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AVALARA, INC. - Annual Report: 2019 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2019

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 001-38525

 

AVALARA, INC.

(Exact name of Registrant as specified in its Charter)

 

 

 

Washington

 

 

91-1995935

(State or other jurisdiction of

incorporation or organization)

 

 

(I.R.S. Employer

Identification No.)

 

 

 

 

255 South King Street, Suite 1800

Seattle, WA

 

 

98104

(Address of principal executive offices)

 

 

(Zip Code)

 

Registrant’s telephone number, including area code: (206) 826-4900

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common Stock, Par Value $0.0001 Per Share

AVLR

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  NO 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES  NO 

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  NO 

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). YES  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.

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

 

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 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on the New York Stock Exchange on June 28, 2019, was $5,012 million.

The number of shares of Registrant’s Common Stock outstanding as of February 21, 2020 was 78,010,310.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement relating to the 2020 Annual Meeting of Shareholders, are incorporated by reference into Part III of this report. The Definitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the 2019 fiscal year.

 

 

 

 


Table of Contents

 

 

 

 

 

Page

PART I

 

 

 

 

Item 1.

 

Business

 

2

Item 1A.

 

Risk Factors

 

13

Item 1B.

 

Unresolved Staff Comments

 

32

Item 2.

 

Properties

 

32

Item 3.

 

Legal Proceedings

 

32

Item 4.

 

Mine Safety Disclosures

 

32

 

 

 

 

 

PART II

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

33

Item 6.

 

Selected Financial Data

 

35

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

37

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

67

Item 8.

 

Financial Statements

 

67

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

119

Item 9A.

 

Controls and Procedures

 

119

Item 9B.

 

Other Information

 

120

 

 

 

 

 

PART III

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

121

Item 11.

 

Executive Compensation

 

121

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

121

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

121

Item 14.

 

Principal Accounting Fees and Services

 

121

 

 

 

 

 

PART IV

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

122

Item 16.

 

Form 10-K Summary

 

125

 

 

i


 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements that involve substantial risks and uncertainties. All statements other than statements of historical facts contained herein, including statements regarding future events or our future results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management, are forward-looking statements. In some cases you can identify forward-looking statements because they contain words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “likely,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or similar expressions and the negatives of those terms. We have based these forward-looking statements largely on our current plans, expectations, and projections about future events and financial trends that we believe may affect our results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management. Our actual future results may be materially different from what we expect. Forward-looking statements are based on information available to our management as of the date of this report and our management’s good faith belief as of such date with respect to future events and are subject to a number of risks, uncertainties, and assumptions that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:

 

our ability to sustain our revenue growth rate, to achieve or maintain profitability, and to effectively manage our anticipated growth;

 

our ability to attract new customers on a cost-effective basis and the extent to which existing customers renew and upgrade their subscriptions;

 

the timing of our introduction of new solutions or updates to existing solutions;

 

our ability to successfully diversify our solutions by developing or introducing new solutions or acquiring and integrating additional businesses, products, services, or content;

 

our ability to maintain and expand our strategic relationships with third parties;

 

our ability to deliver our solutions to customers without disruption or delay;

 

our exposure to liability from errors, delays, fraud, or system failures, which may not be covered by insurance;

 

our ability to expand our international reach; and

 

other factors discussed in other sections, including the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. New risk factors emerge from time to time, and it is not possible for our management to predict all risk factors nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in, or implied by, any forward-looking statements. Further, our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.

You should not place undue reliance on our forward-looking statements and you should not rely on forward-looking statements as predictions of future events. The results, events, and circumstances reflected in the forward-looking statements may not be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements. The forward-looking statements made in this report speak only as of the date of this report. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

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PART I

Item 1. Business.

Overview

Avalara’s motto is “Tax compliance done right.” The rise of digital commerce and international trade, coupled with constantly shifting taxation and reporting obligations imposed by the global patchwork of local, regional, state, and national taxing authorities, has created a tremendously complex and onerous compliance burden for businesses of all sizes. Avalara’s mission is to provide solutions for this challenge, allowing companies to focus on their core operations. We provide a leading suite of cloud-based solutions designed to improve accuracy and efficiency by automating the processes of determining taxability, identifying applicable tax rates, determining and collecting taxes, preparing and filing returns, remitting taxes, maintaining tax records, and managing compliance documents. Our vision is to be the global cloud compliance platform.

Thousands of local, regional, state, and national taxing authorities in the United States and internationally impose a variety of transaction taxes that businesses operating in those jurisdictions collect from customers. Businesses must comply with these transaction tax obligations, which require determination, collection, and remittance of taxes, as well as maintaining records of registrations, taxes collected, tax exemption certificates, and other compliance documents. Transaction tax rules and regulations change frequently and are neither intuitive nor consistent across taxing jurisdictions, creating a massively complex compliance challenge. Determining the tax due on a particular sale depends not only on the precise geographic location of the transaction within the relevant taxing jurisdictions and the classification of the product or service in one of thousands of categories, it can also vary because of temporary tax incentives that change the tax rate for specific products, time periods, and transaction thresholds. Further complications arise from the thousands of rule changes enacted every year as taxing authorities amend their tax rates and taxability rules, modify jurisdictional boundaries, and implement other regulatory changes.

In addition to being complex, transaction tax determinations often must be performed and communicated to various invoice-generating systems in real time, at the time of the transaction. Compliance is even more burdensome for businesses required to collect tax on numerous products or services in multiple jurisdictions, which is increasingly common with the rise of ecommerce, globalization, and omnichannel retailing.

Today, many businesses attempt to handle transaction tax compliance processes manually, often through the use of static tax tables in spreadsheet software and reliance on internal staff to track relevant transaction tax requirements and changes. Businesses relying on manual processes for transaction tax compliance risk miscalculations and incorrect collections, which can result in customer dissatisfaction and financial penalties. Many businesses conduct transactions using business applications such as accounting, enterprise resource planning (“ERP”), ecommerce, point of sale (“POS”), recurring billing, and customer relationship management (“CRM”) systems. Although these systems may include rudimentary tax calculation capabilities, they are not sufficiently robust or current to provide accurate tax determinations for many businesses.

The Avalara Compliance Cloud combines an advanced database of broad, deep, and up-to-date tax content with technology for executing compliance processes, including tax determination, tax document management, and returns preparation and filing. Our platform powers a suite of solutions that enable businesses to address the complexity of transaction tax compliance, process transactions in real time, produce detailed records of transaction tax determinations, and reduce errors, audit exposure, and total transaction tax compliance costs. Businesses that use our solutions can allocate fewer personnel to manage transaction tax compliance and focus their efforts on core business operations.

The Avalara Compliance Cloud is designed to integrate seamlessly with our customers’ business applications and be easy to administer and maintain. As transactions are executed in our customers’ business applications, the Avalara Compliance Cloud performs a series of operations to deliver tax compliance functionality in real time. This functionality is enabled through our extensive collection of pre-built integrations that are designed to link the Avalara Compliance Cloud to business applications used for accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. These integrations typically require little customer configuration or ongoing oversight. Our cloud architecture ensures that our tax content updates are immediately and automatically applied to our customers’ transactions. Our powerful and intuitive web-based console simplifies configuration and unifies administration, reporting, and returns processing across a customer’s multiple business applications.

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As a result of our competitive strengths, our platform becomes deeply embedded in our customers’ business processes and systems, providing them with an automated solution central to their ability to transact. Our strategic position drives long-term customer relationships, as evidenced by our net revenue retention rate, which was 111% on average for the four quarters ended December 31, 2019.

Businesses across industries and of all sizes, ranging from small businesses to Fortune 100 companies, use our solutions. Mid-market customers, with 20 to 500 employees, have been and remain our primary target market segment for marketing and selling our solutions. Our diverse customer base included approximately 11,960 core customers as of December 31, 2019.

A summary of our core customers and net revenue retention rate is as follow:

 

 

 

Dec 31,

2019

 

 

Sep 30,

2019

 

 

Jun 30,

2019

 

 

Mar 31,

2019

 

 

Dec 31,

2018

 

 

Sep 30,

2018

 

 

Jun 30,

2018

 

 

Mar 31,

2018

 

Number of core

   customers (as of

   end of period)

 

 

11,960

 

 

 

11,240

 

 

 

10,430

 

 

 

9,700

 

 

 

9,070

 

 

 

8,490

 

 

 

8,080

 

 

 

7,760

 

Net revenue

   retention rate

 

111%

 

 

113%

 

 

111%

 

 

107%

 

 

108%

 

 

105%

 

 

108%

 

 

109%

 

 

For additional information regarding these metrics, see section title “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics.”

In 2019, our core customers represented more than 80% of our total revenue. As the offerings on our platform have expanded, so too has our addressable customer base. Our number of core customers represents less than half of our total number of customers and does not include a substantial number of customers of various sizes who do not meet the revenue threshold to be considered a core customer. Many of these customers are in the small business and self-serve segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers. While most of our revenue is currently generated by customers located in the United States, we support transaction tax compliance in Europe, South America, and Asia, and we are continuing to expand our international presence.

 

In addition to end user customers with whom we have a direct relationship, some of our customers are business application publishers (including ecommerce platforms) that include automated tax determination powered by Avalara. While those platform customers may be core customers to Avalara, their end user customers generally are not.

We sell our solutions primarily on a subscription basis. We target most prospects via cost-effective digital marketing strategies and initially qualify them using predictive analytics. The majority of our sales, to new and existing customers, are direct and conducted via telephone, requiring minimal in-person interaction. In some cases, particularly for customers with larger and more complex needs, we conduct in-person sales. Our sales force also manages a network of business application providers and other customer referral sources that provide us with qualified leads and, in some cases, purchase functionality from us for use by their customers. We execute marketing programs targeting the ecosystems of these business application providers. Our small business customers can subscribe to our solutions via an automated, self-service ordering process.

We have acquired and integrated multiple businesses, primarily to augment the tax content of the Avalara Compliance Cloud, serve the needs of businesses in different geographies or industries, or improve our ability to serve all aspects of transaction tax compliance. Substantial portions of our business, including our tax return preparation and filing and our compliance document management solutions, are based on acquired content and technology. Since 2014 we have acquired fuel excise tax, lodging tax, communications tax, portions of European value-added-tax (“VAT”), and Brazilian tax solutions. In 2018, we acquired technology assets to facilitate cross-border transactions (e.g. tariffs and duties). In January 2019, we acquired the operating assets of Compli, Inc. (“Compli”), a provider of compliance services and technology to producers, distributors, and importers of alcoholic beverages in the United States. In February 2019, we acquired intellectual property and other assets of Indix Corporation (“Indix”), an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide. In July 2019, we acquired substantially all the assets of Portway International Inc. (“Portway”), a provider of Harmonized System classifications and outsourced customs brokerage support services. We intend to continue pursuing opportunities to broaden our suite of solutions and international presence and integrating new content and solutions.

3


 

We generated revenue of $382.4 million, $272.1 million, and $213.2 million in 2019, 2018, and 2017, respectively. We had net losses of $50.2 million, $75.6 million, and $64.1 million in 2019, 2018, and 2017, respectively, primarily due to our investments in growth. We operate our business as one operating segment.

Industry and Competition

Transaction taxes are ubiquitous and complex, and compliance is increasingly difficult for businesses of all sizes. Businesses, regardless of size, industry, or location, are subject to transaction tax compliance requirements. These requirements are burdensome even for a business transacting only in a single location and become exponentially more complex for companies doing business in multiple taxing jurisdictions and offering numerous products and services that are each taxed in different ways.

The responsibility for accurately determining and collecting sales tax generally falls on the seller, which must go through a series of steps to determine the tax due for each transaction. These steps involve complexities that are often prone to error and difficult to manage when conducted manually. Varying dynamics in local, regional, state, and national legislative processes in the United States and internationally have resulted in a patchwork of transaction tax rules that are not intuitive, often confusing, and inconsistent across jurisdictions. Further complications arise from the thousands of changes enacted every year as taxing authorities amend their tax rates and taxability rules, modify taxing jurisdictions, and implement other regulatory changes.

Due to the importance of tax revenue, taxing authorities conduct transaction tax audits to verify accurate and timely collection and payment. These audits can be time consuming and distracting to a business, and can cost hundreds of thousands, or even millions, of dollars, including internal and external audit management costs, as well as payment of uncollected taxes, penalties, and interest.

Commerce across multiple jurisdictions increases the burden of transaction tax compliance. Conducting commerce across multiple jurisdictions involves a complex set of location-by-location, region-by-region, state-by-state, country-by-country, and product-by-product application of tax laws. Ecommerce, globalization, and omnichannel retailing have facilitated cross-jurisdiction transactions for businesses of all sizes, increasing their transaction tax compliance burden and risk, and the need for an automated compliance solution.

Many businesses currently attempt to handle transaction tax compliance processes manually, risking miscalculations and incorrect collections, which can result in customer dissatisfaction and/or financial penalties. Some businesses supplement their internal manual efforts with costly outsourced professional service firms to perform tax compliance functions. Many businesses conduct transactions using business applications such as accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. These systems sometimes include rudimentary tax calculation capabilities, but they are usually not sufficiently robust or current to provide accurate tax determinations. Businesses may also rely on tax-specific software products from providers other than Avalara, but these may offer limited pre-built integrations with critical business applications, require ongoing updates, be deployed on-premises, or have a high cost of ownership.

The industry that provides support for transaction tax compliance is highly competitive and fragmented. Businesses employ a mix of approaches to address transaction tax compliance, including:

 

people-intensive, do-it-yourself approaches that rely on transaction-specific research, manual determination, static tax tables, spreadsheet software, or rate calculator services, as well as manual filing and remittance activities;

 

outsourced transaction tax compliance services offered by accounting and specialized consulting firms; and

 

tax-specific solutions from other vendors, including CCH Incorporated (a subsidiary of Wolters Kluwer NV), ONESOURCE Indirect Tax (a division of Thomson Reuters), Sovos, TPS Unlimited, Inc. d/b/a TaxJar, and Vertex, Inc.

4


 

We believe customers, including customers who are business applications providers, consider the following factors when selecting a transaction tax compliance solution:

 

ability to improve overall transaction tax compliance;

 

ability to deliver real time tax determinations;

 

ease of deployment and use;

 

ease of integration with the customer’s business applications;

 

ability to address multiple transaction tax compliance functions, from initial taxability and tax rate determination through remittance of funds;

 

total cost of ownership; and

 

tax content applicable to the customer’s business.

We believe our cloud-based solutions compare favorably across these factors, but different customers will weigh each of these factors in different ways, and we may not be competitive for some customers, depending on specific customer needs. For example, our longer established competitors may have better name recognition or more established relationships. Some customers may have less complex tax determination and compliance needs or require transaction tax types for which we do not currently have extensive content. We are aware of these competitive factors, and we will continue to consider and develop functionalities, service offerings, pricing structures, and additional content to further strengthen our competitive position.

Avalara Compliance Cloud

The Avalara Compliance Cloud enables customers to address the complexity of transaction tax compliance, process transactions in real time, produce detailed records of transaction tax determinations, and reduce errors, audit exposure, and total transaction tax compliance costs. Key strengths of our Avalara Compliance Cloud include:

 

Comprehensive compliance with a broad array of transaction tax obligations.  Our platform powers a suite of compliance solutions for a wide and growing range of transaction taxes, such as sales and use tax, VAT, fuel excise tax, beverage alcohol, cross-border taxes (including tariffs and duties), lodging tax, and communications tax. Our platform handles transaction tax determination; cross-border taxes like tariffs and duties; tax return preparation, filing, and remittance; tax records maintenance; and exemption certificate and other compliance document storage and management.

 

Real time tax determination.  As transactions are executed in our customers’ business applications, the Avalara Compliance Cloud performs a series of functions to deliver tax determinations in real time. Our engine validates physical transaction addresses, uses geolocation technology to determine applicable tax jurisdictions, checks taxability against our extensive tax rules and regulations database, identifies applicable tax rates, and identifies applicable tax exemptions and holidays to determine the applicable transaction tax.

 

Easy to implement.  Our cloud-based solutions are designed to be easy to implement and deploy and can often be configured and operational in a matter of hours. To ease implementation, we have invested in developing and maintaining an extensive collection of pre-built integrations that are designed to connect our solutions to a broad range of leading business applications, including accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. Our integrations enable rapid deployment and are designed to seamlessly embed into our customers’ business applications, reducing the need for costly custom implementations.

 

Easy to use.  Our cloud-based solutions minimize day-to-day operating and maintenance tasks for our customers because tax determinations occur in real time within their business applications. Furthermore, our cloud architecture ensures that our tax content updates are immediately and automatically applied to our customers’ transactions. Our solutions are managed via a powerful and intuitive web-based console that simplifies configuration and unifies administration, reporting, and returns processing across a customer’s multiple business applications.

 

Lower total cost of ownership.  Compared to on-premises products, our comprehensive, integrated suite of automated, cloud-based compliance solutions require substantially less upfront deployment effort, hardware purchases, and ongoing maintenance and support costs. Our solutions reduce our customers’ need for manual research and the related higher personnel costs and eliminate the need for a patchwork of disparate products and services for separate transaction tax compliance functions.

5


 

Products and Solutions

We offer a comprehensive suite of solutions for transaction tax compliance. These solutions can be purchased individually or as an integrated transaction tax compliance solution.

 

AvaTax for Tax Determination.  We entered the tax compliance industry in 2004 with AvaTax, a unique and disruptive solution for determining sales tax in the United States. Since then, we have added determination for multiple additional tax types to effectively address additional industries and geographies, and we can now determine sales and use tax, VAT, fuel excise tax, lodging tax, and communications tax. With the addition of the VAT determination capability, we can manage our customers’ transaction tax determination needs both in the United States and internationally. To further accommodate our customers’ international needs, this solution also includes an add-on option for tariff and duty rate determinations for cross-border transactions. AvaTax is generally sold on an annual subscription basis. The AvaTax determination solutions can integrate with the Avalara Returns and Compliance Document Management solutions discussed below for a seamless end-to-end transaction tax compliance solution.

 

Avalara Returns for Tax Return Preparation, Filing, and Remittance.  In addition to correctly determining the amount of tax, businesses face the burden of filing jurisdiction-specific tax return forms that detail the transactions and remitting collected taxes on a timely basis to the appropriate taxing authorities. Our returns solutions are either integrated and embedded inside AvaTax, offered on a standalone managed basis, or accessed online via a self-serve web tool. Avalara Returns is generally sold on an annual subscription basis. Customers can also purchase Avalara Returns on a per filing basis.

Integrated Solutions.  We offer our tax return preparation, filing, and remittance solutions as an add-on to AvaTax. These combined solutions automate and streamline the process of transaction tax return preparation, filing, and remittance. These solutions are fully integrated with AvaTax determination and leverage stored transaction data to populate tax return forms that we provide to the customer to file or that we file on their behalf. For some of our returns types, we also offer to execute the remittance of tax collections to the taxing authorities.

Standalone Managed Solutions.  We also offer our returns preparation, filing, and remittance solutions on a standalone basis for customers who use other tax decision processes but entrust the return preparation, filing, and remittance process to us. We work with customers to ensure that determination data is properly formatted and entered into our returns engine, which then populates the appropriate tax return forms. As with our integrated solution, the tax return forms are either provided to the customer to file or can be filed by us on their behalf. Although we provide this solution to numerous U.S. customers, it is one of the primary offerings in our European VAT business. While the VAT regime in Europe reduces the complexity of tax determination, businesses in Europe continue to face significant challenges in registering to collect VAT, preparing returns, filing returns, and remitting payments because each country has its own specific rules and regulations governing these processes. Our European returns preparation and filing solution helps customers manage these challenges in an efficient and cost-effective manner.

Self-Serve Solutions.  We offer two self-serve solutions for customers who have less complex filing requirements. TrustFile is a standalone self-serve web solution that customers use to populate sales and use tax return forms. Customers upload their tax collection data via a web interface, which our solution then formats for the appropriate tax returns. We then can either provide the customer with a signature-ready return form or automatically complete the entire submission and payment process for them. Our MyLodgeTax solution prepares and files returns on a self-serve basis for our lodging tax customers. MyLodgeTax is a web-based solution into which customers upload transaction data, and that data is then formatted onto the appropriate tax return forms for filing.

6


 

 

Avalara Compliance Document Management.  Businesses of all sizes face myriad requirements for the collection, storage, and management of numerous official forms, including tax exemption certificates, W-8 forms, W-9 forms, and licenses and registrations. We provide compliance document management solutions that are either integrated into AvaTax or that function as a standalone solution. Our most significant compliance document solution offering is CertCapture, which creates, validates, stores, and manages sales tax exemption and reseller certificates. This solution makes tax documents available for easy retrieval and helps our customers validate them and keep them up to date. Sellers collect tax exemption certificates (both paper and electronic) to demonstrate that purchasers are exempt from sales tax. Our solution helps our customers limit audit exposure by establishing an audit trail for tax exempt transactions.

 

Professional Services.  A small percentage of our revenue is derived from a broad range of specialized tax compliance services that we deliver on a standalone basis or in conjunction with the sale or implementation of our automated determination, returns, or document management solutions. These services include such projects as nexus studies and analysis, voluntary compliance initiatives, complex tax registrations, and specialized tax research.

 

Additional Solutions.

MatrixMaster is our large-scale product taxability database for retail operations. MatrixMaster enables businesses that identify products with universal product codes (“UPCs”) to calculate taxability at the point of sale.

Avalara CloudConnect is a hardware device that we offer to a small number of U.S. customers who have specifically requested an on-premises solution. Avalara CloudConnect is linked to our core AvaTax solution and kept up to date via that connection. It processes and stores transactions on-site for regularly scheduled uploads to AvaTax. This configuration enables Avalara CloudConnect to process tax determinations at all times, even in the event of service downtime or communication network slowdowns or outages.

Avalara Licensing and Avalara’s registration services help customers complete jurisdictional and product licensing requirements as well as country, state, and local tax registrations.

VAT Expert is a web-based solution that checks the validity of customer and supplier VAT numbers and provides VAT determinations in the form of invoices that comply with relevant return forms across the European market.

Brazilian tax compliance solutions were added to our suite of solutions through technology, content, and personnel acquisitions. Our Brazilian tax compliance suite includes a variety of highly specialized solutions that address the Brazilian transaction tax regimes. These solutions include electronic compliance report validation, electronic invoice authentication and preparation, tax determination, and returns preparation.

 

Avalara Item Classification is a service added with our acquisitions of Tradestream Technologies Inc. and Portway. This solution addresses the complex process of assigning proper country-specific Harmonized System (“HS”) codes to products. This enables e-retailers and other merchants to easily classify products being sold across international borders so appropriate customs and duty taxes can be applied.

7


 

Competitive Strengths

Our key competitive strengths include:

Powerful technology.  Our proprietary platform powers a comprehensive and integrated set of transaction tax compliance solutions that enable our customers to automate and accurately manage their compliance processes. Our platform combines an extensive proprietary database containing tax jurisdiction boundaries, tax rates, product- and date-specific taxability rules, and return preparation and filing requirements, with advanced algorithms for precise real time address validation via geolocation technology, application of taxability rules, tax determination, tax return preparation and filing, tax remittance, and tax forms and records management. Our platform processes billions of tax determinations per year, with speed, reliability, and security capabilities designed to serve the needs of even the largest of enterprise customers.

Extensive integrations.  We have invested in developing and maintaining an extensive collection of pre-built integrations that are designed to embed our solutions seamlessly into leading business applications, including accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. We believe that maintaining pre-built integrations with a broad range of business applications provides a competitive advantage, to which we refer as a moat, as these integrations dramatically reduce implementation time, effort, and cost; enable our solutions to function seamlessly with the core applications our customers use to process and manage their transactions; and allow customers to easily and efficiently manage tax compliance across multiple business applications. We offer far more pre-built integrations with these applications than other tax software providers and we plan to continue adding more. We have pre-built integrations with leading business application providers such as Magento, QuickBooks, Microsoft, NetSuite, Sage, 3dcart, Salesforce Commerce Cloud, and Epicor, that customers can use to connect our solutions with their applications. In addition, we have relationships with some application providers, including BigCommerce, Shopify, and others, that include our pre-built integrations in their platforms, allowing customers to easily choose our solutions to automate transaction tax determinations.

Extensive content.  We have amassed, expanded, and integrated an extensive database of statutory tax content, including product classifications and taxability rules, exemption conditions, tax holidays, jurisdiction boundaries, tax rates, thresholds, registration, and return preparation and filing requirements, as well as millions of UPCs, linked to taxability rules. We employ a large group of tax research analysts who continually update this library, which is processed by our determination engine and delivered to our customers via our cloud connection. In addition to internal development, we have acquired multiple transaction tax related businesses and acquired or licensed databases containing deep stores of knowledge to augment the tax content that supports the Avalara Compliance Cloud. We also have built and maintain a library of thousands of local, regional, state, and national tax return forms, tax exemption certificate forms, VAT invoice templates, and other compliance documents. Our extensive tax content and forms databases have enabled us to serve the compliance needs of an ever-expanding list of businesses in different geographies and industries such as fuels, communications, beverage alcohol, and lodging.

Comprehensive, easy-to-use, scalable solutions.  We provide solutions to a full range of transaction tax compliance burdens. Our solutions can be configured and managed using our intuitive administrative consoles, which we regard as a significant differentiator from other transaction tax services because they facilitate fast and easy company-specific configuration, detailed transaction analysis, and access to detailed reports, worksheets, calendars, and other management functions. The consoles also provide a single point of management for various compliance solutions, scale as a customer’s needs grow or change, and automatically aggregate transactions from multiple business applications. We believe our comprehensive solutions enable us to provide added value to our customers, increase their loyalty and satisfaction, and raise their potential long-term value to us.

Broad ecosystem.  We have strategically built a broad range of relationships with our network of business application publishers (including ecommerce platforms) and their reseller channels, integration developers, implementation specialists, and accounting and financial advisors. These relationships provide us with an effective distribution channel, the majority of our pre-built integrations, a source of referral business, occasions for cross-selling, new opportunities for compliance automation, and early access to developing technologies.

As a result of our competitive strengths, our platform becomes deeply embedded in our customers’ business processes and systems, providing them with an automated solution central to their ability to transact. Our strategic position drives long-term customer relationships, as evidenced by our net revenue retention rate, which was 111% on average for the four quarters ended December 31, 2019.

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Growth Strategies

We plan to continue investing to provide our customers with best-in-class solutions and to expand our market opportunity. Our primary growth strategies include:

 

Broaden our base of customers.  We believe that the market for comprehensive, automated transaction tax compliance solutions is large and underserved, and therefore we can significantly increase our customer base. In addition, as businesses expand their product and jurisdictional footprints, we believe the need for cost-effective transaction tax compliance solutions increases. We will continue to invest in our sales and marketing efforts, both domestically and internationally, and intend to expand into new markets to grow our customer base.

 

Grow revenue from our existing customers.  Many of our customers begin with a single solution, such as our AvaTax determination solution. This initial entry point establishes Avalara as a trusted part of a customer’s financial system, and as a customer’s sales increase and the number of transactions processed grows, our volume-based subscription model generates more revenue. The initial entry point also provides us with significant cross-sell opportunities, including tax return preparation, filing and remittance, and tax exemption certificate and other compliance documents management. These solutions work together to provide customers with a comprehensive automated solution for all of their transaction tax compliance needs.

 

Expand our partner ecosystem.  We have an extensive network of business application providers and other customer referral sources that provides us with qualified leads and new customer opportunities. In some cases, providers purchase functionality from us for use by their customers. We intend to continue to expand our partner ecosystem by actively seeking new relationships that offer exposure to potential customers and integrations with more business applications.

 

Expand international reach.  We believe that we have a significant opportunity to expand our suite of solutions for use outside of the United States. Of our 15 worldwide offices, seven are located outside the United States and we support transaction tax compliance in Europe, South America, and Asia. We plan to continue investing in these geographies, while also expanding our solutions and growing our sales force to expand into new regions.

 

Broaden our content and suite of solutions.  We devote substantial resources to continuously improve the Avalara Compliance Cloud, add innovative new features and functionalities, add content, build technology to support new content types, and improve the user experience for our solutions. We intend to continue to make significant investments to acquire accurate, relevant content and expertise to best serve the transaction tax compliance needs of our customers. For example, we acquired fuel and alcohol excise tax, lodging tax, communications tax, European VAT, and Brazilian tax solutions. These acquisitions accelerate the expansion of our tax content, solutions, customer base, cross-selling opportunities, and geographic reach. We intend to continue pursuing opportunities to acquire businesses and technologies that align with our strategic objectives.

Customers

Our customers include businesses across industries and of all sizes, ranging from small businesses to Fortune 100 companies.

The mid-market has been and remains our primary target market segment for marketing and selling our solutions. We use core customers as a metric to focus our customer count reporting on our primary target market segment. As of December 31, 2019, 2018, and 2017, we had approximately 11,960, 9,070, and 7,490 core customers, respectively, representing less than half of our total number of customers. In 2019, our core customers represented more than 80% of our total revenue.

We define a core customer as:

 

a unique account identifier in our billing system (multiple companies or divisions within a single consolidated enterprise that each have a separate unique account identifier are each treated as separate customers);

 

that is active as of the measurement date; and

 

for which we have recognized, as of the measurement date, greater than $3,000 in total revenue during the last twelve months.

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Currently, our core customer count includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries or certain legacy billing systems, primarily related to past acquisitions. As we increase our international operations and sales in future periods, we may add customers billed from our international subsidiaries to the core customer metric.

We also have a substantial number of customers of various sizes who do not meet the revenue threshold to be considered a core customer. Many of these customers are in the small business and self-serve segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers.

In addition to end user customers with whom we have a direct relationship, some of our customers are business application publishers (including ecommerce platforms) that include automated tax determination powered by Avalara. While those platform customers may be core customers to Avalara, their end user customers generally are not.

No single customer, including considering on an aggregate basis those customers that we know are under common control or are affiliates, represented more than 10% of our total revenue in 2019, 2018, or 2017.

Sales and Marketing

We sell our solutions primarily on a subscription basis. Most of our customers purchase pre-built or custom integrations into their business applications and choose from various subscription plans that are priced according to the volume of transactions, tax returns, or tax documents they require. Our solutions are capable of addressing the transaction tax compliance needs of businesses of all sizes, from the smallest sole proprietors to Fortune 100 enterprises. While the mid-market has been and remains our primary target market segment for marketing and selling our solutions, we also maintain distinct teams and processes for pursuing enterprise and small businesses.

While we generally identify and engage directly with our customer prospects, we leverage the sales and referral resources of a broad ecosystem of partners across all market segments. These partners include our network of business application publishers, integration developers, technology developers and implementation specialists, and value-added resellers. This network provides us with pre-sold customers as well as qualified leads through a variety of incentive programs. In some cases, providers purchase functionality from us for use by their customers, and we market our additional services to those end users. Additionally, we actively conduct programs to engage with state regulators, tax and accounting firms, payroll vendors, and financial services providers.

The majority of our mid-market sales are conducted via telephone, requiring few to no in-person interactions with customer prospects. We target prospects via an array of marketing automation strategies and tactics, including paid and unpaid digital advertising, content marketing, prospect database nurturing, and other automated outbound marketing activities. We also engage in awareness advertising activities using traditional print and electronic media.

We maintain a specialized sales force that sells into the enterprise market predominantly via telephone, but in some cases through in-person sales. These prospects have historically been concentrated in our fuel excise, communications, and compliance document management businesses, but we believe we have a significant and growing opportunity to sell our sales tax, use tax, VAT determination and returns, and cross-border classification and determination solutions into this market.

In addition to reaching highly targeted enterprise and mid-market prospects, our marketing investments and activities generate interest from large numbers of small businesses that also are burdened by transaction tax compliance requirements. Small business customers can purchase and configure smaller plans at lower price points through our self-service online marketplace without the involvement of our primary selling or customer onboarding teams. Additionally, we have established relationships with certain business application providers that target small businesses that have purchased our functionality for use by their customers and embedded our solutions into their offering. We believe serving small businesses is important because it expands our footprint and establishes customer relationships that may become more valuable to us over time as these customers grow, and also provides a potential barrier to entry from competitors that may seek to build market share by targeting the small business segment.

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Partners

Expanding and maintaining our partner ecosystem has been an essential part of our growth. Enabling easy, quick, and low-cost integration into customers’ business applications, gathering high-quality new customer leads, and participating with professional service providers to help manage transaction tax compliance are all important to our continued success, and we work hard to maintain and grow an ecosystem that we believe is unmatched in the industry.

Our partner ecosystem consists of different types of relationships that provide us access to their customers and clients:

Integration Partners.  Our integration partners build integrations for business applications, including accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. These integrations are designed to link the Avalara Compliance Cloud to business applications and share data relevant to transaction tax determination and compliance. Some of our integration partners are the actual publishers of the business applications, who work with us to provide transaction tax functionality to their customers through those applications. Other integration partners are independent software developers or resellers who we engage to build and maintain the integrations. In either case, the integration partners are paid a commission based on a percentage of the sales of our solutions that use the integration. In general, integration partners are paid a higher commission for the initial sale to a new customer and lower recurring commissions for renewal subscription terms.

Referral Partners.  Our referral partners refer new customers to us, and receive a commission based on a percentage of the first-year sales of our solutions to those new customers. Many referral partners are software resellers or other participants in the marketplace who have access to high quality new customer leads. Many of our integration partners also refer customers who have purchased their application and who need additional assistance with transaction taxes. Some professional service partners, as discussed below, can be an additional source of new customer referrals.

Avalara Included Partners.  Some of the publishers who build integrations to connect our solutions to their business applications also purchase our solutions from us to distribute to their customers, either as part of their offering or as an add-on to their application. For example, certain ecommerce platform providers purchase an AvaTax subscription so they can include sales tax determination as part of their offering to their retailer customers. We refer to these partners as Avalara Included Partners, and they provide our solutions to their customers either on a white label basis or as “powered by Avalara.” In either case, most Avalara Included Partners are also referral partners who refer their customers to us to purchase additional solutions, such as our returns or document management solutions.

Professional Service Partners.  We also have partners who are professional service providers who work directly with the customers for transaction tax related services. These partners may implement and/or configure our solutions for customers, either alone or as part of a larger enterprise software implementation. Other professional service partners are accountants or other advisors who assist customers with transaction tax issues. Payments to these partners vary, depending on the specific relationship, with some partners billing customers directly, some subcontracting with us, and some participating in the referral program.

Research & Development and Tax Content Team

Our research and development organization is responsible for the design, development, and testing of the Avalara Compliance Cloud. We devote substantial resources to continuously improve our platform, add innovative new features and functionalities, build technology to support new content types, and improve the user experience for our platform and solutions.

Our content team works to improve and support our solutions by adding new tax content and maintaining existing content on our platform. This large team continually monitors, tests, and updates our tax content to incorporate new tax rates, rules, taxing jurisdiction boundaries, and exemption conditions.

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Intellectual Property

We primarily rely upon a combination of confidentiality procedures, contractual provisions, copyright, trademark, patent, and trade secret laws, and other similar measures to protect our proprietary information and intellectual property. Our trademarks and service marks include Avalara, the Avalara logo, AvaTax, the Avalara Compliance Cloud, “Tax compliance done right,” marks for our acquired businesses, and various marketing slogans. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our solutions or to obtain and use information that we regard as proprietary and may also attempt to develop similar technology independently. Our means of protecting our proprietary rights may not be adequate.

The software and Internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third parties may claim that our current or future solutions infringe their intellectual property rights. We may have to defend ourselves against claims of intellectual property infringement, which could be expensive for us and harm our business and financial condition.

Government Regulation

Our business is subject to a range of complex laws and regulations, mostly relating to our involvement in our customers’ financial transactions. To be successful, we must promote and monitor compliance with these legal and regulatory requirements.

We perform critical business functions for our customers, including tax determination, returns preparation and filing, and tax remittance. The federal Bank Secrecy Act requires that financial institutions, of which money transmitters are a subset, register with the U.S. Department of Treasury’s Financial Crimes Enforcement Network and maintain policies and procedures reasonably designed to monitor, identify, report and, where possible, avoid money laundering and criminal or terrorist financing by customers. Most U.S. states also have laws that apply to money transmitters, and impose various licensure, examination, and bonding requirements on them. We believe these federal and state laws and regulations were not intended to cover the business activity of remitting transaction taxes that taxpayers owe to the various states. However, if federal or state regulators were to apply these laws and regulations to this business activity, whether through expansion of enforcement activities, new interpretations of the scope of certain of these laws and regulations or of available exemptions, or otherwise, or if our activities were held by a court to be covered by such laws or regulations, we could be required to expend time, money, and other resources to deal with enforcement actions and any penalties that might be asserted, to institute and maintain a compliance program specific to money transmission laws, and possibly to change aspects of how we conduct business to achieve compliance or minimize regulation. We have contractually agreed with certain states collecting sales tax that in determining and remitting taxes on behalf of certain customers, we will comply with various technical, filing, privacy, confidentiality, bonding, and trust account requirements.

In the course of selling products and services, retailers and other businesses often come into possession of credit card numbers and other personal information of consumers. Determining the transaction taxes owed by our customers involves providing our platform with the types and prices of products they sell, as well as information regarding addresses that products are shipped from and delivered to. Our tax exemption certificate management solution also requires input of certain information regarding the purchasers who are entitled to tax exemptions. Our beverage alcohol business requires collection of personal information about certain individuals associated with each customer, as well as information regarding beverage alcohol product purchasers and recipients. Numerous local, regional, state, and national laws and regulations govern the collection, dissemination, use, and safeguarding of certain information that could be used to commit identity theft or fraud. Although most of the data that is provided to our solutions by our customers cannot be used to identify individual consumers, we may be subject to these laws in certain circumstances. Most states have also adopted data security breach laws that require notice to affected consumers of any security breach as to their personal information. In the event of a security breach, our compliance with these laws may subject us, depending on the personal information in question, to costs associated with notice and remediation, as well as potential investigations from federal regulatory agencies and state attorneys general. Failures to safeguard data adequately or to destroy data securely could subject us to regulatory investigations or enforcement actions under federal or state data security, unfair practices, or consumer protection laws. The scope and interpretation of these laws, and the burdens and costs of complying with them, could increase in the future.

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Employees and Culture

As of December 31, 2019, we had 2,601 full-time employees. Of these employees, 1,452 are based in the United States, 19 are based in Canada, 241 are in the United Kingdom and continental Europe, 749 are based in India, and 140 are based in Brazil. With the exception of Brazil, where collective bargaining agreements are commonplace, none of our employees are covered by collective bargaining agreements. We believe our employee relations are good and we have not experienced any work stoppages.

We believe our corporate culture provides an advantage in recruiting new employees and retaining our best talent, as well as driving behaviors across our entire organization that help us succeed in the marketplace. This culture is characterized in the many employees who embody our nine success traits: Optimism, Passion, Adaptability, Humility, Fun, Ownership, Curiosity, Urgency, and Simplicity. The rallying point of our culture is the color orange. Our employees wear this color with pride every day in all of our locations and we have trademarked the slogan “The Power of Orange.” Our culture permeates our sales and marketing outreach and the significance of the color orange has been featured in multiple news articles. As a result, we believe our customers, partners, and many prospects readily identify and appreciate our culture in their interactions with the Avalara team.

Corporation Information

We were incorporated in 1999 in Washington state under the name Advantage Solutions, Inc. and changed our name to Avalara, Inc. in December 2005. Our principal executive offices are located at 255 South King Street, Suite 1800, Seattle, WA 98104. Our website address is www.avalara.com. The information on, or that can be accessed through, our website is not part of this report.  

Additional Information

We also maintain a website at investor.avalara.com, through which we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All such filings are available free of charge.

Item 1A. Risk Factors.

You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making an investment decision. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the events or circumstances described in the following risk factors actually occurs, our business, operating results, financial condition, cash flows, and prospects could be materially and adversely affected.

Risks Relating to Our Business and Industry

We have incurred significant operating losses in the past and may never achieve or maintain profitability.

We have incurred significant operating losses since our inception, including net losses of $50.2 million, $75.6 million, and $64.1 million in 2019, 2018, and 2017, respectively. We had an accumulated deficit of $510.2 million as of December 31, 2019. Because the market for our solutions is not fully developed and is rapidly evolving, it is difficult for us to predict our results of operations. We expect our operating expenses to continue to increase in future periods as we hire additional sales and other personnel, improve the Avalara Compliance Cloud, invest in sales and marketing initiatives, expand our international reach, and potentially acquire complementary technology and businesses. If our revenue does not increase to offset increases in our operating expenses, we may never achieve or maintain profitability. Revenue growth may slow, revenue may decline, or we may incur significant losses in the future for a number of possible reasons, including slowing demand for our solutions, general macroeconomic conditions, increasing competition, a decrease or slowing in the growth of the markets in which we compete, or if we fail for any reason to capitalize on growth opportunities. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays, service delivery and quality problems, regulatory or legislative changes, and other unknown factors that may result in losses in future periods. If these losses exceed our expectations or if our revenue growth expectations are not met in future periods, our financial performance will be harmed.

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Our revenue growth rate depends on existing customers renewing and upgrading their subscriptions, and if we fail to retain our customers or upgrade their subscriptions, our business will be harmed.

We cannot accurately predict customer behavior. Our customers have no obligation to renew their subscriptions for our solutions after the expiration of their subscription periods and our customers may not renew subscriptions for a similar mix of solutions or transaction volumes. Our renewal rates may decline as a result of a number of factors, including customer dissatisfaction, customers’ spending levels, decreased customer transaction volumes, increased competition, changes in tax laws or rules, pricing changes, deteriorating general economic conditions, or legislative changes affecting tax compliance providers. If our customers do not renew their subscriptions, or reduce the solutions or transaction volumes purchased under their subscriptions, our revenue may decline and our business may be harmed.

Our future success also depends in part on our ability to sell additional solutions and transaction volumes to existing customers. For example, many of our customers initially start with our AvaTax sales tax determination solution and then later combine that determination solution with one or more of our other solutions, such as returns preparation and filing, tax remittance, determination for additional tax types, or tax exemption certificate management. If our efforts to sell our additional solutions to our customers are not successful, it may decrease our revenue growth and harm our business, results of operations, and financial condition.

If we are unable to attract new customers on a cost-effective basis, our business will be harmed.

To grow our business, we must continue to grow our customer base in a cost-effective manner. Increasing our customer base and achieving broader market acceptance of our solutions will depend, to a significant extent, on our ability to effectively expand our sales and marketing activities, as well as our partner network of business application providers and other customer referral sources. We may not be able to recruit qualified sales and marketing personnel, train them to perform, and achieve an acceptable level of sales production from them on a timely basis or at all. In the past, it has usually taken new members of our sales force at least six months to integrate into our operations and start converting sales leads at our expected levels. In addition, if we cannot continue to maintain or expand our relationships with our partner network, we may receive fewer referrals, the set of integrations we offer may not keep up with the market, and our customer acquisition strategy may become less effective. If we are unable to maintain effective sales and marketing activities and maintain and expand our partner network, our ability to attract new customers could be harmed, our sales and marketing expenses could increase substantially, and our business, results of operations, and financial condition may suffer.

