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AVLR Avalara

Filed: 4 Aug 20, 4:27pm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended June 30, 2020

OR

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

For the transition period from to

Commission File Number: 001-38525

 

AVALARA, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Washington

 

 

91-1995935

(State or other jurisdiction of

incorporation or organization)

 

 

(I.R.S. Employer

Identification No.)

 

 

 

 

255 South King Street, Suite 1800

Seattle, WA

 

 

98104

(Address of principal executive offices)

 

 

(Zip Code)

 

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

 

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

 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common Stock, Par Value $0.0001 Per Share

AVLR

New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

  

Accelerated filer

 

Non-accelerated filer

 

  

 

Small reporting company

 

 

  

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

 

 

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

 

As of July 30, 2020, the registrant had 79,572,496 shares of common stock, $0.0001 par value per share, outstanding.

 

 

 

 


Table of Contents

 

 

i


Special Note Regarding Forward-Looking Statements

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

our ability to expand our international reach;

 

the potential effects on our business of events beyond our control such as the current novel coronavirus (“COVID-19”) pandemic; and

 

other factors discussed in other sections of this Quarterly Report on Form 10-Q, including the sections of this report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and under Part II, Item 1A. “Risk Factors” and in our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report”) under Part I, Item 1A, “Risk Factors.”

You should not place undue reliance on our forward-looking statements and you should not rely on forward-looking statements as predictions of future events. The results, events, and circumstances reflected in the forward-looking statements may not be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements. The forward-looking statements made in this Quarterly Report on Form 10-Q speak only as of the date of this report. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

 

 

ii


PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

AVALARA, INC.

Consolidated Balance Sheets

(In thousands, except for per share data)

 

 

June 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

474,411

 

 

$

466,950

 

Trade accounts receivable—net of allowance for doubtful accounts of $3,859 and

   $1,179, respectively

 

 

59,783

 

 

 

51,644

 

Deferred commissions

 

 

10,293

 

 

 

9,279

 

Prepaid expenses and other current assets

 

 

17,612

 

 

 

14,127

 

Total current assets before customer fund assets

 

 

562,099

 

 

 

542,000

 

Funds held from customers

 

 

21,523

 

 

 

24,383

 

Receivable from customers—net of allowance of $791 and $270, respectively

 

 

779

 

 

 

420

 

Total current assets

 

 

584,401

 

 

 

566,803

 

Noncurrent assets:

 

 

 

 

 

 

 

 

Deferred commissions

 

 

33,063

 

 

 

29,137

 

Operating lease right-of-use assets—net

 

 

51,924

 

 

 

49,321

 

Property and equipment—net

 

 

33,820

 

 

 

34,997

 

Intangible assets—net

 

 

19,319

 

 

 

22,932

 

Goodwill

 

 

101,198

 

 

 

101,224

 

Other noncurrent assets

 

 

4,496

 

 

 

2,853

 

Total assets

 

$

828,221

 

 

$

807,267

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Trade payables

 

$

14,345

 

 

$

11,693

 

Accrued expenses

 

 

51,754

 

 

 

62,104

 

Deferred revenue

 

 

166,207

 

 

 

160,271

 

Accrued earnout liabilities

 

 

142

 

 

 

4,120

 

Operating lease liabilities

 

 

10,194

 

 

 

8,756

 

Total current liabilities before customer fund obligations

 

 

242,642

 

 

 

246,944

 

Customer fund obligations

 

 

22,835

 

 

 

24,783

 

Total current liabilities

 

 

265,477

 

 

 

271,727

 

Noncurrent liabilities:

 

 

 

 

 

 

 

 

Deferred revenue

 

 

1,512

 

 

 

970

 

Accrued earnout liabilities

 

 

 

 

 

9,835

 

Operating lease liabilities

 

 

57,119

 

 

 

58,301

 

Deferred tax liability

 

 

472

 

 

 

337

 

Other noncurrent liabilities

 

 

3,439

 

 

 

2,375

 

Total liabilities

 

 

328,019

 

 

 

343,545

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Shareholders' equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value – 0 shares issued and outstanding at

  June 30, 2020 and December 31, 2019, and 20,000 shares authorized as of

   June 30, 2020 and December 31, 2019

 

 

 

 

 

 

Common stock, $0.0001 par value – 79,515 and 77,448 shares issued and

   outstanding at June 30, 2020 and December 31, 2019, respectively, and

   600,000 shares authorized as of June 30, 2020 and December 31, 2019

 

 

8

 

 

 

8

 

Additional paid-in capital

 

 

1,037,470

 

 

 

976,627

 

Accumulated other comprehensive loss

 

 

(1,659

)

 

 

(2,719

)

Accumulated deficit

 

 

(535,617

)

 

 

(510,194

)

Total shareholders’ equity

 

 

500,202

 

 

 

463,722

 

Total liabilities and shareholders' equity

 

$

828,221

 

 

$

807,267

 

 

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

1


AVALARA, INC.

Consolidated Statements of Operations (unaudited)

(In thousands, except per share data)

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

$

108,519

 

 

$

85,008

 

Professional services

 

 

7,968

 

 

 

6,291

 

Total revenue

 

 

116,487

 

 

 

91,299

 

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

28,779

 

 

 

22,938

 

Professional services

 

 

4,551

 

 

 

4,397

 

Total cost of revenue

 

 

33,330

 

 

 

27,335

 

Gross profit

 

 

83,157

 

 

 

63,964

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

26,844

 

 

 

18,996

 

Sales and marketing

 

 

46,040

 

 

 

41,742

 

General and administrative

 

 

20,322

 

 

 

18,019

 

Total operating expenses

 

 

93,206

 

 

 

78,757

 

Operating loss

 

 

(10,049

)

 

 

(14,793

)

Other (income) expense:

 

 

 

 

 

 

 

 

Interest income

 

 

(168

)

 

 

(1,282

)

Interest expense

 

 

 

 

 

173

 

Other (income) expense, net

 

 

122

 

 

 

381

 

Total other (income) expense, net

 

 

(46

)

 

 

(728

)

Loss before income taxes

 

 

(10,003

)

 

 

(14,065

)

Provision for income taxes

 

 

137

 

 

 

172

 

Net loss

 

$

(10,140

)

 

$

(14,237

)

 

 

 

 

 

 

 

 

 

Net loss per share attributable to common shareholders,

   basic and diluted

 

$

(0.13

)

 

$

(0.20

)

Weighted average shares of common stock outstanding,

   basic and diluted

 

 

78,924

 

 

 

71,568

 

 

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


2


AVALARA, INC.

Consolidated Statements of Operations (unaudited)

(In thousands, except per share data)

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

$

214,065

 

 

$

163,239

 

Professional services

 

 

13,865

 

 

 

13,030

 

Total revenue

 

 

227,930

 

 

 

176,269

 

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

58,296

 

 

 

43,916

 

Professional services

 

 

9,288

 

 

 

8,726

 

Total cost of revenue

 

 

67,584

 

 

 

52,642

 

Gross profit

 

 

160,346

 

 

 

123,627

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

52,691

 

 

 

34,952

 

Sales and marketing

 

 

95,674

 

 

 

81,061

 

General and administrative

 

 

41,710

 

 

 

33,253

 

Total operating expenses

 

 

190,075

 

 

 

149,266

 

Operating loss

 

 

(29,729

)

 

 

(25,639

)

Other (income) expense:

 

 

 

 

 

 

 

 

Interest income

 

 

(1,610

)

 

 

(2,049

)

Interest expense

 

 

 

 

 

284

 

Other (income) expense, net

 

 

(3,250

)

 

 

429

 

Total other (income) expense, net

 

 

(4,860

)

 

 

(1,336

)

Loss before income taxes

 

 

(24,869

)

 

 

(24,303

)

Provision for income taxes

 

 

554

 

 

 

288

 

Net loss

 

$

(25,423

)

 

$

(24,591

)

 

 

 

 

 

 

 

 

 

Net loss per share attributable to common shareholders,

   basic and diluted

 

$

(0.32

)

 

$

(0.35

)

Weighted average shares of common stock outstanding,

   basic and diluted

 

 

78,414

 

 

 

69,983

 

 

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

 

3


AVALARA, INC.

Consolidated Statements of Comprehensive Loss (unaudited)

(In thousands)

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Net loss

 

$

(10,140

)

 

$

(14,237

)

Other comprehensive income — Foreign currency translation

 

 

435

 

 

 

276

 

Total comprehensive loss

 

$

(9,705

)

 

$

(13,961

)

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Net loss

 

$

(25,423

)

 

$

(24,591

)

Other comprehensive income (loss) — Foreign currency translation

 

 

1,060

 

 

 

(186

)

Total comprehensive loss

 

$

(24,363

)

 

$

(24,777

)

 

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

 

4


AVALARA, INC.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(25,423

)

 

$

(24,591

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

21,978

 

 

 

15,984

 

Depreciation and amortization

 

 

7,999

 

 

 

7,668

 

Deferred tax expense

 

 

135

 

 

 

78

 

Non-cash operating lease costs

 

 

3,960

 

 

 

2,167

 

Non-cash change in earnout liabilities

 

 

(2,325

)

 

 

476

 

Non-cash bad debt expense

 

 

1,373

 

 

 

450

 

Other

 

 

445

 

 

 

195

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Trade accounts receivable

 

 

(8,991

)

 

 

(3,728

)

Prepaid expenses and other current assets

 

 

(3,486

)

 

 

(596

)

Deferred commissions

 

 

(4,940

)

 

 

(9,377

)

Other noncurrent assets

 

 

(1,643

)

 

 

(782

)

Trade payables

 

 

2,891

 

 

 

2,468

 

Accrued expenses

 

 

(9,750

)

 

 

(3,401

)

Deferred revenue

 

 

6,477

 

 

 

15,127

 

Operating lease liabilities

 

 

(4,795

)

 

 

(2,559

)

Net cash used in operating activities

 

 

(16,095

)

 

 

(421

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchase of property and equipment

 

 

(3,556

)

 

 

(4,950

)

Cash paid for acquisitions of businesses

 

 

 

 

 

(17,310

)

Cash paid for acquired intangible assets

 

 

 

 

 

(131

)

Net decrease (increase) in customer fund assets

 

 

1,981

 

 

 

(11,878

)

Net cash used in investing activities

 

 

(1,575

)

 

 

(34,269

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from common stock offering, net of underwriting discounts

 

 

 

 

 

274,705

 

Payments of deferred financing costs

 

 

 

 

 

(398

)

Proceeds from exercise of stock options

 

 

25,423

 

 

 

40,417

 

Proceeds from purchases of stock under employee stock purchase plan

 

 

5,716

 

 

 

7,664

 

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

 

 

 

 

 

(93

)

Payments related to business combination earnouts

 

 

(3,760

)

 

 

 

Payments related to asset acquisition earnouts

 

 

(65

)

 

 

 

Net (decrease) increase in customer fund obligations

 

 

(1,981

)

 

 

11,797

 

Net cash provided by financing activities

 

 

25,333

 

 

 

334,092

 

Foreign currency effect on cash and cash equivalents

 

 

(202

)

 

 

(140

)

Net change in cash and cash equivalents

 

 

7,461

 

 

 

299,262

 

Cash and cash equivalents—Beginning of period

 

 

466,950

 

 

 

142,322

 

Cash and cash equivalents—End of period

 

$

474,411

 

 

$

441,584

 

 

(Continued)


5


 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Supplemental cash flow disclosures:

 

 

 

 

 

 

 

 

Cash paid for interest expense

 

$

 

 

$

122

 

Cash paid for operating lease liabilities

 

 

6,771

 

 

 

4,383

 

Cash paid for income taxes

 

 

499

 

 

 

134

 

 

 

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Stock issued related to business combinations

 

$

7,500

 

 

$

 

Accrued purchase price related to acquisitions

 

 

 

 

 

2,984

 

Accrued value of earnout related to acquisitions of businesses

 

 

 

 

 

5,952

 

Accrued purchase of intangible assets

 

 

110

 

 

 

55

 

Property and equipment additions in accounts payable and

   accrued expenses

 

 

836

 

 

 

652

 

Deferred financing costs in accounts payable and accrued

   expenses

 

 

 

 

 

156

 

Fair value of common stock issued to purchase

   intangible assets

 

 

87

 

 

 

50

 

Operating lease right-of-use assets in exchange for lease obligations

 

 

6,562

 

 

 

2,839

 

 

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

 

(Concluded)

 

 

 

6


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

1.

Nature of Operations

 

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

 

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

2.

Significant Accounting Policies

Interim Financial Information

The accompanying consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Certain information and disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. Accordingly, these consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes for the year ended December 31, 2019, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report”) filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2020. The accompanying interim consolidated balance sheet as of June 30, 2020, the consolidated interim statements of operations for the three and six months ended June 30, 2020 and 2019, the consolidated statements of comprehensive loss for the three and six months ended June 30, 2020 and 2019, and the consolidated statements of cash flows for the six months ended June 30, 2020 and 2019, are unaudited. The unaudited interim consolidated financial statements have been prepared on a basis consistent with that used to prepare the audited annual consolidated financial statements and include, in the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the consolidated financial statements. The operating results for the three and six months ended June 30, 2020, respectively, are not necessarily indicative of the results expected for the full year ending December 31, 2020.

