Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K/A. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs, and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K/A, particularly in the sections of this report titled “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”
Overview
We are a leading provider of tax compliance automation for businesses of all sizes. The Avalara Compliance Cloud includes calculation, returns, compliance document management, licensing and registration, fiscal representation, tax content, and insight solutions. We sell our solutions primarily on a subscription basis through our sales force, which focuses on selling to qualified leads provided by our marketing efforts and by partner referrals. Revenue from subscriptions and returns represented 91% of total revenue in 2021 and 93% of total revenue in 2020.
We focus on maintaining and expanding our partner network, which has been and will continue to be an essential part of our growth. We continue to increase the available number of partner integrations, which are designed to link the Avalara Compliance Cloud to a wide variety of business applications, including accounting, ERP, ecommerce, marketplace, POS, recurring billing, and CRM systems. Through marketing activities, we generate awareness from many businesses, both large and small, and enhance communications with our existing customers.
We make substantial investments by increasing headcount, investing in better software tools and technologies, and making strategic acquisitions to continuously improve the Avalara Compliance Cloud. With these investments, we will continue scaling our platform for continued growth, adding new features and functionality, supporting new products and content types, and improving the user experience. We have made multiple acquisitions in the last few years to augment our tax content, serve the needs of customers in different geographies or industries, and improve additional aspects of tax compliance solutions. We expect to continue to make significant investments, both organically and through acquisitions, to gain new and relevant content, technology, and expertise that best serve the transaction tax needs of our customers.
Our business continued to be impacted by the COVID-19 pandemic during 2021, which over the last two years has resulted in authorities implementing numerous preventative measures to contain or mitigate the extent of the impact, including travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas. Even though we began to re-open certain of our office locations in 2021, the vast majority of our employees continue working from home. We expect these arrangements to continue for most of our workforce for an undetermined portion of 2022. During 2021, some of the geographic areas we serve and work from began to loosen travel bans and restrictions, and, where it is safe to do so, we have resumed some in-person customer activities and events. However, we continue to host many customer activities and events virtually and continue to limit employee travel. As the COVID-19 pandemic continues to progress, 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 future revenue growth, the timing of the resumption of normal operating expenses, and the extent to which any incremental expenses associated with the preventative and precautionary measures will be necessary.
Total revenue for 2021 was $699.0 million, an increase of 40% from $500.6 million in 2020. Excluding the $55.7 million of revenue growth from recent acquisitions, total revenue for 2021 increased by 29%. This compares to an increase in total revenue of 31% in 2020 from 2019, or an increase of 29% excluding acquisitions. Revenue growth from our international operations, excluding acquisitions, increased $15.9 million, an increase of 51% from 2020. While we intend to continue aggressively investing internationally to expand non-U.S. revenue, as base revenue increases for our international operations, we expect the pace of revenue growth to moderate.
Total revenue for 2021 and 2020 generated outside the U.S. was 8% and 6% of total revenue, respectively.
Under the revised calculation methodologies, we added approximately 3,250 core customers during 2021 and delivered a net revenue retention rate of 115% on average over the past four quarters. In 2021, our non-core customer revenue continued to grow faster than our revenue from core customers. We use net revenue retention rate to reflect the stability of our revenue base and to provide insight into our ability to grow existing customer revenues. See the section titled “Key Business Metrics” for more information.
We maintained a total gross margin of 70% in 2021, despite an increase in the proportion of revenue generated from professional services, which has a lower gross margin. Revenue from subscription and returns comprised approximately 91% of our revenue for 2021 compared to 93% of our revenue for 2020.
Operating expenses increased to $609.6 million in 2021 from $424.9 million in 2020, as we continued to make significant investments in our future growth. As a percentage of total revenue, operating expenses in 2021 were consistent with 2020. Sales and marketing expenses were $298.5 million in 2021, or 43% of total revenue, compared to $206.0 million in 2020, or 41% of total revenue reflecting our continued investments to grow and expand our business.
Our net loss was $135.6 million during 2021 compared to a net loss of $55.3 million during 2020. Operating loss was $116.9 million during 2021 compared to an operating loss of $68.1 million during 2020. Operating loss increased due primarily to a $44.2 million increase in stock-based compensation expense. Non-GAAP operating income was $5.5 million during 2021 compared to a non-GAAP operating loss of $3.1 million during 2020. For the year ended December 31, 2021, net cash provided by operating activities was $34.1 million compared to net cash provided of $42.6 million for the year ended December 31, 2020. During 2021, we generated free cash flow of $12.7 million compared to free cash flow of $34.0 million in 2020. See the section titled “Use and Reconciliation of Non-GAAP Financial Measures” for more information about our non-GAAP financial measures.
In August 2021, we completed a private offering of $977.5 million of convertible senior notes. The convertible senior notes are unsecured obligations and bear interest at a fixed rate of 0.25% per annum, payable semi-annually. The net proceeds from the sale of the convertible senior notes were $959.9 million after deducting the issuance costs. The convertible senior notes will mature on August 1, 2026, unless earlier converted, redeemed, or repurchased. We used $75.3 million of the net proceeds from the convertible senior notes offering to pay for the cost of the capped call transactions which are intended to offset potential dilution to our common stock or offset any cash payments we are required to make in excess of the principal amount.
As of December 31, 2021, we had $977.5 million in borrowings outstanding related to the convertible senior notes, with a net carrying value of $961.3 million. We ended the year with $1.5 billion of cash and cash equivalents. We believe our strong balance sheet positions us well to continue to make additional investments to grow and expand both our products and services, along with the customers we serve.
Key Business Metrics
We regularly review several metrics to evaluate growth trends, measure our performance, formulate financial projections, and make strategic decisions. We discuss revenue and the components of operating results under “Key Components of Consolidated Statements of Operations,” and we discuss other key business metrics below.
Dec 31,
Sep 30,
Jun 30,
Mar 31,
Dec 31,
Sep 30,
Jun 30,
Mar 31,
Number of core
customers
(as of end
of period) - legacy
Number of core
customers
(as of end
of period) - revised (1)
Net revenue
retention rate - legacy
Net revenue
retention rate - revised (2)
(1) During the second quarter of 2021, we revised the methodology for calculating core customers to include revenue from SST (see Number of Core Customers below for details). The table above includes the number of core customers using both the legacy and the revised methodologies.
(2) During the second quarter of 2021, we revised the methodology for calculating net revenue retention rate to include revenue from SST. In addition, professional services revenue is no longer included in the revised calculation methodology, as these services tend to be more one-time in nature (see Net Revenue Retention Rate below for details). The table above includes the net revenue retention rate using both the legacy and the revised methodologies.
Number of Core Customers
We believe core customers is a key indicator of our market penetration, growth, and potential future revenue. The small and mid-market customer segments have been and remain our primary target market segments 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. During the second quarter of 2021, we revised our core customer calculation methodology to include revenue from our Streamlined Sales Tax solution (“SST”), which results in additional customers being included in reported core customers. Under the revised calculation methodology, as of December 31, 2021, and 2020, we had approximately 18,270 and 15,020 core customers, respectively.
We define a core customer as:
a unique account identifier in our primary U.S. billing systems (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 previous 12 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 that subscribe to our solutions through our international subsidiaries and certain legacy and acquired billing systems that have not yet been integrated into our primary U.S. billing systems (e.g., recent acquisitions and 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.
As noted above, we revised our core customer calculation methodology during the second quarter of 2021. Under the prior methodology, revenue from SST was not included in our calculation of total revenue during the previous 12 months. This meant customers that would have otherwise met the definition of a core customer, with inclusion of attributable SST revenue, were excluded from our core customer count as well as our disclosures on the percentage of total revenue attributable to core customers. The revised methodology for core customers includes revenue from SST.
We believe these changes improve the usefulness of this key business metric, which is to measure both the growth of existing customers into core customers and the acquisition of new customers of a certain size.
We also have a substantial number of customers of various sizes that do not meet the revenue threshold to be considered a core customer. Many of these customers are in the emerging and small business segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers. In addition, we have numerous enterprise-level customers that only utilize our services for small segments of their business, providing opportunities over time for us to extend our relationship and make them core customers.
In addition to customers with whom we have a direct relationship, some of our customers are business application publishers (including ecommerce platforms) that include automated tax determination powered by Avalara. While those platform providers may be core customers to Avalara, their end-user customers generally are not.
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 subscription and returns revenue in the current quarter from any billing accounts that generated revenue during the corresponding quarter of the prior year by (b) total subscription and returns revenue in such corresponding quarter from those same billing accounts. This calculation includes changes during the period for such billing accounts, such as additional solutions purchased, changes in pricing and transaction volume, and terminations, but does not reflect revenue for new billing accounts added during the one-year period.
Currently, our net revenue retention rate 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 that have not been integrated into our primary U.S. billing systems.
