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Section 1: 10-Q (RP-2018.06.30 10Q)

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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
¨
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: 001-34846 
 
RealPage, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
75-2788861
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
2201 Lakeside Boulevard
Richardson, Texas
 
75082-4305
(Address of principal executive offices)
 
(Zip Code)
(972) 820-3000
(Registrant’s telephone number, including area code) 
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
ý
 
 
Accelerated filer
¨
Non-accelerated filer
¨
  (Do not check if a smaller reporting company)
 
Smaller reporting company
¨
 
 
 
 
Emerging growth company
¨
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. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
July 20, 2018
Common Stock, $0.001 par value
 
93,817,205


Table of Contents

INDEX
 
 
 
 


Table of Contents

PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
RealPage, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
 
June 30, 2018
 
December 31, 2017
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
373,174

 
$
69,343

Restricted cash
102,518

 
96,002

Accounts receivable, less allowance for doubtful accounts of $8,442 and $3,951 at June 30, 2018 and December 31, 2017, respectively
112,484

 
124,505

Prepaid expenses
15,493

 
12,107

Other current assets
15,812

 
6,622

Total current assets
619,481

 
308,579

Property, equipment, and software, net
145,340

 
148,428

Goodwill
918,785

 
751,052

Identified intangible assets, net
276,983

 
252,337

Deferred tax assets, net
42,607

 
44,887

Other assets
20,710

 
11,010

Total assets
$
2,023,906

 
$
1,516,293

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
28,394

 
$
26,733

Accrued expenses and other current liabilities
97,484

 
79,379

Current portion of deferred revenue
111,238

 
116,622

Current portion of term loans
16,133

 
14,116

Convertible notes, net
286,908

 

Customer deposits held in restricted accounts
102,512

 
96,057

Total current liabilities
642,669

 
332,907

Deferred revenue
5,181

 
5,538

Revolving facility

 
50,000

Term loans, net
295,382

 
303,261

Convertible notes, net

 
281,199

Other long-term liabilities
41,299

 
41,513

Total liabilities
984,531

 
1,014,418

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value: 10,000,000 shares authorized and zero shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively

 

Common stock, $0.001 par value: 250,000,000 and 125,000,000 shares authorized, 96,485,983 and 87,153,085 shares issued and 93,959,957 and 83,180,401 shares outstanding at June 30, 2018 and December 31, 2017, respectively
96

 
87

Additional paid-in capital
1,159,831

 
637,851

Treasury stock, at cost: 2,526,026 and 3,972,684 shares at June 30, 2018 and December 31, 2017, respectively
(67,360
)
 
(61,260
)
Accumulated deficit
(53,445
)
 
(75,046
)
Accumulated other comprehensive income
253

 
243

Total stockholders’ equity
1,039,375

 
501,875

Total liabilities and stockholders’ equity
$
2,023,906

 
$
1,516,293

See accompanying notes.

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Table of Contents

RealPage, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 
 
On demand
$
206,945

 
$
154,727

 
$
400,245

 
$
300,940

Professional and other
9,307

 
6,579

 
17,308

 
13,285

Total revenue
216,252

 
161,306

 
417,553

 
314,225

Cost of revenue
85,741

 
67,544

 
162,401

 
130,586

Gross profit
130,511

 
93,762

 
255,152

 
183,639

Operating expenses:
 
 
 
 
 
 
 
Product development
30,771

 
21,290

 
59,811

 
41,677

Sales and marketing
54,488

 
39,235

 
104,729

 
74,382

General and administrative
28,444

 
27,370

 
55,534

 
51,621

Total operating expenses
113,703

 
87,895

 
220,074

 
167,680

Operating income
16,808

 
5,867

 
35,078

 
15,959

Interest expense and other, net
(8,518
)
 
(2,786
)
 
(16,188
)
 
(3,872
)
Income before income taxes
8,290

 
3,081

 
18,890

 
12,087

Income tax benefit
(189
)
 
(3,132
)
 
(490
)
 
(2,321
)
Net income
$
8,479

 
$
6,213


$
19,380

 
$
14,408

 
 
 
 
 
 
 
 
Net income per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.08

 
$
0.23

 
$
0.18

Diluted
$
0.09

 
$
0.08

 
$
0.22

 
$
0.18

Weighted average shares used in computing net income per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
85,124

 
79,018

 
83,156

 
78,642

Diluted
90,005

 
81,925

 
87,332

 
81,644

See accompanying notes.

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RealPage, Inc.
Condensed Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
8,479

 
$
6,213

 
$
19,380

 
$
14,408

(Loss) gain on interest rate swaps, net
(36
)
 
(24
)
 
123

 
82

Foreign currency translation adjustment
14

 
48

 
(113
)
 
(2
)
Comprehensive income
$
8,457

 
$
6,237

 
$
19,390

 
$
14,488

See accompanying notes.

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RealPage, Inc.
Condensed Consolidated Statements of Stockholders’ Equity
(in thousands)
(unaudited)
 
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Accumulated Deficit
 
Treasury Stock
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Shares
 
Amount
 
Balance as of December 31, 2017
87,153

 
$
87

 
$
637,851

 
$
243

 
$
(75,046
)
 
(3,973
)
 
$
(61,260
)
 
$
501,875

Cumulative effect of adoption of ASU 2014-09

 

 

 

 
2,221

 

 

 
2,221

Public offering of common stock, net of $17,051 of offering costs
8,050

 
8

 
441,791

 

 

 

 

 
441,799

Issuance of common stock at closing for acquisition of ClickPay
683

 
1

 
35,854

 

 

 

 

 
35,855

Shares held in escrow for acquisition of ClickPay
187

 

 

 

 

 

 

 

Redemption of noncontrolling interest in connection with acquisition of ClickPay
395

 

 
20,756

 

 

 

 

 
20,756

Stock option exercises
18

 

 
5,469

 

 

 
367

 
2,270

 
7,739

Issuance of restricted stock

 

 
(6,394
)
 

 

 
1,533

 
6,394

 

Treasury stock purchases, at cost

 

 
4

 

 

 
(453
)
 
(14,764
)
 
(14,760
)
Stock-based expense

 

 
24,500

 

 

 

 

 
24,500

Interest rate swap agreements

 

 

 
367

 

 

 

 
367

Foreign currency translation

 

 

 
(113
)
 

 

 

 
(113
)
Reclassification of realized gain on cash flow hedge to earnings, net of tax

 

 

 
(244
)
 

 

 

 
(244
)
Net income

 

 

 

 
19,380

 

 

 
19,380

Balance as of June 30, 2018
96,486

 
$
96

 
$
1,159,831

 
$
253

 
$
(53,445
)
 
(2,526
)
 
$
(67,360
)
 
$
1,039,375

See accompanying notes.

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RealPage, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
19,380

 
$
14,408

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
48,389

 
29,533

Amortization of debt discount and issuance costs
6,121

 
1,424

Deferred taxes
(2,973
)
 
(3,088
)
Stock-based expense
24,013

 
23,968

Loss on disposal and impairment of other long-lived assets
1,098

 
87

Acquisition-related consideration
1,124

 
1,024

Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
 
 
 
Accounts receivable
6,815

 
6,430

Prepaid expenses and other current assets
(9,395
)
 
(1,369
)
Other assets
(2,248
)
 
(464
)
Accounts payable
5,899

 
4,066

Accrued compensation, taxes, and benefits
(1,379
)
 
(759
)
Deferred revenue
(2,034
)
 
3,607

Customer deposits
5,142

 
15,389

Other current and long-term liabilities
2,268

 
1,396

Net cash provided by operating activities
102,220

 
95,652

Cash flows from investing activities:
 
 
 
Purchases of property, equipment, and software
(22,493
)
 
(27,129
)
Acquisition of businesses, net of cash and restricted cash acquired
(137,475
)
 
(123,241
)
Purchase of other investment
(1,800
)
 

Net cash used in investing activities
(161,768
)
 
(150,370
)
Cash flows from financing activities:
 
 
 
Payments on term loans
(6,049
)
 
(767
)
Proceeds from revolving credit facility
140,000

 

Payments on revolving line of credit
(190,000
)
 

Proceeds from borrowings on convertible notes

 
345,000

Purchase of convertible note hedges

 
(62,549
)
Proceeds from issuance of warrants

 
31,499

Deferred financing costs
(1,139
)
 
(10,755
)
Payments on capital lease obligations
(211
)
 
(136
)
Payments of acquisition-related consideration
(7,371
)
 
(7,185
)
Proceeds from public offering, net of underwriters’ discount and offering costs
441,799

 

Proceeds from exercise of stock options
7,739

 
13,151

Purchase of treasury stock related to stock-based compensation
(14,760
)
 
(11,008
)
Net cash provided by financing activities
370,008

 
297,250

Net increase in cash, cash equivalents and restricted cash
310,460

 
242,532

Effect of exchange rate on cash
(113
)
 
(2
)
Cash, cash equivalents and restricted cash:
 
 
 
Beginning of period
165,345

 
188,540

End of period
$
475,692

 
$
431,070

See accompanying notes.

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RealPage, Inc.
Condensed Consolidated Statements of Cash Flows, continued
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2018
 
2017
Supplemental cash flow information:
 
 
 
Cash paid for interest
$
9,200

 
$
1,976

Cash paid for income taxes, net of refunds
$
722

 
$
1,157

Non-cash investing and financing activities:
 
 
 
Fair value of stock consideration in connection with acquisition of ClickPay
$
35,855

 
$

Redemption of noncontrolling interest in connection with acquisition of ClickPay
$
20,756

 
$

Accrued property, equipment, and software
$
1,101

 
$
951

 
 
 
 
       The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Condensed Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Condensed Consolidated Statements of Cash Flows:
 
June 30, 2018
 
December 31, 2017
Cash and cash equivalents
$
373,174

 
$
69,343

Restricted cash
102,518

 
96,002

Total cash, cash equivalents and restricted cash shown in the Condensed Consolidated Statements of Cash flows
$
475,692

 
$
165,345

See accompanying notes.

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RealPage, Inc.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
1. The Company
RealPage, Inc., a Delaware corporation (together with its subsidiaries, the “Company” or “we” or “us”), is a leading global provider of software and data analytics to the real estate industry. Our platform of data analytics and software solutions enables the rental real estate industry to manage property operations (such as marketing, pricing, screening, leasing, and accounting), identify opportunities through market intelligence, and obtain data-driven insight for better operational and financial decision-making. Our integrated, on demand platform provides a single point of access and a massive repository of real-time lease transaction data, including prospect, renter, and property data. By leveraging data as well as integrating and streamlining a wide range of complex processes and interactions among the rental real estate ecosystem (owners, managers, prospects, renters, service providers, and investors), our platform helps our clients improve financial and operational performance and prudently place and harvest capital.
During May 2018 and as disclosed in our Form 10-Q for the quarter ended March 31, 2018, we were the subject of a targeted email phishing campaign that led to a business email compromise, pursuant to which an unauthorized party gained access to an external third party system used by a subsidiary that we acquired in 2017. The incident resulted in the diversion of approximately $6.2 million, net of recovered funds, intended for disbursement to three clients. We immediately restored all funds to the client accounts. We have since remediated the security weakness that gave rise to the incident, as well as implemented additional preventive and detective control procedures.
We maintain insurance coverage to limit our losses related to criminal and network security events. At June 30, 2018, we recognized a receivable of $6.2 million included in “Other current assets” in the accompanying Condensed Consolidated Balance Sheet for losses and related expenses arising from this incident that we believe are probable of recovery from our insurance carriers. For the three months ended June 30, 2018, we also recognized a charge of $0.3 million included in “General and administrative” expenses in the accompanying Condensed Consolidated Statement of Operations for losses and related expenses that we do not expect to recover.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements and footnotes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. We believe that the disclosures made are appropriate and conform to those rules and regulations, and that the condensed or omitted information is not misleading.
The unaudited Condensed Consolidated Financial Statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. All intercompany balances and transactions have been eliminated in consolidation. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.
These financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 1, 2018 (“Form 10-K”).
Segment and Geographic Information
Our chief operating decision maker is our Chief Executive Officer, who reviews financial information presented on a company-wide basis. As a result, we determined that the Company has a single reporting segment and operating unit structure.
Principally, all of our revenue for the three and six months ended June 30, 2018 and 2017 was earned in the United States. Net property, equipment, and software located in the United States amounted to $136.9 million and $140.0 million at June 30, 2018 and December 31, 2017, respectively. Net property, equipment, and software located in our international subsidiaries amounted to $8.4 million at both June 30, 2018 and December 31, 2017. Substantially all of the net property, equipment, and software held in our international subsidiaries was located in the Philippines, Spain, and India at both June 30, 2018 and December 31, 2017.
Concentrations of Credit Risk
Our cash accounts are maintained at various financial institutions and may, from time to time, exceed federally insured limits. We have not experienced any losses in such accounts.

