Avalara, Inc.

Good afternoon, and welcome to Avalara’s fourth quarter and fiscal year 2019 earnings call. We will be discussing the results announced in our press release issued after market closed today.

With me are Avalara’s CEO, Scott McFarlane; CFO, Bill Ingram; and Executive Vice President of Strategic Initiatives, Ross Tennenbaum. Today’s call will contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements include statements concerning financial and business trends, our expected future business and financial performance and financial condition, and our guidance for the first quarter and fiscal year and can be identified by words such as expect, anticipate, intend, plan, believe, seek or will. These statements reflect our views as of today only, should not be relied upon as representing our views at any subsequent date, and we do not undertake any duty to update these statements.

Forward-looking statements, by their nature, address matters that are subject to risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to the risks discussed in today’s press release, our annual report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2019, and our other periodic filings with the SEC.

During the call, we will also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of the GAAP and non-GAAP results is included in our earnings press release, which has been filed with the SEC and is also available on our website at investor.avalara.com.

With that, let me turn the call over to Scott.

Thanks, Greg, and welcome to everyone joining our Q4 2019 earnings call. Q4 was another strong quarter for Avalara capping off an amazing year.

In Q4, we reported total revenue of $107.6 million, representing an increase of 40% over the same quarter last year. Our growth rate was driven by continued strong execution across the business.

We saw a new customer wins across a wide range of industry segments and geographies and we experienced strong customer retention and solid upsell activity. I would like to thank all of our customers and partners who contributed to our success in 2019.

And I would like to thank our employees for their hard work, their continued commitment to our customers, our vision and each other is greatly appreciated. We recently had a chance to celebrate our success and hard work at our all-hands company meeting.

It was amazing to see the involvement, excitement, and enthusiasm of all of our employees at this annual event. The highlight of our meeting this year was the introduction of our new five-year vision document, the fourth, we’ve written at Avalara.

Before I share some of the key aspects of our vision with you, I would like to outline how we got here. We all live in a digital world that thrives because of automation.

We see it every day in our personal lives and we see it in our work lives as well. Many of the once manual repeatable business requirements have been automated such as salesforce management, enterprise resource planning, inventory management, account receivable, payments and fulfillment among others, but there are laggards.

As you know, governments worldwide require businesses to collect and remit taxes, and the state government impose a complicated and endless evolving array of compliance obligations and the bulk of the processes surrounding global compliance are still manual for most businesses. This is where Avalara steps in.

We exist to ease the confounding government mandated burden, every business on the planet must face, the obligations of transaction tax and regulatory compliance. It is our core belief that compliance should not and will not remain a manual process.

We believe it should and will be automated. We believe compliance automation is inevitable and to think otherwise is simply irrational.

This brings me back to our vision for Avalara and how it is evolved. I’ve said before that we wanted to be part of every transaction in the world.

This is as true today as it was over a decade ago when we first articulated it. But what’s exciting to me is how that vision has grown to encompass an even broader view of the compliance challenge.

When we started Avalara more than 15 years ago, our only service was tax calculation. So naturally our grand vision was very focused on transactions.

Today, Avalara is an end-to-end compliance provider, having added robust automated returns and remittance services, exemption certificate and other document collection, storage and management solutions, licensing and registration services, cross-border compliance and more. So for some time now, oddly enough, just seeking to be part of every transaction on the planet wasn’t really big enough to capture everything we do.

What about the returns we filed for customers, payments we make on their behalf, compliance documents we manage and so forth. We undertook a lengthy and thorough process to frame our updated vision and the key principles required to pursue it.

And we now take our long-range claim to becoming the global cloud compliance platform and automate all aspects of compliance for global businesses. Through this process, we also reconfirm our commitment to meeting our promises to our customers and clarified that while growth remains our prime directive, driving efficiencies in our business is also an imperative.

During 2019, we focused on improving sales and marketing efficiency and on driving the business towards cash flow breakeven. I’m proud of the continuing results we achieve from those efforts and excited about the emphasis we are placing on improving our margins in the long term.

Efficiency initiatives touch every element of our business today from customer and partner onboarding, the self service support initiatives, for the continued application of advanced technologies to manual parts of the compliance journey. These investments have a profound and exciting impact on our business.

So we believe they remain in the early days of value creation for Avalara. A good example is the application of artificial intelligence and machine learning technology that we acquired from Index last year.

As you may recall, one of the primary initial projects we asked the team to explore was using AI to accelerate the acquisition of new content and the mapping of a massive database of global product codes, the tax code. We are excited to share amazing progress by the team in this area.