Our revenue growth rate may not be sustainable.

Our revenue has grown rapidly, from $213.2 million in 2017, and $272.1 million in 2018, to $382.4 million in 2019. As our revenue base grows, we expect that our revenue growth rate will decline over time, and you should not rely on the revenue growth of any prior period as an indication of our future performance. This risk may increase with any future acquisition, particularly if the revenue growth rate of the acquired business has been lower than ours.

If we fail to effectively manage our growth, our business, results of operations, and financial condition would likely be harmed.

We have experienced, and may continue to experience, rapid growth in our headcount and operations, both domestically and internationally, which has placed, and may continue to place, significant demands on our management and our administrative, operational, and financial reporting resources. We have also experienced significant growth in the number of customers, number of transactions, and the amount of tax content that our platform and solutions support. Our growth will require us to hire additional employees and make significant expenditures, particularly in sales and marketing but also in our technology, professional services, finance, and administration teams, as well as in our facilities and infrastructure. Our ability to effectively manage our growth will also require the allocation of valuable management and employee resources and improvements to our operational and financial controls and our reporting procedures and systems. In addition, as we seek to continue to expand internationally, we will likely encounter unexpected challenges and expenses due to unfamiliarity with local requirements, practices, and markets. Our expenses may increase more than we plan and we may fail to hire qualified personnel, expand our customer base, enhance our existing solutions, develop new solutions, integrate any acquisitions, satisfy the requirements of our existing customers, respond to competitive challenges, or otherwise execute our strategies. If we are unable to effectively manage our growth, our business, results of operations, and financial condition would likely be harmed.  

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We derive a substantial portion of our revenue from the delivery of our sales and use tax determination solution, and any failure of this solution to satisfy customer demands or to achieve increased market acceptance could adversely affect our business, results of operations, financial condition, and growth prospects.

We currently derive a substantial portion of our revenue from subscriptions to our sales and use tax determination solution. We have added, and will continue to add, additional solutions to expand our offerings, but, at least in the near term, we expect to continue to derive the majority of our revenue from sales and use tax determination. As such, market acceptance of our sales and use tax determination solution is critical to our success. Demand for any of our solutions is affected by a number of factors, many of which are beyond our control, such as continued market acceptance of our solutions by existing and new customers, the timing of development and release of upgraded or new solutions on our platform, products and services introduced or upgraded by our competitors, pricing offered by our competitors, technological change, and growth or contraction in our addressable market. Revenue received as a certified provider in the Streamlined Sales Tax (“SST”) program also is subject to price negotiations with the SST Governing Board and its member states. If we are unable to meet customer demands to offer our sales and use tax determination solution in a manner that is effective and at a price that the market will accept, if SST payment rates were to decrease, or if we otherwise fail to achieve more widespread market acceptance of alternative solutions, our business, results of operations, financial condition, and growth prospects will suffer.

We may not successfully develop or introduce new solutions that achieve market acceptance, or successfully integrate acquired products, services, or content with our existing solutions, and our business could be harmed and our revenue could suffer as a result.

Our ability to attract new customers and increase revenue from existing customers will likely depend upon the successful development, introduction, and customer acceptance of new and enhanced versions of our solutions and on our ability to integrate any products, services, and content that we may acquire into our existing and future solutions. Moreover, if we are unable to expand our solutions beyond our current transaction tax compliance solutions, our customers could migrate to competitors who may offer a broader or more attractive range of products and services. Our business could be harmed if we fail to deliver new versions, upgrades, or other enhancements to our existing solutions to meet customer needs on a timely and cost-effective basis. Unexpected delays in releasing new or enhanced versions of our solutions, or errors following their release, could result in loss of sales, delay in market acceptance of our solutions, or customer claims against us, any of which could harm our business. The success of any new solution depends on several factors, including timely completion, adequate quality testing, and market acceptance. We may not be able to develop new solutions successfully or to introduce and gain market acceptance of new solutions in a timely manner, or at all. Additionally, we must continually modify and enhance our solutions to keep pace with changes in hardware systems and software applications, database technology, and evolving technical standards and interfaces. As a result, uncertainties related to the timing and nature of business application providers, announcements or introductions of new solutions, or modifications by vendors of existing hardware systems or back-office or Internet-related software applications, could harm our business and cause our revenue to decline.

Our business and success depend in part on our strategic relationships with third parties, including our partner ecosystem, and our business would be harmed if we fail to maintain or expand these relationships.

We depend on, and anticipate that we will continue to depend on, various third-party relationships to sustain and grow our business. We are highly dependent on relationships with third-party publishers of software business applications, including accounting, enterprise resource planning (ERP), ecommerce, point-of-sale (POS), recurring billing, and customer relationship management (CRM) systems, because the integration of our solutions with their applications allows us to reach their sizeable customer bases. Our sales and our customers’ user experience are dependent on our ability to connect easily to such third-party software applications. We may fail to retain and expand these integrations or relationships for many reasons, including due to third parties’ failure to maintain, support, or secure their technology platforms in general and our integrations in particular, or errors, bugs, or defects in their technology, or changes in their or our technology platforms. Any such failure could harm our relationship with our customers, our reputation and brand, and our business and results of operations.

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As we seek to add different types of partners to our partner ecosystem, including integration partners, referral partners, Avalara Included Partners (who purchase our solutions to distribute to their customers), and professional service partners, it is uncertain whether these third parties will be successful in building integrations, co-marketing our solutions to provide a significant volume and quality of lead referrals and orders, and continuing to work with us as their own products evolve. Identifying, negotiating, and documenting relationships with additional partners requires significant resources. In addition, integrating third-party technology can be complex, costly, and time-consuming. Third parties may be unwilling to build integrations, and we may be required to devote additional resources to develop integrations for business applications on our own. Providers of business applications with which we have integrations may decide to compete with us or enter into arrangements with our competitors, resulting in such providers withdrawing support for our integrations. In addition, any failure of our solutions to operate effectively with business applications could reduce the demand for our solutions, resulting in customer dissatisfaction and harm to our business. If we are unable to respond to these changes or failures in a cost-effective manner, our solutions may become less marketable, less competitive, or obsolete, and our results of operations may be negatively impacted.

In addition, we leverage the sales and referral resources of our network of referral partners through a variety of incentive programs. In the event that we are unable to effectively utilize, maintain, and expand these relationships, our revenue growth would slow, we would need to devote additional resources to the development, sales, and marketing of our solutions, and our financial results and future growth prospects would be harmed. Additionally, our referral partners may demand, or demand greater, referral fees or commissions.

Our acquisitions of, and investments in, other businesses, products, or technologies may not yield expected benefits and our inability to successfully integrate acquisitions may negatively impact our business, financial condition, and results of operations.

We have acquired a significant number of businesses, products, content (such as tax rate information), and technologies over the past several years, and we may acquire or invest in other businesses, products, content, or technologies in the future. Since 2014 we have acquired fuel and alcohol excise tax, lodging tax, communications tax, portions of European VAT, Brazil tax, cross-border transaction solutions, and artificial intelligence technology and expertise. We may not realize the anticipated benefits, or any benefits, from our past or future acquisitions. In addition, if we finance acquisitions by incurring debt or by issuing equity or convertible or other debt securities, our existing shareholders may be diluted or we could face constraints related to the repayment of indebtedness, which could affect the market value of our capital stock. To the extent that the acquisition consideration is paid in the form of an earnout on future financial results, the success of such an acquisition will not be fully realized by us for a period of time as it is shared with the sellers. Further, if we fail to properly evaluate and execute acquisitions or investments, our business and prospects may be seriously harmed and the value of your investment may decline. For us to realize the benefits of past and future acquisitions, we must successfully integrate the acquired businesses, products, or technologies with ours, which may take time. Some of the challenges to successful integration of our acquisitions include:

 

unanticipated costs or liabilities resulting from our acquisitions;

 

retention of key employees from acquired businesses;

 

difficulties integrating acquired operations, personnel, technologies, products, or content;

 

diversion of management attention from business operations and strategy;

 

diversion of resources that are needed in other parts of our business;

 

potential write-offs of acquired assets or investments;

 

inability to generate sufficient revenue to offset acquisition or investment costs;

 

inability to maintain relationships with customers and partners of the acquired business;

 

difficulty of transitioning acquired technology and related infrastructures onto our existing platform;

 

maintaining security and privacy standards consistent with our other solutions;

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potential financial and credit risks associated with the acquired business or customers;

 

the need to implement controls, procedures, and policies at the acquired company; and

 

the tax effects of any such acquisitions.

Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments and negatively impact our business, financial condition, and results of operations.

We face significant competition from other transaction tax compliance software providers and professional services firms, as well as the challenge of convincing businesses using do-it-yourself approaches to switch to our solutions.

We face significant competitive challenges from do-it-yourself approaches, outsourced transaction tax compliance services offered by accounting and specialized consulting firms, and tax-specific software vendors. Traditional do-it-yourself approaches are people-intensive and involve internal personnel manually performing compliance processes, often relying on transaction-specific research, static tax tables, non-tax specific software, or rate calculator services, as well as manual filing and remittance activities. Many businesses using do-it-yourself approaches believe that these manual processes are adequate and may be unaware that there is an affordable solution that is more effective, resulting in an inertia that can be difficult to overcome. In addition, the up-front costs of our solutions can limit our sales to businesses using do-it-yourself processes.

In addition, there are a number of competing tax-specific software vendors, some of which have substantially greater revenue, personnel, and other resources than we do. Our larger competitors, such as CCH Incorporated (a subsidiary of Wolters Kluwer NV), ONESOURCE Indirect Tax (a division of Thomson Reuters), Sovos, and Vertex, Inc., as well as the state and local tax services offered by large accounting firms, have historically targeted primarily large enterprise customers, but many of them also market to small to medium-sized businesses in search of growth in revenue or market share. In addition, our competitors who currently focus their tax compliance services on small to medium-sized businesses, such as TPS Unlimited, Inc. d/b/a TaxJar, may be better positioned than larger competitors to increase their market share with small to medium-sized businesses, whether competing based on price, service, or otherwise. We also face a growing number of competing private transaction tax compliance businesses focused primarily on ecommerce. Increased competition may impact our ability to add new customers at the rates we have historically achieved. It is also possible that large enterprises with substantial resources that operate in adjacent compliance, finance, or ecommerce verticals may decide to pursue transaction tax compliance automation and become immediate, significant competitors. Our failure to successfully and effectively compete with current or future competitors could lead to lost business and negatively affect our revenue growth.

We face significant risks in selling our solutions to enterprise customers, and if we do not manage these efforts effectively, our results of operations and ability to grow our customer base could be harmed.

Sales to enterprise customers typically involve higher customer acquisition costs and longer sales cycles and we may be less effective at predicting when we will complete these sales. The historical sales cycle and conversion rate trends associated with our existing customers, most of whom to date have been mid-market businesses, may not apply to larger enterprise businesses for whom purchasing decisions may require the approval of more technical personnel and management levels. This potential customer base may require us to invest more time educating prospects about the benefits of our solutions, causing our sales cycle to lengthen and become less predictable. In addition, larger customers may demand more integration services and customization, and our standard pricing model may be less attractive to certain customers with very high volumes of transactions. As a result of these factors, sales opportunities to larger businesses may require us to devote greater research and development, sales, support, and professional services resources to individual prospective customers, resulting in increased acquisition costs and strains on our limited resources. Moreover, these larger transactions may require us to delay recognizing the associated revenue we derive from these prospective customers until any technical or implementation requirements have been met. Furthermore, because we have limited experience selling to larger businesses, our investment in marketing our solutions to these potential customers may not be successful, which could harm our results of operations and our overall ability to grow our customer base.

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Our quarterly and annual results of operations are likely to fluctuate in future periods.

We expect to experience quarterly or annual fluctuations in our results of operations due to a number of factors, many of which are outside of our control. This makes our future results difficult to predict and could cause our results of operations to fall below expectations or our predictions. Factors that might cause quarterly or annual fluctuations in our results of operations include:

 

our ability to attract new customers and retain and grow revenue from existing customers;

 

our ability to maintain, expand, train, and achieve an acceptable level of production from our sales and marketing teams;

 

our ability to find and nurture successful sales opportunities;

 

the timing of our introduction of new solutions or updates to existing solutions;

 

our ability to grow and maintain our relationships with our network of third-party partners, including integration partners, referral partners, Avalara Included Partners, and professional service partners;

 

the success of our customers’ businesses;

 

our ability to successfully sell to enterprise businesses;

 

the timing of large subscriptions and customer renewal rates;

 

new government regulation;

 

changes in our pricing policies or those of our competitors;

 

the amount and timing of our expenses related to the expansion of our business, operations, and infrastructure;

 

any impairment of our intangible assets and goodwill;

 

any seasonality in connection with new customer agreements, as well as renewal and upgrade agreements, each of which have historically occurred at a higher rate in the fourth quarter of each year;

 

future costs related to acquisitions of content, technologies, or businesses and their integration; and

 

general economic conditions.

Any one of the factors above, or the cumulative effect of some or all of the factors referred to above, may result in significant fluctuations in our quarterly and annual results of operations. This variability and unpredictability could result in our failure to meet or exceed our internal operating plan. In addition, a percentage of our operating expenses is fixed in nature and is based on forecasted financial performance. In the event of revenue shortfalls, we may not be able to mitigate the negative impact on our results of operations quickly enough to avoid short-term impacts.

Because we recognize revenue from subscriptions for our solutions over the terms of the subscriptions and expense a portion of the commissions associated with sales of our solutions immediately upon execution of a subscription agreement with a customer, our financial results in any period may not be indicative of our financial health and future performance.

We generally recognize revenue from subscription fees paid by customers ratably over the terms of their subscription agreements. As a result, most of the subscription revenue we report in each quarter is the result of agreements entered into during previous quarters. Consequently, a decline in new or renewed subscriptions in any one quarter will not be fully reflected in our revenue results for that quarter. Any such decline, however, will negatively affect our revenue in future quarters. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as subscription revenue from new customers must be recognized over the applicable subscription terms.

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In contrast, we expense a portion of the commissions paid to our sales personnel and to our referral partners in the period in which we enter into an agreement for the sale of our solutions. Beginning January 1, 2019, the Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be greater than one year. These deferred costs are amortized to expense over a period of benefit of generally six years. Although we believe increased sales is a positive indicator of the long-term health of our business, increased sales could increase our operating expenses and decrease earnings in any particular period. Thus, we may report poor results of operations due to higher sales or customer referral source commissions in a period in which we experience strong sales of our solutions. Alternatively, we may report better results of operations due to the reduction of sales or customer referral source commissions in a period in which we experience a slowdown in sales. Therefore, you should not rely on our financial results during any one quarter as an indication of our financial health and future performance.

Our business is substantially dependent upon the continued development of the market for cloud-based software solutions.

We derive, and expect to continue to derive, substantially all of our revenue from the sale of subscriptions for our cloud-based software solutions. The market for cloud-based software solutions is not as mature as the market for on-premises software applications. We do not know whether the trend of adoption of cloud-based software solutions that we have experienced in the past will continue in the future, and the adoption rate of cloud-based software solutions may be slower at companies in industries with heightened data security interests or sensitivity to communication network slowdowns or outages. Our success will depend to a substantial extent on the widespread adoption of cloud-based software solutions in general, and of cloud-based tax software solutions in particular. Many businesses have invested substantial personnel and financial resources to integrate on-premises software products into their businesses and have been reluctant or unwilling to migrate to cloud-based software solutions. Furthermore, many larger businesses have been reluctant or unwilling to use cloud-based solutions because they have concerns regarding the risks associated with the security of their data and the reliability of the technology and service delivery model associated with solutions like ours. In addition, if we or other cloud-based providers experience security incidents, loss of customer data, disruptions in delivery, or other problems, the market for cloud-based software solutions as a whole, including for our solutions, may be negatively impacted. If the market for these solutions stops developing or develops more slowly than we expect, our results of operations may be harmed.

We hold significant amounts of money that we remit to taxing authorities on behalf of our customers, and this may expose us to liability from errors, delays, fraud, or system failures, which may not be covered by insurance.

We handle significant amounts of our customers’ money so that we can remit those amounts to various taxing jurisdictions on their behalf. If our banks’ or our own internal compliance procedures regarding cash management fail, are hacked or sabotaged, or if our banks or we are the subject of fraudulent behavior by personnel or third parties, we could face significant financial losses. Our efforts to remit tax payments to applicable taxing jurisdictions only after receiving the corresponding funds from our customers may fail, which would expose us to the financial risk of collecting from our customers after we have remitted funds on their behalf.

Additionally, we are subject to risk from concentration of cash and cash equivalent accounts, including cash from our customers that is to be remitted to taxing jurisdictions, with financial institutions where deposits routinely exceed federal insurance limits. If the financial institutions in which we deposit our customers’ cash were to experience insolvency or other financial difficulty, our access to cash deposits could be limited, any deposit insurance may not be adequate, we could lose our cash deposits entirely, and we could be exposed to liability to our customers. Any of these events would negatively impact our liquidity, results of operations, and our reputation.

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If we make errors in our customers’ transaction tax determinations, or remit their tax payments late or not at all, our reputation, results of operations, and growth prospects could suffer.

The tax determination functions we perform for customers are complicated from a data management standpoint, time-sensitive, and dependent on the accuracy of the database of tax content underlying our solutions. Some of our processes are not fully automated, such as our process for monitoring updates to tax rates and rules, and even to the extent our processes are automated, our solutions are not proven to be without any possibility of errors. If we make errors in our customers’ tax determinations, or remit their tax payments late or not at all, our customers may be assessed interest and penalties. For example, as a certified provider in the Streamlined Sales Tax program we determine and remit sales taxes to certain states on behalf of our customers, and that agreement contains provisions detailing the circumstances under which we may become liable to member states in the event of delinquent payment of taxes. In a situation where the state is conducting a sales tax audit and our customer has declared bankruptcy or otherwise terminated operations before the appropriate documentation or tax liabilities have been remitted to the taxing jurisdiction, we could be held to be financially responsible for certain tax liabilities. For certain of our solutions, we guarantee the accuracy of the results or output provided by those solutions, and could be liable under such guarantee for up to 12 months’ service fees for those solutions in the event of an error that results in uncollected taxes, penalties, or interest. Although our agreements have disclaimers of warranties and limit our liability (beyond the amounts we agree to pay pursuant to our guarantee, if applicable), a court could determine that such disclaimers and limitations are unenforceable as a matter of law and hold us liable for these errors. Further, in some instances we have negotiated agreements with specific customers or assumed agreements in connection with our acquisitions that do not limit this liability or disclaim these warranties. Additionally, erroneous tax determinations could result in overpayments to taxing authorities that are difficult to reclaim from the applicable taxing authorities. Any history of erroneous tax determinations or failures to timely remit tax payments for our customers could also cause our reputation to be harmed, could result in negative publicity, loss of or delay in market acceptance of our solutions, loss of customer renewals, and loss of competitive position. In addition, our errors and omissions insurance coverage may not cover all amounts claimed against us if such errors or failures occur. The financial and reputational costs associated with any erroneous tax determinations or failures to timely remit tax payments may be substantial and could harm our results of operations.

Changes in tax laws and regulations or their interpretation or enforcement may cause us to invest substantial amounts to modify our solutions, cause us to change our business model, or draw new competitors to the market.

Changes in tax laws or regulations or interpretations of existing taxation requirements in the United States or in other countries may require us to change the manner in which we conduct some aspects of our business and could harm our ability to attract and retain customers. For example, a material portion of our revenue is generated by performing what can be complex transaction tax determinations and corresponding preparation of tax returns and remittance of taxes. Changes in tax laws or regulations that reduce complexity or decrease the frequency of tax filings could negatively impact our revenue. In addition, there is considerable uncertainty as to if, when, and how tax laws and regulations might change. As a result, we may need to invest substantially to modify our solutions to adapt to new tax laws or regulations. If our platform and solutions are not flexible enough to adapt to changes in tax laws and regulations, our financial condition and results of operations may suffer.

Following the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc., upholding South Dakota’s economic nexus law, many states have begun requiring out-of-state retailers to collect sales taxes. Many states also have adopted or are considering marketplace facilitator laws that shift the burden of tax collection to online marketplaces. There also has been consideration of federal legislation related to taxation of interstate sales, which, if enacted into law, would place guidelines or restrictions on states’ authority to require online and other out of state merchants to collect and remit sales and use tax on products and services that they may sell. Similar issues exist outside of the United States, where the application of value-added taxes or other indirect taxes on online retailers is uncertain and evolving. The effect of changes in tax laws and regulations is uncertain and dependent on a number of factors. Depending on the content of any sales tax legislation, the role of third-party compliance vendors may change, we may need to invest substantial amounts to modify our solutions or our business model, we could see a decrease in demand, we could see new competitors enter the market, or we could be negatively impacted by such legislation in a way not yet known.

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Cybersecurity, data security, and data privacy breaches may create liability for us, damage our reputation, and harm our business.

As a cloud-based business, we face risks of cyber-attacks, computer break-ins, theft, misuse, denial-of-service attacks, and other improper activity that could jeopardize the performance of our platform and solutions and expose us to financial and reputational harm. Such harm could be in the form of theft of our or our customers’ confidential information, the inability of our customers to access our systems, or the improper re-routing of customer funds through fraudulent transactions or other frauds perpetrated to obtain inappropriate payments and may result from accidental events (such as human error) or deliberate attacks. In some cases, we must rely on the safeguards put in place by third parties to protect against security threats. These third parties, including vendors that provide products and services for our operations, could also be a source of security risk to us in the event of a failure of their own security systems and infrastructure. Our network of business application providers could also be a source of vulnerability to the extent their business applications interface with ours, whether unintentionally or through a malicious backdoor. We do not review the software code included in third-party integrations in all instances. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we or these third parties may be unable to anticipate these techniques or to implement adequate preventative measures. With the increasing frequency of cyber-related frauds to obtain inappropriate payments, we need to ensure our internal controls related to authorizing the transfer of funds are adequate. We may also be required to expend resources to remediate cyber-related incidents or to enhance and strengthen our cyber security. Any of these occurrences could create liability for us, put our reputation in jeopardy, and harm our business.

Our customers provide us with information that our solutions store, some of which is confidential information about them or their financial transactions. In addition, we store personal information about our employees and, to a lesser extent, those who purchase products or services from our customers. We have security systems and information technology infrastructure designed to protect against unauthorized access to such information. The security systems and infrastructure we maintain may not be successful in protecting against all security breaches and cyber-attacks, social-engineering attacks, computer break-ins, theft, and other improper activity. Threats to our information technology security can take various forms, including viruses, worms, and other malicious software programs that attempt to attack our solutions or platform or to gain access to the data of our customers or their customers. Non-technical means, for example, actions or omissions by an employee, can also result in a security breach. Any significant violations of data privacy could result in the loss of business, litigation, regulatory investigations, loss of customers, and penalties that could damage our reputation and adversely affect the growth of our business.

Failures in Internet infrastructure or interference with broadband or wireless access could cause current or potential customers to believe that our platform or solutions are unreliable, leading these customers to switch to our competitors or to avoid using our solutions, which could negatively impact our revenue or harm our opportunities for customer growth.

Our solutions depend on our customers’ high-speed broadband or wireless access to the Internet, particularly for our POS and ecommerce customers whose businesses require real time tax determinations. Increasing numbers of customers and bandwidth requirements may degrade the performance of our solutions due to capacity constraints and other Internet infrastructure limitations, and additional network capacity to maintain adequate data transmission speeds may be unavailable or unacceptably expensive. If adequate capacity is not available to us, our solutions may be unable to achieve or maintain sufficient data transmission, reliability, or performance. In addition, if Internet service providers and other third parties providing Internet services, including incumbent phone companies, cable companies, and wireless companies, have outages or suffer deterioration in their quality of service, our customers may not have access to or may experience a decrease in the quality of our solutions. These providers may take measures that block, degrade, discriminate, disrupt, or increase the cost of customer access to our solutions. Any of these disruptions to data transmission could lead customers to switch to our competitors or avoid using our solutions, which could negatively impact our revenue or harm our opportunities for growth.

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Our platform, solutions, and internal systems may be subject to disruption that could harm our reputation and future sales or result in claims against us.

Because our operations involve delivering a suite of transaction tax compliance solutions to our customers through a cloud-based software platform, our continued growth depends in part on the ability of our platform and related computer equipment, infrastructure, and systems to continue to support our solutions. In the past, we have experienced temporary and limited platform disruptions, outages in our solutions, and degraded levels of performance due to human and software errors, file corruption, and first and third-party capacity constraints associated with the number of customers accessing our platform simultaneously. While our past experiences have not materially impacted us, in the future we may face more extensive disruptions, outages, or performance problems. In addition, malicious third parties may also conduct attacks designed to sabotage our platform, impede the performance of our solutions, or temporarily deny customers access to our solutions. If an actual or perceived disruption, outage, performance problem, or attack occurs, it could:

 

adversely affect the market perception of our solutions;

 

harm our reputation;

 

divert the efforts of our technical and management personnel;

 

impair our ability to operate our business and provide solutions to our customers;

 

cause us to lose customer information; or

 

harm our customers’ businesses.

Any of these events may increase non-renewals, limit our ability to acquire new customers, result in delayed or withheld payments from customers, or result in claims against us.

Undetected errors, bugs, or defects in our solutions could harm our reputation or decrease market acceptance of our solutions, which would harm our business and results of operations.

Our solutions may contain undetected errors, bugs, or defects. We have experienced these errors, bugs, or defects in the past in connection with new solutions and solution upgrades and we expect that errors, bugs, or defects may be found from time to time in the future in new or enhanced solutions after their commercial release. Our solutions are often used in connection with large-scale computing environments with different operating systems, system management software, equipment, and networking configurations, which may cause or reveal errors or failures in our solutions or in the computing environments in which they are deployed. Despite testing by us, errors, bugs, or defects may not be found in our solutions until they are deployed to or used by our customers. In the past, we have discovered software errors, bugs, and defects in our solutions after they have been deployed to customers.

Since our customers use our solutions for compliance reasons, any errors, bugs, defects, disruptions in service, or other performance problems with our solutions may damage our customers’ business and could hurt our reputation. We may also be required, or may choose, for customer relations or other reasons, to expend additional resources to correct actual or perceived errors, bugs, or defects in our solutions. If errors, bugs, or defects are detected or perceived to exist in our solutions, we may experience negative publicity, loss of competitive position, or diversion of the attention of our key personnel; our customers may delay or withhold payment to us or elect not to renew their subscriptions; or other significant customer relations problems may arise. We may also be subject to liability claims, including pursuant to our accuracy guarantee, for damages related to errors, bugs, or defects in our solutions. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our solutions may harm our business and results of operations.

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We rely on third-party computer hardware, software, content, and services for use in our solutions. Errors and defects, or failure to successfully integrate or license necessary third-party software, content, or services, could cause delays, errors, or failures of our solutions, increases in our expenses, and reductions in our sales, which could harm our results of operations.

We rely on computer hardware purchased or leased from, software licensed from, content licensed from, and services provided by a variety of third parties to offer our solutions, including database, operating system, virtualization software, tax requirement content, and geolocation content and services. Any errors, bugs, or defects in third-party hardware, software, content, or services could result in errors or a failure of our solutions, which could harm our business. For example, in the past, we experienced a period of higher than usual latency and outages that impacted some customers resulting from a third-party provider data center infrastructure failure. In the future, we might need to license other hardware, software, content, or services to enhance our solutions and meet evolving customer requirements. Any inability to use hardware or software could significantly increase our expenses and otherwise result in delays, a reduction in functionality, or errors or failures of our products until equivalent technology is either developed by us or, if available, is identified, obtained through purchase or license, and integrated into our solutions, any of which may reduce demand for our solutions. In addition, third-party licenses may expose us to increased risks, including risks associated with the integration of new technology, the diversion of resources from the development of our own proprietary technology, and our inability to generate revenue from new technology sufficient to offset associated acquisition and maintenance costs, all of which may increase our expenses and harm our results of operations.

We rely upon data centers and other systems and technologies provided by third parties to operate our business, and interruptions or performance problems with these centers, systems, and technologies may adversely affect our business and operating results.

We rely on data centers and other technologies and services provided by third parties in order to operate our business. We currently operate both physical data centers supported by Equinix and cloud data centers supported by Amazon Web Services (“AWS”) and Microsoft Azure. If any of our data centers become unavailable or otherwise are unable to serve our requirements, there could be a failover recovery latency.

Our business depends on our ability to protect the growing amount of information stored in our data centers and related systems, offices, and hosting facilities, against damage from earthquake, floods, fires, other extreme weather conditions, power loss, telecommunications failures, hardware failures, unauthorized intrusion, overload conditions, and other events. If our data centers or related systems fail to operate properly or become disabled even for a brief period of time, we could suffer financial loss, a disruption of our business, liability to customers, or damage to our reputation. Our response to any type of disaster may not be successful in preventing the loss of customer data, service interruptions, and disruptions to our operations, or damage to our important facilities.

Most of our current cloud service infrastructure is run on AWS and neither AWS nor our other data center providers are obligated to renew their agreements with us on commercially reasonable terms, or at all, and it is possible that we will not be able to switch our operations to another provider in a timely and cost-effective manner should the need arise. If we are unable to renew our agreements with any of our data center providers on commercially reasonable terms, or if in the future we add data center facility providers, we may face additional costs or expenses or downtime, which could harm our business.

Any unavailability of, or failure to meet our requirements by, third-party data centers, technologies, or services, could impede our ability to provide services to our customers, harm our reputation, subject us to potential liabilities, result in contract terminations, and adversely affect our customer relationships. Any of these circumstances could adversely affect our business and operating results.

Incorrect or improper implementation, integration, or use of our solutions could result in customer dissatisfaction and negatively affect our business, results of operations, financial condition, and growth prospects.

Our solutions are deployed in a wide variety of technology environments and integrated into a broad range of complex workflows and third-party software. If we or our customers are unable to implement our solutions successfully, are unable to do so in a timely manner, or our integration partners are unable to integrate with our solutions through our integrations, customer perceptions of our solutions may be impaired, our reputation and brand may suffer, and customers may choose not to renew or expand the use of our solutions.

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Our customers may need training or education in the proper use of and the variety of benefits that can be derived from our solutions to maximize their potential benefits. If our solutions are not implemented or used correctly or as intended, inadequate performance may result. Because our customers rely on our solutions to manage a wide range of tax compliance operations, the incorrect or improper implementation or use of our solutions, or our failure to provide adequate support to our customers, may result in negative publicity or legal claims against us, which could harm our business, results of operations and financial condition. Also, as we continue to expand our customer base, any failure by us to properly provide training and support will likely result in lost opportunities for additional subscriptions for our solutions.

If we fail to effectively maintain and enhance our brand, our business may suffer.

We believe that continuing to strengthen our brand will be critical to achieving widespread acceptance of our solutions and will require continued focus on active marketing efforts. We may need to increase our investment in, and devote greater resources to, sales, marketing, and other efforts to create and maintain brand awareness among customers. Our brand awareness efforts will require investment not just in our core U.S. sales tax determination service, but also in newer services we have developed or acquired, such as our excise or lodging tax services, and in foreign markets. The demand for and cost of online and traditional advertising have been increasing and may continue to increase. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses incurred in building our brand. If we fail to promote and maintain our brand, or if we incur substantial expense in an unsuccessful attempt to promote and maintain our brand, our business could suffer.

Changes in the application, scope, interpretation, or enforcement of laws and regulations pertaining to our business may harm our business or results of operations, subject us to liabilities, and require us to implement new compliance programs or business methods.

We perform a number of critical business functions for our customers, including remittance of the taxes our customers owe to taxing authorities. Our electronic payment of customers’ taxes may be subject to federal or state laws or regulations relating to money transmission. The federal Bank Secrecy Act requires that financial institutions, of which money transmitters are a subset, register with the U.S. Department of Treasury’s Financial Crimes Enforcement Network and maintain policies and procedures reasonably designed to monitor, identify, report and, where possible, avoid money laundering and criminal or terrorist financing by customers. Most U.S. states also have laws that apply to money transmitters, and impose various licensure, examination, and bonding requirements on them. We believe these federal and state laws and regulations were not intended to cover the business activity of remitting transaction taxes that taxpayers owe to the various states. However, if federal or state regulators were to apply these laws and regulations to this business activity, whether through expansion of enforcement activities, new interpretations of the scope of certain of these laws or regulations or of available exemptions, or otherwise, or if our activities are held by a court to be covered by such laws or regulations, we could be required to expend time, money, and other resources to deal with enforcement actions and any penalties that might be asserted, to institute and maintain a compliance program specific to money transmission laws, and possibly to change aspects of how we conduct business to achieve compliance or minimize regulation. Application of these laws to our business could also make it more difficult or costly for us to maintain our banking relationships. Financial institutions may also be unwilling to provide banking services to us due to concerns about the large dollar volume moving into and out of our accounts on behalf of our customers in the ordinary course of our business. As we continue to expand the solutions we offer and the jurisdictions in which we offer them, we could become subject to other licensing, examination, or regulatory requirements relating to financial services.

Determining the transaction taxes owed by our customers involves providing our platform with the types and prices of products they sell, as well as information regarding addresses that products are shipped from and delivered to. Our tax exemption certificate management solution also requires input of certain information regarding the purchasers who are entitled to tax exemptions. Numerous federal, state, and local laws and regulations govern the collection, dissemination, use, and safeguarding of certain personal information. Additional laws and regulations have been proposed or enacted that would impose new requirements with respect to personal information. Although most of the data that is provided to our services by our customers cannot be used to identify individual consumers, we are subject to these laws in certain circumstances. For example, the California Consumer Privacy Act, which became effective on January 1, 2020, imposes restrictions on companies’ use of personal data. Most states have also adopted data security breach laws that require notice be given to affected consumers in the event of a security breach. In the event of a security breach, our compliance with these laws may subject us to costs associated with

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notice and remediation, as well as potential investigations from federal regulatory agencies and state attorneys general. A failure on our part to safeguard consumer data adequately or to destroy data securely would subject us, depending on the personal information in question, to costs associated with notice and remediation, as well as potential regulatory investigations or enforcement actions, and possibly to civil liability, under federal or state data security or unfair practices or consumer protection laws. If federal or state regulators were to expand their enforcement activities, or change their interpretation of the applicability of these laws, or if new laws regarding privacy and protection of consumer data were to be adopted, the burdens and costs of complying with them could increase significantly, harming our results of operations and possibly the manner in which we conduct our business.

As our business increasingly involves dealings with foreign customers or compliance with foreign tax regimes, we also are subject to data security and privacy protection requirements in foreign jurisdictions. For example, the European Union (the E.U.) adopted the General Data Protection Regulation (GDPR), which became effective on May 25, 2018. This regulation requires certain operational changes for companies that receive or process personal data of residents of the E.U. and includes significant penalties for non-compliance. Moreover, Brazil’s General Data Protection Law will impose detailed rules for the collection, use, processing, and storage of personal data in Brazil when it becomes effective in August 2020. In addition, on December 11, 2019, India’s Minister for Electronics and Information Technology introduced an updated draft of its personal data protection bill in India’s lower house of Parliament. Other governmental authorities around the world are considering implementing similar types of legislative and regulatory proposals concerning data protection. We may incur significant costs to comply with these mandatory privacy and security standards.

Economic conditions and regulatory changes resulting from the United Kingdom’s exit from the European Union could adversely affect our business, financial condition, and results of operations.

On January 31, 2020, the United Kingdom (the U.K.) exited from the E.U., commonly referred to as “Brexit.” The impact of Brexit is uncertain, but it has the potential to significantly disrupt the free movement of goods, services, and people between the U.K., the E.U., and other nations, increase legal and regulatory complexities, increase costs of conducting business in Europe, and lead to global economic uncertainty. Because we have based our European operations in the U.K., any of these effects of Brexit, among others, could adversely affect our financial position, results of operations, or cash flows.

We may not be able to secure financing on favorable terms, or at all, to meet our future capital needs, which could harm our business, results of operations, financial condition, and prospects.

From time to time, we may need to engage in equity or debt financings. The success of any future financing efforts depends on many factors outside of our control, including market forces, investment banking trends, and demand by investors. We may not be successful in raising additional capital on favorable terms when we require it. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may suffer.

Our ability to use our net operating loss to offset future taxable income may be subject to certain limitations.

As of December 31, 2019, we had U.S. federal net operating loss carryforwards, or NOLs, of approximately $651.9 million due to prior period losses. In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. Our existing NOLs may be subject to limitations arising from previous ownership changes. Future changes in our stock ownership, the causes of which may be outside of our control, could result in an ownership change under Section 382 of the Code. Our NOLs may also be impaired under state laws. Furthermore, our ability to utilize NOLs of companies that we may acquire in the future may be subject to limitations. There is also a risk that due to regulatory changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. For these reasons, we may not be able to realize a tax benefit from the use of our NOLs, whether or not we attain profitability.

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If we fail to attract and retain qualified personnel, our business could be harmed.

Our success depends in large part on our ability to attract, integrate, motivate, and retain highly qualified personnel at a reasonable cost, particularly sales and marketing personnel, software developers, technical support, and research and development personnel on the terms we desire. Competition for skilled personnel is intense and we may not be successful in attracting, motivating, and retaining needed personnel. We also may be unable to attract or integrate into our operations qualified personnel on the schedule we desire. Our inability to attract, integrate, motivate, and retain the necessary personnel could harm our business. Dealing with the loss of the services of our executive officers or key personnel and the process to replace any of our executive officers or key personnel may involve significant time and expense, take longer than anticipated, and significantly delay or prevent the achievement of our business objectives, which would harm our financial condition, results of operations, and business.

We need to continue making significant investments in software development and equipment to improve our business.

To improve the scalability, security, efficiency, and failover aspects of our solutions, and to support the expansion of our solutions into other tax types, such as international VAT, additional excise taxes, or additional lodging taxes, we will need to continue making significant capital equipment expenditures and also invest in additional software and infrastructure development. If we experience increasing demand in subscriptions, we may not be able to augment our infrastructure quickly enough to accommodate such increasing demand. In the event of decreases in subscription sales, certain of our fixed costs, such as for capital equipment, may make it difficult for us to adjust our expenses downward quickly. Additionally, we are continually updating our software and content, creating expenses for us. We may also need to review or revise our software architecture as we grow, which may require significant resources and investments.

If economic conditions worsen, it may negatively affect our business and financial performance.

Our financial performance depends, in part, on the state of the economy. Declining levels of economic activity may lead to declines in spending and fewer transactions for which transaction tax is due, which may result in decreased revenue for us. Concern about the strength of the economy may slow the rate at which businesses of all sizes are willing to hire an outside vendor to perform the determination and remittance of their transaction taxes and filing of related returns. If our customers and potential customers experience financial hardship as a result of a weak economy, industry consolidation, or other factors, the overall demand for our solutions could decrease. If economic conditions worsen, our business, results of operations, and financial condition could be harmed.

Sales to customers or operations outside the United States may expose us to risks inherent in international sales.

Historically, transactions occurring outside of the United States have represented a very small portion of our transactions processed. However, we intend to continue to expand our international sales efforts, including through our sales operations in Europe, India, and Brazil. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic, and political risks that are different from those in the United States. Because of our limited experience with international operations, our international expansion efforts may not be successful. We may rely heavily on third parties outside of the United States, in which event we may be harmed if we invest time and resources into such business relationships but do not see significant sales from such efforts. Potential risks and challenges associated with sales to customers and operations outside the United States include:

 

compliance with multiple conflicting and changing governmental laws and regulations, including employment, tax, money transmission, privacy, and data protection laws and regulations;

 

laws and business practices favoring local competitors;

 

new and different sources of competition;

 

securing new integrations for international technology platforms;

 

localization of our solutions, including translation into foreign languages, obtaining and maintaining local content, and customer care in various native languages;

26


 

 

treatment of revenue from international sources and changes to tax rules, including being subject to foreign tax laws and being liable for paying withholding of income or other taxes in foreign jurisdictions;

 

fluctuation of foreign currency exchange rates;

 

different pricing environments;

 

restrictions on the transfer of funds;

 

difficulties in staffing and managing foreign operations;

 

availability of reliable broadband connectivity in areas targeted for expansion;

 

different or lesser protection of our intellectual property;

 

longer sales cycles;

 

natural disasters, acts of war, terrorism, pandemics, or security breaches;

 

compliance with various anti-bribery and anti-corruption laws such as the U.S. Foreign Corrupt Practices Act;

 

regional or national economic and political conditions; and

 

pressure on the creditworthiness of sovereign nations resulting from liquidity issues or political actions.

Any of these factors could negatively impact our business and results of operations.

Our ability to protect our intellectual property is limited and our solutions are, and may in the future be, subject to claims of infringement by third parties.

Our success depends, in part, upon our proprietary technology, processes, trade secrets, and other proprietary information and our ability to protect this information from unauthorized disclosure and use. We primarily rely upon a combination of confidentiality procedures, contractual provisions, copyright, trademark, and trade secret laws, and other similar measures to protect our proprietary information and intellectual property. We also use patents, including those of our acquired businesses, to protect certain of our intellectual property. Our trademarks and service marks include Avalara, the Avalara logo, AvaTax, the Avalara Compliance Cloud, “Tax compliance done right,” marks for our acquired businesses, and various marketing slogans. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our solutions or to obtain and use information that we regard as proprietary, and third parties may attempt to develop similar technology independently. Our means of protecting our proprietary rights may not be adequate.

In addition, third parties have claimed, and may in the future claim, infringement by us with respect to current or future solutions or other intellectual property rights. See “Legal Proceedings” in Part I, Item 3 of this Annual Report on Form 10-K for more information regarding recent litigation. The software and Internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. The outcome of any claims or litigation, regardless of the merits, is inherently uncertain. Any existing or future claims and lawsuits, and the disposition of such claims and lawsuits, whether through settlement or licensing discussions, or litigation, could be time-consuming and expensive to resolve, divert management attention from executing our strategies, result in efforts to enjoin our activities, lead to attempts on the part of other parties to pursue similar claims, and, in the case of intellectual property claims, require us to change our technology, change our business practices, pay monetary damages, or enter into short- or long-term royalty or licensing agreements. Any adverse determination related to any existing or future intellectual property claims or other litigation could prevent us from offering our solutions to others, could be material to our financial condition or cash flows, or both, or could otherwise harm our results of operations.

27


 

Indemnity provisions in our subscription agreements potentially expose us to substantial liability for intellectual property infringement and other losses.

In many of our subscription agreements with our customers, we agree to indemnify our customers against any losses or costs incurred in connection with claims by a third party alleging that a customer’s use of our solutions infringes on the intellectual property rights of the third party. Customers facing infringement claims may in the future seek indemnification from us under the terms of our contracts. If such claims are successful, or if we are required to indemnify or defend our customers from these or other claims, these matters could be disruptive to our business and management and harm our business, results of operations, and financial condition.

We use open source software in our platform and solutions, which may subject us to litigation or other actions that could harm our business.