 

Prior Period Restatements and Adjustments

 

In preparing the 2019 annual consolidated financial statements, the Company discovered an immaterial error in recording deferred sales commissions for the first three quarters of 2019 impacting its previously reported quarterly financial results. The correction to sales commission expense resulted in an increase in sales and marketing expenses and accumulated deficit of $1.1 million and $2.2 million for three and six months ended June 30, 2019, respectively. The correction resulted in an increase in net loss per share of $0.02 and $0.03 for the three and six months ended June 30, 2019, respectively. The restatement of these prior period corrected amounts is presented in the accompanying unaudited consolidated statements of operations for the three and six months ended June 30, 2019, the consolidated statements of comprehensive loss for the three and six months ended June 30, 2019, and the consolidated statement of cash flows for the six months ended June 30, 2019.

 

Avalara adopted the new lease accounting standard as of January 1, 2019 in the 2019 Annual Report. Due to the timing of adoption, the Company’s 2019 interim financial statements did not reflect the new lease accounting standard. As a result, the presentation of cash flows from operating activities presented in the accompanying unaudited consolidated statement of cash flows for the six months ended June 30, 2019 include adjustments for the adoption of the new lease accounting standard. The adjustments do not impact previously reported net cash used in operating activities.

 

Principles of Consolidation

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

7


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

Segments

The Company operates its business as 1 operating segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, the Company’s Chief Executive Officer, in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates and judgments related to revenue are described below in the Revenue Recognition Accounting Policy. Significant estimates impacting expenses include: expected credit losses associated with the allowance for doubtful accounts; the measurement of fair values of stock-based compensation award grants; the expected earnout obligations in connection with acquisitions; the expected term of the customer relationship for capitalized contract cost amortization; the valuation of acquired intangible assets; and the valuation of the fair value of reporting units for analyzing goodwill. Actual results could materially differ from those estimates.

Fair Value Measurements

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

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

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

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

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

Long-Lived Assets

The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. An impairment is recognized in the event the carrying value of such assets is not recoverable. If the carrying value is not recoverable, the fair value is determined, and an impairment is recognized for the amount by which the carrying value exceeds the fair value. NaN impairment of long-lived assets occurred in the six months ended June 30, 2020 or for the year ended December 31, 2019.

Self-Insurance

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

8


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

Income Taxes

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

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

Stock-Based Compensation

The Company accounts for stock-based compensation by calculating the fair value of each option, restricted stock unit (“RSU”), or purchase right issued under the Company’s 2018 Employee Stock Purchase Plan (“ESPP”) at the date of grant. The fair value of stock options and purchase rights issued under the ESPP is estimated by applying the Black-Scholes option-pricing model. This model uses the fair value of the Company’s underlying common stock at the measurement date, the expected or contractual term of the option or purchase right, the expected volatility of its common stock, risk-free interest rate, and expected dividend yield of its common stock. The fair value of an RSU is determined using the fair value of the Company’s underlying common stock on the date of grant. The Company accounts for forfeitures as they occur.

 

 

Revenue Recognition

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

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

 

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

 

Identification of the performance obligations in the contract;

 

Determination of the transaction price;

 

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

 

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

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

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

9


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

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

Subscription and Returns Revenue

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

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

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

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

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

Professional Services Revenue

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

Judgments and Estimates

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

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

10


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

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

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

 

Leases

 

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

 

Leases are classified at commencement as either operating or finance leases. As of June 30, 2020, all of the Company’s leases are classified as operating leases. Rent expense for operating leases is recognized on the straight-line method over the term of the agreement beginning on the lease commencement date. Operating lease costs are generally fixed payments. Lease-related costs, which are variable rather than fixed, are expensed in the period incurred. Variable lease costs consist primarily of common area maintenance and utilities costs for the Company’s office spaces that are due based on the actual costs incurred by the landlord. Lease payments that depend on an index or a rate are measured using the index or rate at the commencement date and are included in operating lease costs. Subsequent increases to lease payments due to a change in the index or rate are expensed as a variable lease cost.

 

Recently Adopted Accounting Standards

 

ASU No. 2016-13

 

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

 

ASU No. 2018-15

 

In August 2018, the FASB issued ASU No. 2018-15, related to implementation costs incurred in a cloud computing arrangement that is a service contract. This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use-software. The guidance in ASU No. 2018-15 is required for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2019, for public business entities. The Company adopted this guidance on January 1, 2020 with prospective application, as permitted by the ASU. For the first half of 2020, $1.5 million of implementation costs were capitalized and are recorded in other noncurrent assets on the consolidated balance sheet as of June 30, 2020.

 

11


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

New Accounting Standards Not Yet Adopted

 

ASU No. 2019-12

 

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

 

 

3.

Fair Value Measurements

Assets and liabilities measured at fair value on a recurring basis

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

 

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

 

 

Quoted Prices

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

Other

 

 

Significant

 

 

 

 

 

 

 

Markets for

 

 

Observable

 

 

Unobservable

 

 

 

Fair

 

 

Identical Assets

 

 

Inputs

 

 

Inputs

 

June 30, 2020

 

Value

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

Money market funds

 

$

466,093

 

 

$

466,093

 

 

$

 

 

$

 

Earnout related to business combinations

 

 

33

 

 

 

 

 

 

 

 

 

33

 

 

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

 

 

Quoted Prices

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

Other

 

 

Significant

 

 

 

 

 

 

 

Markets for

 

 

Observable

 

 

Unobservable

 

 

 

Fair

 

 

Identical Assets

 

 

Inputs

 

 

Inputs

 

December 31, 2019

 

Value

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

Money market funds

 

$

458,248

 

 

$

458,248

 

 

$

 

 

$

 

Earnout related to business combinations

 

 

13,808

 

 

 

 

 

 

 

 

 

13,808

 

 

 

Earnout Liabilities

 

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

 

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

 

The Company generally estimates the fair value of earnout liabilities for business combinations using probability-weighted discounted cash flows and Monte Carlo simulations. The earnout liability associated with the 2019 acquisition of Portway International Inc. (“Portway”) is based on the achievement of specific revenue and operating metrics through January 2021. As of June 30, 2020, the operating metrics were achieved, but the revenue metrics are not projected to be met, which resulted in a decrease to the carrying value of the earnout liability during the six months ended June 30, 2020. The earnout periods for the 2019 acquisitions of Compli, Inc. (“Compli”) and Indix Corporation (“Indix”) ended as of January 31, 2020 and February 6, 2020, respectively. Additional information regarding payments of earnout liabilities that occurred during the six months ended June 30, 2020 is included in Note 5.

12


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

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

 

 

 

Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Earnout liabilities:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

3,599

 

 

$

5,952

 

Fair value recorded at acquisition

 

 

 

 

 

 

Payments of earnout liabilities

 

 

(3,750

)

 

 

 

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

 

 

184

 

 

 

476

 

Balance end of period

 

$

33

 

 

$

6,428

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Earnout liabilities:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

13,808

 

 

$

 

Fair value recorded at acquisition

 

 

 

 

 

5,952

 

Payments of earnout liabilities

 

 

(11,450

)

 

 

 

Total unrealized net (gain) loss included in other (income) expense, net

 

 

(2,325

)

 

 

476

 

Balance end of period

 

$

33

 

 

$

6,428

 

 

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

 

The Company’s non-financial assets and liabilities, which include goodwill, intangible assets, and long-lived assets, are not required to be measured at fair value on a recurring basis. There were 0 fair value measurements of these assets during the first half of 2020.

 

 

4.

Balance Sheet Detail

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

 

 

 

Useful

 

June 30,

 

 

December 31,

 

 

 

Life (Years)

 

2020

 

 

2019

 

Computer equipment and software

 

3 to 5

 

$

14,565

 

 

$

15,636

 

Internally developed software

 

6

 

 

7,452

 

 

 

5,948

 

Furniture and fixtures

 

5

 

 

6,930

 

 

 

6,589

 

Office equipment

 

3 to 5

 

 

862

 

 

 

1,058

 

Leasehold improvements

 

1 to 10

 

 

29,484

 

 

 

28,984

 

 

 

 

 

 

59,293

 

 

 

58,215

 

Accumulated depreciation

 

 

 

 

(25,473

)

 

 

(23,218

)

Property and equipment—net

 

 

 

$

33,820

 

 

$

34,997

 

 

Depreciation expense was $2.3 million and $4.5 million for the three and six months ended June 30, 2020, respectively and $2.2 million and $4.2 million for the three and six months ended June 30, 2019, respectively.

 

Prepaid expenses and other current assets consisted of the following (in thousands):

 

 

 

June 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

Prepaid expenses

 

$

15,101

 

 

$

11,064

 

Accrued investment income

 

 

24

 

 

 

565

 

Deposits

 

 

427

 

 

 

197

 

Other

 

 

2,060

 

 

 

2,301

 

Total

 

$

17,612

 

 

$

14,127

 

 

13


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

 

Accrued expenses consisted of the following (in thousands):

 

 

 

June 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

Accrued payroll and related taxes

 

$

6,294

 

 

$

3,985

 

Accrued federal, state, and local taxes

 

 

2,694

 

 

 

2,635

 

Accrued bonus

 

 

7,554

 

 

 

20,206

 

Self-insurance reserves

 

 

2,223

 

 

 

2,238

 

Employee stock purchase plan contributions

 

 

4,913

 

 

 

4,716

 

Accrued sales commissions

 

 

3,875

 

 

 

5,397

 

Accrued partner commissions

 

 

6,996

 

 

 

7,043

 

Contract liabilities

 

 

6,195

 

 

 

5,197

 

Accrued purchase price related to acquisitions

 

 

3,368

 

 

 

2,763

 

Other

 

 

7,642

 

 

 

7,924

 

Total

 

$

51,754

 

 

$

62,104

 

 

Contract liabilities represent amounts that are collected in advance of the satisfaction of performance obligations. See Contract Liabilities in Note 6.

 

 

5.

Acquisitions of Businesses

January 2019 Acquisition of Compli

On January 22, 2019, the Company completed the acquisition of substantially all the assets of Compli under an Asset Purchase Agreement (the “Compli Purchase”). Compli is a provider of compliance services, technology, and software to producers, distributors, and importers of beverage alcohol in the United States. The Company accounted for the Compli Purchase as a business combination. As a result of the acquisition, the Company expanded its ability to provide transaction tax solutions and content for the beverage alcohol industry.

The total consideration transferred related to this transaction was $17.1 million, consisting of $11.8 million paid in cash at closing, an additional $1.6 million of cash to be paid out after twelve months, and an earnout provision fair valued upon acquisition at $3.8 million. The earnout provision is for a one-time payment and has a maximum payout of $4.0 million based on revenue recognized by the Company from the acquired operating assets for the twelve-month period ended January 31, 2020. The earnout was originally recognized at fair value at the date of the business combination and $4.0 million was paid in the first quarter of 2020.

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

 

Assets acquired:

 

 

 

 

Current assets

 

$

505

 

Developed technology, customer relationships, and other intangibles

 

 

4,288

 

Goodwill

 

 

12,807

 

Total assets acquired

 

 

17,600

 

Liabilities assumed:

 

 

 

 

Current liabilities

 

 

482

 

Total liabilities assumed

 

 

482

 

Net assets acquired

 

$

17,118

 

 

14


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

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

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

 

Estimated Useful

Life

Customer relationships

 

$

3,250

 

 

Multi-period excess

earnings-income approach

 

 

13

%

 

6 years

Trademarks and trade names

 

 

32

 

 

Relief from royalty-

income approach

 

 

13

%

 

2 years

Developed technology and

   customer database

 

 

910

 

 

Relief from royalty-

income approach

 

 

13

%

 

6 years

Noncompetition agreements

 

 

96

 

 

With-and-without valuation-

income approach

 

 

13

%

 

3 years

 

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

  

February 2019 Acquisition of Indix

On February 6, 2019, the Company completed the acquisition of substantially all the assets of Indix under an Asset Purchase Agreement (the “Indix Purchase”). Indix is an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide. The Company accounted for the Indix Purchase as a business combination. As a result of the acquisition, the Company intends to use the Indix artificial intelligence to maintain and expand its tax content database.

The total consideration transferred related to this transaction was $9.1 million, consisting of $5.5 million paid in cash at closing, an additional $1.4 million cash to be paid after eighteen months, and an earnout provision valued upon acquisition at $2.2 million. The earnout provision has a maximum payout of $3.0 million based on the successful transition and achievement of development milestones established in the purchase agreement. The earnout provides for interim payments based on milestones to be evaluated as follows: $0.5 million within three months of closing, $0.65 million within seven months of closing, $0.65 million within eight months of closing, and $1.2 million within 12 months of closing. The earnout was originally recognized at fair value at the date of the business combination and is adjusted to fair value quarterly (see Note 3). The first earnout milestone was achieved in the second quarter of 2019 and was paid in July 2019. The second and fourth milestones were not achieved. A portion of the third milestone was achieved and $0.03 million is recorded within current accrued earnout liabilities on the consolidated balance sheet as of June 30, 2020.

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

 

Assets acquired:

 

 

 

 

Current assets

 

$

94

 

Developed technology

 

 

4,472

 

Goodwill

 

 

4,953

 

Total assets acquired

 

 

9,519

 

Liabilities assumed:

 

 

 

 

Current liabilities

 

 

392

 

Total liabilities assumed

 

 

392

 

Net assets acquired

 

$

9,127

 

 

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

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

Estimated Useful

Life

Developed technology

 

$

4,472

 

 

Relief from royalty-

income approach

 

24.5%

 

6 years

15


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

 

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

 July 2019 Acquisition of Portway

On July 31, 2019, the Company completed the acquisition of substantially all the assets of Portway under an Asset Purchase Agreement (the “Portway Purchase”). Portway is a provider of Harmonized System classifications and outsourced customs brokerage services. The Company accounted for the Portway Purchase as a business combination. As a result of the acquisition, the Company expanded its cross-border solutions.