During the second quarter of 2021, we revised our net revenue retention rate calculation methodology. Under the prior methodology, revenue from our SST solution was not included in net revenue retention rate. This means that revenue expansion from existing customers adopting our SST solution was not included, while revenue contraction from customers replacing one or more of Avalara’s other solutions with SST was included. The revised calculation methodology for net revenue retention rate includes revenue from SST. In addition, professional services revenue is no longer included in the revised calculation methodology, as these services tend to be more one-time in nature. Under the revised calculation methodology, our net revenue retention rate was 116% for the quarter ended December 31, 2021, and on average has been 115% over the last four quarters ended December 31, 2021. Under the legacy calculation methodology, our net revenue retention rate was 113% for the quarter ended December 31, 2021, and on average has been 110% over the last four quarters ended December 31, 2021.
Strategic Acquisitions
We have pursued and expect to continue to pursue acquisitions that align with our strategic objectives to build relevant content, technology, and expertise to best serve the transaction tax compliance needs of our current and future customers. Accordingly, the comparability of periods covered by our financial statements are, and in the future may be, affected by the impact of these acquisitions.
2021 Acquisitions
Inposia. On April 1, 2021, we acquired the outstanding equity of INPOSIA Solutions, GmbH (“Inposia”), under a Share Purchase Agreement. Inposia is a German software company that delivers e-invoicing, digital tax reporting, and system and data integration to support digital transformation efforts and address real-time compliance requirements for businesses. Inposia will build upon Avalara’s existing e-invoicing capabilities in Brazil and India to support customers worldwide with real-time compliance. The total consideration transferred related to this transaction was €31.8 million (or approximately $37.4 million using the exchange rate on April 1, 2021), consisting of net cash consideration of $14.5 million and 164,416 shares of the Company’s common stock paid at closing with an acquisition date fair value of $23.0 million.
Davo. On April 20, 2021, we acquired substantially all the assets of DAVO Technologies LLC (“Davo”) under an Asset Purchase Agreement. Davo helps emerging small businesses automate the daily and ongoing requirements for sales tax. As a result of the acquisition, Davo extends Avalara’s ability to provide integrated sales tax compliance processes to alleviate the burden of compliance on small businesses. The total consideration transferred related to this transaction was $56.7 million, consisting of $23.5 million cash paid at close, a $0.3 million cash deposit paid in the first quarter of 2021, an acquisition holdback with a fair value upon acquisition of $2.6 million, and an earnout provision with a fair value upon acquisition of $30.3 million.
3CE. On September 7, 2021, we acquired substantially all the assets of 3CE Technologies, Inc. (“3CE”) under an Asset Purchase Agreement. 3CE is a Canadian company that provides software and services for Harmonized System code classifications and verifications, primarily to government entities and logistics services providers. The acquisition will expand and improve our Harmonized System code classification content and provide a new self-service model to sell to the Company’s customers. The total consideration related to this transaction is $ 11.2 million, consisting of $ 9.9 million cash paid at close and an acquisition holdback with a fair value upon acquisition of $ 1.3 million.
Track1099. On October 1, 2021, we acquired substantially all the assets of Track1099 LLC (“Track1099”) under an Asset Purchase Agreement. Track1099 provides online software and services for cost-effectively managing, e-filing, and e-delivering Internal Revenue Service forms, including Forms 1099, W-2, and W-9. The total consideration related to this transaction is $ 48.8 million, consisting of $ 35.0 million cash paid at close, an acquisition holdback with a fair value upon acqu isition of $5.0 million, and an earnout provision with a fair value upon acquisition of $8.8 million.
CrowdReason. On October 18, 2021, we acquired substantially all the assets of CrowdReason Limited Liability Company, a Texas limited liability company, and CorrelationAdvisors LLC, a Texas limited liability company (together, “CrowdReason”) under an Asset Purchase Agreement. CrowdReason is a technology services company that provides software applications, solutions, and services for property tax compliance, along with consulting services related to property valuation and property tax compliance. The total consideration related to this transaction is $ 36.4 million, consisting of $ 8.3 million cash paid at close, an acquisition holdback with a fair value upon acqu isition of $1.7 million, and an earnout provision with a fair value upon acquisition of $26.3 million.
2020 Acquisitions
Transaction Tax Resources. On October 5, 2020, we acquired all the outstanding equity of Transaction Tax Resources, Inc. (“TTR”), a leading provider of tax content, research, consulting, and automation tools in the U.S., with products that include software solutions for companies and governments. The total cash consideration related to this transaction was approximately $378.0 million. Approximately $57.6 million of the purchase price will be paid to TTR shareholders over the next three years. In addition, up to $26.4 million of the purchase price will be paid to TTR’s founder and shareholder if certain TTR performance metrics are achieved during the 2021 and 2022 fiscal years.
Business Licenses. On November 5, 2020, we acquired substantially all of the assets of Business Licenses, LLC (“Business Licenses”), a leading provider of business license and registration content, software, management, and services that automate and streamline license and registration compliance for companies of all sizes. The total consideration related to this transaction was approximately $97.0 million. Approximately $64.9 million of the purchase price was paid at the time of acquisition and approximately $11.4 million of the purchase price will be paid to Business Licenses’ shareholders after 18 months. Up to $20.7 million will be paid, in shares of our common stock, to Business Licenses’ shareholders if certain Business Licenses performance metrics are achieved during the next four years.
Impendulo. On December 1, 2020, the Company acquired the shares of Impendulo Limited (“Impendulo”), a London-based provider of insurance tax compliance software and services, specializing in support for multi-national insurance companies. The total consideration related to this transaction was $13.6 million, consisting of $11.7 million paid in cash at closing, $1.2 million paid in the Company’s common stock, and an additional $0.7 million that was accrued for cash payable to the sellers in the first quarter of 2021 based on final revenue metrics achieved up to the date of the acquisition.
2019 Acquisitions
Compli. On January 22, 2019, we acquired substantially all the assets of Compli, Inc. (“Compli”), a provider of compliance services, technology, and software to producers, distributors, and importers of beverage alcohol in the United States. Total consideration 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 12 months, and an earnout provision fair valued upon acquisition at $3.8 million.
I ndix. On February 6, 2019, we acquired substantially all the assets of Indix Corporation (“Indix”), an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide. Total consideration 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 18 months, and an earnout provision valued upon acquisition at $2.2 million.
Portway. On July 31, 2019, we acquired substantially all the assets of Portway International Inc. (“Portway”), a provider of Harmonized System code classifications and outsourced customs brokerage services. Total consideration 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 18 months with an acquisition date fair value of $1.9 million, and an earnout provision fair valued upon acquisition at $9.4 million.
Key Components of Consolidated Statements of Operations
Revenue
We generate revenue from two primary sources: (1) subscription and returns; and (2) professional services. Subscription and returns revenue is driven primarily by the acquisition of customers, customer renewals, and additional service offerings purchased by existing customers. Revenue from subscription and returns comprised approximately 91% of our revenue for 2021 and 93% of our revenue for 2020 and 2019.
Subscription and Returns Revenue . Subscription and returns revenue primarily consists of fees paid by customers to use our solutions. Subscription plan customers select a price plan that includes an allotted maximum number of transactions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and our customers are not entitled to any refund of fees paid or relief from fees due if they do not use the allotted number of transactions. If a subscription plan customer exceeds the selected maximum transaction level, we will generally upgrade the customer to a higher tier or, in some cases, charge overage fees on a per transaction or return basis. Customers purchase tax return preparation on a subscription basis for an allotted number of returns. Fees paid for subscription services to tax content vary depending on the volume of tax information accessible to the customer.
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 12 to 18 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.
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. During the first quarter of 2021, we renewed our agreement with the SST Governing Board to provide SST services at a lower percentage rate than we previously earned.
Subscription and returns revenue also includes interest income generated on funds held from customers. In order to provide tax remittance services to customers, we hold funds from customers in advance of remittance to tax authorities. These funds are held in trust accounts at FDIC-insured institutions. Prior to remittance, we earn interest on these funds.
Professional Services . We generate professional services revenue from providing tax analysis and services, including tax registrations, voluntary disclosure agreements, nexus studies, and back filing services. We also provide configurations, data migrations, integration, and training for our subscriptions and returns products. Our 2020 acquisitions of TTR and Business Licenses expanded the scope of professional services we offer to include business licenses and registration services and tax refund claims and recovery assistance. 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 and the amortization of capitalized software development costs. In addition, cost of revenue includes direct costs associated with information technology, such as software hosting costs, tax content maintenance, and certain services provided by third parties. Cost of revenue also includes allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as acquired technology from acquisitions. We plan to continue to significantly expand our infrastructure and personnel to support our future growth, including through acquisitions, which we expect to result in higher cost of revenue in absolute dollars.
