10-K 1 appf201710-k.htm 10-K Document



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________

 FORM 10-K
_________________


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

For the fiscal year ended December 31, 2017

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

For the transition period from                      to                     

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

Delaware
 
26-0359894
(State of incorporation or organization)
 
(I.R.S. Employer Identification No.)

50 Castilian Drive
Santa Barbara, California
 
93117
(Address of principal executive offices)
 
(Zip Code)

 (805) 364-6093
Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Exchange Act:
 
Title of each class
 
Name of exchange on which registered
Class A common stock, par value $0.0001 per share
 
The NASDAQ Stock Market LLC

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of Act. YES  o NO x




Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    YES x NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      YES x NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
 
Accelerated filer
x
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
¨
 
 
 
 
 
 
 
 
 
 
Emerging growth company
x
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  x

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the closing price of the registrant’s Class A common stock on June 30, 2017 (the last business day of the registrant’s mostly recently completed second fiscal quarter), as reported on the NASDAQ Global Market on such date, was approximately $398.7 million. Shares of the registrant’s Class A common stock and Class B common stock held by each executive officer, director and holder of 10% or more of the registrant’s outstanding Class A common stock and Class B common stock have been excluded from this calculation as such persons may be deemed to be affiliates. This calculation does not reflect a determination that these persons are affiliates of the registrant for any other purpose.

As of February 16, 2018, the number of shares of the registrant’s Class A common stock outstanding was 14,966,515 and the number of shares of the registrant’s Class B common stock outstanding was 19,102,408.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2018 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed with the Securities and Exchange Commission (the “SEC”) pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K (this“Annual Report”), are incorporated by reference in Part III, Items 10-14 of this Annual Report. Except for the portions of the Proxy Statement specifically incorporated by reference in this Annual Report, the Proxy Statement shall not be deemed to be filed as part hereof.
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________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________ 

 






APPFOLIO, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017


TABLE OF CONTENTS
 
 
Section
 
Page No.
 
 
 
 
Item 1.
 
Item 1A.
 
Item 1B.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
Item 5.
 
Item 6.
 
Item 7.
 
Item 7A.
 
Item 8.
 
Item 9.
 
Item 9A.
 
Item 9B.
 
 
 
 
Item 10.
 
Item 11.
 
Item 12.
 
Item 13.
 
Item 14.
 
 
 
 
Item 15.
 
 
 
 
 
 





CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K for the fiscal year ended December 31, 2017, or Annual Report, includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which statements are subject to considerable risks and uncertainties. Forward-looking statements include all statements that are not statements of historical facts contained in this Annual Report and can be identified by words such as “anticipates,” “believes,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts, “projects,” “should,” “could,” “will,” “would” or similar expressions and the negatives of those expressions. In particular, forward looking statements contained in this Annual Report relate to, among other things, our future or assumed financial condition, results of operations, business forecasts and plans, seasonality and other trends affecting our business, capital needs and financing plans, including our potential repurchase of shares, research and product development plans, services provided, the expansion of these services, growth in the size of our business and number of customers, strategic plans and objectives, acquisitions and investments, and the application of accounting guidance. We caution you that the foregoing list may not include all of the forward-looking statements made in this Annual Report.

Forward-looking statements represent our management’s current beliefs and assumptions based on information currently available. Forward-looking statements involve numerous known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks and uncertainties in greater detail in the section entitled “Risk Factors” in Part I, Item 1A of this Annual Report, as well as in our other filings with the Securities and Exchange Commission, or SEC. You should read this Annual Report, and the other documents that we have filed with the SEC, with the understanding that our actual future results may be materially different from the results expressed or implied by these forward-looking statements.

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

Except as required by applicable law or the rules of the NASDAQ Global Market, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

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


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PART I

ITEM 1.
BUSINESS
Unless otherwise stated in this Annual Report, references to "AppFolio," "we," "us," and "our" refer to AppFolio, Inc. and its consolidated subsidiaries.
Overview
We were formed in 2006 with a vision to revolutionize the way that small and medium-sized businesses, or SMBs, grow and compete by enabling their digital transformation. Today we provide industry-specific, cloud-based software solutions to the real estate market, which comprises a significant majority of our revenue, and the legal market, and we intend to enter new vertical markets over time. In 2008, we entered the real estate market with our first product, AppFolio Property Manager, or APM, a property management solution designed to address the unique operational and business requirements of property management companies. Recognizing that our customers would benefit from additional business-critical services that they can purchase as needed, we launched a series of Value+ services beginning in 2009. In 2012, we entered the legal market by acquiring MyCase, a legal practice and case management solution primarily for solo practitioners and small law firms.
SMBs face a common set of challenges that divert limited time and resources away from serving their clients and growing their businesses. Day-to-day operations are often managed through inefficient manual processes and disparate software point solutions. This lack of automation and integrated technology results in a significant administrative burden on these businesses, particularly in industries that involve unique workflows, relationships among multiple industry participants, significant data inputs and management, and compliance or regulatory requirements. While larger enterprises and consumers have been experiencing a transformational shift into the digital age, the legacy systems and manual business processes currently used by many SMBs are lagging behind in terms of technological sophistication and ease of use.
Our mission is to revolutionize vertical industry businesses by providing great software and services. We accomplish this mission by delivering software solutions and services that provide our customers with a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and vendors, and, increasingly, a system of intelligence to anticipate, influence, and optimize customer experiences using data to take action in real time. We have built our software solutions using a modern cloud-based architecture, and our mobile-optimized software solutions are designed for use across multiple devices and operating systems.
Although specific functionality varies by product, our core solutions address common business operations and interactions of SMBs in our targeted verticals by providing key functionality, including accounting, document management, real-time interactive search, data analytics and communication options. In addition to our core solutions, we offer a range of optional, but often business-critical, Value+ services. Our Value+ services are available on an as-needed basis and enable our customers to adapt our platform to their specific operational requirements. Over time, we anticipate offering additional Value+ services across our targeted verticals as appropriate for each particular market. We apply our disciplined market validation approach and customer-focused philosophy to select and develop additional Value+ services, as well as new core functionality, and to identify the most suitable adjacent markets and new verticals to target.
For the years ended December 31, 2017, 2016 and 2015, our revenue was $143.8 million, $105.6 million and $75.0 million, respectively. During each of these years we have derived more than 90% of our revenue from our solutions serving the real estate market. Our revenue has limited seasonality as discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report, within the section entitled "Quarterly Revenue and Cost Trends." We have invested, and intend to continue to invest, heavily in our business to capitalize on our market opportunity.
Our Solutions
AppFolio Property Manager - Core Solution

APM is a cloud-based software solution for the real estate market that provides property managers of various sizes (including both third-party managers and owner-operators) innovative tools and services designed to streamline their property management businesses. Our software solution serves a variety of property types, including single- and multi-family residential, commercial, community association, and student housing, and is continuously evolving to help our customers more effectively market, manage and grow their businesses. Core functionality addresses key operational issues, including posting and tracking vacancies, efficiently leasing vacant properties, facilitating tenant, owner and vendor communications, and accounting, among other things.

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AppFolio Property Manager - Value+ Services

In addition to our core solution, we offer the following optional Value+ services to our APM customers. These Value+ services are integrated with our software solution and built to support workflows essential to our customers’ businesses.

Website Services. We deliver and maintain professionally designed and architected websites that showcase our customers’ businesses. Our websites are fully-integrated with APM functionality, including vacancy postings, payment options, owner portals, and maintenance requests. Property managers can track and analyze site traffic and lead generation and identify prospects by evaluating guest cards that are completed by prospective tenants who visit the websites in connection with posted vacancies.

Electronic Payment Services. Our payments platform allows property managers to streamline their payables and receivables online. Our customers can collect rental application fees, rent payments, and other tenant charges all through a secure online portal, as well as receive owner contributions. They can quickly and conveniently pay owners, vendors and even their own management companies through APM.

Tenant Screening Services. We offer instant background screening and credit checks for use in connection with the rental application process, leveraging an automated nationwide eviction and criminal records search. Customers also have the option to access and/or contribute to Experian Rent Bureau rental payments history data, updated every 24 hours, to identify quality residents and reduce the risk of bad debts.

Insurance. We offer two insurance products — legal liability to landlord insurance and renters insurance — that can be tailored to help property managers get the maximum protection for their properties and meet renters’ needs, whether proof of insurance is required or not. Customers can instantly enroll residents in legal liability to landlord, which offers owners and investors increased protection against resident-caused damage. Individual renters also have the option to purchase renters insurance to protect their personal belongings, as well as the property itself from unexpected damages.

Contact Center. Our contact center is staffed 24 hours a day, 7 days a week, and serves as an extension of our property manager customers’ offices to resolve or route incoming maintenance requests. Contact center agents are able to enter non-emergency work orders directly into APM’s property maintenance software for a property manager’s approval and dispatch vendors immediately in case of an emergency.

Premium Leads. Our customers have the option to upgrade a property vacancy listing to premium status, thereby instantly syndicating it to dozens of pay-to-list websites, including featured placement on many free sites. Customers also receive advanced call tracking and only pay for verified leads that they receive through the service.

Tenant Debt Collections. Our customers may choose to utilize a nationwide contingency-based debt collection service provided by a nationally-licensed third party provider. Property managers are able to electronically send past due tenant debt from their APM database directly to the collections service for processing. The service also includes reporting unpaid balances to three major credit bureaus.

MyCase - Core Solution

Our legal software solution, MyCase, enables solo practitioners and small law firms to more efficiently administer their practice and manage their caseload. MyCase is continuously evolving to help our customers more effectively market, manage and grow their businesses, and contains core functionality that addresses key operational issues, including managing calendars, contacts and documents, time tracking, billing and collections, communicating with clients and sharing sensitive and privileged materials.

MyCase - Value+ Services

In addition to our core solution for MyCase, we offer the following optional Value+ services to our legal customers.

Website Services. We deliver and maintain professionally designed and architected websites that practitioners and their clients can utilize to access case and matter information, communicate, and manage bills. Our websites are fully-integrated with the MyCase platform and designed to improve the effectiveness of law firm marketing, streamline daily business tasks, and increase mobile presence.


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Electronic Payment Services. Our payments platform allows practitioners to streamline billing and receivables online. Our customers can quickly and conveniently bill their clients and receive payments electronically through MyCase's secure online portal.
Our Customers
As of December 31, 2017, we had 11,708 property manager customers that directly and indirectly accounted for more than 90% of our annual revenue. Our property manager customers typically manage portfolios ranging from 50 to 3,000 units, and include third-party managers and owner-operators who manage single- and multi-family residences, commercial properties, community associations and student housing, as well as mixed real estate portfolios.
We also had 9,349 solo practitioners and small law firms - the latter typically with fewer than 20 lawyers - that directly and indirectly accounted for less than 10% of our annual revenue.
We define our customer base as the number of customers subscribing to our core solutions, exclusive of free trial periods with respect to MyCase. No individual customer represented 10% or more of our total revenue for our fiscal year ended December 31, 2017.
Our Culture and Employees
We believe our people are at the heart of our success and our customers’ success, and have worked hard not only to attract and hire quality individuals but also to nurture and develop our valuable human resources. We believe in the strong team we have cultivated, particularly in our deep bench of leaders who continue to execute our strategic plans and encourage innovation across the organization. We further believe that our company culture, driven by a dedication to the following six core values, provides us with a significant competitive advantage:
Simpler Is Better
Great, Innovative Products Are Key To A Great Business
Great People Make A Great Company
Listening To Customers Is In Our DNA
Small, Focused Teams Keep Us Agile
We Do The Right Thing Because It’s Good For Business
As of December 31, 2017, we had 672 employees, and we consider our relationship with them to be very good. We also hire temporary employees and consultants, and feel similarly about our relationships with them. None of our employees is represented by a labor union or covered by a collective bargaining agreement.
Our Growth Strategy
We have managed, and plan to continue to manage, our business towards the achievement of long-term growth that we believe will positively impact long-term stockholder value, rather than the realization of short-term financial or business metrics, or short-term stockholder value. Our growth strategy is to provide increasingly valuable cloud-based business management software solutions to SMBs within each specific vertical we choose to target. Key components of our growth strategy include:
Maintain Product and Technology Leadership. We have made, and will continue to make, significant investments in research and product development to expand our core functionality and add new Value+ services in existing and/or new vertical markets. We intend to continue using our market validation techniques and close relationships with our customers as a key source of feedback to inform and direct our product roadmap. We may also choose to acquire rather than build certain functionality to serve our existing verticals or facilitate our entry into adjacent markets or new verticals.
Keep Our Existing Customers Happy. Customer success is essential to our long-term success. We place significant emphasis on customer service to differentiate our software solutions from competing products and this will continue to be a critical component of our business strategy in the future. We believe that maintaining our focus on customer satisfaction will drive greater adoption and utilization of our software solutions over time.
Expand Adoption and Use By Existing Customers. We have made, and will continue to make, significant investments that expand our core functionality and add new Value+ services in existing vertical markets to meet the evolving needs

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and requirements of our customers. We expect our customers will continue to use our technology to manage their businesses and increasingly adopt and use additional Value+ services.
Target New Customers. We plan to grow our customer base with our sales and marketing programs, including evolving industry thought leadership and education, and the referral power of satisfied customers promoting our software solutions within our targeted verticals.
Enter New Adjacent Markets. We continue to evaluate adjacent markets based on our market validation strategy and customer feedback. We firmly believe that, while we are continuously developing our software solution within one market, we can apply certain relevant product enhancements and learnings from that market as we extend our platform into each successive adjacent market.
Expand into New Verticals. We continue to review potential opportunities to expand into additional vertical markets. In that regard, we use market validation techniques to assess the scope and nature of business challenges in any potential new vertical, as well as the likelihood that our target customers may purchase a cloud-based solution to solve their problems in that vertical, and their potential spend on such solutions. Any new vertical also must fit within our overall business strategy, including our management team's assessment of available alternatives, such as the number and size of potential adjacent market opportunities, and the relative risk and return of these opportunities.
Sales and Marketing

We leverage a modern marketing approach along with marketing automation technology to build brand recognition and our reputation as an industry leader in our targeted verticals.

We participate in and drive industry thought leadership and education with both online and offline activities, and use a variety of marketing techniques to promote our software solutions. Our sales development team acts in partnership with our marketing organization to reach potential customers, generate additional sales opportunities and speed the time from evaluation to close. Our sales representatives then assist prospective property manager customers as they evaluate APM, while prospective law firm customers generally sign up for a 30-day free trial on a self-service basis (with additional support from a live sales development representative as needed).

Our interactive sales methodology allows our sales team to quickly build relationships, assess our customers’ business challenges, and demonstrate the benefits of our core functionality and Value+ services. Throughout the customer relationship, we continue to promote adoption and usage of our Value+ services through a variety of channels, including email, webinars, training, sales outreach and from within our software solution via in-app messaging.

Customer Service

Our success is based on long-term customer retention, not a one-time sale, and we partner with our customers throughout the life of the relationship to help them navigate their digital transformation. We design our software solutions to be simple and easy to implement, use and manage, and offer unlimited training and support at no extra charge. We pride ourselves on being customer-centric and strive to educate our customers on the additional core functionality and Value+ services they can use to improve business efficiency and productivity.

Our onboarding team strives to ensure that customers are prepared to run their businesses on our platform and provide a seamless onboarding experience. As a result of our assistance with data migration matters, we are able to provide valuable insights into data integrity and work diligently with our customers to help resolve any issues in their underlying business processes. We also assist our customers with the configuration of our platform for particular property types or cases, as appropriate. We provide a dedicated team throughout the onboarding process and beyond, and share insights on best practices in both of our targeted verticals. In addition, certain members of our Value+ teams are focused on guiding our customers through the adoption and utilization of our Value+ services.

Technology and Operations

Data Security and Availability

We use Ruby-on-Rails as our web application framework for both APM and MyCase. Our software solutions run on a combination of both public and private cloud infrastructure, consisting of both our own servers and Amazon’s Elastic Compute Cloud platform. Our servers are located in state-of-the-art data centers operated by third-party service providers. Physical security

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at these facilities includes a variety of access controls, including electronic keycards, pin codes, biometric hand scans and mantraps, and policing by high resolution, motion sensitive video surveillance. These facilities provide redundant power and a system of heating, ventilating and air conditioning, as well as fire-threat detection and suppression. We utilize a system of redundant routers, switches, server clusters and back-up systems to help ensure high availability. Amazon is widely recognized for operating state-of-the-art, highly available data centers.

With respect to Internet security, sensitive data, such as passwords, Social Security and tax identification numbers, are encrypted before being written to disk. In addition, all sensitive data is encrypted both in transit and at rest. Data is backed up using Amazon’s Simple Storage Service providing high durability, and we also perform regular backups of all customer data. We evaluate our Internet security regularly, including through third-party penetration testing.

In addition, our software solutions allow our customers to define roles that provide different levels of access to users, allowing them to view and modify specific items depending on their role. Supervisors can distribute work to on-site staff in a secure and controlled environment, while leadership retains visibility across the entire system.

Research and Product Development

We entrust product design, development and testing to our team of engineers, who coordinate closely with our product management team to launch new core functionality and Value+ services. Our engineers are organized in smaller groups to foster agility and continued innovation in responding to the evolving needs of our customers. We leverage a collaborative, team-based and test-driven approach to engineering in order to release new code frequently. We believe that it is easier for our customers to adjust to continuous updates to our software solutions, which incrementally change and improve their user experience, than it is to adapt to infrequent, but more drastic upgrades of legacy on-premise software.

We rely heavily on input from our customers in developing products that meet their needs and in anticipating developments in their respective industries. Our product management team leads our research and market validation efforts and provides guidance to management and our engineering team based on our collective domain expertise and in-depth knowledge and understanding of our customers. As a result, our product management team engages regularly with customers, partners and other industry participants, as well as our customer service and sales and marketing organizations. Our product management team manages our development projects generally and serves to align separate functions within the company with a single strategic vision.
    
