt, net of current portion
 
$
48,290

Scheduled principal payments for the Term Loan at March 31, 2019 are as follows (in thousands):
Years Ending December 31,
 
 
2019
 
$
938

2020
 
1,250

2021
 
2,500

2022
 
2,500

2023
 
42,500

Total principal payments
 
$
49,688

Credit Agreement
On December 24, 2018, we amended our credit agreement (Amendment Number Two to the Credit Agreement, or "Second Amendment") with Wells Fargo Bank, National Association ("Wells Fargo"), as administrative agent, and the lenders that are parties thereto (as amended, the "Credit Agreement"). Under the terms of the Second Amendment, the lenders made available to us a $50.0 million term loan (the "Term Loan") and increased the existing revolving line of credit from $25.0 million to $50.0

19


million ("Revolving Credit Agreement"). The maturity date of the Term Loan and Revolving Facility is December 24, 2023. In addition, the Second Amendment permits us to make certain restricted junior payments, including without limitation stock repurchases and enter into acquisitions in which we are the purchaser ("Acquisitions"), with no dollar cap on such Acquisitions, so long as we maintain certain specified liquidity requirements and leverage ratios.
The Second Amendment also modifies certain financial covenants by, among other things, requiring us to maintain (i) an EBITDA to interest expense ratio of not less than 3.0 to 1.0, and (ii) a funded indebtedness to EBITDA ratio of not more than 3.5:1.0 (the "Required Leverage Ratio") (decreasing by 0.25 per year until the Required Leverage Ratio is 2.5 to 1.0); provided, however, that we are not required to maintain the foregoing ratios if our liquidity (sum of remaining borrowing capacity and available cash) has equaled or exceeded the greater of $20.0 million and 20% of the sum of the outstanding principal amount of the Term Loan and commitments under the Revolving Facility. If we enter into an Acquisition with a purchase price greater than or equal to $20.0 million, then the Required Leverage Ratio will be increased by 0.5 for the 12-month period immediately following the consummation of such Acquisition.
The Credit Agreement contains customary affirmative, negative and financial covenants. The affirmative covenants require us to, among other things, disclose financial and other information to the lenders, maintain our business and properties, and maintain adequate insurance. The negative covenants restrict us from, among other things, incurring additional indebtedness, prepaying certain types of indebtedness, encumbering or disposing of our assets, making fundamental changes to our corporate structure, and making certain dividends and distributions. At March 31, 2019, we were in compliance with the financial covenants under the Credit Agreement.
Under the terms of the Second Amendment, borrowings under the Credit Agreement bear interest at a fluctuating rate per annum equal to, at our option, (i) the adjusted London Interbank Offered Rate ("LIBOR") or (ii) an alternate base rate, in each case plus the applicable interest rate margin. The interest rate will fluctuate between adjusted LIBOR plus 1.5% per annum and adjusted LIBOR plus 2.0% per annum (or between the alternate base rate plus 0.5% per annum and the alternate base rate plus 1.0% per annum), based upon our leverage ratio. The average interest rate during the three months ended March 31, 2019 was 4.4%.
Fees payable on the unused portion of the Revolving Facility are 25 basis points per annum, unless the average usage of the Revolving Facility is equal to or less than $30.0 million for the applicable period, in which case the fees on the unused portion of the Revolving Facility are 0.375% per annum.    
At March 31, 2019 and December 31, 2018, there was no outstanding balance under the Revolving Facility.
Debt Financing Costs
As a result of the Second Amendment, we incurred $0.4 million in financing fees that were capitalized and will be amortized over the remaining life of the related debt, $0.2 million of which was related to the Term Loan and $0.2 million of which was related to the Revolving Facility. The Second Amendment is accounted for as a debt modification, and as a result, the unamortized deferred debt financing costs related to the Revolving Facility prior to the Second Amendment were added to the $0.2 million of deferred debt financing costs related to the Second Amendment and are amortized over the remaining life of the Revolving Facility.
Debt financing costs are deferred and amortized using the straight-line method, which approximates the effective interest method, for costs related to the Term Loan and the straight-line method for costs related to the Revolving Facility over the term of the debt arrangement; such amortization is included in interest expense in the Condensed Consolidated Statements of Operations. Amortization of deferred debt financing costs was $24,000 and $16,000 for the three months ended March 31, 2019 and 2018, respectively. At March 31, 2019 and December 31, 2018, the remaining unamortized deferred debt financing costs were $0.5 million, of which $0.2 million was offset against debt. At March 31, 2019 and December 31, 2018, $0.3 million of the remaining unamortized deferred debt financing costs were recorded in Prepaid expenses and other current assets and Other assets on the Condensed Consolidated Balance Sheets, as they pertained to the Revolving Facility.