We can now source sales and use tax rates for most states at the click of a button. In addition, we have delivered automation tools that assist with cross-border product classification.

Our content team, a dedicated group of tax and compliance experts that Avalara relies on to maintain and expand our extensive content database to now use these automation tools to work more efficiently, leaving time to assemble new content. As a reminder new tax and compliance content unlocks new markets for Avalara, expanding our potential customer and partner base with each new vertical, geographic or tax type added to our global database.

If I take a minute to articulate the difficulty of the content acquisition and maintenance tasks, I want to share some of the stats around the changes made to our U.S. database last year.

These changes are based on ever-changing laws and regulations that governs state and local taxes and the rate of change can be busy. In 2019, we made almost 300,000 updates to our AvaTax calculation engine.

These changes include everything from rate updates, the taxability rule changes, boundary amendments, tax holidays, and more. Imagine trying to keep up with all that in the accounting office of a small or medium sized business or even a large accounting firm.

I’m excited that our technology investments not only drive major efficiencies in our internal processes, but also show up as big usability improvements for our customers, existing and new. We are in the final testing of automatic AvaTax code classifications and automated taxability analysis to accelerate new customer onboarding.

The process of mapping a customer’s product portfolio and the SKUs to tax codes can be labor intensive and our new system will substantially ease the burden for new customers. We’re also updating our tax rate lookup tool with an AI powered backend and better search technology.

Finally, and before I close my comments today, allow me to touch briefly on our talent today at Avalara. Last year, we brought in an astounding caliber of new leadership for the organization.

I want to recognize two of our most recent hires who have joined the team. Jay Lee joined Avalara as Chief Marketing Officer in November, coming into the team from prior marketing leadership roles at PayPal, American Express and GE.

And last month, Salim Ali joined Avalara as SVP of International. Prior to Avalara, Salim was CEO of Loyakk, an enterprise data sharing platform built on blockchain technology and has overseeing global marketing products and partnership efforts for notable enterprise technology companies including SAP and Veritas Technologies.

With that, allow me to close this section with what I’m sure many of you are waiting for. I’m about to hand this earnings call over to my partner Bill Ingram for the last time.

It has been a great honor of my career to work alongside Bill for the past several years and I could not be more grateful for his willingness and enthusiasm to join our company. I can confidently say that we would not be where we are today without his leadership and skill.

I believe we’ve been led by one of the best CFOs in the business. As a testament to that, I believe his transition plan was one of his final stellar strategies and Ross Tennenbaum is the best choice to follow in his footsteps.

Ross has worked with Avalara since 2014 when he began helping us prep for our IPO. In his managing director role at Goldman Sachs, Ross led the team that managed our IPO.

Ross’ experience was built over a 10-year investment banking career at Goldman Sachs and Credit Suisse and nearly seven years in leadership roles at VIACK Corporation, a web collaboration software company. Since arriving at Avalara last year, Ross has led our Strategic Initiatives Group including our cross-border, lodging, communications and excise businesses, which represents strategic growth areas for our business.

They will deliver our financial updates side-by-side today and I trust that folks on the phone will enjoy working with Ross in the years to come. With that over to you, Bill.

Thanks, Scott. As a reminder, Avalara adopted the new revenue recognition accounting standard, ASC 606, effective January 1, 2019 on a modified retrospective basis.

As a result, financial results during 2019 are presented in compliance with ASC 606, while historical financial results prior to 2019 are presented in conformity with ASC 605. Our earnings press release includes additional information to reconcile the impacts of the adoption of the ASC 606 standard.

Our fourth quarter and fiscal year 2019 results were highlighted by strong sales execution and continued market demand. For the year, our total revenue under ASC 606 grew 41% to $382.4 million.

For the fourth quarter, total revenue was $107.6 million, up 40% on a year-over-year basis. A strong growth in the quarter was once again driven by increased demand from both new and existing customers combined with strong sales execution across channels.

Subscription and returns revenue was $99.9 million. This represented 93% of our total revenue and it grew 39% year-over-year.

Professional services revenue was $7.7 million. Our core customer count increased by 720 to approximately 11,960 at the end of Q4 2019.

Our net revenue retention rate was 111% in Q4 and is averaged 111% over the last four quarters. Our revenue retention rate, supported by low gross churn, contributes to strong customer lifetime value.

In discussing the remainder of the income statement, please note that unless otherwise stated all references to our expenses, operating results and share count are on a non-GAAP basis and are reconciled to our GAAP results in the earnings press release that was issued just before this call. Gross profit was $76.8 million for Q4 2019, representing a 71% gross margin.