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Concentrations of credit risk with respect to accounts receivable result from substantially all of our clients being in the residential rental housing market. Our clients, however, are dispersed across different geographic areas. We do not require collateral from clients. We maintain an allowance for doubtful accounts for credits we offer our clients in certain instances and to reflect our best estimate of the amount of consideration we will ultimately receive based on relevant factors such as our historical experience, current contractual requirements, potential client buying patterns, age of the outstanding balance, and our clients’ ability to pay.
No single client accounted for 10% or more of our revenue or accounts receivable for the three or six months ended June 30, 2018 or 2017.
Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates include the allowance for doubtful accounts; the useful lives of intangible assets and the recoverability or impairment of tangible and intangible asset values; fair value measurements; contingent commissions related to the sale of insurance products; valuation of net assets acquired and contingent consideration in connection with business combinations; revenue and deferred revenue and related reserves; stock-based expense; and our effective income tax rate and the recoverability of deferred tax assets, which are based upon our expectations of future taxable income and allowable deductions. Actual results could differ from these estimates. For greater detail regarding these accounting policies and estimates, refer to our Form 10-K.
Cash and Cash Equivalents
We consider all highly liquid investments with a maturity date, when purchased, of three months or less to be cash equivalents.
Restricted Cash
Restricted cash consists of cash collected from tenants that will be remitted primarily to our clients.
Business Combinations
We apply the guidance contained in ASC Topic 805, Business Combinations (“ASC 805”) in determining whether an acquisition transaction constitutes a business combination. ASC 805 defines a business as consisting of inputs and processes applied to those inputs that have the ability to create outputs. The acquisition transactions in Note 3 were determined to constitute business combinations and were accounted for under ASC 805.
Purchase consideration includes assets transferred, liabilities assumed, and/or equity interests issued by us, all of which are measured at their fair value as of the date of acquisition. Our business combination transactions may be structured to include a combination of up-front, deferred and contingent payments. These payments may include a combination of cash and common stock. Deferred and contingent payments are made at specified dates subsequent to the date of acquisition. Deferred cash payments and stock issuances are included in the acquisition consideration based on their fair value as of the acquisition date. The fair value of these obligations is estimated based on the present value, as of the date of acquisition, of the anticipated future payments. The future payments are discounted using a rate that considers an estimate of the return expected by a market-participant and a measurement of the risk inherent in the cash flows, among other inputs. These deferred obligations are generally subject to adjustments specified in the underlying purchase agreement related to the seller’s indemnification obligations. Contingent cash payments are obligations to make future cash payments to the seller, the payment of which is contingent upon the achievement of stipulated operational or financial targets in the post-acquisition period. Contingent cash payments are included in the purchase consideration at their fair value as of the acquisition date. The fair value of these payments is estimated using a probability weighted discount model based on the achievement of the specified targets. The fair value of these liabilities is re-evaluated on a quarterly basis, and any change is reflected in the line “General and administrative” in the accompanying Condensed Consolidated Statements of Operations. These estimates are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur that would affect the accuracy or validity of these estimates.
The total purchase consideration is allocated to the assets acquired and liabilities assumed based on their estimated fair values. Any excess consideration is classified as goodwill. Acquired intangibles are recorded at their estimated fair value based on the income approach using market-based estimates. Acquired intangibles generally include developed product technologies, which are amortized over their useful life on a straight-line basis, and client relationships, which are amortized over their useful life proportionately to the expected discounted cash flows derived from the asset. When trade names acquired are not classified as indefinite-lived, they are amortized on a straight-line basis over their expected useful life.

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Acquisition costs are expensed as incurred and are included in the line “General and administrative” in the accompanying Condensed Consolidated Statements of Operations. We include the results of operations from acquired businesses in our Condensed Consolidated Financial Statements from the effective date of the acquisition.
Derivative Financial Instruments
We are exposed to interest rate risk related to our variable rate debt. We manage this risk through a program that includes the use of interest rate derivatives, the counterparties to which are major financial institutions. Our objective in using interest rate derivatives is to add stability to interest cost by reducing our exposure to interest rate movements. We do not use derivative instruments for trading or speculative purposes.
Our interest rate derivatives are designated as cash flow hedges and are carried in the Condensed Consolidated Balance Sheets at their fair value. Unrealized gains and losses resulting from changes in the fair value of these instruments are classified as either effective or ineffective. The effective portion of such gains or losses is recorded as a component of accumulated other comprehensive income (“AOCI”), while the ineffective portion is recorded as a component of interest expense in the period of change. Amounts reported in AOCI related to interest rate derivatives are reclassified into interest expense as interest payments are made on our variable-rate debt. If an interest rate derivative agreement is terminated prior to its maturity, the amounts previously recorded in AOCI are recognized into earnings over the period that the forecasted transactions impact earnings. If the hedging relationship is discontinued because it is probable that the forecasted transactions will not occur according to our original strategy, any related amounts previously recorded in AOCI are recognized in earnings immediately.
Accounts Receivable
Accounts receivable primarily represent trade receivables from clients that are recorded at the invoice amount, net of an allowance for doubtful accounts and credits. For certain transactions, we have met the requirements to recognize revenue in advance of invoicing the client. In these instances, we record unbilled receivables for the amount that will be due from the client upon invoicing.
We maintain an allowance for doubtful accounts for credits we offer our clients in certain instances and to reflect our best estimate of the amount of consideration to which we are entitled and that we will ultimately receive. In evaluating the sufficiency of the allowance for doubtful accounts, we consider relevant factors such as our historical experience, current contractual requirements, potential client buying patterns, age of the outstanding balance, and our clients’ ability to pay. Any change in the assumptions used in analyzing a specific account receivable might result in an additional allowance for doubtful accounts being recognized in the period in which the change occurs. A portion of our allowance is for services not yet rendered and is therefore classified as an offset to deferred revenue.
Accounts receivable are written off upon determination of non-collectability following established Company policies. We incurred bad debt expense of $1.5 million and $0.8 million for the three months ended, and $2.1 million and $1.3 million for the six months ended June 30, 2018 and 2017, respectively.
Accounts receivable includes commissions due to us related to the sale of insurance products to individuals and commissions which are contingent based upon the activity in the underlying policies. Contingent commissions receivables are recorded at their estimated net realizable value, based on estimates and considerations which include, but are not limited to, the historical and projected loss rates incurred by the underlying policies.
Deferred Revenue
Deferred revenue primarily consists of billings issued or payments received for service obligations we have not yet completed. For several of our solutions, we invoice our clients in annual, monthly, or quarterly installments in advance of the commencement of the service period. Accordingly, the deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancellable subscription agreements. Deferred revenue that will be recognized during the succeeding twelve-month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.
Revenue Recognition
We derive our revenue from two primary sources: (1) on demand software solutions and (2) professional services and other goods and services. We recognize revenue as we satisfy one or more service obligations under the terms of a contract, generally as control of goods and services are transferred to our clients. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. We include estimates of variable consideration in revenue to the extent that it is probable that a significant reversal of cumulative revenue will not occur once the uncertainty is resolved.
We determine revenue recognition through the following steps:
identification of the contract, or contracts, with a client;
identification of the performance obligations in the contract;

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determination of the transaction price;
allocation of the transaction price to the performance obligations in the contract; and
recognition of revenue when, or as, we satisfy a performance obligation.
On Demand Revenue
Our on demand revenue consists of license and subscription fees, transaction fees related to certain of our software-enabled value-added services, and commissions derived from our sales of certain risk mitigation services.
We generally recognize revenue from subscription fees on a straight-line basis over the access period beginning on the date that we make our service available to the client. Our subscription agreements generally are non-cancellable, have an initial term of one year or longer and are billed either monthly or annually in advance. Recognition on subscription fees starts and is recorded when, or as, service obligations are satisfied. Non-refundable upfront fees billed at the initial order date that are not associated with an upfront service obligation are recognized as revenue on a straight-line basis over the period over which the client is expected to benefit, which we consider to be three years.
We recognize revenue from transaction fees in the month the related services are performed based on the amount we have a right to invoice.
As part of our resident services offerings, we offer risk mitigation services to our clients by acting as an insurance agent and derive commission revenue from the sale of insurance products to our clients’ residents. The commissions are based upon a percentage of the premium that our insurance company underwriting partners charge to the policyholder and are subject to forfeiture in instances where a policyholder cancels prior to the end of the policy. Our contracts with our underwriting partners also provide for contingent commissions to be paid to us in accordance with the agreements. Such commissions are variable in nature and based on a calculation that considers, on the policies sold by us, earned premiums less i) earned agent commissions; ii) a percent of premium retained by our underwriting partner; iii) incurred losses; and iv) profit retained by our underwriting partner during the time period. Our estimate of contingent commission revenue considers historical loss experience on the policies sold by us. If the policy is cancelled, our commissions are forfeited as a percent of the unearned premium. As a result, we recognize commissions related to these services as earned ratably over the policy term.
Professional and Other Revenue
Professional services and other revenues generally consist of the fees we receive for providing implementation and consulting services, submeter equipment and ongoing maintenance of our existing on premise licenses.
Professional services are billed either on a fixed rate per hour (time) and materials basis or on a fixed price basis, and revenue is recognized over time as we perform the obligation. Professional services are typically sold bundled in a contract with other on demand solutions but may be sold separately. Professional service contracts sold separately generally have terms of one year or less. For bundled arrangements, where the Company accounts for individual services as a separate performance obligation, the transaction price is allocated between separate services in the bundle based on their relative standalone selling prices.
Other revenues consist primarily of submeter equipment sales that include related installation services. Such sales are considered bundled, and revenue from these bundled sales is recognized in proportion to the number of fully installed units completed to date as compared to the total contracted number of units to be provided and installed. For all other equipment sales, we generally recognize revenue when control of the hardware has transferred to our client. Revenue recognized for on premise software sales generally consists of annual maintenance renewals on existing term or perpetual licenses, which is recognized ratably over the service period.
Contracts with Multiple Performance Obligations
The majority of the contracts we enter into with clients, including multiple contracts entered into at or near the same time with the same client, require us to provide one or more on demand software solutions, professional services and/or equipment. For these contracts, we account for individual performance obligations separately i) if they are distinct or ii) if the promised obligations represent a series of distinct services that are substantially the same and have the same pattern of transfer to the client. Once we determine the performance obligations, we determine the transaction price, which includes estimating the amount of variable consideration, if any, to be included in the transaction price. If the contract contains a single performance obligation, we allocate the entire transaction price to the single performance obligation. For contracts with multiple performance obligations, we allocate the transaction price to the separate performance obligations on a relative standalone selling price basis. The standalone selling prices of our services are typically estimated using a market assessment approach based on our overall pricing objectives taking into consideration market conditions and other factors including the number of solutions sold, client demographics, and the number and types of users within our contracts.
Sales, value add, and other taxes we collect from clients and remit to governmental authorities are excluded from revenues.