20


9. Commitments and Contingencies
Legal Liability to Landlord Insurance
We have a wholly owned subsidiary, Terra Mar Insurance Company, Inc., which was established to provide our customers with the option to purchase legal liability to landlord insurance. If our customers choose to use this insurance service, they are issued an insurance policy underwritten by our third-party service provider. The policy has a limit of $100,000 per incident for each insured residence. We have entered into a reinsurance agreement with our third-party service provider and, as a result, we assume a 100% quota share of the legal liability to landlord insurance provided to our customers through our third-party service provider. Included in cost of revenue we accrue for reported claims, and an estimate of losses incurred but not reported by our property manager customers, as we bear the risk related to all such claims. Our liability for reported claims and incurred but not reported claims as of March 31, 2019 and December 31, 2018 was $0.7 million and $0.6 million, respectively, and is included in Other current liabilities on the Condensed Consolidated Balance Sheets.
Included in Prepaid expenses and other current assets as of March 31, 2019 and December 31, 2018, are $1.7 million and $1.8 million, respectively, of deposits held with a third party related to requirements to maintain collateral for this insurance service.
Litigation
In December 2018, we received a Civil Investigative Demand ("CID") from the Federal Trade Commission ("FTC") requesting certain information relating to our compliance with the Fair Credit Reporting Act ("FCRA") in connection with our tenant screening Value+ service. We continue to fully cooperate with the FTC, and do not presently have sufficient information to predict the outcome of, or any potential costs or penalties associated with, the investigation.
In September 2017, a putative federal class action styled Leo v. AppFolio, Inc. (Civ. No. 3:17-cv-05771; W.D. Wash.) was filed naming us as a defendant and alleging certain violations of the FCRA in connection with our tenant screening Value+ service (the "Leo Litigation"). The parties reached an agreement to settle the Leo Litigation on a class-wide basis in the fourth quarter of 2018. The court has approved the proposed settlement on a preliminary basis, and the parties continue to work through the class settlement process. We have not admitted and will not admit any liability whatsoever in connection with the claims and allegations in the Leo Litigation. The final settlement will be subject to court approval.
From time to time, we are involved in various other legal proceedings arising from or related to claims incident to the ordinary course of our business activities, including without limitation actions involving intellectual property, employment and contractual matters. Although the results of such legal proceedings and claims cannot be predicted with certainty, we believe that we are not currently a party to any legal proceeding(s) which, if determined adversely to us, would, individually or taken together, have a material adverse effect on our business, operating results, financial condition or cash flows.
Indemnification
In the ordinary course of business, we may provide indemnification of varying scope and terms to customers, investors, directors and officers with respect to certain matters, including, but not limited to, losses arising out of our breach of any applicable agreements, services to be provided by us, or intellectual property infringement claims made by third parties. These indemnification provisions may survive termination of the underlying agreement and the maximum potential amount of future payments we could be required to make under these indemnification provisions may not be subject to maximum loss clauses and is indeterminable. We have never paid a material claim, nor have any legal claims been brought against us in connection with these indemnification arrangements. As of March 31, 2019 and December 31, 2018, we had not accrued a liability for these indemnification arrangements because we determined that the likelihood of incurring any payment obligation, in connection with these indemnification arrangements is not probable or reasonably possible and the amount or range of amounts of any such liability is not reasonably estimable.
10. Share Repurchase Program
On February 20, 2019, the Board of Directors authorized a $100.0 million Share Repurchase Program (the "Program") of our outstanding Class A Common Stock. Under the Program, share repurchases may be made from time to time as directed by a Committee consisting of three Directors, in open market purchases or privately negotiated transactions at a repurchase price that the members of the Committee unanimously believe is below intrinsic value conservatively determined. The Program does not obligate us to repurchase any specific dollar amount or number of shares, there is no expiration date to the Program, and it may be modified, suspended or terminated at any time and for any reason. We did not repurchase any Class A Common Stock under the Program during the three months ended March 31, 2019.