This compares with gross profit of $56.2 million and a 73% gross margin in the same period last year. The two percentage point decline in gross margin primarily results from third-party software hosting costs and our expansion into international markets as we have discussed in prior quarters.

Turning to operating expenses. We continue to invest in sales and marketing to fuel long-term growth and new customer acquisition.

Sales and marketing expense was $43.4 million in Q4 or 40% of revenue. On a 605 basis, sales and marketing expense would have been $49.3 million or 46% of revenue.

While sales and marketing expense was up on a sequential basis, this was in line with our expectations and due mainly to seasonality. We are pleased with our continued sales and marketing efficiency.

For Q4, research and development expense was $23.7 million or 22% of revenue. The increase in research and development expense was consistent with our expectations as we continue to invest in new products, content and features to drive sales growth efficiency and increase our competitive mode.

For Q4, general and administrative expense was $14.8 million or 14% of revenue. The decrease from the prior quarter in general and administrative expense was driven primarily by an insurance litigation recovery, which was recognized during the quarter.

Non-GAAP operating loss was $5.1 million for Q4, which is better than our previous guidance due primarily to the revenue upside in the quarter. On a 605 basis, non-GAAP operating loss was $10.9 million compared to $13.3 million non-GAAP operating loss in Q4 2018.

Non-GAAP loss per share was $0.03 in the fourth quarter based on 77.1 million shares outstanding. On a 605 basis, non-GAAP loss per share was $0.10 compared to a loss of $0.19 per share in the fourth quarter of 2018 based on 66.7 million shares outstanding.

In preparing our 2019 annual financial statements, we discovered an immaterial error in recording deferred sales commissions for the first three quarters of 2019 impacting our previously reported ASC 606 financial results. On the last page of the financial schedules, we have presented for each of the first three quarters of 2019, are unaudited consolidated statements of operations as previously reported and as corrected.

The correction resulted in additional sales and marketing expenses of approximately $1 million for each of the first three quarters of 2019 under ASC 606. There is no change to our previously reported ASC 605 financial results.

Looking now at our fiscal year 2019 results. Total revenue of $382.4 million, was up 41% on a year-over-year basis.

Subscription and returns revenue contributed $355.2 million. This represented 93% of our total revenue and it grew 40% year-over-year.

Professional services and other revenue contributed $27.2 million. Non-GAAP gross profit was $275.1 million for 2019, representing a 72% gross margin.

This compares with gross profit of $199.1 million and a 73% gross margin in 2018. The same factors discussed earlier, which impacted our Q4 gross margin also contributed to the gross margin results for the full year.

Non-GAAP operating loss for 2019 was $14.4 million compared with a $45 million loss in the prior year. Of note, $18.6 million of the year-over-year improvement in operating loss was due to the adoption of ASC 606.

The results are consistent with our expectations as we continue to invest in our business to drive long-term growth and new customer acquisition. Turning to our balance sheet and cash flow statement.

Our cash and cash equivalents were $467 million at the end of Q4 2019, an increase of $20.4 million from $446.6 million at the end of Q3 2019. Total deferred revenue as of Q4 2019 under ASC 606 was $161.2 million, up 9% from $148.5 million at the end of Q3 2019.

Calculated billings is a non-GAAP metric that takes into consideration revenue and the change in deferred revenue as well as the change in contract liabilities. Calculated billings were $120.8 million in Q4 2019, up 29% from $93.4 million in the same period last year.

As a reminder, our calculated billings growth rate began increasing meaningfully in late 2018. We will continue to face challenging year-over-year comparisons relative to this trend throughout fiscal year 2020.

Free cash flow was $14 million for the quarter compared to $4.5 million in the same quarter last year. As we have stated on past calls, our free cash flow will fluctuate from quarter-to-quarter caused by many factors, including the timing of working capital, the seasonality of our billing and expense cycles, as well as our overall level of investment in the business.

As we previously announced, I will be retiring on March 31, and have joined our Board of Directors. Ross Tennenbaum, our Executive Vice President of Strategic Initiatives will take over the role of Chief Financial Officer.

Ross’ experience was built over a 10-year investment banking career at Goldman Sachs and Credit Suisse including working with Avalara since 2014 and leading its IPO in 2018. Scott and I have great confidence in Ross and we were very fortunate to have him step into the role of Chief Financial Officer.

In addition, I want to thank our team for the strong financial operations we’ve built at Avalara. I firmly believe the company is well positioned for the future.

With that, let me turn the call over to Ross.

Thanks, Bill. On behalf of Avalara, I would like to thank Bill for his leadership as Chief Financial Officer over the last four years.