We use open source software in our platform and solutions, and we may use more open source software in the future. In the past, companies that have incorporated open source software into their products have faced claims challenging the ownership of open source software or compliance with open source license terms. Accordingly, we could be subject to suits by parties claiming ownership of what we believe to be open source software or claiming noncompliance with open source licensing terms. Some open source software licenses require users who incorporate open source software as part of their software or services to publicly disclose all or part of the source code to such software or make available any derivative works of the open source code on unfavorable terms or at no cost. If applicable, such licenses could require us to release our proprietary source code, pay damages, re-engineer our applications, discontinue sales, or take other remedial action, any of which could harm our business. In addition, if the license terms for updated or enhanced versions of the open source software we utilize change, we may be forced to re-engineer our platform or solutions or incur additional costs.

Risks Relating to Ownership of Our Common Stock

Our stock price has been and likely will continue to be volatile and may decline regardless of our operating performance, resulting in substantial losses for investors in our common stock.

The market price and trading volume of our common stock may fluctuate significantly regardless of our operating performance, in response to numerous factors, many of which are beyond our control, including:

 

actual or anticipated fluctuations in our results of operations;

 

the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;

 

failure of securities analysts to initiate or maintain coverage of our company, changes in financial estimates or ratings by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors;

 

announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, results of operations, or capital commitments;

 

changes in our Board of Directors or management;

 

changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;

 

price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole;

 

sales of large blocks of our common stock, including sales by our executive officers, directors, or significant shareholders;

 

lawsuits threatened or filed against us;

 

changes in laws or regulations applicable to our business;

 

the expiration of contractual lock-up agreements;

 

changes in our capital structure, such as future issuances of debt or equity securities;

28


 

 

short sales, hedging, and other derivative transactions involving our capital stock;

 

general economic conditions in the United States and internationally;

 

other events or factors, including those resulting from war, incidents of terrorism, or responses to these events; and

 

the other factors described in these risk factors.

In addition, stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, shareholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business, and harm our business, financial condition, and results of operations.

 

Substantial future sales of shares of our common stock could cause the market price of our common stock to decline.

As of December 31, 2019, there were 7,393,023 shares of common stock issuable upon vesting and exercise of outstanding options and vesting of outstanding RSUs. In connection with our initial public offering (“IPO”), we filed a registration statement on Form S-8 under the Securities Act to register shares of our common stock issued or reserved for issuance under our equity compensation plans and agreements. Accordingly, these shares will be able to be freely sold in the public market upon issuance as permitted by any applicable securities laws and applicable vesting requirements. We are unable to predict the effect that such sales may have on the prevailing market price of our common stock.

Certain holders of our common stock are entitled to rights, subject to some conditions, to require us to file registration statements covering their shares, or to include their shares in registration statements that we may file for ourselves or our shareholders.

If securities or industry analysts do not publish research or reports about our business, or publish inaccurate or negative reports about our business, our share price and trading volume could decline.

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business, our market, and our competitors. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our shares or publish inaccurate or negative reports about our business, our share price would likely decline. If few securities analysts commence coverage of us, or if one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our share price or trading volume to decline.

The requirements of being a public company may strain our resources, divert management’s attention, affect our ability to attract and retain additional executive management and qualified board members, and result in litigation.

As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the listing requirements of the New York Stock Exchange, and other applicable securities rules and regulations. Compliance with these rules and regulations has increased our legal and financial compliance costs, made some activities more difficult, time-consuming, or costly, and increased demand on our systems and resources, and such costs and demands may increase further. The Exchange Act requires, among other things, that we timely file annual, quarterly, and current reports with respect to our business and results of operations. The Sarbanes-Oxley Act also requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Significant resources and management oversight will be required to improve and maintain our disclosure controls and procedures and internal control over financial reporting. As a result, management’s attention may be diverted from other business concerns, which could harm our business and results of operations. Although we already have hired additional employees to comply with these requirements, we may need to hire more employees or engage outside consultants to comply with these requirements, increasing our costs and expenses.

29


 

In addition, changing laws, regulations, and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs, and making some activities more time-consuming. These laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations, and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from other business concerns. If our efforts to comply with new laws, regulations, and standards do not meet the standards intended by regulatory or governing bodies, regulatory authorities may initiate legal proceedings against us, and our business may suffer.

Being a public company also has made it more expensive for us to obtain and maintain director and officer liability insurance, and, in the future, we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified executive officers and qualified members of our Board of Directors, particularly to serve on our Audit Committee and our Compensation and Leadership Development Committee.

We have identified a material weakness in our internal controls over financial reporting that led to several significant deficiencies and have identified a material weakness and significant deficiencies in the past.  If we fail to remediate this material weakness and related significant deficiencies or if we experience additional material weaknesses in the future or fail to otherwise maintain effective financial reporting systems and processes, we may be unable to accurately and timely report our financial results or comply with the requirements of being a public company, which could cause the price of our common stock to decline and harm our business.

We identified a material weakness due to a lack of adequate controls to effectively design, implement, and operate process-level and information technology controls to sufficiently mitigate risks of material misstatement associated with certain complex business processes and changes in those processes or applicable accounting standards.  This material weakness led to the following individual significant deficiencies:

 

Design and implementation of controls over a portion of the underlying data used to derive the accounting entries related to the adoption of ASC 606;

 

Design and implementation of control activities to address changes in ongoing revenue and deferred commission accounting following the adoption of ASC 606;

 

Design and implementation of controls related to the enforcement of segregation of duties in key areas of financial reporting, including sales order pricing and approvals; and

 

Operating effectiveness of controls related to the review of manual journal entries.

We cannot assure you that the measures we have taken to date, and are continuing to implement, will be sufficient to remediate this material weakness and significant deficiencies or to avoid potential future material weaknesses or significant deficiencies. Moreover, we cannot be certain that we will not in the future have additional material weaknesses or significant deficiencies in our internal controls over financial reporting, or that we will successfully remediate any that we find. In addition, the processes and systems we have developed to date have not been fully tested, and they may not be adequate. Accordingly, there could continue to be a reasonable possibility that the material weakness we have identified or other material weaknesses or deficiencies could result in a misstatement of our accounts or disclosures that would result in a material misstatement of our financial statements that would not be prevented or detected on a timely basis, or cause us to fail to meet our obligations to file periodic financial reports on a timely basis. Any of these failures could result in adverse consequences that could materially and adversely affect our business, including an adverse impact on the market price of our common stock, potential action by the SEC against us, shareholder lawsuits, delisting of our stock, and general damage to our reputation.

30


 

Provisions in our charter documents and under Washington law could make an acquisition of our company more difficult and limit attempts by our shareholders to replace or remove our current management.

Our amended and restated articles of incorporation, or our Articles, and our amended and restated bylaws, or our Bylaws, include a number of provisions that may have the effect of deterring takeovers or delaying or preventing changes in control or changes in our management that a shareholder might deem to be in his or her best interest. These provisions include the following:

 

our Board of Directors may issue up to 20,000,000 shares of preferred stock, with any rights or preferences as it may designate;

 

our Articles and Bylaws provide (1) for the division of our Board of Directors into three classes, as nearly equal in number as possible, with the directors in each class serving for three-year terms, and one class being elected each year by our shareholders, (2) that a director may only be removed from the Board of Directors for cause by the affirmative vote of our shareholders, (3) that vacancies on our Board of Directors may be filled only by the Board of Directors, and (4) that only our Board of Directors may change the size of our Board of Directors, which provisions together generally make it more difficult for shareholders to replace a majority of our Board of Directors;

 

Washington law, our Articles, and Bylaws limit the ability of shareholders from acting by written consent by requiring unanimous written consent for shareholder action to be effective;

 

our Bylaws limit who may call a special meeting of shareholders to our Board of Directors, chairperson of our Board of Directors, chief executive officer, or president;

 

our Bylaws provide that shareholders seeking to present proposals before a meeting of shareholders or to nominate candidates for election as directors at a meeting of shareholders must provide timely advance written notice to us, and specify requirements as to the form and content of a shareholder’s notice, which may preclude shareholders from bringing matters before a meeting of shareholders or from making nominations for directors at a meeting of shareholders;

 

our Articles do not provide for cumulative voting for our directors, which may make it more difficult for shareholders owning less than a majority of our capital stock to elect any members to our Board of Directors; and

 

our Articles and Bylaws provide that shareholders can amend or repeal the Bylaws only by the affirmative vote of the holders of at least two-thirds of the outstanding voting power of our capital stock entitled to vote generally in the election of directors, voting together as a single group.

Additionally, unless approved by a majority of our “continuing directors,” as that term is defined in our Articles, specified provisions of our Articles may not be amended or repealed without the affirmative vote of the holders of at least two-thirds of the outstanding voting power of our capital stock entitled to vote on the action, voting together as a single group, including the following provisions:

 

those providing that shareholders can amend or repeal the Bylaws only by the affirmative vote of the holders of at least two-thirds of the outstanding voting power of our capital stock entitled to vote generally in the election of directors, voting together as a single group;

 

those providing for the division of our Board of Directors into three classes, as nearly equal in number as possible, with the directors in each class serving for three-year terms, and one class being elected each year by our shareholders;

 

those providing that a director may only be removed from the Board of Directors for cause by the affirmative vote of our shareholders;

 

those providing that vacancies on our Board of Directors may be filled only by the affirmative vote of a majority of the directors then in office or by the sole remaining director;

 

those providing that only our Board of Directors may change the size of our Board of Directors;

 

those requiring the affirmative vote of the holders of at least two-thirds of the outstanding voting power of our capital stock entitled to vote on the action, voting together as a single group, to amend or repeal specified provisions of our Articles; and

 

those that limit who may call a special meeting of shareholders to only our Board of Directors, chairperson of our Board of Directors, chief executive officer, or president.

31


 

The provisions described above may frustrate or prevent any attempts by our shareholders to replace or remove our current management by making it more difficult for shareholders to replace members of our Board of Directors, which is responsible for appointing our management. In addition, because we are incorporated in the State of Washington, we are governed by the provisions of Chapter 23B.19 of the Washington Business Corporation Act, which prohibits certain business combinations between us and certain significant shareholders unless specified conditions are met. These provisions may also have the effect of delaying or preventing a change in control of our company, even if this change in control would benefit our shareholders.

We have never paid cash dividends and do not anticipate paying any cash dividends on our capital stock.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends on our capital stock in the foreseeable future. In addition, our ability to pay dividends on our capital stock may be prohibited or limited by the terms of future debt financing arrangements.

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

Our corporate headquarters are located in Seattle, Washington, where we occupy approximately 133,554 square feet of office space under a lease that expires in 2028. We maintain additional offices in the United States, Canada, United Kingdom, Belgium, Brazil, and India.

We lease all of our facilities, and we do not own any real property. We believe that our existing facilities are adequate for our current needs and that suitable additional or alternative space would be available to us to lease on commercially reasonable terms if and when we need it.

From time to time, we may become involved in other legal proceedings or be subject to claims arising in the ordinary course of our business. Regardless of the outcome of any existing or future litigation, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

On October 22, 2018, PTP OneClick, LLC (“PTP”) filed a lawsuit against Avalara, Inc. in the United States District Court for the Eastern District of Wisconsin. The lawsuit alleges that making, using, offering to sell, and selling AvaTax, Avalara Returns, and TrustFile (the “Avalara Products”) infringe U.S. Patent No. 9,760,915 held by PTP and also alleges unspecified trade secret misappropriation, unfair competition, and breach of contract. PTP seeks judgments of willful patent infringement, willful trade secret misappropriation, unfair competition, and breach of contract. PTP requests preliminary and permanent injunctions to enjoin the Company from making, using, offering to sell, and selling the Avalara Products along with treble damages and attorneys’ fees. Based upon the Company’s review of the complaint and the specified patent, the Company believes that the Company has meritorious defenses to PTP’s claims. On November 7, 2018, the Company moved to dismiss the lawsuit and to have the patent held invalid, and also moved to transfer the matter to the United States District Court located in Seattle, Washington. On April 30, 2019, the United States District Court for the Eastern District of Wisconsin granted the Company’s motion to transfer, reserving resolution of the motion to dismiss for the United States District Court for the Western District of Washington. On October 7, 2019, the United States District Court for the Western District of Washington invalidated the patent and dismissed the patent and unfair competition claims with prejudice but did not dismiss the trade secret misappropriation or breach of contract claims. The court has set the trial date for October 26, 2020. The Company intends to continue to vigorously defend against PTP’s allegations. For a description of the risks of this and similar litigation, see the section of this prospectus titled “Risk Factors—Our ability to protect our intellectual property is limited and our solutions are, and may in the future be, subject to claims of infringement by third parties.”

Item 4. Mine Safety Disclosures.

Not applicable.

32


 

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information for Common Stock

Our common stock has been listed on the New York Stock Exchange, under the symbol “AVLR” since June 15, 2018. Prior to that date, there was no public trading market for our common stock.

 

Dividend Policy

We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determination to declare dividends will be made at the discretion of our Board of Directors and will depend on our financial condition, results of operations, capital requirements, general business conditions, and other factors that our Board of Directors may deem relevant.

Holders

As of December 31, 2019, we had 129 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of shareholders represented by these record holders.

33


 

Stock Performance Graph

The graph below compares the cumulative total return on our common stock with that of the S&P 500 Index and the RDG Software Composite. The period shown commences on June 15, 2018, and ends on December 31, 2019, the end of our last fiscal year. The graph assumes an investment of $100 in each of the above on the close of market on June 15, 2018. The stock price performance graph is not necessarily indicative of future price performance.

 

 

 

 

Base Period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company/Index:

 

6/15/2018

 

 

6/30/2018

 

 

9/30/2018

 

 

12/31/2018

 

 

3/31/2019

 

 

6/30/2019

 

 

9/30/2019

 

 

12/31/2019

 

Avalara, Inc.

 

$

100.00

 

 

$

118.76

 

 

$

77.73

 

 

$

69.31

 

 

$

124.14

 

 

$

160.66

 

 

$

149.73

 

 

$

163.00

 

S&P 500

 

 

100.00

 

 

 

100.62

 

 

 

108.37

 

 

 

93.72

 

 

 

106.51

 

 

 

111.10

 

 

 

112.98

 

 

 

123.23

 

RDG Software

   Composite

 

 

100.00

 

 

 

99.54

 

 

 

114.41

 

 

 

99.76

 

 

 

119.86

 

 

 

129.69

 

 

 

128.15

 

 

 

142.12

 

 

Our common stock cumulative total return presented on the graph and table above is based on our closing stock price of $44.94 per share on June 15, 2018.

Recent Sales of Unregistered Securities

None.

Use of Proceeds

On June 14, 2018, the SEC declared effective the Registration Statement on Form S-1 (File No. 333- 224850) for our IPO. Using a portion of the proceeds from the IPO, on August 15, 2018, we repaid all amounts outstanding under our term loan facility. Apart from the repayment of our term loan facility, there has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC pursuant to Rule 424(b).

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

34


 

Item 6. Selected Financial Data.

We derived the following selected consolidated statements of operations data for the years ended December 31, 2019, 2018, and 2017 and the selected consolidated balance sheet data as of December 31, 2019 and 2018 from audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the year ended December 31, 2016, and the selected consolidated balance sheet data as of December 31, 2017, have been derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The selected financial data set forth below should be read together with the financial statements and the related notes to those statements, as well as the section of this report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

2016

 

 

 

As Reported

(ASC 606)

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

 

(in thousands, except for per share data)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

355,181

 

 

$

355,925

 

 

$

254,056

 

 

$

199,942

 

 

$

154,967

 

Professional services

 

 

27,240

 

 

 

27,082

 

 

 

18,042

 

 

 

13,217

 

 

 

12,459

 

Total revenue

 

 

382,421

 

 

 

383,007

 

 

 

272,098

 

 

 

213,159

 

 

 

167,426

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

97,824

 

 

 

97,824

 

 

 

66,556

 

 

 

48,849

 

 

 

41,307

 

Professional services

 

 

17,475

 

 

 

17,475

 

 

 

12,093

 

 

 

9,128

 

 

 

7,206

 

Total cost of revenue(1)

 

 

115,299

 

 

 

115,299

 

 

 

78,649

 

 

 

57,977

 

 

 

48,513

 

Gross profit

 

 

267,122

 

 

 

267,708

 

 

 

193,449

 

 

 

155,182

 

 

 

118,913

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development(1)

 

 

82,442

 

 

 

82,442

 

 

 

51,909

 

 

 

41,264

 

 

 

32,848

 

Sales and marketing(1)

 

 

168,634

 

 

 

187,783

 

 

 

168,817

 

 

 

133,794

 

 

 

103,483

 

General and administrative(1)

 

 

71,918

 

 

 

71,918

 

 

 

39,603

 

 

 

34,286

 

 

 

36,875

 

Restructuring charges

 

 

 

 

 

 

 

 

 

 

 

752

 

 

 

 

Goodwill impairment

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

 

 

 

Total operating expenses

 

 

322,994

 

 

 

342,143

 

 

 

269,503

 

 

 

218,514

 

 

 

173,206

 

Operating loss

 

 

(55,872

)

 

 

(74,435

)

 

 

(76,054

)

 

 

(63,332

)

 

 

(54,293

)

Total other (income) expense, net

 

 

(6,613

)

 

 

(6,613

)

 

 

472

 

 

 

2,013

 

 

 

2,955

 

Loss before income taxes

 

 

(49,259

)

 

 

(67,822

)

 

 

(76,526

)

 

 

(65,345

)

 

 

(57,248

)

Provision for (benefit from) income taxes

 

 

955

 

 

 

955

 

 

 

(976

)

 

 

(1,219

)

 

 

640

 

Net loss

 

$

(50,214

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

 

$

(57,888

)

Net loss attributable to common shareholders -

   basic and diluted(2)

 

$

(50,214

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

 

$

(57,888

)

Net loss per share attributable to common

   shareholders - basic and diluted(2)

 

$

(0.68

)

 

$

(0.94

)

 

$

(1.95

)

 

$

(11.39

)

 

$

(5.69

)

Weighted average shares of common stock

   outstanding - basic and diluted(2)

 

 

73,345

 

 

 

73,345

 

 

 

38,692

 

 

 

5,632

 

 

 

11,265

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP operating loss(3)

 

$

(14,383

)

 

$

(18,563

)

 

$

(44,971

)

 

$

(37,425

)

 

$

(41,107

)

Free cash flow(4)

 

 

12,206

 

 

 

12,206

 

 

 

(18,545

)

 

 

(17,496

)

 

 

(28,356

)

 

(1)

The stock-based compensation expense included above was as follows:

35


 

 

 

 

 

 

 

For the Year Ended December 31,

 

 

 

 

 

2019

 

 

2018

 

 

2017

 

 

2016

 

 

 

 

 

(in thousands)

 

Cost of revenue

 

 

 

$

3,122

 

 

$

1,665

 

 

$

976

 

 

$

856

 

Research and development

 

 

 

 

6,666

 

 

 

3,179

 

 

 

2,391

 

 

 

1,265

 

Sales and marketing

 

 

 

 

8,736

 

 

 

5,492

 

 

 

3,789

 

 

 

2,209

 

General and administrative

 

 

 

 

15,825

 

 

 

5,585

 

 

 

4,601

 

 

 

3,782

 

Total stock-based compensation

 

 

 

$

34,349

 

 

$

15,921

 

 

$

11,757

 

 

$

8,112

 

 

The amortization of acquired intangibles included above was as follows:

 

 

 

 

 

For the Year Ended December 31,

 

 

 

 

 

2019

 

 

2018

 

 

2017

 

 

2016

 

 

 

 

 

(in thousands)

 

Cost of revenue

 

 

 

$

4,854

 

 

$

4,020

 

 

$

3,717

 

 

$

3,244

 

Research and development

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

 

 

2,271

 

 

 

1,951

 

 

 

1,913

 

 

 

1,706

 

General and administrative

 

 

 

 

15

 

 

 

17

 

 

 

102

 

 

 

124

 

Total amortization of acquired intangibles

 

 

 

$

7,140

 

 

$

5,988

 

 

$

5,732

 

 

$

5,074

 

 

(2)

See Note 14 of the notes to our consolidated financial statements included in this report for an explanation of the method used to calculate basic and diluted net loss per share attributable to common shareholders and the weighted-average number of shares used in the computation of the per share amounts.

(3)

We calculate non-GAAP operating loss as operating loss before stock-based compensation expense, amortization of acquired intangibles, and goodwill impairments. For more information about non-GAAP operating loss and a reconciliation of non-GAAP operating loss to operating loss, the most directly comparable financial measure calculated and presented in accordance with U.S. generally accepted accounting principles, or GAAP, see “Use and Reconciliation of Non-GAAP Financial Measures”.

(4)

We define free cash flow as net cash (used in) provided by operating activities less cash used for the purchase of property and equipment. For more information about free cash flow and a reconciliation of free cash flow to net cash used in operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, see “Use and Reconciliation of Non-GAAP Financial Measures”.

 

 

 

As of December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As Reported

(ASC 606)

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

 

(in thousands)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

466,950

 

 

$

466,950

 

 

$

142,322

 

 

$

14,075

 

Working capital (excluding deferred revenue)

 

 

455,347

 

 

 

452,446

 

 

 

146,886

 

 

 

7,998

 

Total assets

 

 

807,267

 

 

 

770,032

 

 

 

322,932

 

 

 

178,812

 

Deferred revenue (current and noncurrent)

 

 

161,241

 

 

 

175,386

 

 

 

134,653

 

 

 

92,231

 

Credit facility (current and noncurrent)

 

 

 

 

 

 

 

 

 

 

 

39,465

 

Total liabilities

 

 

343,545

 

 

 

352,493

 

 

 

213,379

 

 

 

201,483

 

Convertible preferred stock

 

 

 

 

 

 

 

 

 

 

 

370,921

 

Total shareholders’ equity (deficit)

 

 

463,722

 

 

 

417,539

 

 

 

109,553

 

 

 

(393,592

)

 

36


 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the sections of this report titled “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We provide a leading suite of cloud-based solutions that help businesses of all types and sizes comply with transaction tax requirements worldwide. Our Avalara Compliance Cloud offers a broad and growing suite of compliance solutions that enable businesses to address the complexity of transaction tax compliance, process transactions in real time, produce detailed records of transaction tax determinations, and reduce errors, audit exposure and total transaction tax compliance costs.

We sell our solutions primarily through our sales force, which focuses on selling to qualified leads provided by our marketing efforts and by partner referrals. Our marketing investments and related activities generate awareness from many businesses, both large and small, and enhance communications with our existing customers. We focus on maintaining and expanding our partner network, which has been an essential part of our growth. We continue to increase the available number of partner integrations, which are designed to link our tax compliance solutions to a wide variety of business applications, including accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. Partners also improve our sales efficiency by bringing us qualified leads and provide for a better onboarding process and customer experience.

During 2019, we continued to benefit from the adoption of economic nexus legislation by many U.S. states following the June 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., which requires certain out-of-state retailers to collect and remit sales taxes on sales into South Dakota. Since that decision, many U.S. states have adopted similar economic nexus legislation. These developments have increased awareness of transaction tax issues and increased the sense of urgency among many businesses to comply with new laws. We believe we are well-positioned to continue to benefit from these changes in 2020 and beyond.

During 2019, we continued our acquisition strategy to provide new solutions and expand our market opportunity. We acquired a provider of U.S. compliance services, technology, and software to the beverage alcohol industry, an artificial intelligence company to expand and maintain our tax content database, and a provider of Harmonized System classifications and outsourced customs brokerage support services to expand our cross-border solutions. In addition to acquisitions, we continued to invest organically by devoting significant resources to continuous improvement of our existing solutions, by adding new features and functionalities, building technology to support new content, and improving our customers’ experience with our products. We expect to continue to make significant investments, both organically and through acquisitions, to gain new and relevant content, technology, and expertise that best serve the transaction tax needs of our customers. We also will continue making significant investments to improve our existing solutions and customer experience.

Total revenue for 2019 was $382.4 million, an increase of 41% from $272.1 million in 2018. Most of our revenue comes from subscriptions and returns, with approximately 93% in both 2019 and 2018. Our revenue growth was attributable to adding new customers and expanding service offerings to existing customers. While only 6% of total revenue for 2019 was generated outside the U.S., we are aggressively targeting and investing internationally, including in Europe and Latin America.

We added approximately 2,890 core customers during 2019 and delivered a net revenue retention rate of 111% on average over the past four quarters. We use core customers, which represent more than 80% of our total revenue, as a metric to focus our customer count reporting on the mid-market segment, which is our primary market. We use net revenue retention rate to reflect the stability of our revenue base and to provide insight into our ability to grow existing customer revenues.

37


 

Despite improved revenue during 2019, our gross margin declined to 70% compared to 71% in 2018. The decline in gross margin was due primarily to higher software hosting costs and, to a lesser extent, higher costs to support our international products and operations.

Operating expenses increased to $323.0 million in 2019 from $269.5 million in 2018, as we continued to make significant investments in our future growth. Sales and marketing expenses were $168.6 million in 2019, or 44% of total revenue, compared to $168.8 million in 2018, or 62% of total revenue. The decrease in sales and marketing expenses as a percentage of revenue in 2019 is partially due to the deferral of sales commission and partner commission expense resulting from our adoption of ASC 606. Excluding these deferrals, sales and marketing expenses were $187.8 million, or 49% of total revenue during 2019, reflecting strong improvement in our sales and marketing efficiency from the prior year.

Operating loss was $55.9 million during 2019 compared to an operating loss of $76.1 million during 2018. Our net loss was $50.2 million during 2019 compared to a net loss of $75.6 million during 2018. Operating loss decreased during 2019 due primarily to the deferral of sales and partner commission expenses of $19.1 million. In addition to the benefit to our operating loss from deferred commissions, our net loss in 2019 included $6.0 million of interest income, compared to $1.6 million in 2018.

Non-GAAP operating loss, excluding the benefit from deferred commissions, was $32.9 million during 2019 compared to non-GAAP operating loss of $45.0 million during 2018. During 2019, we generated positive free cash flow of $12.2 million compared to negative free cash flow of $18.5 million in 2018. See the section titled “Use and Reconciliation of Non-GAAP Financial Measures” for more information about our non-GAAP financial measures.

In June 2019, we completed a follow-on public offering of our common stock and sold 4.1 million shares for net proceeds of $274.7 million. As of December 31, 2019, we had no borrowings outstanding. We ended the year with $467.0 million of cash and cash equivalents. We believe our strong balance sheet positions us well to continue to make additional investments to grow and expand both our products and services, along with the customers we serve.

Key Business Metrics

We regularly review several metrics to evaluate growth trends, measure our performance, formulate financial projections, and make strategic decisions. We discuss revenue and the components of operating results under “Key Components of Consolidated Statements of Operations,” and we discuss other key business metrics below.

 

 

 

Dec 31,

2019

 

 

Sep 30,

2019

 

 

Jun 30,

2019

 

 

Mar 31,

2019

 

 

Dec 31,

2018

 

 

Sep 30,

2018

 

 

Jun 30,

2018

 

 

Mar 31,

2018

 

Number of core

   customers (as of

   end of period)

 

 

11,960

 

 

 

11,240

 

 

 

10,430

 

 

 

9,700

 

 

 

9,070

 

 

 

8,490

 

 

 

8,080

 

 

 

7,760

 

Net revenue

   retention rate

 

111%

 

 

113%

 

 

111%

 

 

107%

 

 

108%

 

 

105%

 

 

108%

 

 

109%

 

 

Number of Core Customers

We believe core customers is a key indicator of our market penetration, growth, and potential future revenue. The mid-market has been and remains our primary target market segment for marketing and selling our solutions. We use core customers as a metric to focus our customer count reporting on our primary target market segment. As of December 31, 2019 and 2018, we had approximately 11,960 and 9,070 core customers, respectively. In 2019, our core customers represented more than 80% of our total revenue.

We define a core customer as:

 

a unique account identifier in our billing system, or a billing account (multiple companies or divisions within a single consolidated enterprise that each have a separate unique account identifier are each treated as separate customers);

 

that is active as of the measurement date; and

 

for which we have recognized, as of the measurement date, greater than $3,000 in total revenue during the last twelve months.

38


 

Currently, our core customer count includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries or certain legacy billing systems, primarily related to past acquisitions that have not been integrated into our primary U.S. billing systems. As we increase our international operations and sales in future periods, we may add customers billed from our international subsidiaries to the core customer metric.

We have a substantial number of customers of various sizes who do not meet the revenue threshold to be considered a core customer. Many of these customers are in the small business and self-serve segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers.

Net Revenue Retention Rate

We believe that our net revenue retention rate provides insight into our ability to retain and grow revenue from our customers, as well as their potential long-term value to us. We also believe it reflects the stability of our revenue base, which is one of our core competitive strengths. We calculate our net revenue retention rate by dividing (a) total revenue in the current quarter from any billing accounts that generated revenue during the corresponding quarter of the prior year by (b) total revenue in such corresponding quarter from those same billing accounts. This calculation includes changes for these billing accounts, such as additional solutions purchased, changes in pricing and transaction volume, and terminations, but does not reflect revenue for new billing accounts added during the one year period. Currently, our net revenue retention rate calculation includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries or certain legacy billing systems, primarily related to past acquisitions. Our net revenue retention rate was 111% on average for the four quarters ended December 31, 2019.

Key Components of Consolidated Statements of Operations

Revenue

We generate revenue from two primary sources: (1) subscription and returns; and (2) professional services. Subscription and returns revenue is driven primarily by the acquisition of customers, customer renewals, and additional service offerings purchased by existing customers. Revenue from subscription and returns comprised approximately 93%, 93%, and 94% of our revenue for 2019, 2018, and 2017, respectively.

Subscription and Returns Revenue.  Subscription and returns revenue primarily consists of fees paid by customers to use our solutions. Subscription plan customers select a price plan that includes an allotted maximum number of transactions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and our customers are not entitled to any refund of fees paid or relief from fees due if they do not use the allotted number of transactions. If a subscription plan customer exceeds the selected maximum transaction level, we will generally upgrade the customer to a higher tier or, in some cases, charge overage fees on a per transaction or return basis. Customers primarily purchase tax return preparation on a subscription basis for an allotted number of returns.  

Our standard subscription contracts are generally non-cancelable after the first 60 days of the contract term. Cancellations under our standard subscription contracts are not material, and do not have a significant impact on revenue recognized. We generally invoice our subscription customers for the initial term at contract signing and upon renewal. Our initial terms generally range from twelve to eighteen months, and renewal periods are typically one year. Amounts that have been invoiced are initially recorded as deferred revenue or contract liabilities. Subscription revenue is recognized on a straight-line basis over the service term of the arrangement beginning on the date that our solution is made available to the customer and ending at the expiration of the subscription term.

We adopted the new revenue recognition accounting standard ASC 606 effective January 1, 2019 on a modified retrospective basis. The new revenue recognition standard impacts the way we recognize subscription and returns revenues related to non-refundable upfront fees charged to new customers. See Note 2 in the accompanying notes to the consolidated financial statements for additional information related to our adoption of the new revenue recognition standard.

39


 

Subscription and returns revenue also includes interest income generated on funds held for customers. In order to provide tax remittance services to customers, we hold funds from customers in advance of remittance to tax authorities. These funds are held in trust accounts at FDIC-insured institutions. Prior to remittance, we earn interest on these funds.

Professional Services.  We generate professional services revenue from providing tax analysis, configurations, data migrations, integration, training and other support services. We bill for service arrangements on a fixed fee, milestone, or time and materials basis, and we recognize the transaction price allocated to professional services performance obligations as revenue as services are performed and are collectable under the terms of the associated contracts.

Costs and Expenses

Cost of Revenue.  Cost of revenue consists of costs related to providing the Avalara Compliance Cloud and supporting our customers and includes employee-related expenses, including salaries, benefits, bonuses, and stock-based compensation. In addition, cost of revenue includes direct costs associated with information technology, such as data center and software hosting costs, tax content maintenance, and certain services provided by third parties. Cost of revenue also includes allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as acquired technology from acquisitions. We plan to continue to significantly expand our infrastructure and personnel to support our future growth, including through acquisitions, which we expect to result in higher cost of revenue in absolute dollars.

Research and Development.  Research and development expenses consist primarily of employee-related expenses for our research and development staff, including salaries, benefits, bonuses, and stock-based compensation, and the cost of third-party developers and other independent contractors. Research and development costs, other than software development expenses qualifying for capitalization, are expensed as incurred. Capitalized software development costs consist primarily of employee-related costs. Research and development expenses also include allocated costs for certain information technology and facility expenses, along with depreciation of equipment.

We devote substantial resources to enhancing and maintaining the Avalara Compliance Cloud, developing new and enhancing existing solutions, conducting quality assurance testing, and improving our core technology. We expect research and development expenses to increase in absolute dollars.

Sales and Marketing.  Sales and marketing expenses consist primarily of employee-related expenses for our sales and marketing staff, including salaries, benefits, bonuses, sales commissions, and stock-based compensation, as well as integration and referral partner commissions, costs of marketing and promotional events, corporate communications, online marketing, solution marketing, and other brand-building activities. Sales and marketing expenses include allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as customer databases from acquisitions.  

We defer the portion of sales commissions that is considered a cost of obtaining a new contract with a customer in accordance with the new revenue recognition standard and amortize these deferred costs over the period of benefit, currently six years. We expense the remaining sales commissions as incurred. Sales commissions are earned when a sales order is completed. For most sales orders, deferred revenue is recorded when a sales order is invoiced, and the related revenue is recognized ratably over the subscription term. The rates at which sales commissions are earned varies depending on a variety of factors, including the nature of the sale (new, renewal, or add-on service offering), the type of service or solution sold, and the sales channel. At the beginning of each year we set group and individual sales targets. Sales commissions are generally earned based on achievement against these targets.

40


 

We defer the portion of partner commissions costs that are considered a cost of obtaining a new contract with a customer in accordance with the new revenue recognition standard and amortize these deferred costs over the period of benefit. The period of benefit is separately determined for each partner and is either six years or corresponds with the contract term. We expense the remaining partner commissions costs as incurred. Our partner commission expense has historically been, and will continue to be, impacted by many factors, including the proportion of new and renewal sales, the nature of the partner relationship, and the sales mix among partners during the period. In general, integration partners are paid a higher commission for the initial sale to a new customer and a lower commission for renewal sales. Additionally, we have several types of partners (e.g., integration and referral) that each earn different commission rates.   

We intend to continue to invest in sales and marketing and expect spending in these areas to increase in absolute dollars as we continue to expand our business. We expect sales and marketing expenses to continue to be among the most significant components of our operating expenses. Because we began to defer a portion of the sales and partner commission costs in 2019, our sales and marketing expense will not be comparable to prior periods in which we expensed these costs.

General and Administrative.  General and administrative expenses consist primarily of employee-related expenses for administrative, finance, information technology, legal, and human resources staff, including salaries, benefits, bonuses, and stock-based compensation, as well as professional fees, insurance premiums, and other corporate expenses that are not allocated to the above expense categories.

We expect our general and administrative expenses to increase in absolute dollars as we continue to expand our operations, hire additional personnel, integrate acquisitions, and incur costs as a public company. Specifically, we expect to incur increased expenses related to accounting, tax and auditing activities, legal, insurance, SEC compliance, and internal control compliance.

Total Other (Income) Expense, Net

Total other (income) expense, net consists of interest income on cash and cash equivalents, interest expense on outstanding borrowings, quarterly remeasurement of contingent consideration for acquisitions accounted for as business combinations, realized foreign currency changes, and other nonoperating gains and losses. Interest expense on our borrowings was based on a floating per annum rate at specified percentages above the prime rate.

41


 

Results of Operations

The comparability of periods covered by our financial statements is impacted by acquisitions and the impact of the adoption of new accounting standards. In May 2018, we acquired developed technology to facilitate cross-border transactions (e.g., tariffs and duties). In January 2019, we acquired substantially all the assets of Compli and in February 2019, we acquired substantially all the assets of Indix. In July 2019, we acquired substantially all the assets of Portway. We adopted the new revenue recognition standard ASC 606 effective January 1, 2019 on a modified retrospective basis. Our results of operations presented in the following tables include financial results for reporting periods during 2019, which are reported in compliance with the new revenue recognition standard. Historical financial results for reporting periods prior to 2019 have not been retroactively restated and are presented in conformity with amounts previously disclosed under the prior revenue recognition standard ASC 605. We have included additional information regarding the impacts from the adoption of the new revenue recognition standard for the year ended December 31, 2019 and included financial results during 2019 under ASC 605 for comparison to the prior year. See Note 2 to the accompanying notes to the consolidated financial statements for additional information related to our adoption of the new revenue recognition standard.

The following sets forth our results of operations for the periods presented.

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

355,181

 

 

$

744

 

 

$

355,925

 

 

$

254,056

 

 

$

199,942

 

Professional services

 

 

27,240

 

 

 

(158

)

 

 

27,082

 

 

 

18,042

 

 

 

13,217

 

Total revenue

 

 

382,421

 

 

 

586

 

 

 

383,007

 

 

 

272,098

 

 

 

213,159

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

97,824

 

 

 

 

 

 

97,824

 

 

 

66,556

 

 

 

48,849

 

Professional services

 

 

17,475

 

 

 

 

 

 

17,475

 

 

 

12,093

 

 

 

9,128

 

Total cost of revenue(1)

 

 

115,299

 

 

 

 

 

 

115,299

 

 

 

78,649

 

 

 

57,977

 

Gross profit

 

 

267,122

 

 

 

586

 

 

 

267,708

 

 

 

193,449

 

 

 

155,182

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development(1)

 

 

82,442

 

 

 

 

 

 

82,442

 

 

 

51,909

 

 

 

41,264

 

Sales and marketing(1)

 

 

168,634

 

 

 

19,149

 

 

 

187,783

 

 

 

168,817

 

 

 

133,794

 

General and administrative(1)

 

 

71,918

 

 

 

 

 

 

71,918

 

 

 

39,603

 

 

 

34,286

 

Restructuring charges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

752

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

Total operating expenses

 

 

322,994

 

 

 

19,149

 

 

 

342,143

 

 

 

269,503

 

 

 

218,514

 

Operating loss

 

 

(55,872

)

 

 

(18,563

)

 

 

(74,435

)

 

 

(76,054

)

 

 

(63,332

)

Total other (income) expense, net

 

 

(6,613

)

 

 

 

 

 

(6,613

)

 

 

472

 

 

 

2,013

 

Loss before income taxes

 

 

(49,259

)

 

 

(18,563

)

 

 

(67,822

)

 

 

(76,526

)

 

 

(65,345

)

Provision for (benefit from) income taxes

 

 

955

 

 

 

 

 

 

955

 

 

 

(976

)

 

 

(1,219

)

Net loss

 

$

(50,214

)

 

$

(18,563

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

 

(1)

The stock-based compensation expense included above was as follows:

42


 

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

(in thousands)

 

Cost of revenue

 

$

3,122

 

 

$

1,665

 

 

$

976

 

Research and development

 

 

6,666

 

 

 

3,179

 

 

 

2,391

 

Sales and marketing

 

 

8,736

 

 

 

5,492

 

 

 

3,789

 

General and administrative

 

 

15,825

 

 

 

5,585

 

 

 

4,601

 

Total stock-based compensation

 

$

34,349

 

 

$

15,921

 

 

$

11,757

 

 

The amortization of acquired intangibles included above was as follows:

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

(in thousands)

 

Cost of revenue

 

$

4,854

 

 

$

4,020

 

 

$

3,717

 

Research and development

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

2,271

 

 

 

1,951

 

 

 

1,913

 

General and administrative

 

 

15

 

 

 

17

 

 

 

102

 

Total amortization of acquired intangibles

 

$

7,140

 

 

$

5,988

 

 

$

5,732

 

 

 

The following sets forth our results of operations as a percentage of our total revenue for the periods presented.

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As Reported

(ASC 606)

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 606)

 

 

As Reported

(ASC 605)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

93

%

 

 

93

%

 

 

93

%

 

 

94

%

Professional services

 

 

7

%

 

 

7

%

 

 

7

%

 

 

6

%

Total revenue

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

26

%

 

 

26

%

 

 

24

%

 

 

23

%

Professional services

 

 

5

%

 

 

5

%

 

 

4

%

 

 

4

%

Total cost of revenue

 

 

30

%

 

 

30

%

 

 

29

%

 

 

27

%

Gross profit

 

 

70

%

 

 

70

%

 

 

71

%

 

 

73

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

22

%

 

 

22

%

 

 

19

%

 

 

19

%

Sales and marketing

 

 

44

%

 

 

49

%

 

 

62

%

 

 

63

%

General and administrative

 

 

19

%

 

 

19

%

 

 

15

%

 

 

16

%

Restructuring charges

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

Goodwill impairment

 

 

0

%

 

 

0

%

 

 

3

%

 

 

4

%

Total operating expenses

 

 

84

%

 

 

89

%

 

 

99

%

 

 

103

%

Operating loss

 

 

(15

)%

 

 

(19

)%

 

 

(28

)%

 

 

(30

)%

Total other (income) expense, net

 

 

(2

)%

 

 

(2

)%

 

 

0

%

 

 

1

%

Loss before income taxes

 

 

(13

)%

 

 

(18

)%

 

 

(28

)%

 

 

(31

)%

Provision for (benefit from) income taxes

 

 

0

%

 

 

0

%

 

 

0

%

 

 

(1

)%

Net loss

 

 

(13

)%

 

 

(18

)%

 

 

(28

)%

 

 

(30

)%

 

43


 

Year Ended December 31, 2019 as compared to the Year Ended December 31, 2018

Revenue

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

355,181

 

 

$

744

 

 

$

355,925

 

 

$

254,056

 

 

 

40

%

 

 

40

%

Professional services

 

 

27,240

 

 

 

(158

)

 

 

27,082

 

 

 

18,042

 

 

 

51

%

 

 

50

%

Total revenue

 

$

382,421

 

 

$

586

 

 

$

383,007

 

 

$

272,098

 

 

 

41

%

 

 

41

%

 

ASC 606 total revenue for the year ended December 31, 2019 increased $110.4 million, or 41%, compared to the year ended December 31, 2018. ASC 606 total revenue for the year ended December 31, 2019 was $382.4 million compared to ASC 605 total revenue of $383.0 million for the same period. ASC 605 total revenue for the year ended December 31, 2019 increased by $110.9 million, or 41%, compared to the year ended December 31, 2018. ASC 605 subscription and returns revenue for the year ended December 31, 2019 increased by $101.9 million, or 40%, compared to the year ended December 31, 2018. ASC 605 professional services revenue for the year ended December 31, 2019 increased by $9.0 million, or 50%, compared to the year ended December 31, 2018.

Growth in total revenue was due primarily to increased demand for our services from new and existing customers. The increase in total ASC 605 revenue for the year ended December 31, 2019 compared to the same period of 2018, was due primarily to $56.3 million from existing U.S. customers, $31.1 million from new U.S. customers, $9.8 million from SST revenue growth, $6.6 million attributable to revenue growth in our international operations, $4.9 million from acquisitions made during 2019, and $2.2 million of revenue growth from interest earned on funds held for customers. Currently a small component of our total revenue, we offer SST services to businesses that are registered to participate in the program. Because we generally provide SST services at no cost to the seller, we earn a fee from the participating state and local governments based on a percentage of sales tax reported and paid.