21


11. Stock-Based Compensation
Stock Options
A summary of our stock option activity for the three months ended March 31, 2019, is as follows (number of shares in thousands):
 
 
Number of
Shares
 
Weighted
Average
Exercise
Price per Share
 
Weighted
Average
Remaining
Contractual Life
in Years
Options outstanding at December 31, 2018
 
1,513

 
$
11.31

 
6.4
Options granted
 

 

 
 
Options exercised
 
(14
)
 
6.35

 
 
Options cancelled/forfeited
 
(50
)
 
13.43

 
 
Options outstanding at March 31, 2019
 
1,449

 
$
11.29

 
6.3
Included in the options outstanding as of March 31, 2019 are 172,000 PSOs granted in 2017. Vesting of these PSOs is based on the achievement of pre-established performance targets for the year ending December 31, 2019 and continued employment throughout the performance period. Of these PSOs, 132,000 shares vest based on the achievement of a pre-established free cash flow performance target for the year ending December 31, 2019, assuming achievement of the performance metric at the maximum level, which is 150% of the performance target, resulting in a maximum payout of 100% of the initial target award. The remaining 40,000 PSOs have a pre-established adjusted gross margin target for the year ending December 31, 2019. PSOs tied to the gross margin performance target have two levels of vesting, with 50% vesting based on the achievement of 110% of the targeted amount and the remaining 50% vesting based on the achievement of 115% of the targeted amount.
During the three months ended March 31, 2019, 200,000 PSOs vested based on the achievement of 120% of the pre-established free cash flow performance target for the year ended December 31, 2018.
We recognize expense for the PSOs based on the grant date fair value of the PSOs that we determine are probable of vesting. Adjustments to compensation expense are made each period based on changes in our estimate of the number of PSOs that are probable of vesting. Our stock-based compensation expense for stock options, including the PSOs, for the three months ended March 31, 2019 and 2018, was $0.2 million and $0.3 million, respectively.
The fair value of stock options is estimated on their date of grant using the Black-Scholes option-pricing model. No stock options were granted during the three months ended March 31, 2019 or the three months ended March 31, 2018.

At March 31, 2019, the total estimated remaining stock-based compensation expense for unvested stock options, including the PSOs, was $0.5 million, which is expected to be recognized over a weighted average period of 1.1 years.
Restricted Stock Units
A summary of activity in connection with our RSUs for the three months ended March 31, 2019 is as follows (number of shares in thousands):
 
 
Number of Shares
 
Weighted Average Grant Date Fair Value per Share
Unvested at December 31, 2018
 
674

 
$
32.61

Granted
 
109

 
71.40

Vested
 
(93
)
 
14.86

Forfeited
 
(14
)
 
33.89

Unvested at March 31, 2019
 
676

 
$
41.26


During the three months ended March 31, 2019, we granted a total of 109,000 RSUs and PSUs: 99,000 RSUs are subject to time-based vesting in equal annual installments over four years; 4,000 PSUs vest based on the achievement of a pre-established consolidated net revenue growth target for the year ending December 31, 2021 and continued employment throughout the performance period; and 6,000 PSUs were granted and vested as a result of the achievement of a pre-established free cash flow performance target for the year ended December 31, 2018. The number of PSUs granted, as included in the above table, assumes

22


achievement of the performance metric at 100% of the performance target. The actual number of shares to be issued at the end of the performance period will range from 0% to 100% of the initial target awards. Achievement of the performance target between 100% and 150% of the performance target will result in a performance based cash bonus payment between 100% and 165% of the initial target awards.

During the three months ended March 31, 2019, 29,000 of the PSUs vested and an additional 6,000 PSUs were granted and vested based on the achievement of 120% of the pre-established free cash flow performance target for the year ended December 31, 2018.
Included in the unvested RSUs as of March 31, 2019 are 102,000 and 88,000 PSUs granted in 2018 and 2017, respectively. Of the PSUs granted in 2018, 54,000 vest based on the achievement of a pre-established consolidated net revenue growth target for the year ending December 31, 2020 and 48,000 vest based on the achievement of a pre-established consolidated net revenue growth target for the year ending December 31, 2021. Vesting of the PSUs granted in 2017 is based on the achievement of pre-established free cash flow performance targets for the year ending December 31, 2019, and continued employment throughout the performance period. The number of PSUs granted assumes achievement of the performance metric at 100% of the performance target. For the PSUs granted in 2018, the actual number of shares to be issued at the end of the performance period will range from 0% to 100% of the initial target awards. Achievement of the performance target between 100% and 150% of the performance target will result in a performance based cash bonus payment between 100% and 165% of the initial target awards. For the PSUs granted in 2017, the actual number of shares to be issued at the end of the performance period will range from 0% to 165% of the initial target award.
We recognize expense for the PSUs based on the grant date fair value of the PSUs that we determine are probable of vesting. Adjustments to compensation expense are made each period based on changes in our estimate of the number of PSUs that are probable of vesting. Our stock-based compensation expense for the RSUs and PSUs for the three months ended March 31, 2019 and 2018 was $1.6 million and $1.1 million, respectively.
As of March 31, 2019, the total estimated remaining stock-based compensation expense for the RSUs and PSUs was $19.1 million, which is expected to be recognized over a weighted average period of 2.4 years.
Restricted Stock Awards
A summary of activity in connection with our restricted stock awards for the three months ended March 31, 2019, is as follows (number of shares in thousands): 
 