Bill has built a strong team and foundation that has scaled our financial operations to support an initial public offering and high growth. Bill has been a great mentor to many Avalarians and I’m grateful that he’s joined our Board of Directors and will remain engaged and accessible as a long-term trusted advisor to me and our entire team.

I joined Avalara almost one year ago after serving as an investment banking advisor to Scott, Bill and the company for nearly six years. Through these experiences, I’ve had the opportunity to immerse myself deeply in the business and work alongside Bill and the finance team to drive operations.

I’m excited to assume the Chief Financial Officer position to help the company achieve its long-term ambitions. I will now conclude the call by providing guidance on revenue and non-GAAP operating loss for Q1 and for the full year of 2020 under the ASC 606 standard.

As a reminder, after a strong 2019 performance highlighted by 41% revenue growth, we expect to face more challenging year-over-year comparisons in 2020. For Q1 2020, we expect total revenue to be between $107.5 million and $108.5 million.

We expect that our Q1 non-GAAP operating loss to be in the range of $8.5 million to $9.5 million. For the full year 2020, we expect total revenue to be between $470 million and $474 million.

We expect our full year non-GAAP operating loss to be in the range of $18 million to $22 million. We continue to expect a modest level of cash burn in 2020 consistent with what we shared on our November 2019 earnings call.

We believe the momentum in our business, compelling customer economics, and our leadership position in a large market all support continued investment in the business to drive long-term growth. Before closing, please note that our Investor and Analyst Day will be held on Wednesday, May 13, in St.

Louis in conjunction with our CRUSH Annual Users Conference. In-person attendance will be limited, so if you’re interested, please contact our Investor Relations team.

For those of you who cannot join us in-person, a webcast of the event will be accessible on our IR website. At this point, we would like to open up the call for your questions.

Okay. Thanks so much and congratulations on a great end of the year.

Scott, in your prepared remarks, you talked a bit about the progress index has been making and aggravating tax content. Can you update us on any content gaps you might still have in certain verticals, how are you thinking about closing those gaps either organically or through M&A and how that could potentially open up, I guess the opportunity for more customer additions in time.

Thanks.

Yes. Thanks, Chris.

We’ve said on calls previously that we have about, I would say we have someplace around 60% of the content of U.S. Now some of that content doesn’t really, there’s not a big market for it.

So we’ve got the majority of the big areas, but there’s a lot of work that we can do, around food and beverage, automotive, manufacturing. Those are the things that we’re going to pick up once as I said in my remarks, once the index kicks in and we’re starting to do maintenance on an automated basis, all of our teams can start focusing on that effort going forward.

And I think that’s a big change for us. One, I think it’ll have gross margin impacts for us in the future, but it will also allow us to add growth.

That’s exactly the kind of initiative that we want to work on efficiency and growth simultaneously. So I’m pretty optimistic about that.

Okay, great. Thank you.

Maybe just one quick follow-up. The full year margin guidance, it looks like it implies a little bit of deleveraging the model and I realized fiscal 2020 was a year of accelerated growth for you all.

They probably came in well out of the original plan. So maybe can you just talk about where you’re investing in 2020 and I guess to the extent that you do see some over delivery, should we’d be thinking about that flowing through to bottom line or do you see kind of continued opportunities to reinvest that in growth?

Thanks.

Thanks, Chris. Yes, this is Bill.

We’re very pleased with the profile of our income statement and we’re going to continue to invest across where we see the ability to drive growth. And as Scott said, long-term improvements in margin.

And so we’ve done a number of investments this year and I’m very pleased with. We’ve invested in the capacity of our network, in the security of our network.

We’ve invested in content product development, product marketing, product management. And then we’ve also invested in other areas along our sales and marketing and our general administrative.

We’re really putting in the foundation building blocks to build a much bigger company here. And so, Scott and Ross and I, we clearly have our eyes keenly on the income statement and all the levers we can pull.

But I don’t think that deleveraging that you pointed out as anything that be overly concerned about is as we’re prudently making investments really to broaden the total served market kind of like what you talked about earlier and also start to deliver some efficiencies across the income statement. The biggest concern we had coming out of the IPO year and a half ago was our sales and marketing efficiency and we’ve done a nice jobs, demonstrating that.

Now, we’re taking the content, the capacity, the scalability, the security of our network and core infrastructure, into a great place also. So, we think we’ve got the great mixture here.

Chris, thanks.

Thanks, Bill.

Yes. Thanks.

Hi guys. So you added over 700 customers again in the fourth quarter.