Research and Development. Research and development expenses consist primarily of employee- related expenses for our research and development staff, including salaries, benefits, bonuses, and stock-based compensation, software hosting costs for research and product development activities, and the cost of third-party developers. Research and development costs, other than software development costs qualifying for capitalization, are expensed as incurred. Capitalized software development costs , which consist primarily of employee-related cost s , are amortized as cost of subscription and returns revenue . Research and development expenses also include allocated costs for certain information technology and facility expenses , along with depreciation of equipment .
We devote substantial resources to enhancing and maintaining the Avalara Compliance Cloud, developing new and enhancing existing solutions, conducting quality assurance testing, and improving our core technology. We expect research and development expenses to increase in absolute dollars.
Sales and Marketing . Sales and marketing expenses consist primarily of employee-related expenses for our sales and marketing staff, including salaries, benefits, bonuses, sales commissions, and stock-based compensation, 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 suspended in-person promotional and customer events and converted many of these activities to virtual events, which temporarily reduced these types of marketing expenses. We began to gradually resume limited in-person marketing activities in the second half of 2021 where it was safe to do so . 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 relationships, customer lists, and backlog from acquisitions. During 2022, we expect to continue to increase in-person marketing activities as conditions allow.
We defer the portion of sales commissions that is considered a cost of obtaining a new contract with a customer in accordance with the revenue recognition standard and amortize these deferred costs over the estimated period of benefit, generally 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 and update targets during the year as appropriate. Sales commissions are generally earned based on achievement against these targets.
We defer the portion of partner commissions 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. Integration partners may be 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. General and administrative expenses include amortization of intangibles such as tradenames and noncompetition agreements from acquisitions.
We expect our general and administrative expenses to increase in absolute dollars as we continue to expand our operations (in the U.S. and internationally) , hire and train additional personnel, evaluate and 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, acquisition evaluation and execution, SEC compliance, and internal control compliance.
Total Other Income (Expense), Net
Total other income (expense), net consists of quarterly remeasurement of earnout liabilities for acquisitions accounted for as business combinations, interest income on cash and cash equivalents, interest expense related to our 2026 Notes , foreign currency gains and losses , and other non-operating gains and losses.
Results of Operations
The comparability of periods covered by our financial statements is impacted by acquisitions (see Strategic Acquisitions above).
The following sets forth our results of operations for the periods presented.
For the Year Ended December 31,
(in thousands)
Revenue:
Subscription and returns
Professional services
Total revenue
Cost of revenue:
Subscription and returns
Professional services
Total cost of revenue (1)
Gross profit
Operating expenses:
Research and development (1)
Sales and marketing (1)
General and administrative (1)
Total operating expenses
Operating loss
Total other income (expense), net
Loss before income taxes
(Provision for) benefit from income taxes
Net loss
(1) The stock-based compensation expense included above was as follows:
For the Year Ended December 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total stock-based compensation
The amortization of acquired intangibles included above was as follows:
For the Year Ended December 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total amortization of acquired intangibles
The following sets forth our results of operations as a percentage of our total revenue for the periods presented.
For the Year Ended December 31,
Revenue:
Subscription and returns
Professional services
Total revenue
Cost of revenue:
Subscription and returns
Professional services
Total cost of revenue
Gross profit
Operating expenses:
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating loss
Total other income (expense), net
Loss before income taxes
(Provision for) benefit from income taxes
Net loss
Year Ended December 31, 2021, as compared to the Year Ended December 31, 2020
Revenue
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Revenue:
Subscription and returns
Professional services
Total revenue
Total revenue for the year ended December 31, 2021, increased by $198.4 million, or 40%, compared to the year ended December 31, 2020. Subscription and returns revenue for the year ended December 31, 2021, increased by $167.3 million, or 36%, compared to the year ended December 31, 2020. Professional services revenue for the year ended December 31, 2021, increased by $31.1 million, or 90%, compared to the year ended December 31, 2020.
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 year ended December 31, 2021 , compared to the same period in 2020, was due primarily to $76.2 million from existing U.S. customers, $55.7 million from recent acquisitions, $35.0 million from new U.S. customers, $15.9 million from revenue growth in our international operations, and $15.7 million from SST revenue growth. Of the growth from recent acquisitions, $31.6 million was generated from subscriptions and returns and $24.1 million from professional services. Despite lower transaction rates for the year ended December 31, 2021, SST revenue increased from the prior period due to higher transaction volume.
Cost of Revenue
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Cost of revenue
Subscription and returns
Professional services
Total cost of revenue
Cost of revenue for the year ended December 31, 2021, increased by $62.6 million, or 44%, compared to the year ended December 31, 2020. The increase in cost of revenue was due primarily to an increase of $41.2 million in employee-related costs from higher headcount, an increase of $8.0 million in software hosting costs, an increase of $6.0 million in allocated overhead cost, an increase of $4.2 million in amortization expense, and an increase of $3.0 million in depreciation expense.
Cost of revenue headcount increased approximately 31% from December 31, 2020, to December 31, 2021, due to our continued growth to support our solutions. Employee-related costs increased due primarily to a $31.1 million increase in salaries and benefits (including $18.4 million from recent acquisitions), a $5.1 million increase in stock-based compensation expense, a $3.0 million increase in compensation expense related to our bonus plans, and a $2.3 million increase in contract and temporary employee costs, partially offset by a $0.4 million decrease in travel costs. Travel costs decreased due primarily to cancelling all in-person customer meetings and events beginning in March of 2020 because of the COVID-19 pandemic.
Software hosting costs have increased due primarily to higher transaction volumes and incremental investment in data management and reporting tools. Allocated overhead consists primarily of facility expenses and shared information technology expenses. Shared information technology expenses were higher, compared to the prior period, due primarily to higher headcount throughout our operations. Amortization expense increased due primarily to acquired intangible assets from recent acquisitions. Depreciation expense increased due primarily to an increase in capitalized software costs for projects placed into service in 2020 and 2021.
Gross Profit
For the Year Ended
December 31,
Change
Amount
Percentage
(dollars in thousands)
Gross profit
Subscription and returns
Professional services
Total gross profit
Gross margin
Subscription and returns
Professional services
Total gross margin
Total gross profit for the year ended December 31, 2021, increased by $135.9 million, or 38%, compared to the year ended December 31, 2020. Total gross margin was 70% for the year ended December 31, 2021, compared to 71% for the same period of 2020.
Research and Development
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Research and development
Research and development expenses for the year ended December 31, 2021, increased by $49.4 million, or 41%, compared to the year ended December 31, 2020. The increase was due primarily to an increase of $40.4 million in employee-related costs from higher headcount, an increase of $6.0 million in software hosting and third-party purchased software costs, an increase of $2.0 million in allocated overhead cost, and an increase of $2.0 million in outside professional fees.
Research and development headcount increased approximately 39% from December 31, 2020, to December 31, 2021. Employee-related costs increased due primarily to a $24.8 million increase in salaries and benefits (including $9.4 million from recent acquisitions), an $12.9 million increase in stock-based compensation expense, a $3.1 million increase in compensation expense related to our bonus plans, partially offset by a $0.4 million decrease in travel costs. Software hosting and third-party purchased software costs increased due primarily to additional investment in tools for product analysis, development and testing activities, and tools for information technology security and reporting. Outside professional services expense increased due primarily to an increase in third-party information technology security and third-party developer services for product integrations.
Sales and Marketing
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Sales and marketing
Sales and marketing expenses for the year ended December 31, 2021, increased by $92.4 million, or 45%, compared to the year ended December 31, 2020. The increase was due primarily to an increase of $56.3 million in employee-related costs, an increase of $11.2 million in marketing campaign expenses, an increase of $9.8 million for partner commission expense, an increase of $6.5 million in amortization expense, an increase of $5.6 million in allocated overhead cost, an increase of $2.0 million in third-party purchased software costs, and an increase of $1.1 million in outside professional services expense.
Sales and marketing headcount increased approximately 36% from December 31, 2020, to December 31, 2021. Employee-related costs increased due primarily to a $33.8 million increase in salaries and benefits (including $7.9 million from recent acquisitions) , a $9.1 million increase in stock-based compensation expense, a $7.6 million increase in sales commissions due to sales growth, a $4.9 million increase in contract and temporary employee costs, and a $2.6 million increase in compensation expense related to our bonus plans, partially offset by a $1.7 million decrease in travel costs. Travel costs decreased due primarily to minimal in-person customer activities and events for all of 2021 as a result of the COVID-19 pandemic. During 2022, we expect to continue to increase in-person marketing activities as conditions allow, which will increase travel costs.
Marketing campaign expenses increased due primarily to increased spending on brand awareness, online advertising (including pay-per-click advertising), and outbound direct mail advertising. Partner commission expense increased due primarily to higher revenues. Amortization expense increased due primarily to acquired intangible assets from recent acquisitions. T hird-party purchased s oftware costs increased due primarily to additional investment in lead generation technology that improves information we use to target potential customers and increased spending for new marketing analytics tools. Outside professional services expenses increased due primarily to increased third-party consulting services to improve the customer experience during onboarding, to develop prospective customer data, and services to integrate websites of recent acquisitions.