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value per Share
Unvested at December 31, 2018
 
6

 
$
51.36

Granted
 

 

Vested
 
(1
)
 
5.64

Forfeited
 

 

Unvested at March 31, 2019
 
5

 
$
61.05

We have the right to repurchase any unvested restricted stock awards subject to certain conditions. Restricted stock awards vest over a four-year period for employees and a one-year period for non-employee directors. We recognized stock-based compensation expense for restricted stock awards of $0.1 million for each of the three months ended March 31, 2019 and 2018.
As of March 31, 2019, the total estimated remaining stock-based compensation expense for unvested restricted stock awards with a repurchasing right was $0.1 million which is expected to be recognized over a weighted average period of 0.2 years.

23


12. Income Taxes
For the three months ended March 31, 2019, we recorded an income tax benefit of $4.3 million. The tax benefit recorded and the difference between the US federal statutory rate of 21% and our tax rate is primarily due to changes in the deferred tax asset valuation allowance resulting from $4.1 million of deferred tax liabilities acquired through the Dynasty acquisition. The acquired deferred tax liabilities are expected to provide a source of income to support realizability of AppFolio's existing deferred tax assets.
For the three months ended March 31, 2018, we recorded income tax expense of $26,000 on pre-tax income of $4.3 million for an effective tax rate of 0.6%. The income tax expense was based on our payments of state minimum and franchise taxes, and the amortization of tax deductible goodwill that was not an available source of income to realize the deferred tax asset.
We have recorded a full valuation allowance related to our NOLs, credit carryforwards, and other net deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets. To the extent we determine that all, or a portion of, our valuation allowance is no longer necessary, we will reverse the valuation allowance and recognize an income tax benefit in the reported financial statement earnings in that period. Once the valuation allowance is eliminated or reduced, its reversal will no longer be available to offset our current financial statement tax provision in future periods. We believe that there is a possibility that, within the next three to 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that some or all of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain net deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the timing and amount of the valuation allowance release are subject to change on the basis of the level of our profitability and other factors.
13. Revenue and Other Information
The following table presents our revenue categories for the three months ended March 31, 2019 and 2018 (in thousands): 
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Core solutions
 
$
20,822

 
$
16,205

Value+ services
 
33,698

 
24,640

Other
 
2,571

 
1,495

Total revenue
 
$
57,091

 
$
42,340

During the three months ended March 31, 2019 and 2018, we recognized $1.7 million and $3.7 million of revenues, respectively, that were included in the deferred revenue balances at December 31, 2018 and 2017, respectively.
Our revenue is generated primarily from customers in the United States. All of our property and equipment is located in the United States.
14. Subsequent Events
On April 1, 2019, we entered into a new lease with Rose Studios, LLC to lease approximately 5,000 square feet of office space located at 215-221 Rose Avenue, Venice, California. The lease is for five years commencing August 1, 2019 and ending on July 31, 2024. The total commitment under this lease is $2.0 million.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and the related notes included elsewhere in this Quarterly Report and in our Annual Report. This discussion and analysis contains forward-looking statements that are based on our current expectations and reflect our plans, estimates and anticipated future financial performance. These statements involve numerous risks and uncertainties. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in the section entitled “Risk Factors” in this Quarterly Report and in our Annual Report, as well as our other public filings with the SEC. Please also refer to the section of this Quarterly Report entitled "Cautionary Note Regarding Forward-Looking Statements" for additional information.