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

The earnout is based, in part, on 2 operating metric targets with a maximum payout of $7.5 million. The remainder of the earnout is based on certain revenue targets with a maximum payout of $2.5 million. Pursuant to the Portway Purchase, the shares will be transferred to the seller when the criteria under each provision are satisfied. During the first half of 2020, 89,318 shares of common stock (with a $7.5 million value under the Portway Purchase) were transferred to the seller to settle both operating metric targets of the earnout. The earnout was originally recognized at fair value at the date of the business combination and is adjusted to fair value quarterly (see Note 3). The remaining earnout liability related to the revenue targets was determined to be 0 as of June 30, 2020.

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

 

Assets acquired:

 

 

 

 

Property and equipment

 

$

76

 

Customer relationships and other intangibles

 

 

1,865

 

Goodwill

 

 

22,376

 

Total assets acquired

 

 

24,317

 

Liabilities assumed:

 

 

 

 

Total liabilities assumed

 

 

 

Net assets acquired

 

$

24,317

 

 

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

 

Intangible

 

Assigned Value

 

 

Valuation Methodology

 

Discount Rate

 

 

Estimated Useful

Life

Customer relationships

 

$

1,759

 

 

Multi-period excess

earnings-income approach

 

 

12

%

 

6 years

Noncompetition agreements

 

 

106

 

 

With-and-without valuation-

income approach

 

 

12

%

 

4 years

 

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

 

16


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

6.

Revenue

See Note 2 for a description of the Company’s revenue recognition accounting policy.

 

Disaggregation of Revenue

 

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

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue (U.S.):

 

 

 

 

 

 

 

 

Subscription and returns

 

 

 

 

 

 

 

 

Tax determination

 

$

61,701

 

 

$

48,707

 

Tax returns and compliance management

 

 

40,864

 

 

 

30,686

 

Interest income on funds held for customers

 

 

58

 

 

 

812

 

Total subscription and returns

 

 

102,623

 

 

 

80,205

 

Professional services

 

 

7,331

 

 

 

5,663

 

Total revenue (U.S.)

 

 

109,954

 

 

 

85,868

 

Total revenue (non-U.S.)

 

 

6,533

 

 

 

5,431

 

Total revenue

 

$

116,487

 

 

$

91,299

 

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue (U.S.):

 

 

 

 

 

 

 

 

Subscription and returns

 

 

 

 

 

 

 

 

Tax determination

 

$

120,672

 

 

$

93,938

 

Tax returns and compliance management

 

 

80,297

 

 

 

57,372

 

Interest income on funds held for customers

 

 

584

 

 

 

1,541

 

Total subscription and returns

 

 

201,553

 

 

 

152,851

 

Professional services

 

 

12,793

 

 

 

11,398

 

Total revenue (U.S.)

 

 

214,346

 

 

 

164,249

 

Total revenue (non-U.S.)

 

 

13,584

 

 

 

12,020

 

Total revenue

 

$

227,930

 

 

$

176,269

 

 

Disclosures Related to Contracts with Customers

 

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

 

Contract Liabilities

 

17


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

A summary of the activity impacting the contract liabilities during the three and six months ended June 30, 2020 and 2019 is presented below (in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Contract liabilities:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

6,330

 

 

$

4,208

 

Contract liabilities transferred to deferred revenue

 

 

(2,716

)

 

 

(1,137

)

Addition to contract liabilities

 

 

2,581

 

 

 

1,437

 

Balance end of period

 

$

6,195

 

 

$

4,508

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Contract liabilities:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

5,197

 

 

$

 

Adoption of ASC 606

 

 

 

 

 

2,090

 

Contract liabilities transferred to deferred revenue

 

 

(5,254

)

 

 

(2,394

)

Addition to contract liabilities

 

 

6,252

 

 

 

4,812

 

Balance end of period

 

$

6,195

 

 

$

4,508

 

 

As of June 30, 2020, contract liabilities are expected to be transferred to deferred revenue within the next 12 months and therefore are included in accrued expenses on the consolidated balance sheets.

 

Deferred Revenue

 

A summary of the activity impacting deferred revenue balances during the three and six months ended June 30, 2020 and 2019 is presented below (in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Deferred revenue:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

165,369

 

 

$

132,714

 

Revenue recognized

 

 

(116,487

)

 

 

(91,299

)

Additional amounts deferred

 

 

118,837

 

 

 

97,396

 

Balance end of period

 

$

167,719

 

 

$

138,811

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Deferred revenue:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

161,241

 

 

$

134,653

 

Adoption of ASC 606

 

 

 

 

 

(11,250

)

Revenue recognized

 

 

(227,930

)

 

 

(176,269

)

Additional amounts deferred

 

 

234,408

 

 

 

191,677

 

Balance end of period

 

$

167,719

 

 

$

138,811

 

 

Assets Recognized from the Costs to Obtain Contracts with Customers

 

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

 

18


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

A summary of the activity impacting the deferred commissions during the three and six months ended June 30, 2020 and 2019 is presented below (in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Deferred commissions:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

40,666

 

 

$

25,644

 

Additional commissions deferred

 

 

5,515

 

 

 

4,706

 

Amortization of deferred commissions

 

 

(2,825

)

 

 

(1,706

)

Balance end of period

 

$

43,356

 

 

$

28,644

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Deferred commissions:

 

 

 

 

 

 

 

 

Balance beginning of period

 

$

38,416

 

 

$

 

Adoption of ASC 606

 

 

 

 

 

19,267

 

Additional commissions deferred

 

 

10,412

 

 

 

12,362

 

Amortization of deferred commissions

 

 

(5,472

)

 

 

(2,985

)

Balance end of period

 

$

43,356

 

 

$

28,644

 

 

As of June 30, 2020, $10.3 million of deferred commissions are expected to be amortized within the next 12 months and therefore are included in current assets on the consolidated balance sheets. The remaining amount of deferred commissions are included in noncurrent assets. There were 0 impairments of assets related to deferred commissions during the six months ended June 30, 2020 or 2019. There were 0 assets recognized related to the costs to fulfill contracts during the six months ended June 30, 2020 or 2019 as these costs were not material.

 

Remaining Performance Obligations

 

Contracts with customers include amounts allocated to performance obligations that will be satisfied at a later date. These amounts include additional performance obligations that are not yet recorded in the consolidated balance sheets. As of June 30, 2020, amounts allocated to these additional contractual obligations are $40.8 million, of which $40.4 million is expected to be recognized as revenue over the next 12 months with the remaining amount thereafter.

 

7.

Intangible Assets

Finite-lived intangible assets

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

 

 

 

 

 

June 30, 2020

 

 

 

Average Useful Life

(Years)

 

Gross

 

 

Accumulated

Amortization

 

 

Net

 

Customer relationships

 

3 to 10

 

$

20,241

 

 

$

(12,469

)

 

$

7,772

 

Developed technology

 

3 to 8

 

 

36,068

 

 

 

(24,664

)

 

 

11,404

 

Noncompete agreements

 

3 to 5

 

 

759

 

 

 

(626

)

 

 

133

 

Tradename and trademarks

 

1 to 4

 

 

439

 

 

 

(429

)

 

 

10

 

 

 

 

 

$

57,507

 

 

$

(38,188

)

 

$

19,319

 

 

19


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

 

 

 

 

December 31, 2019

 

 

 

Average Useful Life

(Years)

 

Gross

 

 

Accumulated

Amortization

 

 

Net

 

Customer relationships

 

3 to 10

 

$

20,390

 

 

$

(11,403

)

 

$

8,987

 

Developed technology

 

3 to 8

 

 

36,422

 

 

 

(22,659

)

 

 

13,763

 

Noncompete agreements

 

3 to 5

 

 

777

 

 

 

(612

)

 

 

165

 

Tradename and trademarks

 

1 to 4

 

 

452

 

 

 

(435

)

 

 

17

 

 

 

 

 

$

58,041

 

 

$

(35,109

)

 

$

22,932

 

 

Finite-lived intangible assets are generally amortized on a straight-line basis over the remaining estimated useful life as management believes this reflects the expected benefit to be received from these assets. Finite-lived intangible assets amortization expense was $1.6 million and $3.5 million for the three and six months ended June 30, 2020, respectively, and $1.8 million and $3.5 million for the three and six months ended June 30, 2019, respectively.

        

 

Goodwill

 

Changes in the carrying amount of goodwill for the six months ended June 30, 2020 are summarized as follows (in thousands):

 

Balance—December 31, 2019

 

$

101,224

 

Cumulative translation adjustments

 

 

(26

)

Balance—June 30, 2020

 

$

101,198

 

 

Goodwill is tested for impairment annually on October 31 at the reporting unit level or whenever circumstances occur indicating goodwill might be impaired. The impairment test involves comparing the fair value of each reporting unit to its carrying value, including goodwill. Fair value reflects the price a market participant would be willing to pay in a potential sale of the reporting unit. If the fair value exceeds carrying value, the Company will conclude that 0 goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, the Company will recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value. The Company has 3 reporting units for goodwill impairment testing consisting of its U.S., European, and Brazilian operations. As of June 30, 2020, the Brazilian reporting unit had 0 associated goodwill.

 

8.

Leases    

 

Total lease cost, net of sublease income, was $3.9 million and $7.7 million for the three and six months ended June 30, 2020, respectively, and $2.9 million and $5.5 million for the three and six months ended June 30, 2019, respectively. Sublease income was $0.4 million and $0.8 million for the three and six months ended June 30, 2020, respectively, and $0.4 million and $0.7 million for the three and six months ended June 30, 2019, respectively. Leases that commenced in the first half of 2020 increased operating lease right-of-use assets by $6.6 million.

 

9.

Commitments and Contingencies

 

Contingencies

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

20


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

  

On October 22, 2018, PTP OneClick, LLC (“PTP”) filed a lawsuit against Avalara, Inc. in the United States District Court for the Eastern District of Wisconsin. The lawsuit alleges that making, using, offering to sell, and selling AvaTax, Avalara Returns, and TrustFile (the “Avalara Products”) infringe U.S. Patent No. 9,760,915 held by PTP and also alleges unspecified trade secret misappropriation, unfair competition, and breach of contract. PTP seeks judgments of willful patent infringement, willful trade secret misappropriation, unfair competition, and breach of contract. PTP requests preliminary and permanent injunctions to enjoin the Company from making, using, offering to sell, and selling the Avalara Products along with treble damages and attorneys’ fees. Based upon the Company’s review of the complaint and the specified patent, the Company believes that the Company has meritorious defenses to PTP’s claims. On November 7, 2018, the Company moved to dismiss the lawsuit and to have the patent held invalid, and also moved to transfer the matter to the United States District Court located in Seattle, Washington. On April 30, 2019, the United States District Court for the Eastern District of Wisconsin granted the Company’s motion to transfer, reserving resolution of the motion to dismiss for the United States District Court for the Western District of Washington. On October 7, 2019, the United States District Court for the Western District of Washington invalidated the patent and dismissed the patent and unfair competition claims with prejudice but did not dismiss the trade secret misappropriation or breach of contract claims. On March 5, 2020, we filed a motion for summary judgment. On May 27, 2020, the United States District Court for the Western District of Washington entered summary judgment in favor of Avalara, Inc. disposing of the remaining trade secret misappropriation and breach of contract claims. Plaintiff filed a notice of appeal but subsequently withdrew the notice. On July 7, 2020, the United States District Court for the Western District of Washington dismissed the appeal with prejudice.

 

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

 

While the Company has never paid a material claim related to these indemnification provisions, the Company believes that, as of June 30, 2020, there is a reasonable possibility that a loss may be incurred pursuant to certain of these arrangements and estimates a range of loss of up to $2.0 million. The Company has not recorded an accrual related to these arrangements as of June 30, 2020 because it has not determined that a loss is probable. The ultimate outcome of these potential obligations is unknown, and it is possible that the actual losses could be higher than the estimated range.  

10.

Debt

 

Loan and Security Agreement

 

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

 

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

 

11.

Shareholders’ Equity

Authorized Capital—Common Stock and Preferred Stock

Under the Amended and Restated Articles of Incorporation, which became effective in June 2018, the Company is authorized to issue 2 classes of stock designated as common stock and preferred stock. The Company’s total authorized capital stock is 620,000,000 shares, consisting of 600,000,000 shares of common stock, $0.0001 par value per share, and 20,000,000 shares of undesignated preferred stock, $0.0001 par value per share.

