S-1 1 d317509ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on May 11, 2018

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

AVALARA, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Washington   7372   91-1995935

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(IRS Employer

Identification No.)

255 South King Street, Suite 1800

Seattle, Washington 98104

(206) 826-4900

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Scott M. McFarlane

Chairman, Chief Executive Officer, and President

Avalara, Inc.

255 South King Street, Suite 1800

Seattle, Washington 98104

(206) 826-4900

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

 

 

Copies to:

 

David F. McShea

Andrew B. Moore

Allison C. Handy

Perkins Coie LLP

1201 Third Avenue, Suite 4900

Seattle, Washington 98101

(206) 359-8000

 

Alesia L. Pinney

Executive Vice President,

General Counsel, and Secretary

Avalara, Inc.

255 South King Street, Suite 1800

Seattle, Washington 98104

(206) 826-4900

 

Eric C. Jensen

John T. McKenna

Alan D. Hambelton

Cooley LLP

1700 Seventh Avenue, Suite 1900

Seattle, Washington 98101

(206) 452-8700

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

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     (do not check if a smaller reporting company)    Smaller reporting company  
Emerging growth company           

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

  Proposed
Maximum
Aggregate
Offering
Price(1)(2)
 

Amount of
Registration

Fee

Common Stock, par value $0.0001 per share

  $150,000,000   $18,675

 

 

(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Includes offering price of shares that the underwriters have the option to purchase from us.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject To Completion. Dated May 11, 2018.

 

                Shares

 

LOGO

Common Stock

 

 

This is an initial public offering of shares of common stock of Avalara, Inc.

 

Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $        and $        . We intend to list our common stock on the New York Stock Exchange under the symbol “AVLR.”

 

Upon the completion of this offering, the members of our Board of Directors, our executive officers and our 5% or greater shareholders will beneficially own, in the aggregate, approximately     % of our outstanding common stock.

 

We are an “emerging growth company” as defined under the federal securities laws and, as such, we intend to comply with reduced disclosure and regulatory requirements.

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 14 to read about factors you should consider before buying shares of our common stock.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total      

Initial public offering price

   $                   $                         

Underwriting discount(1)

   $      $    

Proceeds, before expenses, to Avalara

   $      $    

 

  (1) See the section titled “Underwriting” for a description of the compensation payable to the underwriters.  

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from us at the initial public offering price less the underwriting discount.

 

 

The underwriters expect to deliver the shares against payment in New York, New York on                 , 2018.

 

Goldman Sachs & Co. LLC

     J.P. Morgan      BofA Merrill Lynch  

 

          JMP Securities   

KeyBanc Capital Markets

   Stifel              

Prospectus dated                 , 2018.


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LOGO

We connect. With more than 600 pre-built software integrations and a robust API, we easily connect with the accounting, ERP, ecommerce, POS, recurring billing, and CRM systems companies of all sizes use to run their businesses, including those shown here solely to demonstrate the broad range of our partners and integrations.


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TABLE OF CONTENTS

Prospectus

 

     Page  

Prospectus Summary

     1  

Risk Factors

     14  

Special Note Regarding Forward-Looking Statements

     39  

Industry and Market Data

     41  

Use of Proceeds

     42  

Dividend Policy

     43  

Capitalization

     44  

Dilution

     46  

Selected Consolidated Financial Data

     49  

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

     53  

Business

     88  

Management

     106  

Executive Compensation

     115  

Certain Relationships and Related Person Transactions

     127  

Principal Shareholders

     131  

Description of Capital Stock

     134  

Shares Eligible for Future Sale

     140  

Material U.S. Federal Income and Estate Tax Consequences for Non-U.S. Holders

     143  

Underwriting

     147  

Legal Matters

     153  

Experts

     153  

Where You Can Find More Information

     153  

Index to Consolidated Financial Statements

     F-1  

 

 

We have not authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We do not take responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

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PROSPECTUS SUMMARY

This summary highlights selected information that is presented in greater detail elsewhere in this prospectus. This summary does not contain all the information you should consider before investing in our common stock. You should carefully read this prospectus in its entirety before investing in our common stock, including the sections of this prospectus titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. Unless the context otherwise requires, we use the terms “Avalara,” the “Company,” “we,” “us,” and “our” in this prospectus to refer to Avalara, Inc. and, where appropriate, our consolidated subsidiaries.

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. In 2017, we processed an average of over 16 million tax determinations per day. Our vision is to be part of every transaction in the world.

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, of which there are more than 12,000 in the United States alone, 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



 

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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. We enable this through our more than 600 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.

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 107% on average for the four quarters ended March 31, 2018. See the section of this prospectus titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics—Net Revenue Retention Rate” for additional information regarding our net revenue retention rate.

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 6,250, 7,490, and 7,760 core customers as of December 31, 2016 and 2017 and March 31, 2018, respectively. In 2017, our core customers represented more than 85% 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 are expanding our international presence. See the section of this prospectus titled “Management’s Discussion and



 

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Analysis of Financial Condition and Results of Operations—Key Business Metrics—Number of Core Customers” for additional information regarding core customers.

We sell our solutions primarily on a subscription basis. We target most prospects via cost-effective digital marketing strategies and 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. 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. In some cases, particularly for customers with larger and more complex needs, we conduct some in-person sales. 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, to serve the needs of businesses in different geographies or industries, or to 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 our excise tax, lodging tax, communications tax, portions of our European VAT, and Brazil tax solutions. We intend to continue pursuing opportunities to broaden our suite of solutions and international presence, and integrating new content and solutions.

We generated revenue of $123.2 million, $167.4 million, $213.2 million, and $61.4 million in 2015, 2016, 2017, and the three months ended March 31, 2018, respectively. We had net losses of $77.8 million, $57.9 million, $64.1 million, and $15.2 million in 2015, 2016, 2017, and the three months ended March 31, 2018, respectively, primarily due to our investments in growth.

Industry Background

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 the increasing number of companies doing business in multiple taxing jurisdictions and offering numerous products and services that are taxed in myriad 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. For example, digital music downloads are currently taxable in New Jersey but tax exempt in Iowa. Even within states, tax rules applied to similar products can vary widely. In New York City, a plain bagel, sliced and toasted is currently taxable, while a plain bagel to go is tax exempt. 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.



 

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Adding to the complexity is the fact that businesses face a variety of transaction tax types that vary based on industry and location, including sales and use tax, VAT, excise tax, lodging tax, and communications tax. Each of these tax types have different methods for calculating and applying the applicable rate, requiring different processes for compliance.

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. Businesses that operate in multiple jurisdictions must stay up to date in each one as governing bodies amend their tax rates and taxability rules, modify jurisdictional boundaries, and implement other regulatory changes. 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.

Challenges exist with current approaches.

Many businesses attempt to handle transaction tax compliance processes manually, risking miscalculations and incorrect collections, which can result in customer dissatisfaction and 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 not sufficiently robust or current to provide accurate tax determinations for many businesses. Businesses may also rely on tax-specific software products from providers other than Avalara, but these often offer limited pre-built integrations with critical business applications, can require ongoing updates, are deployed on-premises, or have a high cost of ownership.

Our Opportunity

We believe that the total addressable market for transaction tax compliance solutions is large and underpenetrated. We estimate that the addressable market in the United States alone for the solutions we offer today is over $8 billion. We calculate this figure by identifying the number of U.S. companies across all industries using certain data from, for companies with 20 or more employees, S&P Global Market Intelligence and, for companies with fewer than 20 employees, the U.S. Census Bureau 2015 Statistics of U.S. Businesses. We then segment these companies into four separate cohorts based on the number of employees: companies that have fewer than 20 employees, companies that have between 20 and 100 employees, companies that have between 101 and 500 employees, and companies that have 501 employees or more. We then multiply the number of U.S. companies in each of these four cohorts by the following:

 

    For companies with fewer than 20 employees, which represent a market that has not historically been our primary focus but which also represent a growth area for us, our expected revenue for a customer that purchases subscriptions through our self-serve web tool for 1,200 determinations and 12 return filings per year.


 

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    For companies with 20 to 100 employees, 101 to 500 employees or 501 or more employees, the 2017 average annual revenue per customer within each respective cohort based on revenues of all customers that we could precisely match between our customer account records and S&P Global Market Intelligence data for the respective cohort.

We believe this $8 billion figure understates our total addressable market, as it does not account for businesses outside the United States, or potential future expansion in the solutions we offer and corresponding potential increases in average annual revenue per customer.

We believe that the total addressable market for our solutions is also driven in part by transaction taxes collected. The Organisation for Economic Co-operation and Development (OECD) estimates that $377 billion of sales taxes were collected in the United States for 2016. We estimate that our AvaTax solution determined approximately $5.8 billion of remitted sales and use taxes in the United States in 2016. In addition, the OECD estimates that $445 billion of other transaction taxes were collected in the United States in 2016, including excise taxes, customs and import duties, and taxes on specific services, such as transportation, communications, insurance, advertising, hotels and lodging, restaurants, entertainments, gambling, and sporting events.

While most of our revenue is currently generated from customers located in the United States, we support transaction tax compliance in Europe, South America, and Asia and believe we have a significant growth opportunity in these markets. For example, the OECD estimates that over $1.2 trillion of VAT was collected in Europe for 2016. Although we are in the early stages of developing our international presence and therefore have less historical data with which to assess the size of our market opportunities, we believe that Europe and other jurisdictions throughout the world represent a significant additional addressable market for our transaction tax compliance solutions.

We intend to capture more of our total addressable market as we pursue our vision to be a part of every transaction in the world and solve compliance challenges with respect to the trillions of dollars of transaction taxes collected globally every year.

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. Our platform powers a suite of compliance solutions for transaction tax determination; tax return preparation, filing, and remittance; tax records maintenance; and exemption certificate and other compliance document storage and management. Our solutions use an advanced database of broad, deep, and up-to-date tax content for a wide and growing range of transaction taxes, such as sales and use tax, VAT, excise tax, lodging tax, and communications tax.

Compared to on-premises products, our comprehensive, integrated suite of automated, cloud-based compliance solutions requires 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.



 

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Our 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 transaction tax 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 AvaTax solution processes transaction tax determinations in under 60 milliseconds on average and in 2017 we processed an average of over 16 million tax determinations per day, including approximately 58.2 million on Cyber Monday 2017, the most significant day for online sales in U.S. history.

 

    Extensive integrations.    We have invested in developing and maintaining more than 600 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, 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 more than 19 million uniform product codes, or UPC codes, linked to taxability rules. We employ a large group of tax research analysts who continually update this extensive library of content. 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, and lodging.

 

    Comprehensive, easy-to-use, scalable solutions.    We provide solutions to a full range of transaction tax compliance burdens. All of our solutions can be configured and managed using our intuitive administrative console, which we regard as a significant differentiator from other transaction tax services because it facilitates fast and easy company-specific configuration, detailed transaction analysis, and access to detailed reports, worksheets, calendars, and other management functions.

 

   

Broad ecosystem.    We have strategically built a broad range of relationships with a network of business application providers 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



 

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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 107% on average for the four quarters ended March 31, 2018.

Our 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 and filing, tax 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 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 12 worldwide offices, four 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 have also made and 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 our excise tax, lodging tax, communications tax, portions of our European VAT, Brazilian transaction tax, and



 

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tariffs and duties 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 accomplish our strategic objectives.

Risks Affecting Us

Our business is subject to numerous risks and uncertainties, including those highlighted in the section of this prospectus titled “Risk Factors” immediately following this prospectus summary. These risks include, but are not limited to:

 

    we have incurred significant operating losses in the past and may never achieve or maintain profitability;

 

    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;

 

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

 

    our revenue growth rate may not be sustainable;

 

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

 

    we derive substantially all 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 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 business and success depends 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;

 

    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 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; and

 

    upon completion of this offering, our directors, officers and 5% or greater shareholders will beneficially own a majority of our outstanding voting stock and will be able to control shareholder decisions on very important matters.

Corporate Information

Our principal executive offices are located at 255 South King Street, Suite 1800, Seattle, Washington 98104, and our telephone number is (206) 826-4900. Our website is www.avalara.com.



 

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Information contained on, or that can be accessed through, our website is not a part of this prospectus and the inclusion of our website address in this prospectus is an inactive textual reference only. We were incorporated in the State of Washington in August 1999 under the name Advantage Solutions, Inc. and changed our name to Avalara, Inc. in December 2005.