Our research and product development expenses were $16.6 million, $12.6 million and $9.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Competition
The overall market for business management software is global, highly competitive and continually evolving in response to changes in technology, operational requirements, laws and regulations. While we focus on providing software solutions to SMBs in each of our targeted verticals, we believe our competitors fall into the following primary categories:
On-premise or cloud-based vertical market business management software providers that serve companies of all sizes in our markets; and
On-premise or cloud-based horizontal business management software providers that offer broad solutions across multiple verticals.
We also see competition from numerous cloud-based solution providers that focus almost exclusively on one or more point solutions. For example, in the property management vertical, we compete with listing services, tenant screening applications and specialists in lease forms. In the legal vertical, we compete with time tracking, legal billing and payment services. Continued consolidation among cloud-based solution providers could lead to significantly increased competition.
We believe the principal competitive factors in each of our vertical markets include the following:
ease of deployment and use of software solutions and applications;
total cost of ownership;
data security and availability;
breadth and depth of functionality in software solutions and applications;
nature and extent of mobile interface;

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level of customer satisfaction;
size of customer base and level of user adoption and usage;
brand awareness and reputation;
ability to innovate and respond to customer needs rapidly;
 domain expertise with respect to our targeted verticals; and
ability to leverage a common technology platform and business strategy.
We believe that we compete favorably on the factors described above. However, some of our competitors may have greater financial, technical and other resources, greater name recognition and larger sales and marketing budgets; therefore, we may not always compare favorably with respect to some or all of the foregoing factors.
Intellectual Property
We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality procedures and contractual restrictions to establish and protect our proprietary rights in our core solutions and Value+ services. As of January 31, 2018, we had twelve issued United States patents that directly relate to our technology and expire between 2026 and 2033. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost effective.
We registered “AppFolio,” "MyCase" and "RentLinx" and certain other marks as trademarks in the United States and several other jurisdictions. We also filed trademark applications and renewals in the United States and certain other jurisdictions and will pursue additional trademark registrations to the extent we believe it would be beneficial and cost effective. We are the registered holder of a variety of domestic and international domain names that include “appfolioinc.com,” “appfolio.com,” “mycase.com” and similar variations. We also license software from third parties for use in our solutions, including open source software and other software available on standard commercial terms.
We control access to our proprietary technology by entering into confidentiality and invention assignment agreements with our employees and contractors and confidentiality agreements with third parties. Despite our precautions, it may be possible for unauthorized third parties to copy our software solutions and use information that we regard as proprietary to create products and services that compete with ours.
Seasonality

We experience limited seasonality in our Value+ services revenue, primarily with respect to the screening services we provide to our property manager customers. These customers historically have processed fewer applications for new tenants during the fourth quarter holiday season; therefore, revenue associated with our screening services and new tenant applications typically declines in the fourth quarter of the year. As a result of this seasonal decline in revenue, we have typically experienced slower sequential revenue growth or a sequential decline in revenue in the fourth quarter of each of our most recent fiscal years. We expect this seasonality to continue in the foreseeable future.

Segments

We have one operating and reportable segment consisting of various products and services that are all related to our cloud-based business management software and Value + platforms for various vertical markets. For our revenue, net loss and total assets, see our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.
Corporate Information
We were formed in 2006 as a Delaware limited liability company and converted to a Delaware corporation in 2007. Our principal executive offices are located at 50 Castilian Drive, Santa Barbara, California 93117, and our telephone number is (805) 364-6093. Our corporate website is www.appfolioinc.com. The information contained on or accessed through our website does not constitute part of, and is not incorporated by reference into this Annual Report. References to our website address in this Annual Report are inactive textual references only.
“AppFolio,” “MyCase,” "RentLinx," the AppFolio logo, the MyCase logo, and other trademarks and trade names of AppFolio, MyCase and RentLinx appearing in this Annual Report are our property. All other trademarks or trade names appearing in this report are the property of their respective owners. Solely for convenience, the trademarks and trade names in this report

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are referred to without the ® and ™ symbols. We do not intend our use or display of the trademarks, trade names or service marks of other parties to imply a relationship with, or endorsement or sponsorship of us by, such other parties.
Available Information
We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, as well as amendments to those reports pursuant to Sections 13(a) and 15(d) of the Exchange Act. We also file proxy statements and information statements pursuant to Section 14 of the Exchange Act. The public may obtain these filings at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains the reports, proxy and information statements, and other information that we file with or furnish to the SEC electronically. Copies of the reports, proxy statements and other information may also be obtained, free of charge, electronically through our corporate website at www.appfolioinc.com as soon as reasonably practical after we file such material with, or furnish it to, the SEC.
ITEM 1A.     RISK FACTORS

An investment in our Class A common stock involves risks. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report, as well as in our other public filings with the SEC, before making an investment decision. If any of the following risks are realized, our business, financial condition, and operating results could be materially and adversely affected. In that case, the trading price of our Class A common stock may decline, and you could lose all or part of your investment. Furthermore, additional risks and uncertainties of which we are currently unaware, or which we currently consider to be immaterial, could have a material adverse effect on our business.
Please be advised that certain of the risks and uncertainties described below contain “forward-looking statements.”  See the section of this Annual Report entitled “Cautionary Note Regarding Forward-Looking Statements” for additional information.
Risks Related to Our Business and Our Industry
We manage our business towards the achievement of long-term growth, which may not be consistent with the short-term expectations of some investors.
We plan to continue to manage our business towards the achievement of long-term growth that we believe will positively impact long-term stockholder value, and not towards the realization of short-term financial or business metrics, or short-term stockholder value. If opportunities arise that might cause us to sacrifice our performance with respect to short-term financial or business metrics, but that we believe are in the best interests of our stockholders, we will take those opportunities.
We focus on growing our customer base by launching new and innovative core functionality and Value+ services to address our customers’ evolving business needs, developing new products for adjacent markets and additional verticals, and improving the experience of our users across our targeted verticals. We prioritize product innovation and user experience over short-term financial or business metrics. We will make product decisions that reduce our short-term operating results if we believe that these decisions are consistent with our strategic objective to achieve long-term growth. These decisions may not be consistent with the short-term expectations of some investors, and may cause significant fluctuations in our operating results from period to period. In addition, notwithstanding our intention to make strategic decisions that positively impact long-term stockholder value, the decisions we make may not produce the long-term benefits we expect.
Our executive officers, directors and principal stockholders control a majority of the combined voting power of our outstanding capital stock. As a result, they are able to exercise significant influence and control over the establishment and implementation of our future business plans and strategic objectives, as well as control all matters submitted to our stockholders for approval. These persons may manage our business in ways with which you disagree and which may be adverse to your interests.
If we fail to manage our growth effectively, it could adversely affect our operating results and preclude us from achieving our strategic objectives.
We have experienced significant growth since our formation in 2006, and we anticipate that we will continue to experience growth and expansion of our operations. This growth in the size, complexity and diversity of our business has placed, and we expect that our growth will continue to place, a significant strain on our management, administrative, operational and financial resources, as well as our company culture. Our future success will depend, in part, on our ability to manage this growth effectively. To manage the expected growth of our operations and personnel, we will need to continue to develop and improve our operational and financial controls and our reporting systems and procedures, and to nurture and build on our company culture. Failure to effectively manage growth could adversely impact our business, including by resulting in errors or delays in deploying new core

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functionality to our customers, delays or difficulties in introducing new Value+ services or other products, declines in the quality or responsiveness of our customer service organization, increases in costs and operating expenses, and other operational difficulties. If any of these risks actually occur, it could adversely affect our operating results, and preclude us from achieving our strategic objectives.
We have a limited operating history and limited experience selling our solutions. As a result of continuing investments across our organization to grow our business, we expect our financial results may fluctuate significantly for the foreseeable future.
We were formed in 2006 and in 2008 we entered the real estate market with our first product, APM, to serve property managers. In 2012, we entered the legal vertical through the acquisition of MyCase. As a result, we have a limited operating history and limited experience selling our software solutions in two continually evolving vertical markets, especially within the legal vertical. These and other factors combine to make it more difficult for us to accurately forecast our future operating results, which in turn makes it more difficult for us to prepare accurate budgets and implement strategic plans. We expect that this uncertainty will continue to exist in our business for the foreseeable future, and will be exacerbated to the extent we introduce new functionality, or enter adjacent markets or new verticals.
We have made substantial investments across our organization to develop our software solutions and capitalize on our market opportunity. In order to implement our business strategy, we intend to continue to make substantial investments in, among other things:
our research and product development organization to enhance the ease of use and functionality of our software solutions by adding new core functionality, Value+ services and other improvements to address the evolving needs of our customers, as well as to develop new products for adjacent markets and new verticals;
our customer service organization to deepen our relationships with our customers, assist our customers in achieving success through the use of our software solutions, and promote customer retention;
our sales and marketing organization, including expansion of our direct sales organization and marketing programs, to increase the size of our customer base, increase adoption and utilization of new and existing Value+ services by our new and existing customers, and enter adjacent markets and new verticals;
maintaining and expanding our technology infrastructure and operational support, including data center operations, to promote the security and availability of our software solutions, and support our growth;
our general and administrative functions, including hiring additional finance, IT, human resources, legal and administrative personnel, to support our growth and assist us in achieving and maintaining compliance with public company reporting and compliance obligations;
the expansion of our existing facilities, including leasing and building out additional office space, to support our growth and strategic expansion; and
our continued strategic efforts to identify and expand into key adjacent and new vertical markets.
As a result of our continuing investments to grow our business in these and other areas, we expect our expenses to increase significantly, and we may not be consistently profitable. Even if we are successful in growing our customer base and increasing revenue from new and existing customers, we may not be able to generate additional revenue in an amount that is sufficient to cover our expenses. We may incur significant losses in a particular period for a number of reasons, and may experience significant fluctuations in our operating results from period to period, including as a result of the other risks and uncertainties described elsewhere in this Annual Report. We cannot assure you that we will continue to achieve profitability in the near term or that we will sustain profitability over any particular period of time. Any additional operating losses will have a negative impact on our stockholders’ equity.
Actual or perceived security vulnerabilities in our software solutions, breaches of our security controls or other unauthorized access to our customers’ data could result in liability or reputational harm to us, or cause us to lose customers, any of which could harm our business and operating results.
In providing our software solutions, we store and transmit large amounts of our customers’ data, including sensitive and proprietary data. Our software solutions are typically the system of record, system of engagement and, increasingly, the system of intelligence for all or a portion of our customers’ businesses, and the data processed through our software solutions is critical to their businesses. Cyber-attacks and other malicious Internet-based activities continue on a regular basis, as evidenced by the recent targeting of a number of high profile companies and organizations. As our business grows, the number of users of our software solutions, as well as the amount of information we store, is increasing, and our brands are becoming more widely

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recognized. We believe these factors combine to make us an even greater target for this type of malicious activity. Techniques used to sabotage, or to obtain unauthorized access to, systems or networks change frequently and generally are not recognized until launched against a target. Therefore, despite our significant efforts to keep our systems and networks up to date, we may be unable to anticipate these techniques, react in a timely manner, or implement adequate preventive measures, any of which may expose us to a risk of loss, litigation and potential liability. In addition, some of our third-party partners also collect information from transactions with our customers, and these third parties are subject to similar threats of cyber-attacks and other malicious Internet-based activities.
If our security measures, or the security measures of our third-party partners, are breached as a result of negligence, wrongdoing or malicious activity on the part of our employees, our partners’ employees, our customers’ employees, or any third party, or as a result of any error, product defect or otherwise, and this results in the disruption of the confidentiality, availability or integrity of our customers’ data, we could incur liability to our customers and to individuals or organizations whose information was being stored by our customers, as well as fines from payment processing networks and regulatory action by governmental bodies. If we experience a widespread security breach, we cannot be certain that our insurance coverage will be sufficient to compensate us for liabilities actually incurred or that insurance will continue to be available to us on reasonable terms, or at all. In addition, any breaches of our security controls or other unauthorized access to our customers’ data could result in reputational damage, adversely affect our ability to attract new customers and cause existing customers to reduce or discontinue the use of our software solutions, any of which could harm our business and operating results. Furthermore, the perception by our current or potential customers that our software solutions could be vulnerable to security breaches, even in the absence of a particular problem or threat, could reduce market acceptance of our software solutions and cause us to lose customers.
Service outages due to malicious activities or performance problems associated with our technology infrastructure could harm our reputation, adversely affect our ability to attract new customers and cause us to lose existing customers.
We have experienced significant growth in the number of users and the amount of data that our technology infrastructure supports, and we expect this growth to continue. We seek to maintain sufficient excess capacity in our technology infrastructure to meet the needs of all of our customers, including to facilitate the expansion of existing customer deployments and the provisioning of new customer deployments. In addition, we need to properly manage our technology infrastructure in order to support version control, changes in hardware and software parameters, and the evolution of our software solutions. However, the provision of new hosting infrastructure requires significant lead-time.
We have experienced, and may in the future experience, website disruptions, service outages and other performance problems with our technology infrastructure. These problems may be caused by a variety of factors, including infrastructure changes, power or network outages, fire, flood or other natural disasters affecting our data centers, human or software errors, viruses, security breaches, fraud or other malicious activity, spikes in customer usage and distributed denial of service issues. In some instances, we may not be able to identify the cause or causes of these service outages and performance problems within an acceptable period of time. If our technology infrastructure fails to keep pace with the increased number of users and amount of data, or if we are unable to avoid service outages and performance problems, or to resolve them quickly, this could adversely affect our ability to attract new customers, result in the loss of existing customers and harm our reputation, any or all of which could adversely affect our business and operating results.
We face a number of risks in our payment processing business that could adversely affect our business or operating results.
In connection with our electronic payment services, we process payments and subsequently submit these payments to our customers after varying clearing times established by us. These payments are settled through our sponsoring clearing bank and, in the case of electronic funds transfers, or EFTs, through our Originating Depository Financial Institutions, or ODFIs, pursuant to agreements with one or more national banking institutions that we may contract with from time to time. Our electronic payment services subject us to a number of risks, including, but not limited to:
liability for customer costs related to disputed or fraudulent transactions if those costs exceed the amount of the customer reserves we have during the clearing period or after payments have been settled to our customers;
electronic processing limits on the amounts that any single ODFI, or collectively all of our ODFIs, will underwrite;
our reliance on sponsoring clearing banks, card payment processors and other electronic payment partners to process electronic transactions, especially where those partners are highly scrutinized and regulated themselves;
failure by us, our partners or our customers to adhere to applicable laws, regulations and standards that may legally or contractually apply to the provision of electronic payment services;
continually evolving and developing laws and regulations governing money transmission and anti-money

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laundering, the application or interpretation of which is not clear in some jurisdictions;
incidences of fraud, security breaches, errors, defects, failures, vulnerabilities or bugs in our electronic payments platform, or our failure to comply with required external audit standards; and
our inability to increase our fees at times when our electronic payment partners increase their transaction processing fees.
If any of these risks related to our electronic payment services were to materialize, our business or operating results could be negatively affected. Although we attempt to structure and adapt our electronic payment services to comply with complex and evolving laws, regulations and standards, our underwriting efforts do not guarantee compliance. In the event that we are found to be in violation of our legal, regulatory or contractual requirements, we may be subject to monetary fines or penalties, cease and desist orders, mandatory product changes, or other liabilities that could have an adverse effect on our operating results.
Additionally, with respect to the processing of EFTs, we are exposed to financial risk. EFTs between our customer and another user may be returned for various reasons such as insufficient funds or stop payment orders. These returns are charged back to the customer by us. However, if we or our sponsoring clearing bank is unable to collect such amounts from the customer’s account (such as if the customer is illegitimate, or if the customer refuses or is unable to reimburse us for the amounts charged back), we bear the risk of loss for the amount of the transfer. While we have not experienced material losses resulting from amounts charged back in the past, there can be no assurance that we will not experience these types of significant losses in the future.
In addition to the foregoing risks associated with our electronic payment services themselves, there is an overarching risk stemming from the potential widespread adoption of quickly evolving financial technology products, including, for example, blockchain or other distributed ledger technologies, that could materially impact the manner in which payments are processed. Such adoption of new disruptive financial technologies could significantly reduce the volume of payments processed by us and our third party partners or change the transaction costs associated with or potential revenue derived from those payments, thereby reducing our revenue and increasing our associated expenses, which could materially impact our business, financial condition, operating results and, ultimately, our stock price.
Evolution and expansion of our electronic payment services may subject us to additional risks and regulatory requirements.
The evolution and expansion of our electronic payment services may subject us to additional risks and regulatory requirements, including laws and regulations governing money transmission and anti-money laundering. These requirements vary throughout the markets in which we operate, and several jurisdictions lack clarity with respect to the application and interpretation of these rules. Our efforts to comply with these rules could require significant management time and effort, as well as significant expenditures, and will not guarantee our compliance with all regulatory requirements, especially given that the applicable regulatory frameworks are constantly changing and subject to evolving interpretation. While we maintain a compliance program focused on applicable laws and regulations throughout our applicable industries, there is no guarantee that we will not be subject to fines, penalties or other regulatory actions in one or more jurisdictions, or be required to adjust our business practices to accommodate future regulatory requirements.
Errors, defects or other disruptions in our software solutions could harm our reputation, cause us to lose customers, and result in significant expenditures to correct the problem.
Our customers use our software solutions to manage critical aspects of their businesses, and any errors, defects or other disruptions in the performance of our software solutions may result in loss of or damage to our customers’ data and disruption to our customers’ businesses, which could harm our reputation. We provide continuous updates to our software solutions and, while our software updates undergo extensive testing prior to their release, these updates may contain undetected errors when first introduced. In the past, we have discovered errors, failures, vulnerabilities and bugs in our software updates after they have been released, and similar problems may arise in the future. Real or perceived errors, failures, vulnerabilities or bugs in our software solutions could result in negative publicity, reputational harm, loss of customers, delay in market acceptance of our software solutions, loss of competitive position, withholding or delay of payment to us, claims by customers for losses sustained by them and potential litigation. In any such event, we may be required to expend additional resources in order to help correct the problem or, in order to address customer service or reputational concerns, we may choose to expend additional resources to take corrective action even where not required. The costs incurred in correcting any material errors, defects or other disruptions could be substantial and there may not be any corresponding increase in revenue to offset these costs. In addition, we may not carry insurance sufficient to compensate us for any losses that may result from claims arising from errors, defects or other disruptions in our software solutions.