21


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

 

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

The changes to the Company’s shareholders’ equity during the six months ended June 30, 2020 is as follows (in thousands, except share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

Other

 

 

 

 

 

 

Total

 

 

Common Stock

 

 

Paid-In

 

 

Comprehensive

 

 

Accumulated

 

 

Shareholders’

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Equity

 

Balance at January 1, 2020

 

77,447,620

 

 

$

8

 

 

$

976,627

 

 

$

(2,719

)

 

$

(510,194

)

 

$

463,722

 

Exercise of stock options

 

532,848

 

 

 

 

 

 

 

7,928

 

 

 

 

 

 

 

 

 

 

 

7,928

 

Vesting of restricted stock units

 

186,475

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation cost

 

 

 

 

 

 

 

 

 

9,749

 

 

 

 

 

 

 

 

 

 

 

9,749

 

Shares issued under employee stock

   purchase plan

 

81,894

 

 

 

 

 

 

 

5,716

 

 

 

 

 

 

 

 

 

 

 

5,716

 

Shares issued related to business

   combination earnouts

 

44,659

 

 

 

 

 

 

 

3,750

 

 

 

 

 

 

 

 

 

 

 

3,750

 

Shares issued to purchase intangible assets

 

1,191

 

 

 

 

 

 

 

87

 

 

 

 

 

 

 

 

 

 

 

87

 

Gain on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

625

 

 

 

 

 

 

 

625

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(15,283

)

 

 

(15,283

)

Balance at March 31, 2020

 

78,294,687

 

 

$

8

 

 

$

1,003,857

 

 

$

(2,094

)

 

$

(525,477

)

 

$

476,294

 

Exercise of stock options

 

1,117,805

 

 

 

 

 

 

 

17,495

 

 

 

 

 

 

 

 

 

 

 

17,495

 

Vesting of restricted stock units

 

57,832

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation cost

 

 

 

 

 

 

 

 

 

12,368

 

 

 

 

 

 

 

 

 

 

 

12,368

 

Shares issued related to business

   combination earnouts

 

44,659

 

 

 

 

 

 

 

3,750

 

 

 

 

 

 

 

 

 

 

 

3,750

 

Gain on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

435

 

 

 

 

 

 

 

435

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(10,140

)

 

 

(10,140

)

Balance at June 30, 2020

 

79,514,983

 

 

$

8

 

 

$

1,037,470

 

 

$

(1,659

)

 

$

(535,617

)

 

$

500,202

 

 

 

22


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

The changes to the Company’s shareholders’ equity for the six months ended June 30, 2019 is as follows (in thousands, except share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

Other

 

 

 

 

 

 

Total

 

 

Common Stock

 

 

Paid-In

 

 

Comprehensive

 

 

Accumulated

 

 

Shareholders’

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Equity

 

Balance at January 1, 2019

 

66,768,563

 

 

$

7

 

 

$

599,493

 

 

$

(2,345

)

 

$

(487,602

)

 

$

109,553

 

Impact of adoption of new accounting

   pronouncements - ASC 606 (see Note 2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,622

 

 

 

27,622

 

Exercise of stock options

 

2,763,291

 

 

 

 

 

 

 

27,311

 

 

 

 

 

 

 

 

 

 

 

27,311

 

Shares tendered for cashless redemption of

   stock-based awards

 

(2,805

)

 

 

 

 

 

 

(93

)

 

 

 

 

 

 

 

 

 

 

(93

)

Stock-based compensation cost

 

 

 

 

 

 

 

 

 

6,571

 

 

 

 

 

 

 

 

 

 

 

6,571

 

Shares issued under employee stock

   purchase plan

 

372,764

 

 

 

 

 

 

 

7,664

 

 

 

 

 

 

 

 

 

 

 

7,664

 

Shares issued to purchase intangible assets

 

1,634

 

 

 

 

 

 

 

50

 

 

 

 

 

 

 

 

 

 

 

50

 

Loss on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

(462

)

 

 

 

 

 

 

(462

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(10,354

)

 

 

(10,354

)

Balance at March 31, 2019

 

69,903,447

 

 

$

7

 

 

$

640,996

 

 

$

(2,807

)

 

$

(470,334

)

 

$

167,862

 

Proceeds from common stock

   offering, net of underwriting discounts

 

4,133,984

 

 

 

1

 

 

 

274,704

 

 

 

 

 

 

 

 

 

 

 

274,705

 

Public offering costs

 

 

 

 

 

 

 

 

 

(1,198

)

 

 

 

 

 

 

 

 

 

 

(1,198

)

Exercise of stock options

 

1,368,510

 

 

 

 

 

 

 

13,106

 

 

 

 

 

 

 

 

 

 

 

13,106

 

Vesting of restricted stock units

 

902

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation cost

 

 

 

 

 

 

 

 

 

9,439

 

 

 

 

 

 

 

 

 

 

 

9,439

 

Shares issued to purchase intangible assets

 

37,708

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain on translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

276

 

 

 

 

 

 

 

276

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(14,237

)

 

 

(14,237

)

Balance at June 30, 2019

 

75,444,551

 

 

$

8

 

 

$

937,047

 

 

$

(2,531

)

 

$

(484,571

)

 

$

449,953

 

 

 

12.

Equity Incentive Plans

The Company has stock-based compensation plans that provide for the award of equity incentives, including stock options, stock awards, RSUs, and purchase rights. As of June 30, 2020, the Company had stock options outstanding under the 2018 Equity Incentive Plan (the “2018 Plan”) and the 2006 Equity Incentive Plan (the “2006 Plan”), had RSUs outstanding under the 2018 Plan, and had purchase rights issued under the ESPP.

In April 2018, the 2018 Plan became effective in connection with the Company’s IPO. The 2018 Plan allows the Company to grant equity incentives to employees, directors, advisors, and consultants providing services to the Company or a subsidiary. The total number of shares of common stock reserved for issuance under the 2018 Plan is equal to (1) 5,315,780 shares (excluding automatic annual share increases) plus (2) any shares subject to outstanding awards under the 2006 Plan as of June 14, 2018 that subsequently cease to be subject to such awards. The available shares automatically increase each January 1, beginning January 1, 2019, by the lesser of (i) 5% of the aggregate number of shares of common stock outstanding on December 31st of the immediately preceding calendar year (rounded up to the nearest whole share) and (ii) an amount determined by the Company’s Board of Directors. As of June 30, 2020, 3,493,168 shares were subject to outstanding awards and 9,111,608 shares were available for issuance under the 2018 Plan. The 2018 Plan provides that on the occurrence of certain strategic events, such as a change in control in which options and RSUs are not assumed or substituted, such outstanding options and RSUs will become fully vested and exercisable or payable.

Prior to the 2018 Plan, the Company awarded stock options under the 2006 Plan. The 2006 Plan was terminated in connection with the Company’s IPO. Outstanding awards under the 2006 Plan continue to be subject to the terms and conditions of the 2006 Plan. As of June 30, 2020, there were 3,119,524 shares subject to outstanding stock options under the 2006 Plan.

23


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

Stock-Based Compensation

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

 

 

 

For the Three Months Ended June 30,

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Stock-based compensation cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

$

4,159

 

 

$

4,196

 

 

$

8,008

 

 

$

8,113

 

Restricted stock units

 

 

7,487

 

 

 

4,551

 

 

 

12,420

 

 

 

6,249

 

Employee stock purchase plan

 

 

722

 

 

 

692

 

 

 

1,689

 

 

 

1,648

 

Total stock-based compensation cost

 

$

12,368

 

 

$

9,439

 

 

$

22,117

 

 

$

16,010

 

 

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

 

Stock Options

The following table summarizes stock option activity for the Company’s stock-based compensation plans for the six months ended June 30, 2020:

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

Average

 

 

Aggregate

 

 

 

 

 

 

 

Average

 

 

Remaining

 

 

Intrinsic

 

 

 

 

 

 

 

Exercise

 

 

Contractual

 

 

Value

 

 

 

Shares

 

 

Price

 

 

Life (Years)

 

 

(in thousands)

 

Options outstanding as of January 1, 2020

 

 

5,884,742

 

 

$

20.09

 

 

 

7.22

 

 

$

312,838

 

Options granted

 

 

245,062

 

 

 

71.75

 

 

 

 

 

 

 

 

 

Options exercised

 

 

(1,650,653

)

 

 

15.40

 

 

 

 

 

 

 

 

 

Options cancelled or expired

 

 

(99,417

)

 

 

15.89

 

 

 

 

 

 

 

 

 

Options outstanding as of June 30, 2020

 

 

4,379,734

 

 

 

24.84

 

 

 

7.10

 

 

 

474,100

 

Options exercisable as of June 30, 2020

 

 

2,257,723

 

 

$

16.51

 

 

 

6.13

 

 

$

263,195

 

 

A summary of options outstanding and vested as of June 30, 2020 is as follows:

 

 

 

Options Outstanding

 

 

Options Vested and Exercisable

 

Exercise

 

Number

 

 

Weighted

Average

 

 

Number Vested

 

 

Weighted

Average

 

Prices

 

Outstanding

 

 

Life (in Years)

 

 

and Exercisable

 

 

Life (in Years)

 

$1.50 to $1.90

 

 

27,763

 

 

 

0.8

 

 

 

27,763

 

 

 

0.8

 

2.86 to 6.40

 

 

89,062

 

 

 

2.6

 

 

 

89,062

 

 

 

2.6

 

8.04 to 11.72

 

 

300,863

 

 

 

3.7

 

 

 

300,863

 

 

 

3.7

 

12.20 to 15.06

 

 

1,394,602

 

 

 

6.2

 

 

 

1,138,188

 

 

 

6.1

 

16.06 to 24.00

 

 

1,307,234

 

 

 

7.6

 

 

 

435,295

 

 

 

7.6

 

31.99 to 42.21

 

 

736,230

 

 

 

8.5

 

 

 

200,115

 

 

 

8.5

 

55.10 to 99.65

 

 

523,980

 

 

 

9.3

 

 

 

66,437

 

 

 

8.5

 

 

 

 

4,379,734

 

 

 

 

 

 

 

2,257,723

 

 

 

 

 

 

The total intrinsic value of options exercised during the six months ended June 30, 2020 and 2019 was $131.2 million and $192.4 million, respectively.

 

The weighted average grant date fair value of options granted during the six months ended June 30, 2020 and 2019 was $30.06 and $18.93 per share, respectively. During the six months ended June 30, 2020, 963,748 options vested. There were 2,122,011 options unvested as of June 30, 2020.

24


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

As of June 30, 2020, $28.8 million of total unrecognized compensation cost related to stock options was expected to be recognized over a weighted average period of approximately 2.5 years.

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

 

 

 

For the Three Months Ended June 30,

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Fair market value of common stock

 

$66.26 - 99.65

 

 

$55.10 - 72.67

 

 

$66.26 - 99.65

 

 

$39.76 - 72.67

 

Volatility

 

43%

 

 

40%

 

 

43%

 

 

40%

 

Expected term

 

5-6 years

 

 

5-6 years

 

 

5-6 years

 

 

5-6 years

 

Expected dividend yield

 

n/a

 

 

n/a

 

 

n/a

 

 

n/a

 

Risk-free interest rate

 

0.33% - 0.51%

 

 

1.77% - 2.49%

 

 

0.33% - 1.25%

 

 

1.77% - 2.65%

 

 

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

 

Beginning in 2020, expected volatility for stock options is based on a combination of annualized daily historical volatility of the Company’s stock price and the historical and implied volatility of comparable publicly traded companies over a similar expected term. Prior to 2020, expected volatility was based only on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

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

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

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

Restricted Stock Units

The following table summarizes RSU activity for the Company’s stock-based compensation plans for the six months ended June 30, 2020:

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Grant Date Fair

 

 

 

Restricted Stock Units

 

 

Value Per Share

 

RSUs outstanding as of January 1, 2020

 

 

1,508,281

 

 

$

51.52

 

RSUs granted

 

 

1,064,457

 

 

 

72.85

 

RSUs vested

 

 

(244,307

)

 

 

48.28

 

RSUs cancelled

 

 

(95,473

)

 

 

51.79

 

RSUs outstanding as of June 30, 2020

 

 

2,232,958

 

 

$

62.03

 

 

Stock-based compensation cost for RSUs is recognized on a straight-line basis in the consolidated statements of operations over the period during which the participant is required to perform services in exchange for the award, based on the fair value of the Company’s underlying common stock on the date of grant. The vesting period of each RSU grant is generally four years for

25


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

employees and one year for non-employee directors. As of June 30, 2020, $126.6 million of total unrecognized compensation cost related to RSUs was expected to be recognized over a weighted average period of approximately 3.3 years.

Employee Stock Purchase Plan

 

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

 

Eligible employees can select a rate of payroll deduction for purchases under the ESPP of between 1% and 15% of their eligible compensation. The purchase price for shares of common stock purchased under the ESPP is 85% of the lesser of the fair market value of the Company’s common stock on (i) the first day of the applicable offering period or (ii) the last day of the purchase period in the applicable offering period.

 

The Company initially reserved 996,709 shares of common stock for sale under the ESPP. The aggregate number of shares reserved for sale under the ESPP increases automatically on each January 1, beginning January 1, 2019, by the number of shares equal to the least of (i) 1,000,000 shares of common stock, (ii) 1% of the aggregate number of shares of common stock outstanding on December 31st of the immediately preceding calendar year (rounded up to the nearest whole share), and (iii) an amount determined by the Board of Directors. No more than an aggregate of 10,102,525 shares of common stock may be issued over the ten-year term of the ESPP. As of June 30, 2020, 1,851,268 shares of common stock are reserved for sale under the ESPP.

 

There were 0 stock purchases under the ESPP during the three months ended June 30, 2020. During the six months ended June 30, 2020, 81,894 shares of common stock were purchased under the ESPP.

 

As of June 30, 2020, there was approximately $0.3 million of unrecognized stock-based compensation cost related to the ESPP that is expected to be recognized over the remaining term of the offering period that began on February 1, 2020 and will end on July 31, 2020.

 

For the periods presented, the fair value of ESPP purchase rights was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

For the Three and Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Fair market value of common stock

 

$85.14

 

 

$40.60

 

Volatility

 

32%

 

 

40%

 

Expected term

 

0.5 years

 

 

0.5 years

 

Expected dividend yield

 

n/a

 

 

n/a

 

Risk-free interest rate

 

1.54%

 

 

2.59%

 

 

 

 

Beginning in 2020, the expected volatility for ESPP purchase rights is based on daily historical volatility of the Company’s stock price. Prior to 2020, expected volatility was based only on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

 

13.