Avalara, the Avalara logo, AvaTax, the Avalara Compliance Cloud, “Tax compliance done right,” and other trademarks or service marks of Avalara appearing in this prospectus are the property of Avalara. Other trade names, trademarks, and service marks appearing in this prospectus are the property of their respective holders. We have omitted the ® and ™ designations, as applicable, for the trademarks used in this prospectus.

Implications of Being an Emerging Growth Company

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act, enacted in April 2012. An emerging growth company may take advantage of reduced disclosure and regulatory requirements that are otherwise generally applicable to public companies, including not being required to obtain an attestation report from our independent registered public accounting firm on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, presenting reduced disclosure regarding executive compensation in our periodic reports and proxy statements, and not being required to hold nonbinding advisory shareholder votes on executive compensation or golden parachute arrangements.

In addition, pursuant to the JOBS Act, as an “emerging growth company” we have elected to take advantage of an extended transition period for complying with new or revised accounting standards. This effectively permits us to delay adoption of certain accounting standards until those standards would otherwise apply to private companies. As a result, our consolidated financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective dates for new or revised accounting standards that are applicable to public companies, which may make our common stock less attractive to investors.

We will cease to be an emerging growth company upon the earlier to occur of: the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; the date we qualify as a “large accelerated filer,” with at least $700 million of equity securities held by non-affiliates; the issuance, in any three-year period, by us of more than $1.0 billion in non-convertible debt securities; and the last day of the fiscal year ending after the fifth anniversary of this offering.



 

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THE OFFERING

 

Common stock offered by us

             shares

 

Option to purchase additional shares

             shares

 

Common stock to be outstanding after this offering

             shares (             shares if the option to purchase additional shares is exercised in full)

 

Use of proceeds

We estimate that the net proceeds from this offering will be approximately $        million (or approximately $        million if the underwriters’ option to purchase additional shares of our common stock is exercised in full), assuming an initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us. We intend to use the net proceeds from this offering for general corporate purposes, which we currently expect will include headcount expansion, continued investment in our sales and marketing efforts, product development, general and administrative matters, and working capital. We also intend to use a portion of the net proceeds from this offering to repay the outstanding balance under our revolving credit facility. As of March 31, 2018, the outstanding principal balance under our revolving credit facility was $28.0 million. We also may use a portion of the net proceeds to acquire or invest in complementary businesses, products, services, technologies, or other assets. However, we have not entered into any agreements or commitments with respect to any specific acquisitions or investments at this time. See the section of this prospectus titled “Use of Proceeds” for additional information.

 

Proposed New York Stock Exchange symbol

“AVLR”

The number of shares of our common stock to be outstanding after the closing of this offering is based on 57,152,436 shares of our common stock outstanding as of March 31, 2018 and excludes:

 

    11,213,733 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2018, with a weighted average exercise price of $10.99 per share;

 

    1,584,824 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan, or the 2006 Plan;

 

    an estimated              shares of common stock reserved for future issuance under our 2018 Equity Incentive Plan, or the 2018 Plan, to be effective on the date of this prospectus; and


 

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    an estimated              shares of common stock reserved for future issuance under our 2018 Employee Stock Purchase Plan, or the ESPP, to be effective on the date of this prospectus.

The 2018 Plan will initially authorize the issuance of 8% of the total number of shares outstanding on the closing of this offering. The ESPP will initially authorize the issuance of 1.5% of the total number of shares of common stock outstanding as of the effective date of this offering, up to 1,500,000 shares. On the date of this prospectus, any shares covered by awards under the 2006 Plan that expire, are settled in cash without the delivery of shares, or are forfeited, surrendered, cancelled, repurchased, or withheld will become available for issuance under the 2018 Plan. The 2018 Plan and the ESPP also provide for automatic annual increases in the number of shares reserved thereunder. See the section of this prospectus titled “Executive Compensation—Employee Benefit and Stock Plans” for additional information.

Unless otherwise noted, the information in this prospectus reflects and assumes the following:

 

    a 2-to-1 reverse stock split of our shares of common stock effected May 10, 2018;

 

    the issuance of                  shares of common stock issuable upon the automatic net exercise of warrants outstanding as of March 31, 2018, with a weighted average exercise price of $10.15 per share, immediately prior to the closing of this offering, assuming an initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus;

 

    the conversion of all outstanding shares of our preferred stock into an aggregate of 50,888,014 shares of common stock immediately prior to the closing of this offering;

 

    the filing of our amended and restated articles of incorporation in connection with the closing of this offering;

 

    no exercise of outstanding options after March 31, 2018; and

 

    no exercise by the underwriters of their option to purchase up to an additional              shares of common stock from us.


 

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SUMMARY CONSOLIDATED FINANCIAL DATA

We derived the following selected consolidated statements of operations data for the years ended December 31, 2015, 2016, and 2017 from audited consolidated financial statements appearing elsewhere in this prospectus. We derived the following selected consolidated statements of operations data for the three months ended March 31, 2017 and 2018 and the summary consolidated balance sheet data as of March 31, 2018 from unaudited consolidated financial statements appearing elsewhere in this prospectus. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, which include normal recurring adjustments, necessary for a fair presentation of the financial statements. Historical results are not necessarily indicative of the results that may be expected in the future and the results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the full year or any other period. 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 sections of this prospectus titled “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    For the Year Ended
December 31,
    For the
Three Months
Ended March 31,
 
    2015     2016     2017     2017     2018  
                      (unaudited)  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

         

Revenue:

         

Subscription and returns

  $ 112,804     $ 154,967     $ 199,942     $ 45,848     $ 57,870  

Professional services and other

    10,354       12,459       13,217       3,117       3,507  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    123,158       167,426       213,159       48,965       61,377  

Cost of revenue(1):

         

Subscription and returns

    34,856       41,307       48,849       11,244       14,817  

Professional services and other

    5,889       7,206       9,128       2,319       2,692  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

    40,745       48,513       57,977       13,563       17,509  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    82,413       118,913       155,182       35,402       43,868  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

         

Research and development(1)

    29,787       32,848       41,264       9,682       12,619  

Sales and marketing(1)

    98,686       103,483       133,794       30,300       37,307  

General and administrative(1)

    33,683       36,875       34,286       10,613       9,211  

Goodwill impairment and restructuring charges(2)

                9,170              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    162,156       173,206       218,514       50,595       59,137  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (79,743     (54,293     (63,332     (15,193     (15,269
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    1,614       2,955       2,013       954       828  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (81,357     (57,248     (65,345     (16,147     (16,097
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for (benefit from) income taxes

    (3,593     640       (1,219     (149     (848
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (77,764   $ (57,888   $ (64,126   $ (15,998   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common shareholders—basic and diluted(3)

  $ (77,764   $ (57,888   $ (64,126   $ (15,998   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common shareholders—basic and diluted(3)

  $ (16.96   $ (10.15   $ (11.39   $ (2.97   $ (2.47
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares of common stock outstanding—basic and diluted(3)

    4,586       5,706       5,632       5,389       6,170  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss attributable to common shareholders—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Pro forma net loss per share attributable to common shareholders—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Pro forma weighted average shares of common stock outstanding—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Non-GAAP Financial Data (unaudited)

         

Non-GAAP operating loss(4)

  $ (68,660   $ (41,107   $ (37,425   $ (10,738   $ (10,349

Free cash flow(5)

    (54,920     (28,356     (17,496     (8,319     (17,000


 

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

 

     For the Year Ended
December 31,
     For the Three
Months Ended
March 31,
 
         2015              2016              2017              2017              2018      
                          (unaudited)  
     (in thousands)  

Cost of revenue

   $ 496      $ 856      $ 976      $ 226      $ 296  

Research and development

     1,120        1,265        2,391        491        581  

Sales and marketing

     1,705        2,209        3,789        837        1,045  

General and administrative

     3,699        3,782        4,601        1,468        1,588  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 7,020      $ 8,112      $ 11,757      $ 3,022      $ 3,510  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The amortization of acquired intangibles included above was as follows:

 

     For the Year Ended
December 31,
     For the Three
Months Ended
March 31,
 
         2015              2016              2017              2017              2018      
                          (unaudited)  
     (in thousands)  

Cost of revenue

   $ 2,512      $ 3,244      $ 3,717      $ 915      $ 898  

Research and development

                                  

Sales and marketing

     1,423        1,706        1,913        480        502  

General and administrative

     128        124        102        38        10  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization of acquired intangibles

   $ 4,063      $ 5,074      $ 5,732      $ 1,433      $ 1,410  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)  The goodwill impairment included above was $8.4 million and the restructuring charges were $0.8 million.
(3)  See Note 12 of the notes to our consolidated financial statements included in this prospectus for an explanation of the method used to calculate basic and diluted net loss per share and pro forma net loss per share attributable to common shareholders and the weighted-average number of shares used in the computation of the per share amounts.
(4)  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 the section of this prospectus titled “Selected Consolidated Financial Data—Use of Non-GAAP Financial Measures.”
(5)  We define free cash flow as net cash used in 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 the section of this prospectus titled “Selected Consolidated Financial Data—Use of Non-GAAP Financial Measures.”

 

     As of March 31, 2018  
     Actual     Pro
Forma(1)
     Pro Forma
As
Adjusted(2)
 
    

(unaudited)

 
Consolidated Balance Sheet Data:    (in thousands)  

Cash and cash equivalents

   $ 12,622     $ 12,622      $               

Working capital (excluding deferred revenue)

     17,315       17,315     

Total assets

     208,865       208,865     

Deferred revenue (current and noncurrent)

     103,878       103,878     

Credit facility (current and noncurrent)

     57,529       57,529     

Total liabilities

     245,174       245,174     

Convertible preferred stock

     370,854           

Total shareholders’ deficit

     (407,163     

 

(1)  Reflects (1) the conversion of all outstanding shares of preferred stock into an aggregate of 50,888,014 shares of common stock as of March 31, 2018, (2) the issuance of              shares of common stock issuable upon the automatic net exercise of warrants outstanding as of March 31, 2018, with a weighted average exercise price of $10.15 per share, immediately prior to the closing of this offering, assuming an initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and (3) the filing and effectiveness of our amended and restated articles of incorporation, in each case as if such conversion, issuance, filing, and effectiveness had occurred on March 31, 2018.
(2)  Reflects the pro forma adjustments described in footnote (1) above and the sale and issuance of shares of our common stock in this offering at the initial public offering price of $             per share after deducting the underwriting discount and commissions and estimated offering expenses payable by us, and the application of the net proceeds therefrom as described in the section of this prospectus titled “Use of Proceeds.”


 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this prospectus, including our consolidated financial statements and related notes, before deciding whether to purchase shares of our common stock. If any of the following risks is realized, our business, financial condition, results of operations, and prospects could be harmed. In that event, the price of our common stock could decline and you could lose part or all of your investment.

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 $77.8 million, $57.9 million, $64.1 million, and $15.2 million in 2015, 2016, 2017, and the three months ended March 31, 2018. We had an accumulated deficit of $427.3 million and a working capital deficit of $78.2 million as of March 31, 2018. 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.

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.

 

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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 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 $123.2 million in 2015, and $167.4 million in 2016 to $213.2 million in 2017. 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.

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

 

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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. 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, 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 depends 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 our technology platform. 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 described in the section of this prospectus titled “Business—Partners,” including integration partners, referral partners, Avalara Included Partners, 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 our fuel excise tax, lodging tax, communications tax, portions of our European VAT, and Brazil tax solutions. 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 earn-out 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;

 

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    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;

 

    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

 

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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.

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

 

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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 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.

In contrast, we expense 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. 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 adoption of cloud-based software solutions does not continue at the rate we anticipate, the market for these solutions may stop developing or may develop more slowly than we expect, either of which would harm our results of operations.

 

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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.

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 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 may be substantial and could harm our results of operations.

 

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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.

A number of states have considered or adopted laws that attempt to require out-of-state retailers to collect sales taxes on their behalf or to provide the jurisdiction with information enabling it to more easily collect use tax. On April 17, 2018, the U.S. Supreme Court heard oral arguments in a challenge to such legislation (South Dakota v. Wayfair, Inc.). There has also been consideration of federal legislation related to taxation of ecommerce sales, including the Marketplace Fairness Act, which, if enacted into law, would allow states 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.