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Our quarterly results may fluctuate significantly and period-to-period comparisons of our results may not be meaningful.
Our quarterly results, including the levels of our revenue, costs, operating expenses, and operating margins, may fluctuate significantly in the future, and period-to-period comparisons of our results may not be meaningful. Accordingly, the results of any one quarter should not be relied upon as an indication of our future performance. In addition, our quarterly results may not fully reflect the underlying performance of our business. Factors that may cause fluctuations in our quarterly results include, but are not limited to:
our ability to retain our existing customers, and to expand adoption and utilization of our core solutions and Value+ services by our existing customers;
our ability to attract new customers, the type of customers we are able to attract, the size and needs of their businesses, and the cost of acquiring these customers;
the mix of our core solutions and Value+ services sold during the period;
the timing and impact of security breaches, service outages or other performance problems with our technology infrastructure and software solutions;
variations in the timing of sales of our core solutions and Value+ services as a result of trends impacting the verticals in which we sell our software solutions;
the timing and market acceptance of new core functionality, Value+ services and other products introduced by us and our competitors;
changes in our pricing policies or those of our competitors;
the timing of our recognition of revenue;
our ability to convert customers who start their accounts on a free trial into paying subscribers;
the amount and timing of costs and operating expenses related to the maintenance and expansion of our business, infrastructure and operations;
the amount and timing of costs and operating expenses associated with assessing or entering adjacent markets or new verticals;
the amount and timing of costs and operating expenses related to the development or acquisition of businesses, services, technologies or intellectual property rights, and potential future charges for impairment of goodwill from these acquisitions;
the timing and costs associated with legal or regulatory actions;
changes in the competitive dynamics of our industry, including consolidation among competitors, strategic partners or customers;
loss of our executive officers or other key employees;
industry conditions and trends that are specific to the verticals in which we sell or intend to sell our software solutions; and
general economic and market conditions.
Fluctuations in quarterly results may negatively impact the value of our Class A common stock, regardless of whether they impact or reflect the overall performance of our business. If our quarterly results fall below the expectations of investors or any securities analysts who follow our stock, or below any guidance we may provide, the price of our Class A common stock could decline substantially.
Business management software for SMBs is a relatively new and developing market and, if the market is smaller than we estimate or develops more slowly than we expect, our operating results could be adversely affected.
We currently provide cloud-based business management software for SMBs in the real estate and legal markets and, as part of our business strategy, we will assess entry into new verticals. While the overall market for cloud-based business management software is rapidly growing, it is not as mature as the market for legacy on-premise software applications. In addition, when

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compared to larger enterprises, SMBs have not historically purchased enterprise resource planning or other enterprise-wide software systems to manage their businesses due to the cost and complexity of implementing such systems, which generally did not address their industry-specific needs. Furthermore, a number of widely adopted cloud-based solutions have not traditionally targeted SMBs. As a result, many SMBs still run their businesses using manual processes and disparate software systems that are not web-optimized, while others may have invested substantial resources to integrate a variety of point solutions into their organizations to address one or more specific business needs and, therefore, may be reluctant to migrate to a vertical cloud-based solution designed to apply to their entire business. Because we derive, and expect to continue to derive, substantially all of our revenue from sales of our cloud-based business management software to SMBs in our targeted verticals, our success will depend, to a substantial extent, on the widespread adoption by SMBs in these verticals of cloud computing in general and of cloud-based business management software in particular.
The market for industry-specific, cloud-based business management software for SMBs, both generally, and specifically within the real estate and legal markets, is evolving and, in comparison to the overall market for cloud-based solutions, is relatively small. The continued expansion of this market depends on numerous factors, including:
the cost and perceived value associated with cloud-based business management software relative to on-premise software applications and disparate point solutions;
the ability of cloud-based solution providers to offer SMBs the functionality they need to operate and grow their businesses;
the willingness of SMBs to transition from their existing software systems, or otherwise alter their existing businesses practices, to migrate their businesses to a vertical cloud-based business management software solution; and
the ability of cloud-based solution providers to address security, privacy, availability and other concerns.
If cloud-based business management software does not achieve widespread market acceptance among SMBs, our revenue may increase at a slower rate than we expect and may even decline, which could adversely affect our operating results. In addition, it is difficult to estimate the rate at which SMBs will be willing to transition to vertical cloud-based business management software in any particular period, which makes it difficult to estimate the overall size and growth rate of the market for cloud-based business management software for SMBs at any given point in time or to forecast growth in our revenue or market share.
Our estimates of market opportunity are subject to significant uncertainty and, even if the markets in which we compete meet or exceed our size estimates, we could fail to increase our revenue or market share.
Market opportunity estimates are subject to significant uncertainty and are based on assumptions and estimates, including our internal analysis and industry experience. Assessing the market for industry-specific, cloud-based business management software for SMBs is particularly difficult due to a number of factors, including limited available information and rapid evolution of the market. If we had made different assumptions, our estimates of market opportunity could be materially different.
In addition, even if the markets in which we compete meet or exceed our size estimates, our business could fail to grow in line with our forecasts, or at all, and we could fail to increase our revenue or market share. Our growth, and our ability to serve a significant portion of our target markets, will depend on many factors, including our success in executing our business strategy, which is subject to many risks and uncertainties, including the other risks and uncertainties described elsewhere in this Annual Report.
 If we are unable to introduce successful enhancements, including new and innovative core functionality and Value+ services for our existing markets and verticals, or new products for adjacent markets or additional verticals, our operating results could be adversely affected.
The software industry in general, and our targeted verticals in particular, are characterized by rapid technological advances, changing industry standards, evolving customer requirements and intense competition. Our ability to attract new customers, increase revenue from our existing customers, and expand into adjacent markets or new verticals depends, in part, on our ability to enhance the functionality of our existing software solutions by introducing new and innovative core functionality and Value+ services that keep pace with technological developments, and provide functionality that addresses the evolving business needs of our customers. In addition, our growth over the long term depends, in part, on our ability to introduce new products for adjacent markets and additional verticals that we identify through our market validation process. Market acceptance of our current and future software solutions will depend on numerous factors, including:
the unique functionality of our software solutions and the extent to which our software solutions meet the business needs of our customers;

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the perceived benefits and security of our cloud-based business management software solutions relative to on-premise software applications or other competitive products;
the pricing of our software solutions relative to competitive products;
perceptions about the security, privacy and availability of our software solutions relative to competitive products;
time-to-market of the updates and enhancements to our core functionality, Value+ services and new products; and
perceptions about the quality and responsiveness of our customer service organization.
If we are unable to successfully enhance the functionality of our existing software solutions, including our core solutions and Value+ services, and develop new products that gain market acceptance in adjacent markets and additional verticals, our revenue may increase at a slower rate than we expect and may even decline, which could adversely affect our operating results.
Our business depends substantially on existing customers renewing their subscriptions with us and expanding their use of our Value+ services, and a decline in customer renewal rates, or failure to convince existing customers to adopt and utilize our Value+ services, could adversely impact our operating results.
In order for us to maintain or increase our revenue and improve our operating results, it is important that our existing customers continue to pay subscription fees for the use of our core solutions, which tend to incrementally rise over time, as well as increase their adoption and utilization of our Value+ services. Our customers have no obligation to renew their subscriptions with us upon expiration of their subscription periods, which typically range from one month to one year. We cannot assure you that our customers will renew their subscriptions with us. In addition, our customers that start their accounts using a 30-day free trial have no obligation to begin a paid subscription. Furthermore, although a significant portion of our revenue growth has historically resulted from the adoption and utilization of our Value+ services by our existing customers, we cannot assure you that our existing customers will continue to broaden their adoption and utilization of our Value+ services, or use our Value+ services at all. If our existing customers do not renew their subscriptions and increase their adoption and utilization of our existing or newly developed Value+ services, our revenue may increase at a slower rate than we expect and may even decline, which could adversely impact our operating results.
Word-of-mouth referrals represent a significant source of new customers for us and provide us with an opportunity to cost-effectively market and sell our software solutions. The loss of our existing customers could have a significant impact on our reputation in our targeted verticals and our ability to acquire new customers cost-effectively. A reduction in the number of our existing customers, even if offset by an increase in new customers, could have the impact of reducing our revenue and operating margins.
     In an effort to retain our customers and to expand our customers’ adoption and utilization of our Value+ services, we may choose to use increasingly costly sales and marketing efforts. In addition, we may make significant investments in research and product development to introduce Value+ services that ultimately are not broadly adopted by our customers. In either of those cases, we could incur significantly increased costs without a corresponding increase in revenue. Furthermore, we may fail to identify Value+ services that our customers need for their businesses, in which case we could miss opportunities to increase our revenue.
We expect to continue to derive a significant portion of our revenue from our property manager customers, and factors resulting in a loss of these customers could adversely affect our operating results.
Historically, more than 90% of our revenue has been derived from APM, our property management solution, and we expect that our property manager customers will continue to account for a significant portion of our revenue for the foreseeable future. We could lose property manager customers as a result of numerous factors, including:
the expiration and non-renewal of subscriptions or termination of subscription agreements;
the introduction of competitive products or technologies;
a failure or inability by us to continue to provide high quality, useful products and services to our customers;
changes in pricing policies by us or our competitors;
acquisitions or consolidations within the property management industry;
bankruptcies or other financial difficulties facing our customers; and

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conditions or trends that are specific to the property management industry such as the economic factors that impact the rental market.
The loss of a significant number of our property manager customers, or the loss of even a small number of our larger property manager customers, could cause our revenue to increase at a slower rate than we expect or even decline. In addition, even if we are able to retain our property manager customers, we may be unable to grow revenue from these property manager customers by increasing their adoption and utilization of our Value+ services. Any of these outcomes could adversely affect our operating results.
Our growth depends in part on the success of our strategic relationships with third parties, and if we are unsuccessful in establishing or maintaining these relationships, our ability to compete in the market place or grow our revenue could be impaired.
In order to grow our business, we anticipate that we will continue to depend on our relationships with third parties, including our data center operators, electronic payment and background and credit check partners, and other third parties that support delivery of our software solutions. Identifying partners, negotiating agreements and maintaining relationships requires significant time and resources. Our competitors may be more effective than us in cost-effectively building relationships with third parties that enhance their products and services, allow them to provide more competitive pricing, or offer other benefits to their customers. In addition, acquisitions of our partners by our competitors could result in a decrease in the number of current and potential strategic partners willing to establish or maintain relationships with us, and could increase the price at which products or services are available to us. If we are unsuccessful in establishing or maintaining our relationships with third parties, our ability to compete in the marketplace or to grow our revenue could be impaired, which could negatively impact our operating results. Even if we are successful, we cannot assure you that these relationships will result in increased customer adoption and usage of our software solutions or improved operating results. Furthermore, if our partners fail to perform as expected, we may be subjected to litigation, our reputation may be harmed, and our business and operating results could be adversely affected.  
We depend on data centers and computing infrastructure operated by third parties and any disruption in these operations could adversely affect our operating results.
We currently serve our customers through a combination of our own servers located in third-party data center facilities, and servers and data centers operated by Amazon and other third parties. While we control and have access to our own servers and the other components of our network that are located in our third-party data centers, we do not control the operation of any of these third-party data center facilities. The owners of our data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one of our third-party data center operators is acquired, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and possible service interruptions in connection with doing so. Further, our third-party data center providers could experience significant outages outside of our control that could adversely affect our business.
Problems faced by our third-party data center operators, or with any of the service providers with whom we or they contract, could adversely affect the experience of our customers. Our third-party data center operators could decide to close their facilities without adequate notice. In addition, any financial difficulties, such as bankruptcy, faced by our third-party data center operators, or any of the service providers with whom we or they contract, may have negative effects on our business. Additionally, if our data centers are unable to keep up with our growing needs for capacity or any spikes in customer demand, this could have an adverse effect on our business. Any changes in third-party service levels at our data centers could result in loss of or damage to our customers’ stored information and service interruptions, which could hurt our reputation. These issues could also cause us to lose customers, harm our ability to attract new customers, and subject us to potential liability, any of which could adversely affect our operating results.
Our systems are not fully redundant, and we have not yet implemented a complete disaster recovery plan or business continuity plan. Although the redundancies we do have in place will permit us to respond, at least to some degree, to service outages, our third-party data centers are vulnerable in the event of failure. We do not yet have adequate structure or systems in place to recover from a data center’s severe impairment or total destruction, and recovery from the total destruction or severe impairment of any of our third-party data centers could be difficult or may not be possible at all.
We use third-party service providers for important payment processing and reporting functions, and their failure to fulfill their contractual obligations could harm our reputation, disrupt our business and adversely affect our operating results.
We use payment processing organizations and other service providers to enable us to provide electronic payment services to our customers, including EFT, and access to various reporting tools, such as background and credit checks. As a result, we rely on these organizations and service providers to provide us with accurate and timely information, and we have significantly less

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control over these payment processing and reporting functions than if we were to maintain and operate them ourselves. In some cases, functions necessary to our business are performed on proprietary third-party systems and software to which we have no access. We also generally do not have long-term contracts with these organizations and service providers. In addition, some of these organizations and service providers compete with us by directly or indirectly selling payment processing or reporting services to customers. The failure of these organizations and service providers to provide us with accurate and timely information, to fulfill their contractual obligations of us, or to renew their contracts with us, could result in direct liability to us, harm our reputation, result in significant disruptions to our business, and adversely affect our operating results.
Our platform must integrate with a variety of devices, operating systems and browsers that are developed by others, and if we are unable to ensure that our software solutions interoperate with such devices, operating systems and browsers, our software solutions may become less competitive, and our operating results may be harmed.
We offer our software solutions across a variety of operating systems and through the Internet. We are dependent on the interoperability of our platform with third-party devices, desktop and mobile operating systems, as well as web browsers that we do not control. Any changes in such devices, systems or web browsers that degrade the functionality of our software solutions or give preferential treatment to competitive services could adversely affect adoption and usage of our software solutions. In addition, in order to deliver high quality software solutions, we will need to continuously enhance and modify our functionality to keep pace with changes in Internet-related hardware, mobile operating systems such as iOS and Android, browsers and other software, communication, network and database technologies. We may not be successful in developing enhancements and modifications that operate effectively with these devices, operating systems, web browsers and other technologies or in bringing them to market in a timely manner. Furthermore, uncertainties regarding the timing or nature of new network platforms or technologies, and modifications to existing platforms or technologies, could increase our research and product development expenses. In the event that it is difficult for our customers to access and use our software solutions, our software solutions may become less competitive, and our operating results could be adversely affected.
The markets in which we participate are intensely competitive and, if we do not compete effectively, our business could be harmed.
The overall market for business management software is global, highly competitive and continually evolving in response to a number of factors, including changes in technology, operational requirements, and laws and regulations. Although relatively early in its development, the market for cloud-based business management software is also highly competitive and subject to similar market factors.
While we focus on providing industry-specific, cloud-based business management software solutions to SMBs in our targeted verticals, we compete with other vertical cloud-based solution providers that serve companies of all sizes, as well as with horizontal cloud-based solution providers that provide broad cloud-based solutions across multiple verticals. Our competitors include established vertical software vendors, as well as newer entrants in the market. We also face competition from numerous cloud-based solution providers that focus almost exclusively on one or more point solutions. Continued consolidation among cloud-based providers could lead to significantly increased competition.
Although the domain expertise required to successfully develop, market and sell cloud-based business management software solutions in the real estate and legal verticals may hinder new entrants that are unable to invest the necessary resources to develop and deploy cloud-based solutions with the same level of functionality as ours, many of our competitors and potential competitors are larger and have greater name recognition, longer operating histories, and significantly greater resources than we do. As a result, our competitors may be able to respond more quickly and effectively to new or changing opportunities, technologies, operational requirements and industry standards. Some of these competitors may have more established customer relationships or strategic partnerships with third parties that enhance their products and services. Other competitors may offer products or services that address one or a number of business functions on a standalone basis at lower prices or bundled as part of a broader product sale, or with greater depth than our software solutions. In addition, our current and potential competitors may develop, market and sell new technologies with comparable functionality to our software solutions, which could cause us to lose customers, slow the rate of growth of new customers and cause us to decrease our prices in order to remain competitive. For all of these reasons, we may not be able to compete effectively against our current and future competitors, which could harm our business.
Pricing pressure may cause us to change our pricing model, which could hurt our renewal rates and our ability to attract new customers, as well as our ability to increase adoption and usage of our Value+ services, which could adversely affect our operating results.
As the markets for our existing software solutions mature, or as current and future competitors introduce new products or services that compete with ours, we may experience pricing pressure and be unable to renew our subscription agreements with existing customers or increase adoption and usage of our Value+ services, or attract new customers at prices that are consistent