Cost of Revenue

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

97,824

 

 

$

 

 

$

97,824

 

 

$

66,556

 

 

 

47

%

 

 

47

%

Professional services

 

 

17,475

 

 

 

 

 

 

17,475

 

 

 

12,093

 

 

 

45

%

 

 

45

%

Total revenue

 

$

115,299

 

 

$

 

 

$

115,299

 

 

$

78,649

 

 

 

47

%

 

 

47

%

 

Cost of revenue for the year ended December 31, 2019 increased by $36.7 million, or 47%, compared to the year ended December 31, 2018. The increase in cost of revenue in absolute dollars was due primarily to an increase of $18.9 million in employee-related costs from higher headcount, an increase of $6.7 million in software hosting costs, an increase of $4.5 million in allocated overhead cost, an increase of $4.1 million in outside services expenses, an increase of $0.8 million in amortization expense from acquired intangible assets, and an increase of $0.6 million in third-party purchased software costs.

44


 

Excluding the impact of our Portway acquisition, cost of revenue headcount increased approximately 47% from December 31, 2018 to December 31, 2019 due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to a $15.2 million increase in salaries and benefits, a $2.0 million increase in compensation expense related to our bonus plans, and a $1.5 million increase in stock-based compensation expense. Outside services expenses increased due primarily to third-party costs associated with Avalara Licensing, a service we began providing in the third quarter of 2018 and, to a lesser extent, the use of third-party consulting firms to support service offerings in our international operations. Software hosting costs have increased due primarily to higher transaction volumes. Allocated overhead consists primarily of facility expenses and shared information technology expenses, both of which were higher compared to the prior period. Software costs increased due primarily to additional investment in enhancing and monitoring our customer production environment.

Gross Profit

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

257,357

 

 

$

744

 

 

$

258,101

 

 

$

187,500

 

 

 

37

%

 

 

38

%

Professional services

 

 

9,765

 

 

 

(158

)

 

 

9,607

 

 

 

5,949

 

 

 

64

%

 

 

61

%

Total gross profit

 

$

267,122

 

 

$

586

 

 

$

267,708

 

 

$

193,449

 

 

 

38

%

 

 

38

%

Gross margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

72

%

 

 

 

 

 

 

73

%

 

 

74

%

 

 

 

 

 

 

 

 

Professional services

 

 

36

%

 

 

 

 

 

 

35

%

 

 

33

%

 

 

 

 

 

 

 

 

Total gross margin

 

 

70

%

 

 

 

 

 

 

70

%

 

 

71

%

 

 

 

 

 

 

 

 

 

ASC 606 total gross profit for the year ended December 31, 2019 increased $73.7 million, or 38%, compared to the year ended December 31, 2018. ASC 605 total gross profit for the year ended December 31, 2019 increased $74.3 million, or 38%, compared to the year ended December 31, 2018. Total gross margin was 70% for the year ended December 31, 2019 compared to 71% for the same period of 2018.

Research and Development

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Research and development

 

$

82,442

 

 

$

 

 

$

82,442

 

 

$

51,909

 

 

 

59

%

 

 

59

%

 

Research and development expenses for the year ended December 31, 2019 increased $30.5 million, or 59%, compared to the year ended December 31, 2018. The increase was due primarily to an increase of $25.9 million in employee-related costs from higher headcount, an increase of $2.9 million in allocated overhead cost, and an increase of $1.1 million in third-party purchased software costs.

Research and development headcount increased approximately 70% from December 31, 2018 to December 31, 2019. Employee-related costs increased due primarily to a $16.0 million increase in salaries and benefits, a $4.6 million increase in compensation expense related to our bonus plans, a $3.5 million increase in stock-based compensation expense, and a $0.9 million increase in contract and temporary employee costs. Software costs increased due primarily to additional investment in information technology security and data privacy tools.

45


 

Sales and Marketing

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

168,634

 

 

$

19,149

 

 

$

187,783

 

 

$

168,817

 

 

 

0

%

 

 

11

%

 

Sales and marketing expenses for the year ended December 31, 2019 decreased $0.2 million compared to the year ended December 31, 2018. ASC 606 sales and marketing expense for the year ended December 31, 2019 was $168.6 million compared to ASC 605 sales and marketing expense of $187.8 million for the same period. The difference of $19.1 million relates to the deferral of sales commissions costs and partner commission costs under ASC 606. All of our sales commission and partner commission costs were expensed as incurred under ASC 605.

ASC 605 sales and marketing expenses for the year ended December 31, 2019 increased $19.0 million, or 11%, compared to the year ended December 31, 2018. The increase was due primarily to an increase of $9.0 million in employee-related costs, an increase of $7.3 million for partner commission expense, an increase of $2.2 million in allocated overhead cost, and an increase of $1.4 million in marketing campaign expenses, partially offset by a decrease in outside services expenses of $1.3 million.

Sales and marketing headcount increased approximately 21% from December 31, 2018 to December 31, 2019. Employee-related costs increased due primarily to a $8.0 million increase in salaries and benefits, a $3.2 million increase in stock-based compensation expense, a $1.7 million increase in employer payroll tax expense on employee stock transactions, and a $1.6 million increase in compensation expense related to our bonus plans, partially offset by a $5.0 million decrease in sales commissions expense, and a $1.3 million decrease in contract and temporary employee costs. Sales commissions expense decreased due to lower average commission rates compared to 2018, which offset increases from strong sales-related activity. Our average commission rates were higher in the prior year due in part to a greater percentage of eligible sales personnel exceeding their annual sales targets. ASC 605 sales commission expense was $30.2 million for the year ended December 31, 2019 compared to $35.2 million for the year ended December 31, 2018. Partner commission expense increased due primarily to higher sales and an increase in the proportion of sales eligible for partner commissions, including new sales which generally earn a higher commission rate compared to renewal sales. ASC 605 partner commission expense was $29.0 million for the year ended December 31, 2019 compared to $21.7 million for the year ended December 31, 2018. Marketing campaign expenses increased due to an increase in our discretionary spending on customer events and lead generation activities. Outside services expenses decreased due to a reduction in our discretionary spending with external advertising and marketing agencies.

General and Administrative

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

$

71,918

 

 

$

 

 

$

71,918

 

 

$

39,603

 

 

 

82

%

 

 

82

%

 

General and administrative expenses for the year ended December 31, 2019 increased $32.3 million, or 82%, compared to the year ended December 31, 2018. The increase was due primarily to an increase of $25.2 million in employee-related costs, a $5.5 million increase in outside service expenses, a $1.8 million increase in bad debt expense, a $1.3 million increase in merchant fees, and a $0.7 million increase in insurance costs, partially offset by a decrease of $3.2 million in allocated overhead cost.

46


 

General and administrative headcount increased 46% from December 31, 2018 to December 31, 2019. Employee-related costs increased due primarily to a $10.2 million increase in stock-based compensation expense, a  $7.6 million increase in salaries and benefits, a $3.3 million increase in compensation expense related to our bonus plans, and a $2.7 million increase in employer payroll tax expense on employee stock transactions. Outside services expenses increased due to higher audit and internal control compliance costs and higher costs from external recruiters for job search and placement fees. Bad debt expense increased due primarily to higher U.S. customer bankruptcies and insolvencies and aging of trade receivables in our European operations. Merchant fees, which are credit card processing fees, increased due to increased payment activity from customers transitioning to our auto-payment program. Insurance costs have increased from the prior period as a result of being a public company for all of 2019.

Goodwill Impairment

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Goodwill impairment

 

$

 

 

$

 

 

$

 

 

$

9,174

 

 

 

-100

%

 

 

-100

%

 

A goodwill impairment charge of $9.2 million was recorded in 2018 related to our Brazilian operations. There were no goodwill impairment charges incurred in the year ended December 31, 2019.

Total Other (Income) Expense, Net

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

$ Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Other (income) expense, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

(6,037

)

 

$

 

 

$

(6,037

)

 

$

(1,553

)

 

$

(4,484

)

 

$

(4,484

)

Interest expense

 

 

289

 

 

 

 

 

 

289

 

 

 

2,608

 

 

 

(2,319

)

 

 

(2,319

)

Other (income) expense, net

 

 

(865

)

 

 

 

 

 

(865

)

 

 

(583

)

 

 

(282

)

 

 

(282

)

Total other (income) expense, net

 

$

(6,613

)

 

$

 

 

$

(6,613

)

 

$

472

 

 

$

(7,085

)

 

$

(7,085

)

 

Total other income for the year ended December 31, 2019 was $6.6 million compared to $0.5 million of other expense for the year ended December 31, 2018. Interest income increased due to interest earned on investing our public offering cash proceeds. Interest expense decreased due to having no outstanding borrowings during the year ended December 31, 2019. We discuss borrowings under “Liquidity and Capital Resources” below. Other (income) expense, net was $0.9 million other income in the year ended December 31, 2019 compared to $0.6 million of other income in the year ended December 31, 2018, primarily due to our earnout liabilities. We estimate the fair value of earnout liabilities related to business combinations quarterly. During the year ended December 31, 2019, the adjustments to fair value decreased the carrying value of the earnout liability for our acquisition of Indix, resulting in other income of $1.7 million, partially offset by an increase in the carrying value of the earnout liabilities for our acquisitions of Compli and Portway, which resulted in other expense of $0.6 million. The fair value of the Indix acquisition earnout liability decreased at December 31, 2019, from the fair value at acquisition in February 2019, due primarily to the last three earnout milestones, which are nonfinancial, being more difficult to complete within the required timeframe than initially assessed. During the year ended December 31, 2018, the adjustments to fair value decreased the carrying value of the earnout liabilities for prior acquisitions, resulting in other income of $0.4 million.

47


 

Provision for (Benefit from) Income Taxes

 

 

 

For the Year Ended December 31,

 

 

 

 

 

 

2019

 

 

2018

 

 

% Change

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As

Reported

 

 

Without

Adoption

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Provision for (benefit from) income taxes

 

$

955

 

 

$

 

 

$

955

 

 

$

(976

)

 

 

-198

%

 

 

-198

%

 

The provision for income taxes for the year ended December 31, 2019 was $1.0 million compared to a benefit from income taxes of $1.0 million for the year ended December 31, 2018. The effective income tax rate was 1.9% for the year ended December 31, 2019 compared to a benefit of 1.3% for the year ended December 31, 2018. For the year ended December 31, 2019, the income tax expense related primarily to foreign tax jurisdictions. The income tax benefit for the year ended December 31, 2018 was due primarily to the determination that indefinite lived goodwill would provide a source of income to realize indefinite lived deferred tax assets, resulting in a tax benefit of $0.9 million.

We have assessed our ability to realize our deferred tax assets and have recorded a valuation allowance against such assets to the extent that, based on the weight of all available evidence, it is more likely than not that all or a portion of the deferred tax assets will not be realized. In assessing the likelihood of future realization of our deferred tax assets, we placed significant weight on our history of generating U.S. tax losses, including in 2019. As a result, we have a full valuation allowance against our net deferred tax assets, including net operating loss carryforwards, and tax credits related primarily to research and development. We expect to maintain a full valuation allowance for the foreseeable future.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Revenue

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

254,056

 

 

$

199,942

 

 

$

54,114

 

 

 

27

%

Professional services

 

 

18,042

 

 

 

13,217

 

 

 

4,825

 

 

 

37

%

Total revenue

 

$

272,098

 

 

$

213,159

 

 

$

58,939

 

 

 

28

%

 

Total revenue for the year ended December 31, 2018 increased by $58.9 million, or 28%, compared to the year ended December 31, 2017. Subscription and returns revenue for the year ended December 31, 2018 increased by $54.1 million, or 27%, compared to the year ended December 31, 2017. Professional services revenue for the year ended December 31, 2018 increased by $4.8 million, or 37%, compared to the year ended December 31, 2017. Growth in total revenue was due primarily to increased demand for our products and services from both new and existing customers. Of the increase in total revenue for the year ended December 31, 2018 compared to 2017, approximately $29.6 million was attributable to existing customers, approximately $28.3 million was attributable to new customers, and approximately $1.1 million was due to interest income on funds held for customers. Total subscription and returns revenue for 2018 included $1.2 million related to our cross-border transactions technology acquired in May 2018.

48


 

Cost of Revenue

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Cost of revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

66,556

 

 

$

48,849

 

 

$

17,707

 

 

 

36

%

Professional services

 

 

12,093

 

 

 

9,128

 

 

 

2,965

 

 

 

32

%

Total cost of revenue

 

$

78,649

 

 

$

57,977

 

 

$

20,672

 

 

 

36

%

 

Cost of revenue for the year ended December 31, 2018 increased by $20.7 million, or 36%, compared to the year ended December 31, 2017. The increase in cost of revenue in absolute dollars was due primarily to an increase of $10.3 million in employee-related costs, an increase of $4.6 million in software hosting costs, an increase of $2.2 million in allocated overhead cost, and an increase of $1.4 million in outside services expenses.

Our cost of revenue headcount increased approximately 15% from December 31, 2017 to December 31, 2018 due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to a $7.6 million increase in salaries and benefits, a $1.0 million increase in contract and temporary employees, a $0.7 million increase in stock-based compensation expense, and a $0.8 million increase in compensation expense related to our bonus plans. Software hosting costs have increased due primarily to higher transaction volumes and transitioning to a third-party hosting vendor. Allocated overhead consists primarily of facility expenses and shared information technology expenses. Facility expenses increased in 2018 due primarily to the costs associated with our new corporate headquarters in Seattle, Washington. We moved into these facilities in February 2018. Outside services expenses increased due primarily to the use of third-party consulting firms to support product and service offerings in our international operations.

Gross Profit

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

187,500

 

 

$

151,093

 

 

$

36,407

 

 

 

24

%

Professional services

 

 

5,949

 

 

 

4,089

 

 

 

1,860

 

 

 

45

%

Total gross profit

 

$

193,449

 

 

$

155,182

 

 

$

38,267

 

 

 

25

%

Gross margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

74

%

 

 

76

%

 

 

 

 

 

 

 

 

Professional services

 

 

33

%

 

 

31

%

 

 

 

 

 

 

 

 

Total gross margin

 

 

71

%

 

 

73

%

 

 

 

 

 

 

 

 

 

Total gross profit for the year ended December 31, 2018 increased $38.3 million, or 25%, compared to the year ended December 31, 2017. Total gross margin was 71% for the year ended December 31, 2018 compared to 73% for the same period of 2017. This decrease was due primarily to higher software hosting costs and to a lesser extent, higher costs for third-party consulting firms to support product and service offerings in our international operations.

 

Research and Development

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Research and development

 

$

51,909

 

 

$

41,264

 

 

$

10,645

 

 

 

26

%

49


 

 

Research and development expenses for the year ended December 31, 2018 increased $10.6 million, or 26%, compared to the year ended December 31, 2017. The increase was due primarily to an increase of $8.5 million in employee-related costs, an increase of $1.4 million in allocated overhead cost, and an increase of $0.3 million in outside services expenses.

While research and development headcount increased only 4% from December 31, 2017 to December 31, 2018, employee-related costs increased due primarily to a $5.4 million increase in salaries and benefits, a $1.0 million increase in compensation expense related to our bonus plans, a $0.9 million increase in contract and temporary employees, and a $0.8 million increase in stock-based compensation expense. Outside services expenses increased due primarily to use of third-party software developers to support product enhancements and maintenance in our international operations.

Sales and Marketing

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Sales and marketing

 

$

168,817

 

 

$

133,794

 

 

$

35,023

 

 

 

26

%

 

Sales and marketing expenses for the year ended December 31, 2018 increased $35.0 million, or 26%, compared to the year ended December 31, 2017. The increase was due primarily to an increase of $28.1 million in employee-related costs, an increase of $7.4 million for partner commission expense, and an increase of $2.7 million in allocated overhead cost offset, in part, by a decrease of $3.9 million for marketing campaign expenses.

While sales and marketing headcount was essentially flat from December 31, 2017 to December 31, 2018, employee-related costs increased due primarily to an $18.5 million increase in sales commissions expense, a $9.1 million increase in salaries and benefits, and a $1.7 million increase in stock-based compensation expense. Sales commissions expense increased due to strong sales-related activity and higher average commission rates. Our average commissions rates were higher in 2018 compared to 2017 due to an increase in the percentage of eligible sales personnel exceeding their annual sales targets. We typically pay higher sales commission rates on additional sales that exceed the established sales target. Partner commission expense increased due primarily to higher revenues and an increase in the proportion of sales eligible for partner commissions, including new sales which generally earn a higher commission rate compared to renewal sales. Partner commission expense was $21.7 million for the year ended December 31, 2018 compared to $14.3 million for the year ended December 31, 2017. Marketing campaign expenses decreased due to a reduction in our discretionary spending on advertising and marketing.

General and Administrative

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

General and administrative

 

$

39,603

 

 

$

34,286

 

 

$

5,317

 

 

 

16

%

 

General and administrative expenses for the year ended December 31, 2018 increased $5.3 million, or 16%, compared to the year ended December 31, 2017. The increase was due primarily to an increase of $2.7 million in employee-related costs, a $0.8 million increase in merchant fees, an increase of $0.8 million in insurance expense as a result of being a public company, and a $0.5 million increase in indirect tax compliance expenses.

General and administrative headcount increased 5% from December 31, 2017 to December 31, 2018. Employee-related costs increased due primarily to $1.0 million increase in stock-based compensation expense and a $1.1 million increase in compensation expense related to our bonus plans. Merchant fees, which are credit card processing fees, increased due to customers transitioning to our auto-payment program which uses credit cards for customer payment and increased payment activity. Indirect tax expenses, which are non-income tax related, increased due primarily to higher business and occupation taxes in certain tax jurisdictions.

50


 

Goodwill Impairment and Restructuring Charges

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

 

(dollars in thousands)

 

Goodwill impairment and restructuring charges:

 

 

 

 

 

 

 

 

 

 

 

 

Restructuring charges

 

$

 

 

$

752

 

 

$

(752

)

Goodwill impairment

 

 

9,174

 

 

 

8,418

 

 

 

756

 

Total goodwill impairment and restructuring charges

 

$

9,174

 

 

$

9,170

 

 

$

4

 

 

A goodwill impairment charge of $9.2 million was recorded in 2018 and a $8.4 million goodwill impairment charge was recorded in 2017, both of which related to our Brazilian operations (see Note 7 of the notes to our consolidated financial statements). There were no restructuring charges incurred in the year ended December 31, 2018, compared to $0.8 million incurred in the year ended December 31, 2017. We incurred restructuring charges in the third quarter of 2017 associated with the closure of our Overland Park office, including termination benefits and other reorganization costs, primarily associated with integrating operations.

Total Other (Income) Expense, Net

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

 

(dollars in thousands)

 

Other (income) expense, net

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

(1,553

)

 

$

(77

)

 

$

(1,476

)

Interest expense

 

 

2,608

 

 

 

2,585

 

 

 

23

 

Other (income) expense, net

 

 

(583

)

 

 

(495

)

 

 

(88

)

Total other (income) expense, net

 

$

472

 

 

$

2,013

 

 

$

(1,541

)

 

Total other expense for the year ended December 31, 2018 was $0.5 million compared to $2.0 million for the year ended December 31, 2017. Interest income increased due to interest earned on investing our IPO cash proceeds in money market accounts. Interest expense remained consistent due to higher interest expense on borrowings under our credit facilities during 2018 prior to repayment of the outstanding borrowings following our IPO. We discuss borrowings under “Liquidity and Capital Resources” below. Other income remained consistent and is comprised primarily of income resulting from the change in the fair value of earnout liabilities associated with prior business acquisitions. We estimate the fair value of earnout liabilities related to acquisitions quarterly. During 2018 and 2017, the adjustments to fair value reduced the carrying value of the earnout liabilities.

Provision for (Benefit from) Income Taxes

 

 

 

For the Year Ended December 31,

 

 

Change

 

 

 

2018

 

 

2017

 

 

Amount

 

 

 

(dollars in thousands)

 

Provision for (benefit from) income taxes

 

$

(976

)

 

$

(1,219

)

 

$

243

 

 

Benefit from income taxes for the year ended December 31, 2018 decreased by $0.2 million compared to the year ended December 31, 2017. The effective income tax rate was a benefit of 1.3% and 1.9% for the years ended December 31, 2018 and 2017, respectively. The difference is due primarily to an update to the provisional amount recorded as of December 31, 2017. We determined that indefinite lived goodwill would provide a source of income to realize indefinite lived deferred tax assets resulting in a tax benefit of $0.9 million during the year ended December 31, 2018.

 

 

51


 

Quarterly Results of Operations

The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the periods presented as well as the percentage of total revenue that each line item represented for each quarter. In management’s opinion, the data below have been prepared on the same basis as the audited consolidated financial statements included elsewhere in this report and reflect all necessary adjustments, consisting of normal recurring adjustments and the immaterial errors described below, necessary for a fair statement of this data. The results of historical periods are not necessarily indicative of the results to be expected for a full year or any future period. The following quarterly financial data should be read in conjunction with our audited financial statements and related notes included elsewhere in this report.

 

 

 

Three Months Ended

 

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

 

2019

 

 

2019

 

 

2019

 

 

2019

 

 

2018

 

 

2018

 

 

2018

 

 

2018

 

 

 

(in thousands, except per share data)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

99,956

 

 

$

91,986

 

 

$

85,008

 

 

$

78,231

 

 

$

71,730

 

 

$

64,611

 

 

$

59,845

 

 

$

57,870

 

Professional services

 

 

7,671

 

 

 

6,539

 

 

 

6,291

 

 

 

6,739

 

 

 

5,193

 

 

 

5,308

 

 

 

4,034

 

 

 

3,507

 

Total revenue

 

 

107,627

 

 

 

98,525

 

 

 

91,299

 

 

 

84,970

 

 

 

76,923

 

 

 

69,919

 

 

 

63,879

 

 

 

61,377

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

28,287

 

 

 

25,621

 

 

 

22,938

 

 

 

20,978

 

 

 

18,572

 

 

 

17,330

 

 

 

15,837

 

 

 

14,817

 

Professional services

 

 

4,592

 

 

 

4,157

 

 

 

4,397

 

 

 

4,329

 

 

 

3,700

 

 

 

2,906

 

 

 

2,795

 

 

 

2,692

 

Total cost of revenue(2)

 

 

32,879

 

 

 

29,778

 

 

 

27,335

 

 

 

25,307

 

 

 

22,272

 

 

 

20,236

 

 

 

18,632

 

 

 

17,509

 

Gross profit

 

 

74,748

 

 

 

68,747

 

 

 

63,964

 

 

 

59,663

 

 

 

54,651

 

 

 

49,683

 

 

 

45,247

 

 

 

43,868

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and

   development(2)

 

 

25,619

 

 

 

21,871

 

 

 

18,996

 

 

 

15,956

 

 

 

13,577

 

 

 

13,285

 

 

 

12,428

 

 

 

12,619

 

Sales and marketing(1)(2)

 

 

46,310

 

 

 

41,263

 

 

 

41,742

 

 

 

39,319

 

 

 

49,630

 

 

 

41,276

 

 

 

40,604

 

 

 

37,307

 

General and

   administrative(2)

 

 

18,154

 

 

 

20,511

 

 

 

18,019

 

 

 

15,234

 

 

 

10,816

 

 

 

10,235

 

 

 

9,341

 

 

 

9,211

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

 

 

 

 

Total operating

   expenses

 

 

90,083

 

 

 

83,645

 

 

 

78,757

 

 

 

70,509

 

 

 

74,023

 

 

 

73,970

 

 

 

62,373

 

 

 

59,137

 

Operating loss

 

 

(15,335

)

 

 

(14,898

)

 

 

(14,793

)

 

 

(10,846

)

 

 

(19,372

)

 

 

(24,287

)

 

 

(17,126

)

 

 

(15,269

)

Total other (income)

   expense, net

 

 

(3,342

)

 

 

(1,935

)

 

 

(728

)

 

 

(608

)

 

 

(789

)

 

 

(93

)

 

 

526

 

 

 

828

 

Loss before income taxes

 

 

(11,993

)

 

 

(12,963

)

 

 

(14,065

)

 

 

(10,238

)

 

 

(18,583

)

 

 

(24,194

)

 

 

(17,652

)

 

 

(16,097

)

Provision for (benefit from)

   income taxes

 

 

326

 

 

 

341

 

 

 

172

 

 

 

116

 

 

 

(151

)

 

 

(91

)

 

 

114

 

 

 

(848

)

Net loss

 

$

(12,319

)

 

$

(13,304

)

 

$

(14,237

)

 

$

(10,354

)

 

$

(18,432

)

 

$

(24,103

)

 

$

(17,766

)

 

$

(15,249

)

Net loss per share attributable

   to common shareholders,

   basic and diluted

 

$

(0.16

)

 

$

(0.17

)

 

$

(0.20

)

 

$

(0.15

)

 

$

(0.28

)

 

$

(0.36

)

 

$

(1.24

)

 

$

(2.47

)

Weighted average shares of

   common stock outstanding,

   basic and diluted

 

 

77,147

 

 

 

76,156

 

 

 

71,568

 

 

 

68,381

 

 

 

66,654

 

 

 

66,590

 

 

 

14,383

 

 

 

6,170

 

 

(1)

In preparing our 2019 annual financial statements, we discovered an immaterial error in recording deferred sales commissions for the first three quarters of 2019 impacting our previously reported quarterly financial results. We have presented the corrected quarterly consolidated statements of operations data and percentage of total revenue that each line item represented for each of the first three quarters of 2019 as presented below. The correction to sales commission expense resulted in additional sales and marketing expenses of $1.1 million, $1.1 million, and $0.9 million for each of the three-month periods ended March 31, 2019, June 30, 2019, and September 30, 2019, respectively.  

52


 

(2)

The stock-based compensation expense included above was as follows:

 

 

 

Three Months Ended

 

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

 

2019

 

 

2019

 

 

2019

 

 

2019

 

 

2018

 

 

2018

 

 

2018

 

 

2018

 

 

 

(in thousands)

 

Cost of revenue

 

$

845

 

 

$

828

 

 

$

708

 

 

$

741

 

 

$

484

 

 

$

508

 

 

$

377

 

 

$

296

 

Research and development

 

 

1,966

 

 

 

1,781

 

 

 

1,627

 

 

 

1,292

 

 

 

908

 

 

 

906

 

 

 

784

 

 

 

581

 

Sales and marketing

 

 

2,325

 

 

 

2,135

 

 

 

2,107

 

 

 

2,169

 

 

 

1,818

 

 

 

1,589

 

 

 

1,040

 

 

 

1,045

 

General and administrative

 

 

3,307

 

 

 

5,178

 

 

 

4,982

 

 

 

2,358

 

 

 

1,300

 

 

 

1,334

 

 

 

1,363

 

 

 

1,588

 

Total stock-based

   compensation

 

$

8,443

 

 

$

9,922

 

 

$

9,424

 

 

$

6,560

 

 

$

4,510

 

 

$

4,337

 

 

$

3,564

 

 

$

3,510

 

 

The amortization of acquired intangibles included above was as follows:

 

 

 

Three Months Ended

 

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

 

2019

 

 

2019

 

 

2019

 

 

2019

 

 

2018

 

 

2018

 

 

2018

 

 

2018

 

 

 

(in thousands)

 

Cost of revenue

 

$

1,219

 

 

$

1,235

 

 

$

1,230

 

 

$

1,170

 

 

$

1,114

 

 

$

1,121

 

 

$

887

 

 

$

898

 

Research and development

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

618

 

 

 

605

 

 

 

543

 

 

 

505

 

 

 

468

 

 

 

474

 

 

 

507

 

 

 

502

 

General and administrative

 

 

4

 

 

 

4

 

 

 

4

 

 

 

3

 

 

 

 

 

 

 

 

 

7

 

 

 

10

 

Total amortization of

   acquired intangibles

 

$

1,841

 

 

$

1,844

 

 

$

1,777

 

 

$

1,678

 

 

$

1,582

 

 

$

1,595

 

 

$

1,401

 

 

$

1,410

 

53


 

 

 

 

Three Months Ended

 

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

 

2019

 

 

2019

 

 

2019

 

 

2019

 

 

2018

 

 

2018

 

 

2018

 

 

2018

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

93

%

 

 

93

%

 

 

93

%

 

 

92

%

 

 

93

%

 

 

92

%

 

 

94

%

 

 

94

%

Professional services

 

 

7

%

 

 

7

%

 

 

7

%

 

 

8

%

 

 

7

%

 

 

8

%

 

 

6

%

 

 

6

%

Total revenue

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

 

 

100

%

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

26

%

 

 

26

%

 

 

25

%

 

 

25

%

 

 

24

%

 

 

25

%

 

 

25

%

 

 

24

%

Professional services

 

 

4

%

 

 

4

%

 

 

5

%

 

 

5

%

 

 

5

%

 

 

4

%

 

 

4

%

 

 

4

%

Total cost of revenue

 

 

31

%

 

 

30

%

 

 

30

%

 

 

30

%

 

 

29

%

 

 

29

%

 

 

29

%

 

 

29

%

Gross profit

 

 

69

%

 

 

70

%

 

 

70

%

 

 

70

%

 

 

71

%

 

 

71

%

 

 

71

%

 

 

71

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

24

%

 

 

22

%

 

 

21

%

 

 

19

%

 

 

18

%

 

 

19

%

 

 

19

%

 

 

21

%

Sales and marketing

 

 

43

%

 

 

42

%

 

 

46

%

 

 

46

%

 

 

65

%

 

 

59

%

 

 

64

%

 

 

61

%

General and administrative

 

 

17

%

 

 

21

%

 

 

20

%

 

 

18

%

 

 

14

%

 

 

15

%

 

 

15

%

 

 

15

%

Goodwill impairment

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

13

%

 

 

0

%

 

 

0

%

Total operating expenses

 

 

84

%

 

 

85

%

 

 

86

%

 

 

83

%

 

 

96

%

 

 

106

%

 

 

98

%

 

 

96

%

Operating loss

 

 

(14

)%

 

 

(15

)%

 

 

(16

)%

 

 

(13

)%

 

 

(25

)%

 

 

(35

)%

 

 

(27

)%

 

 

(25

)%

Total other (income) expense,

   net

 

 

(3

)%

 

 

(2

)%

 

 

(1

)%

 

 

(1

)%

 

 

(1

)%

 

 

0

%

 

 

1

%

 

 

1

%

Loss before income taxes

 

 

(11

)%

 

 

(13

)%

 

 

(15

)%

 

 

(12

)%

 

 

(24

)%

 

 

(35

)%

 

 

(28

)%

 

 

(26

)%

Provision for (benefit from)

   income taxes

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

0

%

 

 

(1

)%

Net loss

 

 

(11

)%

 

 

(14

)%

 

 

(16

)%

 

 

(12

)%

 

 

(24

)%

 

 

(34

)%

 

 

(28

)%

 

 

(25

)%

 

 

 

 

Three Months Ended

 

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

Dec 31,

 

 

Sep 30,

 

 

Jun 30,

 

 

Mar 31,

 

 

 

2019

 

 

2019

 

 

2019

 

 

2019

 

 

2018

 

 

2018

 

 

2018

 

 

2018

 

 

 

(in thousands)

 

Non-GAAP Financial Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free cash flow(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used

   in) operating activities

 

$

16,955

 

 

$

5,852

 

 

$

10,000

 

 

$

(10,421

)

 

$

7,036

 

 

$

1,178

 

 

$

2,099

 

 

$

(13,375

)

Purchases of property and

   equipment

 

 

(2,984

)

 

 

(2,246

)

 

 

(2,836

)

 

 

(2,114

)

 

 

(2,569

)

 

 

(4,745

)

 

 

(4,544

)

 

 

(3,625

)

Free cash flow

 

$

13,971

 

 

$

3,606

 

 

$

7,164

 

 

$

(12,535

)

 

$

4,467

 

 

$

(3,567

)

 

$

(2,445

)

 

$

(17,000

)

 

(1)

Free cash flow is a non-GAAP financial measure. For more information about free cash flow, see “Use and Reconciliation of Non-GAAP Financial Measures.”

Seasonality and Quarterly Trends

We have historically signed a higher percentage of agreements with new customers, as well as renewal and upgrade agreements with existing customers, in the fourth quarter of each year and usually during the last month. This can be attributed to buying patterns typical in the software industry. Since the terms of most of our customer agreements are annual, agreements initially entered into in the fourth quarter or last month of any quarter will generally come up for renewal at that same time in subsequent years. As a result, we have historically seen a higher percentage of customer agreement cancellations in the fourth quarter of each year. While this seasonality is reflected in our revenues, the impact to overall annual or quarterly revenues is minimal since we recognize subscription revenue ratably over the term of the customer contract. Additionally, this seasonality is reflected in commission expenses to our sales personnel and our partners.

54


 

Our quarterly revenue has increased in each period presented primarily due to increased sales to new customers, as well as increased usage by our existing customers. Our operating expenses generally have increased sequentially in every quarter primarily due to increases in headcount and related expenses to support our growth. Increases in our sales and marketing expenses primarily reflects the impacts of personnel additions and various sales and marketing initiatives that may fluctuate from quarter to quarter. Research and development expenses have fluctuated based on the timing of personnel additions and related spending on product development. We anticipate our operating expenses will continue to increase in absolute dollars in future periods as we invest in the long-term growth of our business. We anticipate that gross profit and gross margin for professional services may also fluctuate from quarter to quarter because of variability in our professional services projects and changes in headcount.

Liquidity and Capital Resources

We require cash to fund our operations, including outlays for infrastructure growth, acquisitions, geographic expansion, expanding our sales and marketing activities, research and development efforts, and working capital for our growth. To date, we have financed our operations primarily through cash received from customers for our solutions, public offerings of our common stock, private placements, and bank borrowings. As of December 31, 2019, we had $467.0 million of cash and cash equivalents, most of which was held in money market accounts.

Borrowings

We had a loan and security agreement with Silicon Valley Bank and Ally Bank (the “Lenders”) that consisted of a $50.0 million revolving credit facility (the “Credit Facility”). On June 25, 2019, we terminated the Credit Facility. As of December 31, 2019, we had no credit facilities in place and had no borrowings outstanding.

Prior to the termination of the Credit Facility, we were required to pay a quarterly fee of 0.50% per annum on the undrawn portion available under the revolving credit facility plus the sum of outstanding letters of credit. Under the Credit Facility, the interest rate on the revolving credit facility was based on the greater of either 4.25% or the current prime rate, plus 1.75%.

Future Cash Requirements

As of December 31, 2019, our cash and cash equivalents included proceeds from our June 2019 and our June 2018 public offerings of common stock. We intend to continue to increase our operating expenses and capital expenditures to support the growth in our business and operations. We may also use our cash and cash equivalents to acquire complementary businesses, products, services, technologies, or other assets. We believe that our existing cash and cash equivalents of $467.0 million as of December 31, 2019, together with cash generated from operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our financial position and liquidity are, and will be, influenced by a variety of factors, including our growth rate, the timing and extent of spending to support research and development efforts, the continued expansion of sales and marketing spending, the introduction of new and enhanced solutions, the cash paid for any acquisitions, and the continued market acceptance of our solutions.

The following table shows our cash flows from operating activities, investing activities, and financing activities for the stated periods:

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

(in thousands)

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

 

Operating Activities

 

$

22,386

 

 

$

(3,062

)

 

$

(3,541

)

Investing Activities

 

 

(52,135

)

 

 

(20,367

)

 

 

(16,256

)

Financing Activities

 

$

354,410

 

 

 

151,421

 

 

 

13,695

 

 

55


 

Operating Activities

Our largest source of operating cash is cash collections from our customers for subscriptions and returns services. Our primary uses of cash from operating activities are for employee-related expenditures, commissions paid to our partners, marketing expenses, and facilities expenses. Cash provided by (used in) operating activities is comprised of our net loss adjusted for certain non-cash items, including stock-based compensation, depreciation and amortization, goodwill impairment, operating lease costs, and other non-cash income and expense items.

For the year ended December 31, 2019, cash provided by operating activities was $22.4 million compared to cash used of $3.1 million for the year ended December 31, 2018. The improvement in cash from operations of $25.5 million was due primarily to an increase in cash collected from customers and, to a lesser extent, earning interest income in 2019 while incurring interest expense in 2018, resulting in a net improvement of $6.8 million. The increase in cash collected from customers is due to growing demand for our subscription and returns services, which is partially offset by increasing costs to support this growth. In 2019, we earned and received interest income on a portion of the cash proceeds included in cash and cash equivalents from our June 2018 and June 2019 public offerings of our common stock, while in 2018 we accrued and paid interest expense on our outstanding borrowings. See “Results of Operations” for further discussion.

For the year ended December 31, 2018, cash used in operating activities was $3.1 million compared to $3.5 million for the year ended December 31, 2017, a decrease in cash used of $0.4 million. During 2017, we received reimbursements for tenant improvements of $10.5 million compared to $1.7 million in 2018. Under the lease for our new corporate headquarters, we were granted approximately $12.3 million of tenant improvements to be paid by the landlord. We initially funded these improvements, which were recorded in investing activities as capital expenditures, and record the reimbursement of these expenditures to deferred rent, which increased cash from operating activities. Excluding reimbursements for tenant improvements, cash used in operating activities decreased by $9.1 million. This improvement in cash flows was due primarily to higher sales and improved cash collection in 2018, but was partially offset by higher operating expenses, primarily employee-related costs.

Investing Activities

Our investing activities primarily include cash outflows related to purchases of property and equipment, changes in customer fund assets, and, from time-to-time, the cash paid for asset and business acquisitions.

For the year ended December 31, 2019, cash used in investing activities was $52.1 million, compared to cash used of $20.4 million for the year ended December 31, 2018. The increase in cash used of $31.7 million was due primarily to cash paid for acquisitions of $30.3 million, and an increase in customer fund assets of $11.6 million, partially offset by lower cash paid for purchases of intangible assets of $4.9 million and lower capital expenditures of $5.3 million. In 2019, we acquired substantially all the assets of Compli, Indix, and Portway for total cash consideration of $30.3 million. In 2018, we acquired developed technology to facilitate cross-border transactions (e.g. duties and tariffs). Capital expenditures decreased due primarily to spending related to our new corporate headquarters in Seattle, Washington and expansion of our Durham, North Carolina office during 2018. Our Seattle headquarters opened in the first quarter of 2018.

For the year ended December 31, 2018, cash used in investing activities was $20.4 million, compared to cash used of $16.3 million for the year ended December 31, 2017. The increase in cash used of $4.1 million was due primarily to cash paid for acquisition of intangible assets of $5.0 million and higher capital expenditures of $1.5 million, partially offset by a decrease in customer fund assets of $2.4 million. In 2018, we acquired a customer list for $0.4 million and developed technology to facilitate cross-border transactions (e.g., tariffs and duties) for total consideration of $7.1 million, which included total cash payments of $4.6 million. Capital expenditures increased $1.5 million from the prior year due primarily to expansion and related tenant improvements for our Durham, North Carolina office.

56


 

Financing Activities

Our financing activities primarily include cash inflows and outflows from issuance and repurchases of capital stock, our employee stock purchase plan, our Credit Facility, and changes in customer fund obligations.

For the year ended December 31, 2019, cash provided by financing activities was $354.4 million compared to cash provided of $151.4 million for the year ended December 31, 2018. This increase in cash provided of $203.0 million was due primarily to increased cash proceeds from offerings of our common stock of $82.2 million, a $51.0 million increase in cash proceeds from exercise of stock options, $12.3 million of cash proceeds from common stock purchased under our employee stock purchase plan, and a $11.6 million increase in customer fund obligations in 2019. We also had net repayments on our Credit Facility of $40.0 million in 2018 with no comparable activity in 2019.

For 2018, cash provided by financing activities was $151.4 million compared to cash provided by financing activities of $13.7 million for the year ended December 31, 2017. This increase in cash provided of $137.7 million was due primarily to cash received from our IPO net of underwriting discounts of $192.5 million and an increase of $6.1 million in cash proceeds from exercise of stock options and stock warrants, partially offset by the repayment of outstanding borrowings under our Credit Facility of $63.0 million. Prior to repayment of our revolving credit line in June 2018 and our term loan in August 2018, we borrowed $23.0 million during the first half of 2018.  

Funds Held from Customers and Customer Funds Obligations

We maintain trust accounts with financial institutions, which allows our customers to outsource their tax remittance functions to us. We have legal ownership over the accounts utilized for this purpose. Funds held from customers represents cash and cash equivalents that, based upon our intent, are restricted solely for satisfying the obligations to remit funds relating to our tax remittance services. Funds held from customers are not commingled with our operating funds, but typically are deposited with funds also held on behalf of our other customers.

Customer funds obligations represent our contractual obligations to remit collected funds to satisfy customer tax payments. Customer funds obligations are reported as a current liability on the consolidated balance sheets, as the obligations are expected to be settled within one year. Cash flows related to the cash received from and paid on behalf of customers are reported as follows:

 

1)

changes in customer funds obligations liability are presented as cash flows from financing activities;

 

2)

changes in customer fund assets (e.g., customer funds held in cash and cash equivalents and receivable from customers and taxing authorities) are presented as net cash flows from investing activities; and

 

3)

changes in customer fund asset account that relate to paying for the trust operations, such as banking fees, are presented as cash flows from operating activities.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations as of December 31, 2019:

 

 

 

Total

 

 

Less than

1 year

 

 

1-3 years

 

 

3-5 years

 

 

More than

5 years

 

 

 

(in thousands)

 

Operating lease obligations

 

$

97,013

 

 

$

14,378

 

 

$

30,034

 

 

$

26,450

 

 

$

26,151

 

Purchase obligations(1)

 

 

14,182

 

 

 

8,248

 

 

 

5,934

 

 

 

 

 

 

 

Customer funds obligations(2)

 

 

24,783

 

 

 

24,783

 

 

 

 

 

 

 

 

 

 

Other liabilities(3)

 

 

8,737

 

 

 

6,796

 

 

 

1,941

 

 

 

 

 

 

 

Total

 

$

144,715

 

 

$

54,205

 

 

$

37,909

 

 

$

26,450

 

 

$

26,151

 

 

 

(1)

Purchase obligations are comprised primarily of long-term software licenses, subscriptions, and software hosting services.

(2)

We maintain trust accounts with financial institution that are solely for satisfying the obligations to remit funds relating to our tax remittance services. Customer funds obligations represent our contractual obligations to remit collected funds to satisfy customer tax payments. At December 31, 2019, we had $24.4 million of funds held from (collected from) customers. Because of in-transit payments and changes in the amounts owed to us or to the taxing authority, the asset and liability amounts presented for any period will generally not offset.

57


 

(3)

Other liabilities include the cash portion of earnout liabilities owed to Tradestream Technologies Inc. for the measurement period ended December 31, 2019 and the fair value of cash earnout liabilities owed to Compli and Indix estimated as of December 31, 2019. Other liabilities also include holdback liabilities owed to Portway, Indix and Compli.

 

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements in the years ended December 31, 2019 or 2018.

Use and Reconciliation of Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we have calculated non-GAAP cost of revenue, non-GAAP gross profit, non-GAAP gross margin, non-GAAP research and development expense, non-GAAP sales and marketing expense, non-GAAP general and administrative expense, non-GAAP operating loss, non-GAAP net loss, free cash flow, and calculated billings, which are non-GAAP financial measures. We have provided tabular reconciliations of each of these non-GAAP financial measures to its most directly comparable GAAP financial measure.