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

We face risks of cyber-attacks, computer break-ins, theft, 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. 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 may be unable to anticipate these techniques or to implement adequate preventative measures. Malicious third parties may also conduct attacks designed to temporarily deny customers access to our solutions, such as denial of service attacks. 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

 

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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. 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.

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 platform disruptions, outages in our solutions, and degraded levels of performance due to human and software errors, file corruption, and 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.

 

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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.

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 operate both physical data centers supported by Equinix and cloud data centers supported by Amazon Web Services and Microsoft Azure. If any of these services becomes unavailable or otherwise is unable to serve our requirements, there could be a delay in activating a mirrored data center or our disaster recovery system.

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.

Our data center providers have no obligations 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 these providers on commercially reasonable terms, or if in the future we add additional data center facility providers, we may face additional costs or expenses or downtime, which could harm our business.

 

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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.

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.

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 2018, a third-party provider data center infrastructure failure resulted in a period of higher than usual latency and outages that impacted some customers. 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.

 

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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 in 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. Although most of the data that is provided to our services 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 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 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

 

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adequately or to destroy data securely may 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 may also become subject to similar data security and privacy protection requirements in foreign jurisdictions. For example, the European Union has adopted a General Data Protection Regulation (GDPR), which will take effect May 25, 2018. This regulation will require certain operational changes to be made by companies that receive or process personal data of residents of the EU and will include significant penalties for non-compliance. In addition, 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.

We may not be able to secure additional 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.

We intend to continue making substantial investments to fund our business and support our growth. In addition to the revenue we generate from our business, we may need to engage in equity or debt financings to provide necessary funds. 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 at an acceptable valuation, on favorable terms, when we require it, or at all. If we raise additional funds through future issuances of equity or convertible debt securities, our existing shareholders could suffer dilution, and any new equity securities we issue could have rights, preferences, and privileges senior to those of holders of our capital stock. Debt financing, if available, may involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which could reduce our operational flexibility or make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. 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. In addition, our inability to generate or obtain the financial resources needed may require us to delay, scale back, or eliminate some or all of our operations, which may harm our business, results of operations, financial condition, and prospects.

Debt service obligations, financial covenants, and other provisions of our credit agreement could adversely affect our financial condition and impair our ability to operate our business.

In November 2017, we amended our loan and security agreement with Silicon Valley Bank and Ally Bank, or the Lenders. The credit arrangements include a senior secured $30.0 million term loan facility and a $50.0 million revolving credit facility or, collectively, the Credit Facilities. The Credit Facilities are described in the section of this prospectus titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Borrowings.”

The Credit Facilities could have significant negative consequences to us, such as:

 

    requiring us to dedicate a substantial portion of our cash flow from operations to pay principal of, and interest on, our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, or other general corporate purposes, or to carry out other business strategies;

 

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    increasing our vulnerability to general adverse economic and industry conditions and limiting our ability to withstand competitive pressures;

 

    harming our results of operations, particularly if our interest expense increases due to an increase in our outstanding indebtedness or an increase in interest rates;

 

    harming our financial condition and impairing our ability to grow and operate our business;

 

    limiting our flexibility in planning for, or reacting to, changes in our business and future business opportunities; and

 

    limiting our ability to obtain additional financing for working capital, capital expenditures, and other business strategies.

Our ability to meet our debt obligations and other expenses will depend on our future performance, which will be affected by financial, business, economic, regulatory, and other factors, many of which we are unable to control. If our business does not perform as expected, or if we generate less than anticipated revenue or encounter significant unexpected costs, we may default under the Credit Facilities, which could require us to repay outstanding obligations, terminate the Credit Facilities, suffer cross-defaults in other contractual obligations, or pay significant damages. For example, for a period in early 2017, we were not in compliance with the minimum net billing covenant under the Credit Facilities and, as a result, we entered into amendments to the Credit Facilities to modify this covenant. If we are unable to satisfy our debt covenants in the future, or otherwise default under the Credit Facilities, our operations may be interrupted, and our ability to fund our operations or obligations, as well as our business, financial results, and financial condition, could suffer.

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

As of December 31, 2017, we had U.S. federal net operating loss carryforwards, or NOLs, of approximately $292.2 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 and in addition, may become subject to limitations in connection with this offering. 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.

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.

 

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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, and have recently acquired or developed 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;

 

    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;

 

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    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 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 may 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. 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 may claim infringement by us with respect to current or future solutions or other intellectual property rights. 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 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 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.

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

 

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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 distribute open source software as part of their software 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 we were to use open source software subject to such licenses, we could be required 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 this Offering and Our Common Stock

There has been no prior market for our common stock. An active market may not develop or be sustainable, and investors may not be able to resell their shares at or above the initial public offering price.

Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined through negotiations between the representatives of the underwriters and us and may vary from the market price of our common stock following the closing of this offering. An active or liquid market in our common stock may not develop following the closing of this offering or, if it does develop, it may not be sustainable. In the absence of an active trading market for our common stock, you may not be able to resell those shares at or above the initial public offering price or at the time you would like to sell. We cannot predict the prices at which our common stock will trade.

Our stock price may be volatile or may decline regardless of our operating performance, resulting in substantial losses for investors purchasing shares in this offering.

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;

 

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    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;

 

    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.

We may not be able to determine in the future that our internal controls over financial reporting are effective, and we may not receive an auditor attestation regarding our internal controls in the foreseeable future.

When we become a public company following this initial public offering, we will be required to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting for the first fiscal year beginning after the effective date of this offering. As discussed below in these risk factors, we have identified a significant deficiency in our internal controls over financial reporting as of December 31, 2017 and previously identified a material weakness in our internal controls over financial reporting as of December 31, 2016. The material weakness was remediated as of December 31, 2017. If we identify other material weaknesses in the future, our management will be unable to conclude that our internal controls over financial reporting are effective. Our independent registered public accounting firm will not be required to attest formally to the effectiveness of our internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until the later of the year following our first annual report required to be filed with the SEC or the date we are no longer an “emerging growth company” as defined in the JOBS Act. Accordingly, you will not be able to depend on any attestation concerning our internal controls over financial reporting from our independent registered public accountants for the foreseeable future.

 

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

Sales of a substantial number of shares of our common stock following the closing of this offering, particularly sales by our directors, executive officers, and significant shareholders, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that such sales may have on the prevailing market price of our common stock.

All of our executive officers, directors, and the holders of substantially all of our capital stock are subject to lock-up agreements or other contractual limitations that restrict their ability to transfer shares of our capital stock for 180 days from the date of this prospectus. Subject to certain exceptions, the lock-up agreements or other contractual limitations limit the number of shares of capital stock that may be sold immediately following this offering. We will have            outstanding shares of our common stock upon the closing of this offering, based on the number of shares outstanding as of March 31, 2018 and assuming the issuance of              shares of common stock upon the net exercise of warrants that will terminate if not exercised in connection with this offering. This includes the shares included in this offering, which may be sold in the public market immediately without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, except for any shares held by our affiliates as defined in Rule 144 under the Securities Act. Subject to certain limitations, as of                     , 2018, approximately              shares of our common stock will become eligible for sale upon expiration of the 180-day lock-up period. Goldman Sachs & Co. LLC and J.P. Morgan Securities LLC may, in their sole discretion, permit our shareholders who are subject to these lock-up agreements or other contractual limitations to sell shares prior to the expiration of the lock-up agreements or other contractual limitations.

In addition, as of March 31, 2018, there were 11,213,733 shares of common stock issuable upon exercise of outstanding options. Following the closing of this offering, we intend to file 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, applicable vesting requirements, and the lock-up agreements described above. See the section of this prospectus titled “Shares Eligible for Future Sale” for a more detailed description of sales that may occur in the future.

After the closing of this offering, the holders of an aggregate of              shares of our common stock, including shares of common stock issuable upon the conversion of our preferred stock and shares of common stock issuable upon the net exercise of warrants that will terminate if not exercised in connection with this offering, or their permitted transferees, will be 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.

Upon the completion of this offering, our directors, officers, and 5% or greater shareholders will beneficially own a majority of our outstanding voting stock and will be able to control shareholder decisions on very important matters.

Upon completion of this offering, the members of our Board of Directors, our executive officers, our 5% or greater shareholders, and their respective affiliates will beneficially own, in the aggregate, approximately     % of our outstanding voting stock. As a result, such shareholders will collectively have the power to control our management policy, fundamental corporate actions, including mergers, substantial acquisitions and dispositions, and election of directors to our Board of Directors. The concentrated voting power of these shareholders could have the effect of delaying or preventing a significant corporate transaction such as a sale, merger, or public offering of our capital stock. This

 

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influence over our affairs could, under some circumstances, be adverse to the interests of the other 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 will depend 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.

We may invest or spend the proceeds of this offering in ways with which you may not agree or in ways that may not yield a return.

Our management will have broad discretion to use our net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply our net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds we receive for working capital and other general corporate purposes. In addition to other investments in our growth strategies, we may also use a portion of the net proceeds that we receive to acquire or invest in complementary businesses, products, services, technologies, or other assets. As of the date of this prospectus, we have not entered into any agreements or commitments with respect to any specific acquisitions or investments at this time. We cannot specify with certainty all of the particular uses of the net proceeds that we will receive from this offering. Accordingly, we will have broad discretion in using these proceeds, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. Furthermore, the amount and timing of our actual expenditures will depend on numerous factors, including the cash used in or generated by our operations, the status of our development, the level of our sales and marketing activities, the pace of our international expansion plans, and our investments and acquisitions. The net proceeds may be used for purposes that do not increase the value of our business or increase the risks to you, which could cause the price of our stock to decline. Until net proceeds are used, they may be placed in investments that do not produce significant income or that may lose value.

We are an “emerging growth company” and intend to comply with the reduced disclosure and regulatory requirements, which may make our common stock less attractive to investors.

We qualify as an “emerging growth company” as defined in the JOBS Act, and we intend to take advantage of reduced disclosure and regulatory requirements that are otherwise generally applicable to public companies. As an emerging growth company:

 

    we are not required to obtain an attestation report from our independent registered public accounting firm on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act;

 

    we may present reduced disclosure regarding executive compensation in our periodic reports and proxy statements; and

 

    we are not required to hold nonbinding advisory shareholder votes on executive compensation or golden parachute arrangements.

 

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We may take advantage of these reduced requirements until we are no longer an “emerging growth company,” which will occur upon the earlier of (1) the last day of the fiscal year following the fifth anniversary of this offering, (2) the last day of the first fiscal year in which our annual gross revenue is $1.07 billion or more, (3) the date on which we have, during the previous rolling three-year period, issued more than $1.0 billion in non-convertible debt securities, and (4) the date on which we are deemed to be a “large accelerated filer” as defined in the Securities Exchange Act of 1934, as amended, or the Exchange Act. Investors may find our common stock less attractive or our company less comparable to certain other public companies because we will rely on these reduced requirements.

In addition, pursuant to the JOBS Act, as an “emerging growth company” we have elected to take advantage of an extended transition period for complying with new or revised accounting standards. This effectively permits us to delay adoption of certain accounting standards until those standards would otherwise apply to private companies. As a result, our consolidated financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective dates for new or revised accounting standards that are applicable to public companies, which may make our common stock less attractive to investors.

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 will be 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 will increase our legal and financial compliance costs, make some activities more difficult, time-consuming, or costly, and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company.” 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. We will likely need to hire additional employees or engage outside consultants to comply with these requirements, increasing our costs and expenses.

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.

We also expect that being a public company will make it more expensive for us to obtain director and officer liability insurance, and 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

 

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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.

As a result of disclosure of information in this prospectus and in filings required of a public company, our business and financial condition will become more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business and results of operations could suffer, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and harm our business, financial condition, and results of operations.

We have identified a significant deficiency, and have in the past experienced a material weakness, in our internal controls over financial reporting, and if we fail to remediate this significant deficiency or experience additional material weaknesses in the future or 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.

To date, we have not been required to complete our annual or quarterly financial reporting on the timeline that we will be required to meet to comply with our Exchange Act reporting obligations after this offering. Only in the last six months, have we been able to complete periodic financial reports on a timeline that would satisfy these obligations. We identified a significant deficiency in our internal controls over financial reporting as of December 31, 2017, which has not been remediated. The significant deficiency resulted from not having sufficient general information technology controls responsive to risk in the information technology environment. We are currently developing a remediation plan for this significant deficiency. We previously identified a material weakness in our internal controls over financial reporting as of December 31, 2016, which has been remediated. For discussion of the remediated material weakness, see the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Controls Over Financial Reporting.”