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with our current pricing model and operating budget. If this were to occur, it is possible that we would have to change our pricing model, offer pricing incentives, or generally reduce our prices. In addition, our customers are SMBs, which are typically more cost sensitive than larger enterprises. Changes to our pricing model could harm our customer retention rates and our ability to attract new customers, whether in connection with our core solutions or our Value+ services, which could adversely affect our operating results.
If we lose key members of our management team, our business may be harmed.
Our success and future growth depend, in part, upon the continued services of our executive officers and other key employees. From time to time, there may be changes in our executive officers or other key employees resulting from the hiring or departure of these personnel, which may disrupt our business. Our executive officers and other key employees are generally employed on an at-will basis, which means that these personnel could terminate their employment with us at any time. Additionally, the equity awards held by many of our executive officers and other key employees are close to fully vested, and these employees may not have sufficient financial incentive to stay with us. The loss of one or more of our executive officers or other key employees, or the failure by our executive team to work effectively with our employees and lead our company, could have an adverse effect on our business.
Our corporate culture has contributed to our success and, if we cannot maintain this culture as we grow, we could lose the passion, creativity, teamwork, focus and innovation fostered by our culture.
We believe that our culture has been and will continue to be a key contributor to our success. If we do not continue to develop our corporate culture or maintain our core values as we grow and evolve, we may be unable to foster the passion, creativity, teamwork, focus and innovation we believe we need to support our growth. Any failure to preserve our culture could negatively affect our ability to recruit and retain personnel and to effectively focus on and pursue our strategic objectives. Moreover, liquidity available to our employee security holders could lead to disparities of wealth among our employees, which could adversely impact relations among employees and our culture in general. As we grow and mature as a public company, we may find it difficult to maintain our corporate culture.
We depend on highly skilled personnel and, if we are unable to retain or hire additional qualified personnel, we may not be able to achieve our strategic objectives.
To execute our growth plan and achieve our strategic objectives, we must continue to attract and retain highly qualified and motivated personnel across our organization. In particular, in order to continue to enhance our software solutions, add new and innovative core functionality and Value+ services, as well as develop new products, it will be critical for us to increase the size of our research and product development organization, including hiring highly skilled engineers with experience in designing, developing and testing cloud-based software solutions. Competition for software engineers is intense within our industry and there continues to be upward pressure on the compensation paid to these professionals. In addition, in order for us to achieve broader market acceptance of our software solutions, grow our customer base, and pursue adjacent markets and new verticals, we will need to continue to significantly increase the size of our sales and marketing organization. Identifying and recruiting qualified sales personnel and training them in the use of our platform requires significant time and expense, and it can be particularly difficult to retain these personnel.
Many of the companies with which we compete for experienced personnel have greater name recognition and financial resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that we or these employees have breached their legal obligations, resulting in a diversion of our time and resources. In addition, our headquarters are located in Santa Barbara, California, which is not generally recognized as a prominent commercial center, and it is challenging to attract qualified professionals due to our geographic location. As a result, we may have difficulty hiring and retaining suitably skilled personnel with the qualifications and motivation to expand our business. If we are unable to attract and retain the personnel necessary to execute our growth plan, we may be unable to achieve our strategic objectives and our operating results may suffer.
In addition, prospective and existing employees often consider the value of the equity awards they receive in connection with their employment. If the perceived value of our equity awards declines, or if the price of our Class A common stock experiences significant volatility, this may adversely affect our ability to recruit and retain highly skilled employees. If we fail to attract new personnel or to retain and motivate our current personnel, we may not be able to achieve our strategic objectives.
If we are unable to enter new verticals, or if our software solution for any new vertical fails to achieve market acceptance, our operating results could be adversely affected and we may be required to reconsider our growth strategy.
Our growth strategy is dependent, in part, on our ability to expand into new verticals, beyond the real estate and legal markets. However, we may be unable to identify new verticals that meet our criteria for selecting industries that cloud-based

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solutions are ideally suited to address. In addition, our market validation process may not support entry into selected verticals due to our perception of the overall market opportunity or of the willingness of market participants within those verticals to adopt our software solutions. Further, instead of pursuing new verticals, we may prefer for various reasons to pursue alternative growth strategies, such as entry into markets that are adjacent to the markets in which we currently participate within our existing verticals, or the development of additional products or services for our existing markets.
Even if we choose to enter new verticals, our market validation process does not guarantee our success in any particular vertical. We may be unable to develop a software solution for a new vertical or, in the event that we enter a new vertical by way of a strategic acquisition, we may be unable to leverage the acquired software solution in time to take advantage of the identified market opportunity, and any delay in our time-to-market could expose us to additional competition or other factors that could impede our success. In addition, any software solution we develop or acquire for a new vertical may not provide the functionality required by potential customers and, as a result, may not achieve widespread market acceptance within the new vertical. To the extent we choose to enter new verticals, whether organically or via strategic acquisition, we may invest significant resources to develop and expand the functionality of our software solutions to meet the needs of customers in those verticals, which investments will occur in advance of our realization of revenue from them. 
In addition, while we expedited our entry into the legal vertical through the acquisition of MyCase in 2012, our practice and case management solution is in an earlier stage of development than APM, our property management solution, and we are at an earlier stage in the process of expanding the core functionality and Value+ services associated with our legal software. We face significant competition in the legal market from both vertical software vendors and cloud-based solution providers that offer one or more point solutions. There can be no assurance that we will be able to achieve market acceptance for our legal software at or near the levels achieved by our property management software. The success of our vertical market strategy depends, in part, on our ability to continue to significantly increase the number of our law firm customers and the revenue derived from them, and our failure to achieve these objectives could have an adverse impact on our operating results.
We have acquired, and may in the future acquire, other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders and otherwise disrupt our operations.
We have acquired, and may in the future acquire, other companies or technologies to complement or expand our software solutions, optimize our technical capabilities, enhance our ability to compete in our targeted verticals, provide an opportunity to expand into an adjacent market or new vertical, or otherwise offer growth or strategic opportunities. For example, in 2012, we acquired MyCase and in April 2015, we acquired RentLinx. The pursuit of acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated.
We have limited experience acquiring other businesses. We may not be able to integrate acquired assets, technologies, personnel and operations successfully or achieve the anticipated synergies or other benefits from the acquired business due to a number of risks associated with acquisitions, including:
incurrence of acquisition-related costs;
difficulties integrating the assets, technologies, personnel or operations of the acquired business in a cost-effective manner, or inability to do so;
difficulties and additional expenses associated with supporting legacy products and services of the acquired business;
difficulties converting the customers of the acquired business to our software solutions and contract terms;
diversion of management’s attention from our business to address acquisition and integration challenges;
adverse effects on our existing business relationships with customers and strategic partners as a result of the acquisition;
cultural challenges associated with integrating employees from the acquired organization into our company;
the loss of key employees;
use of resources that are needed in other parts of our business;
use of substantial portions of our available cash to consummate the acquisition; and
unanticipated costs or liabilities associated with the acquisition.

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If an acquired business fails to meet our expectations in terms of its contribution to our overall business strategy, or if the costs of acquiring or integrating the acquired business exceed our estimates, our business, operating results and financial condition may suffer. In addition, acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could impose restrictions on our ability to operate our business and adversely affect our operating results. Furthermore, a significant portion of the purchase price of companies we may acquire could be allocated to goodwill and other intangible assets, which must be assessed for impairment. In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our operating results based on this impairment assessment process, which could adversely affect our operating results.
If our property manager customers stop requiring residents to provide proof of legal liability to landlord insurance, if insurance premiums decline or if insureds experience greater than expected losses, our operating results could be harmed.
We generate revenue by offering legal liability to landlord insurance through a wholly owned subsidiary. Some of our property manager customers require residents to provide proof of legal liability to landlord insurance and offer to enroll residents in their legal liability to landlord insurance policy. If demand for rental housing declines, or if our property manager customers believe that it may decline, these customers may reduce their rental rates and stop requiring residents to provide proof of legal liability to landlord insurance in order to reduce the overall cost of renting and make their rental offerings more competitive. If our property manager customers stop requiring residents to provide proof of legal liability to landlord insurance or elect to enroll residents in insurance programs offered by competing providers, or if insurance premiums otherwise decline, our revenues from insurance services could be adversely affected.
Additionally, our legal liability to landlord insurance policies are underwritten by us, and we are required by our insurance partner to maintain a reserve to cover potential claims under the policies. While our policies have a limit of $100,000 per occurrence, there is no limit on the dollar amount of claims that could be made against us in any particular period or in the aggregate. In the event that claims by the insureds increase unexpectedly, our reserve may not be sufficient to cover our resulting liability under the policies. To the extent we are required to pay out amounts to insureds that are significantly higher than our current reserves, this could have a material adverse effect on our operating results.
Our insurance business is subject to state governmental regulation, which could limit the growth of our insurance business and impose additional costs on us.
Our insurance-related wholly owned subsidiaries and third-party service providers maintain licenses with a number of individual state departments of insurance. Collectively, we are subject to state governmental regulation and supervision in connection with the operation of our insurance business, which includes both our legal liability to landlord insurance and more recent renters insurance businesses. This state governmental supervision could limit the growth of our insurance business by increasing the costs of regulatory compliance, limiting or restricting the products or services we provide or the methods by which we provide them, and subjecting us to the possibility of regulatory actions or proceedings. Our continued ability to maintain these insurance licenses in the jurisdictions in which we are licensed depends on our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions. Furthermore, state insurance departments conduct periodic examinations, audits and investigations of the affairs of insurance companies and agencies, any of which could result in the expenditure of significant management time or financial resources.
     In all jurisdictions, the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities are vested with relatively broad discretion to grant, renew and revoke licenses and approvals and to implement and interpret rules and regulations. Accordingly, we may be precluded or temporarily suspended from carrying on some or all of the activities of our insurance business or otherwise be fined or penalized in a given jurisdiction. No assurances can be given that our insurance business can continue to be conducted in any given jurisdiction as it has been conducted in the past or that we will be able to expand our insurance business in the future.

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All of our revenues are generated by sales to customers in our targeted verticals, and factors that adversely affect the applicable industry could also adversely affect us.
Currently, all of our sales are to customers in the real estate and legal markets. Demand for our software solutions could be affected by factors that are unique to and adversely affect our targeted verticals. In particular, the real estate and legal markets are highly regulated, subject to intense competition and impacted by changes in general economic and market conditions. For example, changes in applicable laws and regulations could significantly impact the software functionality demanded by our customers and require us to expend significant resources to ensure our software solutions continue to meet their evolving needs. In addition, other industry-specific factors, such as industry consolidation or the introduction of competing or disruptive technology, could lead to a significant reduction in the number of customers that use our software solutions within a particular vertical or the Value+ services demanded by these customers. Further, if the real estate or legal markets decline, our customers may decide not to renew their subscriptions or they may cease using our Value+ services in order to reduce costs to remain competitive. As a result, our ability to generate revenue from our real estate and legal market customers could be adversely affected by specific factors that affect the real estate or legal markets.
In addition to the foregoing risks associated with our targeted verticals themselves, there is an overarching risk stemming from potential widespread adoption of quickly evolving financial or other disruptive technology products that could significantly impact our targeted verticals, even if that technology is not specifically designed to apply directly to our targeted verticals. The adoption of these new technologies could significantly reduce the volume or demand of customers in our targeted verticals, thereby reducing our revenue, which could materially impact our business, financial condition, operating results and, ultimately, our stock price.
Our software solutions address functions within the heavily regulated real estate and legal markets, and our customers’ failure to comply with applicable laws and regulations could subject us to litigation.
We sell our software solutions to customers within the real estate and legal markets. Our customers use our software solutions for business activities that are subject to a number of laws and regulations, including without limitation state and local real property laws and legal ethics rules. Any failure by our customers to comply with laws and regulations applicable to their businesses could result in fines, penalties or claims for substantial damages against our customers. To the extent our customers believe that our software solutions or our customer service organization caused or contributed to such failures, our customers may make claims for damages against us, regardless of whether we are responsible for the failure. As a result, we may be subject to lawsuits that, even if unsuccessful, could divert our resources and our management’s attention and adversely affect our business, and our insurance coverage may not be sufficient to cover such claims against us.
If we are unable to deliver effective customer service, it could harm our relationships with our existing customers and adversely affect our ability to attract new customers.
Our business depends, in part, on our ability to satisfy our customers, both by providing software solutions that address their business needs, and by providing on-boarding services and ongoing customer service, which contributes to retaining customers and increasing adoption and utilization of our Value+ services by our existing customers. Once our software solutions are deployed, our customers depend on our customer service organization to resolve technical issues relating to their use of our solutions. We may be unable to respond quickly to accommodate short-term increases in customer demand for support services or may otherwise encounter a customer issue that is difficult to resolve. If a customer is not satisfied with the quality or responsiveness of our customer service, we could incur additional costs to address the situation. As we do not separately charge our customers for support services, increased demand for our support services would increase costs without corresponding revenue, which could adversely affect our operating results. In addition, regardless of the quality or responsiveness of our customer service efforts, a customer that is not satisfied with an outcome may choose to terminate, or not to renew, their relationship with us.
     Our sales process is highly dependent on the ease of use of our software solutions, our reputation and positive recommendations from our existing customers. Any failure to maintain high-quality or responsive customer service, or a market perception that we do not maintain high-quality or responsive customer service, could harm our reputation, cause us to lose customers and adversely impact our ability to sell our software solutions to prospective customers.
If we are unable to maintain and promote our brands, or to do so in a cost-effective manner, our ability to maintain and expand our customer base will be impaired, and our operating results could be adversely affected.
We believe that maintaining and promoting our brands is critical to achieving widespread awareness and acceptance of our software solutions, and maintaining and expanding our customer base. We also believe that the importance of brand recognition will increase as competition in our targeted verticals increases. If we do not continue to build awareness of our brands, we could be placed at a competitive disadvantage as compared to companies whose brands are, or become, more recognizable than ours. Maintaining and promoting our brands will depend, in part, on our ability to continue to provide new and innovative core

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functionality and Value+ services and best-in-class customer service, as well as the effectiveness of our sales and marketing efforts. If we fail to deliver products and functionality that address our customers’ business needs, or if we fail to meet our customers’ expectations for customer service, it could weaken our brands and harm our reputation. Additionally, the actions of third parties which are out of our control may affect our brands and reputation if customers do not have a positive experience using the services of our third-party partners that support our software solutions. Maintaining and enhancing our brands may require us to make substantial investments, and these investments may not result in commensurate increases in our revenue. If we fail to successfully maintain and promote our brands, or if we make investments that are not offset by increased revenue, our operating results could be adversely affected.
If we are unable to increase sales of our software solutions to larger customers while mitigating the risks associated with serving such customers, our business and operating results may suffer.
While we plan to continue to market and sell our software solutions to SMBs, our growth strategy is dependent, in part, upon increasing sales of our software solutions to larger customers within the SMB market. Sales to larger customers may involve risks that are not present, or are present to a lesser extent, in sales to smaller businesses. As we seek to increase our sales to larger customers, we may invest considerably greater amounts of time and financial resources in our sales and marketing efforts. In addition, we may face longer sales cycles and experience less predictability and greater competition in completing some of our sales than we have in selling our software solutions to smaller businesses. Although we generally have not configured our software solutions or negotiated our pricing for specific customers, which has historically resulted in reduced upfront selling costs, our ability to successfully sell our software solutions to larger customers may be dependent, in part, on our ability to develop functionality, or to implement pricing policies, that are unique to particular customers. It may also be dependent on our ability to attract and retain sales personnel with experience selling to larger organizations. Also, because security breaches or other performance problems with respect to larger customers may result in greater economic harm to these customers and more adverse publicity, there is increased financial and reputational risk associated with serving such customers. If we are unable to increase sales of our software solutions to larger customers, while mitigating the risks associated with serving such customers, our business and operating results may suffer.
Because we recognize revenue from subscriptions for our software solutions over the term of each subscription agreement, downturns or upturns in new business may not be immediately reflected in our operating results.
We recognize revenue from customers ratably over the term of each subscription agreement, which typically ranges from one month to one year. As a result, some of the revenue we report in each period is derived from the recognition of deferred revenue relating to subscription agreements entered into during previous periods. Consequently, a decline in new or renewed subscriptions in any one period may not be reflected in our revenue results for that period. However, any such decline 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 revenue from new customers must be recognized over the applicable subscription period. Accordingly, the effect of downturns or upturns in our sales, the market acceptance of our software solutions, and potential changes in our customer retention rates, may not be apparent in our operating results until future periods.
Because our invoicing is generally for periods less than one year, our revenue growth is heavily dependent on new subscription sales, consumption of our usage-based Value+ services and renewals of our subscription services in the current year.
Our growth is heavily dependent on subscription sales, adoption and consumption of our usage-based Value+ services and renewals of our subscription services in the current year. We offer our core solutions and Value+ subscription services to customers pursuant to subscription agreements with relatively short terms, typically ranging from one month to one year. We generally invoice our customers for subscription services in monthly, quarterly or annual installments, typically in advance of the subscription period. We do not currently intend to extend the typical terms of our subscription agreements with any regularity, or to invoice our customers less frequently, and we expect that we will continue to depend on current-year sales and renewals to drive our growth.
Failure to protect our intellectual property rights could impair our ability to protect our proprietary technology and our brands, which could harm our business.
We currently rely on patent, trademark, copyright and trade secret laws, trade secret protection and confidentiality or license agreements with our employees, customers, partners and others to protect our intellectual property rights. Our success and ability to compete depend, in part, on our ability to continue to protect our intellectual property, including our proprietary technology and our brands. If we are unable to protect our proprietary rights adequately, our competitors could use the intellectual property we have developed to enhance their own products and services, which could harm our business.
In order to monitor and protect our intellectual property rights, we may be required to expend significant resources. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to

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management, and could result in the impairment or loss of portions of our intellectual property or require us to pay costly royalties. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights. Accordingly, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. Our failure to secure, protect and enforce our intellectual property rights could adversely affect our business and operating results.
We may be sued by third parties for alleged infringement of their proprietary rights, which could cause us to incur significant expenses and require us to pay substantial damages.
There is considerable patent, trademark, copyright, trade secret and other intellectual property development activity in our industry. Our success depends, in part, on our not infringing upon the intellectual property rights of others. Our competitors, as well as a number of other entities and individuals, may legally own or claim to own intellectual property relating to our technology or software solutions. From time to time, our competitors or other third parties may claim that we are infringing upon their intellectual property rights. However, we may be unaware of the intellectual property rights that others may claim cover some or all of our technology or software solutions. Any claims or litigation, regardless of merit, could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages, settlement costs or ongoing royalty payments, require that we comply with other unfavorable license and other terms, or prevent us from offering our software solutions in their current form. 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 attention of our management and key personnel from our business operations and harm our operating results.
Our software solutions contain both third-party and open source software, which may pose risks to our proprietary source code and/or introduce security vulnerabilities, and could have a negative impact on our business and operating results.