24


Overview
Our mission is to revolutionize vertical industry businesses by providing great software and services. To that end, today we offer industry-specific, cloud-based business software solutions, services and data analytics to the real estate market, which comprises a significant majority of our revenue, and, to a lesser extent, to the legal market. Our real estate software solutions provide our customers with a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and other stakeholders, and a system of intelligence designed to leverage data to predict and optimize business workflows in order to enable superior customer experiences and increase efficiency across our customers' businesses. Our mobile-optimized software solutions are designed for use across multiple devices and operating systems. Our software solutions are all offered as a service for our customers and hosted using a modern cloud-based architecture. This architecture leads to rich data sets that have a consistent schema across our customer base and enables us to deploy data-powered products and services for our customers. We also provide software solutions to the legal market that enable law firms to administer their practice and manage their caseloads more efficiently by centralizing case details in a single system of record and system of engagement.
We were formed in 2006 with a vision to revolutionize the way that small and medium-sized businesses ("SMBs"), grow and compete by enabling their digital transformation. In 2008, we entered the real estate market with our first product, AppFolio Property Manager ("APM"), a property management solution designed to address the unique operational and business requirements of property management companies. Recognizing that our customers and their stakeholders would benefit from additional business critical services, we launched a series of Value+ services beginning in 2009. Our first Value+ service assisted our customers in the marketing of their rental properties by offering property level website design and hosting services. In 2010, we commenced the roll out of our electronic payment services, thereby facilitating the payment of rent via ACH by tenants. In 2011, we launched tenant screening services, further assisting our customers with the leasing process. In 2012, we introduced our legal liability to landlord insurance program, which protects property owners and managers from certain defined losses. In 2013, we expanded our electronic payment services by allowing residents to pay rent by Electronic Cash Payment and credit or debit card. In 2014, we launched a tenant-facing contact center solution to assist our property managers with resolving incoming maintenance requests. In 2015, with the acquisition of RentLinx, we expanded the marketing services offered to our property manager customers with a premium leads service and expanded our electronic payment services to facilitate payments made between our customers and property owners and vendors. In 2016, we introduced a tenant debt collection Value+ service to assist our property managers with running a more efficient business. In 2017, we expanded our insurance services to enable tenants to purchase renters insurance from within APM, protecting both our property manager customers and their tenants. In 2018, we acquired substantially all of the assets of WegoWise, Inc. ("WegoWise"), a provider of cloud-based utility analytics software solutions and have recently began offering AppFolio Utility Management as Value+ service to our property manager customers. In 2018, we also released AppFolio Property Manager PLUS, ("APM PLUS"), a new tier of APM designed for larger businesses with more complex needs. APM PLUS builds upon the functionality of APM and additionally offers data analytics, configurable workflows, and revenue management and optimization functionality for our customers. In January 2019, we acquired Dynasty Marketplace, Inc., ("Dynasty"), and expect the team and technology related to this acquisition, combined with our internal resources, technology and data, will serve as a foundation for future artificial-intelligence, ("AI"), software and services for the real estate market. In April 2019, we launched AppFolio Investment Management, which enables real estate investment managers to better manage their investor relationships by increasing transparency and streamlining fundraising, reporting, and communications.
We entered the legal market with the acquisition of MyCase in 2012. In 2013, we introduced website design and hosting services, our first Value+ service for our legal market customers, designed to assist smaller law firms and solo practitioners with the marketing of their practices, electronic storage of case information and communications. In 2016, we launched electronic payments services for the legal market, which streamlined the billing and receivables process through MyCase.
We have focused on growing our revenue by increasing the size of our customer base in the markets we serve, increasing the number of units under management, introducing new or expanded Value+ services, retaining customers, and increasing the adoption and utilization of our Value+ services by new and existing customers.
To date, we have experienced rapid revenue growth due to our investments in research and product development, sales and marketing, customer service and support, and infrastructure. We intend to continue to invest in growth across our organization as we expand in our current markets, adjacent markets and into new verticals. These investments to grow our business will continue to increase our costs and operating expenses on an absolute basis. Many of these investments will occur in advance of our realization of revenue or any other benefit, which will make it difficult to determine if we are allocating our resources efficiently. We expect our operating margins will improve over the long term, but this trend may be interrupted from time to time as a result of accelerated investment opportunities occurring in advance of realization of revenue.
We have managed, and plan to continue to manage, our business towards the achievement of long-term growth that we believe will positively impact long-term stockholder value, and not towards the realization of short-term financial or business metrics, or short-term stockholder value. Accordingly, if opportunities arise that might cause us to sacrifice our performance with

25


respect to short-term financial or business metrics, but that we believe are in the best interests of our stockholders in the long term, we will take those opportunities.
Today our real estate property manager customers directly and indirectly account for more than 90% of our annual revenue. We define our real estate property manager customer base as the number of customers subscribing to AppFolio Property Manager and AppFolio Property Manager PLUS core solutions. Customer count and property manager units under management are presented in the table below:
 
