NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
1. Nature of Business
AppFolio, Inc. ("we," "us" or "our") is a leading provider of cloud business management solutions for the real estate industry. Our solutions are designed to enable our customers to digitally transform their businesses, address critical business operations and deliver a better customer experience. Digital transformation is effectively a requirement for business success in the modern world, and the way we work and live requires powerful software solutions.
2. Summary of Significant Accounting Policies
Basis of Presentation and Significant Accounting Policies
The accompanying unaudited Condensed Consolidated Financial Statements were prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information and disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted. Accordingly, these Condensed Consolidated Financial Statements should be read in conjunction with our audited consolidated financial statements and the related notes included in our Annual Report, which was filed with the SEC on February 9, 2023. The year-end condensed balance sheet was derived from our audited consolidated financial statements. Our unaudited interim Condensed Consolidated Financial Statements include, in the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair statement of our Condensed Consolidated Financial Statements. The operating results for the three months ended March 31, 2023 are not necessarily indicative of the results expected for the full year ending December 31, 2023.
Reclassification
We reclassified certain amounts in our Condensed Consolidated Statements of Cash Flows within the cash flows from operating activities section in the prior year to conform to the current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue, expenses, other income, and provision for income taxes during the reporting period. Assets and liabilities which are subject to judgment and use of estimates include the fair value of financial instruments, capitalized software development costs, period of benefit associated with deferred costs, incremental borrowing rate used to measure operating lease liabilities, the recoverability of goodwill and long-lived assets, income taxes, useful lives associated with property and equipment and intangible assets, contingencies, assumptions underlying performance-based compensation (whether cash or stock-based), and assumptions underlying stock-based compensation. Actual results could differ from those estimates and any such differences may have a material impact on our Condensed Consolidated Financial Statements.
Net Loss per Common Share
Net loss per common share was the same for shares of our Class A and Class B common stock because they are entitled to the same liquidation and dividend rights and are therefore combined in the table below. The following table presents a reconciliation of the weighted average number of shares of our Class A and Class B common stock used to compute net loss per common share (in thousands):
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| | Three Months Ended March 31, | | |
| | 2023 | | 2022 | | | | |
Weighted average common shares outstanding | | 35,451 | | | 34,840 | | | | | |
Less: Weighted average unvested restricted shares subject to repurchase | | 8 | | | 4 | | | | | |
Weighted average common shares outstanding; basic and diluted | | 35,443 | | | 34,836 | | | | | |
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Because we reported a net loss for all periods presented, all potentially dilutive common shares are anti-dilutive for these periods and have been excluded from the calculation of net loss per share.
Recent Accounting Pronouncements Not Yet Adopted
In October 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2021-08, "Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers," which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, "Revenue from Contracts with Customers," as if the acquirer had originated the contracts. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. We adopted ASU 2021-08 on January 1, 2023. Adoption did not have an impact on our condensed consolidated financial statements.
3. Investment Securities and Fair Value Measurements
Investment Securities
Investment securities classified as available-for-sale consisted of the following as of March 31, 2023 and December 31, 2022 (in thousands):
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| March 31, 2023 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Corporate bonds | $ | 9,631 | | | $ | — | | | $ | (52) | | | $ | 9,579 | |
Agency securities | 11,259 | | | — | | | (317) | | | 10,942 | |
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Treasury securities | 58,249 | | | — | | | (1,025) | | | 57,224 | |
Total available-for-sale investment securities | $ | 79,139 | | | $ | — | | | $ | (1,394) | | | $ | 77,745 | |
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| December 31, 2022 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Corporate bonds | $ | 17,497 | | | $ | 2 | | | $ | (112) | | | $ | 17,387 | |
Agency securities | 17,507 | | | — | | | (484) | | | 17,023 | |
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Treasury securities | 81,605 | | | — | | | (1,557) | | | 80,048 | |
Total available-for-sale investment securities | $ | 116,609 | | | $ | 2 | | | $ | (2,153) | | | $ | 114,458 | |
As of March 31, 2023, the decline in fair value below amortized cost basis was not considered other than temporary as it is more likely than not we will hold the securities until maturity or recovery of the cost basis. No allowance for credit losses for available-for-sale investment securities was recorded as of March 31, 2023 or December 31, 2022.