We use open source software in our software solutions and expect to continue to do so in the future. The terms of many open source licenses to which we are subject have not been interpreted by United States or foreign courts, and there is a risk that open source licenses could be construed in a manner that imposes unanticipated conditions, restrictions or costs on our ability to provide or distribute our software solutions. Additionally, we may from time to time face claims from third parties alleging ownership of, or demanding release of, the open source software or of derivative works that we developed using such software, which could include our proprietary source code, or otherwise seeking to enforce the terms of the applicable open source license. These claims could result in litigation, which could be costly for us to defend, and could require us to make our source code freely available, purchase a costly license or cease offering the implicated core functionality and Value+ services unless and until we can re-engineer them to avoid infringement. This re-engineering process could require significant additional research and product development resources, and we may not be able to complete it successfully or in a timely manner. In addition to risks related to license requirements, usage of certain open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of software. These risks could be difficult to eliminate or manage, and could have a negative impact on our business and operating results.

We also use third-party commercial software in our software solutions and expect to continue to do so in the future. Third-party commercial software is developed outside of our direct control, and may introduce security vulnerabilities that may be difficult to anticipate or mitigate. Further, there is no guarantee that third-party software developers will continue active work on the third-party software that we use. Should development of in-use third-party software cease, significant engineering effort may be required to create an in-house solution. These risks could also be difficult to eliminate or manage, and could have a negative impact on our business and operating results.
Changes in laws and regulations related to the Internet or changes in the Internet infrastructure itself may diminish the demand for our software solutions, and could have a negative impact on our business.
The future success of our business depends upon the continued use of the Internet as a primary medium for commerce, communication and business services. Federal, state or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations affecting the use of the Internet as a commercial medium. Changes in these laws or regulations, including laws impacting net neutrality, could decrease the demand for our software solutions and services and/or increase our cost of doing business, or require us to modify our software solutions to comply with or otherwise address any new or changed laws or regulations.
In addition, government agencies or private organizations may begin to impose taxes, fees or other charges for accessing the Internet, or for the commerce conducted via the Internet. These laws or charges could limit the growth of Internet-related commerce or communications generally, result in reductions in the demand for Internet-based business services such as ours, and cause us to incur significant expenses.
The use of the Internet in general could be adversely affected by delays in the development or adoption of new standards

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and protocols to handle increased demands of Internet activity, accessibility, reliability, security, cost, ease of use and quality of service. In addition, the use of the Internet as a medium for commerce, communication and business services may have been, and may continue to be, adversely affected by concerns regarding network outages, software errors, viruses, security breaches, fraud or other malicious activity. If the use of the Internet is adversely affected by these issues, demand for our software solutions could decrease.
Privacy and data security laws and regulations could impose additional costs on us and reduce the demand for our software solutions.
Our customers store and transmit a significant amount of personal or identifying information through our technology platform. Privacy and data security have become significant issues in the United States and in other jurisdictions where we may offer our software solutions. The regulatory framework relating to privacy and data security worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future. Federal, state and foreign government bodies and agencies have in the past adopted, and may in the future adopt, laws and regulations regarding the collection, use, processing, storage and disclosure of personal or identifying information obtained from customers and other individuals. In addition to government regulation, privacy advocates and industry groups may propose various self-regulatory standards that may legally or contractually apply to our business. Because the interpretation and application of many privacy and data security laws, regulations and applicable industry standards are uncertain, it is possible that these laws, regulations and standards may be interpreted and applied in a manner inconsistent with our existing privacy and data management practices. As we expand into new jurisdictions or verticals, we will need to understand and comply with various new requirements applicable in those jurisdictions or verticals.
To the extent applicable to our business or the businesses of our customers, these laws, regulations and industry standards could have negative effects on our business, including by increasing our costs and operating expenses, and/or delaying or impeding our deployment of new or existing core functionality or Value+ services. Compliance with these laws, regulations and industry standards requires significant management time and attention, and failure to comply could result in negative publicity, subject us to fines or penalties, or result in demands that we modify or cease existing business practices. In addition, the costs of compliance with, and other burdens imposed by, such laws, regulations and industry standards may adversely affect our customers’ ability or desire to collect, use, process and store personal information using our software solutions, which could reduce overall demand for them. Even the perception of privacy and data security concerns, whether or not valid, may inhibit market acceptance of our software solutions in certain verticals. Furthermore, privacy and data security concerns may cause our customers’ clients, vendors, employees and other industry participants to resist providing the personal information necessary to allow our customers to use our applications effectively. Any of these outcomes could adversely affect our business and operating results.
We may require additional capital to support our operations or the growth of our business, and we cannot be certain that this capital will be available on favorable terms when required, or at all.
We may need additional capital to grow our business and meet our strategic objectives. Our ability to obtain additional capital, if and when required, will depend on numerous factors, including investor and lender demand, our historical and forecasted financial and operating performance, our market position, and the overall condition of the capital markets. We cannot guarantee that additional financing will be available to us on favorable terms when required, or at all. In addition, if we raise additional funds through the issuance of equity securities, those securities may have powers, preferences or rights senior to the rights of our Class A common stock, and our existing stockholders may experience dilution. If we raise additional funds through the issuance of debt securities, we may incur interest expense or other costs to service the indebtedness, or we may be required to encumber certain assets, which could negatively impact our operating results. Furthermore, 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 the growth of our business and the achievement of our strategic objectives could be significantly impaired and our operating results may be harmed.
Financing agreements that we are party to or may become party to may contain operating and financial covenants that restrict our business and financing activities. Failure to comply with these covenants, or other restrictions, could result in default under these agreements.
Our existing credit agreement with Wells Fargo as administrative agent, and the lenders that are parties thereto, which we refer to as our Credit Agreement, contains certain operating and financial restrictions and covenants, including limitations on dividends, dispositions, mergers or consolidations, incurrence of indebtedness and liens, and other corporate activities. These restrictions and covenants, as well as those contained in any future financing agreements that we may enter into, may restrict our ability to finance our operations, and to engage in, expand or otherwise pursue our business activities and strategic objectives. Our ability to comply with these covenants may be affected by events beyond our control, and breaches of these covenants could result in a default under our existing Credit Agreement and any future financing agreements that we may enter into. If not waived, defaults could cause any outstanding indebtedness under our Credit Agreement and any future financing agreements that we may enter into to become immediately due and payable.

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Because our long-term growth strategy involves expansion of our sales to customers outside the United States, our business will be susceptible to the risks associated with international operations.
A component of our growth strategy involves the expansion of our international operations and worldwide customer base. To date, we have realized an immaterial amount of revenue from customers outside the United States. Operating in international markets will require significant resources and management attention and will subject us to regulatory, economic, geographic and political risks that are different from those in the United States. Because of our limited experience with international operations and significant differences between the United States and international markets, our international expansion efforts may not be successful in creating demand for our software solutions outside of the United States or in effectively selling our software solutions in any international markets we may enter. If we invest substantial time and resources to expand our international operations and are unable to do so successfully, our business and operating results could suffer.

If we fail to maintain an effective system of internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired.
In connection with the audit of our consolidated financial statements for fiscal year 2014, our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting. As of December 31, 2015, we completed remediation of these material weaknesses. However, the completion of remediation does not provide assurance that our controls will continue to operate properly or that our financial statements will not contain any material errors. There may be future material weaknesses in our internal control over financial reporting, and as a result we may not detect financial statement errors on a timely basis. Moreover, in the future we may engage in business transactions, such as acquisitions or reorganizations, implement new accounting standards, or adopt other changes to our business processes, any of which could require us to develop and implement new controls or to modify existing controls, which could negatively affect our internal control over financial reporting and result in material weaknesses.
In the event we experience a material weakness in our internal control over financial reporting in the future, we may not detect errors on a timely basis and our financial statements may be materially misstated. Ineffective internal control over financial reporting, failure to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner and the inability to express an opinion as to the effectiveness of our internal control over financial reporting could cause investors to lose confidence in our reported financial statements and other information, which could have a negative effect on the market price of our Class A common stock. Additionally, it could lead to an investigation by the SEC, NASDAQ Global Market or other regulatory authorities, which could require the expenditure of additional financial and management resources.
We are an emerging growth company and our decision to comply with certain reduced reporting and disclosure requirements could make our Class A common stock less attractive to investors.

We qualify as an emerging growth company under the Jumpstart Our Business Startups, or JOBS Act. An emerging growth company may take advantage of specified reduced reporting requirements and may be relieved of other significant requirements that are otherwise generally applicable to public companies. These provisions include:
an exemption from compliance with the auditor attestation requirement on the effectiveness of our internal control over financial reporting;
an exemption from compliance with any requirement that the Public Company Accounting Oversight Board may adopt regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements;
reduced disclosure about our executive compensation arrangements; and
exemptions from the requirements to obtain a non-binding advisory vote on executive compensation or stockholder approval of any golden parachute arrangements.

We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. However, in this Annual Report, we are taking advantage of the other exemptions discussed above. Accordingly, the information that we provide to our stockholders may be different from the information you receive from other public companies in which you have invested. If some investors find our Class A common stock less attractive as a result of our reliance on these exemptions, there may be a less active trading market for our Class A common stock, the market price of our Class A common stock may be more volatile, and the trading price of our Class A common stock may be lower than that of comparable companies.


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Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.

As of December 31, 2017, we had United States federal net operating loss carryforwards of approximately $73.5 million and state net operating loss carryforwards of approximately $48.0 million, which begin to expire in 2027 and 2023, respectively. As of December 31, 2017 we also had federal and state research and development credit carryforwards of $5.0 million and $5.4 million, respectively. The federal credits carryforwards will begin to expire in 2027, while the state credit carryforwards apply indefinitely. Under Section 382 of the Internal Revenue Code of 1986, as amended, if a corporation undergoes an “ownership change,” the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes, such as research tax credits, to offset its post-change income and taxes may be limited. In general, an “ownership change” occurs if there is a cumulative change in our ownership by “5% shareholders” that exceeds 50 percentage points over a rolling three-year period. Similar rules may apply under state tax laws. It is possible that our existing net operating loss and/or credit carryforwards may be subject to limitations arising from previous ownership changes, and future issuances of our stock could cause an ownership change. Furthermore, our ability to utilize net operating loss and/or credit carryforwards of companies that we have acquired or may acquire in the future may be subject to limitations. Any such limitations on our ability to use our net operating loss carryforwards and other tax assets could adversely impact our business, financial condition and operating results.
Tax laws or regulations could be enacted or changed and existing tax laws or regulations could be applied to us or to our customers in a manner that could increase the costs of our software solutions and adversely impact our operating results.

The application of federal, state, local and foreign tax laws to services provided electronically is continuously evolving. New income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted or amended at any time, possibly with retroactive effect, and could be applied solely or disproportionately to services provided over the Internet. These enactments or amendments could adversely affect our sales activity due to the inherent cost increase the taxes would represent and could ultimately result in a negative impact on our operating results.

In addition, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, modified or applied adversely to us, possibly with retroactive effect, which could require us or our customers to pay additional tax amounts, as well as require us or our customers to pay fines or penalties, as well as interest on past amounts. If we are unsuccessful in collecting such taxes due from our customers, we could be held liable for such costs, thereby adversely impacting our operating results.
We may be subject to additional tax liabilities.

We are subject to income, sales, use, value added and other taxes in the United States and other jurisdictions in which we conduct business, and such laws and rates vary by jurisdiction. Certain jurisdictions in which we do not collect sales, use, value added or other taxes on our sales may assert that such taxes are applicable, which could result in tax assessments, penalties and interest, and we may be required to pay or collect such taxes in the future. If we receive an adverse determination as a result of an audit or related litigation, or we unilaterally determine that we have misinterpreted provisions of the tax regulations to which we are subject, there could be a material effect on our tax provision, net income or cash flows in the period or periods for which that determination is made.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.

Generally accepted accounting principles in the United States, are subject to interpretation by the Financial Accounting Standards Board, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant impact on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change.
Risks Related to Our Class A Common Stock
The market price of our Class A common stock may be volatile or may decline regardless of our operating performance, which could result in substantial losses for our stockholders.

The market price of our Class A common stock has been, and is likely to continue to be, highly volatile, and fluctuations in the price of our Class A common stock could cause you to lose all or part of your investment. For example, during 2017, the share price of our Class A common stock on the NASDAQ Global Market fluctuated between $21.63 and $52.25.

25



There are numerous factors that could cause fluctuations in the market price of our Class A common stock, including:
price and volume fluctuations in the overall stock market from time to time;
volatility in the market prices and trading volumes of securities issued by software companies;
changes in operating performance and stock market valuations of other software companies generally, and of companies that sell cloud-based solutions within our targeted verticals in particular;
sales of shares of our Class A common stock by us or our stockholders, or perceptions that such sales may occur;
any future announcements to repurchase our Class A common stock;
failure of securities analysts to maintain coverage of us, changes in financial estimates by securities analysts who follow us, or our failure to meet these estimates or the expectations of investors;
the guidance we may provide to the public, any changes in that guidance, and our performance relative to that guidance;
announcements by us or our competitors of new products or services;
public reaction to our press releases, filings with the SEC and other public announcements;
rumors and market speculation involving us or other software companies;
actual or anticipated changes in our operating results or fluctuations in our operating results;
actual or anticipated developments in our business, our competitors’ businesses or the competitive landscape generally;
litigation involving us, our industry or both, or investigations by regulators into our operations or those of our competitors;
developments or disputes concerning our intellectual property or other proprietary rights;
announced or completed acquisitions of businesses or technologies by us or our competitors;
new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
changes in accounting standards, policies, guidelines, interpretations or principles;
changes in our management; and
general economic conditions and trends, including slow or negative growth of our markets.

In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. If instituted against us, any such litigation, regardless of its merit or final outcome, could result in substantial costs and a diversion of our management’s attention, thereby adversely affecting our operating results and, potentially, the price of our Class A common stock.

The dual class structure of our common stock has the effect of concentrating voting control with a limited number of stockholders, including our executive officers, directors and principal stockholders, which will limit your ability to influence corporate matters.
Our Class B common stock has 10 votes per share, and our Class A common stock has one vote per share. As of December 31, 2017, the holders of the outstanding shares of our Class B common stock, including our executive officers, directors, and principal stockholders, collectively hold approximately 93% of the combined voting power of our outstanding capital stock. Because of the 10-to-1 voting ratio between our Class B common stock and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our outstanding capital stock and therefore are able to exercise significant influence and control over the establishment and implementation of our future business plans and strategic objectives, as well as to control all matters submitted to our stockholders for approval. These persons may manage our business in ways with which you disagree and which may be adverse to your interests. This concentrated control may also have the effect of delaying, deterring or preventing a change-in-control transaction, depriving our stockholders of an opportunity to receive a premium for their capital stock or negatively affecting the market price of our Class A common stock.

26



    
Transfers by holders of our Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions. The conversion of our Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of the holders of our Class B common stock who retain their shares over the long term.

We cannot predict the impact that our capital structure may have on our stock price.
 
In July 2017, S&P Dow Jones, a provider of widely followed stock indices, announced that companies with multiple share classes, such as ours, will not be eligible for inclusion in certain of their indices. As a result, our Class A common stock will likely not be eligible for those stock indices. Additionally, FTSE Russell, another provider of widely followed stock indices, recently stated that it plans to require new constituents of its indices to have at least five percent of their voting rights in the hands of public stockholders. As of December 31, 2017, the holders of the outstanding shares of our Class B common stock, including our executive officers, directors, and principal stockholders, collectively hold approximately 93% of the combined voting power of our outstanding capital stock. Many investment funds are precluded from investing in companies that are not included in such indices, and these funds would be unable to purchase our Class A common stock. We cannot assure you that other stock indices will not take a similar approach to S&P Dow Jones or FTSE Russell in the future. Exclusion from indices could make our Class A common stock less attractive to investors and, as a result, the market price of our Class A common stock could be adversely affected.
Anti-takeover provisions contained in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions of Delaware law, could impair a takeover attempt.

Our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that could have the effect of rendering more difficult hostile takeovers, change-in-control transactions or changes in our board of directors or management. Among other things, these provisions:
authorize the issuance of preferred stock with powers, preferences and rights that may be senior to our common stock, which can be created and issued by our board of directors without prior stockholder approval;
provide for the adoption of a staggered board of directors whereby our board is divided into three classes, each of which has a different three-year term;
provide that the number of directors will be fixed by our board of directors;
prohibit our stockholders from filling vacancies on our board of directors;
provide for the removal of a director only for cause and then only by the affirmative vote of the holders of a majority of the combined voting power of our outstanding capital stock;
prohibit stockholders from calling special stockholder meetings;
prohibit stockholders from acting by written consent without holding a meeting of stockholders;
require the vote of at least two-thirds of the combined voting power of our outstanding capital stock to approve amendments to our certificate of incorporation or bylaws;
require advance written notice of stockholder proposals and director nominations;
provide for a dual-class common stock structure, as discussed above; and
require the approval of the holders of at least a majority of the outstanding shares of our Class B common stock, voting as a separate class, prior to consummating a change-in-control transaction.