We cannot assure you that the measures we have taken to date, and are continuing to implement, will be sufficient to avoid potential future material weaknesses or significant deficiencies. Moreover, we cannot be certain that we will not in the future have additional significant deficiencies or material weaknesses in our internal controls over financial reporting, or that we will successfully remediate any that we find. In addition, because we are not yet subject to Exchange Act reporting obligations, 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 significant deficiency 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, possible defaults under our debt agreements, shareholder lawsuits, delisting of our stock, and general damage to our reputation.

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.

Upon the closing of this offering, our amended and restated articles of incorporation, in the form to be effective upon the closing of this offering, or our Articles, and our amended and restated bylaws, in the form to become effective upon the closing of this offering, or our Bylaws, will include a number of provisions that may have the effect of deterring takeovers or delaying or preventing changes in control

 

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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

 

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    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.

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. See the section of this prospectus titled “Description of Capital Stock.”

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 is restricted by our Credit Facilities and may be prohibited or limited by the terms of our current and future debt financing arrangements.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this prospectus, 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. You should read this prospectus and the documents that we have filed as exhibits to the registration statement of which this prospectus forms a part completely and with an understanding that 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 prospectus 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 of this prospectus, including the sections of this prospectus 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

 

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prospectus, 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 prospectus speak only as of the date of this prospectus. We undertake no obligation to update any forward-looking statements made in this prospectus to reflect events or circumstances after the date of this prospectus 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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INDUSTRY AND MARKET DATA

Unless otherwise indicated, information contained in this prospectus concerning our industry and the market in which we operate, including our market position, market opportunity, and market size, is based on information from various sources, on assumptions that we have made based on such data and other similar sources, and on our knowledge of the markets for our solutions. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such information. In addition, projections, assumptions, and estimates of our future performance and the future performance of the industry in which we operate is necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the section of this prospectus titled “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates, projections, and assumptions made by third parties and by us.

The following reports present data, research opinions, or viewpoints published by each of the respective publishers thereof and are not representations of fact. Such reports speak as of their respective original publication dates (and not as of the date of this prospectus), and the opinions expressed in such reports are subject to change without notice. References to websites where such reports can be found are inactive textual references only. We believe the information from the industry publication and other third-party sources included in this prospectus is reliable. The industry publications, reports, surveys, and forecasts containing the market and industry data cited in this prospectus are provided below:

 

    OECD (2016), “Revenue Statistics: Comparative tables (Edition 2016),” OECD Tax Statistics (database) (Accessed on March 15, 2018);

 

    S&P Global Market Intelligence; Capital IQ Company Screening Report (Accessed on March 1, 2018); and

 

    U.S. Census Bureau 2015 Statistics of U.S. Businesses.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of              shares of our common stock that we are selling in this offering will be approximately $        million, based upon the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us. If the underwriters exercise their option to purchase additional shares in full, we estimate that the net proceeds to us will be approximately $        million, after deducting the underwriting discount and estimated offering expenses payable by us.

Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share would increase (decrease) the net proceeds to us from this offering by approximately $        million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1,000,000 shares of common stock offered by us would increase (decrease) the net proceeds to us from this offering by approximately $        million, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

The principal purposes of this offering are to increase our financial flexibility, improve brand awareness, create a public market for our common stock, and facilitate our future access to the public capital markets. We intend to use the net proceeds that we receive from this offering for general corporate purposes, which we currently expect will include headcount expansion, continued investment in our sales and marketing efforts, product development, general and administrative matters, and working capital. We also intend to use a portion of the net proceeds from this offering to repay the outstanding balance under our revolving credit facility. As of March 31, 2018, we had $28.0 million outstanding under our revolving credit facility bearing interest at an annual rate of 6.50%. The revolving credit facility must be repaid in November 2019. We borrowed approximately $26.0 million under the revolving credit facility in the twelve months ended March 31, 2018 and used the proceeds for general corporate purposes, including working capital. In addition to other investments in our growth strategies, we may also use a portion of the net proceeds that we receive to acquire or invest in complementary businesses, products, services, technologies, or other assets. However, we have not entered into any agreements or commitments with respect to any specific acquisitions or investments at this time.

We cannot specify with certainty all of the particular uses of the net proceeds that we will receive from this offering and have not quantified or allocated any specific portion of the net proceeds or range of net proceeds to any particular purpose. Accordingly, we will have broad discretion in using these proceeds. Furthermore, the amount and timing of our actual expenditures will depend on numerous factors, including the cash used in or generated by our operations, the status of our development, the level of our sales and marketing activities, the pace of our international expansion plans, and our investments and acquisitions. Pending the use of proceeds as described above, we plan to invest the net proceeds that we receive in short-term and intermediate-term interest-bearing obligations, investment-grade investments, certificates of deposit, or direct or guaranteed obligations of the U.S. government. We cannot predict whether the invested proceeds will yield a favorable return.

 

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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. Our ability to pay dividends on our common stock is restricted by the Credit Facilities. 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.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2018:

 

    on an actual basis;

 

    on a pro forma basis, giving effect to (1) the conversion of all outstanding shares of preferred stock into an aggregate of 50,888,014 shares of common stock immediately prior to the closing of this offering, (2) the issuance of                  shares of common stock issuable upon the automatic net exercise of warrants outstanding as of March 31, 2018, with a weighted average exercise price of $10.15 per share, immediately prior to the closing of this offering, assuming an initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and (3) the filing and effectiveness of our amended and restated articles of incorporation, in each case as if such conversion, issuance, filing, and effectiveness had occurred on March 31, 2018; and

 

    on a pro forma as adjusted basis to reflect, in addition to the pro forma adjustments set forth above, our sale and issuance of              shares of common stock at the assumed initial public offering price of $        per share, which is the midpoint of the price range shown on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us, and the application of the net proceeds therefrom as described under “Use of Proceeds.”

You should read the following table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Description of Capital Stock,” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    As of March 31, 2018  
    Actual     Pro Forma     Pro Forma
As Adjusted
 
          (unaudited)        
   

(in thousands, except share

and per share data)

 

Cash and cash equivalents

  $ 12,622     $ 12,622     $  
 

 

 

   

 

 

   

 

 

 

Credit Facilities (current and noncurrent)

  $ 57,529     $ 57,529     $  

Convertible preferred stock, $0.0001 par value—106,346,091 shares authorized and 101,776,205 shares issued and outstanding, actual; no shares authorized, issued, and outstanding, pro forma and pro forma as adjusted

    370,854              

Total shareholders’ equity (deficit):

     

Preferred stock, $0.0001 par value—no shares authorized, issued and outstanding, actual and pro forma;              shares authorized, no shares issued and outstanding, pro forma as adjusted

                 

Common stock, $0.0001 par value—153,944,895 shares authorized and 6,264,422 shares issued and outstanding, actual;              shares authorized and              shares issued and outstanding, pro forma;              shares authorized and              shares issued and outstanding, pro forma as adjusted

    1      

Additional paid-in capital

    19,196      

Accumulated other comprehensive income (loss)

    941       941    

Accumulated deficit

    (427,301     (427,301  
 

 

 

   

 

 

   

 

 

 

Total shareholders’ equity (deficit)

    (407,163    
 

 

 

   

 

 

   

 

 

 

Total capitalization

  $ 21,220     $     $                   
 

 

 

   

 

 

   

 

 

 

 

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Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the amount of cash and cash equivalents, additional paid-in capital, total shareholders’ equity (deficit), and total capitalization by approximately $        million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1,000,000 shares of our common stock offered by us would increase (decrease) the amount of cash and cash equivalents, total shareholders’ equity (deficit), and total capitalization by approximately $        million, assuming that the assumed initial public offering price remains the same, after deducting the underwriting discount and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and the other terms of this offering determined at pricing.

Except as otherwise indicated, the above discussion and table are based on 57,152,436 shares of our common stock outstanding as of March 31, 2018, do not reflect any other issuance of our securities after that date, and exclude the following:

 

    11,213,733 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2018, with a weighted average exercise price of $10.99 per share;

 

    1,584,824 shares of common stock reserved for future issuance under our 2006 Plan;

 

    an estimated              shares of common stock reserved for future issuance under our 2018 Plan, to be effective on the date of this prospectus; and

 

    an estimated              shares of common stock reserved for future issuance under our ESPP, to be effective on the date of this prospectus.

 

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DILUTION

If you invest in our common stock in this offering, your ownership interest will be diluted immediately to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering. Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of our common stock in this offering and the pro forma as adjusted net tangible book value per share of our common stock immediately after the closing of this offering.

Our pro forma net tangible book value as of March 31, 2018 was $(121.2) million, or $2.10 per share, based on the number of shares of our common stock outstanding as of March 31, 2018, after giving effect to (1) the conversion of our preferred stock into 50,888,014 shares of common stock upon the effectiveness of the registration statement of which this prospectus forms a part and (2) the issuance of                  shares of common stock issuable upon the automatic net exercise of warrants outstanding as of March 31, 2018, with a weighted average exercise price of $10.15 per share, immediately prior to the closing of this offering, assuming an initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus.

After giving effect to the sale by us of              shares of common stock offered by in this offering at the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us and the application of the net proceeds therefrom as described under “Use of Proceeds,” our pro forma as adjusted net tangible book value as of March 31, 2018 would have been $        million, or $        per share. This represents an immediate increase in pro forma net tangible book value of $        per share to existing shareholders and an immediate dilution in pro forma net tangible book value of $        per share to investors in purchasing shares of our common stock in this offering at the assumed initial public offering price. The following table illustrates this dilution on a per share basis:

 

Assumed initial public offering price per share

      $               

Pro forma net tangible book value per share as of March 31, 2018, before giving effect to this offering

   $                  

Increase in net tangible book value per share attributable to new investors

     
  

 

 

    

Pro forma as adjusted net tangible book value per share after giving effect to this offering

     
     

 

 

 

Dilution in pro forma as adjusted net tangible book value per share to new investors in this offering

      $  
     

 

 

 

If the underwriters exercise their option to purchase additional shares of our common stock in full, our pro forma as adjusted net tangible book value will be $        million, or $        per share, and the dilution per share of common stock to new investors will be $        per share.

Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by $        per share and the dilution to new investors by $        per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting the underwriting discount and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1,000,000 shares of our common stock offered by us would increase (decrease) our pro forma as adjusted net tangible book value by approximately $        per share and the dilution to new investors by $        per share, assuming the assumed initial public offering price remains the same and after deducting the

 

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underwriting discount and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.

The following table presents, as of March 31, 2018, after giving effect to (1) the conversion of our preferred stock into 50,888,014 shares of common stock immediately prior to the closing of this offering and (2) the issuance of              shares of common stock issuable upon the automatic net exercise of warrants outstanding as of March 31, 2018, with a weighted average exercise price of $10.15 per share, immediately prior to the closing of this offering, assuming an initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus, the differences between existing shareholders and new investors purchasing shares of our common stock in this offering with respect to the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid to us, which includes net proceeds received from the issuance of our common stock and preferred stock, cash received from the exercise of stock options and warrants, or to be paid to us at the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, before deducting the underwriting discount and estimated offering expenses payable by us:

 

     Shares Purchased     Total Consideration     Average
Price Per
Share
 
     Number      Percent     Amount      Percent    

Existing shareholders

               $                            $               

New investors

            
  

 

 

    

 

 

   

 

 

    

 

 

   

Totals

        100     $        100  
  

 

 

    

 

 

   

 

 

    

 

 

   

Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the total consideration paid to us by new investors and total consideration paid to us by all shareholders by $        million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, before deducting the underwriting discount and estimated offering expenses payable by us.

Except as otherwise indicated, the above discussion and tables assume no exercise of the underwriters’ option to purchase additional shares of our common stock from us. If the underwriters exercise their option to purchase additional shares of our common stock in full, the number of shares held by existing shareholders would be             , or     % of the total number of shares of our common stock outstanding after this offering, and the number of shares held by new investors would increase to             , or     % of the total number of shares of our common stock outstanding after this offering.