Net Loss Per Share Attributable to Common Shareholders

 

The Company calculates basic and diluted net loss per share attributable to common shareholders in conformity with the two-class method required for companies with participating securities.

 

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

 

26


AVALARA, INC.

Notes to Consolidated Financial Statements

(unaudited)

 

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

 

 

 

For the Three Months Ended June 30,

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shareholders

 

$

(10,140

)

 

$

(14,237

)

 

$

(25,423

)

 

$

(24,591

)

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares

   outstanding-basic

 

 

78,924

 

 

 

71,568

 

 

 

78,414

 

 

 

69,983

 

Dilutive effect of share equivalents resulting from stock

   options, restricted stock units, and ESPP shares

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares

   outstanding-diluted

 

 

78,924

 

 

 

71,568

 

 

 

78,414

 

 

 

69,983

 

Net loss per common share, basic and diluted

 

$

(0.13

)

 

$

(0.20

)

 

$

(0.32

)

 

$

(0.35

)

 

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

 

 

 

For the Three Months Ended June 30,

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Options to purchase common shares

 

 

4,928

 

 

 

8,458

 

 

 

5,296

 

 

 

9,343

 

Unvested restricted stock units

 

 

2,204

 

 

 

1,213

 

 

 

1,879

 

 

 

924

 

Employee stock purchase plan shares

 

 

50

 

 

 

82

 

 

 

30

 

 

 

48

 

Total

 

 

7,182

 

 

 

9,753

 

 

 

7,205

 

 

 

10,315

 

 

 

 

 

 

 

27


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and our 2019 Annual Report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors,” in Part II, Item 1A of this Quarterly Report on Form 10-Q and our 2019 Annual Report. See “Special Note Regarding Forward-Looking Statements” above.

Overview

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

We derive most of our revenue from subscriptions to our solutions. Subscriptions and returns revenue accounted for 94% and 93% of our total revenue during the six months ended June 30, 2020 and 2019, respectively. The initial term of our subscription contracts generally ranges from twelve to eighteen months, and renewal periods are typically one year in length. Subscription and returns revenue is primarily driven by the number of customers we have and the price plans they select for volumes of tax calculations, returns, and tax exemption certificates. We also derive revenue from providing professional services. During the first half of 2020, we generated approximately 94% of our revenue in North America and we are expanding our international presence to support transaction tax compliance in Europe, South America, and Asia.

Our total revenue for the three months ended June 30, 2020 was $116.5 million compared to $91.3 million for the three months ended June 30, 2019. Our total revenue for the six months ended June 30, 2020 was $227.9 million compared to $176.3 million for the six months ended June 30, 2019. Our net loss for the three months ended June 30, 2020 was $10.1 million compared to a net loss of $14.2 million for the three months ended June 30, 2019. Our net loss for the six months ended June 30, 2020 was $25.4 million compared to a net loss of $24.6 million for the six months ended June 30, 2019.

 

Impact of COVID-19 Pandemic

Our global operations expose us to risks associated with public health crises and pandemics, such as the recent novel coronavirus (“COVID-19”) pandemic. Our priority remains the health and safety of our employees and their families. Almost all of our employees are able to work offsite and most have been working from home since March 2020. In some locations, where allowed by local authorities, we have begun reopening office locations for a limited number of employees. Currently, almost all of our employees are working from home and we expect these arrangements to continue for most of our workforce for the rest of the year.

In the second quarter of 2020, operating expenses were lower than initially planned partially due to the COVID-19 pandemic. We temporarily reduced spending on in-person marketing events, company-wide travel costs, and, to a lesser extent, we slowed the pace of hiring new employees.  These expense reductions were partially offset by one-time bonus payments to employees to assist with work from home expenses, additional spending on systems and applications that do not depend on employees being physically present in our offices, and incremental expenses incurred to prepare our offices to reopen safely. In the second quarter of 2020, our operating cash flows were negatively impacted to the extent we experienced a slowdown in collections on accounts receivable as a result of extending longer than typical credit terms for new customers and a slowdown in payments from customers, but this was partially offset by the deferral of U.S. employer payroll tax payments under the Coronavirus Aid, Relief and Economic Security Act (“the CARES Act”). While we are impacted by the COVID-19 pandemic and the resulting global economic decline, we currently believe that our strong cash position, which was $474.4 million as of June 30, 2020, will be sufficient to meet our anticipated cash needs for at least the next 12 months.

As the COVID-19 pandemic continues to evolve in all locations in which we operate, the extent and timing of the broader impact of the pandemic on our results of operations, overall financial performance and operating cash flows remains uncertain, including the impact on our revenue growth, the timing of resumption of normal operating expenses, and incremental expenses associated with preventative and precautionary measures that we are taking in response to the pandemic.

 

28


 

Key Business Metrics

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

 

 

Jun 30,

2020

 

 

Mar 31,

2020

 

 

Dec 31,

2019

 

 

Sep 30,

2019

 

 

Jun 30,

2019

 

 

Mar 31,

2019

 

 

Dec 31,

2018

 

 

Sep 30,

2018

 

 

Jun 30,

2018

 

 

Mar 31,

2018

 

Number of core

   customers (as of

   end of period)

- as reported (1)

 

13,300

 

 

 

12,710

 

 

 

11,960

 

 

 

11,240

 

 

 

10,430

 

 

 

9,700

 

 

 

9,070

 

 

 

8,490

 

 

 

8,080

 

 

 

7,760

 

Number of core

   customers (as of

   end of period)

- as revised (1)

 

13,560

 

 

 

12,940

 

 

 

12,150

 

 

 

11,400

 

 

 

10,560

 

 

 

9,800

 

 

 

9,150

 

 

 

8,540

 

 

 

8,120

 

 

 

7,780

 

Net revenue

   retention rate

107%

 

 

109%

 

 

111%

 

 

113%

 

 

111%

 

 

107%

 

 

108%

 

 

105%

 

 

108%

 

 

109%

 

 

 

(1)

During the second quarter of 2020, we determined there were a small number of core customers that terminate and subsequently repurchase Avalara services, that previously were not included in reported core customers. The number of core customers as revised for each period presented includes these customers.

 

Number of Core Customers

We believe core customers is a key indicator of our market penetration, growth, and potential future revenue. The mid-market has been and remains our primary target market segment for marketing and selling our solutions. We use core customers as a metric to focus our customer count reporting on our primary target market segment. As of June 30, 2020 and December 31, 2019, we had approximately 13,300  and 11,960  core customers, respectively. Including the revised calculation, as of June 30, 2020 and December 31, 2019, we had approximately 13,560 and 12,150 core customers, respectively. In the first half of 2020, our core customers represented more than 80% of our total revenue.

We define a core customer as:

 

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

 

that is active as of the measurement date; and

 

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

Currently, our core customer count includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries and certain legacy billing systems that have not been integrated into our primary U.S. billing systems (e.g., our lodging tax compliance solution). As we increase our international operations and sales in future periods, we may add customers billed from our international subsidiaries to the core customer metric.

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

Net Revenue Retention Rate

We believe that our net revenue retention rate provides insight into our ability to retain and grow revenue from our customers, as well as their potential long-term value to us. We also believe it reflects the stability of our revenue base, which is one of our core competitive strengths. We calculate our net revenue retention rate by dividing (a) total revenue in the current quarter from any billing accounts that generated revenue during the corresponding quarter of the prior year by (b) total revenue in such corresponding quarter from those same billing accounts. This calculation includes changes for these billing accounts, such as additional solutions purchased, changes in pricing and transaction volume, and terminations, but does not reflect revenue for new billing accounts added during the one-year period. Our

29


 

Streamlined Sales Tax (SST) solution is not included in net revenue retention rate. This means that revenue expansion from existing customers adopting our SST solution is not included, while revenue contraction from customers downgrading one or more of Avalara’s other solutions in favor of SST is included.

Currently, our net revenue retention rate calculation includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries or certain legacy billing systems, primarily related to past acquisitions. Our net revenue retention rate was 107% for the quarter ended June 30, 2020 and on average has been 110% over the last four quarters ended June 30, 2020.

Key Components of Consolidated Statements of Operations

Revenue

We generate revenue from two primary sources: (1) subscription and returns; and (2) professional services. Subscription and returns revenue are driven primarily by the acquisition of customers, customer renewals, and additional service offerings purchased by existing customers. Revenue from subscriptions and returns comprised approximately 94% of our revenue for the six months ended June 30, 2020 and 93% of our revenue for the six months ended June 30, 2019.

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

Our standard subscription contracts are generally non-cancelable after the first 60 days of the contract term. Cancellations under our standard subscription contracts are not material, and do not have a significant impact on revenue recognized. We generally invoice our subscription customers for the initial term at contract signing and upon renewal. Our initial terms generally range from twelve to eighteen months, and renewal periods are typically one year. Amounts that have been invoiced are initially recorded as deferred revenue or contract liabilities. Subscription revenue is recognized on a straight-line basis over the service term of the arrangement beginning on the date that our solution is made available to the customer and ending at the expiration of the subscription term. Subscription and returns revenue also include interest income generated on funds held for customers. In order to provide tax remittance services to customers, we hold funds from customers in advance of remittance to tax authorities. These funds are held in trust accounts at FDIC-insured institutions. Prior to remittance, we earn interest on these funds.

Currently a small component of our total revenue, we offer SST services to businesses that are registered to participate in the program. We earn a fee (SST revenue) from participating state and local governments based on a percentage of the sales tax reported and paid, and as a result, we generally provide SST services at no cost to the seller.

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

Costs and Expenses

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

Research and Development.  Research and development expenses consist primarily of employee-related expenses for our research and development staff, including salaries, benefits, bonuses, stock-based compensation, the cost of third-party developers and other independent contractors, and the amortization of capitalized software development costs. Research and development costs, other than

30


 

software development expenses qualifying for capitalization, are expensed as incurred. Capitalized software development costs consist primarily of employee-related costs. Research and development expenses also include allocated costs for certain information technology and facility expenses.

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

Sales and Marketing.  Sales and marketing expenses consist primarily of employee-related expenses for our sales and marketing staff, including salaries, benefits, bonuses, sales commissions, and stock-based compensation, integration and referral partner commissions, costs of marketing and promotional events, corporate communications, online marketing, solution marketing, and other brand-building activities. As a result of the current COVID-19 pandemic, we have suspended in-person promotional and customer events and have converted many of these activities to virtual events, which has temporarily reduced these types of marketing expenses. We expect to resume in-person marketing activities when conditions allow. Sales and marketing expenses include allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as customer databases from acquisitions.

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

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

We intend to continue to invest in sales and marketing and expect spending in these areas to increase in absolute dollars as we continue to expand our business. We expect sales and marketing expenses to continue to be among the most significant components of our operating expenses.

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

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

Total Other (Income) Expense, Net  

Total other (income) expense, net consists of interest income on cash and cash equivalents, quarterly remeasurement of contingent consideration for acquisitions accounted for as business combinations, foreign currency gains and losses, and other nonoperating gains and losses.

31


 

Results of Operations

The following sets forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.

The comparability of periods covered by our financial statements is impacted by acquisitions. In the first quarter of 2019, we acquired substantially all the assets of Compli and Indix and in the third quarter of 2019, we acquired substantially all the assets of Portway.