General and Administrative
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
General and administrative
General and administrative expenses for the year ended December 31, 2021, increased by $42.8 million, or 44%, compared to the year ended December 31, 2020. The increase was due primarily to an increase of $31.4 million in employee-related costs , an increase of $5.5 million in outside professional services expense, an increase of $2.8 million in amortization expense, an increase of $2.6 million in third-party purchased software costs, an increase of $1.6 million in insurance expense, an increase of $1.2 million in merchant fees, partially offset by a $2.4 million decrease in non-income tax, a decrease of $0.8 million in impairment related to operating lease right-of-use assets and property and equipment, and a $0.7 million expense to settle a contract dispute in the prior year period.
General and administrative headcount increased 31% from December 31, 2020, to December 31, 2021. Employee-related costs increased due primarily to a $17.1 million increase in stock-based compensation expense, $12.3 million increase in salaries and benefits (including $2.9 million from recent acquisitions), a $1.4 million increase in contract and temporary employees, and a $1.0 million increase in compensation expense related to our bonus plans, partially offset by a $0.4 million decrease in travel costs.
Outside professional services expenses increased due primarily to increased investment in employee engagement, principally satisfaction surveys, recruiting services, and training programs, partially offset by higher acquisition-related costs in the prior period. Amortization increased due to a full year of expense for acquired intangible assets from our 2020 acquisitions and amortization of acquired intangible assets from our 2021 acquisitions. Software costs increased due primarily to an increase in the number of licenses purchased and higher subscription fees for key financial and human resources information system applications. Insurance expenses have increased due to higher insurance premiums in the current year. Merchant fees, which are credit card processing fees, increased due primarily to an increase in volume of credit card transactions. Non-income tax expense decreased due primarily to lower state indirect taxes. Operating lease right-of-use asset and property and equipment impairment decreased due to the closure during the third quarter of 2020 of four offices in the U.S. and Canada that had remaining lease terms extending beyond the date we vacated the leased office space, with no comparable impairment in the current period. During the year ended December 31, 2020, we agreed to settle a contract dispute, with no comparable costs in the current period.
Total Other Income (Expense), Net
For the Year Ended December 31,
Change
Amount
(dollars in thousands)
Other income (expense), net
Fair value changes in earnout liabilities
Interest income
Interest expense
Other income (expense), net
Total other income (expense), net
Total other expense for the year ended December 31, 2021, was $15.4 million compared to $4.5 million of other income for the year ended December 31, 2020. Fair value changes in earnout liabilities was $12.2 million of expense for the year ended December 31, 2021, compared to $2.3 million of income for the same period in 2020. During the year ended December 31, 2021, post-acquisition fair value adjustments to earnout liabilities for our acquisitions of TTR, Business Licenses, Davo, and Track1099, resulted in other expense of $12.2 million. During the year ended December 31, 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. 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 202 1 . Interest expense increased due to the August 2021 offering of the 2026 Notes , for which there is no comparable expense for the year ended December 31, 2020. Other income (expense), net was $ 0.9 million of expense for the year ended December 31, 202 1 , compared to $ 0.4 million of income for the same period in 20 20 . The variance is due primarily to losses on foreign exchange rates .
(Provision for) Benefit from Income Taxes
For the Year Ended December 31,
Change
Amount
(dollars in thousands)
(Provision for) benefit from income taxes
The provision for income taxes for the year ended December 31, 2021, was $3.3 million compared to a benefit from income taxes of $8.3 million for the year ended December 31, 2020. The effective income tax rate was an expense of 2.5% for the year ended December 31, 2021, compared to a benefit of 13.1% for the year ended December 31, 2020. The effective tax rate in both periods differs from the U.S. Federal statutory rate due primarily to providing a valuation allowance on deferred tax assets. The increase in tax expense and decrease in effective rate is due primarily to the 2020 release of valuation allowance resulting from deferred tax liabilities recorded in purchase accounting for the TTR and Impendulo acquisitions.
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 tax losses in the U.S., U.K., and Brazil, including in 2021. As a result, we have a full valuation allowance against our net deferred tax assets in these jurisdictions, including net operating loss carryforwards and research and development tax credits. We expect to maintain a full valuation allowance in these jurisdictions for the foreseeable future.
Year Ended December 31, 2020, as compared to the Year Ended December 31, 2019
Revenue
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Revenue:
Subscription and returns
Professional services
Total revenue
Total revenue for the year ended December 31, 2020, increased $118.1 million, or 31%, compared to the year ended December 31, 2019. Subscription and returns revenue for the year ended December 31, 2020, increased by $110.6 million, or 31%, compared to the year ended December 31, 2019. Professional services revenue for the year ended December 31, 2020, increased by $7.5 million, or 28%, compared to the year ended December 31, 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 year ended December 31, 2020, compared to the same period in 2019, was due primarily to $50.8 million from existing U.S. customers, $29.4 million from new U.S. customers, $24.3 million from SST revenue growth, $6.5 million from 2020 acquisitions, and $7.9 million from revenue growth in our international operations, partially offset by $2.4 million lower interest earned on funds held from customers.
Cost of Revenue
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Cost of revenue
Subscription and returns
Professional services
Total cost of revenue
Cost of revenue for the year ended December 31, 2020, increased by $28.3 million, or 24%, compared to the year ended December 31, 2019. The increase in cost of revenue was due primarily to an increase of $20.9 million in employee-related costs from higher headcount, an increase of $2.7 million in software hosting costs, an increase of $2.6 million in allocated overhead cost, an increase of $2.5 million in third-party purchased software, an increase of $1.1 million in depreciation expense, and an increase of $0.3 million in amortization expense, partially offset by a $1.3 million decrease in outside professional service expenses.
Cost of revenue headcount increased approximately 27% from December 31, 2019, to December 31, 2020. Excluding the impact of 2020 acquisitions, cost of revenue headcount increased approximately 13% due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to a $16.0 million increase in salaries and benefits (including $2.5 million from 2020 acquisitions), a $3.3 million increase in stock-based compensation expense, a $1.6 million increase in compensation expense related to our bonus plans, and a $1.1 million increase in contract and temporary employee costs, partially offset by a $1.0 million decrease in travel costs.
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. As a result of the COVID-19 pandemic, almost all our employees worked from their homes during most of 2020. Despite being unable to safely access our facilities, we were not able to materially reduce our lease expenses and related committed costs. 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. Depreciation expense increased due primarily to an increase in leasehold improvements and an increase in capitalized software costs for projects placed into service in 2020. Amortization expense increased due primarily to acquired intangible assets from our 2020 acquisition of TTR. Outside professional service expenses decreased due to declining use of third-party consulting firms to support service offerings in our European operations.
Gross Profit
For the Year Ended
December 31,
Change
Amount
Percentage
(dollars in thousands)
Gross profit
Subscription and returns
Professional services
Total gross profit
Gross margin
Subscription and returns
Professional services
Total gross margin
Total gross profit for the year ended December 31, 2020, increased $89.9 million, or 34%, compared to the year ended December 31, 2019. Total gross margin was 71% for the year ended December 31, 2020, compared to 70% for the same period of 2019. The increase in gross margin was due primarily to continued process automation for service offerings in our European operations, and to a lesser extent, improved service delivery and efficiency in U.S. professional services.
Research and Development
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Research and development
Research and development expenses for the year ended December 31, 2020, increased $38.6 million, or 46%, compared to the year ended December 31, 2019. The increase was due primarily to an increase of $33.1 million in employee-related costs from higher headcount, an increase of $3.7 million in third-party purchased software costs, and an increase of $1.6 million in allocated overhead cost.
Research and development headcount increased approximately 43% from December 31, 2019, to December 31, 2020. Excluding the impact of 2020 acquisitions, research and development headcount increased approximately 35%. Employee-related costs increased due primarily to a $23.5 million increase in salaries and benefits (including $0.6 million from 2020 acquisitions), a $7.9 million increase in stock-based compensation expense, and a $4.2 million increase in compensation expense related to our bonus plans, partially offset by a $1.5 million decrease in travel costs and a $1.0 million decrease in contract and temporary employee costs. Software costs increased due primarily to additional investment in information technology security and reporting tools and software hosting costs.
Sales and Marketing
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
Sales and marketing
Sales and marketing expenses for the year ended December 31, 2020, increased $36.9 million, or 22%, compared to the year ended December 31, 2019. The increase was due primarily to an increase of $18.6 million in employee-related costs, an increase of $8.2 million for partner commission expense, an increase of $4.1 million in marketing campaign expenses, an increase of $2.4 million in amortization expense, an increase of $1.4 million in allocated overhead cost, an increase of $1.3 million in outside professional services expense, and an increase of $1.1 million in third-party purchased software costs.