As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which may delay, deter or prevent a change-in-control transaction. Section 203 imposes certain restrictions on mergers, business combinations and other transactions between us and holders of 15% or more of our common stock.
Any provision of Delaware law, our amended and restated certificate of incorporation, or our amended and restated bylaws, that has the effect of rendering more difficult, delaying, deterring or preventing a change-in-control transaction could limit the opportunity for our stockholders to receive a premium for their shares of our capital stock, and could also affect the

27



price that some investors are willing to pay for our Class A common stock.
Future sales of shares of our Class A common stock, or the perception that these sales could occur, could depress the market price of our Class A common stock.
     Sales of a substantial number of shares of our Class A common stock in the public market, or the perception that these sales might occur, could cause the market price of our Class A common stock to decline or make it more difficult for you to sell your Class A common stock at a time and price that you deem appropriate, and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that sales, or the perception that our shares may be available for sale, will have on the prevailing market price of our Class A common stock.
As of December 31, 2017, we had an aggregate of 1.7 million options outstanding that, if fully exercised, would result in the issuance of additional shares of Class A common stock or Class B common stock, as applicable. Our Class B common stock converts into Class A common stock on a one-for-one basis. In addition, as of December 31, 2017, we had 0.6 million restricted stock units, or RSUs, outstanding which, if fully vested and settled in shares, would result in the issuance of additional shares of Class A common stock. All of the shares of Class A common stock issuable upon the exercise of options (or upon conversion of shares of Class B common stock issued upon the exercise of options), or upon the vesting and settlement of RSUs, have been registered for public resale under the Securities Act. Accordingly, these shares will be able to be freely sold in the public market upon issuance.
Certain holders of our Class A common stock and Class B common stock have rights, subject to certain conditions, to require us to file registration statements for the public resale of such shares (in the case of Class B common stock, the Class A common stock issuable upon conversion of such shares) or to include such shares in registration statements that we may file for us or other stockholders.  Any sales of securities by these stockholders could have a material adverse effect on the market price of our Class A common stock.
If securities or industry analysts do not publish or cease publishing research or reports about us, our business, our market or our competitors, or if they adversely change their recommendations regarding our Class A common stock, the market price and trading volume of our Class A common stock could decline.
The trading market for our Class A common stock is influenced, to some extent, by the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. If any of the analysts who cover us adversely change their recommendations regarding our Class A common stock or provide more favorable recommendations about our competitors, the market price of our Class A common stock may decline. If any of the analysts who cover us were to cease coverage of us or fail to publish reports on us regularly, visibility of our company in the financial markets could decrease, which in turn could cause the market price or trading volume of our Class A common stock to decline.
We do not expect to declare any dividends in the foreseeable future.
We have never declared or paid any cash dividends on our existing common stock. We do not anticipate declaring or paying any cash dividends to holders of our Class A common stock in the foreseeable future and intend to retain all future earnings for use in the growth of our business. In addition, the terms of our Credit Agreement restrict our ability to pay dividends. Consequently, investors may need to rely on sales of our Class A common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors should not purchase our Class A common stock with the expectation of receiving cash dividends.
ITEM 1B.     UNRESOLVED STAFF COMMENTS

None.

ITEM 2.
PROPERTIES
Our corporate headquarters is located in two adjacent buildings in Santa Barbara, California. The lease on the first building covers approximately 43,300 square feet and expires in December 2021. The lease on the second building covers approximately 35,900 square feet and expires in November 2020.
We also lease space in San Diego, California and Richardson, Texas under leases that expire at various times between 2021 and 2022.

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We intend to procure additional space as we add employees and expand our operations geographically. We believe our current facilities are adequate for our current needs and that, should it be needed, suitable additional or alternative space will be available to us to accommodate any such expansion of our operations.
We lease all of our facilities and do not own any real property.

ITEM 3.
LEGAL PROCEEDINGS

From time to time, we are involved in various legal proceedings arising from or related to claims incident to the normal course of our business activities. Although the results of such legal proceedings and claims cannot be predicted with certainty, we believe we are not currently a party to any legal proceeding(s) which, if determined adversely to us, would, individually or taken together, have a material adverse effect on our business, operating results, financial condition or cash flows. However, regardless of the merit of any claims raised or the ultimate outcome, legal proceedings may generally have an adverse impact on us as a result of defense and settlement costs, diversion of management resources and other factors.
 
ITEM 4.     MINE SAFETY DISCLOSURES

Not applicable.

29





PART II

ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information for our Class A Common Stock
    
Our Class A common stock began trading publicly on the NASDAQ Global Market under the symbol "APPF" on June 26, 2015. Prior to that date, there was no public trading market for our Class A common stock. The following table sets forth the high and low intraday sales prices per share of our Class A common stock as reported on the NASDAQ Global Market for the periods indicated:
 
High
 
Low
Year ended December 31, 2017:
 
 
 
First quarter
$
27.90

 
$
21.63

Second quarter
$
35.20

 
$
25.05

Third quarter
$
48.40

 
$
31.15

Fourth quarter
$
52.25

 
$
39.60

 
 
 
 
 
High
 
Low
Year ended December 31, 2016:
 
 
 
First quarter
$
15.19

 
$
11.07

Second quarter
$
15.57

 
$
12.07

Third quarter
$
19.98

 
$
14.12

Fourth quarter
$
24.50

 
$
18.27


Holders of Record

As of February 1, 2018, there were 30 holders of record of our Class A common stock and 116 holders of record of our Class B common stock. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.

Dividend Policy

We have never declared or paid any cash dividends on our capital stock. We have no plans to declare or pay any dividends on our capital stock in the foreseeable future and intend to retain all future earnings, if any, generated by our operations for use in the growth of our business. Any future decision to declare or pay dividends will be made by our board of directors in its sole discretion and will depend upon our financial condition, results of operations, capital requirements, general economic conditions and other factors that our board of directors deems relevant at the time of its decision. Investors should not purchase our Class A common stock with the expectation of receiving cash dividends. In addition, the terms of our Credit Agreement may restrict our ability to pay dividends.

Stock Repurchase Program
    
Our board of directors may, from time to time, authorize our management to repurchase shares of our Class A common stock in open market transactions, privately negotiated transactions or otherwise.


30



Stock Performance Graph

The following performance graph compares the cumulative total return on our Class A common stock with that of the S&P 500 Index and the NASDAQ Computer Index. This chart assumes $100 was invested at the close of market on June 26, 2015, which was our initial trading day, in our Class A common stock, the S&P 500 Index and the NASDAQ Computer Index, and assumes the reinvestment of any dividends.

The comparisons in the graph below are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common stock.


chart-378c1bf2da4b54dba75.jpg    
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any of our other filings under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

Unregistered Sales of Equity Securities
None.

Use of Proceeds
None.


31



ITEM 6.     SELECTED FINANCIAL DATA

The following tables provide our historical selected consolidated financial data for the periods indicated. We have derived the selected Consolidated Statements of Operations data for the fiscal years ended December 31, 2017, 2016 and 2015 and the selected Consolidated Balance Sheet data as of December 31, 2017 and 2016 from our audited Consolidated Financial Statements included elsewhere in this Annual Report. We have derived the selected Consolidated Statements of Operations data for the fiscal years ended December 31, 2014 and 2013 and the selected Consolidated Balance Sheet data as of December 31, 2015, 2014 and 2013 from our audited Consolidated Financial Statements, which are not included in this Annual Report. Our historical results are not necessarily indicative of the results we expect in the future.
The following historical selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, the section of this Annual Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the related notes included elsewhere in this Annual Report.
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
 
2013
 
 
(in thousands, except per share data)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
$
143,803

 
$
105,586

 
$
74,977

 
$
47,671

 
$
26,542

Costs and operating expenses:
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)(1)
55,283

 
44,630

 
33,903

 
22,555

 
13,616

Sales and marketing(1)
28,709

 
28,827

 
26,076

 
16,876

 
10,337

Research and product development(1)
16,578

 
12,638

 
9,554

 
6,505

 
5,057

General and administrative(1)
21,199

 
17,979

 
14,343

 
6,489

 
2,286

Depreciation and amortization
12,699

 
9,935

 
6,104

 
3,805

 
2,850

Total costs and operating expenses
134,468

 
114,009

 
89,980

 
56,230

 
34,146

Income (loss) from operations
9,335

 
(8,423
)
 
(15,003
)
 
(8,559
)
 
(7,604
)
Other income (expense), net
(96
)
 
(37
)
 
5

 
(121
)
 
287

Interest income (expense), net
535

 
246

 
(595
)
 
59

 
12

Income (loss) before provision for income taxes
9,774

 
(8,214
)
 
(15,593
)
 
(8,621
)
 
(7,305
)
Provision for income taxes
58

 
67

 
75

 

 

Net income (loss)
$
9,716

 
$
(8,281
)
 
$
(15,668
)
 
$
(8,621
)
 
$
(7,305
)
Net income (loss) per common share:
 
 
 
 
 
 
 
 
 
    Basic
0.29

 
(0.25
)
 
(0.73
)
 
(0.98
)
 
(0.87
)
    Diluted
0.28

 
(0.25
)
 
(0.73
)
 
(0.98
)
 
(0.87
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
    Basic
33,849

 
33,561

 
21,336

 
8,757

 
8,437

    Diluted
35,151

 
33,561

 
21,336

 
8,757

 
8,437

(1) Includes stock-based compensation expense as follows (in thousands):
 
 
 
 
 
 
 

32



 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
 
2013
 
 
(in thousands)
Stock-based compensation expense included in Costs and operating expenses:
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)
$
725

 
$
471

 
$
124

 
$
68

 
$
63

Sales and marketing
723

 
442

 
115

 
48

 
39

Research and product development
657

 
382

 
41

 
19

 
49

General and administrative
3,991

 
3,006

 
727

 
757

 
96

Total stock-based compensation expense
$
6,096

 
$
4,301

 
$
1,007

 
$
892

 
$
247


 
December 31,
 
2017
 
2016
 
2015
 
2014
 
 
2013
 
 
(in thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents and investment securities(1)
$
68,310

 
$
52,860

 
$
56,715

 
$
5,412

 
$
11,269

Total assets
110,248

 
92,583

 
90,481

 
25,434

 
27,707

Deferred revenue
7,080

 
7,638

 
4,953

 
3,780

 
2,943

Convertible preferred stock

 

 

 
63,166

 
63,166

Total stockholders’ equity (deficit)
85,079

 
69,682

 
72,697

 
(51,467
)
 
(43,959
)
(1) Amounts for the years ended December 31, 2017, 2016 and 2015 include cash and cash equivalents, investment securities-current and investment securities-noncurrent. We held no investment securities during the years ended December 31, 2014 and 2013.

ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and the related notes included elsewhere in this Annual Report. This discussion and analysis contains forward-looking statements that are based on our current expectations and reflect our plans, estimates and anticipated future financial performance. See the section of this Annual Report entitled “Cautionary Note Regarding Forward-Looking Statements” for additional information. These statements involve numerous risks and uncertainties. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in the section of this Annual Report entitled “Risk Factors.”
Overview
AppFolio is a provider of industry-specific, cloud-based software solutions to the real estate market, which comprises a significant majority of our revenue, as well as to the legal market, and we intend to enter new vertical markets over time. We were formed in 2006 with a vision to revolutionize the way that small and medium-sized businesses, or SMBs, grow and compete by enabling their digital transformation.
In 2008, we entered the real estate market with our first product, AppFolio Property Manager, or APM, a property management solution designed to address the unique operational and business requirements of property management companies. In 2012, we entered the legal market by acquiring MyCase, a legal practice and case management solution primarily for solo practitioners and small law firms. Recognizing that our customers would benefit from additional business-critical services that they can purchase as needed, we launched a series of Value+ services beginning in 2009. Through our market validation approach and ongoing investment in product development, we continuously update our software solutions with new and innovative core functionality and Value+ services, as well as assess opportunities in adjacent markets and new verticals.
Our solutions are designed to be a system of record to automate essential business processes, a system of engagement to enhance business interactions between our customers and their clients and vendors, and, increasingly, a system of intelligence to anticipate, influence, and optimize customer experiences using data to take action in real time.
We have focused on growing our revenue by increasing the size of our customer base in the markets we serve, increasing the number of units under management, introducing new or expanded Value+ services, retaining customers, and increasing the

33



adoption and utilization of our Value+ services by new and existing customers. We define our customer base as the number of customers subscribing to our core solutions, exclusive of free trials.
Our property management software solution for the real estate market provides property managers of various sizes (including both third-party managers and owner-operators) innovative tools and services designed to streamline their property management businesses. Our software solution serves a variety of property types, including single- and multi-family residential, commercial, community association, and student housing, and is continuously evolving to help our customers more effectively market, manage and grow their businesses. Core functionality addresses key operational issues, including posting and tracking vacancies, efficiently leasing vacant properties, facilitating tenant, owner and vendor communications, and accounting, among other things.
Today our property manager customers directly and indirectly account for more than 90% of our annual revenue. We define our property manager customer base as the number of customers subscribing to our core solutions. Customer count and property manager units under management are summarized in the table below:
 
Quarter Ended
 
2017
 
2016
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
Property manager
11,708

 
11,258

 
10,820

 
10,468

 
10,038

 
9,612

 
9,275

 
8,816

Property manager units under management (in millions)
3.25

 
3.08

 
2.93

 
2.83

 
2.68

 
2.53

 
2.41

 
2.30


Our legal software solution, MyCase, enables solo practitioners and small law firms to more efficiently administer their practice and manage their caseload. MyCase is continuously evolving to help our customers more effectively market, manage and grow their businesses, and contains core functionality that addresses key operational issues, including managing calendars, contacts and documents, time tracking, billing and collections, communicating with clients and sharing sensitive and privileged materials.
Our legal customers directly and indirectly account for less than 10% of our annual revenue. We define our legal customer base as the number of customers subscribing to our core solutions, exclusive of free trial periods. Law firm customer count is summarized in the table below:
 
Quarter Ended
 
2017
 
2016
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
Law firm
9,349

 
9,128(1)
 
8,913

 
8,676

 
8,135

 
7,799

 
7,349

 
6,834

(1)    This customer count has been corrected from the previously-reported count of 9,214.
To date, we have experienced rapid revenue growth due to our investments in research and product development, sales and marketing, customer service and support, and infrastructure. We intend to continue to invest in growth across our organization as we expand in our current markets, adjacent markets and enter into new verticals. These investments to grow our business will continue to increase our costs and operating expenses on an absolute basis. Many of these investments will occur in advance of our realization of revenue or any other benefit and will make it difficult to determine if we are allocating our resources efficiently. We expect cost of revenue, research and product development expense, sales and marketing expense, and general and administrative expense to decrease as a percentage of revenue over the long term as revenue increases and we gain additional operating leverage in our business. As a result of this increased operating leverage, we expect our operating margins will improve over the long term, but this trend may be interrupted from time to time as a result of accelerated investment opportunities occurring in advance of realization of revenue.
We have managed, and plan to continue to manage, our business towards the achievement of long-term growth that we believe will positively impact long-term stockholder value, and not towards the realization of short-term financial or business metrics, or short-term stockholder value. Accordingly, if opportunities arise that might cause us to sacrifice our performance with respect to short-term financial or business metrics, but that we believe are in the best interests of our stockholders, we will take those opportunities.
Key Components of Results of Operations
Revenue
We charge our customers on a subscription basis for our core solutions and certain of our Value+ services. Our subscription fees are designed to scale to the size of our customers’ businesses. We recognize subscription revenue ratably over the terms of

34



the subscription agreements, which typically range from one month to one year. We generally invoice our customers for subscription services in monthly, quarterly or annual installments, typically in advance of the subscription period. Revenue from subscription services is impacted by a number of factors, including the change in the number and type of our customers, the size and needs of our customers’ businesses, our customer renewal rates, and the level of adoption of our Value+ subscription services by new and existing customers.
We also charge our customers usage-based fees for using certain Value+ services, although fees for electronic payment processing are paid by either our customers or clients of our customers. Usage-based fees are charged on a flat fee per transaction basis with no minimum usage commitments. We recognize revenue for usage-based services in the period the service is rendered. We generally invoice our customers for usage-based services on a monthly basis for services rendered in the preceding month. Revenue from usage-based services is impacted by a number of factors, including the number of new and existing customers that adopt and utilize our Value+ services, the size and needs of our customers and our customer renewal rates.
We experience some seasonality in our Value+ services revenue, primarily with respect to the screening services we provide to our property manager customers. These customers historically have processed fewer applications for new tenants during the fourth quarter holiday season; therefore, revenue associated with our screening services and new tenant applications typically declines in the fourth quarter of the year. As a result of this seasonal decline in revenue, we have typically experienced slower sequential revenue growth or a sequential decline in revenue in the fourth quarter of each of our most recent fiscal years. We expect this seasonality to continue in the foreseeable future.
We also offer assistance to our customers with on-boarding to our core solutions, as well as website design services. We generally invoice our customers for other services in advance of the services being completed. We recognize revenue for these other services upon completion of the related service. We also generate revenue from legacy RentLinx customers by providing services that allow these customers to advertise rental houses and apartments online. Revenue derived from customers using the RentLinx services outside of our property manager core solution platform is being recorded under other revenue.
Costs and Operating Expenses
Cost of Revenue. Cost of revenue consists of fees paid to third-party service providers, personnel-related costs (including salaries, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on customer service and the support of our operations, platform infrastructure costs (such as data center operations and hosting-related costs), payment processing fees, and allocated shared costs. We typically allocate shared costs across our organization based on headcount within the applicable part of our organization. Cost of revenue excludes depreciation of property and equipment, and amortization of capitalized software development costs and intangible assets. We intend to continue to invest in customer service and support and the expansion of our technology infrastructure as we grow the number of our customers and roll out additional Value+ services. We also intend to expand our Value+ offerings over time, which will impact cost of revenue both in absolute dollars and overall percentage of revenue.
Sales and Marketing. Sales and marketing expense consists of personnel-related costs (including salaries, sales commissions, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on sales and marketing, costs associated with sales and marketing activities, and allocated shared costs. Marketing activities include advertising, online lead generation, lead nurturing, customer and industry events, and the creation of industry-related content and collateral. Sales commissions and other incremental costs to acquire customers and grow adoption and utilization of our Value+ services by new and existing customers are expensed as incurred. We focus our sales and marketing efforts on generating awareness of our software solutions, creating sales leads, establishing and promoting our brands, and cultivating an educated community of successful and vocal customers. We intend to continue to invest in sales and marketing as we grow to increase the size of our customer base and increase the adoption and utilization of Value+ services by our new and existing customers.
Research and Product Development. Research and product development expense consists of personnel-related costs (including salaries, incentive-based compensation, benefits, and stock-based compensation) for our employees focused on research and product development, fees for third-party development resources, and allocated shared costs. Our research and product development efforts are focused on enhancing the ease of use and functionality of our existing software solutions by adding new core functionality, Value+ services and other improvements, as well as developing new products and services. We capitalize the portion of our software development costs that meets the criteria for capitalization. Amortization of capitalized software development costs is included in depreciation and amortization expense. We intend to continue to invest in research and product development as we continue to introduce new core functionality, roll out new Value+ services, develop new products and services, and expand into adjacent markets and new verticals.
General and Administrative. General and administrative expense consists of personnel-related costs (including salaries, incentive-based compensation, benefits, and stock-based compensation) for employees in our executive, finance, information technology, or IT, human resources, corporate development, legal and administrative organizations. In addition, general and