The fair values of available-for-sale investment securities, by remaining contractual maturity, are as follows (in thousands):
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| March 31, 2023 | | December 31, 2022 |
| Amortized Cost | | Estimated Fair Value | | Amortized Cost | | Estimated Fair Value |
Due in one year or less | $ | 66,348 | | | $ | 65,022 | | | $ | 90,822 | | | $ | 89,297 | |
Due after one year through three years | 12,791 | | | 12,723 | | | 25,787 | | | 25,161 | |
Total available-for-sale investment securities | $ | 79,139 | | | $ | 77,745 | | | $ | 116,609 | | | $ | 114,458 | |
During the three months ended March 31, 2023 and 2022, we had sales and maturities of investment securities, as follows (in thousands):
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| Three Months Ended March 31, 2023 |
| Gross Realized Gains | | Gross Realized Losses | | Gross Proceeds from Sales | | Gross Proceeds from Maturities |
Corporate bonds | $ | 3 | | | $ | — | | | $ | 1,013 | | | $ | 6,860 | |
Agency securities | — | | | — | | | — | | | 6,250 | |
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Treasury securities | — | | | — | | | — | | | 24,780 | |
Total | $ | 3 | | | $ | — | | | $ | 1,013 | | | $ | 37,890 | |
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| Three Months Ended March 31, 2022 |
| Gross Realized Gains | | Gross Realized Losses | | Gross Proceeds from Sales | | Gross Proceeds from Maturities |
Corporate bonds | $ | — | | | $ | — | | | $ | — | | | $ | 12,343 | |
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Treasury securities | — | | | — | | | — | | | 11,000 | |
Total | $ | — | | | $ | — | | | $ | — | | | $ | 23,343 | |
Fair Value Measurements
Recurring Fair Value Measurements
The following tables present our financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2023 and December 31, 2022 by level within the fair value hierarchy (in thousands):
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| March 31, 2023 |
| Level 1 | | Level 2 | | | | Total Fair Value |
Cash equivalents: | | | | | | | |
Money market funds | $ | 24,442 | | | $ | — | | | | | $ | 24,442 | |
Treasury securities | 56,173 | | | — | | | | | 56,173 | |
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Available-for-sale investment securities: | | | | | | | |
Corporate bonds | — | | | 9,579 | | | | | 9,579 | |
Agency securities | — | | | 10,942 | | | | | 10,942 | |
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Treasury securities | 57,224 | | | — | | | | | 57,224 | |
Total | $ | 137,839 | | | $ | 20,521 | | | | | $ | 158,360 | |
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| December 31, 2022 |
| Level 1 | | Level 2 | | | | Total Fair Value |
Cash equivalents: | | | | | | | |
Money market funds | $ | 41,973 | | | $ | — | | | | | $ | 41,973 | |
Treasury securities | 1,287 | | | — | | | | | 1,287 | |
Available-for-sale investment securities: | | | | | | | |
Corporate bonds | — | | | 17,387 | | | | | 17,387 | |
Agency securities | — | | | 17,023 | | | | | 17,023 | |
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Treasury securities | 80,048 | | | — | | | | | 80,048 | |
Total | $ | 123,308 | | | $ | 34,410 | | | | | $ | 157,718 | |
The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities approximate their fair value because of the short maturity of these items.
Fair value for our Level 1 investment securities is based on market prices for identical assets. Our Level 2 securities were priced by a pricing vendor. The pricing vendor utilizes the most recent observable market information in pricing these securities or, if specific prices are not available for these securities, other observable inputs like market transactions involving comparable securities are used.
4. Capitalized Software Development Costs, net
Capitalized software development costs were as follows (in thousands):
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| | March 31, 2023 | | December 31, 2022 |
Capitalized software development costs, gross | | $ | 128,120 | | | $ | 129,749 | |
Less: Accumulated amortization | | (97,653) | | | (94,434) | |
Capitalized software development costs, net | | $ | 30,467 | | | $ | 35,315 | |
Capitalized software development costs were $1.0 million and $4.1 million for the three months ended March 31, 2023 and 2022, respectively. Amortization expense with respect to capitalized software development costs totaled $5.9 million and $6.1 million for the three months ended March 31, 2023 and 2022. During the three months ended March 31, 2023 and 2022, we disposed of $2.2 million and $0.8 million, respectively, of fully amortized capitalized software development costs.