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

$

108,519

 

 

$

85,008

 

Professional services

 

 

7,968

 

 

 

6,291

 

Total revenue

 

 

116,487

 

 

 

91,299

 

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

28,779

 

 

 

22,938

 

Professional services

 

 

4,551

 

 

 

4,397

 

Total cost of revenue(1)

 

 

33,330

 

 

 

27,335

 

Gross profit

 

 

83,157

 

 

 

63,964

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development(1)

 

 

26,844

 

 

 

18,996

 

Sales and marketing(1)

 

 

46,040

 

 

 

41,742

 

General and administrative(1)

 

 

20,322

 

 

 

18,019

 

Total operating expenses

 

 

93,206

 

 

 

78,757

 

Operating loss

 

 

(10,049

)

 

 

(14,793

)

Total other (income) expense, net

 

 

(46

)

 

 

(728

)

Loss before income taxes

 

 

(10,003

)

 

 

(14,065

)

Provision for income taxes

 

 

137

 

 

 

172

 

Net loss

 

$

(10,140

)

 

$

(14,237

)

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cost of revenue

 

$

1,477

 

 

$

708

 

Research and development

 

 

3,080

 

 

 

1,627

 

Sales and marketing

 

 

2,956

 

 

 

2,107

 

General and administrative

 

 

4,734

 

 

 

4,982

 

Total stock-based compensation

 

$

12,247

 

 

$

9,424

 

 

 

 

 

 

 

 

 

 

The amortization of acquired intangibles included above was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cost of revenue

 

$

1,065

 

 

$

1,230

 

Research and development

 

 

 

 

 

 

Sales and marketing

 

 

549

 

 

 

543

 

General and administrative

 

 

4

 

 

 

4

 

Total amortization of acquired intangibles

 

$

1,618

 

 

$

1,777

 

 

 

32


 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

$

214,065

 

 

$

163,239

 

Professional services

 

 

13,865

 

 

 

13,030

 

Total revenue

 

 

227,930

 

 

 

176,269

 

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

58,296

 

 

 

43,916

 

Professional services

 

 

9,288

 

 

 

8,726

 

Total cost of revenue(1)

 

 

67,584

 

 

 

52,642

 

Gross profit

 

 

160,346

 

 

 

123,627

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development(1)

 

 

52,691

 

 

 

34,952

 

Sales and marketing(1)

 

 

95,674

 

 

 

81,061

 

General and administrative(1)

 

 

41,710

 

 

 

33,253

 

Total operating expenses

 

 

190,075

 

 

 

149,266

 

Operating loss

 

 

(29,729

)

 

 

(25,639

)

Total other (income) expense, net

 

 

(4,860

)

 

 

(1,336

)

Loss before income taxes

 

 

(24,869

)

 

 

(24,303

)

Provision for income taxes

 

 

554

 

 

 

288

 

Net loss

 

$

(25,423

)

 

$

(24,591

)

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cost of revenue

 

$

2,673

 

 

$

1,449

 

Research and development

 

 

5,474

 

 

 

2,919

 

Sales and marketing

 

 

5,771

 

 

 

4,276

 

General and administrative

 

 

8,060

 

 

 

7,340

 

Total stock-based compensation

 

$

21,978

 

 

$

15,984

 

 

 

 

 

 

 

 

 

 

The amortization of acquired intangibles included above was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cost of revenue

 

$

2,295

 

 

$

2,400

 

Research and development

 

 

 

 

 

 

Sales and marketing

 

 

1,156

 

 

 

1,048

 

General and administrative

 

 

8

 

 

 

7

 

Total amortization of acquired intangibles

 

$

3,459

 

 

$

3,455

 

33


 

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

 

 

 

For the Three Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

93

%

 

 

93

%

Professional services

 

 

7

%

 

 

7

%

Total revenue

 

 

100

%

 

 

100

%

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

25

%

 

 

25

%

Professional services

 

 

4

%

 

 

5

%

Total cost of revenue

 

 

29

%

 

 

30

%

Gross profit

 

 

71

%

 

 

70

%

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

23

%

 

 

21

%

Sales and marketing

 

 

40

%

 

 

46

%

General and administrative

 

 

17

%

 

 

20

%

Total operating expenses

 

 

80

%

 

 

86

%

Operating loss

 

 

(9

)%

 

 

(16

)%

Total other (income) expense, net

 

 

0

%

 

 

(1

)%

Loss before income taxes

 

 

(9

)%

 

 

(15

)%

Provision for income taxes

 

 

0

%

 

 

0

%

Net loss

 

 

(9

)%

 

 

(16

)%

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

94

%

 

 

93

%

Professional services

 

 

6

%

 

 

7

%

Total revenue

 

 

100

%

 

 

100

%

Cost of revenue:

 

 

 

 

 

 

 

 

Subscription and returns

 

 

26

%

 

 

25

%

Professional services

 

 

4

%

 

 

5

%

Total cost of revenue

 

 

30

%

 

 

30

%

Gross profit

 

 

70

%

 

 

70

%

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

23

%

 

 

20

%

Sales and marketing

 

 

42

%

 

 

46

%

General and administrative

 

 

18

%

 

 

19

%

Total operating expenses

 

 

83

%

 

 

85

%

Operating loss

 

 

(13

)%

 

 

(15

)%

Total other (income) expense, net

 

 

(2

)%

 

 

(1

)%

Loss before income taxes

 

 

(11

)%

 

 

(14

)%

Provision for income taxes

 

 

0

%

 

 

0

%

Net loss

 

 

(11

)%

 

 

(14

)%

 

 

34


 

Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019

Revenue

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

108,519

 

 

$

85,008

 

 

$

23,511

 

 

 

28

%

Professional services

 

 

7,968

 

 

 

6,291

 

 

 

1,677

 

 

 

27

%

Total revenue

 

$

116,487

 

 

$

91,299

 

 

$

25,188

 

 

 

28

%

 

Total revenue for the three months ended June 30, 2020 increased by $25.2 million, or 28%, compared to the three months ended June 30, 2019. Subscription and returns revenue for the three months ended June 30, 2020 increased by $23.5 million, or 28%, compared to the three months ended June 30, 2019. Professional services revenue for the three months ended June 30, 2020 increased by $1.7 million, or 27%, compared to the three months ended June 30, 2019.  

 

Growth in total revenue was due primarily to increased demand for our services from new and existing customers. The increase in total revenue for the three months ended June 30, 2020 compared to the same period in 2019, was due primarily to $13.8 million from new U.S. customers, $5.3 million from existing U.S. customers, $5.1 million from SST revenue growth, and $0.6 million from acquisitions made during 2019.

 

Cost of Revenue

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Cost of revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

28,779

 

 

$

22,938

 

 

$

5,841

 

 

 

25

%

Professional services

 

 

4,551

 

 

 

4,397

 

 

 

154

 

 

 

4

%

Total cost of revenue

 

$

33,330

 

 

$

27,335

 

 

$

5,995

 

 

 

22

%

 

Cost of revenue for the three months ended June 30, 2020 increased by $6.0 million, or 22%, compared to the three months ended June 30, 2019. The increase in cost of revenue in absolute dollars was due primarily to an increase of $4.6 million in employee-related costs from higher headcount, an increase of $0.9 million in software hosting costs and an increase of $1.0 million in allocated overhead cost, partially offset by a $0.9 million decrease in outside professional services expense.

 

Excluding the impact of our 2019 Portway acquisition, cost of revenue headcount increased approximately 21% from the second quarter of 2019 to the second quarter of 2020 due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to a $4.2 million increase in salaries and benefits, a $0.8 million increase in stock-based compensation expense and a $0.3 million increase in contract and temporary employee costs, partially offset by a $0.3 million decrease in travel costs and a $0.2 million decrease in compensation expense related to our bonus plans. Software hosting costs increased due primarily to higher transaction volumes. Allocated overhead consists primarily of facility expenses and shared information technology expenses, both of which were higher in total compared to the prior period due primarily to higher headcount throughout our operations. Outside professional service expenses decreased primarily due to declining use of third-party consulting firms to support service offerings in our European operations.

 

35


 

Gross Profit

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

79,740

 

 

$

62,070

 

 

$

17,670

 

 

 

28

%

Professional services

 

 

3,417

 

 

 

1,894

 

 

 

1,523

 

 

 

80

%

Total gross profit

 

$

83,157

 

 

$

63,964

 

 

$

19,193

 

 

 

30

%

Gross margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

73

%

 

 

73

%

 

 

 

 

 

 

 

 

Professional services

 

 

43

%

 

 

30

%

 

 

 

 

 

 

 

 

Total gross margin

 

 

71

%

 

 

70

%

 

 

 

 

 

 

 

 

 

Total gross profit for the three months ended June 30, 2020 increased by $19.2 million, or 30% compared to the three months ended June 30, 2019. Total gross margin was 71% for the three months ended June 30, 2020 compared to 70% for the same period of 2019. This increase in gross margin was due primarily to a declining use of third-party consulting firms to support service offerings in our European operations.

Research and Development

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Research and development

 

$

26,844

 

 

$

18,996

 

 

$

7,848

 

 

 

41

%

 

Research and development expenses for the three months ended June 30, 2020 increased by $7.8 million, or 41%, compared to the three months ended June 30, 2019. The increase was due primarily to an increase of $6.4 million in employee-related costs from higher headcount, an increase of $0.7 million in allocated overhead cost, and an increase of $0.6 million in third-party purchased software costs.

 

Research and development headcount increased approximately 44% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to a $5.5 million increase in salaries and benefits and a $1.4 million increase in stock-based compensation expense, partially offset by a $0.4 million decrease in travel costs and a $0.3 million decrease in contract and temporary employee costs. Software costs increased due primarily to additional investment in information technology security and reporting tools.

Sales and Marketing

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Sales and marketing

 

$

46,040

 

 

$

41,742

 

 

$

4,298

 

 

 

10

%

 

Sales and marketing expenses for the three months ended June 30, 2020 increased by $4.3 million, or 10%, compared to the three months ended June 30, 2019. The increase was due primarily to an increase of $2.5 million in employee-related costs, an increase of $1.4 million for partner commission expense, an increase of $0.8 million in allocated overhead cost, an increase of $0.5 million in third-party purchased software, and an increase of $0.4 million in outside professional service expenses, partially offset by a decrease of $1.2 million in marketing campaign expenses.

 

Sales and marketing headcount increased approximately 17% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to a $3.9 million increase in salaries and benefits and a $0.7 million increase in stock-based compensation expense, partially offset by a $1.5 million decrease in travel costs, a $0.6 million decrease in compensation expense related to our bonus plans and a $0.2 million decrease in sales commission expense. Travel costs decreased due primarily to cancelling all in-person customer activities and events as a result of the COVID-19 pandemic.

 

36


 

Partner commission expense increased due primarily to higher revenues. Software costs increased due primarily to additional investment in lead generation technology that improves information we use to target potential customers and new marketing analytics tools. Outside professional services expenses increased due to increased third-party consulting services as we continue to improve the customer experience during onboarding. Marketing expenses decreased due primarily to a reduction in customer event spend as a result of the COVID-19 pandemic.

 

General and Administrative

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

General and administrative

 

$

20,322

 

 

$

18,019

 

 

$

2,303

 

 

 

13

%

 

General and administrative expenses for the three months ended June 30, 2020 increased by $2.3 million, or 13%, compared to the three months ended June 30, 2019. The increase was due primarily to an increase of $2.1 million in employee-related costs, and a $0.5 million increase in bad debt expense, partially offset by a $0.6 million decrease in outside professional services expense.

 

General and administrative headcount increased approximately 46% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to a $2.8 million increase in salaries and benefits and a $0.2 million increase in stock-based compensation expense, partially offset by a $0.4 million decrease in compensation expense related to our bonus plans and a $0.4 million decrease in travel costs. Bad debt expense increased due primarily to a higher estimate of credit losses resulting from our assessment of a less favorable economic outlook for certain customer segments as a result of the COVID-19 pandemic. Outside professional services expenses decreased due primarily to lower legal costs in the current period related to the PTP litigation.

Total Other (Income) Expense, Net

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

 

(dollars in thousands)

 

Other (income) expense, net

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

(168

)

 

$

(1,282

)

 

$

1,114

 

Interest expense

 

 

 

 

 

173

 

 

 

(173

)

Other (income) expense, net

 

 

122

 

 

 

381

 

 

 

(259

)

Total other (income) expense, net

 

$

(46

)

 

$

(728

)

 

$

682

 

 

Total other income for the three months ended June 30, 2020 was $0.05 million compared to total other income of $0.7 million for the three months ended June 30, 2019. Interest income decreased due primarily to a decline in the interest rate earned on our cash and cash equivalents.       

 

Provision for Income Taxes

 

 

 

For the Three Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

 

(dollars in thousands)

 

Provision for income taxes

 

$

137

 

 

$

172

 

 

$

(35

)

 

The provision for income taxes for the three months ended June 30, 2020 was $0.1 million compared to a provision for income taxes of $0.2 million for the three months ended June 30, 2019. The decrease was due primarily to a decrease in foreign income taxes. The effective income tax rate was 1.4% for the three months ended June 30, 2020 compared to 1.2% for the three months ended June 30, 2019. The effective tax rate in both quarters differs from the U.S. Federal statutory rate due primarily to providing a valuation allowance on deferred tax assets.

 

 

37


 

Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019

Revenue

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

214,065

 

 

$

163,239

 

 

$

50,826

 

 

 

31

%

Professional services

 

 

13,865

 

 

 

13,030

 

 

 

835

 

 

 

6

%

Total revenue

 

$

227,930

 

 

$

176,269

 

 

$

51,661

 

 

 

29

%

 

Total revenue for the six months ended June 30, 2020 increased by $51.7 million or 29%, compared to the six months ended June 30, 2019. Subscription and returns revenue for the six months ended June 30, 2020 increased by $50.8 million, or 31%, compared to the six months ended June 30, 2019. Professional services revenue for the six months ended June 30, 2020 increased by $0.8 million, or 6%, compared to the six months ended June 30, 2019.

 

Growth in total revenue was due primarily to increased demand for our services from new and existing customers. The increase in total revenue for the six months ended June 30, 2020 compared to the same period in 2019, was due primarily to $23.0 million from new U.S. customers, $17.7 million from existing U.S. customers, $9.1 million from SST revenue growth, $1.6 million attributable to revenue growth in our international operations, and $1.2 million from acquisitions made during 2019, partially offset by a $1.0 million decrease from interest earned on funds held for customers.

 

Cost of Revenue

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Cost of revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

58,296

 

 

$

43,916

 

 

$

14,380

 

 

 

33

%

Professional services

 

 

9,288

 

 

 

8,726

 

 

 

562

 

 

 

6

%

Total cost of revenue

 

$

67,584

 

 

$

52,642

 

 

$

14,942

 

 

 

28

%

 

Cost of revenue for the six months ended June 30, 2020 increased by $14.9 million, or 28%, compared to the six months ended June 30, 2019. The increase in cost of revenue in absolute dollars was due primarily to an increase of $9.6 million in employee-related costs from higher headcount, an increase of $3.1 million in software hosting costs, an increase of $2.5 million in allocated overhead cost, and an increase of $1.3 million in third-party purchased software, partially offset by a $1.1 million decrease in outside professional service expenses.