Except as otherwise indicated, the above discussion and tables are based on 57,152,436 shares of common stock outstanding as of March 31, 2018, do not reflect any other issuance of our securities after that date, and exclude the following:

 

    11,213,733 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2018, with a weighted average exercise price of $10.99 per share;

 

    1,584,824 shares of common stock reserved for future issuance under our 2006 Plan;

 

    an estimated              shares of common stock reserved for future issuance under our 2018 Plan, to be effective on the date of this prospectus; and

 

    an estimated              shares of common stock reserved for future issuance under our ESPP, to be effective on the date of this prospectus.

 

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The shares reserved for future issuance under our 2018 Plan and our ESPP will be subject to automatic annual increases in accordance with the terms of the plans. To the extent that options are exercised, new options or restricted stock units are issued under our equity incentive plans, or we issue additional shares of common stock in the future, there will be further dilution to investors participating in this offering. In addition, we may choose to raise additional capital because of market conditions or strategic considerations, even if we believe that we have sufficient funds for our current or future operating plans. If we raise additional capital through the sale of equity or convertible debt securities, the issuance of these securities could result in further dilution to our shareholders.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

We derived the following selected consolidated statements of operations data for the years ended December 31, 2015, 2016, and 2017 and the selected consolidated balance sheet data as of December 31, 2016 and 2017 from audited consolidated financial statements appearing elsewhere in this prospectus. We derived the following selected consolidated statements of operations data for the three months ended March 31, 2017 and 2018 and the summary consolidated balance sheet data as of March 31, 2018 from unaudited consolidated financial statements appearing elsewhere in this prospectus. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, which include normal recurring adjustments, necessary for a fair presentation of the financial statements. Historical results are not necessarily indicative of the results that may be expected in the future and the results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the full year or any other period. 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 sections of this prospectus titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    For the Year Ended
December 31,
    For the
Three Months
Ended March 31,
 
    2015     2016     2017     2017     2018  
                      (unaudited)  
   

(in thousands, except per share data)

 

Consolidated Statements of Operations Data:

         

Revenue:

         

Subscription and returns

  $ 112,804     $ 154,967     $ 199,942     $ 45,848     $ 57,870  

Professional services and other

    10,354       12,459       13,217       3,117       3,507  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    123,158       167,426       213,159       48,965       61,377  

Cost of revenue(1):

         

Subscription and returns

    34,856       41,307       48,849       11,244       14,817  

Professional services and other

    5,889       7,206       9,128       2,319       2,692  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

    40,745       48,513       57,977       13,563       17,509  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    82,413       118,913       155,182       35,402       43,868  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

         

Research and development(1)

    29,787       32,848       41,264       9,682       12,619  

Sales and marketing(1)

    98,686       103,483       133,794       30,300       37,307  

General and administrative(1)

    33,683       36,875       34,286       10,613       9,211  

Goodwill impairment and restructuring charges(2)

                9,170              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    162,156       173,206       218,514       50,595       59,137  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (79,743     (54,293     (63,332     (15,193     (15,269
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    1,614       2,955       2,013       954       828  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (81,357     (57,248     (65,345     (16,147     (16,097
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for (benefit from) income taxes

    (3,593     640       (1,219     (149     (848
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (77,764   $ (57,888   $ (64,126   $ (15,998   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common shareholders—basic and diluted(3)

  $ (77,764   $ (57,888   $ (64,126   $ (15,998   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common shareholders—basic and diluted(3)

  $ (16.96   $ (10.15   $ (11.39   $ (2.97   $ (2.47
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares of common stock outstanding—basic and diluted(3)

    4,586       5,706       5,632       5,389       6,170  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss attributable to common shareholders—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Pro forma net loss per share attributable to common shareholders—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Pro forma weighted average shares of common stock outstanding—basic and diluted (unaudited)(3)

         
     

 

 

     

 

 

 

Non-GAAP Financial Data (unaudited)

         

Non-GAAP operating loss(4)

  $ (68,660   $ (41,107   $ (37,425   $ (10,738   $ (10,349

Free cash flow(5)

    (54,920     (28,356     (17,496     (8,319     (17,000

 

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

 

     For the Year Ended
December 31,
     For the
Three Months
Ended March 31,
 
         2015              2016              2017              2017              2018      
                         

(unaudited)

 
    

(in thousands)

 

Cost of revenue

   $ 496      $ 856      $ 976      $ 226      $ 296  

Research and development

     1,120        1,265        2,391        491        581  

Sales and marketing

     1,705        2,209        3,789        837        1,045  

General and administrative

     3,699        3,782        4,601        1,468        1,588  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 7,020      $ 8,112      $ 11,757      $ 3,022      $ 3,510  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The amortization of acquired intangibles included above was as follows:

 

     For the Year Ended
December 31,
     For the
Three Months
Ended March 31,
 
         2015              2016              2017              2017              2018      
                         

(unaudited)

 
    

(in thousands)

 

Cost of revenue

   $ 2,512      $ 3,244      $ 3,717      $ 915      $ 898  

Research and development

                                  

Sales and marketing

     1,423        1,706        1,913        480        502  

General and administrative

     128        124        102        38        10  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization of acquired intangibles

   $ 4,063      $ 5,074      $ 5,732      $ 1,433      $ 1,410  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)  The goodwill impairment included above was $8.4 million and the restructuring charges were $0.8 million.
(3)  See Note 12 of the notes to our consolidated financial statements included in this prospectus for an explanation of the method used to calculate basic and diluted net loss per share and pro forma net loss per share attributable to common shareholders and the weighted-average number of shares used in the computation of the per share amounts.
(4)  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 GAAP, see “—Use of Non-GAAP Financial Measures” below in this section.
(5)  We define free cash flow as net cash used in 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 of Non-GAAP Financial Measures” below in this section.

 

     As of December 31,     As of March 31,  
       2016         2017         2018    
                 (unaudited)  
    

(in thousands)

 

Consolidated Balance Sheet Data:

      

Cash and cash equivalents

   $ 20,230     $ 14,075     $ 12,622  

Working capital (excluding deferred revenue)

     13,341       7,998       17,315  

Total assets

     182,514       178,812       208,865  

Deferred revenue (current and noncurrent)

     72,480       92,231       103,878  

Credit facility (current and noncurrent)

     24,683       39,465       57,529  

Total liabilities

     154,754       201,483       245,174  

Convertible preferred stock

     370,921       370,921       370,854  

Total shareholders’ deficit

     (343,161     (393,592     (407,163

 

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Use of Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we have disclosed non-GAAP operating loss and free cash flow, which are non-GAAP financial measures. We have provided a reconciliation of each non-GAAP financial measure used in this prospectus to its most directly comparable GAAP financial measure.

 

    Non-GAAP operating loss: Non-GAAP operating loss is a non-GAAP financial measure used by our management and Board of Directors in measuring trends and financial performance. We consider non-GAAP operating loss to be an important measure because we believe it provides useful information in understanding and evaluating our operating results period-over-period without the impact of certain expenses that do not directly correlate to our operating performance and that vary significantly from period to period. Non-GAAP operating loss excludes stock-based compensation expense, amortization expense from acquired intangible assets, and goodwill impairments from GAAP operating loss.

 

    Free cash flow: Free cash flow is a non-GAAP financial measure used by our management and Board of Directors in facilitating period-to-period comparisons of liquidity. We consider free cash flow to be an important measure because it measures the amount of cash we generate from our operations after our capital expenditures and reflects changes in working capital. We use free cash flow in conjunction with traditional GAAP measures as part of our overall assessment of liquidity. Free cash flow is the total of net cash used in operating activities and purchases of property and equipment.

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. We believe that non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our results, prospects, and liquidity and in comparing our financial results to those of other companies.

Our definitions of non-GAAP operating loss and free cash flow 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 operating loss and free cash flow should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP.

We provide investors and other users of our financial information reconciliations of non-GAAP operating loss and free cash flow to the related GAAP financial measures, operating loss and net cash used in operating activities. 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 operating loss and free cash flow in conjunction with the related GAAP financial measure.

 

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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,
    For the
Three Months
Ended March 31,
 
         2015             2016             2017             2017             2018      
    

(unaudited)

(in thousands)

 

Non-GAAP Financial Measures:

          

Non-GAAP operating loss

   $ (68,660   $ (41,107   $ (37,425   $ (10,738   $ (10,349

Free cash flow

     (54,920     (28,356     (17,496     (8,319     (17,000

Reconciliation of Non-GAAP Financial Measures:

          

Non-GAAP Operating Loss:

          

Operating loss

   $ (79,743   $ (54,293   $ (63,332   $ (15,193   $ (15,269

Stock-based compensation expense

     7,020       8,112       11,757       3,022       3,510  

Amortization of acquired intangibles

     4,063       5,074       5,732       1,433       1,410  

Goodwill impairment

                 8,418              
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP Operating Loss

   $ (68,660   $ (41,107   $ (37,425   $ (10,738   $ (10,349
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free Cash Flow:

          

Net cash used in operating activities

   $ (47,008   $ (21,696   $ (3,541   $ (7,282   $ (13,375

Purchases of property and equipment

     (7,912     (6,660     (13,955     (1,037     (3,625
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ (54,920   $ (28,356   $ (17,496  

 

$

 

(8,319

 

 

 

$

 

(17,000

 

  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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 prospectus. 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 prospectus, particularly in the sections of this prospectus 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 tax requirements for transactions 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. Businesses that use our solutions can allocate fewer personnel to manage transaction tax compliance and focus their efforts on core business operations. Businesses across industries and of all sizes, ranging from small businesses to Fortune 100 companies, use our solutions.

We generated revenue of $123.2 million, $167.4 million, $213.2 million, and $61.4 million in 2015, 2016, 2017, and the three months ended March 31, 2018, respectively. We derive most of our revenue from subscriptions to our solutions. Subscription and returns revenue accounted for 92%, 93%, 94%, and 94% of our total revenue during 2015, 2016, 2017, and the three months ended March 31, 2018, respectively. We also derive revenue from providing professional services, which accounted for 8%, 7%, 6%, and 6% of our total revenue during 2015, 2016, 2017, and the three months ended March 31, 2018, respectively. In 2017, we generated approximately 95% of our revenue in North America, but we are expanding our international presence to support transaction tax compliance in Europe, South America, and Asia. During the first quarter of 2018, we generated approximately 94% of our revenue in North America.

Our revenue churn rate for each of 2016 and 2017 was less than 5%. We calculate our revenue churn rate by measuring the revenue contribution associated with billing accounts that cancel all of their product and service agreements with us over the measurement year. This cancelled revenue contribution for each such billing account is calculated as the revenue recognized for such billing accounts over the trailing four quarters prior to the quarter in which such billing account cancelled its product and service agreements. We then divide this cancelled revenue contribution by our total annual revenue recognized for the measurement year to calculate our revenue churn rate. Our calculation of revenue churn rate 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 legacy billing systems, primarily related to past acquisitions.

We sell our solutions primarily through our sales force, which focuses on selling to qualified leads provided by our marketing efforts, and network of referral partners. The majority of these sales, to new and existing customers, are direct and are conducted via telephone, requiring minimal in-person interactions with customer prospects. In some cases, particularly for customers with larger and more complex needs, we conduct in-person sales. In addition, our marketing investments and activities generate interest from large numbers of small businesses that also are burdened by transaction tax

 

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compliance requirements. Because these customers typically purchase smaller plans at lower price points, we have established an online marketplace through which these customers purchase and configure their solutions without the involvement of our primary selling or customer onboarding teams. Additionally, we have relationships with business application providers that, in some cases, purchase functionality from us for use by their customers, many of which are small businesses.

We launched our first solution, AvaTax, in 2004, and have continued investing organically and through acquisitions to provide best-in-class solutions and to expand our market opportunity. We devote substantial resources to continuously improve the Avalara Compliance Cloud, add innovative new features and functionalities, build technology to support new content types, and improve the user experience for our solutions. We have also made, and expect to continue to make, significant investments to acquire accurate, relevant content and expertise to best serve the transaction tax compliance needs of customers.

 

LOGO

We focus on expanding and maintaining our partner network, which has been an essential part of our growth. As transactions are executed in our customers’ business applications, the Avalara Compliance Cloud performs a series of functions to deliver tax compliance functionality in real time. We enable this through our more than 600 pre-built integrations that are designed to link our platform to business applications including accounting, ERP, ecommerce, POS, recurring billing, and CRM systems. 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 business 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.