Quarter Ended
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
2019
 
2018
Property manager customers
13,409

 
13,046

 
12,641

 
12,317

 
12,030

Property manager units under management (in millions)
4.08

 
3.91

 
3.70

 
3.55

 
3.40


Our legal software solution, MyCase, enables small law firms to administer their practices and manage their caseloads more efficiently. MyCase is continuously evolving to help our customers more effectively market, manage and grow their businesses, and contains core functionality that addresses key operational issues, including managing calendars, contacts and documents, time tracking, billing and collections, communicating with clients and sharing sensitive and privileged materials.
Our legal customers directly and indirectly account for less than 10% of our annual revenue. We define our legal customer base as the number of customers subscribing to MyCase core solutions, exclusive of free trial periods. Legal customer count is summarized in the table below:
 
Quarter Ended
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
2019
 
2018
Law firm customers
10,485

 
10,279

 
10,173

 
10,001

 
9,706

At March 31, 2019, we had approximately 1,040 employees, and we consider our relationship with them to be very good. We also hire temporary employees and consultants, and feel similarly about our relationships with them. None of our employees is represented by a labor union or covered by a collective bargaining agreement.
Key Components of Results of Operations
Revenue
We charge our customers on a subscription basis for our core solutions and certain of our Value+ services. Our subscription fees are designed to scale to the size of our customers’ businesses. We recognize subscription revenue over time on a straight-line basis over the contract term beginning on the date that our service is made available to the customer. We generally invoice our customers for subscription services in monthly or annual installments, typically in advance of the subscription period. Revenue from subscription services is impacted by a number of factors, including the change in the number and type of our customers, the size and needs of our customers’ businesses, our customer renewal rates, and the level of adoption of our Value+ subscription services by new and existing customers.
We also charge our customers usage-based fees for using certain Value+ services. Certain of the usage-based fees are paid by either our customers or clients of our customers. Usage-based fees are charged on a flat fee per transaction basis with no minimum usage commitments. We recognize revenue for usage-based services in the period the service is rendered. We generally invoice our customers for usage-based services on a monthly basis for services rendered in the preceding month. Revenue from usage-based services is impacted by a number of factors, including the number of new and existing customers that adopt and utilize our Value+ services, the size and needs of our customers and our customer renewal rates.
We experience limited seasonality in our Value+ services revenue, primarily with respect to certain leasing-related services we provide to our property manager customers, including our tenant screening services and new tenant applications. These customers historically have processed fewer applications for new tenants during the winter holiday season; therefore, revenue associated with our leasing services typically declines in the fourth quarter. As a result of this seasonal decline in revenue, we have typically experienced slower sequential revenue growth or a sequential decline in revenue in the fourth quarter of each of our most