 

Excluding the impact of our 2019 Portway acquisition, cost of revenue headcount increased approximately 21% from the second quarter of 2019 to the second quarter of 2020 due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to an $8.2 million increase in salaries and benefits, a $1.1 million increase in stock-based compensation expense and a $0.6 million increase in contract and temporary employee costs, partially offset by a $0.2 million decrease in travel costs and a $0.1 million decrease in compensation expense related to our bonus plans. Software hosting costs have increased due primarily to higher transaction volumes. Allocated overhead consists primarily of facility expenses and shared information technology expenses, both of which were higher in total compared to the prior period due primarily to higher headcount throughout our operations. Third-party purchased software costs have increased due primarily to an increase in the number of user licenses purchased and higher subscription fees for key applications. Outside professional service expenses decreased due to declining use of third-party consulting firms to support service offerings in our European operations.

38


 

 

Gross Profit

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

$

155,769

 

 

$

119,323

 

 

$

36,446

 

 

 

31

%

Professional services

 

 

4,577

 

 

 

4,304

 

 

 

273

 

 

 

6

%

Total gross profit

 

$

160,346

 

 

$

123,627

 

 

$

36,719

 

 

 

30

%

Gross margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription and returns

 

 

73

%

 

 

73

%

 

 

 

 

 

 

 

 

Professional services

 

 

33

%

 

 

33

%

 

 

 

 

 

 

 

 

Total gross margin

 

 

70

%

 

 

70

%

 

 

 

 

 

 

 

 

 

Total gross profit for the six months ended June 30, 2020 increased $36.7 million, or 30% compared to the six months ended June 30, 2019. Total gross margin was 70% for the six months ended June 30, 2020 compared to 70% for the same period of 2019.

Research and Development

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Research and development

 

$

52,691

 

 

$

34,952

 

 

$

17,739

 

 

 

51

%

 

Research and development expenses for the six months ended June 30, 2020 increased by $17.7 million, or 51%, compared to the six months ended June 30, 2019. The increase was due primarily to an increase of $14.4 million in employee-related costs from higher headcount, an increase of $1.7 million in allocated overhead cost, an increase of $1.0 million in third-party purchased software costs, and an increase of $0.4 million in depreciation expense.

 

Research and development headcount increased approximately 44% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to an $11.5 million increase in salaries and benefits, $2.3 million increase in stock-based compensation expense and a $1.2 million increase in compensation expense related to our bonus plans, partially offset by a $0.4 million decrease in travel costs and a $0.3 million decrease in contract and temporary employee costs. Software costs increased due primarily to additional investment in information technology security and reporting tools. Depreciation increased due primarily to an increase in capitalized software costs for projects placed into service since June 30, 2019.

Sales and Marketing

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

Sales and marketing

 

$

95,674

 

 

$

81,061

 

 

$

14,613

 

 

 

18

%

 

Sales and marketing expenses for the six months ended June 30, 2020 increased by $14.6 million, or 18%, compared to the six months ended June 30, 2019. The increase was due primarily to an increase of $7.9 million in employee-related costs, an increase of $3.5 million for partner commission expense, an increase of $1.9 million in allocated overhead cost, an increase of $0.8 million in third-party purchased software costs and an increase of $0.4 million in outside professional services expense.

 

Sales and marketing headcount increased approximately 17% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to a $7.4 million increase in salaries and benefits and a $1.0 million increase in stock-based compensation expense, partially offset by a $0.5 million decrease in travel costs and a $0.2 million decrease in sales commission expense. Travel costs decreased due primarily to cancelling all in-person customer activities and events during the second quarter of 2020 as a result of the COVID-19 pandemic.

39


 

 

Partner commission expense increased due primarily to higher revenues. Software costs increased due primarily to additional investment in lead generation technology that improves information we use to target potential customers and new marketing analytics tools. Outside professional services expenses increased due to increased third-party consulting services as we continue to improve the customer experience during onboarding.

 

General and Administrative

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

Percentage

 

 

 

(dollars in thousands)

 

General and administrative

 

$

41,710

 

 

$

33,253

 

 

$

8,457

 

 

 

25

%

 

General and administrative expenses for the six months ended June 30, 2020 increased by $8.5 million, or 25%, compared to the six months ended June 30, 2019. The increase was due primarily to an increase of $6.0 million in employee-related costs, an increase of $1.1 million in non-income tax expense, an increase of $0.9 million in bad debt expense, and an increase of $0.6 million in outside professional services expense.

 

General and administrative headcount increased approximately 46% from the second quarter of 2019 to the second quarter of 2020. Employee-related costs increased due primarily to a $4.6 million increase in salaries and benefits and a $1.9 million increase in stock-based compensation expense, partially offset by a $0.6 million decrease in compensation expense related to our bonus plans. Non-income tax expenses increased due primarily to higher foreign indirect taxes and higher state franchise taxes. Bad debt expense increased due primarily to a higher estimate of credit losses resulting from our assessment of a less favorable economic outlook for certain customer segments as a result of the COVID-19 pandemic. Outside professional services expenses increased due to higher legal fees associated with expanding our international operations, partially offset by lower legal costs in the current period related to the PTP litigation.

 

Total Other (Income) Expense, Net

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

 

(dollars in thousands)

 

Other (income) expense, net

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

(1,610

)

 

$

(2,049

)

 

$

439

 

Interest expense

 

 

 

 

 

284

 

 

 

(284

)

Other (income) expense, net

 

 

(3,250

)

 

 

429

 

 

 

(3,679

)

Total other (income) expense, net

 

$

(4,860

)

 

$

(1,336

)

 

$

(3,524

)

 

Total other income for the six months ended June 30, 2020 was $4.9 million compared to total other income of $1.3 million for the six months ended June 30, 2019. Interest income decreased due to a decline in the interest rate earned on our cash and cash equivalents, partially offset by higher average cash balances during the first half of 2020. Other income (expense), net was $3.3 million other income for the six months ended June 30, 2020 compared to $0.4 million other expense for the six months ended June 30, 2019, primarily due to changes to our earnout liabilities. We estimate the fair value of earnout liabilities related to business combinations quarterly. During 2020 , the adjustments to fair value decreased the carrying value of the earnout liability for our acquisition of Portway, resulting in other income of $2.3 million. The fair value of the Portway acquisition earnout liability decreased at June 30, 2020 due primarily to a reduction in the revenue projections used to estimate the fair value of the earnout to reflect a decrease in anticipated cross-border transactions as a result of the economic disruption caused by the COVID-19 pandemic. During the first half of 2019, the adjustments to fair value increased the carrying value of the earnout liabilities for our Compli and Indix acquisitions, resulting in other expense of $0.5 million.

 

 

Provision for Income Taxes

 

 

For the Six Months Ended June 30,

 

 

Change

 

 

 

2020

 

 

2019

 

 

Amount

 

 

 

(dollars in thousands)

 

Provision for income taxes

 

$

554

 

 

$

288

 

 

$

266

 

 

40


 

The provision for income taxes for the six months ended June 30, 2020 was $0.6 million compared to a provision for income taxes of $0.3 million for the six months ended June 30, 2019. The increase was due primarily to additional foreign income taxes. The effective income tax rate was 2.2% for the six months ended June 30, 2020 compared to 1.2% for the six months ended June 30, 2019. The effective tax rate in both quarters differs from the U.S. Federal statutory rate due primarily to providing a valuation allowance on deferred tax assets.

 

We have assessed our ability to realize our deferred tax assets and have recorded a valuation allowance against such assets to the extent that, based on the weight of all available evidence, it is more likely than not that all or a portion of the deferred tax assets will not be realized. In assessing the likelihood of future realization of our deferred tax assets, we placed significant weight on our history of generating U.S. tax losses, including in the first half of 2020. As a result, we have a full valuation allowance against our net deferred tax assets, including net operating loss carryforwards, and tax credits related primarily to research and development. We expect to maintain a full valuation allowance for the foreseeable future.

 

 

Liquidity and Capital Resources

We require cash to fund our operations, including outlays for infrastructure growth, acquisitions, geographic expansion, expanding our sales and marketing activities, research and development efforts, and working capital for our growth. To date, we have financed our operations primarily through cash received from customers for our solutions, public offerings of our common stock, private placements, and bank borrowings. As of June 30, 2020, we had $474.4 million of cash and cash equivalents, most of which was held in money market accounts.

Borrowings

We had a loan and security agreement with Silicon Valley Bank and Ally Bank (the “Lenders”) that consisted of a $50.0 million revolving credit facility (the “Credit Facility”). On June 25, 2019, we terminated the Credit Facility. As of June 30, 2020, we had no credit facilities in place and had no borrowings outstanding.

Future Cash Requirements

As of June 30, 2020, our cash and cash equivalents included proceeds from our June 2019 and our June 2018 public offerings of common stock. We intend to continue to increase our operating expenses and capital expenditures to support the growth in our business and operations. We may also use our cash and cash equivalents to acquire complementary businesses, products, services, technologies, or other assets. We believe that our existing cash and cash equivalents of $474.4 million as of June 30, 2020 will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our financial position and liquidity are, and will be, influenced by a variety of factors, including our growth rate, the timing and extent of spending to support research and development efforts, the continued expansion of sales and marketing spending, the introduction of new and enhanced solutions, the cash paid for any acquisitions, and the continued market acceptance of our solutions.

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

 

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

 

(in thousands)

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

Operating Activities

 

$

(16,095

)

 

$

(421

)

Investing Activities

 

 

(1,575

)

 

 

(34,269

)

Financing Activities

 

 

25,333

 

 

 

334,092

 

 

Operating Activities

Our largest source of operating cash is cash collections from our customers for subscriptions and returns services. Our primary uses of cash from operating activities are for employee-related expenditures, commissions paid to our partners, marketing expenses, and facilities expenses. Cash used in operating activities is comprised of our net loss adjusted for certain non-cash items, including stock-based compensation, depreciation and amortization, other non-cash charges, and net changes in operating assets and liabilities.

41


 

For the six months ended June 30, 2020, net cash used in operating activities was $16.1 million compared to net cash used of $0.4 million for the six months ended June 30, 2019. The increase in cash used in operations of $15.7 million was due primarily to higher annual incentive bonus payments of $10.4 million and higher software subscription payments of $3.7 million. In addition, we offered a sales promotion beginning in the second quarter of 2020 with extended credit terms for new customers, and we extended payment terms to some of our existing customers, resulting in an estimated $5.0 million reduction in cash collected from customers during the first six months of 2020. This was partially offset by a $2.9 million decrease in cash used due to our deferral of U.S. employer payroll tax payments under the CARES Act. We pay bonuses under our annual incentive plan each March for the previous year ended performance. During the first quarter of each year, we also pay a significant portion of our annual software subscription licenses. These payments were higher in the first half of 2020 due to timing of payments and an increased spend compared to the same period of the prior year due primarily to new software subscriptions for information technology security and reporting tools and more user licenses for renewing subscriptions due to higher headcount. We expect to continue our sales promotion during the third quarter of 2020, and we expect to continue to defer payment of employer payroll tax payments through the rest of 2020.

Investing Activities

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

For the six months ended June 30, 2020, cash used in investing activities was $1.6 million, compared to cash used of $34.3 million for the six months ended June 30, 2019. The decrease in cash used in investing activities of $32.7 million was due primarily to a reduction in cash paid for acquisitions of businesses of $17.3 million, a decrease in customer fund assets of $2.0 million in the first half of 2020 compared to an increase of $11.9 million in the prior period, and lower capital expenditures of $1.4 million. In the first half of 2019, we acquired substantially all the assets of Compli and Indix for total cash consideration of $17.3 million.

Financing Activities

Our financing activities primarily include cash inflows and outflows from issuance and repurchases of capital stock, our employee stock purchase plan, deferred cash payments made in connection with acquisitions of businesses, and changes in customer fund obligations.

For the six months ended June 30, 2020, cash provided by financing activities was $25.3 million compared to cash provided of $334.1 million for the six months ended June 30, 2019. This decrease in cash provided by financing activities of $308.8 million was due primarily to a decrease in cash proceeds from offerings of our common stock of $274.7 million, a $15.0 million decrease in cash proceeds from exercise of stock options, a $1.9 million decrease in cash proceeds from common stock purchased under our employee stock purchase plan, a $3.8 million increase in cash paid related to business combination earnouts, and a $2.0 million decrease in customer fund obligations in the first half months of 2020 compared to a $11.8 million increase in customer fund obligations in the prior period.

Funds Held from Customers and Customer Fund Obligations

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

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

 

1)

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

 

2)

changes in customer fund assets held and receivables from customers are presented as net cash flows from investing activities; and

 

3)

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

42


 

Contractual Obligations and Commitments

In the first half of 2020, our purchase commitments increased approximately $120 million compared to December 31, 2019, primarily related to software hosting and software license subscriptions that extend up to five years beyond June 30, 2020. In the second quarter of 2020, our operating lease obligations increased $1.4 million for additional office space that has not yet commenced that extends up to five years beyond June 30, 2020. There were no other material changes to our contractual obligations as of June 30, 2020 compared to December 31, 2019.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements in the six months ended June 30, 2020 or 2019.