We also work with referral partners who 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

 

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quality new customer leads. In 2015, 2016, 2017, and for the three months ended March 31, 2018, commissions earned by our partners amounted to approximately 7%, 6%, 7%, and 6% of total revenue, respectively, and was recorded as a component of sales and marketing expense.

The growth of our business and our future success depends on many factors, including our ability to continue to expand our customer base and the solutions used by existing customers, innovate and broaden our solutions, integrate acquisitions, and expand our content types and geographic scope. While these areas represent significant opportunities for us, we also face significant risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results. We anticipate that we will continue to expand our operations and headcount. The expected addition of new personnel and the investments that we anticipate will be necessary to manage our anticipated growth will make it more difficult for us to achieve or maintain profitability. Many of these investments will occur in advance of experiencing any direct benefit and will make it difficult to determine if we are allocating our resources efficiently.

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 below under “Key Components of Consolidated Statements of Operations,” and we discuss other key business metrics below.

We disclose the number of core customers as of each quarter-end beginning with June 30, 2016 and our net revenue retention rate for each quarter beginning with the second quarter of 2016. Our accounting and financial reporting systems and processes in place prior to the second quarter of 2016 were not configured to allow us to calculate our core customer count or net revenue retention rate on a comparable basis.

 

                                                                                                                                                                                                       
    June 30,
2016
  September 30,
2016
  December 31,
2016
  March 31,
2017
  June 30,
2017
  September 30,
2017
  December 31,
2017
  March 31,
2018

Number of core customers (as of end of period)

  5,660   5,990   6,250   6,650   6,970   7,250   7,490   7,760

Net revenue retention rate

  107%   106%   104%   109%   106%   107%   105%   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, 2016 and 2017, and March 31, 2018, we had approximately 6,250, 7,490, and 7,760 core customers, respectively, representing less than half of our total number of customers. In 2017, our core customers represented more than 85% 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.

 

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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.

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 107% on average for the four quarters ended March 31, 2018.

Key Components of Consolidated Statements of Operations

Revenue

We generate revenue from two sources: (1) subscriptions and returns; and (2) professional services. Subscription and returns revenue is driven primarily by the acquisition of customers, customer renewals, and additional product offerings purchased by existing customers. Revenue from subscriptions and returns comprised approximately 92%, 93%, 94%, and 94% of our revenue for 2015, 2016, and 2017, and the three months ended March 31, 2018, 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 who purchase tax return preparation can purchase on a subscription basis for an allotted number of returns or on a per filing basis.

Our subscription contracts are generally non-cancelable after the first 60 days of the contract term. We reserve for estimated cancellations based on actual history. We generally invoice our subscription plan customers for the initial term at contract signing and in advance for renewals. Our

 

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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. 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 recognize revenue for returns purchased on a per filing basis when the return is filed. Since our customers typically file tax returns on a monthly or quarterly basis continuously through the year, the pattern of revenue recognition is similar regardless of the selling arrangement.

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 or time and materials basis, and we recognize 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 personnel and 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, and tax content maintenance. 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.

Sales and Marketing.    Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including salaries, benefits, bonuses, commissions to our sales personnel, stock-based compensation, 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.

Integration and referral partner commissions are also included in sales and marketing expenses. We expense commissions as incurred rather than recognizing them over the subscription period. Our partner commission expense has historically been, and will continue to be, impacted by many factors, including the proportion of new and renewal revenues, the nature of the partner relationship, and the sales mix among similar types of 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. For 2015, 2016, 2017, and the three months ended March 31, 2018, we incurred $9.0 million, $9.9 million, $14.3 million, and $3.9 million in commission expense to partners, respectively.

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.

Research and Development.    Research and development expenses consist primarily of personnel and 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 contractors. Research and development costs, other than software development expenses qualifying for

 

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capitalization, are expensed as incurred. For the years ended December 31, 2015, 2016, and 2017, and the three months ended March 31, 2018, $0.7 million, $0.8 million, $1.0 million, and $0.3 million of software development costs were capitalized, respectively. Capitalized software development costs consist primarily of employee-related costs. Research and development expenses also includes allocated costs for certain information technology and facility expenses.

We devote substantial resources to enhancing 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.

General and Administrative.    General and administrative expenses consist primarily of personnel and related expenses for administrative, finance, information technology, legal, and human resources staff, including salaries, benefits, bonuses, and stock-based compensation, 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. 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, interest expense, fair value expense of common and preferred stock warrants, quarterly remeasurement of contingent consideration, realized foreign currency changes and other nonoperating gains and losses. Interest expense results from interest payments on our borrowings, which are based on a floating per annum rate at specified percentages above the prime rate. Fair value expense of preferred stock warrants consisted of changes in the fair value during the period, which include preferred stock warrants and other similar instruments that contain down-round provisions. During 2016, all remaining preferred stock warrants were exercised.

Results of Operations

The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.

We have pursued and expect to continue to pursue acquisitions to increase the scope of our product offerings. The comparability of periods covered by our financial statements can be, and may be in the future, impacted by acquisitions. In February 2015, we acquired a U.S. business that provides comprehensive, cloud-based, automated software solutions for lodging tax compliance. In June 2015, we acquired a business in Belgium that was a developer of VAT compliance software and compliance services for the European market. Also in June 2015, we acquired a U.S. business that provides automated software solutions for telecommunications sales tax compliance. In September 2016, we acquired a business in Brazil that provides certain tax-related compliance solutions and content for the Brazilian market.

 

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

 

    For the Year Ended December 31,     For the Three Months
Ended March 31,
 
    2015     2016     2017     2017     2018  
                     

(unaudited)

 
   

(in thousands)

 

Revenue:

         

Subscription and returns

  $ 112,804     $ 154,967     $ 199,942     $ 45,848     $ 57,870  

Professional services and other

    10,354       12,459       13,217       3,117       3,507  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    123,158       167,426       213,159       48,965       61,377  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

         

Subscription and returns

    34,856       41,307       48,849       11,244       14,817  

Professional services and other

    5,889       7,206       9,128       2,319       2,692  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue(1)

    40,745       48,513       57,977       13,563       17,509  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    82,413       118,913       155,182       35,402       43,868  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

         

Research and development(1)

    29,787       32,848       41,264       9,682       12,619  

Sales and marketing(1)

    98,686       103,483       133,794       30,300       37,307  

General and administrative(1)

    33,683       36,875       34,286       10,613       9,211  

Goodwill impairment and restructuring charges(2)

                9,170              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    162,156       173,206       218,514       50,595       59,137  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (79,743     (54,293     (63,332     (15,193     (15,269
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    1,614       2,955       2,013       954       828  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (81,357     (57,248     (65,345     (16,147     (16,097

Provision for (benefit from) income taxes

    (3,593     640       (1,219     (149     (848
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (77,764   $ (57,888   $ (64,126   $ (15,998   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

     For the Year Ended December 31,      For the Three Months
Ended March 31,
 
         2015              2016              2017              2017              2018      
                         

(unaudited)

 
    

(in thousands)

 

Cost of revenue

   $ 496      $ 856      $ 976      $ 226      $ 296  

Research and development

     1,120        1,265        2,391        491        581  

Sales and marketing

     1,705        2,209        3,789        837        1,045  

General and administrative

     3,699        3,782        4,601        1,468        1,588  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 7,020      $ 8,112      $ 11,757      $ 3,022      $ 3,510  

The amortization of acquired intangibles included above was as follows:

 

     For the Year Ended December 31,      For the Three Months
Ended March 31,
 
         2015              2016              2017              2017              2018      
                         

(unaudited)

 
    

(in thousands)

 

Cost of revenue

   $ 2,512      $ 3,244      $ 3,717      $ 915      $ 898  

Research and development

                                  

Sales and marketing

     1,423        1,706        1,913        480        502  

General and administrative

     128        124        102        38        10  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization of acquired intangibles

   $ 4,063      $ 5,074      $ 5,732      $ 1,433      $ 1,410  

 

(2) The goodwill impairment included above was $8.4 million and the restructuring charges were $0.8 million.

 

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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,     For the Three Months
Ended March 31,
 
    2015     2016     2017     2017     2018  
                      (unaudited)  

Revenue:

         

Subscription and returns

    92     93     94     94     94

Professional services and other

    8     7     6     6     6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    100     100     100     100     100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

         

Subscription and returns

    28     25     23     23     24

Professional services and other

    5     4     4     5     4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

    33     29     27     28     29
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    67     71     73     72     71
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

         

Research and development

    24     20     19     20     21

Sales and marketing

    80     62     63     62     61

General and administrative

    27     22     16     22     15

Goodwill impairment and restructuring charges

    0     0     4     0     0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    132     103     103     103     96
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (65 )%      (32 )%      (30 )%      (31 )%      (25 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other (income) expense:

         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    1     2     1     (2 )%      (1 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (66 )%      (34 )%      (31 )%      (33 )%      (26 )% 

Provision for (benefit from) income taxes

    (3 )%      0     (1 )%      0     (1 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (63 )%      (35 )%      (30 )%      (33 )%      (25 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2018

Revenue

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount      Percentage  
     (dollars in thousands)  

Revenue:

           

Subscription and returns

   $ 45,848      $ 57,870      $ 12,022        26

Professional services and other

     3,117        3,507        390        13
  

 

 

    

 

 

    

 

 

    

Total revenue

   $ 48,965      $ 61,377      $ 12,412        25
  

 

 

    

 

 

    

 

 

    

Total revenue for the three months ended March 31, 2018 increased by $12.4 million, or 25%, compared to the three months ended March 31, 2017. Subscription and returns revenue for the three months ended March 31, 2018 increased by $12.0 million, or 26%, compared to the three months ended March 31, 2017. Growth in total revenue was due primarily to increased demand for our products and services from new and existing customers. Of the increase in total revenue for the three months ended March 31, 2018 compared to the same period of 2017, approximately $4.1 million was attributable to existing customers and approximately $8.3 million was attributable to new customers.

 

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Cost of Revenue

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount      Percentage  
     (dollars in thousands)  

Cost of revenue

           

Subscription and returns

   $ 11,244      $ 14,817      $ 3,573        32

Professional services and other

     2,319        2,692        373        16
  

 

 

    

 

 

    

 

 

    

Total cost of revenue

   $ 13,563      $ 17,509      $ 3,946        29
  

 

 

    

 

 

    

 

 

    

Cost of revenue for the three months ended March 31, 2018 increased by $3.9 million, or 29%, compared to the three months ended March 31, 2017. The increase in cost of revenue in absolute dollars was due primarily to an increase of $2.4 million in employee-related costs from higher headcount, an increase of $0.7 million in software hosting costs, and an increase of $0.7 million in allocated overhead cost. Our cost of revenue headcount increased approximately 18% from the first quarter of 2017 to the first quarter of 2018 due to our continued growth to support our solutions and expand content. 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 the first quarter of 2018 due primarily to the costs associated with our new corporate headquarters in Seattle, Washington. We moved into these facilities in February 2018.

Gross Profit

 

     For the Three Months
Ended March 31,
    Change  
     2017     2018     Amount      Percentage  
     (dollars in thousands)  

Gross profit

         

Subscription and returns

   $ 34,604     $ 43,053     $ 8,449        24

Professional services and other

     798       815       17        2
  

 

 

   

 

 

   

 

 

    

Total gross profit

   $ 35,402     $ 43,868     $ 8,466        24
  

 

 

   

 

 

   

 

 

    

Gross margin

         

Subscription and returns

     75     74     

Professional services and other

     26     23     
  

 

 

   

 

 

      

Total gross margin

     72     71     
  

 

 

   

 

 

      

Total gross profit for the three months ended March 31, 2018 increased $8.5 million, or 24%, compared to the three months ended March 31, 2017. Total gross margin was 71% for the three months ended March 31, 2018 compared to 72% for the same period of 2017. This decrease was due primarily to higher software hosting costs and allocated overhead costs.

Research and Development

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount      Percentage  
     (dollars in thousands)  

Research and development

   $ 9,682      $ 12,619      $ 2,937        30

 

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Research and development expenses for the three months ended March 31, 2018 increased $2.9 million, or 30%, compared to the three months ended March 31, 2017. The increase was due primarily to an increase of $2.3 million in employee-related costs from higher headcount and an increase of $0.4 million in allocated overhead cost. Research and development headcount increased approximately 11% from the first quarter of 2017 to the first quarter of 2018 due primarily to increasing headcount in our U.S. operations as we continue to enhance existing solutions.