Can you help us understand what are the profile, the customers that you’re adding today versus let’s say a year ago? And what I mean by profile, how would you characterize, so these larger companies smaller and even mix what is the focus of those customers and what’s kind of the tip of the spear?

Is it always tax calc that’s bringing them in or is there kind of another tip of the spear that you’re starting to see develop?

Thanks, Sterling. This is Bill.

I will start in, others can jump in and add to kind of cover the rent. That’s a good question.

So first of all, I just want to remind everybody, the core customer count we report is not purely new net ads. It’s our metric of those customers that have generated more than $3,000 of revenue in the last 12 months.

And so it’s a very nice metric. We like it because it’s very predictable.

But to your point we are seeing on margin newer customers slightly larger than we’ve seen a year ago. That was your premise compare a year ago to now.

So, first comment I make would be the average customer size is larger. And it’s not just the entry point of tax calc.

I know as Scott even said a few minutes ago, that’s where we started the company. But we really have multiple entry points for our business, not just tax calc, but also returns, compliance, and a couple of other cross-border now and certain verticals that that our expertise comes through.

So the other thing I was going to make on your point about core customer counts, don’t again over emphasize the last decimal, the growth rate or the numbers. If you remember last quarter, we reported 80 of those core customers came inorganically from our Compli acquisition.

And so again, the nice thing about the core customer count is it still represents – that cohort represents more than 80% of our revenue currently. And the average selling price is increasing on the margin, but it’s a nice solid base as you see now over 11,000 which grows at a very steady basis.

And that brings me back to my tagline, which is we’ve liked the business here because it’s a large TAM, low churn, and we see real strong, steady, stable growth for many, many years. Scott?

Let me add just a little bit of color to that. Right.

I mean, I think I said it in my opening remarks a little bit which is, we’re doing a lot of things other than just the tax calculation that we did. And I always say that there’s the four horsemen of sales of tax, right, which is, I mean, you have one or all of these problems.

I mean, you have a calculation problem, you have a returns filing problem, you have an exemption certificate issue, right – those or you have a use tax problem. Those are the ways.

And so Avalara has really tried to work to build out our product offering. So wherever your problem is, you have an entry point into Avalara.

Now, we’ve added cross border and then of course you have VAT as well. So we really have seven ways that customers feel pain, they can come into our business and we want to make it easy for them to do that.

That makes sense. And then one follow-up on the investment in the margin outlook.

Can you give us a sense how much of this is actual just people? So in other words, headcount increase, how much of it is other investment, like the infrastructure in terms of cloud and the support international?

And maybe to help us with that, can you give us a sense, what was the headcount at the end of the year and directionally where do we see that going?

Thanks, Sterling. It’s Bill.

We don’t break out headcount at the end of the year. But what I can tell you is we have absolutely grown headcount in the company.

Scott talked about new leadership, we brought in and I got to tell you in the four plus years I’ve been here, the company has really matured and attracted, great people to join us. So I’m very pleased with the profile of the workforce.

In terms of the investment, we don’t have it broken out in terms of percentages, but I would say, for your kind of way you phrased the question, it’s kind of 50:50, 50% of the overall investment is in people and talent and training and development. We’re doing some great things on the training development front.

But the other 50% really has come from some big systems, I think, I’ve talked about earlier and that are kind of a step function in investment for us because we feel very confident about the long-term future of the business. And so just for example, we’re putting in a worldwide HR system that’s going to be really very good for the company.

I’m having to – my team overseeing SOX for core implementation because of our market cap makes us a large accelerated filer now. So there’s just some kind of big company things that we’re doing now, which I think, are very prudent.

And so to your question I’d say it was kind of fifty-fifty headcount in systems.

Thank you.

Great, hi guys. Thanks for taking my question.

I wanted to ask about international. I know this has been a focus on the content side.

Where do you feel you are in kind of the build-out of content, particularly in Europe and LatAm, such that we're getting close to potential investment in go-to-market in those regions to kind of originate more customers in international geographies.

Thanks Brad. I’ll take this one.

International, as we’ve said, is a really, sort of big focus for us. And let me lay the groundwork for this.

When we talk about international, we are talking about businesses that reside outside of the U.S. But I'll remind everybody that because of the promise of the internet, anything, anywhere, any place, anytime, I mean AvaTax, we have to calculate, I mean, be prepared to do international rates at the highest level for 210 countries around the world.

And in fact we do over 160 different countries, every every year or at least in 2019 calculating. So in order to do really good service and which I think sort of distinguishes Avalara at times is that you have to be able to calculate that at all, so, I mean, our basic business is centered around being able to do 210 countries.