Sales and marketing headcount increased approximately 19% from December 31, 2019, to December 31, 2020. Excluding the impact of 2020 acquisitions, sales and marketing headcount increased approximately 15%. Employee-related costs increased due primarily to a $13.4 million increase in salaries and benefits (including $0.5 million from 2020 acquisitions), a $4.5 million increase in stock-based compensation expense, a $2.5 million increase in compensation expense related to our bonus plans, and a $1.2 million increase in contract and temporary employee costs, partially offset by a $3.3 million decrease in travel costs. Travel costs decreased due primarily to cancelling all in-person customer activities and events beginning in March of 2020 as a result of the COVID-19 pandemic.
Partner commission expense increased due primarily to higher revenues. Marketing campaign expenses increased due primarily to increased spending on brand awareness, online advertising, and outbound direct mail advertising, partially offset by a reduction in customer event spend as a result of the COVID-19 pandemic.
Amortization expense increased due to acquired intangibles from our TTR and Business Licenses acquisitions. Outside professional services expenses increased due to increased third-party consulting services as we continue to improve the customer experience during onboarding. Software costs increased due primarily to additional investment in lead generation technology that improves information we use to target potential customers, along with spending for new marketing analytics tools.
General and Administrative
For the Year Ended December 31,
Change
Amount
Percentage
(dollars in thousands)
General and administrative
General and administrative expenses for the year ended December 31, 2020, increased $24.9 million, or 34%, compared to the year ended December 31, 2019. The increase was due primarily to an increase of $10.5 million in employee-related costs, an increase of $2.9 million in outside professional services expense, an increase of $2.7 million in non-income tax expense, an increase of $2.2 million in third-party purchased software costs, an increase of $1.4 million in insurance expense, a $0.8 million impairment related to operating lease right-of-use assets and property and equipment recorded in 2020, an increase of $0.8 million in merchant fees, an increase of $0.8 million in amortization expense, and an increase of $0.7 million in bad debt expense.
General and administrative headcount increased 39% from December 31, 2019, to December 31, 2020. Excluding the impact of 2020 acquisitions, general and administrative headcount increased 31%. Employee-related costs increased due primarily to a $6.3 million increase in salaries and benefits (including $0.7 million from 2020 acquisitions), a $3.1 million increase in stock-based compensation expense, and a $1.5 million increase in compensation expense related to our bonus plans, partially offset by a $0.7 million decrease in travel costs.
Outside professional services expenses increased due primarily to an increase in acquisition-related costs and investments in expanding our international business operations, partially offset by higher legal costs in the prior period related to the PTP litigation. Non-income tax expenses increased due primarily to higher foreign and state indirect taxes and higher state franchise taxes. Software costs increased due primarily to an increase in the number of licenses purchased and higher subscription fees for key financial and human resources information system applications. Insurance expenses have increased due to higher insurance premiums in the current year. 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 because of the COVID-19 pandemic. Operating lease right-of-use asset and property and equipment impairment resulted from the closure of four offices in the U.S. and Canada during the third quarter of 2020 that had remaining lease terms that extended beyond the date we vacated the leased office space. Merchant fees, which are credit card processing fees, increased due primarily to an increase in volume of credit card transactions. Amortization increased due to acquired intangibles from our acquisitions of TTR and Business Licenses.
Total Other Income (Expense), Net
For the Year Ended December 31,
Change
Amount
(dollars in thousands)
Other income (expense), net
Fair value changes in earnout liabilities
Interest income
Interest expense
Other income (expense), net
Total other income (expense), net
Total other income for the year ended December 31, 2020, was $4.5 million compared to $6.6 million of other income for the year ended December 31, 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 2020. Other income (expense), net was $2.8 million other income for the year ended December 31, 2020, compared to $0.9 million for the same period in 2019, due primarily to changes to our earnout liabilities. We estimate the fair value of earnout liabilities related to business combinations quarterly. During the year ended December 31, 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 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 year ended December 31, 2019, the adjustments to fair value decreased the carrying value of the earnout liability for our acquisition of Indix, resulting in other income of $1.7 million, partially offset by an increase in the carrying value of the earnout liabilities for our acquisitions of Compli and Portway, which resulted in other income of $0.9 million.
(Provision for) Benefit from Income Taxes
For the Year Ended December 31,
Change
Amount
(dollars in thousands)
(Provision for) benefit from income taxes
The benefit from income taxes for the year ended December 31, 2020, was $8.3 million compared to a provision for income taxes of $1.0 million for the year ended December 31, 2019. The effective income tax rate was a benefit of 13.1% for the year ended December 31, 2020, compared to an expense of 1.9% for the year ended December 31, 2019. The effective tax rate in both periods differs from the U.S. Federal statutory rate due primarily to providing a valuation allowance on deferred tax assets. The increase in tax benefit and increase in effective rate is due primarily to the release of valuation allowance in 2020 resulting from deferred tax liabilities recorded in purchase accounting for the TTR and Impendulo acquisitions.
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 tax losses in the U.S., U.K., and Brazil, including in 2020. As a result, we have a full valuation allowance against our net deferred tax assets, including net operating loss carryforwards and research and development tax credits.
Quarterly Results of Operations
The following tables set forth our unaudited quarterly consolidated statements of operations data for each of the periods presented, and the effect of correcting the accounting error on each of our previously issued quarterly consolidated statements of operations. The data below have been prepared on the same basis as the audited consolidated financial statements included elsewhere in this Form 10-K/A and reflect all necessary adjustments, consisting of normal recurring adjustments and the immaterial corrections of errors described in Note 15, necessary for a fair statement of this data. The results of historical periods are not necessarily indicative of the results to be expected for a full year or any future period. The following quarterly financial data should be read in conjunction with our audited financial statements and related notes included elsewhere in this report.
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands, except per share data)
Revenue:
Subscription and returns
Professional services
Total revenue
Cost of revenue:
Subscription and returns
Professional services
Total cost of revenue ( 1)
Gross profit
Operating expenses:
Research and development ( 1)
Sales and marketing ( 1)
General and administrative ( 1)
Total operating expenses
Operating loss
Total other income
(expense), net
Loss before income taxes
(Provision for) benefit from income taxes
Net loss
Net loss per share attributable
to common shareholders,
basic and diluted
Weighted average shares of
common stock outstanding,
basic and diluted
The stock-based compensation expense included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total stock-based
compensation
The amortization of acquired intangibles included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total amortization of
acquired intangibles
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands, except per share data)
Revenue:
Subscription and returns
Professional services
Total revenue
Cost of revenue:
Subscription and returns
Professional services
Total cost of revenue ( 1)
Gross profit
Operating expenses:
Research and development ( 1)
Sales and marketing ( 1)
General and administrative ( 1)
Total operating expenses
Operating loss
Total other income
(expense), net
Loss before income taxes
(Provision for) benefit from income taxes
Net loss
Net loss per share attributable
to common shareholders,
basic and diluted
Weighted average shares of
common stock outstanding,
basic and diluted
The stock-based compensation expense included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total stock-based
compensation
The amortization of acquired intangibles included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total amortization of
acquired intangibles
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands, except per share data)
Revenue:
Subscription and returns
Professional services
Total revenue
Cost of revenue:
Subscription and returns
Professional services
Total cost of revenue ( 1)
Gross profit
Operating expenses:
Research and development ( 1)
Sales and marketing ( 1)
General and administrative ( 1)
Total operating expenses
Operating loss
Total other income
(expense), net
Loss before income taxes
(Provision for) benefit from income taxes
Net loss
Net loss per share attributable
to common shareholders,
basic and diluted
Weighted average shares of
common stock outstanding,
basic and diluted
The stock-based compensation expense included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total stock-based
compensation
The amortization of acquired intangibles included above was as follows:
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total amortization of
acquired intangibles
Consolidated Statement of Operations Information
(in thousands, except per share data)
Three Months Ended
Dec 31, 2021
Sep 30, 2021
Jun 30, 2021
Mar 31, 2021
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
Cost of revenue: subscription and returns
Cost of revenue: professional services
Total cost of revenue
Gross profit
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating loss
Loss before income taxes
Net loss
Net loss per share attributable to common shareholders, basic and diluted
Consolidated Statement of Operations Information
(in thousands, except per share data)
Three Months Ended
Dec 31, 2020
Sep 30, 2020
Jun 30, 2020
Mar 31, 2020
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
Cost of revenue: subscription and returns
Cost of revenue: professional services
Total cost of revenue
Gross profit
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating loss
Loss before income taxes
Net loss
Net loss per share attributable to common shareholders, basic and diluted
Consolidated Statement of Operations Information
(in thousands, except per share data)
Three Months Ended
Dec 31, 2019
Sep 30, 2019
Jun 30, 2019
Mar 31, 2019
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
As Previously Issued
Adjustment
As Revised
Cost of revenue: subscription and returns
Cost of revenue: professional services
Total cost of revenue
Gross profit
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating loss
Loss before income taxes
Net loss
Net loss per share attributable to common shareholders, basic and diluted
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. We have financed our operations primarily through cash received from customers for our solutions, public offerings of our common stock, and a private offering of convertible senior notes. As of December 31, 2021, we had $1.5 billion of cash and cash equivalents, most of which was held in money market accounts.