Future amortization expense with respect to capitalized software development costs is estimated as follows (in thousands):
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Years Ending December 31, |
2023 | | $ | 13,707 | |
2024 | | 11,598 | |
2025 | | 4,567 | |
2026 | | 595 | |
Total amortization expense | | $ | 30,467 | |
5. Intangible Assets, net
Intangible assets consisted of the following (in thousands, except years):
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| | March 31, 2023 |
| | Gross Carrying Value | | Accumulated Amortization | | Net Carrying Value | | Weighted Average Useful Life in Years |
Customer relationships | | $ | 1,670 | | | $ | (1,503) | | | $ | 167 | | | 5.0 |
Database | | 4,710 | | | (2,002) | | | 2,708 | | | 10.0 |
Technology | | 6,539 | | | (6,539) | | | — | | | 4.0 |
Trademarks and trade names | | 1,520 | | | (1,288) | | | 232 | | | 5.0 |
Partner relationships | | 680 | | | (680) | | | — | | | 3.0 |
Non-compete agreements | | 7,340 | | | (6,239) | | | 1,101 | | | 5.0 |
Domain names | | 90 | | | (84) | | | 6 | | | 5.0 |
Patents | | 252 | | | (252) | | | — | | | 5.0 |
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Total intangible assets, net | | $ | 22,801 | | | $ | (18,587) | | | $ | 4,214 | | | 5.8 |
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| | December 31, 2022 |
| | Gross Carrying Value | | Accumulated Amortization | | Net Carrying Value | | Weighted Average Useful Life in Years |
Customer relationships | | $ | 1,670 | | | $ | (1,448) | | | $ | 222 | | | 5.0 |
Database | | 4,710 | | | (1,884) | | | 2,826 | | | 10.0 |
Technology | | 6,539 | | | (6,539) | | | — | | | 4.0 |
Trademarks and trade names | | 1,520 | | | (1,211) | | | 309 | | | 5.0 |
Partner relationships | | 680 | | | (680) | | | — | | | 3.0 |
Non-compete agreements | | 7,340 | | | (5,872) | | | 1,468 | | | 5.0 |
Domain names | | 90 | | | (82) | | | 8 | | | 5.0 |
Patents | | 252 | | | (252) | | | — | | | 5.0 |
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Total intangible assets, net | | $ | 22,801 | | | $ | (17,968) | | | $ | 4,833 | | | 4.7 |
Amortization expense with respect to intangible assets totaled $0.6 million and $1.2 million for the three months ended March 31, 2023 and 2022, respectively. Future amortization expense with respect to intangible assets is estimated as follows (in thousands):
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Years Ending December 31, |
2023 | | $ | 1,857 | |
2024 | | 473 | |
2025 | | 471 | |
2026 | | 471 | |
2027 | | 471 | |
Thereafter | | 471 | |
Total amortization expense | | $ | 4,214 | |
6. Accrued Employee Expenses
Accrued employee expenses consisted of the following (in thousands):
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| | March 31, 2023 | | December 31, 2022 |
Accrued vacation | | $ | 13,263 | | | $ | 12,067 | |
Accrued bonuses | | 5,525 | | | 13,806 | |
Accrued severance | | 16,693 | | | 496 | |
Accrued payroll and other | | 11,606 | | | 8,007 | |
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Total accrued employee expenses | | $ | 47,087 | | | $ | 34,376 | |
Accrued severance as of March 31, 2023 is primarily related to $14.9 million of separation costs associated with our former Chief Executive Officer's Transition and Separation Agreement, dated March 1, 2023 ("Separation Agreement"), which will be paid out in the second quarter of 2023.
7. Leases
Operating leases for our corporate offices have remaining lease terms ranging from one to ten years, some of which include options to extend the leases for up to ten years. These options to extend have not been recognized as part of our operating lease right-of-use assets and lease liabilities as it is not reasonably certain that we will exercise these options. Our lease agreements do not contain any residual value guarantees or material restrictive covenants. Certain leases contain provisions for property-related costs that are variable in nature for which we are responsible, including common area maintenance, which are expensed as incurred.
The components of lease expense recognized in the Condensed Consolidated Statements of Operations were as follows (in thousands):
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| Three Months Ended March 31, | | |
| 2023 | | 2022 | | | | |
Operating lease cost | $ | 1,145 | | | $ | 1,447 | | | | | |
Variable lease cost | 573 | | | 123 | | | | | |
Total lease cost | $ | 1,718 | | | $ | 1,570 | | | | | |
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Lease-related assets and liabilities were as follows (in thousands):
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| March 31, 2023 | | December 31, 2022 |
Assets | | | |
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Operating lease right-of-use assets | $ | 20,849 | | | $ | 23,485 | |
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Liabilities | | | |
Other current liabilities | $ | 3,132 | | | $ | 3,357 | |
Operating lease liabilities | 45,257 | | | 50,237 | |
Total lease liabilities | $ | 48,389 | | | $ | 53,594 | |
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In January 2023, we entered into an amendment to the lease agreement for our San Diego facility. We remeasured the lease liability and recorded a reduction to the lease liability and right-of-use asset using the discount rate at the modification date, which resulted in a gain of $2.4 million in the Condensed Consolidated Statements of Operations.
