Tax compliance software maker Avalara (NYSE:AVLR) announced better-than-expected results in the Q2 FY2021 quarter, with revenue up 45.1% year on year to $169 million. Avalara made a GAAP loss of $27.6 million, down on its loss of $10.1 million, in the same quarter last year.
Avalara (AVLR) Q2 FY2021 Highlights:
- Revenue: $169 million vs analyst estimates of $154.2 million (9.62% beat)
- EPS (non-GAAP): $0.02 vs analyst estimates of -$0.10 ($0.12 beat)
- Revenue guidance for Q3 2021 is $170 million at the midpoint, above analyst estimates of $164.9 million
- The company lifted revenue guidance for the full year, from $652 million to $674 million at the midpoint, a 3.37% increase
- Free cash flow of $20.2 million, up from negative free cash flow of -$31.93 million in previous quarter
- Net Revenue Retention Rate: 116%, up from 107% previous quarter
- Customers: 16,570, up from 15,580 in previous quarter
- Gross Margin (GAAP): 71.2%, in line with previous quarter
Founded in 2004, Avalara offers software as a service that provides companies with real-time information on how much tax to charge and automates tax compliance. Transactional taxes are complex, with thousands of rules set by local, regional, state, federal and international authorities.
For example, in New York sliced bagel is taxed, but if you just take a plain bagel to go - no tax. Navigating these rules and staying up to date is challenging for any company, but especially for small and mid-sized businesses that have limited resources and have been typically keeping track of tax rates for their products manually in spreadsheets.
Avalara works through integration with a wide variety of point-of-sales systems (cash registers) and online billing platforms like Shopify or Stripe. Every time a customer is about to be charged, either in the real world or online, a request is sent to Avalara to determine the tax. The company maintains a huge database of millions of products and their appropriate tax rates in different geographies worldwide, and within a few milliseconds returns back the correct tax amount to be charged. It then passes the information into the merchant's tax software and even helps with filing the tax.
The company was started with a focus on small and medium size businesses that have until recently been lacking the tools to deal with transaction tax compliance. Most of them are in the United States, but the company also supports transaction tax compliance in Europe, South America, and Asia.
The demand for tax management software is driven by an increase in digital commerce and ongoing adoption of modern technology platforms which are scalable and make it easy to automate business processes.
Avalara is mainly replacing work their customers either used to do manually themselves or with outside help, but there are other software companies operating in this space like Vertex (NASDAQ:VERX), TaxJar, and Thomson Reuters.
As you can see below, Avalara's revenue growth has been very strong over the last year, growing from quarterly revenue of $116.4 million, to $169 million.
And unsurprisingly, this was another great quarter for Avalara with revenue up an absolutely stunning 45.1% year on year. On top of that, revenue increased $15.4 million quarter on quarter, a very strong improvement on the $8.84 million increase in Q1 2021, and a sign of acceleration of growth.
Analysts covering the company are expecting the revenues to grow 22.1% over the next twelve months, although we would expect them to review their estimates once they get to read these results.
You can see below that Avalara reported 16,570 customers at the end of the quarter, an increase of 990 on last quarter. That is quite a bit better customer growth than last quarter and quite a bit above the typical customer growth we have seen lately, demonstrating that the business itself has good sales momentum. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is working very well.
We want to note that Avalara revised their customer calculation methodology to include revenue from the Streamlined Sales Tax solution (SST), which results in additional customers being included in reported customers.
One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.
Avalara's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 116% in Q2. That means even if they didn't win any new customers, Avalara would have grown its revenue 16% year on year. Significantly up from the last quarter, this a good retention rate and a proof that Avalara's customers are satisfied with their software and are getting more value from it over time. That is good to see.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Avalara's gross profit margin, an important metric measuring how much money there is left after paying for servers, licences, technical support and other necessary running expenses was at 71.2% in Q2.
That means that for every $1 in revenue the company had $0.71 left to spend on developing new products, marketing & sales and the general administrative overhead. This is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.
Key Takeaways from Avalara's Q2 Results
With market capitalisation of $14.4 billion, more than $639.4 million in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
We were impressed by how strongly Avalara outperformed analysts’ revenue expectations this quarter. And we were also glad to see the improvement in net revenue retention rate. Zooming out, we think this impressive quarter should have shareholders feeling very positive. The company is up 5.25% on the results and currently trades at $178.61 per share.
Is Now The Time?
Avalara may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although we have other favorites, we understand the arguments that Avalara is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been strong, over the last two years. And while its gross margins aren't as good as other tech businesses we look at, the good news is its very efficient customer acquisition hints at the potential for strong profitability.
The market is certainly expecting long term growth from Avalara given its price to sales ratio based on the next twelve months is 20.2. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Avalara doesn't trade at a completely unreasonable price point.