Now specifically I think to your question is we take that high level rates and now we start driving down. So EMEA and the countries around that – I think we have pretty good content.

We made an acquisition about four years ago and they were the leading group with their content. So we've been able to take EMEA and have a pretty good base for growing that business.

Getting it integrated into AvaTax is what we're doing today. So we can expand that content and send it out even further and I think use our really good UI and UX experiences to help more customers.

LatAm, we really started in Brazil. And Brazil as we all know is the hardest tax regime.

And we continually build out that content. And that job is never done because it's a lot to update and a lot to continue to grow and we'll continue to do that.

But we're moving into, I mean, Mexico and other regions in that area and we'll grow outlet LatAm over this year and the coming years. So those are our two – our main bases right now obviously.

And we've talked about that with the investments that we've made – the investment that we got in our secondary and the like that we want to expand that even faster and further beyond. So I think we have a long ways to go on an international basis.

But we've got a good start in two base areas. And we'll continue to grow from there.

That's great. Thanks Scott.

And then one more if I may please. On the net revenue retention at 111% is it possible to unpack a little bit what's driving that?

Transaction, volume growth is obviously key, more states, more geographies, I am sure is the secondary driver. And then you've got other services like cross border, landed cost, et cetera.

I guess where are those – I guess those three, how do they rank today versus say a year ago when you look at your net revenue retention, which one would you say is contributing more? And then do you think that this kind of 110%-ish level is sustainable?

Thank you.

Sure, Brad thanks. Well, we always say we encourage you to look at kind of the four quarter average as opposed to any one quarter.

And so 111% we are pretty pleased with that. A year ago the four quarter average would have been less than 111%.

So I think it's fair to say that it has moved up a few points year-over-year. Again I'm talking about a four quarter average, not quarter-to-quarter.

You kind of weighted out we’ve talked a lot as you know in the past about Wayfair. Well Wayfair really is a long term tailwind for the business that is driving existing and new customers basically to registering file in more states and that contributes to our existing customers to the net revenue retention.

We talked in the past, I think, a little bit about SST revenue that's with existing customers primarily which picks up a point or two. And then cross-border is starting to come into play.

I think it's fair to say that most companies, not all, but most companies have some early requirement for an international transaction, whether they're using us or not today we think that's a really, again a steady kind of long tailwind for us. So you can’t answer the question as you asked it.

I can't add much more to what you said, but those things are driving and have picked up a few points for us in net revenue retention from a year ago.

Great. Thanks Bill.

Yes.

Great, thank you. One for Scott and then one for Ross and Bill.

So Scott first in your prepared remarks you talked about applying some AI-powered tools. What do you mean by that?

I mean, you know, AI sort of broad category robotic process, automation, machine learning, intelligent assistance, can you get us some specific examples of something that you think you can do better?

Sure, and I think I've said this in the past Pat. But what I would like to focus everybody on for AI, for us, I mean there's just lots of app and machine learning, there's lots of applications because there's things like when you have to go and find tax updates and information today we do that in a very manual way.

We're on the phone, we're doing research on the computer, we're looking around for where the changes have happened, we're taking information that the states send us and get – and consolidating all of that. But that can be done way more efficiently with AI.

I mean, people that could – I mean, machines that can go out, crawl and look for that information, consolidate that information, test that information and then be able to produce it to a group of people that can audit it and get it out. So manual becomes only the auditing function, whereas all of that extra work can and should be done, I mean, automatically.

The ability to find new content, I mean, that's really the Holy Grail for us, is then to extend that out. And so now we no longer have to use people to go find all that content that we don't have today.

I mean, we can do that in an automated fashion. My goodness, I mean that is a big boon to gross margin and it's also a way to accelerate growth because you are able to expand your market in a way faster.

Doing onboarding, making sure taking information that the customers have inside their accounting systems and being able to take that, manipulate that and suggest solutions for them as to where they have nexus, or how their products are going to be taxed from a tax-ability perspective. Presenting that to them and then being able to allow them to do it without having to do the manual step, and the taking of product codes and mapping at the tax decisions, all of that stuff is so manual, it's a burden for the customer and it's a burden for us in onboarding.

So to the degree that we can take the information that we've got from – the IP that we got out of index and provide it to our customers and us internally, it's a fantastic thing, Pat.

All right, that's super helpful. Thank you.

So on the CFO front, Ross, congratulations. Bill, thank you for helping guide us for the last four years.

So listen, to the extent that you're willing to share it, than you might not be, what advice have you given Ross about dealing with investors and analysts like me?

Yes, that was a great question. That's a good question.