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Reserves for Variable Consideration
We recognize revenues from on demand and professional service sales at the net sales price (transaction price), which includes estimates of reserves we establish for credits we offer our clients in certain instances. These reserves are based on the amounts expected to be credited on the related sales and are classified as reductions of revenue and the related accounts receivable. Where appropriate, these estimates take into consideration relevant factors such as the Company’s historical experience, current contractual requirements, specific known market events and trends, and forecasted buying and payment patterns. These reserves reduce revenue to an amount that reflects the Company’s best estimates of the amount of consideration to which it is entitled and that it will ultimately receive based on the terms of the contract. The amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts of consideration ultimately received may differ from the Company’s estimates. If actual results in the future vary from the Company’s estimates, the Company will adjust these estimates, which will affect net revenue and earnings in the period such variances become known.
Deferred Commissions
Sales commissions, including sales-based incentive payments, earned by our direct sales force are considered incremental and recoverable costs of obtaining a contract with a client. These costs are deferred in “Other current assets” and “Other assets” and amortized into “Sales and marketing expense” on a straight line basis over a period of benefit that we have determined to be three years. We determined the period of benefit by taking into consideration our client contracts, our technology, historical pricing practices and other factors. We periodically review these capitalized costs for impairment.
Fair Value Measurements
Certain assets and liabilities are carried at fair value under GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Legal Contingencies
We review the status of each legal matter and record a provision for a liability when we consider that it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We review these provisions quarterly and make adjustments where needed as additional information becomes available. If either or both of the criteria are not met, we assess whether there is at least a reasonable possibility that a loss, or additional losses beyond those already accrued, may be incurred. If there is a reasonable possibility that a material loss (or additional material loss in excess of any accrual) may be incurred, we disclose an estimate of the amount of loss or range of losses, either individually or in the aggregate, as appropriate, if such an estimate can be made, or disclose that an estimate of loss cannot be made.
Recently Adopted Accounting Standards
Accounting Standards Update 2014-09
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09, as amended by certain supplementary ASU’s released in 2016, replaces all current GAAP guidance on this topic and eliminates all industry-specific guidance. The new revenue recognition standard requires the recognition of revenue when promised goods or services are transferred to clients in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also includes Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers, which requires the deferral of incremental costs of obtaining a contract with a client. Collectively, we refer to Topic 606 and Subtopic 340-40 as the “new revenue standard” or “ASC 606.”
We adopted the requirements of the new revenue standard on January 1, 2018 using the modified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings at the beginning of 2018. Comparative information from prior year periods has not been restated and continues to be reported under the accounting standards in effect for those periods. The cumulative effects of the changes made to our condensed consolidated January 1, 2018 balance sheet for the adoption of the new revenue standard were as follows:

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Balance at
December 31, 2017
 
Adjustments due
to ASU 2014-09
 
Balance at
January 1, 2018
 
(in thousands)
Assets
 
 
 
 
 
Accounts receivable, less allowance for doubtful accounts
$
124,505

 
$
(7,925
)
 
$
116,580

Other current assets
6,622

 
2,771

 
9,393

Deferred tax assets, net
44,887

 
(780
)
 
44,107

Other assets
11,010

 
4,459

 
15,469

Liabilities
 
 
 
 
 
Current portion of deferred revenue
116,622

 
(3,696
)
 
112,926

Stockholders’ Equity
 
 
 
 
 
Accumulated deficit
(75,046
)
 
2,221

 
(72,825
)
Adoption of the new revenue standard resulted in changes to our accounting policies for revenue recognition, certain variable considerations, and commissions expense. The adoption of the new revenue standard did not have a significant effect on our revenue; however, it did have an impact on the timing of when we expense commission costs incurred to obtain a contract and the reserves we establish for variable consideration from credits or other pricing accommodations we provide our clients. We expect the effect of the new revenue standard to be immaterial to our revenue on an ongoing basis. The primary effect to our net income on an ongoing basis relates to the reserve for credit accommodations and deferral of incremental commission costs incurred to obtain new contracts. Under the new revenue standard, we accrue for credit accommodations in our reserve during the month of billing and credits reduce this reserve when issued. Further, we now initially defer commission costs and amortize these costs to expense over a period of benefit that we have determined to be three years.
See Note 4 for additional required disclosures related to the impact of adopting the new revenue standard and our accounting for costs to obtain a contract.
Accounting Standards Update 2016-18
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash, which requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. This ASU must be adopted retrospectively.
We adopted ASU 2016-18 effective January 1, 2018. As a result of our adoption, changes in customer deposits held in restricted accounts will result in an increase or reduction in our cash flows from operating activities. Under previous rules, such changes were largely offset by the corresponding change in restricted cash and had a minimal impact on our statement of cash flows. The prior period financial statements included in this filing have been adjusted to reflect the adoption of ASU 2016-18. The effects of those adjustments to the Condensed Consolidated Statements of Cash Flows have been summarized in the table below:
 
Originally Reported
 
Effect of Change
 
As Adjusted
 
(in thousands)
Statement of Cash Flows for the six months ended June 30, 2017
 
 
 
 
 
Net cash provided by operating activities
$
80,464

 
$
15,188

 
$
95,652

Net cash used in investing activities
(158,007
)
 
7,637

 
(150,370
)
Cash, cash equivalents and restricted cash at end of period
324,591

 
106,479

 
431,070

Accounting Standards Update 2017-09
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. This ASU does not change the accounting for modifications but clarifies that modification accounting guidance should only be applied if there is a change to the fair value, vesting conditions, or award classification (as equity or liability) and would not be required if the changes are considered non-substantive. This new standard was effective for the Company on January 1, 2018. Adoption of ASU 2017-09 did not have a material impact on our consolidated financial statements.

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Accounting Standards Update 2017-01
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business to assist entities with evaluating whether a set of transferred assets and activities (a "set") is a business. Under the new guidance, an entity first determines whether substantially all of the fair value of the set is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the set is not a business. If the threshold is not met, the entity evaluates whether the set meets the requirements that a business include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. The provisions of this ASU became effective for the Company on January 1, 2018, and the adoption did not have a significant impact on our classification of businesses and complementary technologies acquired.
Accounting Standards Update 2016-01
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities and ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10) in February 2018, which provides clarification on certain guidance issued under ASU 2016-01. Among other things, ASU 2016-01 eliminates the cost method of accounting and requires that investments in equity securities that were previously accounted for under the cost method must now be measured at fair value, with changes in fair value recognized in net income. Equity instruments that do not have readily determinable fair values may be measured at cost less impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. This ASU became effective on January 1, 2018. The Company holds an investment which was accounted for under the cost method of accounting prior to January 1, 2018, which does not have a readily determinable fair value and has had no observable price change. Therefore, we continue to measure this investment at cost, less any impairment. The adoption of this standard did not have a material impact on our consolidated financial statements.
Recently Issued Accounting Standards
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under this ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. The amendments in this ASU are to be applied through a cumulative-effect adjustment to retained earnings as of the first reporting period in which the ASU is effective. We are currently evaluating this ASU, but the adoption is not expected to have a material impact on our consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which provides companies the option to reclassify tax effects stranded in accumulated other comprehensive income as a result of the 2017 Tax Cuts and Jobs Act (“Tax Reform Act”) to retained earnings. ASU 2018-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years, and should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Reform Act is recognized. Early adoption is permitted. We are currently evaluating this ASU, but the adoption is not expected to have a material impact on our consolidated financial statements.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which expands an entity’s ability to apply hedge accounting for nonfinancial and financial risk components and allows for a simplified approach for fair value hedging of interest rate risk. Certain of the amendments in this ASU as they relate to cash flow hedges, eliminate the requirement to separately record hedge ineffectiveness currently in earnings. Instead, the entire change in the fair value of the hedging instrument is recorded in Other Comprehensive Income (“OCI”), and amounts deferred in OCI will be reclassified to earnings in the same income statement line item in which the earnings effect of the hedged item is reported. Additionally, this ASU simplifies the hedge documentation and effectiveness assessment requirements under the previous guidance. ASU 2017-12 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. The changes in this ASU will be applied on a modified retrospective basis through a cumulative effect adjustment to the opening balance of retained earnings as of the initial application date.
While we are continuing to assess all potential impacts of ASU 2017-12 on our consolidated financial statements, its most immediate effect will be the initial recognition of the entire change in the fair value of our interest rate swaps in other comprehensive income. Similar to our current treatment of the effective portion of a change in fair value, the ineffective portion will be reclassified into interest expense as interest payments are made on our variable rate debt. Under our current practice, the ineffective portion is initially recorded as a component of interest expense in the period of change. We have not yet selected an adoption date and do not expect the changes in the ASU to have a material impact on our consolidated financial statements.

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In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments of this ASU allow companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, and the guidance is to be applied using a full or modified retrospective approach. We are currently evaluating the impact of adopting ASU 2017-11 on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted in fiscal years beginning after December 15, 2018. The amendments in this ASU are to be applied through a cumulative-effect adjustment to retained earnings as of the first reporting period in which the ASU is effective. We have not yet selected a transition date and are currently evaluating the impact of adopting ASU 2016-13 on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new guidance requires lessees to recognize assets and liabilities arising from all leases with a lease term of more than 12 months, including those classified as operating leases under previous accounting guidance. It also requires disclosure of key information about leasing arrangements to increase transparency and comparability among organizations.
ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. In July 2018, the FASB approved an optional transition method to allow companies to initially account for the impact of the adoption with a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2019. This will eliminate the need to restate amounts presented prior to January 1, 2019. We will adopt the standard effective January 1, 2019, and we expect to elect this optional transition method, as well as certain practical expedients permitted under the transition guidance. We are in the process of assessing the population for the new standard and evaluating the impact to our consolidated financial statements. We continue to anticipate that the standard will have a material impact on our balance sheet, but do not expect a material impact to the income statement. The most significant impact will be from the recognition of right of use assets and lease liabilities for operating leases, while we expect our accounting for finance leases to remain substantially unchanged.
3. Acquisitions
Current Acquisition Activity
ClickPay
In April 2018, we entered into an acquisition agreement by which we acquired substantially all of the outstanding membership units of NovelPay, LLC (“NovelPay”), other than those owned by ClickPay Services, Inc. On the same day, we also entered into an agreement and plan of merger, by which we acquired all of the outstanding stock of ClickPay Services, Inc. (collectively with NovelPay, “ClickPay”). ClickPay provides an electronic payment platform servicing resident units across multiple segments of real estate, which offers integrated payment services to increase operational efficiencies for property owners and managers. The acquisition of ClickPay broadens our presence in the real estate industry, and solidifies the integration of our leasing platform with third-party property management systems.
We acquired ClickPay for a purchase price of $216.9 million. The purchase price consisted of a cash payment of $138.8 million, net of cash acquired of $7.5 million, the issuance of 682,688 shares of our common stock valued at $35.9 million, a deferred obligation of up to $20.0 million, which had a fair value of $18.9 million on the date of acquisition, and a liability of $23.6 million related to put and call option agreements, which had a fair value of $23.3 million on the date of acquisition. Subject to any indemnification claims made, the deferred obligation will be released on the first and second anniversary dates of the closing date. The acquisition of ClickPay was financed using funds available under our Credit Facility, as defined in Note 7, and cash on hand.
Pursuant to the acquisition agreement, certain holders initially retained units representing approximately 12% of the membership units of NovelPay, subject to put rights that may be exercised by the holders on or after September 1, 2018, and call rights that may be exercised by us on or after October 1, 2018. The exercise price of the put and call rights is the same as the per unit price of the membership units purchased at the closing. We evaluated the put and call options and determined the put and call options were embedded within the noncontrolling interests, and the economic substance represented a financing