 

We calculate non-GAAP cost of revenue, non-GAAP research and development expense, non-GAAP sales and marketing expense, and non-GAAP general and administrative expense as GAAP cost of revenue, GAAP research and development expense, GAAP sales and marketing expense, and GAAP general and administrative expense before stock-based compensation expense and the amortization of acquired intangible assets included in each of the expense categories.

 

We calculate non-GAAP gross profit as GAAP gross profit before the stock-based compensation expense and amortization of acquired intangibles included in cost of revenue. We calculate non-GAAP gross margin as GAAP gross margin before the impact of stock-based compensation expense and the amortization of acquired intangibles included in cost of revenue as a percentage of revenue.

 

We calculate non-GAAP operating loss as GAAP operating loss before stock-based compensation expense, amortization of acquired intangibles, and goodwill impairments. We calculate non-GAAP net loss as GAAP net loss before stock-based compensation expense, amortization of acquired intangibles, and goodwill impairments.

 

We define free cash flow as net cash (used in) provided by operating activities less cash used for the purchases of property and equipment.

 

We define calculated billings as total revenue plus the changes in deferred revenue and contract liabilities in the period.

Management uses these non-GAAP financial measures to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, and to evaluate financial performance and liquidity. In addition, because we recognize subscription revenue ratably over the subscription term, management uses calculated billings to measure our subscription sales activity for a particular period, to compare subscription sales activity across particular periods, and as a potential indicator of future subscription revenue, the actual timing of which will be affected by several factors, including subscription start date and duration. We believe that non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our results, prospects, and liquidity period-over-period without the impact of certain items that do not directly correlate to our performance and that may vary significantly from period to period for reasons unrelated to our operating performance, as well as comparing our financial results to those of other companies. Our definitions of these non-GAAP financial measures may differ from the definitions used by other companies and therefore comparability may be limited. In addition, other companies may not publish these or similar metrics. Thus, our non-GAAP financial measures should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP.

We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view non-GAAP cost of revenue, non-GAAP gross profit, non-GAAP gross margin, non-GAAP research and development expense, non-GAAP sales and marketing expense, non-GAAP general and administrative expense, non-GAAP operating loss, non-GAAP net loss, free cash flow, and calculated billings in conjunction with the related GAAP financial measure.

58


 

As a result of adoption of ASC 606 effective January 1, 2019, non-GAAP financial measures for the twelve months ended December 31, 2019, as computed in accordance with ASC 606, are not as comparable to non-GAAP financial measures for the twelve months ended December 31, 2018 and 2017, which are computed in accordance with ASC 605. Except for calculated billings, the reconciliation of non-GAAP measures provided below includes additional information to reconcile the impacts of the adoption of ASC 606 on the non-GAAP financial measures for the twelve months ended December 31, 2019, including presentation of the non-GAAP measures for 2019 under ASC 605 for comparison to the prior years.

The following schedule reflects our non-GAAP financial measures and reconciles our non-GAAP financial measures to the related GAAP financial measures:

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

 

As Reported

(ASC 605)

 

Reconciliation of Non-GAAP Cost of Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

$

115,299

 

 

$

 

 

$

115,299

 

 

$

78,649

 

 

$

57,977

 

Stock-based compensation expense

 

 

(3,122

)

 

 

 

 

 

(3,122

)

 

 

(1,665

)

 

 

(976

)

Amortization of acquired intangibles

 

 

(4,854

)

 

 

 

 

 

(4,854

)

 

 

(4,020

)

 

 

(3,717

)

Non-GAAP Cost of Revenue

 

$

107,323

 

 

$

 

 

$

107,323

 

 

$

72,964

 

 

$

53,284

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Gross Profit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

$

267,122

 

 

$

586

 

 

$

267,708

 

 

$

193,449

 

 

$

155,182

 

Stock-based compensation expense

 

 

3,122

 

 

 

 

 

 

3,122

 

 

 

1,665

 

 

 

976

 

Amortization of acquired intangibles

 

 

4,854

 

 

 

 

 

 

4,854

 

 

 

4,020

 

 

 

3,717

 

Non-GAAP Gross Profit

 

$

275,098

 

 

$

586

 

 

$

275,684

 

 

$

199,134

 

 

$

159,875

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Gross Margin:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

70

%

 

 

0

%

 

 

70

%

 

 

71

%

 

 

73

%

Stock-based compensation expense as a percentage of revenue

 

 

1

%

 

 

0

%

 

 

1

%

 

 

1

%

 

 

0

%

Amortization of acquired intangibles as a percentage of revenue

 

 

1

%

 

 

0

%

 

 

1

%

 

 

1

%

 

 

2

%

Non-GAAP Gross Margin

 

 

72

%

 

 

0

%

 

 

72

%

 

 

73

%

 

 

75

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Research and Development Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

82,442

 

 

$

 

 

$

82,442

 

 

$

51,909

 

 

$

41,264

 

Stock-based compensation expense

 

 

(6,666

)

 

 

 

 

 

(6,666

)

 

 

(3,179

)

 

 

(2,391

)

Amortization of acquired intangibles

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Research and Development Expense

 

$

75,776

 

 

$

 

 

$

75,776

 

 

$

48,730

 

 

$

38,873

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Sales and Marketing Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

168,634

 

 

$

19,149

 

 

$

187,783

 

 

$

168,817

 

 

$

133,794

 

Stock-based compensation expense

 

 

(8,736

)

 

 

 

 

 

(8,736

)

 

 

(5,492

)

 

 

(3,789

)

Amortization of acquired intangibles

 

 

(2,271

)

 

 

 

 

 

(2,271

)

 

 

(1,951

)

 

 

(1,913

)

Non-GAAP Sales and Marketing Expense

 

$

157,627

 

 

$

19,149

 

 

$

176,776

 

 

$

161,374

 

 

$

128,092

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP General and Administrative Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

$

71,918

 

 

$

 

 

$

71,918

 

 

$

39,603

 

 

$

34,286

 

Stock-based compensation expense

 

 

(15,825

)

 

 

 

 

 

(15,825

)

 

 

(5,585

)

 

 

(4,601

)

Amortization of acquired intangibles

 

 

(15

)

 

 

 

 

 

(15

)

 

 

(17

)

 

 

(102

)

Non-GAAP General and Administrative Expense

 

$

56,078

 

 

$

 

 

$

56,078

 

 

$

34,001

 

 

$

29,583

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Operating Loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

$

(55,872

)

 

$

(18,563

)

 

$

(74,435

)

 

$

(76,054

)

 

$

(63,332

)

Stock-based compensation expense

 

 

34,349

 

 

 

 

 

 

34,349

 

 

 

15,921

 

 

 

11,757

 

Amortization of acquired intangibles

 

 

7,140

 

 

 

 

 

 

7,140

 

 

 

5,988

 

 

 

5,732

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

Non-GAAP Operating Loss

 

$

(14,383

)

 

$

(18,563

)

 

$

(32,946

)

 

$

(44,971

)

 

$

(37,425

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Net Loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(50,214

)

 

$

(18,563

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

Stock-based compensation expense

 

 

34,349

 

 

 

 

 

 

34,349

 

 

 

15,921

 

 

 

11,757

 

Amortization of acquired intangibles

 

 

7,140

 

 

 

 

 

 

7,140

 

 

 

5,988

 

 

 

5,732

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

Non-GAAP Net Loss

 

$

(8,725

)

 

$

(18,563

)

 

$

(27,288

)

 

$

(44,467

)

 

$

(38,219

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free Cash Flow:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

$

22,386

 

 

$

 

 

$

22,386

 

 

$

(3,062

)

 

$

(3,541

)

Purchases of property and equipment

 

 

(10,180

)

 

 

 

 

 

(10,180

)

 

 

(15,483

)

 

$

(13,955

)

Free Cash Flow

 

$

12,206

 

 

$

 

 

$

12,206

 

 

$

(18,545

)

 

$

(17,496

)

59


 

 

The following table reflects calculated billings and reconciles to GAAP revenues. In addition to the defined reconciling items for calculated billings, the first quarter of 2019 also includes one-time reconciling adjustments related to the impact of adoption of ASC 606 as of January 1, 2019.

 

 

Three Months Ended

 

 

Dec 31,

2019

 

 

Sep 30,

2019

 

 

Jun 30,

2019

 

 

Mar 31,

2019

 

 

Dec 31,

2018

 

 

Sep 30,

2018

 

 

Jun 30,

2018

 

 

Mar 31,

2018

 

Total revenue

$

107,627

 

 

$

98,525

 

 

$

91,299

 

 

$

84,970

 

 

$

76,923

 

 

$

69,919

 

 

$

63,879

 

 

$

61,377

 

Add:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

   (end of period)

 

161,241

 

 

 

148,466

 

 

 

138,811

 

 

 

132,714

 

 

 

134,653

 

 

 

118,209

 

 

 

109,344

 

 

 

103,878

 

Contract liabilities

   (end of period)

 

5,197

 

 

 

4,843

 

 

 

4,508

 

 

 

4,208

 

 

 

 

 

 

 

 

 

 

 

 

 

Impact of adoption

   of ASC 606 on

   deferred revenue

 

 

 

 

 

 

 

 

 

 

11,250

 

 

 

 

 

 

 

 

 

 

 

 

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

   (beginning of

   period)

 

(148,466

)

 

 

(138,811

)

 

 

(132,714

)

 

 

(134,653

)

 

 

(118,209

)

 

 

(109,344

)

 

 

(103,878

)

 

 

(92,231

)

Contract liabilities

   (beginning of

   period)

 

(4,843

)

 

 

(4,508

)

 

 

(4,208

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impact of adoption

   of ASC 606 on

   contract liabilities

 

 

 

 

 

 

 

 

 

 

(2,090

)

 

 

 

 

 

 

 

 

 

 

 

 

Calculated billings

$

120,756

 

 

$

108,515

 

 

$

97,696

 

 

$

96,399

 

 

$

93,367

 

 

$

78,784

 

 

$

69,345

 

 

$

73,024

 

 

 

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the revenue and expenses during the reporting periods. These estimates, assumptions, and judgments are necessary because future events and their effects on our consolidated financial statements cannot be determined with certainty and are made based on our historical experience and on other assumptions that we believe to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. Because the use of estimates is inherent in the financial reporting process, actual results could materially differ from those estimates.

We believe the following critical accounting policies affect our most significant judgments and estimates used in preparation of our consolidated financial statements:

 

Revenue Recognition;

 

Assets Recognized from the Costs to Obtain a Contract with a Customer

 

Stock-based Compensation;

 

Common Stock Valuations; and

 

Business Combinations, including Intangible Assets, Contingent Consideration and Goodwill.

60


 

Revenue Recognition

We primarily generate revenue from fees paid for subscriptions to tax compliance solutions and fees paid for services performed in preparing and filing tax returns on behalf of our customers. Amounts that have been invoiced are recorded in trade accounts receivable and deferred revenue, contract liabilities, or revenue, depending upon whether the revenue recognition criteria have been met. Revenue is recognized once the customer is provisioned and services are provided. Beginning in 2019, our revenue recognition policy follows guidance from ASC 606, Revenue from Contracts with Customers.

We determine revenue recognition through the following five-step framework:

 

Identification of the contract, or contracts, with a customer;

 

Identification of the performance obligations in the contract;

 

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.

We identify performance obligations in our contracts with customers, which primarily include subscription services and professional services. The transaction price is determined based on the amount we expect to be entitled to in exchange for providing the promised services to the customer. The transaction price in the contract is allocated to each distinct performance obligation on a relative standalone selling price basis. Revenue is recognized when performance obligations are satisfied.

Contract payment terms are typically net 30 days. Collectability is assessed based on a number of factors including collection history and creditworthiness of the customer, and we may mitigate exposure to credit risk by requiring payments in advance. If collectability of substantially all consideration to which we are entitled under the contract is determined to be not probable, revenue is not recorded until collectability becomes probable at a later date.

Subscription and Returns Revenue

Subscription and returns revenue primarily consist of contractually agreed upon fees paid for using our cloud-based solutions, which include tax determination and compliance management services, and fees paid for preparing and filing transaction tax returns on behalf of customers. Under our subscription agreements, customers select a price plan that includes an allotted maximum number of transactions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and customers are not entitled to refunds of fees paid or relief from fees due in the event they do not use the allotted number of transactions. If customers exceed the maximum transaction level within their price plan, we will generally upgrade the customer to a higher transaction price plan or, in some cases, charge overage fees on a per transaction basis.

Our subscription arrangements do not provide the customer with the right to take possession of the software supporting the cloud-based application services. Our standard subscription contracts are non-cancelable except where contract terms provide rights to cancel in the first 60 days of the contract term. Cancellations under our standard subscription contracts are not material, and do not have a significant impact on revenue recognized. Tax returns processing services include collection of tax data and amounts, preparation of compliance forms, and submission to taxing authorities. Returns processing services are primarily charged on a subscription basis for an allotted number of returns to process within a given time period.

Revenue is recognized ratably over the contractual term of the arrangement, beginning on the date that the service is made available to the customer. We invoice our subscription customers for the initial term at contract signing and at each subscription renewal. Initial terms generally range from 12 to 18 months, and renewal periods are typically one year. Amounts that are contractually billable and have been invoiced, or which have been collected as cash, are initially recorded as deferred revenue or contract liabilities. While most of our customers are invoiced once at the beginning of the term, a portion of customers are invoiced semi-annually, quarterly, or monthly.

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Included in the total subscription fee for cloud-based solutions are non-refundable upfront fees that are typically charged to new customers. These fees are associated with work performed to set up a customer with our services, and do not represent a distinct good or service. Instead, the fees are included within the transaction price and are allocated to the remaining performance obligations in the contract. We recognize revenue for these fees in accordance with the revenue recognition for those performance obligations.

Professional Services Revenue

We invoice for professional service arrangements on a fixed fee, milestone, or time and materials basis. Professional services revenue includes fees from providing tax analysis, configurations, registrations, data migrations, integration, training, and other support services. The transaction price allocated to professional services performance obligations is recognized as revenue as services are performed or upon completion of work.

Judgments and Estimates

Our contracts with customers often include obligations to provide multiple services to a customer. Determining whether services are considered distinct performance obligations that should be accounted for separately from one another requires judgment. Subscription services and professional services are both distinct performance obligations that are accounted for separately.

Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. We allocate revenue to each performance obligation based on the relative SSP. We determine SSP for performance obligations based on overall pricing objectives, which take into consideration observable prices, market conditions and entity-specific factors. This includes a review of historical data related to the services being sold and customer demographics. We use a range of amounts to estimate SSP for performance obligations. There is typically more than one SSP for individual services due to the stratification of those services by information, such as size and type of customer.

The revenue recognition critical accounting policy under ASC 605 is included in the Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 28, 2019.

Assets Recognized from the Costs to Obtain a Contract with a Customer

We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain costs related to employee sales incentive programs (sales commissions) and partner commission programs represent incremental costs of obtaining a contract and, therefore, should be capitalized. Capitalized costs are included in deferred commissions on the consolidated balance sheets. Deferred commissions are amortized over an estimated period of benefit, generally six years. We determine the period of benefit by taking into consideration past experience with customers, the expected life of acquired technology that generates revenue, industry peers, and other available information. The period of benefit is generally longer than the term of the initial contract because of anticipated renewals. We elected to apply the practical expedient to recognize the incremental costs of obtaining a contract as an expense if the amortization period of the asset would have been one year or less. For 2019, amortization of deferred commissions was $7.3 million. If the estimated period of benefit was changed from 6 years to 5 years, amortization of deferred commissions would have increased by $0.4 million. If the estimated period of benefit was changed from 6 years to 7 years, amortization of deferred commissions would have decreased by $0.6 million.

Stock-Based Compensation

Stock-based compensation expense is measured and recognized in our consolidated financial statements based on the fair value of our common stock underlying the stock-based awards. These awards include stock options, restricted stock units (“RSUs”), and purchase rights issued under our 2018 Employee Stock Purchase Plan (“ESPP”). The fair value of each award, excluding RSUs, is estimated on the grant date using the Black-Scholes option-pricing model. The fair value of each RSU is determined using the fair value of the underlying common stock on the date of the grant. Stock-based compensation expense is recognized on a straight-line basis in the consolidated statements of operations over the period during which the participant is required to perform services in exchange for the award, which is generally four years for stock options and RSUs and generally six months for purchase rights issued under the ESPP. Forfeitures are accounted for upon occurrence.

62


 

The determination of the grant date fair value of stock-based awards using the Black-Scholes option-pricing model is affected by our estimated common stock fair value as well as other highly subjective assumptions, including the expected term of the awards, our expected volatility over the expected term of the awards, expected dividend yield, and risk-free interest rates. The assumptions used in our option-pricing model require significant judgment and represent management’s best estimates. These assumptions and estimates are as follows:

 

Fair Value of Common Stock.    Prior to our initial public offering, we estimated the fair value of common stock as discussed in “Common Stock Valuations” below.

 

Expected Term.    The expected term of employee stock-based awards represents the weighted average period that the stock awards are expected to remain outstanding. To determine the expected term for stock options, we apply the simplified approach in which the expected term of an award is presumed to be the mid-point between the vesting date and the expiration date of the award.

 

Expected Volatility.    As we have limited trading history for our common stock, the selected volatility used is representative of expected future volatility. We based expected future volatility on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

 

Expected Dividend Yield.    We have never declared or paid cash dividends and do not presently intend to pay cash dividends in the foreseeable future. As a result, we used an expected dividend yield of zero.

 

Risk-Free Interest Rates.    We based the risk-free interest rate on the rate for a U.S. Treasury zero-coupon issue with a term that closely approximates the expected life of the stock award grant at the date nearest the stock award grant date.

If any assumptions used in the Black-Scholes option-pricing model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously. For 2019, 2018, and 2017, stock-based compensation expense was $34.4 million, $15.9 million, and $11.8 million, respectively. As of December 31, 2019, we had approximately $30.3 million of total unrecognized stock-based compensation expense related to stock options, $66.6 million of unrecognized stock-based compensation expense related to RSUs, and $0.3 million of unrecognized stock-based compensation expense related to the ESPP, which we expect to recognize over a period of approximately 2.5 years, 3.3 years, and one month, respectively.

Common Stock Valuations

Following the closing of our IPO, the fair value per share of our common stock for purposes of determining stock-based compensation is the closing price of our common stock as reported on the applicable grant date. Prior to our IPO in June 2018, the fair value of the common stock underlying our stock options and common stock warrants was estimated by our Board of Directors, with input from management. Because stock-based compensation is recognized over the requisite service period (generally four years), our 2019 stock-based compensation expense includes a significant portion attributable to the common stock valuations described below.

The estimated fair value of our common stock was determined at each valuation date in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Each valuation of our common stock was done using significant judgment and considering a variety of factors, including the following:

 

contemporaneous valuations performed at periodic intervals by unrelated third-party valuation firms;

 

the prices, rights, preferences and privileges of our preferred stock relative to our common stock;

 

the lack of marketability of our common stock;

 

our actual operating and financial performance;

 

current business conditions and projections;

 

hiring of key personnel and the experience of our management;

 

our stage of development;

 

the likelihood of achieving a liquidity event, such as an initial public offering, a merger, or an acquisition of our business;

 

the market performance of comparable publicly traded companies; and

 

macroeconomic conditions, including U.S. and global capital market conditions.

63


 

The enterprise value utilized in determining the fair value of common stock for financial reporting purposes was estimated using the market approach and the income approach. Under the market approach, we used the guideline public company method, which estimates the fair value of the business enterprise based on market prices of stock of guideline public companies and an option pricing method (OPM) that considered our September 12, 2016 Series D-2 preferred stock financing. Indications of value were estimated by utilizing revenue multiples to measure enterprise value. The guideline merged and acquired company method was not utilized in our valuation, as we regarded the method as less reliable as we believe it did not directly reflect our future prospects. The income approach estimates the enterprise value based on the present value of our future estimated cash flows and our residual value beyond the forecast period. The residual value was based on an exit (or terminal) multiple observed in the comparable company method analysis. The future cash flows and residual value are discounted to present value to reflect the risks inherent in us achieving these estimated cash flows. The discount rate was based on venture capital rates of return for companies nearing an initial public offering. The discount rate was applied using the mid-year convention. The mid-year convention assumes that cash flows are generated evenly throughout the year, as opposed to in a lump sum at the end of the year.

Our indicated enterprise value at each valuation date was allocated to the shares of our convertible preferred stock, common stock, warrants, and options using either an OPM or a probability-weighted expected return method, or PWERM. An OPM treats common stock and convertible preferred stock as call options on a business, with exercise prices based on the liquidation preference of the convertible preferred stock. Therefore, the common stock has value only if the funds available for distribution to shareholders exceed the value of the liquidation preference at the time of a liquidity event, such as a merger, sale, or initial public offering, assuming the business has funds available to make a liquidation preference meaningful and collectible by shareholders. The common stock is modeled as a call option with a claim on the business at an exercise price equal to the remaining value immediately after the convertible preferred stock is liquidated. The OPM uses the Black-Scholes option-pricing model to price the call option. Under a PWERM approach, the value ascribed to each share is based upon the probability-weighted present value of expected future investment returns, considering each of the possible future scenarios available to the business enterprise, as well as the rights of each class of stock. Finally, because we were a privately held company, we also applied a non-marketability discount in determining the fair value of our common stock based on the protective put model, which we deemed appropriate because it typically results in a low discount, to derive a fair value of our common stock on a non-marketable basis.

Business Combinations, including Intangible Assets, Contingent Consideration, and Goodwill

The results of a business acquired in a business combination are included in our consolidated financial statements from the date of the acquisition. Purchase accounting results in assets and liabilities of an acquired business being recorded at their estimated fair values on the acquisition date. Any excess consideration over the fair value of assets acquired and liabilities assumed is recognized as goodwill.

We perform valuations of assets acquired and liabilities assumed and allocate the purchase price to the respective assets and liabilities. Determining the fair value of assets acquired and liabilities assumed requires significant judgment and estimates, including the selection of valuation methodologies, estimates of future revenue, costs and cash flows, discount rates, and selection of comparable companies. We engage the assistance of third-party valuation specialists in concluding on fair value measurements in connection with determining fair values of assets acquired and liabilities assumed in a business combination.

These estimates are inherently uncertain and unpredictable, and if different estimates were used the purchase price for the acquisition could be allocated to the acquired assets and liabilities differently from the allocation that we have made. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates, and if such events occur, we may be required to record a charge against the value ascribed to an acquired asset or an increase in the amounts recorded for assumed liabilities. Under the current accounting guidance, we are allowed a one-year measurement period from the date of the acquisition to finalize our preliminary valuation of the tangible and intangibles assets and liabilities acquired and make necessary adjustments to goodwill.

64


 

Intangible Assets.    We evaluate our intangible assets for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our intangible assets consist primarily of developed technology and customer relationships arising from business acquisitions. Factors that could trigger an impairment analysis include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business or significant negative industry or economic trends. If this evaluation indicates that the value of the intangible asset may be impaired, we assess the likelihood of recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining useful life, we reduce the net carrying value of the related intangible asset to fair value.

Contingent Consideration (Earnout Liability).   Contingent consideration arising from business combinations may be payable in cash or the company’s common stock and is recorded as a liability upon acquisition and measured at fair value each subsequent reporting period. Changes in fair value are recorded in Other (income) expense, net in the consolidated statements of operations. As of December 31, 2019, our total liability related to contingent consideration for business combinations was $13.8 million. For 2019, 2018, and 2017, other income for subsequent period fair value measurements was $1.0 million, $0.4 million, and $0.7 million, respectively.  

Determining the fair value of contingent consideration requires us to make assumptions and judgments. We estimate the fair value of contingent consideration using the probability-weighted discounted cash flow and Monte Carlo simulations. These estimates involve inherent uncertainties and if different assumptions had been used, the fair value of contingent consideration could have been materially different from the amounts recorded.

Goodwill.    Goodwill is assessed for impairment at the reporting unit level at least annually on October 31, or in the event of certain occurrences. We have three reporting units for purposes of analyzing goodwill, consisting of our U.S., European, and Brazilian operations. Our impairment assessment involves comparing the fair value of each reporting unit to its carrying value, including goodwill. If the fair value exceeds the carrying value, we conclude that no goodwill impairment has occurred.

In assessing goodwill for impairment, we first assess the qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value. The next step in our assessment is to perform a quantitative analysis, if necessary, which involves determining the fair value of the reporting unit. We estimate the fair value of the reporting unit using both an income approach and a market approach, which are Level 3 measurements under the fair value hierarchy. The income approach uses discounted future cash flows derived from current internal forecasts, which include assumptions for long-term growth rates and a residual value (the hypothetical terminal value) for the reporting unit. Cash flows are discounted using the weighted average cost of capital, which is risk-adjusted to reflect the specific risk profile of the reporting unit. The market approach identifies similar publicly traded companies to the reporting unit and develops a correlation, referred to as a multiple, to apply to the operating results of the reporting unit. The primary market multiple we compare to is revenue. The market approach also reflects a reasonable control premium to compute the fair value. These estimates involve inherent uncertainties and if different assumptions are used, the fair value of a reporting unit could be materially different from the amount we computed.

As part of our annual impairment test, a qualitative impairment test was performed for the Company’s U.S. reporting unit. We concluded it is more likely than not that the fair value of the reporting unit exceeds its carrying value.

A quantitative test was performed for the European reporting unit. The European reporting unit had goodwill with a carrying value of $10.6 million as of October 31, 2019. From our quantitative assessment, we determined that the fair value of the European reporting unit was substantially in excess of its carrying value. Our internal cash flow forecast includes significant revenue growth attributable to a single customer. While this single customer is not currently significant to our consolidated results, it is expected to be significant to the European reporting unit representing assumed future revenues contributed in the near-term and long-term of approximately 45% of the total reporting unit revenue. If our revenue growth assumptions are not realized or our expectations with respect to future revenue growth are reduced, the fair value of the European reporting unit would be adversely impacted.

Significant estimates and assumptions used in the income approach for the European reporting unit included using a discount rate of 25% and a hypothetical terminal value of 1.65 times revenue. For the market approach, significant estimates and assumptions included our selection of an appropriate peer group, consisting of publicly traded U.S. and European companies, which allowed us to derive revenue multiples (e.g., trailing twelve months and next fiscal year) averaging approximately 3.0 times revenue and a selected control premium of 10%.

 

65


 

JOBS Act Accounting Election

Prior to December 31, 2019, the Company qualified as an emerging growth company, or “EGC” as defined in the Jump-start Our Business Start-ups Act (“JOBS Act”), which allowed the Company to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Effective December 31, 2019, the Company is no longer an EGC and has transitioned to a large accelerated filer status as a result of the market value of the common stock held by the Company’s non-affiliates as of June 30, 2019. As a result, the Company will adopt new or revised accounting pronouncements at dates applicable to public companies. Additionally, as a result of losing EGC status, the Company is required to have an independent registered public accounting firm issue an opinion on the effectiveness of internal control over financial reporting on an annual basis.

 

Recent Accounting Pronouncements

For further information on recent accounting pronouncements, refer to Note 2 in the accompanying notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

 

66


 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

We had cash and cash equivalents of $467.0 million and $142.3 million as of December 31, 2019 and 2018, respectively. We maintain our cash and cash equivalents in deposit accounts and money market funds with financial institutions. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income.

On June 25, 2019, we terminated our Credit Facility. At December 31, 2019, we had no borrowings outstanding. Any debt we incur in the future may bear interest at variable rates and may expose us to risk related to changes in interest rates.

Foreign Currency Exchange Risk

Our revenue and expenses are primarily denominated in U.S. dollars. For our foreign operations, the majority of our revenues and expenses are denominated in other currencies, such as the Euro, British Pound, Indian Rupee and Brazilian Real. Decreases in the relative value of the U.S. dollar as compared to these currencies may negatively affect our revenue and other operating results as expressed in U.S. dollars. For 2019, 2018, and 2017, approximately 6%, 6%, and 5%, respectively, of our revenues were generated in currencies other than U.S. dollars.

We have experienced and will continue to experience fluctuations in our net loss as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. We recognized immaterial amounts of foreign currency gains and losses in each of the periods presented. We have not engaged in the hedging of our foreign currency transactions to date. We may in the future hedge selected significant transactions denominated in currencies other than the U.S. dollar as we expand our international operation and our risk grows.

Inflation

We do not believe that inflation had a material effect on our business, financial condition, or results of operations in the last two fiscal years. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, and results of operations.

 

Item 8. Financial Statements.

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Board of Directors and Shareholders of Avalara, Inc.

Avalara, Inc.

Seattle, Washington

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Avalara, Inc. and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive loss, convertible preferred stock and shareholders’ equity (deficit), and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2020 expressed an adverse opinion on the Company's internal control over financial reporting because of a material weakness.

 

Change in Accounting Principle

 

As discussed in Note 2 to the financial statements, the Company changed its methods of accounting for costs to obtain customer contracts and accounting for leases during the year ended December 31, 2019 due to the adoption of the new revenue and lease standards. The Company adopted the new revenue and lease standards using the modified retrospective approach.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Critical Audit Matter

 

The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

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Revenue Recognition— Refer to Note 2 to the financial statements

 

Critical Audit Matter Description

 

The Company primarily generates revenue from fees paid for subscriptions to tax compliance solutions and fees paid for services performed in preparing and filing tax returns on behalf of its customers.  The Company’s subscription revenue consists of a significant volume of transactions, sourced from multiple systems, databases, and other tools. The processing and recording of revenue, including interfaces between systems and databases, is both manual and automated, and therefore the Company uses a complex set of procedures and systems to generate complete and accurate data to process and record its revenue transactions. For the year ended December 31, 2019, subscription revenue was $355.2 million.

 

We identified subscription revenue as a critical audit matter as the Company has a significant volume of subscription revenue transactions and a complex set of manual and automated procedures and systems to generate complete and accurate data to process and record revenue. This required an increased extent of effort to audit the subscription revenue transaction data and the need for us to involve professionals with expertise in data analytics.

 

How the Critical Audit Matter Was Addressed in the Audit

 

Our audit procedures related to the Company’s significant transaction volume and complex procedures and processing of subscription revenue transactions included the following, among others:

 

With the assistance of our data analytics specialists, we performed a recalculation of subscription revenue recorded through the Company’s relevant systems utilizing key attributes of subscription revenue transaction data, including the transaction price, standalone selling price, and subscription revenue recognition timing. We compared our recalculation of subscription revenue to the Company’s recorded subscription revenue and evaluated significant differences.  

For a sample of subscription revenue transactions, we evaluated the accuracy of the data used in our recalculation of subscription revenue by comparing key attributes utilized in our recalculation to source documents.

We tested the completeness of the subscription revenue transaction data by selecting transactions from multiple independent sources and evaluating whether those transactions were included in the subscription revenue transaction data.

 

/s/ Deloitte & Touche LLP

 

Seattle, Washington

February 28, 2020

 

We have served as the Company's auditor since 2012.


69


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Board of Directors and Shareholders of Avalara, Inc.

Avalara, Inc.

Seattle, Washington

 

Opinion on Internal Control over Financial Reporting

 

We have audited the internal control over financial reporting of Avalara, Inc., and subsidiaries (the “Company”) as of December 31, 2019 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, because of the effect of the material weakness identified below on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements as of and for the year ended December 31, 2019 of the Company and our report dated February 28, 2020 expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of new accounting standards.

 

Basis for Opinion

 

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definitions and Limitations of Internal Control over Financial Reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

70


 

Material Weakness

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management's assessment:  The Company has a material weakness as it does not have adequate controls to effectively design, implement, and operate process-level and information technology controls to sufficiently mitigate risks of material misstatement associated with certain complex business processes and changes in those processes or applicable accounting standards.

 

This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the year ended December 31, 2019, of the Company, and this report does not affect our report on such financial statements

 

/s/ Deloitte & Touche LLP

 

 

Seattle, Washington

February 28, 2020

71


 

AVALARA, INC.

Consolidated Balance Sheets

(In thousands, except per share data)

 

 

 

December 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

466,950

 

 

$

142,322

 

Trade accounts receivable—net of allowance for doubtful accounts of $1,179 and

   $521, respectively

 

 

51,644

 

 

 

40,287

 

Deferred commissions

 

 

9,279

 

 

 

 

Prepaid expenses and other current assets

 

 

14,127

 

 

 

11,307

 

Total current assets before customer fund assets

 

 

542,000

 

 

 

193,916

 

Funds held from customers

 

 

24,383

 

 

 

13,113

 

Receivable from customers—net of allowance of $270 and $198, respectively

 

 

420

 

 

 

270

 

Total current assets

 

 

566,803

 

 

 

207,299

 

Noncurrent assets:

 

 

 

 

 

 

 

 

Deferred commissions

 

 

29,137

 

 

 

 

Operating lease right-of-use assets—net

 

 

49,321

 

 

 

 

Property and equipment—net

 

 

34,997

 

 

 

33,373

 

Intangible assets—net

 

 

22,932

 

 

 

19,371

 

Goodwill

 

 

101,224

 

 

 

61,300

 

Other noncurrent assets

 

 

2,853

 

 

 

1,589

 

Total assets

 

$

807,267

 

 

$

322,932

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Trade payables

 

$

11,693

 

 

$

4,847

 

Accrued expenses

 

 

62,104

 

 

 

42,101

 

Deferred revenue

 

 

160,271

 

 

 

125,260

 

Accrued earnout liabilities

 

 

4,120

 

 

 

116

 

Operating lease liabilities

 

 

8,756

 

 

 

 

Total current liabilities before customer fund obligations

 

 

246,944

 

 

 

172,324

 

Customer fund obligations

 

 

24,783

 

 

 

13,349

 

Total current liabilities

 

 

271,727

 

 

 

185,673

 

Noncurrent liabilities:

 

 

 

 

 

 

 

 

Deferred revenue

 

 

970

 

 

 

9,393

 

Accrued earnout liabilities

 

 

9,835

 

 

 

 

Operating lease liabilities

 

 

58,301

 

 

 

 

Deferred rent

 

 

 

 

 

17,317

 

Deferred tax liability

 

 

337

 

 

 

560

 

Other noncurrent liabilities

 

 

2,375

 

 

 

436

 

Total liabilities

 

 

343,545

 

 

 

213,379

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Shareholders' equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value– no shares issued and outstanding at

   December 31, 2019 and December 31, 2018, and 20,000 shares authorized as of

   December 31, 2019 and December 31, 2018

 

 

 

 

 

 

Common stock, $0.0001 par value– 77,448 and 66,769 shares issued and

   outstanding at December 31, 2019 and December 31, 2018, respectively, and

   600,000 shares authorized as of December 31, 2019 and December 31, 2018

 

 

8

 

 

 

7

 

Additional paid-in capital

 

 

976,627

 

 

 

599,493

 

Accumulated other comprehensive loss

 

 

(2,719

)

 

 

(2,345

)

Accumulated deficit

 

 

(510,194

)

 

 

(487,602

)

Total shareholders’ equity

 

 

463,722

 

 

 

109,553

 

Total liabilities and shareholders' equity

 

$

807,267

 

 

$

322,932

 

 

The accompanying notes are an integral part of these consolidated financial statements.

72


 

AVALARA, INC.

Consolidated Statements of Operations

(In thousands, except per share data)

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

355,181

 

 

$

254,056

 

 

$

199,942

 

Professional services

 

 

27,240

 

 

 

18,042

 

 

 

13,217

 

Total revenue

 

 

382,421

 

 

 

272,098

 

 

 

213,159

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

97,824

 

 

 

66,556

 

 

 

48,849

 

Professional services

 

 

17,475

 

 

 

12,093

 

 

 

9,128

 

Total cost of revenue

 

 

115,299

 

 

 

78,649

 

 

 

57,977

 

Gross profit

 

 

267,122

 

 

 

193,449

 

 

 

155,182

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

82,442

 

 

 

51,909

 

 

 

41,264

 

Sales and marketing

 

 

168,634

 

 

 

168,817

 

 

 

133,794

 

General and administrative

 

 

71,918

 

 

 

39,603

 

 

 

34,286

 

Restructuring charges

 

 

 

 

 

 

 

 

752

 

Goodwill impairment

 

 

 

 

 

9,174

 

 

 

8,418

 

Total operating expenses

 

 

322,994

 

 

 

269,503

 

 

 

218,514

 

Operating loss

 

 

(55,872

)

 

 

(76,054

)

 

 

(63,332

)

Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

(6,037

)

 

 

(1,553

)

 

 

(77

)

Interest expense

 

 

289

 

 

 

2,608

 

 

 

2,585

 

Other (income) expense, net

 

 

(865

)

 

 

(583

)

 

 

(495

)

Total other (income) expense, net

 

 

(6,613

)

 

 

472

 

 

 

2,013

 

Loss before income taxes

 

 

(49,259

)

 

 

(76,526

)

 

 

(65,345

)

Provision for (benefit from) income taxes

 

 

955

 

 

 

(976

)

 

 

(1,219

)

Net loss

 

$

(50,214

)

 

$

(75,550

)

 

$

(64,126

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share attributable to common shareholders,

   basic and diluted

 

$

(0.68

)

 

$

(1.95

)

 

$

(11.39

)

Weighted average shares of common stock outstanding,

   basic and diluted

 

 

73,345

 

 

 

38,692

 

 

 

5,632

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

73


 

AVALARA, INC.

Consolidated Statements of Comprehensive Loss

(In thousands)

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Net loss

 

$

(50,214

)

 

$

(75,550

)

 

$

(64,126

)

Other comprehensive income (loss)—Foreign currency translation

 

 

(374

)

 

 

(2,683

)

 

 

1,806

 

Total comprehensive loss

 

$

(50,588

)

 

$

(78,233

)

 

$

(62,320

)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

74


 

AVALARA, INC.

Consolidated Statements of Convertible Preferred Stock and Shareholders’ Equity (Deficit)

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Convertible

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

Other

 

 

 

 

 

 

Total

 

 

 

Preferred Stock

 

 

 

Common Stock

 

 

Paid-In

 

 

Comprehensive

 

 

Accumulated

 

 

Shareholders’

 

 

 

Shares

 

 

Amount

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Deficit

 

Balance at December 31, 2016

 

 

101,786,205

 

 

$

370,921

 

 

 

 

5,297,833

 

 

$

1

 

 

$

6,122

 

 

$

(1,468

)

 

$

(347,816

)

 

$

(343,161

)

Shares tendered for cashless exercise

 

 

 

 

 

 

 

 

 

 

 

(167,250

)

 

 

 

 

 

 

(2,481

)

 

 

 

 

 

 

 

 

 

 

(2,481

)

Exercise of stock options

 

 

 

 

 

 

 

 

 

 

 

593,698

 

 

 

 

 

 

 

2,283

 

 

 

 

 

 

 

 

 

 

 

2,283

 

Exercise of warrants

 

 

 

 

 

 

 

 

 

 

 

268,012

 

 

 

 

 

 

 

308

 

 

 

 

 

 

 

 

 

 

 

308

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11,779

 

 

 

 

 

 

 

 

 

 

 

11,779

 

Impact of adoption of new accounting pronouncements - ASU 2016-09

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

110

 

 

 

 

 

 

 

(110

)

 

 

 

Gain on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,806

 

 

 

 

 

 

 

1,806

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(64,126

)

 

 

(64,126

)

Balance at December 31, 2017

 

 

101,786,205

 

 

 

370,921

 

 

 

 

5,992,293

 

 

 

1

 

 

 

18,121

 

 

 

338

 

 

 

(412,052

)

 

 

(393,592

)

Proceeds from initial public offering, net of underwriting discounts

 

 

 

 

 

 

 

 

 

 

 

8,625,000

 

 

1

 

 

 

192,509

 

 

 

 

 

 

 

 

 

 

 

192,510

 

Initial public offering costs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,425

)

 

 

 

 

 

 

 

 

 

 

(3,425

)

Conversion of preferred stock to common stock

 

 

(101,776,205

)

 

 

(370,854

)

 

 

 

50,888,014

 

 

5

 

 

 

370,849

 

 

 

 

 

 

 

 

 

 

 

370,854

 

Shares tendered for cashless redemption

 

 

 

 

 

 

 

 

 

 

 

(613,567

)

 

 

 

 

 

 

(11,589

)

 

 

 

 

 

 

 

 

 

 

(11,589

)

Exercise of stock options

 

 

 

 

 

 

 

 

 

 

 

1,373,962

 

 

 

 

 

 

 

10,478

 

 

 

 

 

 

 

 

 

 

 

10,478

 

Exercise of warrants

 

 

 

 

 

 

 

 

 

 

 

570,000

 

 

 

 

 

 

 

5,783

 

 

 

 

 

 

 

 

 

 

 

5,783

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15,950

 

 

 

 

 

 

 

 

 

 

 

15,950

 

Repurchase of shares

 

 

(10,000

)

 

 

(67

)

 

 

 

(104,847

)

 

 

 

 

 

 

(1,738

)

 

 

 

 

 

 

 

 

 

 

(1,738

)

Loss on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,683

)

 

 

 

 

 

 

(2,683

)

Shares issued to purchase intangible assets

 

 

 

 

 

 

 

 

 

 

 

37,708

 

 

 

 

 

 

 

2,555

 

 

 

 

 

 

 

 

 

 

 

2,555

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(75,550

)

 

 

(75,550

)

Balance at December 31, 2018

 

 

 

 

 

 

 

 

 

66,768,563

 

 

 

7

 

 

 

599,493

 

 

 

(2,345

)

 

 

(487,602

)

 

 

109,553

 

Proceeds from common stock offering, net of underwriting discounts

 

 

 

 

 

 

 

 

 

 

 

4,133,984

 

 

 

 

 

 

 

274,705

 

 

 

 

 

 

 

 

 

 

 

274,705

 

Public offering costs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,198

)

 

 

 

 

 

 

 

 

 

 

(1,198

)

Impact of adoption of new accounting pronouncements - ASC 606 (see Note 2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,622

 

 

 

27,622

 

Exercise of stock options

 

 

 

 

 

 

 

 

 

 

 

5,924,142

 

 

1

 

 

 

58,019

 

 

 

 

 

 

 

 

 

 

 

58,020

 

Shares tendered for cashless redemption of stock-based awards

 

 

 

 

 

 

 

 

 

 

 

(16,517

)

 

 

 

 

 

 

(1,183

)

 

 

 

 

 

 

 

 

 

 

(1,183

)

Vesting of restricted stock units

 

 

 

 

 

 

 

 

 

 

 

52,827

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

34,400

 

 

 

 

 

 

 

 

 

 

 

34,400

 

Shares issued under employee stock purchase plan

 

 

 

 

 

 

 

 

 

 

 

506,897

 

 

 

 

 

 

 

12,293

 

 

 

 

 

 

 

 

 

 

 

12,293

 

Shares issued to purchase intangible assets

 

 

 

 

 

 

 

 

 

 

 

77,724

 

 

 

 

 

 

 

98

 

 

 

 

 

 

 

 

 

 

 

98

 

Loss on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(374

)

 

 

 

 

 

 

(374

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(50,214

)

 

 

(50,214

)

Balance at December 31, 2019

 

 

 

 

 

 

 

 

 

77,447,620

 

 

$

8

 

 

$

976,627

 

 

$

(2,719

)

 

$

(510,194

)

 

$

463,722

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

75


 

AVALARA, INC.