26


recent fiscal years. We expect this seasonality to continue in the foreseeable future although the impact from seasonality may decline as our revenue from other services increases.
We offer assistance to our customers with on-boarding to our core solutions, as well as website design services. We generally invoice our customers for these other services in advance of the services being completed. We recognize revenue for these other services upon completion of the related service. We generate revenue from legacy RentLinx customers by providing services that allow these customers to advertise rental houses and apartments online. Revenue derived from customers using the RentLinx services outside of our property manager core solution platform is recorded in other revenue. We also generate revenue from legacy WegoWise by providing utility analytics services and from Dynasty customers by providing artificial intelligence solutions for the real estate market. Revenue derived from customers using the WegoWise and Dynasty services outside of our property manager core solution platform is also recorded in other revenue.
Costs and Operating Expenses
Cost of Revenue. Cost of revenue consists of fees paid to third-party service providers associated with delivering certain of our Value+ services (including legal fees and costs associated with the delivery and provision of those services, as well as loss reserves and other costs associated with our legal liability to landlord insurance services), personnel-related costs (including salaries, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on customer service and the support of our operations, platform infrastructure costs (such as data center operations and hosting-related costs), payment processing fees, and allocated shared costs. We typically allocate shared costs across our organization based on headcount within the applicable part of our organization. Cost of revenue excludes depreciation of property and equipment, and amortization of capitalized software development costs and intangible assets. We intend to continue to invest in customer service and support and the expansion of our technology infrastructure as we grow the number of our customers, enter new markets and offer additional Value+ services. These investments could impact cost of revenue both in absolute dollars and as an overall percentage of revenue.
Sales and Marketing. Sales and marketing expense consists of personnel-related costs (including salaries, sales commissions, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on sales and marketing, costs associated with sales and marketing activities, and allocated shared costs. Marketing activities include advertising, online lead generation, lead nurturing, customer and industry events, and the creation of industry-related content and collateral. Sales commissions and other incremental costs to acquire customers and grow adoption and utilization of our Value+ services by our new and existing customers are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be three years. We focus our sales and marketing efforts on generating awareness of our software solutions, creating sales leads, establishing and promoting our brands, and cultivating an educated community of successful and vocal customers. We intend to continue to invest in sales and marketing as we grow to increase our customer base in new and existing markets and increase the adoption and utilization of Value+ services by our new and existing customers.
Research and Product Development. Research and product development expense consists of personnel-related costs (including salaries, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on research and product development, fees for third-party development resources, and allocated shared costs. Our research and product development efforts are focused on enhancing the ease of use and functionality of our existing software solutions by adding new core functionality, Value+ services and other improvements, as well as developing new products and services for new and existing markets. We capitalize the portion of our software development costs that meets the criteria for capitalization. Amortization of capitalized software development costs is included in depreciation and amortization expense. We intend to continue to invest in research and product development as we continue to introduce new core functionality, roll out new Value+ services, develop new products and services, and expand into adjacent markets and new verticals.
General and Administrative. General and administrative expense consists of personnel-related costs (including salaries, a majority of total incentive-based compensation, benefits, and stock-based compensation) for employees in our executive, finance, information technology, human resources, corporate development, legal and administrative organizations. In addition, general and administrative expense includes fees for third-party professional services (including audit, legal, tax, and consulting services), transaction costs related to business combinations, other corporate expenses, and allocated shared costs. We intend to continue to incur incremental general and administrative costs associated with supporting the growth of our business.
Depreciation and Amortization. Depreciation and amortization expense includes depreciation of property and equipment, amortization of capitalized software development costs and amortization of intangible assets. We depreciate or amortize property and equipment, software development costs and intangible assets over their expected useful lives on a straight-line basis, which approximates the pattern in which the economic benefits of the assets are consumed. As we continue to invest in our research and product development organization and the development or acquisition of new technology, we expect to have increased capitalized software development costs and incremental amortization. Further, we may incur additional amortization expense to the extent that we enter into additional arrangements to acquire or invest in new technologies or markets adjacent to those we serve today

27


or entirely new verticals. Finally, as we expand our facilities footprint and increase our base of employees, we expect to have increased property and equipment expenditures and incremental depreciation expense.
Interest Income (Expense), net. Interest income includes interest earned on investment securities, amortization and accretion of the premium and discounts paid from the purchase of investment securities, and interest earned on notes receivable and on cash deposited in our bank accounts. Interest expense includes interest paid on outstanding borrowings under the credit agreement with Wells Fargo, as administrative agent, and the lenders that are parties thereto, ("the Credit Agreement").
Results of Operations
The following table sets forth our results of operations for the periods presented in dollars (in thousands) and as a percentage of revenue:
 
Three Months Ended
March 31,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Consolidated Statements of Operations Data:
 
 
 
 
 
 
Revenue
$
57,091

 
100.0
 %
 
$
42,340

 
100.0
 %
Costs and operating expenses:
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization) (1)
24,181

 
42.4

 
16,613

 
39.2

Sales and marketing (1)
11,219

 
19.7

 
7,405

 
17.5

Research and product development (1)
8,481

 
14.9

 
5,333

 
12.6

General and administrative (1)
8,192

 
14.3

 
5,316

 
12.6

Depreciation and amortization
5,076

 
8.9

 
3,500

 
8.3

Total costs and operating expenses
57,149

 
100.1

 
38,167

 
90.1

Income (loss) from operations
(58
)
 
(0.1
)
 
4,173

 
9.9

Other expense, net
(1
)
 

 
(3
)
 

Interest income (expense), net
(497
)
 
(0.9
)
 
176

 
0.4

Income (loss) before provision for income taxes
(556
)
 
(1.0
)
 
4,346

 
10.3

Provision for (benefit from) income taxes
(4,281
)
 
(7.5
)
 
26

 
0.1

Net income
$
3,725

 
6.5
 %
 
$
4,320

 
10.2
 %

(1) Includes stock-based compensation expense as follows (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Stock-based compensation expense included in costs and operating expenses:
 
 
 
Cost of revenue (exclusive of depreciation and amortization)
 