Borrowings
In August 2021, we completed a private offering of the 2026 Notes. The 2026 Notes are unsecured obligations and bear interest at a fixed rate of 0.25% per annum, payable semi-annually in arrears on February 1 and August 1 of each year, commencing on February 1, 2022. The initial conversion price of the 2026 Notes represented a premium of 47.5% over the closing price of our common stock on August 10, 2021, the date the 2026 Notes offering was priced. The net proceeds from the sale of the 2026 Notes were $959.9 million after deducting the issuance costs. The 2026 Notes will mature on August 1, 2026, unless earlier converted, redeemed, or repurchased.
We used $75.3 million of the net proceeds from the 2026 Notes offering to pay for the cost of the capped call transactions entered into with certain financial institutions. The capped call instruments are intended to offset potential dilution to our common stock or offset any cash payments we are required to make in excess of the principal amount, as the case may be, with such reduction or offset subject to a cap. The capped call instruments are subject to adjustments for certain corporate events and standard anti-dilution provisions.
Future Cash Requirements
As of December 31, 2021, our cash and cash equivalents included proceeds from our previous public offerings of common stock and our recent private offering of the 2026 Notes. We intend to continue to increase our operating expenses and capital expenditures to support the growth in our business and operations. We expect to also use our cash and cash equivalents to continue to acquire complementary businesses, products, services, technologies, or other assets. We believe that our existing cash and cash equivalents of $1.5 billion as of December 31, 2021, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our financial position and liquidity are, and will be, influenced by a variety of factors, including our growth rate, the timing and extent of spending to support research and development efforts, the continued expansion of sales and marketing spending, the introduction of new and enhanced solutions, the cash paid for any acquisitions, and the continued market acceptance of our solutions.
The following table shows our cash flows from operating activities, investing activities, and financing activities for the stated periods:
For the Year Ended December 31,
(in thousands)
Cash provided by (used in):
Operating Activities
Investing Activities
Financing Activities
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, technology costs such as software hosting costs and subscriptions to a wide variety of software-as-a-service platforms, and facilities expenses. Cash provided by operating activities is comprised of our net loss adjusted for certain non-cash items, including stock-based compensation, depreciation and amortization, other non-cash income and expense items, and net changes in operating assets and liabilities .
For the year ended December 31, 2021, net cash provided by operating activities was $34.1 million compared to net cash provided of $42.6 million for the year ended December 31, 2020. The decrease in cash from operations of $8.5 million was due primarily to an increase in working capital, primarily accounts receivable and prepaid expenses. Notwithstanding the unfavorable impact of working capital changes on operating cash flows, cash collected from customers continues to increase, but is almost entirely offset by higher cash expenditures to fund our continuing product and customer expansion. The increase in cash collected from customers is due primarily to growing demand for our subscription and returns services.
Investing Activities
Our investing activities primarily include cash outflows related to purchases of property and equipment, additions of capitalized software assets and business acquisitions.
For the year ended December 31, 2021, cash used in investing activities was $100.4 million, compared to cash used of $378.1 million for the year ended December 31, 2020. The decrease in cash used of $277.7 million was due primarily to a decrease in cash paid for acquisitions of $291.5 million. In 2021, we acquired the outstanding equity of Inposia and substantially all the assets of Davo, 3CE, Track1099, and CrowdReason for total cash consideration, net of cash acquired of $76.6 million. In 2020, we acquired the outstanding shares of TTR and Impendulo and substantially all the assets of Business Licenses for total cash consideration, net of cash acquired of $368.2 million.
Financing Activities
Our financing activities primarily include cash inflows and outflows from issuance of common stock, our private offering of convertible senior notes , our employee stock purchase plan, deferred cash payments made in connections with acquisitions of businesses, and changes in customer fund obligations.
For the year ended December 31, 2021, cash provided by financing activities was $918.9 million compared to cash provided of $606.1 million for the year ended December 31, 2020. This increase in cash provided of $312.9 million was due primarily to $959.9 million of proceeds, net of issuance costs, from the 2026 Notes, a $14.6 million increase from the net change in customer fund obligations, a $2.5 million decrease in deferred payments related to acquisition earnouts, and a $3.1 million increase in proceeds from common stock purchased under our employee stock purchase plan. These cash inflows were partially offset by a $556.3 million decrease in proceeds from offerings of our common stock, $75.3 million cash paid for purchases of capped calls related to the 2026 Notes, an $18.2 million decrease in proceeds from exercise of stock options, and an $18.1 million increase in cash paid for purchase price holdbacks related to recent acquisitions .
Funds Held from Customers and Customer Funds Obligations
We maintain trust accounts with FDIC-insured 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 are not commingled with our operating funds but are typically deposited with funds also held on behalf of our other customers. Funds held from customers primarily represent restricted cash equivalents that, based upon our intent, are restricted solely for satisfying the obligations to remit funds relating to our tax remittance services. Additionally, a portion of funds held from customers is invested in available-for-sale securities . The cash flows related to the purchases of available-for-sale securities with customer funds are presented on a gross basis in investing activities. Changes in customer funds assets account that relate to activities paying for the trust operations, such as banking fees, are included as cash flows from operating activities.
Customer funds obligations represent our contractual obligations to remit collected funds to satisfy customer tax payments. Customer funds obligations are reported as a current liability on the consolidated balance sheets, as the obligations are expected to be settled within one year. Changes in customer funds obligations liability are presented as cash flows from financing activities.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of December 31, 2021:
Total
Less than
1 year
1-3 years
3-5 years
More than
5 years
(in thousands)
Principal payments on debt obligations (1)
Interest payments on debt obligations
Operating lease obligations
Purchase obligations (2)
Customer funds obligations (3)
Earnout obligations (4)
Holdback liabilities (5)
Total
The principal balance of $ 977.5 million of the 2026 Notes are reflected in the payment period in the table above based on the contractual maturity assuming no conversion or repurchase.
Purchase obligations are comprised primarily of network infrastructure, hosting services, and software licenses.
We maintain trust accounts with financial institution that are solely for satisfying the obligations to remit funds relating to our tax remittance services. Customer funds obligations represent our contractual obligations to remit collected funds to satisfy customer tax payments. At December 31, 2021, we had $62.5 million of funds held from customers and $1.5 million of receivable from customers for a total of $64.0 million customer fund assets. Because of in-transit payments and changes in the amounts owed to us or to the taxing authority, the asset and liability amounts presented for any period will generally not completely offset.
Earnout obligations include the cash portion of earnout liabilities owed to Tradestream Technologies Inc. for the measurement periods ending through December 31, 2021, and the fair value of cash earnout liabilities owed to TTR, Davo, CrowdReason, and Track1099, estimated as of December 31, 2021. The fair value of the earnout liability owed to Business Licenses is excluded from the table above because it will be paid in shares of our common stock.
Holdback liabilities include cash payments owed to the sellers of TTR, Business Licenses, Davo, 3CE, CrowdReason, and Track1099.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements in the years ended December 31, 2021, or 2020.
Use and Reconciliation of Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we have disclosed 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 all non-GAAP financial measures. We have provided tabular reconciliations of each non-GAAP financial measure 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 provided by operating activities less cash used for the purchases of property and equipment and capitalized software development costs.
We define calculated billings as total revenue plus the changes in deferred revenue and contract liabilities in the period, excluding the acquisition date impact of deferred revenue and contract liabilities assumed in a business combination. Because we generally recognize subscription revenue ratably over the subscription term, calculated billings can be used 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.
Management uses these non-GAAP financial measures to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, and to evaluate financial performance and liquidity. We believe that non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our results, prospects, and liquidity 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 when 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 financial measures in conjunction with the related GAAP financial measure.