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arrangement of the noncontrolling interests because of the substantially fixed exercise price and stated exercise dates. In June 2018, we and one of the remaining NovelPay noncontrolling interest holders agreed to waive the put and call exercise date, and we completed the purchase of such holder’s membership units for 395,206 shares of common stock valued at $20.8 million. As of June 30, 2018, approximately 3% of the membership units of NovelPay were held by the remaining noncontrolling interest holders. No earnings have been attributed to the noncontrolling interests in the accompanying Condensed Consolidated Statements of Operations. Such interests, valued at $2.8 million, are recorded as a liability in the accompanying Condensed Consolidated Balance Sheet.
The acquired identified intangible assets consisted of developed technology, client relationships, and trade names. These intangible assets were assigned estimated useful lives of seventen, and ten years, respectively. Preliminary goodwill recognized of $168.0 million is primarily comprised of anticipated synergies from leveraging ClickPay’s electronic payment platform, which is compatible with multiple third-party property management systems. Goodwill and the acquired identified intangible assets arising from the acquisition of NovelPay are deductible for tax purposes; those arising from the acquisition of ClickPay Services, Inc. are not. Accounts receivable acquired had a gross contractual value of $2.8 million at acquisition, of which $0.1 million was estimated to be uncollectible. Acquisition costs associated with this transaction totaled $1.4 million and were expensed as incurred.
Purchase Price Allocation
The estimated fair values of assets acquired and liabilities assumed are provisional and are based primarily on the information available as of the acquisition date. We believe this information provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed, but we are awaiting additional information necessary to finalize those values. Therefore, the provisional measurements of fair value are subject to change, and such changes could be significant. We expect to finalize the valuation of these assets and liabilities as soon as practicable, but no later than one year from the acquisition date. The preliminary allocation of the ClickPay purchase price is as follows, in thousands:
Restricted cash
 
 
 
 
 
 
 
 
$
1,313

Accounts receivable
 
 
 
 
 
 
 
 
2,714

Property, equipment, and software
 
 
 
 
 
 
 
 
89

Intangible assets:
 
 
 
 
 
 
 
 
 
Developed product technologies
 
 
 
 
 
 
 
 
29,100

Client relationships
 
 
 
 
 
 
 
 
20,700

Trade names
 
 
 
 
 
 
 
 
2,900

Goodwill
 
 
 
 
 
 
 
 
168,033

Other assets
 
 
 
 
 
 
 
 
489

Accounts payable and accrued liabilities
 
 
 
 
 
 
 
 
(2,698
)
Client deposits held in restricted accounts
 
 
 
 
 
 
 
 
(1,313
)
Deferred tax liability, net
 
 
 
 
 
 
 
 
(4,430
)
Total purchase price

 

 

 

 
$
216,897

At June 30, 2018, the deferred obligation related to this acquisition totaled $20.0 million and was carried net of a discount of $0.9 million, in the Condensed Consolidated Balance Sheet.
2017 Acquisitions
Lease Rent Options
In February 2017, we entered into an agreement with The Rainmaker Ventures, LLC (“Rainmaker”) to acquire substantially all of the assets and liabilities that comprised Rainmaker’s multifamily revenue optimization business (“LRO”). We completed the acquisition when the transaction closed in December 2017. LRO is a revenue management solution that empowers optimized pricing for multifamily housing communities. This acquisition extended our revenue management footprint, augmented our repository of real-time lease transaction data, and increased our data science talent and capabilities. We also expect the acquisition of LRO to increase the market penetration of our YieldStar Revenue Management solution and drive revenue growth in our other asset optimization solutions.
We acquired LRO for a purchase price of $299.9 million. The purchase price consisted of a cash payment of $298.0 million, a deferred cash obligation of up to $1.6 million, which had a fair value of $1.5 million on the date of acquisition, and the assumption of certain liabilities totaling $0.4 million. Subject to any indemnification claims made, the deferred cash obligation will be released on the first anniversary of the closing date. The acquisition of LRO was financed using funds available under our Credit Facility, as defined in Note 7, and cash on hand.

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The acquired identified intangible assets consisted of developed technology, client relationships, and trade names. These intangible assets were assigned estimated useful lives of seven, ten, and two years, respectively. Preliminary goodwill recognized of $202.9 million is primarily comprised of anticipated synergies from leveraging LRO’s repository of lease transaction data and data science talent with our existing platform of pricing, demand, and credit optimization tools. Goodwill and the acquired identified intangible assets are deductible for tax purposes. Accounts receivable acquired had a gross contractual value of $4.7 million at acquisition, of which $0.2 million was estimated to be uncollectible. Acquisition costs associated with this transaction totaled $13.8 million, including $10.7 million incurred related to the Hart-Scott-Rodino Antitrust Improvements Act review process, and were expensed as incurred.
PEX Software
In October 2017, we acquired all of the issued and outstanding shares of PEX Software Limited (“PEX”). PEX is a rental housing solution provider based in the United Kingdom that helps companies transform work practices and service delivery models, create and leverage competitive advantage, reduce costs, and scale businesses. PEX’s platform serves market-leading clients in the United Kingdom, European Union, and Australia. The acquisition of PEX will help us to secure a leading market position in the private rental segment of the United Kingdom’s housing market and facilitate our expansion into the European Union and other international markets.
We acquired PEX for a purchase price of $6.0 million. The purchase price consisted of a cash payment of $5.1 million at closing, net of cash acquired of $0.1 million, and a deferred cash obligation of up to $1.0 million. The deferred cash obligation is payable over a period of 24 months, and its fair value was $0.9 million at the date of acquisition. This acquisition was financed using cash on hand, which included a portion of the net offering proceeds from the issuance of the Convertible Notes.
The acquired identified intangible assets consisted of developed technology, client relationships, and trade names. These intangible assets were assigned estimated useful lives of seven, nine, and six years, respectively. Preliminary goodwill recognized of $3.3 million is chiefly attributable to the presence we gained in international markets and anticipated synergies from combining PEX’s consumer facing solutions with our platform of property management, accounting, and asset optimization solutions. Goodwill and the acquired identified intangible assets are not deductible for tax purposes. Acquisition costs associated with this transaction totaled $0.4 million and were expensed as incurred.
On-Site
In September 2017, we acquired certain discrete assets of On-Site Manager, Inc., including its ownership interest in its majority-owned subsidiary, DepositIQ & RentersIQ Insurance Agency, LLC (“DIQ”) (collectively, “On-Site”). We also acquired the remaining minority interest in DIQ. On-Site is a leasing platform for property managers and renters that assimilates leads from any source and converts them into signed leases for both the multifamily and single family housing industries. The acquisition of On-Site increased the footprint of our screening services and added incremental consumer-oriented data that benefits our data analytics solutions. Additionally, we anticipate On-Site will improve the integration of our leasing solutions into other major property management systems.
We acquired On-Site, including the minority interest in DIQ, for an aggregate purchase price of $253.4 million. The purchase price consisted of a cash payment of $225.3 million at closing, net of cash acquired of $1.7 million, and a deferred cash obligation of up to $29.6 million. The fair value of the deferred cash obligation was $28.1 million at the date of acquisition. Subject to any indemnification claims made, the deferred cash obligation will be paid over a period of 36 months, with the majority due approximately twelve months following the acquisition date. This acquisition was financed using cash on hand, which included a portion of the net offering proceeds from the issuance of the Convertible Notes.
The acquired identifiable intangible assets consisted of trade names, developed technologies, and client relationships, which will be amortized over estimated useful lives of two, five, and ten years, respectively. Preliminary goodwill recognized of $184.5 million primarily arises from anticipated synergies from leveraging our existing cost structure and integrated sales force. Goodwill and the acquired identified intangible assets arising from the acquisition of On-Site Manager are deductible for tax purposes; those arising from the acquisition of DIQ are not. Accounts receivable acquired had a gross contractual value of $5.6 million at acquisition, of which $0.9 million was estimated to be uncollectible. Acquisition costs associated with this transaction, including those related to the Hart-Scott-Rodino Antitrust Improvements Act review process, totaled $1.8 million and were expensed as incurred.
American Utility Management
In June 2017, RealPage acquired substantially all of the assets of American Utility Management (“AUM”), a provider of utility and energy management services for the multifamily housing industry. AUM helps maximize cost recovery, reduces energy usage and expense, and provides the tools operators of rental real estate need to manage their utilities more effectively. Additionally, AUM’s platform includes tools that enable operators to benchmark energy cost and consumption against their peers. The acquired assets will be integrated with our existing resident utility management platform and our data analytics tools.

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We acquired AUM for a purchase price of $69.4 million. The purchase price consisted of a cash payment of $64.8 million at closing, net of cash acquired of $0.1 million, and a deferred cash obligation of up to $5.1 million. The fair value of the deferred cash obligation was $4.6 million at the date of acquisition and is payable over a period of four years following the date of acquisition. This acquisition was financed using cash on hand, which included a portion of the net offering proceeds from the issuance of the Convertible Notes.
The acquired identifiable intangible assets consisted of trade names, developed technology, non-compete agreements, and client relationships, which will be amortized over estimated useful lives of two, three, five, and ten years, respectively. Preliminary goodwill recognized of $45.9 million primarily arises from anticipated synergies from integrating the acquired assets with our existing resident utility management system and leveraging the energy cost and consumption benchmarking capabilities and data acquired. Goodwill and the acquired identified intangible assets are deductible for tax purposes. Accounts receivable acquired had a gross contractual value of $2.7 million at acquisition, of which $0.3 million was estimated to be uncollectible. Acquisition costs associated with this transaction totaled $0.3 million and were expensed as incurred.
Axiometrics LLC
In January 2017, we acquired substantially all of the assets of Axiometrics LLC (“Axiometrics”). Axiometrics provides its customers with timely market intelligence on apartment markets accumulated from survey and research data. Axiometrics also provides tools to analyze the data at an asset level by multiple variables such as asset class, age, and specific competitive floor plans. The acquisition of Axiometrics expanded our multifamily data analytics platform and was integrated with MPF Research, our market research database, to form Data Analytics.
We acquired Axiometrics for a purchase price of $73.8 million. The purchase price consisted of a cash payment of $66.1 million at closing; deferred cash obligations of up to $7.5 million, payable over a period of two years following the date of acquisition; and contingent cash obligations of up to $5.0 million if certain revenue targets are achieved during the twelve-month period ending December 31, 2018. The fair value of the deferred and contingent cash obligations was $6.9 million and $0.8 million, respectively, at the date of acquisition. This acquisition was financed using cash on hand.
The acquired identified intangible assets consisted of developed technology, client relationships, and trade names. These intangible assets were assigned estimated useful lives of five, ten, and three years, respectively. We recognized goodwill in the amount of $54.2 million related to this acquisition, which is primarily comprised of anticipated synergies with our existing multifamily data analytics platform. Goodwill and the acquired identified intangible assets are deductible for tax purposes. Acquisition costs associated with this transaction totaled $0.3 million and were expensed as incurred.