I have no idea how they're going to answer it, but it's a great question.

Well, I got to give you one, Pat. We didn't prep for that.

But we're so fortunate to have Ross here. Scott and I just couldn't be more poised.

For us it's going to be great, super smart, very high integrity. And so I think you'll find working with Ross just outstanding.

So he doesn't need my advice, but I'll give him all the support and encouragement that I can. Ross, over to you.

Yes, the number one piece of advice he's given me is big market low churn. So I hang to that.

But I would say now having about six years working with the company externally, and leading the company through the IPO and now here for a year I really, I joined the company really believing in the long-term, opportunity we have. And it's been really a great plan that Bill and Scott have put into place in terms of the transition.

Spending a year operating several of our important businesses that are important growth areas for the company, and really getting deeply immersed into the business, how it operates, working with the whole team and working with Bill, alongside Bill from an operating me being the operator, he being the financial leader and his great team. And now as we spend hours a day together and deeply immerse myself in the financial operation, I would just say overall, there has been a lot of wisdom and advice.

And I'm thankful that Bill will continue on as a Board member. So I will continue to have his advice and tutelage.

That’s not any one thing, but it's a smart transition that Bill and Scott have affected here and I'm appreciative of it.

Pat, this is Scott. What I would say is, I mean, this is something that I really believe in deeply in the business we have all the new executives.

And I say the same thing to everybody joining the company because the tendency for people is to the jump in and want to do everything right away. And my advice to all the new leaders we have here is take your time, you’ll never get this opportunity again.

And Bill and Ross have been doing this and Ross did it for a year is learn the business. Learn the business, understand the customers, understand how we operate and then once you do that then you’re ready to take on the job.

So that’s the same for Ross as it for Amit, as it for Saleem and all of the other people. Learn our business it’s complicated, it’s hard, I mean demo the product, be able to do that and then from that you can just really be effective in your jobs.

Thank you all for those perspectives.

Hi, great. Thanks very much.

Bill, would you be willing to sort of help us out and maybe point to when you think gross margins will bottom?

Well, I can't really do that Brad. But what I can say is we've got our hands on the controls.

And we're really taking – you probably heard me say this, we're really taking a very manual process, this process of kind of tax compliance. And as Scott says it's pretty funny.

It hasn’t been around for decades, it's been around for thousands of years. And so we're taking this very, very manual process and we're really automating it for the first time, at least in a cloud solution.

And so as a result, there's a lot of friction to that automation. We've talked about it.

You heard Scott talk about it on that question earlier. And so I'm just very confident that over time I emphasized time, you'll see nice margin improvement here.

But I can't say when that's going to be and I wouldn't focus on any near term quarters, because again we're taking this manual process, we're automating an industry, a market that has never done this before, it's still very much internal status quo. And as we do these numerous things across the business I'm confident we'll see steady, gradual and inevitable gross margin expansion.

And on the operating marginal lines, I think we'll see a really reasonable improvement there just due to scale because we have such a long, steady growth opportunity ahead of us.

Great. Thanks very much.

Hi Scott. Bill and Ross congrats on a good quarter and thanks for taking my questions.

I guess a Bill good luck in the the next adventure. And I guess this technically makes you Scott's new boss, is that correct?

We like that.

And on the Board.

And I don't think I haven't heard it.

I guess the two questions from me, Scott, let's start or on the Index acquisition, I mean kind of enamored with that one, since you made it because of how obviously it could make onboarding of your customers more quickly given some of the content mapping that you have there. But have you seen any maybe change in competitive win rates or opportunities that are out in the end market today, specifically based on that functionality?

So I mean I'm enamored with it as well. And I think it's a real game changer.

I mean, Bill said it, I've said it, I mean I think it's a big game changer for Avalara and for our customers. And we have not rolled it out yet.

And I think I said that in the opening remarks that were just very, very close to – I mean, doing that. So we have high hopes that it will provide the kind of customer service that we really want and the efficiencies around that in the quarters to come.

So stay tuned on that one because, I think, it's important for us.

Great. And then from a follow-up perspective, probably for Bill or for Ross is you've had nice core customer growth over the last four or five quarters, nice increase in acceleration there.

But can you comment on customer ARPU trends? Maybe if some of those new customers that are coming into the Avalara ecosystem over the last year relative to may be that 12-month or 24-month timeframe before that?

Yes, sure. This is Bill.

I'll take it Scott. And thanks for your kind comments.

We are seeing again on the margin slightly larger deals coming through. I don't want to overemphasize that fact.