35



administrative expense includes fees for third-party professional services (including audit, legal, tax, and consulting services), other corporate expenses, and allocated shared costs. We intend to incur incremental general and administrative costs associated with supporting the growth of our business.
Depreciation and Amortization. Depreciation and amortization expense includes depreciation of property and equipment, amortization of capitalized software development costs and amortization of intangible assets. We depreciate or amortize property and equipment, software development costs and intangible assets over their expected useful lives on a straight-line basis, which approximates the pattern in which the economic benefits of the assets are consumed. As we expand our facilities footprint and increase our base of employees, we expect to have increased property and equipment expenditures and incremental depreciation expense. In addition, as we continue to invest in our research and product development organization and the development or acquisition of new technology, we expect to have increased capitalized software development costs and incremental amortization.
Interest Income (Expense). Interest income includes interest earned on investment securities, amortization and accretion of the premium and discounts paid from the purchase of investment securities, interest earned on notes receivable and on cash deposited within our bank accounts. Interest expense includes interest paid on outstanding borrowings under our Credit Agreement.
Results of Operations for the Years Ended December 31, 2017, 2016, and 2015
The following table sets forth our results of operations for the periods presented in dollars (in thousands) and as a percentage of revenue:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
 
 
Revenue
$
143,803

 
100.0
 %
 
$
105,586

 
100.0
 %
 
$
74,977

 
100.0
 %
Costs and operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)(1)
55,283

 
38.4

 
44,630

 
42.3

 
33,903

 
45.2

Sales and marketing(1)
28,709

 
20.0

 
28,827

 
27.3

 
26,076

 
34.8

Research and product development(1)
16,578

 
11.5

 
12,638

 
12.0

 
9,554

 
12.7

General and administrative(1)
21,199

 
14.7

 
17,979

 
17.0

 
14,343

 
19.1

Depreciation and amortization
12,699

 
8.8

 
9,935

 
9.4

 
6,104

 
8.1

Total costs and operating expenses
134,468

 
93.5

 
114,009

 
108.0

 
89,980

 
120.0

Income (loss) from operations
9,335

 
6.5

 
(8,423
)
 
(8.0
)
 
(15,003
)
 
(20.0
)
Other income (expense), net
(96
)
 
(0.1
)
 
(37
)
 

 
5

 

Interest income (expense), net
535

 
0.4

 
246

 
0.2

 
(595
)
 
(0.8
)
Income (loss) before provision for income taxes
9,774

 
6.8

 
(8,214
)
 
(7.8
)
 
(15,593
)
 
(20.8
)
Provision for income taxes
58

 

 
67

 
0.1

 
75

 
0.1

Net income (loss)
$
9,716

 
6.8
 %
 
$
(8,281
)
 
(7.8
)%
 
$
(15,668
)
 
(20.9
)%
(1) Includes stock-based compensation expense as follows (in thousands):
 
Year Ended December 31,
 
2017
 
2016
 
2015
Costs and operating expenses:
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)
$
725

 
$
471

 
$
124

Sales and marketing
723

 
442

 
115

Research and product development
657

 
382

 
41

General and administrative
3,991

 
3,006

 
727

Total stock-based compensation expense
$
6,096

 
$
4,301

 
$
1,007



36



        
Revenue
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Core solutions
$
57,132

 
$
43,775

 
$
32,119

 
31
%
 
36
 %
Value+ services
80,847

 
56,965

 
37,998

 
42
%
 
50
 %
Other
5,824

 
4,846

 
4,860

 
20
%
 
 %
Total revenues
$
143,803

 
$
105,586

 
$
74,977

 
36
%
 
41
 %
Fiscal 2017 Compared to Fiscal 2016
Revenue increased $38.2 million, or 36%, in 2017 compared to 2016, the substantial majority due to the growth in the number of property manager customers and units under management. We experienced a 17% year over year increase in the number of property manager customers and a 21% year over year increase in the number of property management units under management. Revenue from our Value+ services increased by $23.9 million, or 42%, in 2017 compared to 2016, mainly driven by increased usage of our electronic payments services and screening services by a larger property manager customer and unit base. We also experienced growth in each of our other Value+ services during that period. Core solutions revenue increased $13.4 million, or 31%, in 2017 compared to 2016, mainly attributed to the growth in the number of our property manager customers, units under management, and strong customer renewal rates.
In each of 2017 and 2016, we derived more than 90% of our revenue from our property manager customers.
Fiscal 2016 Compared to Fiscal 2015
Revenue increased $30.6 million, or 41%, in 2016 compared to 2015, mainly reflecting increased revenue from a 22% year over year increase in the number of our property manager customers. The overall increase in revenue was mostly attributable to revenue from Value+ services which increased by $19.0 million, or 50% when compared to the prior year. The increase in Value+ services was mainly driven by increased usage of our electronic payments services and screening services by a larger property manager customer base, and the increase in property manager units under management of 25% year over year. We also had strong growth in our legal liability to landlord insurance programs, customer contact center and website hosting services offered within our Value+ services. In addition, during 2016, we launched Premium Leads as a Value+ services for our property manager customers. The overall increase in revenue was also the result of an increase in revenue from our core solutions of $11.7 million, or 36%, driven by the growth in the number of our customers, units under management, and strong customer renewal rates.
In each of 2016 and 2015, we derived more than 90% of our revenue from our property manager customers.
Cost of Revenue (Exclusive of Depreciation and Amortization)
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Cost of revenue (exclusive of depreciation and amortization)
$
55,283

 
$
44,630

 
$
33,903

 
24
%
 
32
%
Percentage of revenue
38.4
%
 
42.3
%
 
45.2
%
 
 
 
 
Fiscal 2017 Compared to Fiscal 2016
Cost of revenue (exclusive of depreciation and amortization) increased $10.7 million, or 24%, in 2017 compared to 2016 based on the 36% increase in revenue over the same period. The increase was primarily due to increased expenditures to third parties of $7.0 million directly associated with the increased adoption and utilization of our Value+ services, as evidenced by the 42% increase in Value+ services revenues. There was also an increase in personnel-related costs of $2.3 million due to an increase in headcount to support the continued growth of our business, as well as increased allocated and other costs of $1.3 million driven by expanded facilities, IT and other expenses supporting our growth.

37



As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) improved to 38.4%, from 42.3% for the year ended December 31, 2017 compared to the year ended December 31, 2016. This improvement was primarily driven by our ability to increase revenue with a more moderate increase in personnel-related costs, and a slight improvement in pricing with our third-party service providers as we continue to grow.
Fiscal 2016 Compared to Fiscal 2015
Cost of revenue (exclusive of depreciation and amortization) increased $10.7 million, or 32%, in 2016 compared to 2015. The increase was primarily due to increased third-party costs of $5.0 million driven by increased Value+ services, increased personnel-related costs of $3.9 million due to our headcount growth, as well as increased allocated and other costs of $1.8 million driven by expanded facilities, IT and other shared expenses supporting our growth.
As a percentage of revenue, cost of revenue (exclusive of depreciation and amortization) improved 2.9 percentage points in 2016 compared to 2015. The improvement was primarily driven by a decrease in personnel-related costs due to our ability to increase revenue with a more moderate increase in headcount, and a decrease in third-party costs due to improved pricing with our third-party service providers as we continue to grow.
Sales and Marketing
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
 
 
 
 
Sales and marketing
$
28,709

 
$
28,827

 
$
26,076

 
 %
 
11
%
Percentage of revenue
20.0
%
 
27.3
%
 
34.8
%
 
 
 
 
Fiscal 2017 Compared to Fiscal 2016
    
Sales and marketing expense remained relatively flat year over year as we focused upmarket in the SMB space and acquired fewer yet larger property manager customers. We intend to continue to invest in sales and marketing as we grow to increase the size of our customer base and increase the adoption and utilization of our Value+ services by our new and existing customers.

Fiscal 2016 Compared to Fiscal 2015
Sales and marketing expense increased $2.8 million, or 11%, in 2016 compared to 2015. The increase was primarily due to increased personnel-related costs of $2.6 million due to our headcount growth and related commission-based compensation, and increased allocated and other costs of $0.2 million driven by expanded facilities, IT and other shared expenses supporting our growth.


Research and Product Development
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Research and product development
$
16,578

 
$
12,638

 
$
9,554

 
31
%
 
32
%
Percentage of revenue
11.5
%
 
12.0
%
 
12.7
%
 
 
 
 

38



Fiscal 2017 Compared to Fiscal 2016
Research and product development expense increased $3.9 million, or 31%, in 2017 compared to 2016. The increase was primarily the result of an increase in personnel-related costs, net of capitalized software development costs of $3.7 million, due to headcount growth within our research and product development organizations. We intend to continue to invest in research and product development as we continue to introduce additional core functionality to our existing customers, roll out new Value+ services to attract new customers and expand offerings to existing customers, develop new products to serve new or existing customers and expand into adjacent markets or new verticals.
Fiscal 2016 Compared to Fiscal 2015
Research and product development expense increased $3.1 million, or 32%, in 2016 compared to 2015. The increase was primarily due to increased personnel-related costs, net of capitalized software development costs of $1.9 million, due to our headcount growth and rate of innovation and increased allocated and other costs of $1.1 million driven by expanded facilities, IT and other shared expenses supporting our growth.
General and Administrative
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
General and administrative
$
21,199

 
$
17,979

 
$
14,343

 
18
%
 
25
%
Percentage of revenue
14.7
%
 
17.0
%
 
19.1
%
 
 
 
 
Fiscal 2017 Compared to Fiscal 2016
General and administrative expense increased $3.2 million, or 18%, in 2017 compared to 2016. The increase was primarily the result of an increase in personnel-related costs due to headcount growth and an increase in incentive-based compensation. The increase in incentive-based compensation is primarily due to the stock option modification of the Company's former Chief Executive Officer who announced his retirement on August 17, 2017.
Fiscal 2016 Compared to Fiscal 2015
General and administrative expense increased $3.6 million, or 25%, in 2016 compared to 2015. The increase was primarily due to increased personnel-related costs of $4.4 million due to headcount growth and incentive-based compensation programs partially off-set by decreased allocated and other costs of $0.7 million related to certain costs incurred in 2015 for our initial public offering, or IPO, and incremental compensation paid to certain RentLinx personnel related to the acquisition that did not reoccur in 2016.
Depreciation and Amortization
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Depreciation and amortization
$
12,699

 
$
9,935

 
$
6,104

 
28
%
 
63
%
Percentage of revenue
8.8
%
 
9.4
%
 
8.1
%
 
 
 
 
Fiscal 2017 Compared to Fiscal 2016
Depreciation and amortization expense increased $2.8 million, or 28%, in 2017 compared to 2016. The increase was the result of increased amortization expense associated with higher capitalized software development balances.
Fiscal 2016 Compared to Fiscal 2015
Depreciation and amortization expense increased $3.8 million, or 63%, in 2016 compared to 2015. The increase was primarily due to increased amortization expense of $2.8 million related to increased capitalized software development balances and increased depreciation expense of $0.9 million from capital purchases and building improvements made during 2016.

39




Interest Income, net
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Interest income (expense), net
$
535

 
$
246

 
$
(595
)
 
117
%
 
N/A
Percentage of revenue
0.4
%
 
0.2
%
 
(0.8
)%
 
 
 
 
Fiscal 2017 Compared to Fiscal 2016
Interest income, net increased by $0.3 million in 2017 compared to 2016. The increase is primarily the result of higher investment security balances in the more recent period.
Fiscal 2016 Compared to Fiscal 2015
Interest income, net increased by $0.8 million in 2016 compared to 2015. The increase is primarily due to holding investment securities for a full year in 2016 versus a few months in 2015, resulting in increased interest income of $0.2 million. In addition, interest expense decreased $0.6 million related to our term loan repaid in 2015 and the associated write-off of deferred financing costs.
Provision for Income Taxes
 
Year Ended December 31,
 
2016 to 2017 % Change
 
2015 to 2016 % Change
 
2017
 
2016
 
2015
 
 
 
(dollars in thousands)
Provision for income taxes
$
58

 
$
67

 
$
75

 
(13
)%
 
(11
)%
Percentage of revenue
%
 
0.1
%
 
0.1
%
 
 
 
 
The provision for income taxes relates to minimum state taxes and the amortization of tax deductible goodwill from the purchase of RentLinx in 2015 that is not an available source of income to realize the deferred tax asset.
    

40



Quarterly Results of Operations
The following table sets forth selected unaudited quarterly consolidated statements of operations data for each of the eight quarters during the years ended December 31, 2017 and December 31, 2016. We have prepared the unaudited quarterly consolidated statements of operations data on a basis consistent with the audited annual Consolidated Financial Statements included elsewhere in this Annual Report. In the opinion of management, the financial information in this table reflects all adjustments, consisting of normal and recurring adjustments, necessary for the fair statement of this data. This information should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this Annual Report. The results of historical periods are not necessarily indicative of the results for any future period.
 
Quarter Ended
 
2017
 
2016
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
(in thousands, except per share data)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
$
37,897

 
$
37,903

 
$
35,877

 
$
32,126

 
$
28,010

 
$
28,162

 
$
26,203

 
$
23,211

Costs and operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)(1)
14,536

 
14,053

 
13,701

 
12,993

 
11,243

 
11,645

 
11,212

 
10,530

Sales and marketing(1)
7,153

 
7,257

 
7,192

 
7,107

 
6,730

 
6,979

 
7,567

 
7,551

Research and product development(1)
4,580

 
4,367

 
4,002

 
3,629

 
3,107

 
3,464

 
3,024

 
3,043

General and administrative(1)
5,889

 
5,405

 
5,101

 
4,804

 
5,399

 
4,642

 
4,389

 
3,549

Depreciation and amortization
3,352

 
3,237

 
3,114

 
2,996

 
2,823

 
2,636

 
2,359

 
2,117

Total costs and operating expenses
35,510

 
34,319

 
33,110

 
31,529

 
29,302

 
29,366

 
28,551

 
26,790

Income (loss) from operations
2,387

 
3,584

 
2,767

 
597

 
(1,292
)
 
(1,204
)
 
(2,348
)
 
(3,579
)
Other income (expense), net
(3
)
 
(5
)
 
(60
)
 
(28
)
 
(3
)
 
(12
)
 
2

 
(24
)
Interest income, net
158

 
155

 
120

 
102

 
25

 
102

 
95

 
24

Income (loss) before provision for income taxes
2,542

 
3,734

 
2,827

 
671

 
(1,270
)
 
(1,114
)
 
(2,251
)
 
(3,579
)
Income tax (benefit) provision
(35
)
 
52

 
30

 
11

 
19

 
11

 
13

 
24

Net income (loss)
$
2,577

 
$
3,682

 
$
2,797

 
$
660

 
$
(1,289
)
 
$
(1,125
)
 
$
(2,264
)
 
$
(3,603
)
Net income (loss) per common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Basic
$
0.08

 
$
0.11

 
$
0.08

 
$
0.02

 
$
(0.04
)
 
$
(0.03
)
 
$
(0.07
)
 
$
(0.11
)
    Diluted
$
0.07

 
$
0.10

 
$
0.08

 
$
0.02

 
$
(0.04
)
 
$
(0.03
)
 
$
(0.07
)
 
$
(0.11
)
  
(1)    Includes stock-based compensation expense as follows (in thousands):
 
 
Quarter Ended
 
2017
 
2016
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
(in thousands)
Cost of revenue (exclusive of depreciation and amortization)
$
198

 
$
189

 
$
209

 
$
129

 
$
150

 
$
138

 
$
138

 
$
45

Sales and marketing
207

 
186

 
210

 
120

 
146

 
124

 
130

 
42

Research and product development
186

 
173

 
182

 
116

 
118

 
109

 
104

 
51

General and administrative
1,201

 
1,040

 
1,018

 
732

 
1,043

 
918

 
720

 
325

Total stock-based compensation expense
$
1,792

 
$
1,588

 
$
1,619

 
$
1,097

 
$
1,457

 
$
1,289

 
$
1,092

 
$
463



41



The following table sets forth selected consolidated statements of operations data for the specified periods as a percentage of our revenue for those periods:
 
Quarter Ended
 
2017
 
2016
 
December 31,
 
September 30,
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
March 31,
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
 
 
 
Revenue
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Costs and operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization)
38.4

 
37.1

 
38.2

 
40.4

 
40.1

 
41.4

 
42.8

 
45.4

Sales and marketing
18.9

 
19.1

 
20.0

 
22.1

 
24.0

 
24.8

 
28.9

 
32.5

Research and product development
12.1

 
11.5

 
11.2

 
11.3

 
11.1

 
12.3

 
11.5

 
13.1

General and administrative
15.5

 
14.3

 
14.2

 
15.0

 
19.3

 
16.5

 
16.7

 
15.3

Depreciation and amortization
8.8

 
8.5

 
8.7

 
9.3

 
10.1

 
9.4

 
9.0

 
9.1

Total costs and operating expenses
93.7

 
90.5

 
92.3

 
98.1

 
104.6

 
104.3

 
109.0

 
115.4

Income (loss) from operations
6.3

 
9.5

 
7.7

 
1.9

 
(4.6
)
 