Sales and Marketing

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount      Percentage  
     (dollars in thousands)  

Sales and marketing

   $ 30,300      $ 37,307      $ 7,007        23

Sales and marketing expenses for the three months ended March 31, 2018 increased $7.0 million, or 23%, compared to the three months ended March 31, 2017. The increase was due primarily to $6.1 million in employee-related costs (including $3.0 million increase in sales commissions expense), an increase of $1.3 million for partner commission expense, and an increase of $0.8 million in allocated overhead cost offset, in part, by a decrease of $1.4 million for marketing campaign expenses. Sales and marketing headcount increased approximately 23% from the first quarter of 2017 to the first quarter of 2018. Sales commissions expense increased due to strong sales-related activity. Partner commission expense increased due primarily to higher revenues and an increase in the proportion of sales eligible for partner commissions. Marketing campaign expenses decreased due to a reduction in our discretionary spending on advertising and marketing in the first quarter of 2018 compared to the first quarter of 2017.

General and Administrative

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount      Percentage  
     (dollars in thousands)  

General and administrative

   $ 10,613      $ 9,211      $ (1,402      (13 )% 

General and administrative expenses for the three months ended March 31, 2018 decreased $1.4 million, or 13%, compared to the three months ended March 31, 2017. The decrease was due primarily to a $1.1 million decrease in professional services expenses. Professional services expenses were lower due primarily to expenses incurred in the prior year’s quarter for legal and accounting fees related to our preliminary activities related to our anticipated initial public offering of our common stock, or IPO. In the first quarter of 2018, IPO-related costs were recorded to deferred financing costs.

Total Other (Income) Expense, Net

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount  
     (dollars in thousands)  

Other (income) expense, net

        

Interest income

   $ (10    $ (36    $ (26

Interest expense

     528        894        366  

Other (income) expense, net

     436        (30      (466
  

 

 

    

 

 

    

 

 

 

Total other (income) expense, net

   $ 954      $ 828      $ (126
  

 

 

    

 

 

    

 

 

 

 

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Total other (income) expense, net for the three months ended March 31, 2018 decreased $0.1 million compared to the three months ended March 31, 2017 due primarily to the change in the fair value of earnout liabilities, partially offset by higher interest expense on borrowings under our credit facility during the first quarter of 2018.

Provision for (Benefit from) Income Taxes

 

     For the Three Months
Ended March 31,
     Change  
     2017      2018      Amount  
     (dollars in thousands)  

Provision for (benefit from) income taxes

   $ (149    $ (848    $ (699

Benefit from income taxes for the three months ended March 31, 2018 increased by $0.7 million compared to the three months ended March 31, 2017. The effective income tax rate was a benefit of 0.9% and 5.3% for the three months ended March 31, 2017 and 2018, 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 three months ended March 31, 2018. We continue to analyze changes under The Tax Cut and Jobs Act and anticipate recording any additional resulting adjustments within the measurement period.

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 the first quarter of 2018. 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, 2016 Compared to Year Ended December 31, 2017

Revenue

 

     For the Year Ended
December 31,
     Change  
     2016      2017      Amount      Percentage  
     (dollars in thousands)  

Revenue:

           

Subscription and returns

   $ 154,967      $ 199,942      $ 44,975        29

Professional services and other

     12,459        13,217        758        6
  

 

 

    

 

 

    

 

 

    

Total revenue

   $ 167,426      $ 213,159      $ 45,733        27
  

 

 

    

 

 

    

 

 

    

Total revenue increased by $45.7 million, or 27%, from 2016 to 2017. Subscription and returns revenue increased by $45.0 million, or 29%, from 2016 to 2017. Growth in total revenue was due primarily to increased demand for our products and services from new and existing customers. In September 2016, we acquired a business in Brazil that provides transaction tax compliance solutions and content. Excluding the impact of the Brazil acquisition, revenue increased by $42.3 million, or 25%, from 2016 to 2017. Of this increase, $23.7 million was attributable to existing customers and $18.6 million was attributable to new customers.

 

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Professional services and other revenue increased $0.8 million, or 6%, from 2016 to 2017 due primarily to the Brazil acquisition.

Cost of Revenue

 

     For the Year Ended
December 31,
     Change  
     2016      2017      Amount      Percentage  
     (dollars in thousands)  

Cost of revenue

           

Subscription and returns

   $ 41,307      $ 48,849      $ 7,542        18

Professional services and other

     7,206        9,128        1,922        27
  

 

 

    

 

 

    

 

 

    

Total cost of revenue

   $ 48,513      $ 57,977      $ 9,464        20
  

 

 

    

 

 

    

 

 

    

Total cost of revenue increased $9.5 million, or 20%, from 2016 to 2017. The increase in cost of revenue in absolute dollars was due primarily to an increase of $6.4 million in employee-related costs due to our September 2016 acquisition in Brazil and higher headcount, an increase of $1.0 million in software hosting costs, $0.9 million in higher depreciation and amortization expense, and an increase of $0.6 million in outside services expense. Our cost of revenue headcount increased approximately 19% from December 31, 2016 to December 31, 2017 due to our continued growth to support our solutions and expand content. Software hosting costs have increased due primarily to higher transaction volumes. Amortization expense increased due primarily to intangible assets acquired as part of the Brazil acquisition. As we expanded our product offerings in Europe in 2017, our outside services expenses increased as we temporarily engaged third parties to assist with certain projects.

Gross Profit

 

     For the Year Ended
December 31,
    Change  
     2016     2017     Amount     Percentage  
     (dollars in thousands)  

Gross profit

        

Subscription and returns

   $ 113,660     $ 151,093     $ 37,433       33

Professional services and other

     5,253       4,089       (1,164     (22 )% 
  

 

 

   

 

 

   

 

 

   

Total gross profit

   $ 118,913     $ 155,182     $ 36,269       31
  

 

 

   

 

 

   

 

 

   

Gross margin

        

Subscription and returns

     73     76    

Professional services and other

     42     31    
  

 

 

   

 

 

     

Total gross margin

     71     73    
  

 

 

   

 

 

     

Gross profit improved $36.3 million, or 31%, from 2016 to 2017. Our total gross margin improved from 71% in 2016 to 73% in 2017. The increase in gross margin was due primarily to increased automation of compliance processes and growing revenue relative to fixed costs of operations.

Research and Development

 

     For the Year Ended
December 31,
     Change  
     2016      2017      Amount      Percentage  
     (dollars in thousands)  

Research and development

   $ 32,848      $ 41,264      $ 8,416        26

 

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Research and development expenses increased $8.4 million, or 26%, from 2016 to 2017. The increase was due primarily to a $6.8 million increase in employee-related costs due to our September 2016 acquisition in Brazil and higher headcount, a $1.0 million increase in allocated overhead cost, and a $0.2 million increase in outside services expense. Research and development headcount increased approximately 18% from December 31, 2016 to December 31, 2017 due primarily to increasing headcount in our U.S operations as we continue to enhance existing solutions. Allocated overhead consists primarily of facility expenses and shared information technology expenses.

Sales and Marketing

 

     For the Year Ended
December 31,
     Change  
     2016      2017      Amount      Percentage  
     (dollars in thousands)  

Sales and marketing

   $ 103,483      $ 133,794      $ 30,311        29

Sales and marketing expenses increased $30.3 million, or 29%, from 2016 to 2017. The increase was due primarily to an increase of $20.3 million in employee-related costs from higher headcount, an increase of $4.9 million for marketing campaign and professional services expenses, and an increase of $4.4 million for partner commissions expense. During 2017, we engaged in a salesforce reorganization and continued to expand our sales force and marketing teams as we seek to accelerate sales growth and new customer acquisition. Sales and marketing headcount increased approximately 30% from December 31, 2016 to December 31, 2017. In pursuing our strategy to accelerate sales growth, we also increased marketing spending primarily on demand generation and customer base marketing activities in 2017. Partner commission expense increased by 44%, from $9.9 million to $14.3 million, due primarily to an increase in the proportion of sales eligible for partner commissions.

General and Administrative

 

     For the Year Ended
December 31,
     Change  
     2016      2017      Amount      Percentage  
     (dollars in thousands)  

General and administrative

   $ 36,875      $ 34,286      $ (2,589      (7 )% 

General and administrative expenses decreased $2.6 million, or 7%, from 2016 to 2017. The decrease was due primarily to a $3.2 million reduction in bad debt expense, a $1.5 million non-recurring charge to terminate a contract in 2016, lower depreciation of $0.7 million, and $0.7 million lower allocated overhead costs, partially offset by a $2.8 million increase in employee-related costs from higher headcount. Bad debt expense decreased due primarily to improved cash collections from our customers compared to the prior year. In 2016, we agreed to terminate a long-term software development agreement with a vendor for $1.5 million. Depreciation expenses decreased due to asset disposals for our Bainbridge Island and Harrisburg offices, which were downsized in 2016. Allocated overhead consists primarily of facility expenses and shared information technology expenses. General and administrative headcount increased approximately 21% from December 31, 2016 to December 31, 2017 as we expanded our support services personnel to effectively handle growth.

Goodwill Impairment and Restructuring Charges

Goodwill impairment and restructuring charges for 2017 were $9.2 million. There were no similar charges in 2016. A goodwill impairment charge of $8.4 million was recorded related to our Brazilian

 

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operations. See Note 6 of the Notes to Consolidated Financial Statements. Separately, we also incurred restructuring charges of $0.8 million in 2017 associated with our plan to close 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  
     2016     2017     Amount  
     (dollars in thousands)  

Other (income) expense, net

      

Interest income

   $ (18   $ (77   $ (59

Interest expense

     2,301       2,585       284  

Change in fair value of preferred stock warrants

     (28     —         28  

Other (income) expense, net

     700       (495     (1,195
  

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

   $ 2,955     $ 2,013     $ (942
  

 

 

   

 

 

   

 

 

 

Total other (income) expense, net decreased by $0.9 million from 2016 to 2017 due primarily to the change in the fair value of earnout liabilities, partially offset by higher interest expense on borrowings under our credit facility during 2017. We estimate the fair value of earnout liabilities related to acquisitions quarterly. The $1.0 million reduction in the fair value of earnout liabilities resulted from income of $0.7 million in 2017, compared to $0.3 million of expense in 2016. Of the $0.7 million recognized in income, $0.4 million was attributable to the reduction in fair value of the VAT Applications earnout, and $0.3 million to the reduction in the fair value of the earnout for our acquisition in Brazil. Interest expense increased 12% in 2017 compared to 2016 due primarily to higher debt levels. As of December 31, 2017, we had variable rate borrowings of $30.0 million outstanding under the term loan facility and $10.0 million under the revolving credit facility bearing interest at an annual rate of 6.75% and 6.25%, respectively.

Provision for (Benefit from) Income Taxes

 

     For the Year Ended
December 31,
    Change  
     2016      2017     Amount  
     (dollars in thousands)  

Provision for (benefit from) income taxes

   $ 640      $ (1,219   $ (1,859

Provision for income taxes decreased by $1.9 million from 2016 to 2017 due primarily to net operating losses in Brazil. In 2017, a deferred tax benefit was recorded for losses incurred up to the amount of our deferred tax liability attributable to our Brazil operations. Upon extinguishment of the deferred tax liability, additional net operating losses resulted in a deferred tax asset for which we have established a full valuation allowance.

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 2017. 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 reported a net deferred tax liability as of December 31, 2016 and

 

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2017 of $3.2 million and $1.9 million, respectively. We expect to maintain a full valuation allowance for the foreseeable future.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2016

Revenue

 

     For the Year Ended
December 31,
     Change  
     2015      2016      Amount      Percentage  
     (dollars in thousands)  

Revenue:

           

Subscription and returns

   $ 112,804      $ 154,967      $ 42,163        37

Professional services and other

     10,354        12,459        2,105        20
  

 

 

    

 

 

    

 

 

    

Total revenue

   $ 123,158      $ 167,426      $ 44,268        36
  

 

 

    

 

 

    

 

 

    

Total revenue increased by $44.3 million, or 36%, from 2015 to 2016. Subscription and returns revenue increased by $42.2 million, or 37%, from 2015 to 2016. Professional services and other revenue increased $2.1 million, or 20%, from 2015 to 2016.