Consolidated Statements of Cash Flows

(In thousands)

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(50,214

)

 

$

(75,550

)

 

$

(64,126

)

Adjustments to reconcile net loss to net cash provided by (used in)

   operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

34,349

 

 

 

15,921

 

 

 

11,757

 

Depreciation and amortization

 

 

15,807

 

 

 

12,802

 

 

 

10,859

 

Goodwill impairment

 

 

 

 

 

9,174

 

 

 

8,418

 

Deferred tax benefit

 

 

(223

)

 

 

(1,294

)

 

 

(1,307

)

Amortization of deferred rent

 

 

 

 

 

190

 

 

 

(698

)

Non-cash operating lease costs

 

 

5,000

 

 

 

 

 

 

 

Non-cash change in earnout liabilities

 

 

(1,043

)

 

 

(402

)

 

 

(715

)

Non-cash bad debt expense (recovery)

 

 

1,367

 

 

 

(288

)

 

 

(86

)

Other

 

 

340

 

 

 

559

 

 

 

270

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Trade accounts receivable

 

 

(12,862

)

 

 

(13,508

)

 

 

159

 

Prepaid expenses and other current assets

 

 

(3,544

)

 

 

(4,850

)

 

 

(1,055

)

Deferred commissions

 

 

(19,149

)

 

 

 

 

 

 

Other noncurrent assets

 

 

(1,265

)

 

 

(808

)

 

 

725

 

Trade payables

 

 

5,783

 

 

 

(4,419

)

 

 

(112

)

Accrued expenses

 

 

16,246

 

 

 

15,266

 

 

 

2,124

 

Deferred revenue

 

 

37,558

 

 

 

42,422

 

 

 

19,752

 

Operating lease liabilities

 

 

(5,764

)

 

 

 

 

 

 

Deferred rent

 

 

 

 

 

1,723

 

 

 

10,494

 

Net cash provided by (used in) operating activities

 

 

22,386

 

 

 

(3,062

)

 

 

(3,541

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Purchase of property and equipment

 

 

(10,180

)

 

 

(15,483

)

 

 

(13,955

)

Cash paid for acquisitions of businesses

 

 

(30,310

)

 

 

 

 

 

 

Cash paid for acquired intangible assets

 

 

(139

)

 

 

(5,002

)

 

 

 

Net (increase) decrease in customer fund assets

 

 

(11,506

)

 

 

118

 

 

 

(2,301

)

Net cash used in investing activities

 

 

(52,135

)

 

 

(20,367

)

 

 

(16,256

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from common stock offering, net of underwriting discounts

 

 

274,705

 

 

 

192,510

 

 

 

 

Payments of deferred financing costs

 

 

(555

)

 

 

(2,084

)

 

 

(1,240

)

Payments on credit facility

 

 

 

 

 

(63,000

)

 

 

(2,935

)

Proceeds from credit facility

 

 

 

 

 

23,000

 

 

 

17,605

 

Repayment of note payable

 

 

 

 

 

(234

)

 

 

 

Payments of debt issuance costs

 

 

 

 

 

 

 

 

(469

)

Proceeds from exercise of stock options and common stock warrants

 

 

58,019

 

 

 

7,041

 

 

 

920

 

Proceeds from purchases of stock under employee stock purchase plan

 

 

12,293

 

 

 

 

 

 

 

Taxes paid related to net share settlement of stock-based awards

 

 

(1,183

)

 

 

(2,365

)

 

 

(811

)

Repurchase of shares

 

 

 

 

 

(1,806

)

 

 

 

Payment related to business combination earnouts

 

 

(375

)

 

 

(1,523

)

 

 

(1,662

)

Payments on capital leases

 

 

 

 

 

 

 

 

(14

)

Net increase (decrease) in customer fund obligations

 

 

11,506

 

 

 

(118

)

 

 

2,301

 

Net cash provided by financing activities

 

 

354,410

 

 

 

151,421

 

 

 

13,695

 

Foreign currency effect on cash and cash equivalents

 

 

(33

)

 

 

255

 

 

 

(53

)

Net change in cash and cash equivalents

 

 

324,628

 

 

 

128,247

 

 

 

(6,155

)

Cash and cash equivalents—Beginning of period

 

 

142,322

 

 

 

14,075

 

 

 

20,230

 

Cash and cash equivalents—End of period

 

$

466,950

 

 

$

142,322

 

 

$

14,075

 

 

(continued)

76


 

AVALARA, INC.

Consolidated Statements of Cash Flows

(In thousands)

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Supplemental cash flow disclosures:

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid for interest expense

 

$

122

 

 

$

2,495

 

 

$

2,112

 

Cash paid for operating lease liabilities

 

$

9,784

 

 

 

 

 

 

 

Cash paid for income taxes

 

 

1,121

 

 

 

390

 

 

 

354

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Accrued purchase price related to acquisitions

 

$

4,902

 

 

$

 

 

$

 

Accrued value of earnout related to acquisitions of businesses

 

 

15,351

 

 

 

 

 

 

 

Property and equipment purchased under tenant improvement

   allowance

 

 

 

 

 

1,062

 

 

 

250

 

Property and equipment additions in accounts payable and

   accrued expenses

 

 

768

 

 

 

729

 

 

 

2,201

 

Deferred financing costs in accounts payable and accrued

   expenses

 

 

 

 

 

100

 

 

 

335

 

Fair value of common stock issued or issuable to purchase

   intangible assets

 

 

98

 

 

 

2,555

 

 

 

 

Cashless exercises of options and warrants

 

 

5

 

 

 

9,224

 

 

 

1,670

 

Cashless redemptions of options and warrants

 

 

98

 

 

 

11,589

 

 

 

2,481

 

Operating lease right-of-use assets exchanged for lease obligations

 

 

15,861

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

77


AVALARA, INC.

Notes to Consolidated Financial Statements

 

1. Nature of Operations

Avalara, Inc. (the “Company”) provides software solutions that help businesses of all types and sizes comply with tax requirements for transactions worldwide. The Company offers a broad and growing suite of compliance solutions for transaction taxes, such as sales and use tax, VAT, fuel excise tax, beverage alcohol, cross-border taxes (including tariffs and duties), lodging tax, and communications tax. These solutions enable customers to automate the process of determining taxability, identifying applicable tax rates, determining and collecting taxes, preparing and filing returns, remitting taxes, maintaining tax records, and managing compliance documents. The Company, a Washington corporation, was originally incorporated in 1999 and is headquartered in Seattle, Washington.

The Company has wholly owned subsidiaries in the United Kingdom, Canada, Belgium, India, and Brazil that provide business development, software development, and support services.

2. Significant Accounting Policies

Accounting Principles

The consolidated financial statements and accompanying notes were prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).

Principles of Consolidation

The accompanying consolidated financial statements include those of the Company and its subsidiaries after elimination of all intercompany accounts and transactions.

Segments

The Company operates its business as one operating segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, the Company’s Chief Executive Officer, in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level. For the years ended December 31, 2019, 2018, and 2017, approximately 6%, 6%, and 5% of the Company’s revenues were generated outside of the United States, respectively. As of December 31, 2019 and 2018, approximately 23% and 7% of the Company’s long-lived assets were held outside of the United States. As of December 31, 2019 and 2018, approximately 9% and 3% of the Company’s long-lived assets were held in the United Kingdom. As of December 31, 2019 and 2018, approximately 14% and 2% of the Company’s long-lived assets were held in India.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates include: the standalone value of each element in multiple-element arrangements for revenue recognition; the allowance for doubtful accounts; the measurement of fair values of stock-based compensation award grants; the expected earnout obligations in connection with acquisitions; the expected term of the customer relationship for capitalized contract cost amortization; the valuation of acquired intangible assets; and the valuation of the fair value of reporting units for analyzing goodwill. Actual results could materially differ from those estimates.

Risks and Uncertainties

The Company has incurred significant operating losses since its inception, including net losses of $50.2 million, $75.6 million, and $64.1 million for the years ended December 31, 2019, 2018, and 2017, respectively. The Company had an accumulated deficit of $510.2 million and $487.6 million as of December 31, 2019 and 2018, respectively. The Company believes that its cash and cash equivalents of $467.0 million as of December 31, 2019 is adequate to satisfy its current obligations.

78


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

Level 1: Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2: Inputs are quoted prices for similar assets and liabilities in active markets or quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

 

Level 3: Inputs are unobservable inputs based on the Company’s assumptions and valuation techniques used to measure assets and liabilities at fair value. The inputs require significant management judgment or estimation.

The Company’s assessment of the significance of an input to the fair value measurement requires judgment, which may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The carrying amounts reported in the consolidated financial statements approximate the fair value for cash equivalents, trade accounts receivable, trade payables, and accrued expenses, due to their short-term nature.

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid securities with original maturities of three months or less and are carried at cost, which approximates market value given their short-term nature.

Customer Funds Assets and Obligations

Funds Held from Customers

The Company maintains trust accounts with financial institutions, which allows customers to outsource their tax remittance functions to the Company. The Company has legal ownership over the accounts utilized for this purpose. Funds held from customers represents cash and cash equivalents that, based upon the Company’s intent, are restricted solely for satisfying the obligations to remit funds relating to the Company’s tax remittance services. Funds held from customers are not commingled with the Company’s operating funds but are typically deposited with funds also held on behalf of other customers of the Company. Funds held from customers are deposited in accounts at FDIC-insured institutions.

Funds held from customers were $24.4 million and $13.1 million as of December 31, 2019 and 2018, respectively.

Receivables from Customers

Occasionally, the Company will pay a tax obligation to taxing authorities on behalf of its customer, prior to receiving funds from the customer or prior to receiving the refund due to the customer from the taxing authority. Accounts receivable from customers represent amounts the customer is contractually obligated to repay to the Company. The future economic benefit to the Company is restricted solely for the repayment of customer funds and taxing authority obligations.

79


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Receivables from customers deemed uncollectible are charged against a separate allowance for doubtful accounts. The allowance against receivables from customers is a result of the Company assuming credit risk associated with its customers’ tax remittance obligations. The table below details the allowance against receivables from customers (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Balance at the beginning of the year

 

$

198

 

 

$

666

 

 

$

754

 

Charged to expense

 

 

166

 

 

 

(83

)

 

 

(88

)

Write-offs

 

 

(94

)

 

 

(385

)

 

 

 

Balance at the end of the year

 

$

270

 

 

$

198

 

 

$

666

 

 

Customer Funds Obligations

Customer funds obligations represent the Company’s contractual obligations to remit collected funds to satisfy customer tax payments. Customer funds obligations are reported as a current liability on the consolidated balance sheets, as the obligations are expected to be settled within one year.

Customer Funds Assets and Obligations in Consolidated Statement of Cash Flows

Cash flows related to the cash received from and paid on behalf of customers are reported as follows:

 

(1)

changes in customer funds obligations liability are presented as cash flows from financing activities;

 

(2)

changes in customer funds assets (e.g., customer funds held in cash and cash equivalents and receivable from customers and taxing authorities) are presented as net cash flows from investing activities; and

 

(3)

changes in customer funds assets account that relate to activities paying for the trust operations, such as banking fees, are included as cash flows from operating activities.

Trade Accounts Receivable

Trade accounts receivable represent amounts due from customers when the Company has invoiced the customer and has not yet received payment. An invoice is issued when the customer is contractually obligated to pay for software subscriptions and/or services. Trade accounts receivable are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in existing trade accounts receivable. The allowance for doubtful accounts is based on the assessment of collectability. The Company regularly reviews the adequacy of the allowance for doubtful accounts by considering several factors, including the age of each outstanding invoice and the collection history of each customer. Trade accounts receivable are recorded to bad debt expense when deemed uncollectible based on either a specific identification or the age of the receivable.

The table below details the allowance for doubtful accounts (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Balance at the beginning of the year

 

$

521

 

 

$

905

 

 

$

1,324

 

Charged to expense

 

 

1,201

 

 

 

(183

)

 

 

(105

)

Write-offs

 

 

(543

)

 

 

(201

)

 

 

(314

)

Balance at the end of the year

 

$

1,179

 

 

$

521

 

 

$

905

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

80


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash, cash equivalents, accounts receivable, and funds held from customers, which are held in financial institutions management believes have a high credit standing. To manage credit risk related to accounts receivable, the Company evaluates customers’ financial condition and generally collateral is not required.

As of December 31, 2019 and 2018, there were no customers that represented more than 10% of the Company’s net trade accounts receivable or more than 10% of the Company’s revenue in any of the periods presented.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation on property and equipment is computed on the straight-line method over the estimated useful life of the asset or the lease term (for leasehold improvements), whichever is shorter.

Upon retirement or sale, the cost of the disposed asset and the related accumulated depreciation are removed and any resulting gain or loss is recorded in the consolidated statements of operations. Maintenance and repairs that do not improve or extend the lives of the respective assets are charged to expense in the period incurred.

Research and Development

Research and development expenses consist primarily of personnel and related expenses for the Company’s software engineering, product development, and quality assurance, including salaries, benefits, bonuses and stock-based compensation, third-party contractors, and allocated overhead. Expenditures for research and development are expensed as incurred.

Software Capitalization

Software development costs for hosting customer transactions (i.e., cloud-based software solutions) are capitalized once the project is in the application development stage in accordance with the accounting guidance for internal-use software. These capitalized costs include external direct costs of services consumed in developing or obtaining the software and personnel expenses for employees who are directly associated with the development. Capitalization of these costs concludes once the project is substantially complete and the software is ready for its intended purpose. Post-configuration training and maintenance costs are expensed as incurred. For the years ended December 31, 2019, 2018, and 2017, $2.3 million, $1.1 million, and $1.0 million of software development costs were capitalized, respectively. Capitalized software development costs are amortized on a straight-line basis over the estimated useful life, generally 6 years.

In circumstances where software is developed for both cloud-based software solutions and for the purpose of being sold, leased, or otherwise marketed (i.e., customer hosted software), capitalization of development costs occurs after technological feasibility of the software is established and continues until the product is available for general release to customers. Since the Company’s developed software is available for general release concurrent with the establishment of technological feasibility, development costs are not capitalized in these circumstances.

Acquisitions and Goodwill

The Company’s identifiable assets acquired and liabilities assumed in a business combination are recorded at their acquisition date fair values. The valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets. Critical estimates in valuing intangible assets include, but are not limited to:

 

future expected cash flows from customer agreements, customer lists, distribution agreements, and proprietary technology and non-compete agreements;

 

assumptions about the length of time the brand will continue to be used in the Company’s suite of solutions; and

81


AVALARA, INC.

Notes to Consolidated Financial Statements

 

 

discount rates used to determine the present value of recognized assets and liabilities.

The Company’s estimates of fair value are based upon assumptions it believes to be reasonable, but that are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

Goodwill is calculated as the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Acquisition-related costs, including advisory, legal, accounting, valuation, and other costs, are expensed in the periods in which these costs are incurred. The results of operations of an acquired business are included in the consolidated financial statements beginning at the acquisition date. Goodwill is tested for impairment annually on October 31, or in the event of certain occurrences. There was no goodwill impairment recorded for the year ended December 31, 2019. Goodwill impairments of $9.2 million and $8.4 million were recorded for the years ended December 31, 2018 and 2017, respectively (See Note 7).

The Company estimates the fair value of the earnout liabilities related to business combinations using various valuation approaches, as well as significant unobservable inputs, reflecting the Company’s assessment of the assumptions market participants would use to value these liabilities. The fair value of the earnout is remeasured each reporting period, with any change in the value recorded as other income or expense. The Company recorded income from decreases in the fair value of earnout liabilities related to business combinations of $1.0 million, $0.4 million, and $0.7 million for the years ended December 31, 2019, 2018, and 2017, respectively (See Note 3).

Long-Lived Assets

The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. An impairment is recognized in the event the carrying value of such assets is not recoverable. If the carrying value is not recoverable, the fair value is determined, and an impairment is recognized for the amount by which the carrying value exceeds the fair value. No impairment of long-lived assets occurred in 2019. In 2018, the Company evaluated the long-lived intangible assets in the Company’s Brazilian reporting unit for impairment as a result of an interim triggering event discussed in Note 7. No impairment of long-lived assets (other than goodwill as discussed in Note 7), including those in the Brazilian reporting unit, occurred in 2018. See Restructuring Charges for impairment recorded in 2017.  

Acquired Intangible Assets

Acquired intangible assets consist of developed technology, customer relationships, noncompetition agreements, and tradenames and trademarks, resulting from the Company’s acquisitions. Acquired intangible assets are recorded at fair value on the date of acquisition and amortized over their estimated useful lives on a straight-line basis.

The Company recognizes an earnout liability for acquisitions of intangible assets that are accounted for as an asset acquisition when the liability is earned and the amount is known. The earnout liability is capitalized as part of the cost of the assets acquired and amortized over the remaining useful life of the asset. Asset acquisition-related costs, primarily legal fees, are capitalized and included in the cost basis of the intangible asset when incurred.

 

Self-Insurance

Beginning August 1, 2019, the Company established a self-insured healthcare plan for eligible U.S. employees. Under the plan, the Company pays healthcare claims and fees to the plan administrator. Total claim payments are limited by stop loss insurance policies. As there generally is a lag between the time a claim is incurred by a participant and the time the claim is submitted for payment, the Company has recorded a self-insurance reserve for estimated outstanding claims within accrued expenses in the consolidated balance sheets.

82


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Income Taxes

The Company’s deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and income tax basis of assets and liabilities and are measured using the tax rates that will be in effect when the differences are expected to reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. The Company assesses its income tax positions and records tax benefits or expense based upon management’s evaluation of the facts, circumstances, and information available at the reporting date.

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. The Company will recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact the consolidated financial statements.

Revenue Recognition – ASC 606

The Company primarily generates revenue from fees paid for subscriptions to tax compliance solutions and fees paid for services performed in preparing and filing tax returns on behalf of its customers. Amounts that have been invoiced are recorded in trade accounts receivable and deferred revenue, contract liabilities, or revenue, depending upon whether the revenue recognition criteria have been met. Revenue is recognized once the customer is provisioned and services are provided in an amount that reflects the consideration expected to be entitled to in exchange for those services. Effective January 1, 2019, the Company’s revenue recognition policy follows guidance from ASC 606, Revenue from Contracts with Customers.

The Company determines revenue recognition through the following five-step framework:

 

Identification of the contract, or contracts, with a customer;

 

Identification of the performance obligations in the contract;

 

Determination of the transaction price;

 

Allocation of the transaction price to the performance obligations in the contract; and

 

Recognition of revenue when, or as, the Company satisfies a performance obligation.

 

The Company identifies performance obligations in its contracts with customers, which primarily include subscription services and professional services. The transaction price is determined based on the amount which the Company expects to be entitled to in exchange for providing the promised services to the customer. The transaction price in the contract is allocated to each distinct performance obligation on a relative standalone selling price basis. Revenue is recognized when performance obligations are satisfied.

Contract payment terms are typically net 30 days. Collectability is assessed based on a number of factors including collection history and creditworthiness of the customer, and the Company may mitigate exposure to credit risk by requiring payments in advance. If collectability of substantially all consideration to which the Company is entitled under the contract is determined to be not probable, revenue is not recorded until collectability becomes probable at a later date.

Revenue is recorded based on the transaction price excluding amounts collected on behalf of third parties, such as sales taxes collected and remitted to governmental authorities.

83


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Subscription and Returns Revenue

Subscription and returns revenue primarily consists of contractually agreed upon fees paid for using the Company’s cloud-based solutions, which include tax determination and compliance management services, and fees paid for preparing and filing transaction tax returns on behalf of customers. Under the Company’s subscription agreements, customers select a price plan that includes an allotted maximum number of transactions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and customers are not entitled to refunds of fees paid or relief from fees due in the event they do not use the allotted number of transactions. If customers exceed the maximum transaction level within their price plan, the Company will generally upgrade the customer to a higher transaction price plan or, in some cases, charge overage fees on a per transaction basis.

The Company’s subscription arrangements do not provide the customer with the right to take possession of the software supporting the cloud-based application services. The Company’s standard subscription contracts are non-cancelable except where contract terms provide rights to cancel in the first 60 days of the contract term. Cancellations under the Company’s standard subscription contracts are not material, and do not have a significant impact on revenue recognized. Tax returns processing services include collection of tax data and amounts, preparation of compliance forms, and submission to taxing authorities. Returns processing services are primarily charged on a subscription basis for an allotted number of returns to process within a given time period.

Revenue is recognized ratably over the contractual term of the arrangement, beginning on the date that the service is made available to the customer. The Company invoices its subscription customers for the initial term at contract signing and at each subscription renewal. Initial terms generally range from 12 to 18 months, and renewal periods are typically one year. Amounts that are contractually billable and have been invoiced, or which have been collected as cash, are initially recorded as deferred revenue or contract liabilities. While most of the Company’s customers are invoiced once at the beginning of the term, a portion of customers are invoiced semi-annually, quarterly, or monthly.

Included in the total subscription fee for cloud-based solutions are non-refundable upfront fees that are typically charged to new customers. These fees are associated with work performed to set up a customer with the Company’s services, and do not represent a distinct good or service. Instead, the fees are included within the transaction price and allocated to the remaining performance obligations in the contract. The Company recognizes revenue for these fees in accordance with the revenue recognition for those performance obligations.

Also included in subscription and returns revenue is interest income on funds held for customers. The Company uses trust accounts at FDIC-insured institutions to provide tax remittance services to customers and collect funds from customers in advance of remittance to tax authorities. After collection and prior to remittance, the Company earns interest on these funds.

Professional Services Revenue

The Company invoices for professional service arrangements on a fixed fee, milestone, or time and materials basis. Professional services revenue includes fees from providing tax analysis, configurations, registrations, data migrations, integration, training, and other support services. The transaction price allocated to professional services performance obligations is recognized as revenue as services are performed or upon completion of work.

 

Judgments and Estimates

 

The Company’s contracts with customers often include obligations to provide multiple services to a customer. Determining whether services are considered distinct performance obligations that should be accounted for separately from one another requires judgment. Subscription services and professional services are both distinct performance obligations that are accounted for separately.

 

84


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. The Company allocates revenue to each performance obligation based on the relative SSP. The Company determines SSP for performance obligations based on overall pricing objectives, which take into consideration observable prices, market conditions and entity-specific factors. This includes a review of historical data related to the services being sold and customer demographics. The Company uses a range of amounts to estimate SSP for performance obligations. There is typically more than one SSP for individual services due to the stratification of those services by information, such as size and type of customer.

 

Assets Recognized from the Costs to Obtain a Contract with a Customer

 

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The Company has determined that certain costs related to employee sales incentive programs (sales commissions) and partner commission programs represent incremental costs of obtaining a contract and therefore should be capitalized. Capitalized costs are included in deferred commissions on the consolidated balance sheets. These deferred commissions are amortized over an estimated period of benefit, generally six years. The Company determines the period of benefit by taking into consideration past experience with customers, the expected life of acquired technology that generates revenue, industry peers, and other available information. The period of benefit is generally longer than the term of the initial contract because of anticipated renewals. The Company elected to apply the practical expedient to recognize the incremental costs of obtaining a contract as an expense if the amortization period of the asset would have been one year or less.

 

ASC 605

 

The revenue recognition accounting policy under ASC 605 is included in the Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 28, 2019. The revenue recognition accounting policy for ASC 605 is applied to the disclosures in Note 6, which include amounts presented for 2019. There were no changes to the ASC 605 policy in 2019.

 

Deferred Revenue

Deferred revenue consists of customer billings and payments in advance of revenue being recognized from the Company’s contracts. The Company typically invoices its customers annually in advance for its subscription-based contracts. Deferred revenue and accounts receivable are recorded at the beginning of the new subscription term. For some customers, the Company invoices in monthly, quarterly, or multi-year installments and, therefore, the deferred revenue balance does not necessarily represent the total contract value of all non-cancelable subscription agreements. Deferred revenue anticipated to be recognized during the succeeding 12-month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent deferred revenue.

Integration and Referral Partner Commissions

The Company utilizes independent partners to build and maintain integrations for business applications, such as accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. These integrations link the business application to the Company’s cloud-based software solutions. Integration partners are paid a commission based on a percentage of the sales that use the integration. In general, integration partners are paid a higher commission for the initial sale to a new customer and a lower commission for renewal sales.

Referral partners bring new customers to the Company and receive a commission that is based on a percentage of the first-year sales. Some of the Company’s integration partners also refer customers that have purchased the partner’s business application.

85


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The Company recognizes commissions related to integration and referral partners in sales and marketing costs when a binding customer order is agreed to by the Company and the customer. The Company defers the portion of partner commissions costs that are considered a cost of obtaining a new contract with a customer in accordance with the new revenue recognition standard and amortizes these deferred costs over the period of benefit. The period of benefit is separately determined for each partner and is either six years or corresponds with the contract term. The Company expenses the remaining partner commissions as incurred. The Company classifies these costs as sales and marketing expenses. For 2019, partner commission expense totaled $22.0 million on an ASC 606 basis (or $29.0 million on an ASC 605 basis). For 2018 and 2017, partner commission expense totaled $21.7 million and $14.3 million, respectively, on an ASC 605 basis. In 2019, we deferred $9.7 million of partner commissions.

An immaterial portion of the Company’s revenue is generated from sales made through integration partners, rather than through the Company. For these transactions, the Company evaluates whether revenue should be presented on a gross basis, which is the amount that a customer pays for the Company’s solution, or on a net basis, which is the customer payment less partner commissions. The Company has determined that a gross presentation is appropriate for revenue generated through these integration partners, because the Company is the primary provider of services to the end customers and is the primary obligor in these relationships. In addition, the Company has customer credit risk for non-payment, and the Company has latitude in establishing and negotiating prices on transactions from these sources.

Cost of Revenue

Cost of revenue consists of personnel and related expenses for providing the Company’s solutions and supporting its customers, including salaries, benefits, bonuses, and stock-based compensation, direct costs and allocated costs associated with information technology, tax content, and allocated rent and overhead.

Advertising Costs

The Company expenses all advertising costs as incurred and classifies these costs as sales and marketing expenses. Advertising expenses were $20.2 million, $18.8 million, and $22.7 million for the years ended December 31, 2019, 2018, and 2017, respectively.

Leases – ASC 842

Effective January 1, 2019, the Company’s lease accounting policy follows guidance from ASC 842, Leases. Leases arise from contracts which convey the right to control the use of identified property or equipment for a period of time in exchange for consideration. The Company’s leasing arrangements are primarily for office space used to conduct operations. The Company determines whether an arrangement is or contains a lease at the inception date, based on whether there is an identified asset and whether the Company controls the use of the identified asset throughout the period of use. Leases commence when the lessor makes the asset available for use.

 

Leases are classified at commencement as either operating or finance leases. As of December 31, 2019, all of the Company’s leases are classified as operating leases. Rent expense for operating leases is recognized on the straight-line method over the term of the agreement beginning on the lease commencement date.

 

At commencement, the Company records an operating lease liability at the present value of future lease payments, net of any future lease incentives to be received. Lease agreements may include cancellable future periods subject to termination or extension options, which are not included in the future lease payments unless it is reasonably certain the Company will continue to utilize the asset for those periods. The discount rate used to determine the present value is the Company’s incremental borrowing rate (“IBR”) unless the interest rate implicit in the lease is readily determinable. The Company’s leases do not have an implicit interest rate readily determinable, and as such, the Company used the IBR as the discount rate for all leases. The IBR is an estimate of the Company’s collateralized borrowing rate, and is estimated based on information available at the lease commencement date, including the lease term and the currency in which the arrangement is denominated. At commencement, a corresponding right-of-use asset is recorded, which is calculated based on the amount of the operating lease liability, adjusted for any advance lease payments paid, initial direct costs incurred, or lease incentives received prior to commencement. Right-of-use assets are subject to evaluation for impairment or disposal on a basis consistent with other long-lived assets.

86


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The Company does not record right-of-use assets or operating lease liabilities for leases with terms of 12 months or less and does not separate nonlease components from the associated lease components for real estate leases. The primary impact of this policy election is that included in the calculation of operating lease liabilities are any fixed and noncancelable future payments due under the contract for items such as common area maintenance, utilities, parking, and other costs. Lease-related costs, which are variable rather than fixed, are expensed in the period incurred. Variable lease costs consist primarily of common area maintenance and utilities costs for the Company’s office spaces that are due based on the actual costs incurred by the landlord. None of the Company’s variable payments depend on an index or a rate.

 

The Company accounts for subleases from the perspective of a lessor and evaluates the duration of subleases based on the reasonable certainty of any sublessor termination and extension options, as well as the lease term for the underlying asset. The Company has one sublease classified as an operating lease. For subleases classified as operating leases, the Company records sublease income as a reduction of lease expense on the straight-line method over the lease term.

 

Prior to 2019, the Company’s lease accounting policy followed guidance under ASC 840. The lease accounting policy under ASC 840 is included in the Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 28, 2019. There were no changes to the ASC 840 policy in 2019.

Foreign Currency Translation

Assets and liabilities of each of the Company’s foreign subsidiaries are translated at the exchange rate in effect at each period-end. Consolidated statement of operations amounts are translated at the average rate of exchange prevailing during the period. Translation adjustments arising from differing exchange rates from period to period are included in accumulated other comprehensive loss within shareholders’ equity.

Employee Benefit Plan

The Company offers a salary deferral 401(k) plan for its U.S. employees. The plan allows employees to contribute a percentage of their pretax earnings annually, subject to limitations imposed by the Internal Revenue Service. The plan also allows the Company to make matching contributions, subject to certain limitations. The Company contributed $3.8 million, $0.8 million, and $0.7 million to the plan in 2019, 2018, and 2017, respectively.

Stock-Based Compensation

The Company accounts for stock-based compensation by calculating the fair value of each stock option, common stock warrant, RSU, or purchase right issued under the Company’s ESPP at the date of grant. The fair value of stock options, common stock warrants, and purchase rights issued under the ESPP is estimated by applying the Black-Scholes option-pricing model. This model uses the fair value of the Company’s underlying common stock at the measurement date, the expected or contractual term of the option, warrant or purchase right, the expected volatility of its common stock, risk-free interest rates, and expected dividend yield of its common stock. The fair value of an RSU is determined using the fair value of the Company’s underlying common stock on the date of grant. The Company accounts for forfeitures as they occur.

Deferred Financing Costs

Deferred financing costs, consisting primarily of legal, accounting, printing and filing services, and other direct fees and costs related to public offerings of common stock, are capitalized. The deferred financing costs related to the Company’s IPO and additional public offering of common stock were offset against proceeds from those offerings upon the closing of the offerings in June 2018 and June 2019, respectively.  

Restructuring Charges

In August 2017, management approved a plan to close the Company’s Overland Park office and consolidate these operations into the Seattle and Durham locations. The restructuring plan was completed March 31, 2018.

87


AVALARA, INC.

Notes to Consolidated Financial Statements

 

In connection with this plan, the Company incurred restructuring charges of $0.8 million in 2017, including $0.7 million of termination benefits and other reorganization costs, primarily associated with integrating the operations and $0.1 million related to an impairment loss on fixed assets. Restructuring charges associated with this plan are included in restructuring charges in the consolidated statements of operations. No restructuring liability remained as of December 31, 2019 or 2018.   

Recently Issued Accounting Pronouncements

Prior to December 31, 2019, the Company qualified as an EGC as defined in the JOBS Act, which allowed the Company to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. The Company had previously elected to use the adoption dates applicable to private companies. As a result, the Company’s consolidated financial statements may not be comparable to the financial statements of issuers who were required to comply with the effective date for new or revised accounting standards that are applicable to public companies. Effective December 31, 2019, the Company no longer qualifies as an EGC, and will adopt accounting pronouncements at dates applicable to public companies.

Recently Adopted Accounting Standards

ASU No. 2014-09

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09 which, along with subsequent ASUs, amends the existing accounting standards for revenue recognition, and is codified as ASC 606 (“ASC 606”). This guidance is based on principles that govern the recognition of revenue at the amount an entity expects to be entitled to receive as services are provided to customers. The Company adopted the new revenue recognition standard as of January 1, 2019 on a modified retrospective basis and applied the new revenue recognition standard only to contracts that were not completed contracts prior to January 1, 2019.

The cumulative effect of the changes made to the consolidated January 1, 2019 balance sheet resulting from the adoption of ASC 606 was as follows (in thousands):

 

 

 

Balance at

December 31,

2018

 

 

Adjustments

due to

ASC 606

 

 

Balance at

January 1,

2019

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Trade accounts receivable

 

$

40,287

 

 

$

(805

)

 

$

39,482

 

Deferred commissions, current

 

 

 

 

 

4,464

 

 

 

4,464

 

Deferred commissions, noncurrent

 

 

 

 

 

14,803

 

 

 

14,803

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

 

 

 

Accrued expenses

 

 

42,101

 

 

 

2,090

 

 

 

44,191

 

Deferred revenue, current

 

 

125,260

 

 

 

(3,157

)

 

 

122,103

 

Deferred revenue, noncurrent

 

 

9,393

 

 

 

(8,093

)

 

 

1,300

 

Accumulated deficit

 

 

(487,602

)

 

 

27,622

 

 

 

(459,980

)

 

The adoption changed the revenue recognition for non-refundable upfront fees included with new or upgraded subscriptions. Prior to the adoption of the new revenue recognition standard, the Company recognized revenue for these fees over the expected term of the customer relationship. Under the new guidance, the transaction price is allocated to distinct performance obligations. Because upfront fees do not represent a distinct performance obligation, any such fees will be recognized over the period in which distinct performance obligations in the contract are satisfied, which is typically the subscription term. The new revenue recognition standard also changed the determination of the contract term associated with subscriptions that were upgraded during the subscription term. Prior to the adoption of the new revenue recognition standard, additional fees associated with an upgraded subscription for services already delivered were recognized upon upgrade. Under the new guidance, the fees related to the upgraded subscriptions are recognized prospectively over the contract term.

88


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The adoption also changed the revenue recognition for contracts that include non-standard, extended customer cancellation provisions. Under the new guidance, a contract only exists for the period of time in which a contract cannot be cancelled, which generally corresponds to the termination notice period. Prior to the adoption of the new revenue recognition standard, non-standard, extended cancellation provisions were not a factor in determining the term of a contract. Under the new guidance, to the extent cash is received for a contract that includes a non-standard, extended cancellation provision, deferred revenue is recognized only for the amount for which the Company has an enforceable right. A separate contract liability is established for the remaining amount.

The new revenue recognition standard requires the Company to estimate variable consideration at contract inception as an increase or decrease to the transaction price. The total transaction price, inclusive of variable consideration, is allocated to performance obligations, or distinct service periods within a performance obligation, on a relative SSP basis and recognized as performance obligations are satisfied. Prior to the adoption of the new revenue recognition standard, overage fees, concessions, and cancellations allowed in the first 60 days of a standard subscription contract were recognized as they occurred. 

The new revenue recognition standard requires capitalization of certain incremental costs of obtaining a contract, such as certain employee sales commissions and partner commissions, which impacts the period in which the expense is recorded. Prior to the adoption of the new revenue recognition standard, those commission costs were expensed as incurred. Under the new revenue recognition standard, the Company is required to capitalize incremental costs of obtaining a contract and amortize them over the expected period of benefit, which is generally six years. This results in a deferral of sales commission and partner commission expense each period.

For further discussion regarding the impacts of adopting the new revenue recognition standard, see Note 6.

ASU No. 2016-02

In February 2016, the FASB issued ASU No. 2016-02, which was subsequently amended in July 2018 by ASU No. 2018-10, “Codification Improvements to Topic 842, Leases” and ASU 2018-11, “Targeted Improvements - Leases (Topic 842)” which is codified as ASC 842 (“ASC 842”). ASC 842 requires lessees to generally recognize most operating leases on the balance sheet but record expenses on the income statement in a manner similar to current accounting standards.

The standard is effective for public entities for annual and interim reporting periods beginning after December 15, 2018, and for private companies in 2020. As an EGC, the Company elected to use adoption dates applicable to private companies. However, the Company lost its EGC status on December 31, 2019. Accordingly, the Company adopted ASC 842 as of January 1, 2019 in this Annual Report on Form 10-K for the year ended December 31, 2019. The Company used the alternative transition method provided in ASU 2018-11, which does not require adjusting comparative period financial information. As a result, prior period comparative financial information was not recast under the new standard and continues to be presented under the prior lease accounting standards. The Company elected the package of practical expedients permitted under the transition guidance which allows the carry forward of the historical lease identification, lease classification and initial direct costs of existing leases. In addition, the Company elected the practical expedient to not separate lease and nonlease components for real estate leases. Further, the Company made an accounting policy election to adopt the short-term lease exception, which allows the Company to not record leases with an initial term of 12 months or less on the balance sheet.

The adoption of ASC 842 on January 1, 2019 resulted in the recognition of operating lease right-of-use assets of $38.5 million and operating lease liabilities of $56.9 million at the date of adoption. In connection with the adoption of this standard, deferred rent of $18.5 million, which was previously recorded in accrued expenses and deferred rent on the consolidated balance sheet as of December 31, 2018, was derecognized. The adoption of ASC 842 did not have a material impact on the Company’s consolidated statements of operations or net cash provided by operating activities.

 

89


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The adjustments to the consolidated January 1, 2019 balance sheet resulting from the adoption of ASC 842 were as follows (in thousands):

 

 

 

Balance at

December 31,

2018

 

 

Adjustments

due to

ASC 842

 

 

Balance at

January 1,

2019

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease right-of-use assets

 

$

 

 

$

38,460

 

 

$

38,460

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

 

 

 

Accrued expenses

 

 

42,101

 

 

 

(1,138

)

 

 

40,963

 

Operating lease liabilities, current

 

 

 

 

$

5,302

 

 

 

5,302

 

Deferred rent, noncurrent

 

 

17,317

 

 

 

(17,317

)

 

 

 

Operating lease liabilities, noncurrent

 

 

 

 

$

51,613

 

 

 

51,613

 

 

For further discussion regarding the impacts of adopting ASC 842, see Note 8.

ASU No. 2018-07

In June 2018, the FASB issued ASU No. 2018-07, related to stock compensation for nonemployee share-based awards. ASU No. 2018-07 expands the scope of Topic 718 – Compensation – Stock Compensation to include share-based payments issued to nonemployees, with certain exceptions, in order to align the accounting for employees and nonemployees. The guidance in ASU No. 2018-07 is required for annual reporting periods beginning after December 15, 2019 for business entities that are not public, with early adoption permitted. The Company early adopted the guidance on January 1, 2019. The adoption had an immaterial impact on the consolidated financial statements.

New Accounting Standards Not Yet Adopted

ASU 2016-13

In June 2016, the FASB issued ASU No. 2016-13, related to credit losses, which amends the current accounting guidance and requires the measurements of all expected losses based on historical experience, current conditions and reasonable and supportable forecasts. The new guidance replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. The guidance in ASU No. 2016-13 is required for annual periods, including interim periods within those annual periods, beginning after December 15, 2019 for public business entities. The Company adopted this guidance on January 1, 2020. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

ASU 2018-15

In August 2018, the FASB issued ASU No. 2018-15, related to implementation costs incurred in a cloud computing arrangement that is a service contract. This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance in ASU No. 2018-15 is required for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2019, for public business entities, with early adoption permitted. The Company adopted this guidance on January 1, 2020 with prospective application, as permitted by the ASU. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

ASU 2019-12

In December 2019, the FASB issued Accounting Standard Update No. 2019-12, which simplifies the accounting for income taxes. The guidance in ASU No. 2019-12 is required for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2020, for public business entities, with early adoption permitted. The Company will adopt this guidance on January 1, 2021. The Company is currently evaluating the impact this guidance will have on the Company’s consolidated financial statements.

 

90


AVALARA, INC.

Notes to Consolidated Financial Statements

 

3. Fair Value Measurements

Assets and liabilities measured at fair value on a recurring basis

The following financial assets and liabilities are measured at fair value on a recurring basis. The fair values recognized in the accompanying consolidated balance sheets and the level within the fair value hierarchy in which the fair value measurements fall is as follows (in thousands):

 

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

 

 

Quoted Prices

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

Other

 

 

Significant

 

 

 

 

 

 

 

Markets for

 

 

Observable

 

 

Unobservable

 

 

 

Fair

 

 

Identical Assets

 

 

Inputs

 

 

Inputs

 

December 31, 2019

 

Value

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

Money market funds

 

$

458,248

 

 

$

458,248

 

 

$

 

 

$

 

Earnout related to business combinations

 

 

13,808

 

 

 

 

 

 

 

 

 

13,808

 

 

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

 

 

Quoted Prices

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

Other

 

 

Significant

 

 

 

 

 

 

 

Markets for

 

 

Observable

 

 

Unobservable

 

 

 

Fair

 

 

Identical Assets

 

 

Inputs

 

 

Inputs

 

December 31, 2018

 

Value

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

Money market funds

 

$

138,483

 

 

$

138,483

 

 

$

 

 

$

 

Earnout related to business combinations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Company uses the fair value hierarchy for financial assets and liabilities. The Company’s non-financial assets and liabilities, which include goodwill, intangible assets, and long-lived assets, are not required to be measured at fair value on a recurring basis.

Earnout Liability

Earnout liabilities recorded in connection with an acquisition accounted for as a business combination under ASC 805 are recorded at estimated fair value on a recurring basis. Business combinations are discussed in Note 5. Earnouts recorded in connection with asset acquisitions are recorded as earnout payments become known. As such, earnouts related to asset acquisitions, which are discussed in Note 7, are not included in these fair value disclosures.

Earnout liabilities are classified as Level 3 liabilities because the Company uses unobservable inputs to value them, reflecting its assessment of the assumptions market participants would use to value these liabilities. Changes in the fair value of earnout liabilities are recorded in other (income) expense, net in the consolidated statements of operations.

The Company generally estimates the fair value of earnout liabilities for business combinations using the probability-weighted discounted cash flow and Monte Carlo simulations. As of December 31, 2019, the earnout liability associated with the 2019 acquisition of Portway was valued utilizing a discount rate of 10.0%. The Portway discount rate was calculated using the build-up method with a risk-free rate commensurate with the term of the earnout.

The earnout periods for the 2019 acquisitions of Compli and Indix ended on January 31, 2020 and February 6, 2020, respectively. As of December 31, 2019, the earnout liability associated with Compli is the Company’s final estimate of the earnout liability, based on known performance in 2019 and projected performance for January 2020. As of December 31, 2019, the earnout liability associated with Indix is based on a probability-weighted estimate of earnout milestone achievement.   As of December 31, 2018, the fair value of the earnout liability associated with the Company’s 2016 acquisition of Gyori Eto Empreendimentos e Particpacoes in Brazil (“the Brazil acquisition”) was determined to be zero. No payments were made under the Brazil acquisition’s earnout provision, which ended on June 30, 2019.

91


AVALARA, INC.