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Purchase Price Allocation
For certain of the acquisitions in the table below, the estimated fair values of assets acquired and liabilities assumed are provisional and are based primarily on the information available as of the acquisition dates. The allocation of each purchase price, including the effects of measurement period adjustments recorded as of June 30, 2018, was as follows:
 
Axiometrics
 
AUM
 
On-Site
 
PEX
 
LRO
 
(Final)
 
(Final)
 
(Provisional)
 
(Provisional)
 
(Provisional)
 
(in thousands)
Restricted cash
$

 
$
5,954

 
$
3,458

 
$

 
$

Accounts receivable
1,620

 
2,409

 
4,718

 
107

 
4,498

Property, equipment, and software
400

 
319

 
789

 
8

 
1,507

Intangible assets:
 
 
 
 
 
 
 
 
 
Developed product technologies
15,500

 
10,800

 
16,960

 
2,350

 
42,000

Client relationships
6,830

 
7,470

 
41,360

 
590

 
49,000

Trade names
3,200

 
208

 
7,000

 
160

 
666

Non-compete agreements

 
3,920

 

 

 

Goodwill
54,190

 
45,907

 
184,520

 
3,309

 
202,852

Other assets
273

 
850

 
826

 
78

 
475

Accounts payable and accrued liabilities
(367
)
 
(2,150
)
 
(938
)
 
(242
)
 
(214
)
Client deposits held in restricted accounts

 
(5,954
)
 
(3,458
)
 

 

Deferred revenue
(7,115
)
 
(321
)
 
(565
)
 
(221
)
 
(861
)
Other long-term liabilities
(774
)
 

 

 

 

Deferred tax liability

 

 
(1,240
)
 
(108
)
 

Total purchase price
$
73,757

 
$
69,412

 
$
253,430

 
$
6,031

 
$
299,923

At June 30, 2018 and December 31, 2017, deferred cash obligations related to acquisitions completed in 2017 totaled $38.2 million and $44.8 million, and were carried net of a discount and indemnified obligations of $0.8 million and $2.3 million, respectively, in the Condensed Consolidated Balance Sheets. The aggregate fair value of contingent cash obligations related to these acquisitions was $0.1 million and $0.2 million at June 30, 2018 and December 31, 2017, respectively. During the three and six months ended June 30, 2018 and 2017, we recognized a gain of $0.1 million and $0.2 million, respectively, due to changes in the fair value of contingent cash obligations related to acquisitions completed in 2017. We made deferred cash payments of $6.0 million during the six months ended June 30, 2018 related to these acquisitions.
Acquisition Activity Prior to 2017
At June 30, 2018 and December 31, 2017, the aggregate carrying value of deferred cash obligations related to acquisitions completed prior to 2017 totaled $2.7 million and $4.4 million, respectively. We paid deferred cash obligations related to these acquisitions in the amount of $1.8 million and $7.0 million during the six months ended June 30, 2018 and 2017, respectively.
No contingent cash obligations remained outstanding at June 30, 2018 related to acquisitions completed prior to 2017. The aggregate carrying value of contingent cash obligations related to these acquisitions was estimated to be $0.2 million at December 31, 2017. During the six months ended June 30, 2018 and 2017, we paid contingent cash obligations in the amount of $0.2 million and $0.5 million, respectively, related to acquisitions completed prior to 2017. We recognized an expense of $0.1 million and $0.2 million during the three and six months ended June 30, 2017, respectively, due to changes in the fair value of contingent cash obligations related to these acquisitions.

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Pro Forma Results of Acquisitions
The following table presents unaudited pro forma results of operations for the three and six months ended June 30, 2018 and 2017, as if the aforementioned 2018 and 2017 acquisitions had occurred as of January 1, 2017 and January 1, 2016, respectively. The pro forma information includes the business combination accounting effects resulting from these acquisitions, including interest expense, tax expense or benefit, and additional amortization resulting from the valuation of amortizable intangible assets. We prepared the pro forma financial information for the combined entities for comparative purposes only, and it is not indicative of what actual results would have been if the acquisitions had occurred at the beginning of the periods presented, or of future results.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
Pro Forma
 
2017
Pro Forma
 
2018
Pro Forma
 
2017
Pro Forma
 
(unaudited)
 
(in thousands, except per share amounts)
Total revenue
$
218,259

 
$
197,492

 
$
427,145

 
$
386,592

Net income
8,966

 
4,867

 
18,757

 
8,001

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.11

 
$
0.06

 
$
0.23

 
$
0.10

Diluted
$
0.10

 
$
0.06

 
$
0.21

 
$
0.10

4. Revenue Recognition
On January 1, 2018, we adopted the new revenue standard using the modified retrospective method for those contracts with remaining service obligations as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue standard, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period.
We recorded a net increase to opening equity of $2.2 million as of January 1, 2018 as the cumulative effect of adopting the new revenue standard. The effect on revenues of adopting the new revenue standard for the three and six months ended June 30, 2018 is presented in the “Impact on Consolidated Financial Statements” section below.
Disaggregation of Revenue
The following table presents our revenues disaggregated by major revenue source. Sales and usage-based taxes are excluded from revenues.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
On demand
 
 
 
 
 
 
 
Property management
$
46,523

 
$
41,405

 
$
91,842

 
$
81,746

Resident services
85,330

 
64,860

 
162,507

 
125,829

Leasing and marketing
42,841

 
29,325

 
82,257

 
57,140

Asset optimization
32,251

 
19,137

 
63,639

 
36,225

Total on demand revenue
206,945

 
154,727

 
400,245

 
300,940

 
 
 
 
 
 
 
 
Professional and other
9,307

 
6,579

 
17,308

 
13,285

Total revenue
$
216,252

 
$
161,306

 
$
417,553

 
$
314,225

On Demand Revenue
We generate the majority of our on demand revenue by licensing software-as-a-service (“SaaS”) solutions to our clients on a subscription basis. We group our SaaS solutions in four primary categories: property management, resident services, leasing and marketing and asset optimization. Each solution category generally represents a different stage of the renter life cycle and the operations of a property owner’s or manager’s rental properties. Each of our solution categories includes multiple product centers that provide distinct capabilities that can be bundled as a package or licensed separately. Each on demand solution is provided pursuant to contractual commitments that typically include a promise that we will stand ready, on a monthly basis, to deliver access to our technology platform over defined service delivery periods. The Company has concluded

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these promises represent a single performance obligation that includes a series of distinct services since they provide a form of rental real estate management and property operation service that we consider to be substantially similar and which has the same pattern of transfer to the client. The majority of our on demand sales revenue continues to be recognized over time as clients receive and consume the benefits of accessing our on demand solutions.
Consideration for the Company’s on demand subscription services consist of fixed, variable and usage-based fees. We invoice a portion of our fees at the initial order date and then monthly or annually thereafter. Subscription fees are generally fixed based on the number of sites and the level of services selected by the client.
We sell certain usage-based services, primarily within our property management, resident services and leasing and marketing solutions, to clients based on a fixed rate per transaction. Revenues are calculated based on the number of transactions processed monthly and will vary from month to month based on actual usage of these transaction-based services over the contract term, which is typically one year in duration. The fees for usage-based services are not associated with every distinct service promised in the series of distinct services we provide our clients. As a result, we allocate variable usage-based fees only to the related transactions and recognize them in the month that usage occurs. Usage-based fees are considered fully constrained until the related usage occurs.
As part of our resident services offerings, we offer risk mitigation services to our clients by acting as an insurance agent and derive commission revenue from the sale of insurance products to our clients’ residents. The commissions are based upon a percentage of the premium that the insurance company underwriting partners charge to the policyholder and are subject to forfeiture in instances where a policyholder cancels prior to the end of the policy. The overall insurance services we provide represent a single performance obligation that qualifies as a separate series in accordance with the new revenue standard. Our contracts with our underwriting partners also provide for contingent commissions to be paid to us in accordance with the agreements. Such commissions are variable in nature and are calculated in accordance with the terms of the agreements, which consider, on the policies sold by us, earned premiums less i) earned agent commissions; ii) a percent of premium retained by our underwriting partners; iii) incurred losses; and iv) profit retained by our underwriting partners during the time period. Our estimate of contingent commission revenue considers historical loss experience on the policies sold by us. The contingent commissions are not associated with every distinct service promised in the series of distinct insurance services we provide. We generally accrue and recognize contingent commissions monthly based on estimates of the factors described above.
Professional Services and Other Revenues
Professional services and other revenues generally consist of the fees we receive for providing implementation and consulting services, submeter equipment and ongoing maintenance of our existing on premise licenses.
Professional Services: Professional services revenues primarily consist of fees for implementation services, consulting services and training. Professional services are billed either on a fixed rate per hour (time) and materials basis or on a fixed price basis. Professional services are typically sold bundled in a contract with other on demand solutions but may be sold separately. Professional service contracts sold separately generally have terms of one year or less. For bundled arrangements, the Company accounts for individual services as a separate performance obligation if a service is separately identifiable from other items in the bundled arrangement and if a client can benefit from it on its own or with other resources readily available to the client. In these cases, the transaction price is allocated between separate services in the bundle based on their relative standalone selling prices.
Equipment: The majority of other revenue is related to our sale of submeter hardware and bundled installation services we provide as part of our utility management solutions. We consider the delivery and installation of submeters to be part of a single performance obligation due to the significance of the integration and interdependency of the installation services with the meter equipment. Our typical payment terms for submeter installations require a percentage of the overall transaction price to be paid upfront, with the remainder billed as progress payments. We recognize submeter revenue in proportion to the number of fully installed units completed to date as compared to the total contracted number of units to be provided and installed. We also sell other hardware used for storing mail packages and for processing renter payments and invoices to our clients. For all other equipment sales, we generally recognize revenue when control of the hardware has transferred to our client, which occurs at a point in time, typically upon delivery to the client.
On Premise: A small percentage of other revenue is derived from sales of our on premise software solutions, which are distributed to our clients and maintained locally on the client’s hardware. We no longer actively market our legacy on premise software solutions to new clients, and the majority of on premise revenue consists of maintenance renewals from clients who renew for an additional one-year term. Maintenance renewal revenue is recognized ratably over the service period based upon the standalone selling price of that service obligation.

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Contract Balances
Contract assets generally consist of amounts recognized as revenue before they can be invoiced to clients or amounts invoiced to clients prior to the period in which the service is provided where the right to payment is subject to conditions other than just the passage of time. These contract assets are included in “Accounts receivable” in the accompanying Condensed Consolidated Financial Statements and related disclosures. Contract liabilities are comprised of billings or payments received from our clients in advance of performance under the contract. We refer to these contract liabilities as “Deferred revenue” in the accompanying Condensed Consolidated Financial Statements and related disclosures. We recognized $86.7 million of on demand revenue during the six months ended June 30, 2018, which was included in the line “Deferred revenue” in the accompanying Condensed Consolidated Balance Sheet as of the beginning of the period.
Contract Acquisition Costs
Under the new revenue standard, we are required to initially capitalize certain contract acquisition costs consisting of commissions earned when contracts are signed. We will subsequently amortize such costs to expense over a period of benefit that we have determined to be three years. Under the previous guidance, we expensed commissions in the period they were earned by our sales representatives. As of June 30, 2018, the current and noncurrent balance of capitalized commissions costs recorded in the lines “Other current assets” and “Other assets” in the accompanying Condensed Consolidated Balance Sheet was $4.7 million and $6.6 million, respectively. During the three and six months ended June 30, 2018, we amortized commission costs totaling $1.0 million and $1.8 million, respectively. No impairment loss was recognized in relation to these costs capitalized.
Transaction Price Allocated to Remaining Performance Obligations
Our client contracts from license and subscription fees relating to our on demand software solutions typically possess a one year renewable term. As such, we disclose within Item 2 the annual client value to allow investors to evaluate future revenue potential.
Certain clients commit to purchase our solutions for terms ranging from two to seven years. We expect to recognize approximately $365.3 million of revenue in the future related to performance obligations for on demand contracts with an original duration greater than one year that were unsatisfied or partially unsatisfied as of June 30, 2018. Our estimate does not include amounts related to:
professional and usage-based services that are billed and recognized based on services performed in a certain period;
amounts attributable to unexercised contract renewals that represent a material right; or
amounts attributable to unexercised client options to purchase services that do not represent a material right.
We expect to recognize revenue on approximately 75.0% of the remaining performance obligations over the next 24 months, with the remainder recognized thereafter. Revenue from remaining performance obligations for professional service contracts as of June 30, 2018 was immaterial.