The increase was due primarily to higher revenue from existing customers, revenues from new customers, and acquisitions in 2015 and 2016. Revenue increased by $10.7 million, or 9%, from acquisitions that were made in 2015 and 2016. Excluding the impact of acquisitions made in 2015 and 2016, revenue increased by $33.6 million, or 30%, from 2015 to 2016. Of this increase, $21.2 million was attributable to existing customers and $12.4 million was attributable to new customers.

Cost of Revenue

 

     For the Year Ended
December 31,
     Change  
           2015                  2016            Amount      Percentage  
     (dollars in thousands)  

Cost of revenue:

           

Subscription and returns

   $ 34,856      $ 41,307      $ 6,451        19

Professional services and other

     5,889        7,206        1,317        22
  

 

 

    

 

 

    

 

 

    

Total cost of revenue

   $ 40,745      $ 48,513      $ 7,768        19
  

 

 

    

 

 

    

 

 

    

Total cost of revenue increased $7.8 million, or 19%, from 2015 to 2016. The increase in cost of revenue in absolute dollars was due primarily to an increase of $4.3 million in employee related payroll expenses, $0.9 million in higher allocated overhead costs, $0.8 million in higher data center and software hosting costs, and $0.7 million in higher amortization expense. Our employee related payroll expenses increased due primarily to higher headcount due to supporting continued customer growth and recent acquisitions. Cost of revenue headcount increased approximately 32% from 2015 to 2016. Allocated overhead costs consists primarily of facility expenses and shared information technology expenses.

 

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Gross Profit

 

     For the Year Ended
December 31,
     Change  
           2015                 2016            Amount      Percentage  
     (dollars in thousands)  

Gross profit:

          

Subscription and returns

   $ 77,948     $ 113,660      $ 35,712        46

Professional services and other

     4,465       5,253        788        18
  

 

 

   

 

 

    

 

 

    

Total gross profit

   $ 82,413     $ 118,913      $ 36,500        44
  

 

 

   

 

 

    

 

 

    

Gross margin:

          

Subscription and returns

     69     73      

Professional services and other

     43     42      

Total gross margin

     67     71      

Gross profit improved $36.5 million, or 44%, from 2015 to 2016. Our total gross margin improved from 67% in 2015 to 71% in 2016. The increase in gross margin was due primarily to increased automation of compliance processes and growing revenue relative to fixed costs of operations.

Research and Development

 

    For the Year Ended
December 31,
    Change  
          2015                 2016           Amount     Percentage  
    (dollars in thousands)  

Research and development

  $ 29,787     $ 32,848     $ 3,061       10

Research and development expenses increased $3.1 million, or 10%, from 2015 to 2016. The increase was due primarily to higher employee related costs of $3.5 million driven by increased headcount, partially offset by lower third party software development costs of $0.3 million. Research and development headcount increased approximately 9% from 2015 to 2016.

Sales and Marketing

 

     For the Year Ended
December 31,
     Change  
           2015                  2016            Amount      Percentage  
     (dollars in thousands)  

Sales and marketing

   $ 98,686      $ 103,483      $ 4,797        5

Sales and marketing expenses increased $4.8 million, or 5%, from 2015 to 2016. The increase was due primarily to the expansion of our sales force and $0.7 million in higher allocated overhead costs. We added employees within our sales, business development, and marketing organizations, which contributed to $4.1 million of increased personnel and related expenses, including commissions and bonuses. Sales and marketing headcount increased approximately 9% from 2015 to 2016. Allocated overhead cost consists primarily of facility expenses and shared information technology.

General and Administrative

 

     For the Year Ended
December 31,
     Change  
           2015                  2016            Amount      Percentage  
     (dollars in thousands)  

General and administrative

   $ 33,683      $ 36,875      $ 3,192        9

 

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General and administrative expenses increased $3.2 million, or 9%, from 2015 to 2016. The increase was due primarily to an increase of $1.5 million for development agreement termination costs, $1.2 million for employee related costs, and $1.0 million for professional services expense, partially offset by lower allocated overhead and depreciation expense of $0.8 million. The increase in employee related costs was driven by higher general and administrative headcount, which increased approximately 34% from 2015 to 2016. In 2016, we agreed to terminate a long-term software development agreement with a vendor for $1.5 million. Professional services expense increased from 2015 to 2016 due primarily to higher acquisition related costs.

Total Other (Income) Expense, Net

 

     For the Year Ended
December 31,
     Change  
           2015                  2016            Amount  
     (in thousands)  

Total other (income) expense, net

   $ 1,614      $ 2,955      $ 1,341  

Total other (income) expense, net increased by $1.3 million from 2015 to 2016 due primarily to higher interest expense on borrowings under our credit facility during 2016. As of December 31, 2016, we had borrowings of $25.0 million outstanding under the term loan facility bearing interest at an annual rate of 6.75%.

Provision for (Benefit from) Income Taxes

 

     For the Year Ended
December 31,
     Change  
           2015                  2016            Amount  
     (in thousands)      

Provision for (benefit from) income taxes

   $ (3,593    $ 640      $ 4,233  

Provision for income taxes increased by $4.2 million from 2015 to 2016 due primarily to tax purchase accounting benefits of $3.5 million recorded in 2015. During 2015, we acquired the stock of two U.S. companies for which we recorded deferred tax liabilities through purchase accounting. These acquired deferred tax liabilities provided a future source of taxable income to support the realization of existing U.S. deferred tax assets, resulting in a discrete income tax benefit during 2015.

 

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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 prospectus and reflect all necessary adjustments, consisting only of normal recurring adjustments, 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. Historical periods are also impacted by acquisitions. In September 2016, we acquired a business in Brazil that provides certain tax-related compliance solutions and content for the Brazilian market. The following quarterly financial data should be read in conjunction with our audited financial statements and related notes included elsewhere in this prospectus.

 

    For the Three Months Ended  
    Mar 31,
2016
    Jun 30,
2016
    Sep 30,
2016
    Dec 31,
2016
    Mar 31,
2017
    Jun 30,
2017
    Sep 30,
2017
    Dec 31,
2017
    Mar 31,
2018
 
    (unaudited)  
    (in thousands)  

Revenue:

                 

Subscription and returns

  $ 35,944     $ 35,929     $ 38,942     $ 44,152     $ 45,848     $ 48,309     $ 51,668     $ 54,117     $ 57,870  

Professional services and other

    2,843       3,100       2,988       3,528       3,117       2,582       3,600       3,918       3,507  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    38,787       39,029       41,930       47,680       48,965       50,891       55,268       58,035       61,377  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

                 

Subscription and returns

    9,823       10,153       10,110       11,221       11,244       12,109       12,330       13,166       14,817  

Professional services and other

    1,771       1,824       1,728       1,883       2,319       2,258       2,329       2,222       2,692  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue(1)

    11,594       11,977       11,838       13,104       13,563       14,367       14,659       15,388       17,509  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    27,193       27,052       30,092       34,576       35,402       36,524       40,609       42,647       43,868  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

                 

Research and development(1)

    8,422       8,691       7,724       8,011       9,682       10,291       10,401       10,890       12,619  

Sales and marketing(1)

    23,665       26,379       25,825       27,614       30,300       33,191       33,151       37,152       37,307  

General and administrative(1)

    8,668       8,375       10,260       9,572       10,613       7,484       8,092       8,097       9,211  

Goodwill impairment and restructuring charges(2)

                                        793       8,377        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    40,755       43,445       43,809       45,197       50,595       50,966       52,437       64,516       59,137  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (13,562     (16,393     (13,717     (10,621     (15,193     (14,442     (11,828     (21,869     (15,269
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    74       1,081       1,033       767       954       1,148       (1,391     1,302       828  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (13,636     (17,474     (14,750     (11,388     (16,147     (15,590     (10,437     (23,171     (16,097
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for (benefit from) income taxes

    101       198       118       223       (149     (141     (172     (757     (848
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (13,737   $ (17,672   $ (14,868   $ (11,611   $ (15,998   $ (15,449   $ (10,265   $ (22,414   $ (15,249
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

    

 
    For the Three Months Ended  
    Mar 31,
2016
    Jun 30,
2016
    Sep 30,
2016
    Dec 31,
2016
    Mar 31,
2017
    Jun 30,
2017
    Sep 30,
2017
    Dec 31,
2017
    Mar 31,
2018
 
    (unaudited)  
    (in thousands)  

Cost of revenue

  $ 194     $ 212     $ 227     $ 223     $ 226     $ 237     $ 277     $ 236     $ 296  

Research and development

    320       335       299       311       491       548       761       591       581  

Sales and marketing

    470       556       519       664       837       933       985       1,034       1,045  

General and administrative

    1,088       753       859       1,082       1,468       1,074       1,159       900       1,588  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stock-based compensation

  $ 2,072     $ 1,856     $ 1,904     $ 2,280     $ 3,022     $ 2,792     $ 3,182     $ 2,761     $ 3,510  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     The amortization of acquired intangibles included above was as follows:

 

    For the Three Months Ended  
    Mar 31,
2016
    Jun 30,
2016
    Sep 30,
2016
    Dec 31,
2016
    Mar 31,
2017
    Jun 30,
2017
    Sep 30,
2017
    Dec 31,
2017
    Mar 31,
2018
 
    (unaudited)  
    (in thousands)  

Cost of revenue

  $ 767     $ 767     $ 810     $ 900     $ 915     $ 912     $ 938     $ 952     $ 898  

Research and development

                                                     

Sales and marketing

    428       425       370       483       480       455       482       496       502  

General and administrative

    29       26       21       48       38       29       26       9       10  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total amortization of acquired intangibles

  $ 1,224     $ 1,218     $ 1,201     $ 1,431     $ 1,433     $ 1,396     $ 1,446     $ 1,457     $ 1,410  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(2)   The goodwill impairment and restructuring charges above include $0.8 million of restructuring charges recorded in the third quarter of 2017 and $8.4 million of goodwill impairment recorded in the fourth quarter of 2017.

 

    

 
    For the Three Months Ended  
    Mar 31,
2016
    Jun 30,
2016
    Sep 30,
2016
    Dec 31,
2016
    Mar 31,
2017
    Jun 30,
2017
    Sep 30,
2017
    Dec 31,
2017
    Mar 31,
2018
 
    (unaudited)  

Revenue:

                 

Subscription and returns

    93     92     93     93     94     95     93     93     94

Professional services and other

    7     8     7     7     6     5     7     7     6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    100     100     100     100     100     100     100     100     100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

                 

Subscription and returns

    25     26     24     24     23     24     22     23     24

Professional services and other

    5     5     4     4     5     4     4     4     4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

    30     31     28     27     28     28     27     27     29
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    70     69     72     73     72     72     73     73     71
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

                 

Research and development

    22     22     18     17     20     20     19     19     21

Sales and marketing

    61     68     62     58     62     65     60     64     61

General and administrative

    22     21     24     20     22     15     15     14     15

Goodwill impairment and restructuring charges

    0     0     0     0     0     0     1     14     0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    105     111     104     95     103     100     95     111     96
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (35 )%      (42 )%      (33 )%      (22 )%      (31 )%      (28 )%      (21 )%      (38 )%      (25 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (income) expense, net

    0     3     2     2     2     2     (3 )%      2     (1 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (35 )%      (45 )%      (35 )%      (24 )%      (33 )%      (31 )%      (19 )%      (40 )%      (26 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for (benefit from) income taxes

    0     1     0     0     (0 )%      (0 )%      (0 )%      (1 )%      1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (35 )%      (45 )%      (35 )%      (24 )%      (33 )%      (30 )%      (19 )%      (39 )%      (25 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    For the Three Months Ended  
    Mar 31,
2016
    Jun 30,
2016
    Sep 30,
2016
    Dec 31,
2016
    Mar 31,
2017
    Jun 30,
2017
    Sep 30,
2017
    Dec 31,
2017
    Mar 31,
2018
 
   

(unaudited)

(in thousands)

 

Non-GAAP Financial Data:

                 

Free cash flow(1)

                 

Net cash provided by (used in) operating activities

  $ (10,194   $ (5,781   $ (4,558   $ (1,163   $ (7,282   $ 403     $ 5,314     $ (1,976   $ (13,375

Purchases of property and equipment

    (1,773     (868     (2,658     (1,361     (1,037     (5,078     (4,235     (3,605     (3,625
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

  $ (11,967   $ (6,649   $ (7,216   $ (2,524   $ (8,319   $ (4,675   $ 1,079