Notes to Consolidated Financial Statements

 

A reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying consolidated balance sheets using significant unobservable (Level 3) inputs, is as follows (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

Earnout liability:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

 

 

$

380

 

Fair value recorded at acquisition

 

 

15,351

 

 

 

 

Payments of earnout liability

 

 

(500

)

 

 

 

Total unrealized net gains included in other (income) expense, net

 

 

(1,043

)

 

 

(380

)

Balance end of period

 

$

13,808

 

 

$

 

 

The unrealized net gain included in other (income) expense, net for the year ended December 31, 2019 relates to the 2019 acquisitions of Compli, Indix, and Portway. The unrealized net gain for the year ended December 31, 2018 relates to the Brazil acquisition.

Assets and liabilities measured at fair value on a non-recurring basis

The Company’s non-financial assets and liabilities, which include goodwill, intangible assets, and long-lived assets, are not required to be measured at fair value on a recurring basis. There were no fair value measurements of these assets during 2019, except as discussed in Note 5. In 2018, goodwill related to the Brazilian reporting unit, with a total carrying value of $9.2 million after considering currency fluctuations during the year, was written down to fair value of zero, resulting in a $9.2 million impairment charge in the year ended December 31, 2018. The fair value was determined using significant unobservable (Level 3) inputs. See Note 7 for additional details on the impairment charge and valuation methodologies.

4. Balance Sheet Detail

Property and equipment, net consisted of the following (in thousands):

 

 

 

Useful

 

December 31,

 

 

December 31,

 

 

 

Life (Years)

 

2019

 

 

2018

 

Computer equipment and software

 

3 to 5

 

$

15,636

 

 

$

12,904

 

Internally developed software

 

6

 

 

5,948

 

 

 

3,620

 

Furniture and fixtures

 

5

 

 

6,589

 

 

 

5,850

 

Office equipment

 

3 to 5

 

 

1,058

 

 

 

586

 

Leasehold improvements

 

1 to 10

 

 

28,984

 

 

 

26,788

 

 

 

 

 

 

58,215

 

 

 

49,748

 

Accumulated depreciation

 

 

 

 

(23,218

)

 

 

(16,375

)

Property and equipment—net

 

 

 

$

34,997

 

 

$

33,373

 

 

Depreciation expense was $8.7 million, $6.8 million, and $4.9 million, for the years ended December 31, 2019, 2018, and 2017, respectively.

92


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Prepaid expenses and other current assets (in thousands):

 

 

 

December 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

Prepaid expenses

 

$

11,064

 

 

$

9,578

 

Accrued investment income

 

 

565

 

 

 

260

 

Deferred financing costs

 

 

 

 

 

643

 

Deposits

 

 

197

 

 

 

325

 

Other

 

 

2,301

 

 

 

501

 

Total

 

$

14,127

 

 

$

11,307

 

 

Accrued expenses consisted of the following (in thousands):

 

 

 

December 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

Accrued payroll and related taxes

 

$

3,985

 

 

$

3,800

 

Accrued federal, state, and local taxes

 

 

2,635

 

 

 

1,827

 

Accrued bonus

 

 

20,206

 

 

 

10,766

 

Self-insurance reserves

 

 

2,238

 

 

 

 

Employee stock purchase plan contributions

 

 

4,716

 

 

 

6,473

 

Accrued sales commissions

 

 

5,397

 

 

 

6,889

 

Accrued partner commissions

 

 

7,043

 

 

 

5,535

 

Contract liabilities

 

 

5,197

 

 

 

 

Accrued purchase price related to acquisitions

 

 

2,763

 

 

 

 

Other

 

 

7,924

 

 

 

6,811

 

Total

 

$

62,104

 

 

$

42,101

 

 

Contract liabilities represent amounts that are collected in advance of the satisfaction of performance obligations under the new revenue recognition standard. See Recently Adopted Accounting Standards in Note 2 and Contract Liabilities in Note 6.

5. Acquisitions of Businesses

January 2019 Acquisition of Compli

On January 22, 2019, the Company completed the acquisition of substantially all the assets of Compli under an Asset Purchase Agreement (the “Compli Purchase”). Compli is a provider of compliance services, technology, and software to producers, distributors, and importers of beverage alcohol in the United States. The Company accounted for the Compli Purchase as a business combination. As a result of the acquisition, the Company expanded its ability to provide transaction tax solutions and content for the beverage alcohol industry. The transaction costs associated with the acquisition were not material.

The total consideration transferred related to this transaction was $17.1 million, consisting of $11.8 million paid in cash at closing, an additional $1.6 million of cash to be paid out after twelve months, and an earnout provision fair valued upon acquisition at $3.8 million. The earnout provision is for a one-time payment and has a maximum payout of $4.0 million based on revenue recognized by the Company from the acquired operating assets for the twelve-month period ending January 31, 2020. The earnout was originally recognized at fair value at the date of the business combination and is recorded as an accrued earnout liability in current liabilities on the consolidated balance sheet as of December 31, 2019. The earnout liability is adjusted to fair value quarterly (see Note 3).

93


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Estimated fair values of the assets acquired and the liabilities assumed in the Compli Purchase as of the acquisition date are provided in the following table (in thousands): 

 

Assets acquired:

 

 

 

 

Current assets

 

$

505

 

Developed technology, customer relationships, and other intangibles

 

 

4,288

 

Goodwill

 

 

12,807

 

Total assets acquired

 

 

17,600

 

Liabilities assumed:

 

 

 

 

Current liabilities

 

 

482

 

Total liabilities assumed

 

 

482

 

Net assets acquired

 

$

17,118

 

 

The Company utilizes different valuation approaches and methodologies to determine the fair value of acquired intangible assets. A summary of the valuation methodologies, significant assumptions, and estimated useful lives of acquired intangible assets in the Compli Purchase are provided in the below table (in thousands):

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

 

Estimated Useful

Life

Customer relationships

 

$

3,250

 

 

Multi-period excess

earnings-income approach

 

 

13

%

 

6 years

Trademarks and trade names

 

 

32

 

 

Relief from royalty-

income approach

 

 

13

%

 

2 years

Developed technology and

   customer database

 

 

910

 

 

Relief from royalty-

income approach

 

 

13

%

 

6 years

Noncompetition agreements

 

 

96

 

 

With-and-without valuation-

income approach

 

 

13

%

 

3 years

 

The excess of the purchase price over the net identified tangible and intangible assets of $12.8 million has been recorded as goodwill, which includes synergies expected from the combined service offerings and the value of the assembled workforce. The goodwill is expected to be deductible for tax purposes.

 

For the period from the date of the Compli acquisition through December 31, 2019, revenue was $3.9 million and pre-tax loss was $0.2 million from the Compli business.

 

February 2019 Acquisition of Indix

On February 6, 2019, the Company completed the acquisition of substantially all the assets of Indix under an Asset Purchase Agreement (the “Indix Purchase”). Indix is an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide. The Company accounted for the Indix Purchase as a business combination. As a result of the acquisition, the Company intends to use the Indix artificial intelligence to maintain and expand its tax content database. The transaction costs associated with the acquisition were not material.

The total consideration transferred related to this transaction was $9.1 million, consisting of $5.5 million paid in cash at closing, an additional $1.4 million cash to be paid after eighteen months, and an earnout provision valued upon acquisition at $2.2 million. The earnout provision has a maximum payout of $3.0 million based on the successful transition and achievement of development milestones established in the purchase agreement. The earnout provides for interim payments based on milestones to be evaluated as follows: $0.5 million within three months of closing, $0.65 million within seven months of closing, $0.65 million within eight months of closing, and $1.2 million within 12 months of closing. The earnout was originally recognized at fair value at the date of the business combination and is adjusted to fair value quarterly (see Note 3). The first earnout milestone was achieved

94


AVALARA, INC.

Notes to Consolidated Financial Statements

 

in the second quarter of 2019 and was paid in July 2019. The second milestone was not achieved. In January 2020, the Company determined the third milestone was partially achieved. In February 2020, the Company determined the fourth milestone was not achieved. The estimated fair value of the unpaid earnout at December 31, 2019 is recorded as an accrued earnout liability in current liabilities on the consolidated balance sheet.

Estimated fair values of the assets acquired and the liabilities assumed in the Indix Purchase as of the acquisition date are provided in the following table (in thousands): 

 

Assets acquired:

 

 

 

 

Current assets

 

$

94

 

Developed technology

 

 

4,472

 

Goodwill

 

 

4,953

 

Total assets acquired

 

 

9,519

 

Liabilities assumed:

 

 

 

 

Current liabilities

 

 

392

 

Total liabilities assumed

 

 

392

 

Net assets acquired

 

$

9,127

 

 

The Company utilizes different valuation approaches and methodologies to determine the fair value of acquired intangible assets. A summary of the valuation methodologies, significant assumptions, and estimated useful lives of acquired intangible assets in the Indix Purchase are provided in the below table (in thousands):

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

Estimated Useful

Life

Developed technology

 

$

4,472

 

 

Relief from royalty-

income approach

 

24.5%

 

6 years

 

The excess of the purchase price over the net identified tangible and intangible assets of $5.0 million has been recorded as goodwill, which includes cost savings expected from the use of the acquired technology and the value of the assembled workforce. The goodwill is expected to be deductible for tax purposes.

The Indix acquisition provided enhanced artificial intelligence technology and tax content, but did not result in additional revenues for the Company. For the period from the date of the Indix acquisition through December 31, 2019, the cumulative operating expenses and pre-tax loss was $4.4 million from the Indix business.

July 2019 Acquisition of Portway  

 

On July 31, 2019, the Company completed the acquisition of substantially all the assets of Portway under an Asset Purchase Agreement (the “Portway Purchase”). Portway is a provider of Harmonized System classifications and outsourced customs brokerage services. The Company accounted for the Portway Purchase as a business combination. As a result of the acquisition, the Company expanded its cross-border solutions. Acquisition-related costs of $0.2 million for the year ended December 31, 2019 were primarily for legal fees.

 

The total consideration transferrable related to this transaction was $24.3 million, consisting of $13.0 million paid in cash at closing, an additional $2.0 million of cash to be paid after eighteen months with an acquisition date fair value of $1.9 million, and an earnout provision fair valued upon acquisition at $9.4 million. The earnout is payable in the Company’s common stock no later than February 2021. The maximum number of shares of common stock that could be earned and transferred to the seller is 119,090 shares, which was based on a maximum payout value of $10.0 million and a per share value of $83.97 under the terms of the Portway Purchase. The earnout is based on the achievement of specific revenue and operating metrics through January 2021, and the shares (which were issued at closing and are held in escrow) will be forfeited and cancelled if the metrics are not achieved. The earnout was originally recognized at fair value at the date of the business combination and is recorded in noncurrent accrued earnout liabilities on the consolidated balance sheet as of December 31, 2019. The earnout liability is adjusted to fair value quarterly (see Note 3).

95


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Estimated fair values of the assets acquired and the liabilities assumed in the Portway Purchase as of the acquisition date are provided in the following table (in thousands):    

 

Assets acquired:

 

 

 

 

Property and equipment

 

$

76

 

Customer relationships and other intangibles

 

 

1,865

 

Goodwill

 

 

22,376

 

Total assets acquired

 

 

24,317

 

Liabilities assumed:

 

 

 

 

Total liabilities assumed

 

 

 

Net assets acquired

 

$

24,317

 

 

The Company utilizes different valuation approaches and methodologies to determine the fair value of acquired intangible assets. A summary of the valuation methodologies, significant assumptions, and estimated useful lives of acquired intangible assets in the Portway Purchase are provided in the below table (in thousands):

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

 

Estimated Useful

Life

Customer relationships

 

$

1,759

 

 

Multi-period excess

earnings-income approach

 

 

12

%

 

6 years

Noncompetition agreements

 

 

106

 

 

With-and-without valuation-

income approach

 

 

12

%

 

4 years

 

The excess of the purchase price over the net identified tangible and intangible assets of $22.4 million has been recorded as goodwill, which includes synergies expected from the expanded cross-border product functionality and customs brokerage services and the value of the assembled workforce. The goodwill is expected to be deductible for tax purposes.

For the period from the date of the Portway acquisition through December 31, 2019, revenue was $1.0 million and pre-tax loss was $0.4 million from the Portway business.

6. Revenues

The Company adopted the new revenue recognition accounting standard ASC 606 effective January 1, 2019 on a modified retrospective basis and applied the new standard only to contracts that were not completed contracts prior to January 1, 2019. See Note 2 for a description of the Company’s ASC 606 revenue recognition accounting policy. Financial results for 2019 are presented in compliance with the new revenue recognition standard. Historical financial results for reporting periods prior to 2019 have not been retroactively restated and are presented in conformity with amounts previously disclosed under ASC 605. This note includes additional information regarding the impacts from the adoption of the new revenue recognition standard on the financial results for the year ended December 31, 2019. This includes the presentation of financial results during 2019 under ASC 605 for comparison to the prior year. The revenue recognition accounting policy for ASC 605 is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 28, 2019. There were no changes to the Company’s ASC 605 policy during the year ended 2019.

96


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Consolidated Balance Sheets – Reconciliation of the Impacts from the Adoption of the New Revenue Recognition Standard

The following schedule summarizes the impacts from the adoption of the new revenue recognition standard on the consolidated balance sheet (in thousands):

 

 

 

December 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

 

As Reported

(ASC 606)

 

 

Impacts from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As Reported

(ASC 605)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

466,950

 

 

$

 

 

$

466,950

 

 

$

142,322

 

Trade accounts receivable—net of allowance for doubtful accounts

 

 

51,644

 

 

 

1,181

 

 

 

52,825

 

 

 

40,287

 

Deferred commissions

 

 

9,279

 

 

 

(9,279

)

 

 

 

 

 

 

Prepaid expenses and other current assets

 

 

14,127

 

 

 

 

 

 

14,127

 

 

 

11,307

 

Total current assets before customer fund assets

 

 

542,000

 

 

 

(8,098

)

 

 

533,902

 

 

 

193,916

 

Funds held from customers

 

 

24,383

 

 

 

 

 

 

24,383

 

 

 

13,113

 

Receivable from customers—net of allowance for doubtful accounts

 

 

420

 

 

 

 

 

 

420

 

 

 

270

 

Total current assets

 

 

566,803

 

 

 

(8,098

)

 

 

558,705

 

 

 

207,299

 

Noncurrent assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred commissions

 

 

29,137

 

 

 

(29,137

)

 

 

 

 

 

 

Operating lease right-of-use assets—net

 

 

49,321

 

 

 

 

 

 

49,321

 

 

 

 

Property and equipment—net

 

 

34,997

 

 

 

 

 

 

34,997

 

 

 

33,373

 

Intangible assets—net

 

 

22,932

 

 

 

 

 

 

22,932

 

 

 

19,371

 

Goodwill

 

 

101,224

 

 

 

 

 

 

101,224

 

 

 

61,300

 

Other noncurrent assets

 

 

2,853

 

 

 

 

 

 

2,853

 

 

 

1,589

 

Total assets

 

$

807,267

 

 

$

(37,235

)

 

$

770,032

 

 

$

322,932

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade payables

 

$

11,693

 

 

$

 

 

$

11,693

 

 

$

4,847

 

Accrued expenses

 

 

62,104

 

 

 

(5,197

)

 

 

56,907

 

 

 

42,101

 

Deferred revenue

 

 

160,271

 

 

 

6,125

 

 

 

166,396

 

 

 

125,260

 

Accrued earnout liabilities

 

 

4,120

 

 

 

 

 

 

4,120

 

 

 

116

 

Operating lease liabilities

 

 

8,756

 

 

 

 

 

 

8,756

 

 

 

 

Total current liabilities before customer fund obligations

 

 

246,944

 

 

 

928

 

 

 

247,872

 

 

 

172,324

 

Customer fund obligations

 

 

24,783

 

 

 

 

 

 

24,783

 

 

 

13,349

 

Total current liabilities

 

 

271,727

 

 

 

928

 

 

 

272,655

 

 

 

185,673

 

Noncurrent liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

 

 

970

 

 

 

8,020

 

 

 

8,990

 

 

 

9,393

 

Accrued earnout liabilities

 

 

9,835

 

 

 

 

 

 

9,835

 

 

 

 

Operating lease liabilities

 

 

58,301

 

 

 

 

 

 

58,301

 

 

 

 

Deferred rent

 

 

 

 

 

 

 

 

 

 

 

17,317

 

Deferred tax liability

 

 

337

 

 

 

 

 

 

337

 

 

 

560

 

Other noncurrent liabilities

 

 

2,375

 

 

 

 

 

 

2,375

 

 

 

436

 

Total liabilities

 

 

343,545

 

 

 

8,948

 

 

 

352,493

 

 

 

213,379

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

8

 

 

 

 

 

 

8

 

 

 

7

 

Additional paid-in capital

 

 

976,627

 

 

 

 

 

 

976,627

 

 

 

599,493

 

Accumulated other comprehensive loss

 

 

(2,719

)

 

 

 

 

 

(2,719

)

 

 

(2,345

)

Accumulated deficit

 

 

(510,194

)

 

 

(46,183

)

 

 

(556,377

)

 

 

(487,602

)

Total shareholders’ equity

 

 

463,722

 

 

 

(46,183

)

 

 

417,539

 

 

 

109,553

 

Total liabilities and shareholders' equity

 

$

807,267

 

 

$

(37,235

)

 

$

770,032

 

 

$

322,932

 

 

97


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Consolidated Statements of Operations – Reconciliation of the Impacts from the Adoption of the New Revenue Recognition Standard

The following schedule summarizes the impacts from the adoption of the new revenue recognition standard on the consolidated statements of operations (in thousands, except per share amounts):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As

Reported

(ASC 606)

 

 

Impacts

from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As

Reported

(ASC 605)

 

 

As

Reported

(ASC 605)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

355,181

 

 

$

744

 

 

$

355,925

 

 

$

254,056

 

 

$

199,942

 

Professional services

 

 

27,240

 

 

 

(158

)

 

 

27,082

 

 

 

18,042

 

 

 

13,217

 

Total revenue

 

 

382,421

 

 

 

586

 

 

 

383,007

 

 

 

272,098

 

 

 

213,159

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

97,824

 

 

 

 

 

 

97,824

 

 

 

66,556

 

 

 

48,849

 

Professional services

 

 

17,475

 

 

 

 

 

 

17,475

 

 

 

12,093

 

 

 

9,128

 

Total cost of revenue

 

 

115,299

 

 

 

 

 

 

115,299

 

 

 

78,649

 

 

 

57,977

 

Gross profit

 

 

267,122

 

 

 

586

 

 

 

267,708

 

 

 

193,449

 

 

 

155,182

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

82,442

 

 

 

 

 

 

82,442

 

 

 

51,909

 

 

 

41,264

 

Sales and marketing

 

 

168,634

 

 

 

19,149

 

 

 

187,783

 

 

 

168,817

 

 

 

133,794

 

General and administrative

 

 

71,918

 

 

 

 

 

 

71,918

 

 

 

39,603

 

 

 

34,286

 

Restructuring charges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

752

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

Total operating expenses

 

 

322,994

 

 

 

19,149

 

 

 

342,143

 

 

 

269,503

 

 

 

218,514

 

Operating loss

 

 

(55,872

)

 

 

(18,563

)

 

 

(74,435

)

 

 

(76,054

)

 

 

(63,332

)

Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

(6,037

)

 

 

 

 

 

(6,037

)

 

 

(1,553

)

 

 

(77

)

Interest expense

 

 

289

 

 

 

 

 

 

289

 

 

 

2,608

 

 

 

2,585

 

Other (income) expense, net

 

 

(865

)

 

 

 

 

 

(865

)

 

 

(583

)

 

 

(495

)

Total other (income) expense, net

 

 

(6,613

)

 

 

 

 

 

(6,613

)

 

 

472

 

 

 

2,013

 

Loss before income taxes

 

 

(49,259

)

 

 

(18,563

)

 

 

(67,822

)

 

 

(76,526

)

 

 

(65,345

)

Provision for (benefit from) income taxes

 

 

955

 

 

 

 

 

 

955

 

 

 

(976

)

 

 

(1,219

)

Net loss

 

$

(50,214

)

 

$

(18,563

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share attributable to common

   shareholders, basic and diluted

 

$

(0.68

)

 

$

(0.25

)

 

$

(0.94

)

 

$

(1.95

)

 

$

(11.39

)

Weighted average shares of common stock

   outstanding, basic and diluted

 

 

73,345

 

 

 

 

 

 

 

73,345

 

 

 

38,692

 

 

 

5,632

 

 

98


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Consolidated Statements of Comprehensive Loss – Reconciliation of the Impacts from the Adoption of the New Revenue Recognition Standard

The following schedule summarizes the impacts from the adoption of the new revenue recognition standard on the consolidated statements of comprehensive loss (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As

Reported

(ASC 606)

 

 

Impacts

from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As

Reported

(ASC 605)

 

 

As

Reported

(ASC 605)

 

Net loss

 

$

(50,214

)

 

$

(18,563

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

Other comprehensive income (loss)—Foreign currency translation

 

 

(374

)

 

 

 

 

 

(374

)

 

 

(2,683

)

 

 

1,806

 

Total comprehensive loss

 

$

(50,588

)

 

$

(18,563

)

 

$

(69,151

)

 

$

(78,233

)

 

$

(62,320

)

 

99


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Consolidated Statements of Cash Flows – Reconciliation of the Impacts from the Adoption of the New Revenue Recognition Standard

 

The following schedule summarizes the impacts from the adoption of the new revenue recognition standard on the consolidated statements of cash flows (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

 

 

As

Reported

(ASC 606)

 

 

Impacts

from

Adoption

 

 

Without

Adoption

(ASC 605)

 

 

As

Reported

(ASC 605)

 

 

As

Reported

(ASC 605)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(50,214

)

 

$

(18,563

)

 

$

(68,777

)

 

$

(75,550

)

 

$

(64,126

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

34,349

 

 

 

 

 

 

34,349

 

 

 

15,921

 

 

 

11,757

 

Depreciation and amortization

 

 

15,807

 

 

 

 

 

 

15,807

 

 

 

12,802

 

 

 

10,859

 

Goodwill impairment

 

 

 

 

 

 

 

 

 

 

 

9,174

 

 

 

8,418

 

Deferred tax benefit

 

 

(223

)

 

 

 

 

 

(223

)

 

 

(1,294

)

 

 

(1,307

)

Amortization of deferred rent

 

 

-

 

 

 

 

 

 

-

 

 

 

190

 

 

 

(698

)

Non-cash operating lease costs

 

 

5,000

 

 

 

 

 

 

5,000

 

 

 

 

 

 

 

Non-cash change in earnout liabilities

 

 

(1,043

)

 

 

 

 

 

(1,043

)

 

 

(402

)

 

 

(715

)

Non-cash bad debt expense (recovery)

 

 

1,367

 

 

 

 

 

 

1,367

 

 

 

(288

)

 

 

(86

)

Other

 

 

340

 

 

 

 

 

 

340

 

 

 

559

 

 

 

270

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade accounts receivable

 

 

(12,862

)

 

 

(372

)

 

 

(13,234

)

 

 

(13,508

)

 

 

159

 

Prepaid expenses and other current assets

 

 

(3,544

)

 

 

 

 

 

(3,544

)

 

 

(4,850

)

 

 

(1,055

)

Deferred commissions

 

 

(19,149

)

 

 

19,149

 

 

 

 

 

 

 

 

 

 

Other noncurrent assets

 

 

(1,265

)

 

 

 

 

 

(1,265

)

 

 

(808

)

 

 

725

 

Trade payables

 

 

5,783

 

 

 

 

 

 

5,783

 

 

 

(4,419

)

 

 

(112

)

Accrued expenses

 

 

16,246

 

 

 

(3,107

)

 

 

13,139

 

 

 

15,266

 

 

 

2,124

 

Deferred revenue

 

 

37,558

 

 

 

2,893

 

 

 

40,451

 

 

 

42,422

 

 

 

19,752

 

Operating lease liabilities

 

 

(5,764

)

 

 

 

 

 

(5,764

)

 

 

 

 

 

 

Deferred rent

 

 

 

 

 

 

 

 

 

 

 

1,723

 

 

 

10,494

 

Net cash provided by (used in) operating activities

 

 

22,386

 

 

 

 

 

 

22,386

 

 

 

(3,062

)

 

 

(3,541

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchase of property and equipment

 

 

(10,180

)

 

 

 

 

 

(10,180

)

 

 

(15,483

)

 

 

(13,955

)

Cash paid for acquisitions of businesses

 

 

(30,310

)

 

 

 

 

 

(30,310

)

 

 

 

 

 

 

Cash paid for acquired intangible assets

 

 

(139

)

 

 

 

 

 

(139

)

 

 

(5,002

)

 

 

 

Net (increase) decrease in customer fund assets

 

 

(11,506

)

 

 

 

 

 

(11,506

)

 

 

118

 

 

 

(2,301

)

Net cash used in investing activities

 

 

(52,135

)

 

 

 

 

 

(52,135

)

 

 

(20,367

)

 

 

(16,256

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from common stock offering, net of

   underwriting discounts

 

 

274,705

 

 

 

 

 

 

274,705

 

 

 

192,510

 

 

 

 

Payments of deferred financing costs

 

 

(555

)

 

 

 

 

 

(555

)

 

 

(2,084

)

 

 

(1,240

)

Payments on credit facility

 

 

 

 

 

 

 

 

 

 

 

(63,000

)

 

 

(2,935

)

Proceeds from credit facility

 

 

 

 

 

 

 

 

 

 

 

23,000

 

 

 

17,605

 

Repayment of note payable

 

 

 

 

 

 

 

 

 

 

 

(234

)

 

 

 

Payments of debt issuance costs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(469

)

Proceeds from exercise of stock options and common

   stock warrants

 

 

58,019

 

 

 

 

 

 

58,019

 

 

 

7,041

 

 

 

920

 

Proceeds from purchases of stock under employee

   stock purchase plan

 

 

12,293

 

 

 

 

 

 

12,293

 

 

 

 

 

 

 

Taxes paid related to net share settlement of

   stock-based awards

 

 

(1,183

)

 

 

 

 

 

(1,183

)

 

 

(2,365

)

 

 

(811

)

Repurchase of shares

 

 

 

 

 

 

 

 

 

 

 

(1,806

)

 

 

 

Payment related to business combination earnouts

 

 

(375

)

 

 

 

 

 

(375

)

 

 

(1,523

)

 

 

(1,662

)

Payments on capital leases

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(14

)

Net increase (decrease) in customer fund obligations

 

 

11,506

 

 

 

 

 

 

11,506

 

 

 

(118

)

 

 

2,301

 

Net cash provided by financing activities

 

 

354,410

 

 

 

 

 

 

354,410

 

 

 

151,421

 

 

 

13,695

 

Foreign currency effect on cash and cash equivalents

 

 

(33

)

 

 

 

 

 

(33

)

 

 

255

 

 

 

(53

)

Net change in cash and cash equivalents

 

 

324,628

 

 

 

 

 

 

324,628

 

 

 

128,247

 

 

 

(6,155

)

Cash and cash equivalents—Beginning of period

 

 

142,322

 

 

 

 

 

 

142,322

 

 

 

14,075

 

 

 

20,230

 

Cash and cash equivalents—End of period

 

$

466,950

 

 

 

 

 

$

466,950

 

 

$

142,322

 

 

$

14,075

 

 

100


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Disaggregation of Revenue

 

The following table disaggregates revenue generated within the United States (U.S.) from revenue generated from customers outside of the U.S. Revenue for transaction tax compliance in the U.S. is further disaggregated based on the solutions or services purchased by customers. Total revenues consisted of the following (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Revenue (U.S.):

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

 

 

 

 

 

 

 

 

 

 

Tax determination

 

$

203,584

 

 

$

147,847

 

 

$

114,575

 

Tax returns and compliance management

 

 

127,815

 

 

 

91,239

 

 

 

74,454

 

Interest income on funds held for customers

 

 

3,213

 

 

 

1,055

 

 

 

 

Total subscription and returns

 

 

334,612

 

 

 

240,141

 

 

 

189,029

 

Professional services

 

 

24,399

 

 

 

15,126

 

 

 

12,476

 

Total revenue (U.S.)

 

 

359,011

 

 

 

255,267

 

 

 

201,505

 

Total revenue (non-U.S.)

 

 

23,410

 

 

 

16,831

 

 

 

11,654

 

Total revenue

 

$

382,421

 

 

$

272,098

 

 

$

213,159

 

 

Disclosures Related to Contracts with Customers

 

Timing may differ between the satisfaction of performance obligations and the invoicing and collection of amounts related to contracts with customers. Liabilities are recorded for amounts that are collected in advance of the satisfaction of performance obligations. To the extent a contract exists, as defined by ASC 606, these liabilities are classified as current and non-current deferred revenue. To the extent that a contract does not exist, as defined by ASC 606 (e.g. customer agreements with non-standard termination rights), these liabilities are classified as contract liabilities. Contract liabilities are transferred to deferred revenue at the point in time when the criteria that establish the existence of a contract are met.

 

Contract Liabilities

 

A summary of the activity impacting the contract liabilities during the year ended December 31, 2019 is presented below (in thousands):

 

 

 

Contract Liabilities

 

Balance at December 31, 2018

 

$

 

Adoption of ASC 606

 

 

2,090

 

Contract liabilities transferred to deferred revenue

 

 

(6,938

)

Addition to contract liabilities

 

 

10,045

 

Balance at December 31, 2019

 

$

5,197

 

 

As of December 31, 2019, contract liabilities are expected to be transferred to deferred revenue within the next 12 months and therefore are included in accrued expenses on the consolidated balance sheets.

 

101


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Deferred Revenue

 

A summary of the activity impacting deferred revenue balances during the year ended December 31, 2019 is presented below (in thousands):

 

 

 

Deferred Revenue

 

Balance at December 31, 2018

 

$

134,653

 

Adoption of ASC 606

 

 

(11,250

)

Revenue recognized

 

 

(382,421

)

Additional amounts deferred

 

 

420,259

 

Balance at December 31, 2019

 

$

161,241

 

 

 

Assets Recognized from the Costs to Obtain Contracts with Customers

 

Assets are recognized for the incremental costs of obtaining a contract with a customer if the benefit of those costs is expected to be longer than one year. These deferred commissions are amortized over an expected period of benefit of generally six years.

 

A summary of the activity impacting the deferred commissions during the year ended December 31, 2019 is presented below (in thousands):

 

 

 

Deferred Commissions

 

Balance at December 31, 2018

 

$

 

Adoption of ASC 606

 

 

19,267

 

Additional commissions deferred

 

 

26,403

 

Amortization of deferred commissions

 

 

(7,254

)

Balance at December 31, 2019

 

$

38,416

 

 

As of December 31, 2019, $9.3 million of deferred commissions are expected to be amortized within the next 12 months and therefore are included in current assets on the consolidated balance sheets. The remaining amount of deferred commissions are included in noncurrent assets. There were no impairments of assets related to deferred commissions during the year ended December 31, 2019. There were no assets recognized related to the costs to fulfill contracts during the year ended December 31, 2019 as these costs were not material.

 

Remaining Performance Obligations

 

Contracts with customers include amounts allocated to performance obligations that will be satisfied at a later date. These amounts include additional performance obligations that are not yet recorded in the consolidated balance sheets. As of December 31, 2019, amounts allocated to these additional contractual obligations are $35.9 million, of which $35.5 million is expected to be recognized as revenue over the next 12 months with the remaining amount thereafter.

 

102


AVALARA, INC.

Notes to Consolidated Financial Statements

 

 

7. Intangible Assets

Finite-lived intangible assets consisted of the following (in thousands):

 

 

 

 

 

December 31, 2019

 

 

 

Average Useful Life

(Years)

 

Gross

 

 

Accumulated

Amortization

 

 

Net

 

Customer relationships

 

3 to 10

 

$

20,390

 

 

$

(11,403

)

 

$

8,987

 

Developed technology

 

3 to 8

 

 

36,422

 

 

 

(22,659

)

 

 

13,763

 

Noncompete agreements

 

3 to 5

 

 

777

 

 

 

(612

)

 

 

165

 

Tradename and trademarks

 

1 to 4

 

 

452

 

 

 

(435

)

 

 

17

 

 

 

 

 

$

58,041

 

 

$

(35,109

)

 

$

22,932

 

 

 

 

 

 

December 31, 2018

 

 

 

Average Useful Life

(Years)

 

Gross

 

 

Accumulated

Amortization

 

 

Net

 

Customer relationships

 

3 to 10

 

$

15,412

 

 

$

(9,202

)

 

$

6,210

 

Developed technology

 

3 to 8

 

 

30,935

 

 

 

(17,806

)

 

 

13,129

 

Noncompete agreements

 

3 to 5

 

 

574

 

 

 

(542

)

 

 

32

 

Tradename and trademarks

 

1 to 4

 

 

420

 

 

 

(420

)

 

 

 

 

 

 

 

$

47,341

 

 

$

(27,970

)

 

$

19,371

 

 

Finite-lived intangible assets are generally amortized on a straight-line basis over the remaining estimated useful life as management believes this reflects the expected benefit to be received from these assets. Finite-lived intangible assets amortization expense was $7.1 million, $6.0 million, and $5.7 million for the years ended December 31, 2019, 2018, and 2017, respectively. Future amortization expense as of December 31, 2019, related to these finite-lived intangible assets is expected to be as follows (in thousands):

 

Years Ending December 31

 

 

 

 

2020

 

$

6,423

 

2021

 

 

5,157

 

2022

 

 

4,192

 

2023

 

 

3,776

 

2024

 

 

2,829

 

Thereafter

 

 

555

 

 

 

$

22,932

 

 

Acquisitions of finite-lived intangible assets

In May 2018, the Company acquired certain intangible assets from Atlantax Systems, Inc (“Atlantax”) pursuant to a purchase arrangement structured to incent Atlantax to convert their existing customers to become Avalara customers. Total consideration for the purchase is based on an earnout computed on future revenue recognized by the Company over the next four years, up to a maximum of $1.9 million. At closing, the Company funded $0.4 million to Atlantax as a prepayment against future earnings. The total prepayment of $0.4 million was capitalized as a customer relationship intangible asset and is being amortized using an estimated useful life of five years. As future earnout payments become known, those costs will be capitalized as part of the customer relationship asset and amortized over the remaining useful life. No earnout payments were earned or paid to Atlantax in 2018 or 2019.The Company incurred immaterial legal costs related to the transaction that were capitalized as part of the customer relationship asset.

103


AVALARA, INC.

Notes to Consolidated Financial Statements

 

In May 2018, the Company acquired developed technology to facilitate cross-border transactions (e.g., tariffs and duties), from Tradestream Technologies Inc. and Wise 24 Inc. (the “Sellers”) for cash and common stock. Total consideration for the purchase includes an earnout computed on future revenue and billings recognized by the Company over the next six years, up to a maximum of $30.0 million. The earnout is payable in cash and common stock at the end of each six-month measurement period ending on June 30 or December 31 through 2023, with the first earnout period ending December 31, 2018. The cash portion of the earnout is computed based on eligible billings in the measurement period. The number of shares of common stock to be issued is computed based on the eligible revenue recognized in the measurement period divided by the average closing price of the Company’s common stock during the last ten days of the measurement period

At closing, the Company made a $1.5 million cash payment to the Sellers and made an additional $2.5 million cash payment in June 2018. Under the asset purchase agreement, the Company was also required to issue 113,122 shares of common stock, all of which have been issued, as follows: 37,708 shares on November 29, 2018, 37,708 shares on May 29, 2019, and 37,706 shares on November 29, 2019. While the initial cash payments totaling $4.0 million are non-refundable, they are a prepayment against future earnout payments and will reduce the future cash portion of the earnout. The earnout payments, initial cash payments and equity issuances described above are all subject to clawback or set-off, as applicable, in the event of certain claims for which the Company is indemnified by the Sellers and their shareholders.

The Company incurred approximately $0.1 million in legal costs related to the transaction that were capitalized as part of the developed technology asset. As of December 31, 2018, total consideration of $7.1 million, consisting of the cash paid, the fair value of the Company’s common stock on the date of the asset purchase, and the transaction costs incurred, was allocated to the acquired assets based on the relative fair value, consisting of a $6.6 million developed technology intangible asset that will be amortized using an estimated useful life of 6 years and a $0.5 million current other receivable for a refundable tax credit owed to the Company related to transfer taxes paid to the Sellers. As future earnout payments become due, those costs will be capitalized as part of the developed technology asset and amortized over the remaining useful life. As of December 31, 2018, an earnout liability of $0.1 million was recorded within accrued expenses on the consolidated balance sheet. During 2019, the Company paid $0.1 million and issued 2,310 shares of common stock to the Sellers for the earnout measurement periods ended December 31, 2018 and June 30, 2019. As of December 31, 2019, an earnout liability of $0.2 million was recorded within the current portion of accrued earnout liabilities for cash and common stock payable to the Sellers for the earnout period ended December 31, 2019.

Goodwill

Changes in the carrying amount of goodwill for the year ended December 31, 2019, are summarized as follows (in thousands):

 

Balance—December 31, 2018

 

$

61,300

 

Acquisition of Compli

 

 

12,807

 

Acquisition of Indix

 

 

4,953

 

Acquisition of Portway

 

 

22,376

 

Cumulative translation adjustments

 

 

(212

)

Balance—December 31, 2019

 

$

101,224

 

 

Goodwill is tested for impairment annually on October 31 at the reporting unit level or whenever circumstances occur indicating goodwill might be impaired. The impairment test involves comparing the fair value of each reporting unit to its carrying value, including goodwill. Fair value reflects the price a market participant would be willing to pay in a potential sale of the reporting unit. If the fair value exceeds the carrying value, the Company will conclude that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, the Company will recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value.

 

The Company has three reporting units for goodwill impairment testing consisting of its U.S., European, and Brazilian operations. As part of the Company’s annual impairment test, a qualitative impairment test was performed for the Company’s U.S. reporting unit. The Company concluded it is more likely than not that the fair value of the reporting unit exceeds its carrying value.

104


AVALARA, INC.

Notes to Consolidated Financial Statements

 

 

A quantitative impairment test was performed for the Company’s European reporting unit. Upon completion, the fair value of the European reporting unit was in excess of the carrying value. When following a quantitative approach, the Company measures the fair value of its reporting units using a combination of a discounted cash flow approach and the market valuation approach using publicly traded company multiples in similar businesses, which are Level 3 measurements. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, determination of the Company’s weighted average cost of capital, which is risk-adjusted to reflect the specific risk profile of the reporting unit being tested, and determination of revenue multiples, which are based on guideline public company multiples and adjusted for the specific size and risk profile of the reporting unit. The weighted average cost of capital used in the Company’s most recent annual impairment test was 25%.

 

The Company had no goodwill associated with the Brazilian reporting unit in 2019, and as such, no goodwill impairment test was performed for the Brazil reporting unit as part of the 2019 annual impairment test. During the third quarter of 2018, the Company updated its long-term cash flow forecast for the Brazilian reporting unit to reflect recent performance indicators that suggested it will take longer to execute on the Company’s long-term strategies to achieve anticipated growth and cash flow objectives. The updated long-term cash flow forecast indicated a longer time horizon to positive cash flow, compared to the previous update in the fourth quarter of 2017. As a result, management concluded that there was an interim triggering event and performed an impairment test during the third quarter of 2018. This resulted in a $9.2 million impairment of the Brazilian goodwill reporting unit, which was recorded during the third quarter of 2018. The goodwill impairment charge is included in goodwill impairment in the consolidated statements of operations.

The Company used a quantitative approach to measure the fair value of its Brazilian reporting unit in 2018 using a discounted cash flow approach, which is a Level 3 measurement. The Company concluded it was not appropriate to use a market valuation approach due primarily to a lack of publicly traded companies in similar businesses. The discounted cash flow analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, determination of the Company’s weighted average cost of capital, which is risk-adjusted to reflect the specific risk profile of the reporting unit being tested, and determination of revenue multiples, which are based on guideline public company multiples and adjusted for the specific size and risk profile of the reporting unit. The weighted average cost of capital used in the Company’s analysis was 30%. Upon completion of the analysis, the fair value of the Brazilian reporting unit was substantially less than the carrying value, resulting in an impairment of the remaining carrying value of goodwill for that reporting unit.

In the first ten months of 2017, the Brazilian reporting unit did not meet revenue or cash flow objectives due primarily to longer than expected integration efforts and a smaller proportion of recurring revenues than previously anticipated. This led to a delay in the forecasted timing of future revenue and cash flow compared to previous expectations. In addition to delaying cash flows, management also updated its internal forecast to reflect lower assumed future revenue growth rates. As a result, management concluded that an $8.4 million impairment adjustment was required in the fourth quarter of 2017. The goodwill impairment charge is included in goodwill impairment in the consolidated statements of operations.

The Company had $17.6 million of accumulated goodwill impairment as of December 31, 2019 and 2018.

8. Leases

 

The Company adopted the new lease accounting standard ASC 842 effective January 1, 2019 using the modified retrospective transition method. See Note 2 for a description of the Company’s ASC 842 lease accounting policy. Financial results for 2019 are presented in compliance with ASC 842. Historical financial results prior to 2019 have not been retroactively restated and are presented in conformity with amounts previously disclosed under ASC 840. This note includes additional information regarding the impacts from the adoption of ASC 842 on the financial results for the year ended December 31, 2019. The lease accounting policy for ASC 840 is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 28, 2019.

 

105


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The Company has non-cancelable operating leases primarily for office facilities in the United States, Canada, United Kingdom, Belgium, Brazil and India that expire through 2028. The remaining operating leases are primarily comprised of leases of office equipment. As of December 31, 2019, the leases have remaining terms of 0.5 to 8.8 years, some of which include options to extend for up to 10 years, and some of which include options to terminate within 2.5 years. Options to extend or terminate a lease which are not reasonably certain to be exercised are not included in the lease term or in the lease payments for purposes of determining the operating lease right-of-use asset and operating lease liability. As of December 31, 2019, the Company was not reasonably certain it would exercise any of its options to extend or terminate a lease and as such, those options are not recognized as part of the operating lease right-of-use assets and operating lease liabilities. The Company’s lease agreements do not contain material residual value guarantees, restrictions, or covenants. As of December 31, 2019, the Company does not have any finance leases.

 

The following table presents future lease payments for long-term operating leases as of December 31, 2019 (in thousands):

 

Period

 

Operating Lease

Commitments

 

2020

 

$

13,027

 

2021

 

 

13,155

 

2022

 

 

12,424

 

2023

 

 

11,764

 

2024

 

 

10,307

 

Thereafter

 

 

23,346

 

Total

 

$

84,023

 

Less: Imputed interest

 

 

(16,966

)

Total operating lease liabilities (1)

 

$

67,057

 

 

(1)

Future lease payments have not been reduced by future sublease receipts of $3.9 million due under noncancelable subleases.

 

As of December 31, 2019, the Company had operating leases for additional office space that had not yet commenced. Future non-cancelable lease payments associated with these agreements total $13.0 million, beginning January 2020 and are payable over lease terms ranging from 4.4 to 7 years.