The following schedule reflects our non-GAAP financial measures and reconciles our non-GAAP financial measures to the related GAAP financial measures:
For the Year Ended December 31,
(dollars in thousands)
Reconciliation of Non-GAAP Cost of Revenue:
Cost of revenue
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Cost of Revenue
Reconciliation of Non-GAAP Gross Profit:
Gross Profit
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Gross Profit
Reconciliation of Non-GAAP Gross Margin:
Gross margin
Stock-based compensation expense as a percentage of revenue
Amortization of acquired intangibles as a percentage of revenue
Non-GAAP Gross Margin
Reconciliation of Non-GAAP Research and Development Expense:
Research and development
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Research and Development Expense
Reconciliation of Non-GAAP Sales and Marketing Expense:
Sales and marketing
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Sales and Marketing Expense
Reconciliation of Non-GAAP General and Administrative Expense:
General and administrative
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP General and Administrative Expense
Reconciliation of Non-GAAP Operating Income (Loss):
Operating loss
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Operating Income (Loss)
Reconciliation of Non-GAAP Net Income (Loss):
Net loss
Stock-based compensation expense
Amortization of acquired intangibles
Non-GAAP Net Income (Loss)
Free cash flow:
Net cash provided by operating activities
Less: Purchases of property and equipment
Less: Capitalized software development costs
Free cash flow
The following table reflects calculated billings and reconciles to GAAP revenues.
Three Months Ended
Dec 31,
Sep 30,
Jun 30,
Mar 31,
Dec 31,
Sep 30,
Jun 30,
Mar 31,
(in thousands)
Total revenue
Add:
Deferred revenue
(end of period)
Contract liabilities
(end of period)
Less:
Deferred revenue
(beginning of
period)
Contract liabilities
(beginning of
period)
Deferred revenue
and contract
liabilities assumed in
business combinations
Calculated billings
These quarters include reconciling adjustments to exclude the acquisition-date fair value of deferred revenue and contract liabilities assumed in business combinations.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the revenue and expenses during the reporting periods. These estimates, assumptions, and judgments are necessary because future events and their effects on our consolidated financial statements cannot be determined with certainty and are made based on our historical experience and on other assumptions that we believe to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. Because the use of estimates is inherent in the financial reporting process, actual results could materially differ from those estimates.
We believe the following critical accounting policies require our most significant judgments and estimates used in preparation of our consolidated financial statements:
Revenue Recognition;
Assets Recognized from the Costs to Obtain a Contract with a Customer;
Stock-based Compensation; and
Business Combinations, including Intangible Assets, Earnout Liabilities and Goodwill.
Revenue Recognition
We primarily generate revenue from fees paid for subscriptions to tax compliance solutions and content and from fees paid for services performed in preparing and filing tax returns on behalf of our customers. Amounts that have been invoiced are recorded in trade accounts receivable and deferred revenue, contract liabilities, or revenue, depending upon whether the revenue recognition criteria have been met. Revenue is recognized once the customer is provisioned and as services are provided. Our revenue recognition policy follows guidance from ASC 606, Revenue from Contracts with Customers .
We determine revenue recognition through the following five-step framework:
Identification of the contract, or contracts, with a customer;
Identification of the performance obligations in the contract;
Determination of the transaction price;
Allocation of the transaction price to the performance obligations in the contract; and
Recognition of revenue when, or as, we satisfy a performance obligation.
We identify performance obligations in our contracts with customers, which primarily include subscription services and professional services. The transaction price is determined based on the amount we expect to be entitled to in exchange for providing the promised services to the customer. The transaction price in the contract is allocated to each distinct performance obligation on a relative standalone selling price basis. Revenue is recognized when performance obligations are satisfied.
Contract payment terms are typically net 30 days. Collectability is assessed based on a number of factors including collection history and creditworthiness of the customer, and we may mitigate exposure to credit risk by requiring payments in advance. If collectability of substantially all consideration to which we are entitled under the contract is determined to be not probable, revenue is not recorded until collectability becomes probable at a later date.
Subscription and Returns Revenue
Subscription and returns revenue primarily consist of contractually agreed upon fees paid for using the Company’s cloud-based solutions, which include tax calculation, preparing and filing transaction tax returns, compliance document management, and tax content subscription services. Under our subscription agreements, customers select a price plan that includes an allotted maximum number of transactions or number of jurisdictions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and customers are not entitled to refunds of fees paid or relief from fees due in the event they do not use the allotted number of transactions. If customers exceed the maximum transaction level within their price plan, we will generally upgrade the customer to a higher transaction price plan or, in some cases, charge overage fees on a per transaction basis. Fees paid for subscription services to tax content vary depending on the volume of tax information accessible to the customer.
Our subscription arrangements do not provide the customer with the right to take possession of the software supporting the cloud-based application services. Our standard subscription contracts are non-cancelable except where contract terms provide rights to cancel in the first 60 days of the contract term. Cancellations under our standard subscription contracts are not material, and do not have a significant impact on revenue recognized. Tax returns processing services include collection of tax data and amounts, preparation of compliance forms, and submission to taxing authorities. Returns processing services are primarily charged on a subscription basis for an allotted number of returns to process within a given time period. We earn SST revenue from participating state and local governments based on a percentage of the sales tax reported and paid.
Revenue is recognized ratably over the contractual term of the arrangement, beginning on the date that the service is made available to the customer. We invoice our subscription customers for the initial term at contract signing and at each subscription renewal. Initial terms generally range from 12 to 18 months, and renewal periods
are typically one year. Amounts that are contractually billable and have been invoiced, or which have been collected as cash, are initially recorded as deferred revenue or contract liabilities. While most of our customers are invoiced once at the beginning of the term, a portion of customers are invoiced semi-annually, quarterly, or monthly.
Included in the total subscription fee for cloud-based solutions are non-refundable upfront fees that are typically charged to new customers. These fees are associated with work performed to set up a customer with our services, and do not represent a distinct good or service. Instead, the fees are included within the transaction price and are allocated to the remaining performance obligations in the contract. We recognize revenue for these fees in accordance with the revenue recognition for those performance obligations.
Professional Services Revenue
We invoice for professional service arrangements on a fixed fee, milestone, or time and materials basis. Professional services revenue includes fees from providing tax analysis, configurations, registrations, data migrations, integration, training, and other support services. The transaction price allocated to professional services performance obligations is recognized as revenue as services are performed or upon completion of work.
Judgments and Estimates
Our contracts with customers often include obligations to provide multiple services to a customer. Determining whether services are considered distinct performance obligations that should be accounted for separately from one another requires judgment. Subscription services and professional services are both distinct performance obligations that are accounted for separately.
Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. We allocate revenue to each performance obligation based on the relative SSP. We determine SSP for performance obligations based on overall pricing objectives, which take into consideration observable prices, market conditions and entity-specific factors. This includes a review of historical data related to the services being sold and customer demographics. We use a range of amounts to estimate SSP for performance obligations. There is typically more than one SSP for individual services due to the stratification of those services by information, such as size and type of customer.
Assets Recognized from the Costs to Obtain a Contract with a Customer
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain costs related to employee sales incentive programs (sales commissions) and partner commission programs represent incremental costs of obtaining a contract and, therefore, should be capitalized. Capitalized costs are included in deferred commissions on the consolidated balance sheets. Deferred commissions are amortized over an estimated period of benefit, generally six years. We determine the period of benefit by taking into consideration past experience with customers, the expected life of acquired technology that generates revenue, industry peers, and other available information. The period of benefit is generally longer than the term of the initial contract because of anticipated renewals. We elected to apply the practical expedient to recognize the incremental costs of obtaining a contract as an expense if the amortization period of the asset would have been one year or less. For 2021, 2020, and 2019 annual amortization of deferred commissions was $15.1 million, $11.5 million and $7.3 million, respectively. If the estimated period of benefit were changed from 6 years to 5 years, annual amortization of deferred commissions would have increased by $2.5 million. If the estimated period of were changed from 6 years to 7 years, annual amortization of deferred commissions would have decreased by $1.7 million.
Stock-Based Compensation
Stock-based compensation expense is measured and recognized in our consolidated financial statements based on either the fair value at the grant date using the Black-Scholes option-pricing model or the fair value of our common stock underlying the stock-based awards. These awards include stock options, restricted stock units (“RSUs”), performance share units (“PSUs”), and purchase rights issued under our 2018 Employee Stock Purchase
Plan (“ESPP”) . PSUs were granted for the first time in 2021. The fair value of each award , excluding RSUs and PSUs , is estimated on the grant date using the Black-Scholes option-pricing model. The fair value of each RSU and PSU is determined using the fair value of the underlying common stock on the grant date. S tock-based compensation expense is recognized on a straight-line basis in the consolidated statements of operations over the period during which the participant is required to perform services in exchange for the award , which is generally four years for stock options and RSUs , three years for PSUs, and six months for purchase rights issued under the ESPP . Forfeitures are accounted for upon occurrence.
The stock-based compensation expense recognized over the performance period for PSUs will equal the fair value of the PSU on the grant date multiplied by the number of PSUs that are ultimately earned. However, the quarterly expense recognized during the performance period for PSUs is based on an estimate of the Company’s future performance and the expected payout level. Changes to management’s estimate of future performance result in adjustments to the stock-based compensation expense for PSUs and are recognized prospectively over the remaining service period. For the year ended December 31, 2021, PSU stock compensation expense was $16.0 million. If we applied a hypothetical increase to the future performance estimate to calculate the maximum possible payout, total PSU stock compensation expense recognized in 2021 would have increased by $2.1 million.