 

Use and Reconciliation of Non-GAAP Financial Measures

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

 

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

 

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

 

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

 

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

 

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

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

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

 

43


 

The following schedules reflect our non-GAAP financial measures and reconcile our non-GAAP financial measures to the related GAAP financial measures:

 

 

 

For the Three Months Ended June 30,

 

 

For the Six Months Ended June 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Reconciliation of Non-GAAP Cost of Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

$

33,330

 

 

$

27,335

 

 

$

67,584

 

 

$

52,642

 

Stock-based compensation expense

 

 

(1,477

)

 

 

(708

)

 

 

(2,673

)

 

 

(1,449

)

Amortization of acquired intangibles

 

 

(1,065

)

 

 

(1,230

)

 

 

(2,295

)

 

 

(2,400

)

Non-GAAP Cost of Revenue

 

$

30,788

 

 

$

25,397

 

 

$

62,616

 

 

$

48,793

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Gross Profit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

$

83,157

 

 

$

63,964

 

 

$

160,346

 

 

$

123,627

 

Stock-based compensation expense

 

 

1,477

 

 

 

708

 

 

 

2,673

 

 

 

1,449

 

Amortization of acquired intangibles

 

 

1,065

 

 

 

1,230

 

 

 

2,295

 

 

 

2,400

 

Non-GAAP Gross Profit

 

$

85,699

 

 

$

65,902

 

 

$

165,314

 

 

$

127,476

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Gross Margin:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

 

71

%

 

 

70

%

 

 

70

%

 

 

70

%

Stock-based compensation expense as a percentage of revenue

 

 

1

%

 

 

1

%

 

 

1

%

 

 

1

%

Amortization of acquired intangibles as a percentage of revenue

 

 

1

%

 

 

1

%

 

 

1

%

 

 

1

%

Non-GAAP Gross Margin

 

 

74

%

 

 

72

%

 

 

73

%

 

 

72

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Research and Development Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

26,844

 

 

$

18,996

 

 

$

52,691

 

 

$

34,952

 

Stock-based compensation expense

 

 

(3,080

)

 

 

(1,627

)

 

 

(5,474

)

 

 

(2,919

)

Amortization of acquired intangibles

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Research and Development Expense

 

$

23,764

 

 

$

17,369

 

 

$

47,217

 

 

$

32,033

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Sales and Marketing Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

46,040

 

 

$

41,742

 

 

$

95,674

 

 

$

81,061

 

Stock-based compensation expense

 

 

(2,956

)

 

 

(2,107

)

 

 

(5,771

)

 

 

(4,276

)

Amortization of acquired intangibles

 

 

(549

)

 

 

(543

)

 

 

(1,156

)

 

 

(1,048

)

Non-GAAP Sales and Marketing Expense

 

$

42,535

 

 

$

39,092

 

 

$

88,747

 

 

$

75,737

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP General and Administrative Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

$

20,322

 

 

$

18,019

 

 

$

41,710

 

 

$

33,253

 

Stock-based compensation expense

 

 

(4,734

)

 

 

(4,982

)

 

 

(8,060

)

 

 

(7,340

)

Amortization of acquired intangibles

 

 

(4

)

 

 

(4

)

 

 

(8

)

 

 

(7

)

Non-GAAP General and Administrative Expense

 

$

15,584

 

 

$

13,033

 

 

$

33,642

 

 

$

25,906

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Operating Income (Loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

$

(10,049

)

 

$

(14,793

)

 

$

(29,729

)

 

$

(25,639

)

Stock-based compensation expense

 

 

12,247

 

 

 

9,424

 

 

 

21,978

 

 

 

15,984

 

Amortization of acquired intangibles

 

 

1,618

 

 

 

1,777

 

 

 

3,459

 

 

 

3,455

 

Non-GAAP Operating Income (Loss)

 

$

3,816

 

 

$

(3,592

)

 

$

(4,292

)

 

$

(6,200

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Non-GAAP Basic Net Income (Loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(10,140

)

 

$

(14,237

)

 

$

(25,423

)

 

$

(24,591

)

Stock-based compensation expense

 

 

12,247

 

 

 

9,424

 

 

 

21,978

 

 

 

15,984

 

Amortization of acquired intangibles

 

 

1,618

 

 

 

1,777

 

 

 

3,459

 

 

 

3,455

 

Non-GAAP Net Income (Loss)

 

$

3,725

 

 

$

(3,036

)

 

$

14

 

 

$

(5,152

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free cash flow:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

$

8,174

 

 

$

10,000

 

 

$

(16,095

)

 

$

(421

)

Purchases of property and equipment

 

 

(1,956

)

 

 

(2,836

)

 

 

(3,556

)

 

 

(4,950

)

Free cash flow

 

$

6,218

 

 

$

7,164

 

 

$

(19,651

)

 

$

(5,371

)

 

44


 

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

 

 

Three Months Ended

 

 

Jun 30,

2020

 

 

Mar 31,

2020

 

 

Dec 31,

2019

 

 

Sep 30,

2019

 

 

Jun 30,

2019

 

 

Mar 31,

2019

 

 

Dec 31,

2018

 

 

Sep 30,

2018

 

Total revenue

$

116,487

 

 

$

111,443

 

 

$

107,627

 

 

$

98,525

 

 

$

91,299

 

 

$

84,970

 

 

$

76,923

 

 

$

69,919

 

Add:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

   (end of period)

 

167,719

 

 

 

165,369

 

 

 

161,241

 

 

 

148,466

 

 

 

138,811

 

 

 

132,714

 

 

 

134,653

 

 

 

118,209

 

Contract liabilities

   (end of period)

 

6,195

 

 

 

6,330

 

 

 

5,197

 

 

 

4,843

 

 

 

4,508

 

 

 

4,208

 

 

 

 

 

 

 

Impact of adoption

   of ASC 606 on

   deferred revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11,250

 

 

 

 

 

 

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

   (beginning of

   period)

 

(165,369

)

 

 

(161,241

)

 

 

(148,466

)

 

 

(138,811

)

 

 

(132,714

)

 

 

(134,653

)

 

 

(118,209

)

 

 

(109,344

)

Contract liabilities

   (beginning of

   period)

 

(6,330

)

 

 

(5,197

)

 

 

(4,843

)

 

 

(4,508

)

 

 

(4,208

)

 

 

 

 

 

 

 

 

 

Impact of adoption

   of ASC 606 on

   contract liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,090

)

 

 

 

 

 

 

Calculated billings

$

118,702

 

 

$

116,704

 

 

$

120,756

 

 

$

108,515

 

 

$

97,696

 

 

$

96,399

 

 

$

93,367

 

 

$

78,784

 

 

 

Critical Accounting Policies and Estimates

There have been no material updates or changes to our critical accounting policies and estimates compared to the critical accounting policies and estimates described in our 2019 Annual Report.

Recent Accounting Pronouncements

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

 

We had cash and cash equivalents of $474.4 million and $467.0 million as of June 30, 2020 and December 31, 2019, respectively. We maintain our cash and cash equivalents in deposit accounts and money market funds with financial institutions. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income.

 

On June 25, 2019, we terminated our Credit Facility. At June 30, 2020, we had no credit facilities in place and had no borrowings outstanding. Any debt we incur in the future may bear interest at variable rates and may expose us to risk related to changes in interest rates.

 

45


 

Foreign Currency Exchange Risk

 

Our revenue and expenses are primarily denominated in U.S. dollars. For our foreign operations, the majority of our revenues and expenses are denominated in other currencies, such as the Brazilian Real, British Pound, Euro, and Indian Rupee. Decreases in the relative value of the U.S. dollar as compared to these currencies may negatively affect our revenue and other operating results as expressed in U.S. dollars. For the three months ended June 30, 2020 and 2019, approximately 6% of our revenues were generated in currencies other than U.S. dollars. For the six months ended June 30, 2020 and 2019, approximately 6% and 7%, respectively, of our revenues were generated in currencies other than U.S. dollars.

 

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

 

Inflation

 

We do not believe that inflation had a material effect on our business, financial condition, or results of operations in the last fiscal year or the first half of 2020. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, and results of operations.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act as of June 30, 2020.

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

Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as of June 30, 2020 due to the material weakness identified as of December 31, 2019 and described below. Management, under the direction and supervision of our chief executive officer and chief financial officer, has performed additional review and analyses and other post-closing procedures and has concluded that, notwithstanding the material weakness in our internal control over financial reporting, the consolidated financial statements for the periods covered by and included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

Previously Identified Material Weakness

As of December 31, 2019, the Company concluded that it had a material weakness as it lacks adequate controls to effectively design, implement, and operate process-level and information technology controls to sufficiently mitigate risks of material misstatement associated with certain complex business processes and changes in those processes or applicable accounting standards. This material weakness led to the following individual significant deficiencies:

 

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

 

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

46


 

 

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

 

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

The Company continues working to remediate the material weakness and resulting significant deficiencies in internal control over financial reporting and is taking steps to improve the internal control environment. During the first half of 2020, the Company formed an internal working group to detail and implement specific remediation plans for its control deficiencies, engaged with outside consultants to provide advice and assistance, and hired additional personnel to assist with performing and monitoring internal control activity. The Company has completed the following:

 

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

 

Implemented additional training to improve documentation that supports effective control operation; and

 

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

The Company continues to work to:

 

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

 

Enhance user access reviews and monitoring controls, where appropriate, to improve segregation of duties.

To remediate the material weakness and resulting significant deficiencies, the Company will require additional time to demonstrate the effectiveness of the remediation efforts. The material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Notwithstanding the material weakness, management has concluded that the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows in conformity with GAAP.

Changes in Internal Control over Financial Reporting

Other than the changes described above regarding the enhanced processes and additional training implemented in connection with the remediation of the material weakness and resulting significant deficiencies, there were no changes in our internal control over financial reporting in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

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

47


 

PART II—OTHER INFORMATION

From time to time, we may be subject to legal proceedings arising in the ordinary course of business. In addition, from time to time, third parties may assert intellectual property infringement claims against us in the form of letters and other forms of communication. Regardless of the outcome of any existing or future litigation, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

On October 22, 2018, PTP OneClick, LLC (“PTP”) filed a lawsuit against Avalara, Inc. in the United States District Court for the Eastern District of Wisconsin. The lawsuit alleges that making, using, offering to sell, and selling AvaTax, Avalara Returns, and TrustFile (the “Avalara Products”) infringe U.S. Patent No. 9,760,915 held by PTP and also alleges unspecified trade secret misappropriation, unfair competition, and breach of contract. PTP seeks judgments of willful patent infringement, willful trade secret misappropriation, unfair competition, and breach of contract. PTP requests preliminary and permanent injunctions to enjoin us from making, using, offering to sell, and selling the Avalara Products along with treble damages and attorneys’ fees. Based upon our review of the complaint and the specified patent, we believe we have meritorious defenses to PTP’s claims. On November 7, 2018, we moved to dismiss the lawsuit and to have the patent held invalid, and also have moved to transfer the matter to the United States District Court located in Seattle, Washington. On April 30, 2019, the United States District Court for the Eastern District of Wisconsin granted our motion to transfer, reserving resolution of the motion to dismiss for the United States District Court for the Western District of Washington. On October 7, 2019, the United States District Court for the Western District of Washington invalidated the patent and dismissed the patent and unfair competition claims with prejudice but did not dismiss the trade secret misappropriation or breach of contract claims. On March 5, 2020, we filed a motion for summary judgment. On May 27, 2020, the United States District Court for the Western District of Washington entered summary judgment in favor of Avalara, Inc. disposing of the remaining trade secret misappropriation and breach of contract claims. Plaintiff filed a notice of appeal but subsequently withdrew the notice. On July 7, 2020, the United States District Court for the Western District of Washington dismissed the appeal with prejudice.

Item 1A. Risk Factors.

Other than the item discussed below, there have been no material changes to the Company’s Risk Factors as disclosed in our 2019 Annual Report.

 

The recent novel coronavirus pandemic could adversely affect our business, financial condition, results of operations, and cash flows.

The recent novel coronavirus (“COVID-19”) pandemic has resulted in widespread disruptions across the United States and the world, including in the states and countries in which we operate. As a result of the COVID-19 pandemic, we have seen decreased demand for our solutions from customers as well as slower collections on accounts receivable. Because we sell our solutions primarily on a subscription basis, the effect of the pandemic may not be fully reflected in our operating results until future periods. Like many companies, including our customers and prospects, most of our employees are working from home, we have limited all non-essential business travel, and we have modified certain other business practices to conform to government restrictions and best practices encouraged by government and regulatory authorities. While we are developing and implementing risk mitigation plans and have reduced our pace of hiring, decreased costs associated with travel and marketing, and delayed certain other non-essential expenditures, these measures may not be sufficient to prevent adverse impacts on our business and financial condition from COVID-19. The degree to which the COVID-19 pandemic may impact our results of operations and financial condition is unknown at this time and will depend on future developments, including the geographic spread of COVID-19, the severity and the duration of the pandemic, and further actions that may be taken by governmental authorities or businesses.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

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

 

48


 

Item 6. Exhibits.

 

Exhibit

Number

 

Description

 

 

 

    3.1

 

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

 

 

 

    3.2

 

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

 

 

 

  10.1+

 

Executive Employment Agreement between the Registrant and Ross Tennenbaum effective April 1, 2020 (incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K, filed April 2, 2020 (File No. 001-38525)).

 

 

 

  31.1*

 

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

 

 

 

  31.2*

 

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

 

 

 

  32.1*

 

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

 

 

 

  32.2*

 

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

 

 

 

101.INS

 

Inline XBRL Instance Document

 

 

 

101.SCH

 

Inline XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

Inline XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

Inline XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

104

 

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

 

*

Filed herewith.

+

Management contract or compensatory plan.

49


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

AVALARA, INC.

 

 

 

 

Date:  August 4, 2020

 

By:

/s/ Ross Tennenbaum

 

 

 

Ross Tennenbaum

 

 

 

Chief Financial Officer and Treasurer

(Principal Financial Officer)

 

50