 

The following table presents supplemental balance sheet information related to operating leases recorded as of December 31, 2019:

 

 

 

December 31, 2019

 

Weighted average remaining lease term (in years)

 

 

6.7

 

Weighted average discount rate

 

 

6.9

%

 

The components of lease expense for the year ended December 31, 2019 were as follows (in thousands):

 

 

 

Year Ended

December 31, 2019

 

Operating lease costs

 

$

9,329

 

Variable lease costs

 

 

2,562

 

Short-term lease costs

 

 

1,065

 

Sublease income

 

 

(1,448

)

Total lease cost, net

 

$

11,508

 

 

106


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Previous Lease Standard Disclosures (ASC 840)

Under ASC 840, the previous lease standard, rent expense was $9.9 million and $5.7 million for the years ended December 31, 2018 and 2017, respectively. Sublease income was $0.3 million for the year ended December 31, 2018 with no sublease income for the year ended December 31, 2017.

The Company’s obligation for payments under its leases as of December 31, 2018 was as follows (in thousands):

 

Years Ending December 31

 

Operating

Leases

 

2019

 

$

9,095

 

2020

 

 

9,533

 

2021

 

 

10,048

 

2022

 

 

9,585

 

2023

 

 

8,965

 

Thereafter

 

 

32,729

 

Total minimum lease payments(1)

 

$

79,955

 

 

(1)

Minimum lease payments above have not been reduced by minimum sublease rentals of $5.4 million due in the future under noncancelable subleases.

 

 

9. Commitments and Contingencies

Commitments

The Company has purchase commitments related to network infrastructure, hosting services, and software licenses that extend up to two years beyond December 31, 2019. The Company’s obligation for future payments under these contracts is $8.2 million and $5.9 million for the years ending December 31, 2020 and 2021, respectively.

Contingencies

Loss contingencies may arise in connection with the ordinary conduct of the Company’s business activities. The Company considers all loss contingencies on a quarterly basis and based on known facts assesses whether potential losses are considered reasonably possible, probable and estimable. The Company establishes an accrual for loss contingencies when the loss is both probable and reasonably estimable. If the estimated loss is a range of potential outcomes and there is no better estimate within the range, management accrues the amount at the low end of the range. These accruals represent management’s estimate of probable losses and, in such cases, there may be an exposure to loss in excess of the amounts accrued. Significant judgment is required to determine both likelihood of there being a probable loss and the estimated amount of a loss. If a loss contingency is not both probable and reasonably estimable, the Company does not establish an accrual, but will evaluate other disclosure requirements and continue to monitor the matter for developments that would make the loss contingency both probable and reasonably estimable. The ultimate outcome of any litigation relating to a loss contingency is uncertain and, regardless of outcome, litigation can have an adverse impact on the Company because of defense costs, negative publicity, diversion of management resources and other factors.

Pursuant to the Company’s agreement with the SST Governing Board, Inc., the Company calculates and remits sales taxes to certain states on behalf of its customers, and that agreement contains provisions detailing the circumstances under which the Company may become liable to member states in the event of delinquent payment of taxes. In a situation where the state is conducting a sales tax audit and the Company’s customer has declared bankruptcy or otherwise terminated operations before the appropriate documentation or tax liabilities have been remitted to the taxing jurisdiction, the Company could be held to be financially responsible for certain tax liabilities.

107


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The Company accrues for estimated losses for SST sales tax audits at the time it recognizes revenue based on an evaluation of the history of loss in comparison to historical revenue. The Company adjusts this estimate as needed when actual experience differs from previously recorded amounts, or when a particularly significant or unusual claim or liability is deemed probable of payment by the Company. The reserve for estimated losses from SST sales tax audits is $0.1 million as of both December 31, 2019 and 2018.

In its standard subscription agreements, the Company has agreed to indemnification provisions with respect to certain matters. Further, from time to time, the Company has also assumed indemnification obligations through its acquisition activity. These indemnification provisions can create a liability to the Company if its services do not appropriately calculate taxes due to tax jurisdictions, or if the Company is delinquent in the filing of returns on behalf of its customers. Although the Company’s agreements have disclaimers of warranties that limit its liability (beyond the amounts the Company agrees to pay pursuant to its indemnification obligations and guarantees, as applicable), a court could determine that such disclaimers and limitations are unenforceable as a matter of law and hold the Company liable for certain errors. Further, in some instances the Company has negotiated agreements with specific customers or assumed agreements in connection with the Company’s acquisitions that do not limit this liability or disclaim these warranties. It is not possible to reasonably estimate the potential loss under these indemnification arrangements.

While the Company has never paid a material claim related to these indemnification provisions, the Company believes that, as of December 31, 2019 and 2018, there is a reasonable possibility that a loss may be incurred pursuant to certain of these arrangements and estimates a range of loss of up to $2.0 million. The Company has not recorded an accrual related to these arrangements as of December 31, 2019 or 2018 because it has not determined that a loss is probable. The ultimate outcome of these potential obligations is unknown, and it is possible that the actual losses could be higher than the estimated range.

On October 22, 2018, PTP OneClick, LLC (“PTP”) filed a lawsuit against Avalara, Inc. in the United States District Court for the Eastern District of Wisconsin. The lawsuit alleges that making, using, offering to sell, and selling AvaTax, Avalara Returns, and TrustFile (the “Avalara Products”) infringe U.S. Patent No. 9,760,915 held by PTP and also alleges unspecified trade secret misappropriation, unfair competition, and breach of contract. PTP seeks judgments of willful patent infringement, willful trade secret misappropriation, unfair competition, and breach of contract. PTP requests preliminary and permanent injunctions to enjoin the Company from making, using, offering to sell, and selling the Avalara Products along with treble damages and attorneys’ fees. Based upon the Company’s review of the complaint and the specified patent, the Company believes that the Company has meritorious defenses to PTP’s claims. On November 7, 2018, the Company moved to dismiss the lawsuit and to have the patent held invalid, and also moved to transfer the matter to the United States District Court located in Seattle, Washington. On April 30, 2019, the United States District Court for the Eastern District of Wisconsin granted the Company’s motion to transfer, reserving resolution of the motion to dismiss for the United States District Court for the Western District of Washington. On October 7, 2019, the United States District Court for the Western District of Washington invalidated the patent and dismissed the patent and unfair competition claims with prejudice but did not dismiss the trade secret misappropriation or breach of contract claims. The court has set the trial date for October 26, 2020.

10. Debt

Loan and Security Agreement  

The Company had a loan and security agreement with Silicon Valley Bank and Ally Bank that consisted of a $50.0 million revolving credit facility (the “Credit Facility”). On June 25, 2019, the Company terminated the Credit Facility.

Prior to termination of the Credit Facility, the Company was required to pay a quarterly fee of 0.50% per annum on the undrawn portion available under the revolving credit facility plus the sum of outstanding letters of credit. Under the Credit Facility, the interest rate on the revolving credit facility was based on the greater of either 4.25% or the current prime rate, plus 1.75%.

 

 

108


AVALARA, INC.

Notes to Consolidated Financial Statements

 

11. Convertible Preferred Stock and Shareholders’ Equity

Authorized Capital—Common Stock and Preferred Stock

Under the Amended and Restated Articles of Incorporation, which became effective in June 2018, the Company is authorized to issue two classes of stock designated as common stock and preferred stock. The Company’s total authorized capital stock is 620,000,000 shares, consisting of 600,000,000 shares of common stock, $0.0001 par value per share, and 20,000,000 shares of undesignated preferred stock, $0.0001 par value per share.

 

In June 2018, the Company completed an initial public offering (“IPO”), in which the Company sold 8,625,000 shares of its common stock, including the full exercise of the underwriters’ option to purchase 1,125,000 additional shares of common stock, at the initial price to the public of $24.00 per share. The Company received net proceeds of $192.5 million, after deducting underwriting discounts and commissions and before deducting offering expenses paid and payable by the Company of $3.4 million.

In June 2019, the Company completed a public offering, in which the Company sold 4,133,984 shares of its common stock, including the full exercise of the underwriters’ option to purchase 539,215 additional shares of common stock, at a price of $69.40 per share. The Company received net proceeds of $274.7 million, after deducting underwriting discounts and commissions and before deducting offering expenses paid and payable by the Company of $1.2 million.

During 2018, the Company repurchased shares from employees and non-employee investors at fair value for $1.7 million. No repurchases occurred in 2019. As of December 31, 2019, 77,447,620 shares of the Company’s common stock were outstanding.

Reverse Stock Split and Convertible Preferred Stock

On May 10, 2018, the Company effected a 2-to-1 reverse stock split of outstanding common stock, including outstanding stock options and common stock warrants. All common share and per common share amounts for all periods presented in these consolidated financial statements and notes thereto, have been adjusted retrospectively, where applicable, to reflect the reverse stock split. Series Preferred Stock amounts have been adjusted retrospectively only where the conversion to common stock is presented. As a result of the reverse stock split, the applicable conversion price was increased for each series of outstanding Series Preferred Stock. Immediately prior to the completion of the IPO, all outstanding shares of preferred stock converted into 50,888,014 shares of the Company’s common stock on a 2-to-1 basis. As of December 31, 2019 and 2018, there were no shares of convertible preferred stock issued and outstanding.

Common Stock Warrants

Prior to the Company’s IPO in 2018, common stock warrants were granted to the Company’s Board of Directors for services provided. No common stock warrants were issued in 2019. During both 2018 and 2017, the Company issued 80,000 common stock warrants with weighted average exercise prices of $16.60 and $13.84 per share, respectively. The warrants were valued with a grant date fair value of $0.5 million in both periods and were expensed as general and administrative expenses for the years ended December 31, 2018 and 2017. The common stock warrants contained net settlement provisions that allowed for net exercise and expired in connection with the closing of a public offering of the Company’s common stock, if unexercised at that date. During 2018, and prior to the completion of the IPO, 363,000 common stock warrants were exercised for total proceeds of $3.7 million. Immediately prior to the completion of the IPO, the remaining common stock warrants then outstanding were automatically net exercised into 144,945 shares of the Company’s common stock. See Note 12 for further discussion of how the Company accounts for stock-based compensation.  

109


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Warrant Instruments

 

There were no warrants to purchase common stock outstanding as of December 31, 2019 and 2018.

 

As of December 31, 2017, the following warrants to purchase common stock were outstanding:

 

Class

 

Shares

(In thousands)

 

 

Exercise

Price

 

Fair Value

at Issuance

 

Term

(Years)

Common stock

 

 

490

 

 

$1.50 to $13.84

 

$0.178 to $6.280

 

10

 

12. Equity Incentive Plans

The Company has stock-based compensation plans that provide for the award of equity incentives, including stock options, stock awards, RSUs, and purchase rights. As of December 31, 2019, the Company had stock options outstanding under the 2018 Equity Incentive Plan (the “2018 Plan”) and the 2006 Equity Incentive Plan (the “2006 Plan”), had RSUs outstanding under the 2018 Plan, and had purchase rights issued under the ESPP.

In April 2018, the 2018 Plan became effective in connection with the Company’s IPO. The 2018 Plan allows the Company to grant equity incentives to employees, directors, advisors, and consultants providing services to the Company. The total number of shares of common stock reserved for issuance under the 2018 Plan is equal to (1) 5,315,780 shares plus (2) any shares subject to outstanding awards under the 2006 Plan as of June 14, 2018 that subsequently cease to be subject to such awards. The available shares automatically increase each January 1, beginning January 1, 2019, by the lesser of (i) 5% of the aggregate number of shares of common stock outstanding on December 31st of the immediately preceding calendar year (rounded up to the nearest whole share) and (ii) an amount determined by the Company’s Board of Directors. As of December 31, 2019, 2,652,632 shares were subject to outstanding awards and 6,347,919 shares were available for issuance under the 2018 Plan. The 2018 Plan provides that on the occurrence of certain strategic events, such as a change in control in which options and RSUs are not assumed or substituted, such outstanding options and RSUs will become fully vested and exercisable or payable.

Prior to the 2018 Plan, the Company awarded stock options under the 2006 Plan. The 2006 Plan was terminated in connection with the Company’s IPO. Outstanding awards under the 2006 Plan continue to be subject to the terms and conditions of the 2006 Plan. As of December 31, 2019, there were 4,740,391 shares subject to outstanding stock options under the 2006 Plan.  

In 2019 the Company amended its Outside Director Compensation Policy to modify the vesting provisions for nonemployee director awards in the event of certain terminations of service. The modification resulted in an acceleration of share-based compensation expense for nonemployee director awards in the third quarter of 2019.

Stock-Based Compensation

The Company recognized total stock-based compensation cost related to equity incentive awards as follows (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Stock-based compensation cost:

 

 

 

 

 

 

 

 

 

 

 

 

Common stock warrants

 

$

 

 

$

512

 

 

$

484

 

Stock options

 

 

16,489

 

 

 

13,279

 

 

 

11,295

 

Restricted stock units

 

 

14,585

 

 

 

90

 

 

 

 

Employee stock purchase plan

 

 

3,326

 

 

 

2,069

 

 

 

 

Total stock-based compensation cost

 

$

34,400

 

 

$

15,950

 

 

$

11,779

 

 

110


AVALARA, INC.

Notes to Consolidated Financial Statements

 

A small portion of stock-based compensation cost above is capitalized in accordance with the accounting guidance for internal-use software. The Company uses the straight-line attribution method for recognizing stock-based compensation expense.

Stock Options

The following table summarizes stock option activity for the Company’s stock-based compensation plans for 2019:

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

Average

 

 

Aggregate

 

 

 

 

 

 

 

Average

 

 

Remaining

 

 

Intrinsic

 

 

 

 

 

 

 

Exercise

 

 

Contractual

 

 

Value

 

 

 

Shares

 

 

Price

 

 

Life (Years)

 

 

(in thousands)

 

Options outstanding as of January 1, 2019

 

 

11,094,070

 

 

$

12.17

 

 

 

6.81

 

 

$

210,523

 

Options granted

 

 

1,020,810

 

 

 

46.15

 

 

 

 

 

 

 

 

 

Options exercised

 

 

(5,924,142

)

 

 

9.80

 

 

 

 

 

 

 

 

 

Options cancelled or expired

 

 

(305,996

)

 

 

19.36

 

 

 

 

 

 

 

 

 

Options outstanding as of December 31, 2019

 

 

5,884,742

 

 

 

20.09

 

 

 

7.22

 

 

 

312,838

 

Options exercisable as of December 31, 2019

 

 

2,944,795

 

 

$

12.92

 

 

 

6.17

 

 

$

177,649

 

 

A summary of options outstanding and vested as of December 31, 2019 is as follows:

 

 

 

Options Outstanding

 

 

Options Vested and Exercisable

 

Exercise

 

Number

 

 

Weighted

Average

 

 

Number Vested

 

 

Weighted

Average

 

Prices

 

Outstanding

 

 

Life (in Years)

 

 

and Exercisable

 

 

Life (in Years)

 

$1.50 to $1.90

 

 

32,913

 

 

 

1.4

 

 

 

32,913

 

 

 

1.4

 

2.86 to 6.40

 

 

209,126

 

 

 

3.3

 

 

 

209,126

 

 

 

3.3

 

8.04 to 11.72

 

 

498,869

 

 

 

4.2

 

 

 

498,869

 

 

 

4.2

 

12.20 to 15.06

 

 

2,227,421

 

 

 

6.7

 

 

 

1,587,924

 

 

 

6.5

 

16.06 to 24.00

 

 

1,772,062

 

 

 

8.1

 

 

 

560,632

 

 

 

8.1

 

31.99 to 42.21

 

 

847,010

 

 

 

9.0

 

 

 

42,839

 

 

 

8.7

 

55.10 to 79.25

 

 

297,341

 

 

 

9.5

 

 

 

12,492

 

 

 

9.3

 

 

 

 

5,884,742

 

 

 

 

 

 

 

2,944,795

 

 

 

 

 

 

The total intrinsic value of options exercised during 2019, 2018, and 2017 was $318.5 million, $17.4 million, and $6.6 million, respectively.

The weighted average grant date fair value of options granted during the years ended December 31, 2019, 2018, and 2017, was $19.80, $9.07, and $6.44 per share, respectively. During the year ended December 31, 2019, 2,141,078 options vested. There were 2,939,947 options unvested as of December 31, 2019.

As of December 31, 2019, $30.3 million of total unrecognized compensation cost related to stock options was expected to be recognized over a weighted average period of approximately 2.5 years.

111


AVALARA, INC.

Notes to Consolidated Financial Statements

 

All stock-based payments to participants, including employees and non-employee directors, are measured based on the grant date fair value of the awards and recognized in the consolidated statements of operations over the period during which the participant is required to perform services in exchange for the award. The vesting period is generally four years for employees and one year for non-employee directors. For the options granted during the periods presented, the fair value of options was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

For the Year Ended December 31,

 

 

2019

 

 

2018

 

 

2017

Fair market value of common stock

 

$39.76 - $79.25

 

 

$16.86 - $42.21

 

 

$13.84 - $16.06

Volatility

 

40%

 

 

40%

 

 

40% to 43%

Expected term

 

5-6 years

 

 

6 years

 

 

6 years

Expected dividend yield

 

n/a

 

 

n/a

 

 

n/a

Risk-free interest rate

 

1.68% - 2.65%

 

 

2.55% - 3.10%

 

 

2.02% - 2.22%

 

The Board of Directors intends all options granted to be exercisable at a price per share not less than the per share fair value of the Company’s common stock underlying those options on the date of grant. Following the closing of the IPO, the fair market value per share of the Company’s common stock for purposes of determining stock-based compensation is the closing price of the Company’s common stock as reported on the applicable grant date.

Prior to the IPO, the fair value of the common stock underlying stock options and common stock warrants was estimated by the Board of Directors, with input from management and third-party valuation firms. The enterprise value utilized in determining the fair value of common stock for financial reporting purposes was estimated using the market approach and the income approach. Under the market approach, the Company used the guideline public company method, which estimates the fair value of the business enterprise based on market prices of stock of guideline public companies and the option pricing method. Indications of value were estimated by utilizing revenue multiples to measure enterprise value. The guideline merged and acquired company method was not utilized in the valuation, as the Company regarded the method as less reliable as management believed it did not directly reflect the Company’s future prospects. The income approach estimated the enterprise value based on the present value of the Company’s future estimated cash flows and the residual value beyond the forecast period. The residual value was based on an exit (or terminal) multiple observed in the comparable company method analysis. The future cash flows and residual value were discounted to their present value to reflect the risks inherent in the Company achieving these estimated cash flows. The discount rate was based on venture capital rates of return for companies nearing an initial public offering. The discount rate was applied using the mid-year convention. The mid-year convention assumes that cash flows are generated evenly throughout the year, as opposed to in a lump sum at the end of the year.

The Company lacks sufficient historical data on the volatility of its stock price. Selected volatility is representative of expected future volatility and was based on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

 

The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. Given the Company’s relative inexperience of significant exercise activity, the expected term assumptions were determined based on application of the simplified method of expected term calculation by averaging the contractual life of option grants and the vesting period of such grants. This application, when coupled with the contractual life of ten years and average vesting term of four years for employees and one year for non-employee directors, creates an expected term of six years and five years, respectively.

The Company has not paid and does not expect to pay dividends.

The risk-free interest rate was based on the rate for a U.S. Treasury zero-coupon issue with a term that closely approximates the expected life of the option grant at the date nearest the option grant date.

112


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Restricted Stock Units

The following table summarizes RSU activity for the Company’s stock-based compensation plans for 2019:

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Grant Date Fair

 

 

 

Restricted Stock Units

 

 

Value Per Share

 

RSUs outstanding as of January 1, 2019

 

 

74,424

 

 

$

32.69

 

RSUs granted

 

 

1,605,267

 

 

 

52.30

 

RSUs vested

 

 

(52,827

)

 

 

63.15

 

RSUs cancelled

 

 

(118,583

)

 

 

45.05

 

RSUs outstanding as of December 31, 2019

 

 

1,508,281

 

 

$

51.52

 

 

Stock-based compensation cost is recorded on a straight-line basis in the consolidated statements of operations over the period during which the participant is required to perform services in exchange for the award, based on the fair value of the Company’s underlying common stock on the date of grant. The vesting period of each RSU grant is generally four years for employees and one year for non-employee directors. As of December 31, 2019, $66.6 million of total unrecognized compensation cost related to RSUs was expected to be recognized over a weighted average period of approximately 3.3 years.

Employee Stock Purchase Plan  

In April 2018, the Company’s Board of Directors adopted the ESPP. The ESPP became effective on June 15, 2018, the first trading day of the Company’s common stock. The ESPP is intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986, as amended. Purchases will be accomplished through participation in discrete offering periods. The first offering period began on June 15, 2018 and ended on January 31, 2019. Subsequent offering periods begin on August 1 and February 1 (or such other date determined by our Board of Directors or our Compensation and Leadership Development Committee).

Under the ESPP, eligible employees can acquire shares of the Company’s common stock by accumulating funds through payroll deductions. Employees generally are eligible to participate in the ESPP if they are a U.S. employee and are employed for at least 20 hours per week. The Company may impose additional restrictions on eligibility. Eligible employees can select a rate of payroll deduction between 1% and 15% of their compensation. The purchase price for shares of common stock purchased under the ESPP is 85% of the lesser of the fair market value of the Company’s common stock on (i) the first day of the applicable offering period or (ii) the last day of the purchase period in the applicable offering period. An employee’s participation automatically ends upon termination of employment for any reason. As of December 31, 2019, 1,157,498 shares of common stock are reserved for sale under the ESPP.

The Company initially reserved 996,709 shares of common stock for sale under the ESPP. The aggregate number of shares reserved for sale under the ESPP increases automatically on each January 1, beginning January 1, 2019, by the number of shares equal to least of (i) 1,000,000 shares of common stock, (ii) 1% of the aggregate number of shares of common stock outstanding on December 31st of the immediately preceding calendar year (rounded up to the nearest whole share), and (iii) an amount determined by the Board of Directors. No more than an aggregate of 10,102,525 shares of common stock may be issued over the ten-year term of the ESPP.

As of December 31, 2019, there was approximately $0.3 million of unrecognized stock-based compensation cost related to the ESPP that is expected to be recognized over the remaining term of the offering period that began on August 1, 2019 and ended January 31, 2020.

113


AVALARA, INC.

Notes to Consolidated Financial Statements

 

For the years ended December 31, 2019 and 2018, the fair value of ESPP purchase rights was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

For the Year Ended December 31,

 

 

2019

 

2018

Fair market value of common stock

 

$40.60 to $82.12

 

$24.00 to $38.18

Volatility

 

40%

 

40%

Expected term

 

0.5 years

 

0.5 years

Expected dividend yield

 

n/a

 

n/a

Risk-free interest rate

 

2.04% to 2.59%

 

2.90% to 2.96%

 

13. Income Taxes

 

Domestic and foreign components of loss before income tax are as follows (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Domestic

 

$

(30,272

)

 

$

(48,949

)

 

$

(41,575

)

Foreign

 

 

(18,987

)

 

 

(27,577

)

 

 

(23,770

)

Total

 

$

(49,259

)

 

$

(76,526

)

 

$

(65,345

)

 

Major components of the income tax provision (benefit) are as follows (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Current:

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

 

 

$

 

 

$

 

State

 

 

 

 

 

 

 

 

 

Foreign

 

 

1,178

 

 

 

317

 

 

 

87

 

Total current income tax provision

 

 

1,178

 

 

 

317

 

 

 

87

 

Deferred:

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

 

90

 

 

 

(825

)

 

 

(368

)

State

 

 

53

 

 

 

64

 

 

 

90

 

Foreign

 

 

(366

)

 

 

(532

)

 

 

(1,028

)

Total deferred income tax benefit

 

 

(223

)

 

 

(1,293

)

 

 

(1,306

)

Total

 

$

955

 

 

$

(976

)

 

$

(1,219

)

 

U.S. Tax Reform

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code, including but not limited to, (1) reduction of the U.S. federal corporate tax rate, (2) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, (3) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries, (4) introduction of a new foreign tax on global intangible low-taxed income, and (5) removal of the definite carryback and carryforward periods of NOLs for an indefinite carryforward.

114


AVALARA, INC.

Notes to Consolidated Financial Statements

 

As of December 31, 2017, the Company remeasured certain deferred tax assets and liabilities based on the rates at which they were expected to reverse in the future (which was generally 21%), by recording a provisional amount of $44.8 million, of which $0.7 million impacted deferred tax expense. The remainder of the re-measurement was offset by a valuation allowance resulting in no impact to tax expense. During 2018, the Company adjusted the provisional amount to $0.9 million tax benefit, which is included as a component of income tax expense from continuing operations.  At December 31, 2018, the Company completed the accounting for all of the enactment-date income tax effects of the Act.

It is the Company’s intention to reinvest the earnings of non-U.S. subsidiaries in those operations. As of December 31, 2019, the Company has not made a provision for U.S. or additional foreign withholding taxes for any outside basis differences inherent in its investments in foreign subsidiaries that are indefinitely reinvested. It is not practicable to estimate the amount of deferred tax liability related to investments in these foreign subsidiaries.

Reconciliation of Provision (Benefit) for Income Taxes

 

Major differences between the U.S. statutory rate (21%, 21%, and 35%, for 2019, 2018, and 2017, respectively) and the effective tax rate are as follows (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Tax at statutory rate

 

$

(10,345

)

 

$

(16,071

)

 

$

(22,871

)

State taxes

 

 

(1,941

)

 

 

(3,375

)

 

 

(2,531

)

Research and development credits

 

 

(2,285

)

 

 

(471

)

 

 

(1,460

)

Changes in tax law

 

 

 

 

 

 

 

 

(840

)

Stock-based compensation

 

 

(67,718

)

 

 

(3,246

)

 

 

(3,110

)

Goodwill impairment

 

 

 

 

 

3,119

 

 

 

2,903

 

Impact of foreign operations

 

 

1,373

 

 

 

(2,488

)

 

 

1,815

 

Change in valuation allowance

 

 

80,284

 

 

 

20,006

 

 

 

21,644

 

Intercompany intangible asset sale

 

 

 

 

 

1,811

 

 

 

 

Other

 

 

1,587

 

 

 

(261

)

 

 

3,231

 

Total

 

$

955

 

 

$

(976

)

 

$

(1,219

)

 

115


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Deferred Tax Assets and Liabilities

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows (in thousands):

 

 

 

December 31,

 

 

 

2019

 

 

2018

 

Deferred tax assets:

 

 

 

 

 

 

 

 

Net operating loss carryforward

 

$

171,192

 

 

$

91,529

 

Stock-based compensation

 

 

8,015

 

 

 

8,219

 

Deferred revenue

 

 

186

 

 

 

2,186

 

Research and development credit, net of

   uncertain tax position reserve

 

 

6,342

 

 

 

4,182

 

Operating lease liabilities

 

 

16,437

 

 

 

 

Definite lived intangibles

 

 

434

 

 

 

 

Other

 

 

5,831

 

 

 

7,134

 

Total deferred tax assets

 

 

208,437

 

 

 

113,250

 

Deferred tax liabilities:

 

 

 

 

 

 

 

 

Deferred commissions

 

 

(9,581

)

 

 

 

Operating lease right-of-use assets

 

 

(12,037

)

 

 

 

Fixed assets

 

 

(3,876

)

 

 

(3,716

)

Definite lived intangibles

 

 

 

 

 

(590

)

Indefinite-lived intangibles

 

 

(2,154

)

 

 

(1,652

)

Other

 

 

(13

)

 

 

 

Total deferred tax liabilities

 

 

(27,661

)

 

 

(5,958

)

Net deferred tax assets before valuation

   allowance

 

 

180,776

 

 

 

107,292

 

Valuation allowance

 

 

(181,113

)

 

 

(107,852

)

Net deferred tax liability

 

$

(337

)

 

$

(560

)

 

As of December 31, 2019 and 2018, the Company had federal net operating loss carryforwards (“NOLs”) of approximately $651.9 million and $342.5 million, respectively, and state NOLs of approximately $448.2 million and $219.2 million, respectively. If not utilized, the federal and state NOLs will expire in varying amounts beginning in 2024 for federal purposes and 2020 for state purposes. In addition, the Company has $358.9 million of net operating loss carryforwards for federal income tax purposes that arose after the 2017 tax year, which are available to reduce future federal taxable income, if any, over an indefinite period. The utilization of those net operating loss carryforwards is limited to 80% of taxable income in any given year. The Company recently performed a Section 382 study to determine whether the use of its organically generated NOLs was subject to limitation and concluded that a Section 382 limitation would apply due to a change of ownership in 2019. None of the NOLs are expected to expire unused as a result of the Section 382 limitation. Future changes in the ownership of the Company could further limit the Company’s ability to utilize its NOLs.

As of December 31, 2019 and 2018, the Company had foreign net operating loss carryforwards of approximately $46.1 million and $29.0 million, respectively. The foreign net operating loss carryforwards may be carried forward indefinitely.

The Company has U.S. research and development credit carryforwards of $12.3 million as of December 31, 2019, which will begin to expire in 2030.

116


AVALARA, INC.

Notes to Consolidated Financial Statements

 

Accounting for Uncertainty in Income Taxes

The Company has assessed its ability to realize its deferred tax assets and has recorded a valuation allowance against such assets to the extent that, based on the weight of all available evidence, it is more likely than not that all or a portion of the deferred tax assets will not be realized. In assessing the likelihood of future realization of its deferred tax assets, the Company placed a significant amount of weight on its history of generating U.S. tax losses, including in the current year. The increase in the valuation allowance each period was primarily related to U.S. federal and state tax losses incurred during the period.

The Company has established an accrual for uncertain tax positions related to its U.S. research and development credits and for the valuation of intellectual property transferred between international entities. As of December 31, 2019 and 2018, the Company has $5.2 million and $4.1 million of unrecognized tax benefits, of which the total amount that would impact the effective tax rate, if recognized, is $0.2 million. As of December 31, 2019, the Company has recorded an immaterial amount of interest penalties related to its unrecognized tax benefits, which are classified as a component of income tax expense. The Company does not believe it is reasonably possible that its unrecognized tax benefits will significantly change in the next twelve months.

A reconciliation of the beginning and ending balances for unrecognized tax benefits is as follows (in thousands):

 

 

 

For the Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Balance at January 1

 

$

4,118

 

 

$

3,300

 

 

$

2,727

 

Additions for tax positions related to the

   current year

 

 

1,435

 

 

 

1,446

 

 

 

867

 

Additions for tax positions related to prior years

 

 

 

 

 

 

 

 

 

Reductions for tax positions related to prior years

 

 

(343

)

 

 

(628

)

 

 

(294

)

Reductions related to settlements

 

 

 

 

 

 

 

 

 

Reductions related to a lapse of statute

 

 

 

 

 

 

 

 

 

Balance at December 31

 

$

5,210

 

 

$

4,118

 

 

$

3,300

 

 

The Company files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. With limited exceptions, all tax years for which the Company has filed a tax return remain open due to the existence of NOLs.

14. Net Loss Per Share Attributable to Common Shareholders

The Company calculates basic and diluted net loss per share attributable to common shareholders in conformity with the two-class method required for companies with participating securities. Prior to the IPO, the Company considered all series of convertible preferred stock to be participating securities. Under the two-class method, the net loss attributable to common shareholders was not allocated to the convertible preferred stock as the holders of convertible preferred stock did not have a contractual obligation to share in losses.

The diluted net loss per share attributable to common shareholders is computed by giving effect to all potential dilutive common stock equivalents outstanding for the period. For purposes of this calculation, all common stock equivalents have been excluded from the calculation of diluted net loss per share attributable to common shareholders as their effect is antidilutive. As a result, basic and diluted net loss per common share was the same for each period presented.

117


AVALARA, INC.

Notes to Consolidated Financial Statements

 

The following table sets forth the computation of basic and diluted net loss per common share (in thousands, except per share amounts):

 

 

 

Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shareholders

 

$

(50,214

)

 

$

(75,550

)

 

$

(64,126

)

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares

   outstanding-basic

 

 

73,345

 

 

 

38,692

 

 

 

5,632

 

Dilutive effect of share equivalents resulting from stock

   options, restricted stock units, common stock warrants,

   ESPP shares and convertible preferred shares (as

   converted)

 

 

 

 

 

 

 

 

 

Weighted-average common shares

   outstanding-diluted

 

 

73,345

 

 

 

38,692

 

 

 

5,632

 

Net loss per common share, basic and diluted

 

$

(0.68

)

 

$

(1.95

)

 

$

(11.39

)

 

The following weighted-average outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share attributable to common shareholders for the periods presented because the impact of including them would have been antidilutive (in thousands):

 

 

 

Year Ended December 31,

 

 

 

2019

 

 

2018

 

 

2017

 

Options to purchase common shares

 

 

7,987

 

 

 

11,271

 

 

 

10,507

 

Unvested restricted stock units

 

 

1,157

 

 

 

9

 

 

 

 

Employee stock purchase plan shares

 

 

13

 

 

 

71

 

 

 

 

Common stock warrants

 

 

 

 

 

236

 

 

 

580

 

Convertible preferred shares (as converted)

 

 

 

 

 

23,562

 

 

 

50,893

 

Total

 

 

9,157

 

 

 

35,149

 

 

 

61,980

 

 

 

 

 

 

 

118


 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act as of December 31, 2019.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our company’s reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as of December 31, 2019 due to the material weakness identified and described below.

Management’s Report on Internal Control over Financial Reporting

Our management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) (2013 framework).  Based on this evaluation our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2019, the Company has not maintained effective internal control over financial reporting.

The Company has a material weakness as it lacks adequate controls to effectively design, implement, and operate process-level and information technology controls to sufficiently mitigate risks of material misstatement associated with certain complex business processes and changes in those processes or applicable accounting standards. This material weakness led to the following individual significant deficiencies:

 

Design and implementation of controls over a portion of the underlying data used to derive the accounting entries related to the adoption of ASC 606;

 

Design and implementation of control activities to address changes in ongoing revenue and deferred commission accounting following the adoption of ASC 606;

 

Design and implementation of controls related to the enforcement of segregation of duties in key areas of financial reporting, including sales order pricing and approvals; and

 

Operating effectiveness of controls related to the review of manual journal entries.

119


 

These deficiencies resulted in immaterial errors to the Company’s consolidated financial statements that were not detected timely through the Company’s internal controls over financial reporting.

Our independent registered public accounting firm, which has audited our financial statements, has also audited the effectiveness of our internal control over financial reporting as of December 31, 2019, and has issued an adverse opinion on the effectiveness of our internal controls over financial reporting, as stated in their report, which is included in Item 8 of this Annual Report on Form 10-K.

Changes in Internal Control over Financial Reporting

We adopted the new lease accounting standard, ASC 842, during the three months ended December 31, 2019 due to the loss of EGC status. We applied this adoption back to January 1, 2019 in this Annual Report on Form 10-K for the year ended December 31, 2019, using the modified retrospective transition method. As a result, we implemented changes to our relevant business processes and internal controls over financial reporting. There were no other changes in our internal control over financial reporting in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the three months ended December 31, 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Management recognizes that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Remediation Activities

The Company is working to remediate the material weakness and resulting significant deficiencies in internal control over financial reporting and is taking steps to improve the internal control environment.  Specifically, the Company is:

 

Enhancing monitoring controls to timely respond to changes in key processes, including any required changes to the design of process level controls;

 

Enhancing processes and review controls around revenue recognition and the deferral of commission costs;

 

Implementing system controls, enhancements and automation to reduce manual error-prone processes;

 

Enhancing user access reviews and monitoring controls, where appropriate, to improve segregation of duties; and

 

Implementing additional training to improve documentation that supports effective control operation.

Item 9B. Other Information.

None.

120


 

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The information required by this item is incorporated by reference to the relevant information from our Proxy Statement to be filed in connection with our 2020 Annual Meeting of Shareholders within 120 days after the end of the fiscal year ended December 31, 2019.

Item 11. Executive Compensation.

The information required by this item is incorporated by reference to the relevant information from our Proxy Statement to be filed in connection with our 2020 Annual Meeting of Shareholders within 120 days after the end of the fiscal year ended December 31, 2019.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information required by this item is incorporated by reference to the relevant information from our Proxy Statement to be filed in connection with our 2020 Annual Meeting of Shareholders within 120 days after the end of the fiscal year ended December 31, 2019.

The information required by this item is incorporated by reference to the relevant information from our Proxy Statement to be filed in connection with our 2020 Annual Meeting of Shareholders within 120 days after the end of the fiscal year ended December 31, 2019.

Item 14. Principal Accounting Fees and Services.

The information required by this item is incorporated by reference from our Proxy Statement to be filed in connection with our 2020 Annual Meeting of Shareholders within 120 days after the end of the fiscal year ended December 31, 2019.

 

121


 

PART IV

Item 15. Exhibits, Financial Statement Schedules.

 

(a)

The following documents are filed as part of this Annual Report on Form 10-K:

 

(1)

Consolidated Financial Statements
The financial statements filed as part of this Annual Report on Form 10-K are listed in the “Index to Consolidated Financial Statements” under Part II, Item 8 of this Annual Report on Form 10-K.

 

(2)

Financial Statement Schedules
All schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or notes to the consolidated financial statements under Part II, Item 8 of this Annual Report on Form 10-K.

 

(3)

Exhibits
The documents listed in the Exhibit Index of this Annual Report on Form 10-K are incorporated by reference or are filed with this Annual Report on Form 10-K, in each case as indicated therein (numbered in accordance with Item 601 of Regulation S-K).

 

122


 

Exhibit Index

 

Exhibit

Number

 

Description

 

 

 

  3.1

 

Amended and Restated Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-38525) filed with the SEC on August 10, 2018)

 

 

 

  3.2

 

Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-38525) filed with the SEC on August 10, 2018)

 

 

 

  4.1

 

Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Registrant’s Registration Statement on Form S-1/A (File No. 333-224850) filed with the SEC on June 4, 2018)

 

 

 

  4.2*

 

Description of the Registrant’s securities

 

 

 

10.1+

 

Avalara, Inc. 2006 Equity Incentive Plan, as amended, and related forms of award agreement (incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.2+

 

Avalara, Inc. 2018 Equity Incentive Plan, as amended and restated, and related forms of award agreements (incorporated by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.3*+

 

Avalara, Inc. 2019 Executive, Sales & Marketing Leadership Bonus Plan

 

 

 

10.4*+

 

Avalara, Inc. 2020 Executive and Leadership Bonus Plan

 

 

 

10.5+

 

Avalara, Inc. 2018 Employee Stock Purchase Plan, as amended and restated, effective August 8, 2018 (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-38525) filed with the SEC on August 10, 2018)

 

 

 

10.6+

 

Avalara, Inc. Outside Director Compensation Policy, amended and restated as of July 25, 2019 (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-38525) filed with the SEC on November 6, 2019)

 

 

 

10.7+

 

Form of Indemnification Agreement made by and between the Registrant and each of its directors and executive officers (incorporated by reference to Exhibit 10.8 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.8+

 

Executive Employment Agreement between the Registrant and Scott McFarlane dated June 19, 2017 (incorporated by reference to Exhibit 10.9 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.9+

 

Executive Employment Agreement between the Registrant and William Ingram dated June 19, 2017 (incorporated by reference to Exhibit 10.10 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.10+

 

Executive Employment Agreement between the Registrant and Alesia Pinney dated June 19, 2017 (incorporated by reference to Exhibit 10.11 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.11+

 

Executive Employment Agreement between the Registrant and Pascal Van Dooren dated April 13, 2018 (incorporated by reference to Exhibit 10.12 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

10.12*+

 

Executive Employment Agreement between the Registrant and Amit Mathradas dated January 6, 2019

 

 

 

123


 

10.13

 

Lease Agreement between W2007 Seattle Office Second and Spring Building Realty, LLC and Avalara, Inc. dated August 14, 2014 (incorporated by reference to Exhibit 10.16 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.14

 

Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated June 9, 2016 (incorporated by reference to Exhibit 10.17 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.15

 

First Amendment of Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated June 1, 2017 (incorporated by reference to Exhibit 10.18 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.16

 

Second Amendment of Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated October 2, 2017 (incorporated by reference to Exhibit 10.19 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.17

 

Third Amendment of Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated November 29, 2017 (incorporated by reference to Exhibit 10.20 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.18

 

Fourth Amendment of Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated February 19, 2018 (incorporated by reference to Exhibit 10.21 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.19

 

Fifth Amendment of Office Building Lease by and between 255 South King Street Limited Partnership and the Registrant dated September 26, 2018 (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q (File No. 001-38525) filed with the SEC on November 8, 2018)

 

 

 

10.20

 

Ninth Amended and Restated Investors’ Rights Agreement, dated September 12, 2016, as amended (incorporated by reference to Exhibit 10.22 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

10.21

 

Tenth Amended and Restated Voting Agreement, dated September 12, 2016 (incorporated by reference to Exhibit 10.23 to the Registrant’s Registration Statement on Form S-1 (File No. 333-224850) filed with the SEC on May 11, 2018)

 

 

 

21.1*

 

List of subsidiaries of the Registrant

 

 

 

23.1*

 

Consent of Deloitte & Touche LLP, Independent Public Accounting Firm

 

 

 

31.1*

 

Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

31.2*

 

Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

32.1*

 

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

32.2*

 

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS*

 

Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

124


 

 

 

 

101.SCH*

 

Inline XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL*

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF*

 

Inline XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB*

 

Inline XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE*

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

104*

 

Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

 

*

Filed herewith.

+

Indicates a management contract or compensatory plan, contract or arrangement.

Item 16. Form 10-K Summary

None

 

125


 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

Avalara, Inc.

 

 

 

 

Date: February 28, 2020

 

By:

/s/ Scott M. McFarlane

 

 

 

Scott M. McFarlane

 

 

 

Chairman and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

 

Name

 

Title

 

Date

 

 

 

 

 

/s/ Scott M. McFarlane

 

Director, Chairman, and Chief Executive Officer

 

February 28, 2020

Scott M. McFarlane

 

(Principal Executive Officer)

 

 

 

 

 

 

 

/s/ William D. Ingram

 

Director, Chief Financial Officer, and Treasurer

 

February 28, 2020

William D. Ingram

 

(Principal Financial Officer)

 

 

 

 

 

 

 

/s/ Daniel E. Manning

 

Chief Accounting Officer

 

February 28, 2020

Daniel E. Manning

 

(Principal Accounting Officer)

 

 

 

 

 

 

 

/s/ Marion R. Foote

 

Director

 

February 28, 2020

Marion R. Foote

 

 

 

 

 

 

 

 

 

/s/ Edward A. Gilhuly

 

Director

 

February 28, 2020

Edward A. Gilhuly

 

 

 

 

 

 

 

 

 

/s/ Tami L. Reller

 

Director

 

February 28, 2020

Tami L. Reller

 

 

 

 

 

 

 

 

 

/s/ Justin L. Sadrian

 

Director

 

February 28, 2020

Justin L. Sadrian

 

 

 

 

 

 

 

 

 

/s/ Rajeev Singh

 

Director

 

February 28, 2020

Rajeev Singh

 

 

 

 

 

 

 

 

 

/s/ Chelsea R. Stoner

 

Director

 

February 28, 2020

Chelsea R. Stoner

 

 

 

 

 

 

 

 

 

/s/ Kathleen M. Zwickert

 

Director

 

February 28, 2020

Kathleen M. Zwickert

 

 

 

 

 

126