$
324

 
$
220

Sales and marketing
 
248

 
210

Research and product development
 
308

 
225

General and administrative
 
672

 
663

Total stock-based compensation expense
$
1,552

 
$
1,318




28


Comparison of the Three Months Ended March 31, 2019 and 2018
The following comparative financial information includes the impact of ongoing investment in our business that we believe will positively impact long-term stockholder value, including (i) the acquisition of substantially all of the assets of WegoWise completed in August 2018, (ii) the development and launch of AppFolio Property Manager PLUS in September 2018, (iii) the acquisition of Dynasty completed in January 2019, and (iv) the development and launch of AppFolio Investment Management in April 2019. The WegoWise platform empowers building owners and third-party property managers to better manage operating and capital expenditures relating to utilities, and the new AppFolio Utility Management Value+ service, which has been developed from certain key aspects of the WegoWise platform, is a fully integrated offering that provides enhanced functionality to our real estate customers for utility analytics and management. Dynasty offers advanced conversational artificial intelligence solutions that automate leasing communications, replace manual tasks and help customers grow their portfolios. We believe that the acquisition of Dynasty strengthens AppFolio's system of intelligence capabilities, and better enables us to offer advanced AI products and services to real estate customers over time.
Revenue
 
 
Three Months Ended
March 31,
 
Change
 
 
2019
 
2018
 
Amount
 
%
 
 
(dollars in thousands)
Core solutions
 
$
20,822

 
$
16,205

 
$
4,617

 
28
%
Value+ services
 
33,698

 
24,640

 
9,058

 
37
%
Other
 
2,571

 
1,495

 
1,076

 
72
%
Total revenue
 
$
57,091

 
$
42,340

 
$
14,751

 
35
%

Total revenue was $57.1 million for the three months ended March 31, 2019 compared to $42.3 million for the three months ended March 31, 2018, an increase of $14.8 million, or 35%. Core solutions revenue was $20.8 million for the three months ended March 31, 2019 compared to $16.2 million for the three months ended March 31, 2018, an increase of $4.6 million, or 28%. Value+ services revenue was $33.7 million for the three months ended March 31, 2019 compared to $24.6 million for the three months ended March 31, 2018, an increase of $9.1 million, or 37%. Other revenue was $2.6 million for the three months ended March 31, 2019, compared to $1.5 million for the three months ended March 31, 2018, an increase of $1.1 million or 72%. The increase in Core solutions and Value+ services revenue was mainly attributed to the growth in the number of property manager customers and units under management. Combining new customer acquisition and strong customer renewal rates, we experienced an 11% year over year increase in the number of property manager customers and a 20% year over year increase in the number of property management units under management. In addition to the growth in customer count and units, property managers, residents, applicants and owners increased usage of our Value+ services platforms during the period. The increase in Other revenue was primarily attributed to revenue generated from customer subscriptions for the WegoWise platform and Dynasty technology services.
For the three months ended March 31, 2019 and 2018, we derived more than 90% of our revenue from our property manager customers.
Cost of Revenue (Exclusive of Depreciation and Amortization)
 
 
Three Months Ended
March 31,
 
Change
 
 
2019
 
2018
 
Amount
 
%
 
 
(dollars in thousands)
Cost of revenue (exclusive of depreciation and amortization)
 
$
24,181

 
$
16,613

 
$
7,568

 
46
%
Percentage of revenue
 
42.4
%
 
39.2
%
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization) was $24.2 million for the three months ended March 31, 2019 compared to $16.6 million for the three months ended March 31, 2018, an increase of $7.6 million, or 46%. The increase in cost of revenue was primarily attributed to the 35% increase in revenue over the same period and an increase in personnel related investments made in advance of expected revenue generation. Personnel-related expense increased by $3.5 million, related to increased headcount to support the increased number of customers, including those acquired in our recent acquisitions and investments made for future growth of our business. There was also an increase in expenditures to third parties of $2.9 million

29


directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the 37% increase in Value+ services revenues. Allocated and other costs increased by $1.2 million primarily driven by an increase in facilities, IT and other expenses incurred in support of our overall growth in personnel.
As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) fluctuates primarily based on the mix and prices of Value+ services in the period and investments made in advance of expected revenue generation. For the three months ended March 31, 2019 compared to the three months ended March 31, 2018, cost of revenue (exclusive of depreciation and amortization), as a percentage of revenue, increased to 42.4% from 39.2%. This increase in cost as a percentage of revenue was primarily due to increased personnel related investments made in advance of expected revenue generation associated with growth initiatives including the Dynasty and WegoWise acquisitions.
Sales and Marketing
<
 
 
Three Months Ended
March 31,
 
Change
 
 
2019
 
2018
 
Amount
 
%
 
 
(dollars in thousands)
Sales and marketing
 
$
11,219

 
$
7,405

 
$
3,814

 
52
%