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Impact on Consolidated Financial Statements
In accordance with the new revenue standard requirements, the following tables summarize the effects of this new standard on selected unaudited line items within our Condensed Consolidated Statements of Operations and Balance Sheet:
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
As reported
 
Balances without adoption of ASU 2014-09
 
Effect of Change
on Net Income
Higher/(Lower)
 
As reported
 
Balances without adoption of ASU 2014-09
 
Effect of Change
on Net Income
Higher/(Lower)
 
(in thousands)
Revenue
 
 
 
 
 
 
 
 
 
 
 
On demand
$
206,945

 
$
207,421

 
$
(476
)
 
$
400,245

 
$
400,876

 
$
(631
)
Professional and other
9,307

 
8,676

 
631

 
17,308

 
16,095

 
1,213

Total revenue
$
216,252

 
$
216,097

 
$
155

 
$
417,553

 
$
416,971

 
$
582

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
54,488

 
$
56,785

 
$
2,297

 
$
104,729

 
$
108,886

 
$
4,157

 
 
 
 
 
 
 
 
 
 
 
 
Net income before income taxes
$
8,290

 
$
5,838

 
$
2,452

 
$
18,890

 
$
14,151

 
$
4,739

Income tax (benefit) expense
(189
)
 
(1,096
)
 
(907
)
 
(490
)
 
(2,243
)
 
(1,753
)
Net income
$
8,479

 
$
6,934

 
$
1,545

 
$
19,380

 
$
16,394

 
$
2,986

 
Balances at June 30, 2018 - as reported
 
Balances at June 30, 2018 without adoption of ASU 2014-09
 
Effect of Change
Higher/(Lower)
 
(in thousands)
Assets
 
 
 
 
 
Accounts receivable, less allowance for doubtful accounts
$
112,484

 
$
119,930

 
$
(7,446
)
Other current assets
15,812

 
11,085

 
4,727

Other assets
20,710

 
14,109

 
6,601

Liabilities
 
 
 
 
 
Current portion of deferred revenue
111,238

 
115,161

 
(3,923
)
Deferred revenue
5,181

 
5,181

 

The adoption of ASU 2014-09 had no net effect on the Company’s Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2018.

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5. Property, Equipment, and Software
Property, equipment, and software consisted of the following at June 30, 2018 and December 31, 2017:
 
June 30, 2018
 
December 31, 2017
 
(in thousands)
Leasehold improvements
$
61,357

 
$
59,179

Data processing and communications equipment
76,357

 
83,922

Furniture, fixtures, and other equipment
31,635

 
28,752

Software
118,735

 
107,924

Property, equipment, and software, gross
288,084

 
279,777

Less: Accumulated depreciation and amortization
(142,744
)
 
(131,349
)
Property, equipment, and software, net
$
145,340

 
$
148,428

Depreciation and amortization expense for property, equipment, and purchased software was $7.5 million and $6.9 million for the three months ended, and $14.4 million and $13.5 million for the six months ended June 30, 2018 and 2017, respectively.
The carrying amount of capitalized software development costs was $83.2 million and $73.4 million at June 30, 2018 and December 31, 2017, respectively. Total accumulated amortization related to these assets was $33.4 million and $27.8 million at June 30, 2018 and December 31, 2017, respectively. Amortization expense related to capitalized software development costs totaled $3.0 million and $1.8 million for the three months ended, and $5.5 million and $3.4 million for the six months ended June 30, 2018 and 2017, respectively.
6. Goodwill and Identified Intangible Assets
Changes in the carrying amount of goodwill during the six months ended June 30, 2018 were as follows, in thousands:
Balance as of December 31, 2017
$
751,052

Goodwill acquired
168,033

Measurement period adjustments
(300
)
Balance as of June 30, 2018
$
918,785

Identified intangible assets consisted of the following at June 30, 2018 and December 31, 2017:
 
 
June 30, 2018
 
December 31, 2017
 
 
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
 
(in thousands)
Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Developed technologies
 
$
194,194

 
$
(88,434
)
 
$
105,760

 
$
164,640

 
$
(76,577
)
 
$
88,063

Client relationships
 
234,418

 
(91,120
)
 
143,298

 
213,728

 
(78,390
)
 
135,338

Vendor relationships
 
5,650

 
(5,650
)
 

 
5,650

 
(5,650
)
 

Trade names
 
20,406

 
(7,786
)
 
12,620

 
17,556

 
(4,325
)
 
13,231

Non-compete agreements
 
4,173

 
(1,000
)
 
3,173

 
4,173

 
(605
)
 
3,568

Total finite-lived intangible assets
 
458,841

 
(193,990
)
 
264,851

 
405,747

 
(165,547
)
 
240,200

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Trade names
 
12,132

 

 
12,132

 
12,137

 

 
12,137

Total identified intangible assets
 
$
470,973

 
$
(193,990
)
 
$
276,983

 
$
417,884

 
$
(165,547
)
 
$
252,337

Amortization expense related to finite-lived intangible assets was $14.7 million and $6.5 million for the three months ended June 30, 2018 and 2017, respectively. For the six months ended June 30, 2018 and 2017, amortization expense related to finite-lived intangible assets was $28.5 million and $12.6 million, respectively.
7Debt
Credit Facility

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On September 30, 2014, we entered into an agreement for a secured credit facility to refinance our outstanding revolving loans. The credit facility agreement was subsequently amended during the years ended 2016 and 2017, and was further amended in March 2018 by the Seventh Amendment, discussed below (inclusive of these amendments, the “Credit Facility”). For more information regarding these amendments, refer to our 2017 Form 10-K. The Credit Facility matures on February 27, 2022, and includes the following:
Revolving Facility: The Credit Facility provides $350.0 million in aggregate commitments for revolving loans, with sublimits of $10.0 million for the issuance of letters of credit and $20.0 million for swingline loans (“Revolving Facility”).
Term Loan: In February 2016, we originated a term loan in the original principal amount of $125.0 million under the Credit Facility (“Term Loan”). We made quarterly principal payments of $0.8 million through March 31, 2018, which increased to $1.5 million beginning on June 30, 2018, and will increase again to $3.1 million beginning on June 30, 2020.
Delayed Draw Term Loan: In December 2017, we drew funds of $200.0 million available under the delayed draw term loan (“Delayed Draw Term Loan”). Subsequent to disbursal of the Delayed Draw Term Loan funds, we began making quarterly principal payments on the Delayed Draw Term Loan equal to an initial amount of $1.3 million through March 31, 2018. The quarterly principal payments increased to $2.5 million beginning on June 30, 2018, and will increase again to $5.0 million beginning on June 30, 2020.
Revolving loans under the Credit Facility may be voluntarily prepaid and re-borrowed. Principal payments on the Term Loan and Delayed Draw Term Loan (collectively, the “Term Loans”) are due in quarterly installments, as described above, and may not be re-borrowed. All outstanding principal and accrued but unpaid interest is due on the maturity date. The Term Loans are subject to mandatory repayment requirements in the event of certain asset sales or if certain insurance or condemnation events occur, subject to customary reinvestment provisions. The Company may prepay the Term Loans in whole or in part at any time, without premium or penalty, with prepayment amounts to be applied to remaining scheduled principal amortization payments as specified by the Company.
Accordion Feature: The Credit Facility also allows us, subject to certain conditions, to request additional term loans or revolving commitments up to an aggregate principal amount of $150.0 million, plus an amount that would not cause our Senior Leverage Ratio, as defined below, to exceed 3.50 to 1.00.
At our option, amounts outstanding under the Credit Facility accrue interest at a per annum rate equal to either LIBOR, plus a margin ranging from 1.25% to 2.25%, or the Base Rate, plus a margin ranging from 0.25% to 1.25% (“Applicable Margin”). The base LIBOR is, at our discretion, equal to either one, two, three, or six month LIBOR. The Base Rate is defined as the greater of Wells Fargo's prime rate, the Federal Funds Rate plus 0.50%, or one month LIBOR plus 1.00%. In each case, the Applicable Margin is determined based upon our Net Leverage Ratio, as defined below. Accrued interest on amounts outstanding under the Credit Facility is due and payable quarterly, in arrears, for loans bearing interest at the Base Rate and at the end of the applicable interest period in the case of loans bearing interest at the adjusted LIBOR.
Certain of our existing and future material domestic subsidiaries are required to guarantee our obligations under the Credit Facility, and the obligations under the Credit Facility are secured by substantially all of our assets and the assets of the subsidiary guarantors. The Credit Facility contains customary covenants, subject in each case to customary exceptions and qualifications. Our covenants include, among other limitations, a requirement that we comply with a maximum Consolidated Net Leverage Ratio, a minimum Consolidated Interest Coverage Ratio, and a maximum Consolidated Senior Secured Net Leverage Ratio.
Consolidated Net Leverage Ratio: The Consolidated Net Leverage Ratio (“Net Leverage Ratio”) is the ratio of consolidated funded indebtedness, as defined in the Credit Facility, on the last day of each fiscal quarter to the sum of the four previous consecutive fiscal quarters’ consolidated EBITDA, as defined in the Credit Facility. As modified by the Seventh Amendment, this ratio generally may not exceed 5.00 to 1.00. The Net Leverage Ratio may increase, at our option, to 5.50 to 1.00 following an acquisition having aggregate consideration greater than $150.0 million and occurring within a specified time period following the Seventh Amendment Effective Date, defined below. The option to increase this ratio may be elected no more than one time during any consecutive 24 month period over the term of the Credit Facility, and lasts for four consecutive fiscal quarters. As of June 30, 2018, we had not exercised our option to increase the Net Leverage Ratio.
Consolidated Interest Coverage Ratio: The Consolidated Interest Coverage Ratio (“Interest Coverage Ratio”) is the ratio of the sum of our four previous fiscal quarters’ consolidated EBITDA to consolidated interest expense, as defined in the Credit Facility, for the same period. The Interest Coverage Ratio must not be less than 3.00 to 1.00 on the last day of each fiscal quarter. The Interest Coverage Ratio excludes non-cash interest attributable to the Convertible Notes (see Convertible Notes below).
Consolidated Senior Secured Net Leverage Ratio: The Consolidated Senior Secured Net Leverage Ratio (“Senior Leverage Ratio”) is the ratio of consolidated senior secured indebtedness, as defined in the Credit Facility, on the last day