The determination of the grant date fair value of stock-based awards using the Black-Scholes option-pricing model is affected by management’s assumptions, including the expected term of the awards, our expected volatility over the expected term of the awards, expected dividend yield, and risk-free interest rates. The assumptions used in our option-pricing model require significant judgment and represent management’s best estimates. These assumptions and estimates are as follows:
Expected Term . The expected term of employee stock-based awards represents the weighted average period that the stock awards are expected to remain outstanding. To determine the expected term for stock options, we apply the simplified approach in which the expected term of an award is presumed to be the mid-point between the vesting date and the expiration date of the award.
Expected Volatility . Expected volatility 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.
Expected Dividend Yield . We have never declared or paid cash dividends and do not presently intend to pay cash dividends in the foreseeable future. As a result, we used an expected dividend yield of zero.
Risk-Free Interest Rates . We based the risk-free interest rate on the rate for a U.S. Treasury zero-coupon issue with a term that closely approximates the expected life of the stock award at the date nearest the stock award grant date.
If any assumptions used in the Black-Scholes option-pricing model change significantly, stock-based compensation for future awards may differ materially compared to the awards granted previously. For 2021, 2020, and 2019, stock-based compensation expense was $98.5 million, $54.3 million, and $36.1 million, respectively. As of December 31, 2021, we had approximately $11.1 million of total unrecognized stock-based compensation expense related to stock options, $220.5 million of unrecognized stock-based compensation expense related to RSUs, $19.9 million of unrecognized stock-based compensation expense related to PSUs, and $0.4 million of unrecognized stock-based compensation expense related to the ESPP, which we expect to recognize over a period of approximately 1.6 years, 2.9 years, 1.9 years, and one month, respectively.
Business Combinations, including Intangible Assets, Earnout Liabilities, and Goodwill
The results of a business acquired in a business combination are included in our consolidated financial statements from the date of the acquisition. Purchase accounting results in assets and liabilities of an acquired business being recorded at their estimated fair values on the acquisition date, which may be considered preliminary and subject to adjustment during the measurement period, which is up to one year from the acquisition date. Any excess consideration over the fair value of assets acquired and liabilities assumed is recognized as goodwill.
We perform valuations of assets acquired and liabilities assumed and allocate the purchase price to the respective assets and liabilities. Determining the fair value of assets acquired and liabilities assumed requires significant judgment and estimates, including the selection of valuation methodologies, estimates of future revenue, costs and cash flows, discount rates, royalty rates, and selection of comparable companies. We engage the assistance of third-party valuation specialists in concluding on fair value measurements in connection with determining fair values of assets acquired and liabilities assumed in a business combination. The resulting fair values and useful lives assigned to acquisition-related intangible assets impact the amount and timing of future amortization expense.
These estimates are inherently uncertain and unpredictable, and if different estimates were used the purchase price for the acquisition could be allocated to the acquired assets and liabilities differently from the allocation that we have made. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates, and if such events occur, we may be required to record a charge against the value ascribed to an acquired asset, an increase in the amounts recorded for assumed liabilities, or an impairment of some or all of the goodwill.
Goodwill recognized in connection with our 2021 acquisitions was $127.4 million and $26.5 million for our U.S. and European reporting units, respectively. We are integrating all these businesses into our existing operations and therefore, these businesses are included in our U.S. and European reporting units, as applicable, for purposes of analyzing goodwill.
For our U.S. operations, the largest identified intangible assets recognized were acquired pre-existing customer relationships. We determined a fair value of $12.8 million using an income approach, specifically the multi-period excess earnings method, with discount rates from 13.5% to 28%, and estimated useful lives of 5 – 8 years. For our European operations, the largest identifiable intangible asset recognized in the Inposia acquisition was for technology. We determined a fair value of $9.6 million (€8.2 million) using a relief from royalties approach, with a discount rate of 18.5% and an estimated useful life of 6 years.
Intangible Assets. We evaluate our intangible assets for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our intangible assets consist primarily of developed technology and customer relationships arising from business acquisitions. Factors that could trigger an impairment analysis include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business or significant negative industry or economic trends. If this evaluation indicates that the value of the intangible asset may be impaired, we assess the likelihood of recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology or customer relationships over its remaining useful life, we reduce the net carrying value of the related intangible asset to an estimated fair value.
Earnout Liabilities. Earnout liabilities arising from business combinations represent contingent consideration that may be payable in cash or our common stock and are recorded as a liability at fair value upon acquisition and re-measured at fair value in each subsequent reporting period. As of December 31, 2021, and 2020, our total earnout liability for business combinations was $114.0 million and $34.5 million, respectively. Changes in fair value are recorded in the consolidated statements of operations in fair value changes in earnout liabilities and included in total other income (expense), net. For 2021, we recorded $12.2 million of expense for subsequent period fair value measurements related to earnout liabilities. For 2020 and 2019, we recorded $2.3 million and $1.0 million, respectively, of income for subsequent period fair value measurements related to earnout liabilities.
Determining the fair value of contingent consideration requires us to make assumptions and judgments. We estimate the fair value of earnout liabilities using probability-weighted discounted cash flows and Monte Carlo simulations or scenario-based valuations, depending on the nature of the earnout and the performance metrics. These estimates involve inherent uncertainties and if different assumptions had been used, the fair value of earnout liabilities could have been materially different from the amounts recorded, including but not limited to forecast inputs, discount rate, and time to maturity. There is inherently more estimation and sensitivity to the model at acquisition as compared to the end of the earnout period for each earnout. In order to evaluate the sensitivity of the estimated fair value of earnout liabilities, we applied a hypothetical increase of 10% to the discount rates for
earnouts that are valued using a Monte Carlo simulations or a scenario-based approach. Based on the results of the hypothetical increase in the discount rates, the fair value of earnout liabilities decreased by $3.7 million
Goodwill. Goodwill is assessed for impairment at the reporting unit level at least annually on October 31, or whenever circumstances occur indicating goodwill might be impaired. Applying the accounting standard to identify reporting units requires judgment. We have three reporting units for purposes of analyzing goodwill, consisting of our U.S., European, and Brazilian operations. Our impairment assessment involves comparing the fair value of each reporting unit to the carrying value, including goodwill. If the fair value exceeds the carrying value, we conclude that no goodwill impairment has occurred. The Company had no goodwill associated with the Brazilian reporting unit in 2021, 2020 and 2019.
In assessing goodwill for impairment, we first assess the qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than the carrying value. The next step in our assessment is to perform a quantitative analysis, if necessary, which involves determining the fair value of the reporting unit. We estimate the fair value of the reporting unit using both an income approach and a market approach, which are Level 3 measurements under the fair value hierarchy. The income approach uses discounted future cash flows derived from current internal forecasts, which include assumptions for long-term growth rates and a residual value (the hypothetical terminal value) for the reporting unit. Cash flows are discounted using the discount rate, which is risk-adjusted to reflect the specific risk profile of the reporting unit. The market approach identifies similar publicly traded companies to the reporting unit and develops a correlation, referred to as a multiple, to apply to the operating results of the reporting unit. The primary market multiple we compare to is revenue. The market approach also reflects a reasonable control premium to compute the fair value. These estimates involve inherent uncertainties and if different assumptions are used, the fair value of a reporting unit could be materially different from the amount we computed.
As part of our annual impairment test, a qualitative impairment test was performed for the Company’s U.S. reporting unit. We concluded it is more likely than not that the fair value of the reporting unit exceeds the carrying value.
A quantitative test was performed for the European reporting unit. The European reporting unit had a carrying value of $58.6 million as of October 31, 2021. From our quantitative assessment, we determined that the fair value of the European reporting unit was substantially in excess of the carrying value. Our internal cash flow forecast includes significant revenue growth attributable to a single marketplace partner. While this single marketplace partner is not currently significant to our consolidated results, it is expected to be significant to the European reporting unit representing assumed future revenues contributed in the near-term and long-term of approximately 50% of the total reporting unit revenue. If our revenue growth assumptions are not realized or our expectations with respect to future revenue growth are reduced, the fair value of the European reporting unit would be adversely impacted.
Significant estimates and assumptions used in the income approach for the European reporting unit included using a discount rate of 25% and a hypothetical terminal value of 1.50 times revenue. For the market approach, significant estimates and assumptions included our selection of an appropriate peer group, consisting of publicly traded U.S. and European companies, which allowed us to derive revenue multiples (e.g., trailing 12 months and next fiscal year) averaging approximately 1.45 times revenue and a selected control premium of 10%.
Recent Accounting Pronouncements
For further information on recent accounting pronouncements, refer to Note 2 in the accompanying notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
