Tax compliance software maker Avalara (NYSE:AVLR) missed analyst expectations in Q2 FY2022 quarter, with revenue up 23.3% year on year to $208.5 million. Avalara made a GAAP loss of $55.8 million, down on its loss of $27.6 million, in the same quarter last year.
Avalara (AVLR) Q2 FY2022 Highlights:
- Revenue: $208.5 million vs analyst estimates of $209.1 million (small miss)
- EPS (non-GAAP): -$0.02 vs analyst estimates of -$0.08 ($0.06 beat)
- Free cash flow was negative $32 thousand, compared to negative free cash flow of $31.1 million in previous quarter
- Net Revenue Retention Rate: 113%, in line with previous quarter
- Customers: 20,110, up from 19,160 in previous quarter
- Gross Margin (GAAP): 70.2%, down from 71.2% same quarter last year
- Avalara has agreed to be acquired by Vista Equity Partners in an all-cash transaction that values Avalara at $8.4 billion.
Founded by Scott McFarlane in 2004, Avalara (NYSE:AVLR) 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 easy to use, integrated cloud based finance software that integrates tax and accounting operations continues to rise in tandem with the difficulty workers find trying to use existing accounting tools like spreadsheets given the growing volume of finance data littered across a multitude of enterprise applications. A related demand driver is the secular increase of e-commerce and rising adoption of modern point of sales and payments platforms which easily integrate with backend financial software.
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.
Sales Growth
As you can see below, Avalara's revenue growth has been very strong over the last year, growing from quarterly revenue of $169 million, to $208.5 million.
Even though Avalara fell short of revenue estimates, its quarterly revenue growth was still up a very solid 23.3% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $4.06 million in Q2, compared to $9.38 million in Q1 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.
Ahead of the earnings results the analysts covering the company were estimating sales to grow 21.2% over the next twelve months.
Customer Growth
You can see below that Avalara reported 20,110 customers at the end of the quarter, an increase of 950 on last quarter. That's in line with the customer growth we have seen over the last couple of quarters, suggesting that the company can maintain its current sales momentum.
Product Success
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 113% in Q2. That means even if they didn't win any new customers, Avalara would have grown its revenue 13% year on year. Despite it going down over the last year this is still 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.
Profitability
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, licenses, technical support and other necessary running expenses was at 70.2% in Q2.
That means that for every $1 in revenue the company had $0.70 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.
Cash Is King
If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Avalara burned through $32,000 in Q2, with cash flow turning negative year on year.
Avalara has burned through $6.73 million in cash over the last twelve months, resulting in a negative 0.85% free cash flow margin. This below average FCF margin is a result of Avalara's need to invest in the business to continue penetrating its market.
Key Takeaways from Avalara's Q2 Results
With a market capitalization of $8.39 billion Avalara is among smaller companies, but its more than $1.46 billion in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.
Avalara delivered solid revenue growth this quarter. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that Avalara missed analysts' revenue expectations and the revenue retention rate deteriorated a little. Overall, this quarter's results were not the best we've seen from Avalara. The company currently trades at $91.75 per share.
Is Now The Time?
When considering Avalara, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in case of Avalara we will be cheering from the sidelines. Its revenue growth has been strong, though we don't expect it to maintain historical growth rates. But while its customers spend noticeably more each year, which is great to see, the downside is that its customer acquisition is less efficient than many comparable companies and its gross margins aren't as good as other tech businesses we look at.
Avalara has agreed to be acquired by Vista Equity Partners in an all-cash transaction that values Avalara at $8.4 billion.
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