Future minimum lease payments under non-cancellable leases as of March 31, 2023 were as follows (in thousands):
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Years ending December 31, | |
2023 | $ | 1,077 | |
2024 | 5,607 | |
2025 | 6,837 | |
2026 | 7,035 | |
2027 | 7,239 | |
Thereafter | 35,043 | |
Total future minimum lease payments | 62,838 | |
Less: imputed interest | (14,449) | |
Total | $ | 48,389 | |
8. Commitments and Contingencies
Legal Liability to Landlord Insurance
We have a wholly owned subsidiary, Terra Mar Insurance Company, Inc., which was established in connection with reinsuring liability to landlord insurance policies offered to our customers by our third-party service provider. Each policy has a limit of $100 thousand per incident. We assume a 100% quota share of the liability to landlord insurance policies placed with our customers by our third-party service provider. We accrue for reported claims, and include an estimate of losses incurred but not reported by our property manager customers, in cost of revenue because we bear the risk related to all such claims. Our estimated liability for reported claims and incurred but not reported claims as of March 31, 2023 and December 31, 2022 was $3.4 million and $2.7 million, respectively, and is included in Other current liabilities on our Condensed Consolidated Balance Sheets.
Included in Prepaid expenses and other current assets as of March 31, 2023 and December 31, 2022 are $2.8 million and $4.5 million, respectively, of deposits held with a third party related to requirements to maintain collateral for this insurance service.
Legal Proceedings
From time to time we may become involved in various legal proceedings, investigative inquiries, and other disputes arising from or related to matters incident to the ordinary course of our business activities. We are not currently a party to any matters, nor are we aware of any pending or threatened matters, that we believe would have a material adverse effect on our business, operating results, cash flows or financial condition should such proceedings be resolved unfavorably.
Indemnification
In the ordinary course of business, we may provide indemnification of varying scope and terms to customers, business partners, investors, directors, officers, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of any applicable agreements, intellectual property infringement claims made by third parties, and other liabilities relating to or arising from our services or our acts or omissions. These indemnification provisions may survive termination of the underlying agreement and the maximum potential amount of future payments we could be required to make under these indemnification provisions may not be subject to maximum loss clauses and is indeterminable. We have not incurred any costs as a result of such indemnification obligations and have not recorded any liabilities related to such obligations in the Condensed Consolidated Financial Statements.
9. Stock-Based Compensation
Stock Options
A summary of activity in connection with our stock options for the three months ended March 31, 2023, is as follows (number of shares in thousands):
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| | Number of Shares | | Weighted Average Exercise Price per Share | | Weighted Average Remaining Contractual Life in Years |
Options outstanding as of December 31, 2022 | | 516 | | | $ | 12.90 | | | 2.7 |
Options granted | | 120 | | | 129.74 | | | |
Options exercised | | (64) | | | 13.05 | | | |
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Options outstanding as of March 31, 2023 | | 572 | | | $ | 37.38 | | | 3.3 |
During the three months ended March 31, 2023, we granted our Chief Executive Officer 120,000 stock options of our Class A common stock. These stock options vest based on service conditions with one-third vesting at the end of each of the years ending December 31, 2025, 2026 and 2027. No stock options were granted during the three months ended March 31, 2022.
Our stock-based compensation expense for stock options was not material for the periods presented.
The fair value of stock options granted is estimated on the date of grant using the Black-Scholes option-pricing model. The following table summarizes information relating to our stock options granted during three months ended March 31, 2023:
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Weighted average grant-date fair value per share | | $ | 67.23 | |
Weighted average Black-Scholes model assumptions: | | |
Risk-free interest rate | | 4.06 | % |
Expected term (in years) | | 6.92 |
Expected volatility | | 44 | % |
Expected dividend yield | | — | |
As of March 31, 2023, the total estimated remaining stock-based compensation expense for the aforementioned stock options was $7.9 million, which is expected to be recognized over a weighted average period of 4.8 years.