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of each fiscal quarter to the sum of the four previous consecutive fiscal quarters’ consolidated EBITDA and, as modified by the Seventh Amendment, may not exceed 3.75 to 1.00. At our option, this ratio may be increased to 4.25 to 1.00 for four consecutive fiscal quarters following the completion of an acquisition having aggregate consideration greater than $150.0 million and occurring within a specified time period following the Seventh Amendment Effective Date, defined below. We are not permitted to exercise this option more than one time during any consecutive 24 month period. As of June 30, 2018, we had not exercised our option to increase the Senior Leverage Ratio.
As of June 30, 2018, we were in compliance with the covenants under our Credit Facility.
Seventh Amendment: On March 12, 2018 (“Seventh Amendment Effective Date”), we entered into the seventh amendment (“Seventh Amendment”) to the Credit Facility. This amendment allowed for an increase of $150.0 million in available credit under our Revolving Facility, consequently providing aggregate commitments for revolving loans up to $350.0 million. Among other modifications, the Seventh Amendment provided for an increase in the maximum Net Leverage Ratio and Senior Leverage Ratio to 5.00 to 1.00 and 3.75 to 1.00, respectively. The Seventh Amendment also modified the Accordion Feature definition to allow for incremental commitments which would not cause our Senior Leverage Ratio to exceed 3.50 to 1.00. We incurred debt issuance costs in the amount of $1.1 million related to the execution of this amendment.
As of June 30, 2018, we had $350.0 million of available credit under our Revolving Facility. Principal outstanding for the Revolving Facility was $50.0 million at December 31, 2017. No principal remained outstanding for the Revolving Facility at June 30, 2018. We incur commitment fees on the unused portion of the Revolving Facility.
Principal outstanding, and unamortized debt issuance costs for the Term Loans, were as follows at June 30, 2018 and December 31, 2017:
 
June 30, 2018
 
December 31, 2017
 
Term Loan
 
Delayed Draw Term Loan
 
Term Loan
 
Delayed Draw Term Loan
 
(in thousands)
Principal outstanding
$
118,057

 
$
195,000

 
$
120,356

 
$
198,750

Unamortized issuance costs
(202
)
 
(754
)
 
(233
)
 
(821
)
Unamortized discount
(161
)
 
(425
)
 
(185
)
 
(490
)
Carrying value
$
117,694

 
$
193,821

 
$
119,938

 
$
197,439

Unamortized debt issuance costs for the Revolving Facility were $1.5 million and $0.6 million at June 30, 2018 and December 31, 2017, respectively, and are included in the line “Other assets” in the Condensed Consolidated Balance Sheets.
Future maturities of principal under the Term Loans are as follows for the years ending December 31, in thousands:
 
Term Loans
2018
$
8,066

2019
16,133

2020
28,232

2021
32,266

Thereafter
228,360

 
$
313,057

Convertible Notes
In May 2017, the Company issued convertible senior notes with aggregate principal of $345.0 million (including the underwriters’ exercise in full of their over-allotment option of $45.0 million) which mature on November 15, 2022 (“Convertible Notes”). The Convertible Notes were issued under an indenture dated May 23, 2017 (“Indenture”), by and between the Company and Wells Fargo Bank, N.A., as Trustee. We received net proceeds from the offering of approximately $304.2 million after adjusting for debt issuance costs, including the underwriting discount, the net cash used to purchase the Note Hedges and the proceeds from the issuance of the Warrants which are discussed below.
The Convertible Notes accrue interest at a rate of 1.50%, payable semi-annually on May 15 and November 15 of each year beginning on November 15, 2017. On or after May 15, 2022, and until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Convertible Notes at their option. The Convertible Notes are convertible at an initial rate of 23.84 shares per $1,000 of principal (equivalent to an initial conversion price of approximately $41.95 per share of our common stock). The conversion rate is subject to customary adjustments for certain events as described in the Indenture. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our

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common stock or a combination of cash and shares of our common stock, at our election. It is our current intent to settle conversions of the Convertible Notes through combination settlement, which involves repayment of the principal portion in cash and any excess of the conversion value over the principal amount in shares of our common stock. Based on our closing stock price of $55.10 on June 30, 2018, the if-converted value exceeded the aggregate principal amount of the Convertible Notes by $108.2 million. As described below, we entered into convertible note hedge transactions, which are expected to reduce the potential dilution with respect to our common stock upon conversion of the Convertible Notes.
Holders may convert their Convertible Notes, at their option, prior to May 15, 2022 only under the following circumstances:
during any calendar quarter commencing after the calendar quarter ending on June 30, 2017 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
during the five business day period after any five consecutive trading day period (the “Measurement Period”) in which the trading price per $1,000 principal amount of the Convertible Notes for each trading day of the Measurement Period was less than 98% of the product of the last reported sales price of our common stock and the conversion rate on each such trading day; or
upon the occurrence of specified corporate events, as defined in the Indenture.
We may not redeem the Convertible Notes prior to their maturity date, and no sinking fund is provided for them. If we undergo a fundamental change, as described in the Indenture, subject to certain conditions, holders may require us to repurchase for cash all or any portion of their Convertible Notes. The fundamental change repurchase price is equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. If holders elect to convert their Convertible Notes in connection with a make-whole fundamental change, as described in the Indenture, the Company will, to the extent provided in the Indenture, increase the conversion rate applicable to the Convertible Notes.
The Convertible Notes are senior unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Convertible Notes and equal in right of payment to any of our existing and future unsecured indebtedness that is not subordinated. The Convertible Notes are effectively junior in right of payment to any of our secured indebtedness (to the extent of the value of assets securing such indebtedness) and structurally junior to all existing and future indebtedness and other liabilities, including trade payables, of our subsidiaries. The Indenture does not limit the amount of debt that we or our subsidiaries may incur. The Convertible Notes are not guaranteed by any of our subsidiaries.
The Indenture does not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness, or the issuance or repurchase of securities by us or any of our subsidiaries. The Indenture contains customary events of default with respect to the Convertible Notes and provides that upon certain events of default occurring and continuing, the Trustee may, and the Trustee at the request of holders of at least 25% in principal amount of the Convertible Notes shall, declare all of principal and accrued and unpaid interest, if any, of the Convertible Notes to be due and payable. In case of certain events of bankruptcy, insolvency or reorganization, involving us or a significant subsidiary, all of the principal of and accrued and unpaid interest on the Convertible Notes will automatically become due and payable.
In accounting for the issuance of the Convertible Notes, we separated the Convertible Notes into liability and equity components. We allocated $282.5 million of the Convertible Notes to the liability component, and $62.5 million to the equity component. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the term of the Convertible Notes using the effective interest method. The equity component will not be remeasured as long as it continues to meet the conditions for equity classification.
We incurred issuance costs of $9.8 million related to the Convertible Notes. Issuance costs were allocated to the liability and equity components based on their relative values. Issuance costs attributable to the liability component are being amortized to interest expense over the term of the Convertible Notes, and issuance costs attributable to the equity component are included along with the equity component in stockholders' equity.
During the quarter ended June 30, 2018, the closing price of our common stock exceeded 130% of the conversion price of the Convertible Notes for more than 20 trading days during the last 30 consecutive trading days of the quarter, thereby satisfying one of the early conversion events. As a result, the Convertible Notes are convertible at any time during the fiscal quarter ending September 30, 2018.
Accordingly, as of June 30, 2018, the carrying amount of the Convertible Notes of $286.9 million was reclassified from non-current liabilities to current liabilities in the accompanying Condensed Consolidated Balance Sheets. No gain or loss was recognized when the debt became convertible.

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The net carrying amount of the Convertible Notes at June 30, 2018 and December 31, 2017, was as follows:
 
June 30, 2018
 
December 31, 2017
 
(in thousands)
Liability component:
 
 
 
Principal amount
$
345,000

 
$
345,000

Unamortized discount
(51,471
)
 
(56,557
)
Unamortized debt issuance costs
(6,621
)
 
(7,244
)
 
$
286,908

 
$
281,199

 
 
 
 
Equity component, net of issuance costs and deferred tax:
$
61,390

 
$
61,390

The following table sets forth total interest expense related to the Convertible Notes for the three and six months ended June 30, 2018 and 2017:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
Contractual interest expense
$
1,294

 
$
561

 
$
2,588

 
$
561

Amortization of debt discount
2,562

 
1,052

 
5,086

 
1,052

Amortization of debt issuance costs
328

 
134

 
651

 
134

 
$
4,184

 
$
1,747

 
$
8,325

 
$
1,747

The effective interest rate of the liability component for the three and six months ended June 30, 2018 and 2017 was 5.87%.
Convertible Note Hedges and Warrants
On May 23, 2017, we entered into privately negotiated transactions to purchase hedge instruments (“Note Hedges”), covering approximately 8.2 million shares of our common stock at a cost of $62.5 million. The Note Hedges are subject to anti-dilution provisions substantially similar to those of the Convertible Notes, have a strike price of approximately $41.95 per share, are exercisable by us upon any conversion under the Convertible Notes, and expire on November 15, 2022.
The Note Hedges are generally expected to reduce the potential dilution to our common stock (or, in the event the conversion is settled in cash, to reduce our cash payment obligation) in the event that at the time of conversion our stock price exceeds the conversion price under the Convertible Notes. The cost of the Note Hedges is expected to be tax deductible as an original issue discount over the life of the Convertible Notes, as the Convertible Notes and the Note Hedges represent an integrated debt instrument for tax purposes. The cost of the Note Hedges was recorded as a reduction of our additional paid-in capital in the accompanying Condensed Consolidated Financial Statements.
On May 23, 2017, the Company also sold warrants for the purchase of up to 8.2 million shares of our common stock for aggregate proceeds of $31.5 million (“Warrants”). The Warrants have a strike price of $57.58 per share and are subject to customary anti-dilution provisions. The Warrants will expire in ratable portions on a series of expiration dates commencing on February 15, 2023. The proceeds from the issuance of the Warrants were recorded as an increase to our additional paid-in capital in the accompanying Condensed Consolidated Financial Statements.
The Note Hedges are transactions that are separate from the terms of the Convertible Notes and the Warrants, and holders of the Convertible Notes and the Warrants have no rights with respect to the Note Hedges. The Warrants are similarly separate in both terms and rights from the Note Hedges and the Convertible Notes. As of June 30, 2018, no Note Hedges or Warrants had been exercised.

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8. Stock-based Expense
During the three and six months ended June 30, 2018, the Company made the following grants of time-based restricted stock:
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
Vesting
163,766

 
978,444

 
Shares vest ratably over a period of twelve quarters beginning on the first day of the second calendar quarter immediately following the grant date.

 
3,600

 
Shares fully vested on the first day of the calendar quarter immediately following the grant date.
33,846

 
33,846

 
Shares vest ratably over a period of four quarters beginning on the first day of the calendar quarter immediately following the grant date.
During the six months ended June 30, 2018, we granted 517,364 shares of restricted stock that become eligible to vest based on the achievement of certain market-based conditions, as described below:
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
Condition to Become Eligible to Vest

 
129,341

 
After the grant date and prior to July 1, 2021, the average closing price per share of our common stock equals or exceeds $60.89 for twenty consecutive trading days.

 
129,341

 
After the grant date and prior to July 1, 2021, the average closing price per share of our common stock equals or exceeds $66.98 for twenty consecutive trading days.

 
129,341

 
After the grant date and prior to July 1, 2021, the average closing price per share of our common stock equals or exceeds $73.07 for twenty consecutive trading days.