(4.3
)
 
(9.0
)
 
(15.4
)
Other income (expense), net

 

 
(0.2
)
 
(0.1
)
 

 

 

 
(0.1
)
Interest income, net
0.4

 
0.4

 
0.3

 
0.3

 
0.1

 
0.4

 
0.4

 
0.1

Income (loss) before provision for income taxes
6.7

 
9.9

 
7.9

 
2.1

 
(4.5
)
 
(4.0
)
 
(8.6
)
 
(15.4
)
Provision for income taxes
(0.1
)
 
0.1

 
0.1

 

 
0.1

 

 

 
0.1

Net income (loss)
6.8
 %
 
9.7
 %
 
7.8
 %
 
2.1
 %
 
(4.6
)%
 
(4.0
)%
 
(8.6
)%
 
(15.5
)%
Quarterly Revenue and Cost Trends
Our quarterly revenue trends generally reflect increased revenue from our property manager customers. The overall increase was primarily a result of a quarter-over-quarter increase in the number of our customers, property manager units under management, as well as strong customer renewal rates, and an increase in Value+ services revenue primarily attributable to the expansion of our electronic payments platform and screening services. We experience some seasonality in our Value+ services revenue, primarily with respect to the screening services we provide to our property manager customers. These customers historically have processed fewer applications for new tenants during the fourth quarter holiday season; therefore, revenue associated with our screening services and new tenant applications typically declines in the fourth quarter of the year. As a result of this seasonal decline in revenue, we have typically experienced slower sequential revenue growth or a sequential decline in revenue in the fourth quarter of each of our most recent fiscal years. We expect this seasonality to continue in the foreseeable future.
Overall, total costs and operating expenses as a percentage of revenue have improved during 2017 when compared to 2016, as we continue to realize operating leverage. Cost of revenue (exclusive of depreciation and amortization) fluctuated each quarter based on the mix of Value+ services and related third party costs. Research and product development costs fluctuated each quarter based on the amount of software development costs that were capitalized each quarter. General and administrative expenses fluctuated each quarter primarily due to the impact of increased compensation due to an increase in headcount and incentive based compensation.
Our quarter-over-quarter total costs and operating expenses as a percentage of revenue for each quarter during 2016 improved, with the exception of general and administrative expenses and depreciation and amortization, as we continue to realize operating leverage. General and administrative expenses fluctuated each quarter during 2016 primarily due to the impact of increased compensation due to an increase in headcount.

Liquidity and Capital Resources
Cash and Cash Equivalents
As of December 31, 2017 and 2016, our principal sources of liquidity were cash and cash equivalents and investment securities-current and investment securities-noncurrent, which had an aggregate balance of $68.3 million and $52.9 million, respectively.

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Working Capital
As of December 31, 2017, we had working capital of $29.9 million, compared to working capital of $10.9 million as of December 31, 2016. The increase in our working capital was primarily due to an increase in the current portion of investment securities, cash and cash equivalents, prepaid expenses and accounts receivable and a decline in deferred revenue, offset by increases in our accrued employee expenses and accrued expenses from the continued growth of our business.
Revolving Facility
As of December 31, 2017, we had a $25.0 million revolving line of credit, which we refer to as our Revolving Facility, under the terms of our Credit Agreement with Wells Fargo, as administrative agent, and the lenders that are parties thereto. As of both December 31, 2017 and 2016, we had no outstanding balance under our Revolving Facility. For additional information regarding our Credit Agreement refer to Note 7, Long-term Debt of our Consolidated Financial Statements included elsewhere in this Annual Report.
Liquidity Requirements
We believe that our existing cash and cash equivalents, investment securities, available borrowing capacity of $25.0 million under our Revolving Facility, and cash generated from operating activities will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months.
Capital Requirements
Our future capital requirements will depend on many factors, including the continued market acceptance of our software solutions, the change in the number of our customers, the adoption and utilization of our Value+ services by new and existing customers, the timing and extent of the introduction of new core functionality and Value+ services in our existing markets and verticals, the timing and extent of our expansion into adjacent markets or new verticals and the timing and extent of our investments across our organization. In addition, we may in the future enter into arrangements to acquire or invest in markets adjacent to those we serve today or entirely new verticals. Furthermore, our board of directors may, from time to time, authorize our management to repurchase shares of our Class A common stock in open market transactions, privately negotiated transactions or otherwise.
Cash Flows
The following table summarizes our cash flows for the periods indicated (in thousands):
 
 
Year Ended
December 31,
 
 
2017
 
2016
 
2015
Net cash provided by (used in) operating activities
 
$
29,371

 
$
11,500

 
$
(6,844
)
Net cash used in investing activities
 
(22,828
)
 
(13,065
)
 
(59,367
)
Net cash (used in) provided by financing activities
 
(1,133
)
 
201

 
72,862

Net increase (decrease) in cash and cash equivalents
 
$
5,410

 
$
(1,364
)
 
$
6,651

Cash Provided by (Used in) Operating Activities
Our primary source of operating cash inflows is cash collected from our customers in connection with their use of our core solutions and Value+ services. Our primary uses of cash from operating activities are for personnel-related expenditures and third-party costs incurred to support the delivery of our software solutions.
For the year ended December 31, 2017, cash provided by operating activities was $29.4 million resulting from our net income of $9.7 million, adjusted by non-cash charges of $18.9 million and a net increase in our operating assets and liabilities of $0.7 million. The non-cash charges primarily consist of $12.7 million of depreciation and amortization of our property and equipment and capitalized software and $6.1 million of stock-based compensation. The net increase in our operating assets and liabilities was mostly attributable to a $3.2 million increase in accrued employee expenses related to an overall increase in personnel-related costs. The increase in our operating assets and liabilities was partially offset by an increase in prepaid expenses and other current assets of $1.0 million, a $0.9 million increase in accounts receivable, and a $0.6 million decrease in deferred revenue.
For the year ended December 31, 2016, cash provided by operating activities was $11.5 million resulting from our net loss of $8.3 million, adjusted by non-cash charges of $14.7 million and a net increase in our operating assets and liabilities of $5.0 million. The non-cash charges primarily consist of $9.9 million of depreciation and amortization of our property and equipment and capitalized software and $4.3 million of stock-based compensation. The net increase in our operating assets and liabilities

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was mostly attributable to an increase of $2.7 million in deferred revenue in line with our increased revenues, a $2.2 million increase in accrued employee expenses related to an overall increase in personnel-related costs, and a $1.1 million increase in accrued expenses primarily due to payment processing fees and fees associated with our resident screening services driven by growth in our Value+ services, and a $0.8 million increase in other liabilities. The increase in our operating assets and liabilities was partially offset by a decrease in accounts payable of $0.9 million, an increase in accounts receivable of $0.5 million, and an increase in our prepaid expenses and current assets of $0.4 million, in conjunction with our growth and expansion during 2016.    
For the year ended December 31, 2015, cash used in operating activities was $6.8 million resulting from our net loss of $15.7 million, adjusted by non-cash charges of $6.8 million and a net increase in our operating assets and liabilities of $2.1 million. The net increase in our non-cash charges was primarily the result of an increase of $6.1 million of depreciation and amortization of our property and equipment and capitalized software and $1.0 million of stock-based compensation. The net increase in our operating assets and liabilities was mostly attributable to an increase of $1.9 million in accrued employee expenses related to an overall increase in personnel-related costs, a $1.2 million increase in deferred revenue in line with our increased revenues, a $1.1 million increase in accrued expenses mostly attributed to payment processing fees driven by growth in our Value+ services, and a $1.0 million increase in other liabilities. The increase in our operating assets and liabilities was offset by an increase in our prepaid expenses and current assets of $1.9 million, an increase in accounts receivable of $0.7 million in conjunction with our growth and expansion during 2015, and a decrease in accounts payable of $0.4 million.
Cash Used in Investing Activities
Cash used in investing activities is generally comprised of purchases, maturities and sales of investment securities, additions to capitalized software development, cash paid for business acquisitions and capital expenditures.
For the year ended December 31, 2017, investing activities used $22.8 million in cash primarily as a result of $26.6 million of investment securities purchased offset by $16.5 million of maturities. In addition, we had an increase in capitalized software development costs of $10.5 million for the continued investment in our software development, and capital expenditures of $2.2 million to purchase property and equipment for the continued growth and expansion of our business.
For the year ended December 31, 2016, investing activities used $13.1 million in cash primarily as a result of $31.6 million of investment securities purchased offset by $21.3 million of maturities and $12.6 million of sales of investment securities. In addition, we had an increase in capitalized software development costs of $11.2 million for the continued investment in our software development, and capital expenditures of $4.2 million to purchase property and equipment for the continued growth and expansion of our business.
For the year ended December 31, 2015, investing activities used $59.4 million in cash primarily as a result of $74.2 million of investment securities purchased offset by $26.1 million of maturities and $4.1 million of sales of investment securities. In addition, we had an increase in capitalized software development costs of $7.7 million for the continued investment in our software development, an increase in capital expenditures of $3.7 million to purchase property and equipment for the continued growth and expansion of our business. We also used $4.0 million of cash for the acquisition of RentLinx.
Cash (Used in) Provided by Financing Activities
Cash (used in) provided by financing activities is generally comprised of proceeds from our IPO, proceeds from the exercise of stock options and restricted stock awards, or RSAs, proceeds from the issuance of debt or draws from our Revolving Facility and principal repayments of our term loan and on our Revolving Facility.
For the year ended December 31, 2017, financing activities used $1.1 million in cash primarily as a result of tax withholdings from RSU net settlements offset by proceeds from stock option exercises.
For the year ended December 31, 2016, financing activities provided $0.2 million in cash primarily as a result of proceeds from stock option exercises offset by tax withholdings from RSU net settlements.
For the year ended December 31, 2015, financing activities provided $72.9 million in cash primarily as a result of net proceeds from the IPO in the amount of $75.4 million, offset by a $2.4 million earnout payment relating to our acquisition of MyCase.

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Contractual Obligations and Other Commitments

Our principal commitments consist of contractual obligations under our operating leases for office space. The following table summarizes our contractual obligations and other commitments as of December 31, 2017:
 
Payments Due by Period
 
Total
 
Less than 1 year
 
1 to 3 years
 
3 to 5 years
 
More than 5 years
 
(in thousands)
Operating lease obligations
$
9,129

 
$
2,446

 
$
5,021

 
$
1,662

 
$

At December 31, 2017, liabilities for unrecognized tax benefits of $2.1 million were not included in our contractual obligations in the table above because, due to their nature, there is a high degree of uncertainty regarding the timing of future cash outflows and other events that would extinguish these liabilities.
For additional information regarding our contractual obligations, commitments and indemnification arrangements refer to Note 8, Commitments and Contingencies of our Consolidated Financial Statements included elsewhere in this Annual Report.
Off-Balance Sheet Arrangements
As of December 31, 2017, we did not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Our financial statements and the related notes included elsewhere in this Annual Report are prepared in accordance with generally accepted accounting principles in the United States. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and operating expenses, provision for income taxes and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. However, actual results could differ significantly from the estimates made by management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
We believe that the following critical accounting policies involve a greater degree of judgment or complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to a full understanding and evaluation of our Consolidated Financial Statements. For additional information, refer to Note 2, Summary of Significant Accounting Policies of our Consolidated Financial Statements included elsewhere in this Annual Report.
Revenue Recognition
We generate revenue primarily from our customers for subscriptions to access our core solutions and Value+ services for our cloud-based property management and legal software solutions. Subscription fees for our core solutions are charged on a per-unit per-month basis for our property management software solution and on a per-user per-month basis for our legal software solution. We recognize subscription revenue on a straight-line basis over the terms of the subscription agreements, which range from one month to one year. We generally invoice our customers for subscription services in monthly, quarterly or annual installments, typically in advance of the subscription period. Any revenues which are billed in advance are recorded as deferred revenue.
We charge our customers on a subscription basis for our core solutions and many of our Value+ services. Our subscription fees are designed to scale to the size of our customers’ businesses. We also charge usage-based fees for using certain Value+ services, including electronic payment processing. Usage-based fees are charged on a flat fee per transaction basis with no minimum usage commitments. We recognize revenue for usage-based services in the period the service is rendered. We generally invoice our customers for usage-based services on a monthly basis for services rendered in the preceding month with the exception of fees for electronic payment processing, which are generally paid by our customers or the clients of our customers at the time the electronic payment is processed.

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Our legal software core solution offers customers a free trial period to try our software. Revenue is not recognized until the free trial period is complete and the customer has entered into a subscription agreement with us.
We recognize revenue when (i) there is persuasive evidence of an arrangement, (ii) our software solutions have been made available or delivered, or services have been performed, (iii) the amount of fees is fixed or determinable, and (iv) collectability is reasonably assured. Evidence of an arrangement generally consists of either a signed customer contract or an online click-through agreement. We consider that delivery of a solution or website has commenced once we provide the customer with access to use the solution or website. Fees are fixed based on rates specified in the subscription agreements, which do not provide for any refunds or adjustments. If collectability is not considered reasonably assured, revenue is deferred until the fees are collected. Some of our subscription agreements contain minimum cancellation fees in the event that the customer cancels the subscription early.
     Internal-Use Software
We account for the costs of computer software obtained or developed for internal use in accordance with ASC 350, Intangibles-Goodwill and Other. These include costs incurred in connection with the development of our internal-use software solutions when (i) the preliminary project stage is completed, (ii) management has authorized further funding for the completion of the project and (iii) it is probable that the project will be completed and performed as intended. These capitalized costs include personnel and related expenses for employees who are directly associated with and who devote time to internal-use software projects and, when material, interest costs incurred during the development. Capitalization of these costs ceases once the project is substantially complete and the software is ready for its intended purpose. Costs incurred for significant upgrades and enhancements to our software solutions are also capitalized. Costs incurred for post-configuration training, maintenance and minor modifications or enhancements are expensed as incurred. Capitalized software development costs are amortized using the straight-line method over an estimated useful life of three years. We do not transfer ownership of our software, or lease our software, to third parties.
Business Combinations
The results of a business acquired in a business combination are included in our consolidated financial statements from the date of acquisition. We allocate the purchase price, including the fair value of contingent consideration, to the identifiable assets and liabilities of the acquired business at their acquisition date fair values. The excess of the purchase price over the amount allocated to the identifiable assets and liabilities, if any, is recorded as goodwill.
Determining the fair value of assets acquired and liabilities assumed requires management to make significant judgments and estimates, including the selection of valuation methodologies, estimates of future revenue and cash flows, discount rates and selection of comparable companies.
Acquisition-related transaction costs are not included as a component of consideration transferred, but are accounted for as an operating expense in the period in which the costs are incurred.
Goodwill and Intangible Assets
Goodwill and intangible assets are evaluated for impairment annually in the fourth quarter or whenever events or circumstances indicate the carrying value of goodwill may not be recoverable or when there is a triggering event. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate or a significant decline in expected cash flows.
When evaluating goodwill for impairment, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform the first of a two-step impairment test.
The first step of the impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary. If, however, the fair value of the reporting unit is less than book value, then the carrying amount of the goodwill is compared with its implied fair value. The estimate of implied fair value of goodwill may require valuations of certain internally generated and unrecognized intangible assets. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess above the estimated fair value.
At December 31, 2017, we determined our goodwill was not impaired as the fair value of our reporting unit significantly exceeded its carrying value.

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Stock-Based Compensation
We account for stock-based compensation awards granted to employees and directors by recording compensation expense based on each award's grant-date estimated fair value, in accordance with ASC 718, Compensation-Stock Compensation over the vesting period. We estimate the fair value of RSAs, RSUs and performance based RSUs, or PSUs, based on the fair value of our common stock on the date of grant. We estimate the fair value of stock options and performance based stock options, or PSOs, using the Black-Scholes option-pricing model. Determining the fair value of stock options under this model requires highly subjective assumptions, including the fair value of the underlying common stock, the risk-free interest rate, the expected term of the award, the expected volatility of the price of our common stock, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If we had made different assumptions, our stock-based compensation expense could have been materially different.
Prior to our IPO, there was no public market for our common stock and our board of directors determined the fair value of our common stock at the time of the grant of stock options and RSAs by considering a number of objective and subjective factors, including our actual operating and financial performance, market conditions and performance of comparable publicly traded companies, developments and milestones in our company, the likelihood of achieving a liquidity event and transactions involving our convertible preferred stock, among other factors. The fair value of the underlying common stock was determined by our board of directors in accordance with applicable elements of the practice aid issued by the American Institute of Certified Public Accountants Valuation of Privately Held Company Equity Securities Issued as Compensation. In valuing our common stock at various dates, our board of directors determined our equity value generally using the income approach and the market comparable approach valuation methods. Once we determined our equity value, we used an option pricing method or the Probability Weighted Expected Return Method to allocate the equity value to preferred stock and common stock. Application of these approaches and methods involves the use of estimates, judgments and assumptions, such as future revenue, expenses and cash flows, selections of comparable companies, probabilities and timing of exit events, and other factors.
Since our IPO in June 2015, the fair value of our common stock is based on the closing price of our Class A common stock, as quoted on the NASDAQ Global Market, on the date of grant and we utilized the following assumptions and estimates when utilizing the Black-Scholes option-pricing model when calculating the fair value of our options and PSOs:
Risk-Free Interest Rate - The risk free interest rate assumption is based upon observed interest rates on United States government securities appropriate for the expected term of the stock option.
Expected Term - Given that we do not have sufficient exercise history to develop reasonable expectations about future exercise patterns and post-vesting employment terminati