Restricted Stock Units
A summary of activity in connection with our RSUs for the three months ended March 31, 2023, is as follows (number of shares in thousands):
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| | Number of Shares | | Weighted Average Grant Date Fair Value per Share |
Unvested as of December 31, 2022 | | 1,162 | | | $ | 116.88 | |
Granted | | 610 | | | 122.08 | |
Vested | | (124) | | | 116.45 | |
Forfeited | | (28) | | | 112.95 | |
Unvested as of March 31, 2023 | | 1,620 | | | $ | 118.94 | |
Unvested RSUs as of March 31, 2023 were composed of 1.4 million RSUs with only service conditions and 0.2 million PSUs with both service conditions and performance conditions. RSUs granted with only service conditions generally vest over a four-year period. The number of PSUs granted, as included in the above table, assumes achievement of the performance metric at 100% of the performance target. Of the unvested PSUs as of March 31, 2023, 0.1 million are subject to vesting based on the achievement of pre-established performance metrics for the year ending December 31, 2023 and will vest over a three year period, assuming continued employment through each vesting date. The actual number of shares to be issued at the end of the performance period will range from 0% to 142% of the target number of shares depending on achievement relative to the performance metric over the applicable period. The remaining 0.1 million PSUs unvested as of March 31, 2023 are subject to vesting based on the achievement of pre-established performance metrics for three year measurement periods ending December 31, 2023, assuming continued employment throughout the performance period. The actual number of shares to be issued at the end of the performance period will range from 0% to 100% of the initial target awards. Achievement of the performance metric between 100% and 150% of the performance target will result in a performance-based cash bonus payment between 0% and 65% of the initial target awards.
We recognized stock-based compensation expense for the RSUs and PSUs of $13.8 million and $7.8 million for the three months ended March 31, 2023 and 2022, respectively. Excluded from stock-based compensation expense is capitalized software development costs of $0.2 million and $0.5 million for the three months ended March 31, 2023 and 2022, respectively. As of March 31, 2023, the total estimated remaining stock-based compensation expense for the aforementioned RSUs and PSUs was $152.7 million, which is expected to be recognized over a weighted average period of 2.9 years.
Restricted Stock Awards
A summary of activity in connection with our restricted stock awards ("RSAs") for the three months ended March 31, 2023 is as follows (number of shares in thousands):
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| | Number of Shares | | Weighted Average Grant Date Fair Value per Share |
Unvested as of December 31, 2022 | | 6 | | | $ | 96.33 | |
Granted | | 2 | | | 126.44 | |
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Unvested as of March 31, 2023 | | 8 | | | $ | 103.59 | |
We have the right to repurchase any unvested RSAs subject to certain conditions. RSAs vest over a one-year period. Our stock-based compensation expense for RSAs was not material for the periods presented.
As of March 31, 2023, the total estimated remaining stock-based compensation expense for unvested RSAs with a repurchase right was $0.4 million, which is expected to be recognized over a weighted average period of 0.7 years.
10. Income Taxes
We calculate our provision for (benefit from) income taxes on a quarterly basis by applying an estimated annual effective tax rate to income/loss from operations and by calculating the tax effect of discrete items recognized during the quarter.
For the three months ended March 31, 2023, we recorded income tax expense of $10.0 million. The effective tax rate as compared to the U.S. federal statutory rate of 21% differs primarily due to the change in valuation allowance against deferred tax assets, non-deductible officers' compensation and state income taxes, partially offset by tax benefits from research and development tax credits.
There were no material changes to our unrecognized tax benefits during the three months ended March 31, 2023.
11. Revenue and Other Information
The following table presents our revenue categories for the three months ended March 31, 2023 and 2022 (in thousands):
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| | Three Months Ended March 31, | | |
| | 2023 | | 2022 | | | | |
Core solutions | | $ | 37,169 | | | $ | 30,809 | | | | | |
Value Added Services | | 96,835 | | | 71,500 | | | | | |
Other | | 2,096 | | | 2,987 | | | | | |
Total revenue | | $ | 136,100 | | | $ | 105,296 | | | | | |
Our revenue is generated primarily from customers in the United States. All of our property and equipment is located in the United States.
Deferred Revenue
Deferred revenue as of March 31, 2023 and December 31, 2022 was $1.0 million and $0.9 million, respectively, and is included in Other current liabilities on our Condensed Consolidated Balance Sheets. During the three months ended March 31, 2023 and 2022, we recognized $0.6 million and $1.3 million of revenue, respectively, which were included in the deferred revenue balances as of December 31, 2022 and 2021, respectively.
Remaining Performance Obligations
As of March 31, 2023, the total non-cancelable remaining performance obligations ("RPO") under our contracts with customers was $20 million, and we expect to recognize revenue on approximately 49% of these RPO over the following 12 months, with the balance to be recognized thereafter.