 
129,341

 
After the grant date and prior to July 1, 2021, the average closing price per share of our common stock equals or exceeds $85.24 for twenty consecutive trading days.
Shares that become eligible to vest, if any, become Eligible Shares. These awards vest ratably over four calendar quarters beginning on the first day of the next calendar quarter immediately following the date on which they become Eligible Shares. Vesting is conditional upon the recipient remaining a service provider, as defined in the plan document, to the Company through each applicable vesting date.
Grants of restricted stock may be fulfilled through the issuance of previously authorized but unissued common stock shares, or the reissuance of shares held in treasury. All awards were granted under the Amended and Restated 2010 Equity Incentive Plan.
The Company capitalized $0.4 million and $0.5 million of stock-based expense for software development costs during the three and six months ended June 30, 2018, respectively.
9. Commitments and Contingencies
Lease Commitments
We lease office facilities and equipment for various terms under long-term, non-cancellable operating lease agreements. The leases expire at various dates through 2028 and provide for renewal options. The agreements generally require us to pay for executory costs such as real estate taxes, insurance, and repairs. At June 30, 2018, minimum annual rental commitments under non-cancellable operating leases were as follows for the years ending December 31, in thousands:
2018
$
8,085

2019
14,342

2020
11,829

2021
10,986

2022
9,336

Thereafter
46,121

 
$
100,699

Guarantor Arrangements
We have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The term of the indemnification period is for the officer or

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director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director and officer insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, we had no liabilities recorded for these agreements as of June 30, 2018 or December 31, 2017.
In the ordinary course of our business, we include standard indemnification provisions in our agreements with clients. Pursuant to these provisions, we indemnify our clients for losses suffered or incurred in connection with third-party claims that our products infringed upon any U.S. patent, copyright, trademark, or other intellectual property right. Where applicable, we generally limit such infringement indemnities to those claims directed solely to our products and not in combination with other software or products. With respect to our products, we also generally reserve the right to resolve any such claims by designing a non-infringing alternative, by obtaining a license on reasonable terms, or by terminating our relationship with the client and refunding the client’s fees.
The potential amount of future payments to defend lawsuits or settle indemnified claims under these indemnification provisions is unlimited in certain agreements; however, we believe the estimated fair value of these indemnification provisions is minimal, and, accordingly, we had no liabilities recorded for these agreements as of June 30, 2018 or December 31, 2017.
Litigation
From time to time, in the normal course of our business, we are a party to litigation matters and claims. Litigation can be expensive and disruptive to our normal business operations. Moreover, the results of complex legal proceedings are difficult to predict, and our view of these matters may change in the future as the litigation and events related thereto unfold. We expense legal fees as incurred. Insurance recoveries associated with legal costs incurred are recorded when they are deemed probable of recovery.
On February 23, 2015, we received from the Federal Trade Commission (“FTC”) a Civil Investigative Demand consisting of interrogatories and a request to produce documents relating to our compliance with the Fair Credit Reporting Act (“FCRA”). We responded to the request and requests for additional information by the FTC. On November 2, 2017, the FTC staff informed us of its belief that there is a basis for claims that could include monetary and injunctive relief against us for failing to follow reasonable procedures to assure maximum possible accuracy of our tenant screening reports. We believe that our business practices did not, and do not, violate the FCRA or any other laws, and we intend to vigorously defend our position. We have had ongoing discussions with the FTC to attempt to resolve the matter. However, we cannot be certain that the matter will be resolved as a result of these discussions.
At June 30, 2018 and December 31, 2017, we had accrued amounts for estimated settlement losses related to legal matters. The Company does not believe there is a reasonable possibility that a material loss exceeding amounts already recognized may have been incurred as of the date of the balance sheets presented herein.
We are involved in other litigation matters not described above that are not likely to be material either individually or in the aggregate based on information available at this time. Our view of these matters may change as the litigation and events related thereto unfold.
10Net Income per Share
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by using the weighted average number of common shares outstanding, after giving effect to all potential dilutive common shares outstanding during the period. Included within diluted net income per share is the dilutive effect of outstanding stock options and restricted stock using the treasury stock method. Weighted average shares from common share equivalents in the amount of 78,968 and 27,422 for the three months ended and 322,234 and 362,522 for the six months ended June 30, 2018 and 2017, respectively, were excluded from the dilutive shares outstanding because their effect was anti-dilutive.
For purposes of considering the Convertible Notes in determining diluted net income per share, it is our current intent to settle conversions of the Convertible Notes through combination settlement, which involves repayment of the principal portion in cash and any excess of the conversion value over the principal amount (the “conversion premium”) in shares of our common stock. Therefore, only the impact of the conversion premium is included in total dilutive weighted average shares outstanding using the treasury stock method. The dilutive effect of the conversion premium for the three and six month periods ended June 30, 2018 is shown in the table below.
The Warrants sold in connection with the issuance of the Convertible Notes will not be considered in calculating the total dilutive weighted average shares outstanding until the price of our common stock exceeds the strike price of $57.58 per share, as described in Note 7. When the price of our common stock exceeds the strike price of the Warrants, the effect of the additional shares that may be issued upon exercise of the Warrants will be included in total dilutive weighted average shares outstanding using the treasury stock method. The Note Hedges purchased in connection with the issuance of the Convertible

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Notes are considered to be anti-dilutive and therefore do not impact our calculation of diluted net income per share. Refer to Note 7 for further discussion regarding the Convertible Notes.
We exclude common shares held in escrow pursuant to business combinations from the calculation of basic weighted average shares outstanding where the release of such shares is contingent upon an event not solely subject to the passage of time. As of June 30, 2018, there were 187,480 contingently returnable shares related to the ClickPay acquisition which are excluded from the computation of basic net income per share as these shares are subject to sellers’ indemnification obligations and are being held in escrow. There were no contingently returnable shares as of June 30, 2017. Dilutive common shares outstanding include the weighted average contingently issuable shares discussed above that are currently in escrow, as well as the weighted average contingently issuable shares to be issued and placed in escrow on the first anniversary date of the acquisition. These shares are subject to release to the sellers on the first and second anniversary date of the acquisition which are contingent on the sellers’ indemnification obligations. Refer to Note 3 for further discussion regarding the ClickPay acquisition.
 
The following table presents the calculation of basic and diluted net income per share:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands, except per share amounts)
Numerator:
 
 
 
 
 
 
 
Net income
$
8,479

 
$
6,213

 
$
19,380

 
$
14,408

Denominator:
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Weighted average common shares used in computing basic net income per share
85,124

 
79,018


83,156


78,642

Diluted:
 
 
 
 
 
 
 
Add weighted average effect of dilutive securities:
 
 
 
 
 
 
 
Stock options and restricted stock
2,474

 
2,907

 
2,310

 
3,002

Convertible Notes
2,116

 

 
1,720

 

Contingently issuable shares in connection with ClickPay acquisition
291

 

 
146

 

Weighted average common shares used in computing diluted net income per share
90,005

 
81,925


87,332


81,644

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.08

 
$
0.23

 
$
0.18

Diluted
$
0.09

 
$
0.08

 
$
0.22

 
$
0.18

11. Income Taxes
We make estimates and judgments in determining our provision for income taxes for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.
Our provision for income taxes in interim periods is based on our estimated annual effective tax rate. We record cumulative adjustments in the quarter in which a change in the estimated annual effective rate is determined. The estimated annual effective tax rate calculation does not include the effect of discrete events that may occur during the year. The effect of these events, if any, is recorded in the quarter in which the event occurs.
On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted into law which changed U.S. tax law, including, but not limited to: (1) reducing the U.S. federal corporate income tax rate from 35% to 21% (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries (3) generally eliminating U.S. federal corporate income taxes on dividends from foreign subsidiaries (4) capitalizing U.S. R&D expenses which are amortized over five years and (5) other changes affecting how foreign and domestic earnings are taxed. Due to the complexities involved in accounting for the enactment of the new law, the SEC issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of US GAAP in situations where a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. At December 31, 2017, we recorded provisional estimates in accordance with SAB 118, including a provisional

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determination of the impact of the change in corporate tax rates on our deferred tax balances, and a provisional estimate of the amount of transition tax associated with the mandatory deemed repatriation of foreign earnings. We did not make any changes to our provisional estimates during the quarter ended June 30, 2018. We will continue to analyze the impact of the Tax Reform Act as additional guidance is provided by the IRS and state taxing authorities. Additional impacts will be recorded as they are identified during the measurement period provided for in SAB 118.
The Tax Reform Act includes a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries and a base erosion anti-abuse tax (“BEAT”) measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. These provisions of the Tax Reform Act were effective for the Company beginning January 1, 2018. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. Given the complexity of the GILTI provisions, we are still evaluating the effects of the GILTI provisions and have not yet determined our accounting policy. At June 30, 2018, because we are still evaluating the GILTI provisions and our analysis of future taxable income that is subject to GILTI, we have included GILTI related to current year operations only in our estimated annual effective tax rate and have not provided additional GILTI on deferred items.
Our effective income tax rate was (2.6)% and (19.2)% for the six months ended June 30, 2018 and 2017, respectively. Our effective rate is lower than the statutory rate for the six months ended June 30, 2018 and 2017, primarily because of excess tax benefits from stock-based compensation of $7.1 million and $7.2 million, respectively, recognized as discrete items, as required by ASU 2016-09.
As a result of our adoption of ASU 2014-09, on January 1, 2018, we recorded a net deferred tax liability of $0.8 million, with a corresponding increase to accumulated deficit.
12. Fair Value Measurements
We record certain assets and financial liabilities at fair value on a recurring basis. We determine fair values based on the price we would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability.
The prescribed fair value hierarchy is as follows:
Level 1 - Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs are quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable; and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 - Inputs are derived from valuation techniques in which one or more of the significant inputs or value drivers are unobservable.
The categorization of an asset or liability within the fair value hierarchy is based on the inputs described above and does not necessarily correspond to our perceived risk of that asset or liability. Moreover, the methods used by us may produce a fair value calculation that is not indicative of the net realizable value or reflective of future fair values. Furthermore, although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments and non-financial assets and liabilities could result in a different fair value measurement at the reporting date.
Assets and liabilities measured at fair value on a recurring basis:
Interest rate swap agreements: The fair value of our interest rate swap agreements are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the swap agreements. This analysis reflects the contractual terms of the swap agreements, including the period to maturity, and uses observable market-based inputs, including interest rate curves. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.
Although we have determined that the majority of the inputs used to value its swap agreements fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our swap agreements utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and our counterparties. We have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our swap agreements’ positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our swap agreements. As a result, we determined that our valuation of the swap agreements in its entirety is classified in Level 2 of the fair value hierarchy.
Contingent consideration obligations: Contingent consideration obligations consist of potential obligations related to our acquisition activity. The amount to be paid under these obligations is contingent upon the achievement of stipulated operational or financial targets by the business subsequent to acquisition. The fair value of contingent consideration obligations is estimated

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using a probability weighted discount model which considers the achievement of the conditions upon which the respective contingent obligation is dependent. The probability of achieving the specified conditions is assessed by applying a Monte Carlo weighted-average model. Inputs into the valuation model include a discount rate specific to the acquired entity, a measure of the estimated volatility, and the risk free rate of return.
In addition to the inputs described above, the fair value estimates consider the projected future operating or financial results for the factor upon which the respective contingent obligation is dependent. The fair value estimates are generally sensitive to changes in these projections. We develop the projected future operating results based on an analysis of historical results, market conditions, and the expected impact of anticipated changes in our overall business and/or product strategies.
Significant unobservable inputs used in the contingent consideration fair value measurements included the following at June 30, 2018 and December 31, 2017:
 
June 30, 2018
 
December 31, 2017
Discount rates
16.5
%
 
16.3
%
Volatility rates
25.0
%
 
24.0
%
Risk free rate of return
2.2
%
 
1.6
%
The following tables disclose the assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017, by the fair value hierarchy levels as described above:
 
Fair value at June 30, 2018
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Interest rate swap agreements
$
1,465

 
$

 
$
1,465

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration related to the acquisition of:
 
 
 
 
 
 
 
Axiometrics
52

 

 

 
52

Total liabilities measured at fair value
$
52

 
$

 
$

 
$
52

 
Fair value at December 31, 2017
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Assets:

 
 
 
 
 
 
Interest rate swap agreements
$
1,329

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