But with a base now of over 11,000 core customers they're ticking up. And you can kind of do the math and we did the math last year at our Analyst Day.

But you're not seeing any degradation in ARPU, I guess, this is what I should say. You're seeing nice, steady, kind of upticks in that average revenue per core customer.

And so if it was only a few hundred core customers, it would be probably more significant, but because of our base, and the size of that group and the size of the opportunity we're going after, you can assume there's a slight uptick in average revenue per core customer. That is going on.

And the new deals coming in are slightly bigger.

Hi, thanks. Look, we all know that hiring is a challenge these days for companies.

And so you guys have done it. We've also seen more acquihire.

I mean, I think the – whatever Portway was reporting to our guys in Toronto was, I don't know, 80 or 100 employees. But how do you – is there a ratio – I've always been wondering, when you are a company, is there a ratio as to how you think about whether you buy a company on acquihire basis?

Is it dollars per employee or versus hiring, because there's two different paths and stuff like that. I'm just curious as you kind of go forward how you guys think about that?

Thanks.

I mean, Richard, thanks, interesting question. So, I said this in the past, I mean one of the really – I think one of the key success aspects of Avalara has been our willingness to make a tuck-in acquisitions.

I mean, I don't think Avalara would be where it is without doing that. Because for us, in the beginning it was always about catching up, it was about getting IP and that was around, rates, and rules and content for the most part.

But some of them were actually around getting people and technology in a combination. And so for us we have a bias towards let's do what we do really, really well internally.

And when we need to learn something where we don't have it internally, we always turn to the outside. I mean, we will – I can just say this with a lot of certainty, we will not, I mean, enter China with just doing it with just our people.

We will look to make it, I mean, an acquisition. We will look for the technology and the expertise to enter those markets.

And that's what we really do. I mean, we start out with a bias towards action and getting that information.

And obviously we do the comparison. We're always looking at what would it cost us to build it internally compared to what we can do externally and the speed at which you do.

So I don't think you can – I think, everybody would say that what I just said. But I think the difference and what I think sort of distinguishes us is our bias towards action and making it happen through, as you say, acquihire.

We really do like that methodology and I think we'll continue to do that.

Thank you very much. I'm all set, but I appreciate it.

Good quarter.

Yes, thanks. I had two questions on international.

First you added the new SVP of international last month. And I think in the release and then again today you talked about his role in shaping the company's go-to-market strategy there.

I know it's only been a month, but can you just talk about any early results or any changes that you're looking to make there?

Sure. Thanks Alex.

I mean, what I'll say is I'll just do a little bit walk down memory lane to begin with. But when we decided to do this move internationally, I mean, I took one of our senior executives, Marshal Kushniruk, moved him to Europe.

And that's how we started to develop our strategy. It's what drove us to make the acquisitions that we've done there.

Pascal Van Dooren, who worked with us for a long time had international. And when he stepped aside, it left this vacancy, which we filled with Salim.

So we've had, I think, a very sort of strategic way of saying, hey, we have to enter Brazil because that's the world's most complex area and it really drives what happens LatAm. And then obviously EMEA and the EU, I mean, we had to cover those.

And I think we had a really great strategy around going to market in those areas. But when I say and your question really is around, I mean Salim is going to say, how do we move out of those and how do we take advantage of India, I mean, more in Asia?

How do we enter these other markets that we're not in today? And which one should we go first?

Which one should we go second and third? How do we actually think about our mote strategy internationally, so we develop that mote internationally the same way we've been able to develop it in the U.S.

I think that that's really the thing that I'm looking to Amit and Salim to drive for us.

Got it, that makes sense. I guess just following up on that, international revenues kind of held steady this year so far at about 6% percent of revenue.

Did that pick up at all in fourth quarter? And with that and kind of how you just answered the last part, do you think we're far enough through the investments internationally that we could see an inflection in that growth rate where it kind of grows faster than the blended average?

Thanks, Alex. It's Bill.

Yes, we've reported international pretty stays percent but you got to remember how well we’ve done overall in the U.S. And so what we like to say, what I say is there's certain fundamental building blocks you got to get into place before you're going to see any sort of change in the revenue profile.

And we're putting those building blocks in place. Remember, this company was founded 15 years ago and there was many, many years of investment, development and effort.

Well, those things are now also being duplicated certainly at a faster rate internationally. But when international revenue gets over 10% of our total our plan is to start breaking it out at that point.

So we're not quite there yet, but we're very pleased with what's going on in international – we’re investing international, we've talked about our investment there, we're seeing similar similar tailwinds and demands internationally and so we think the international marketplace presents a very, very compelling, long-term opportunity for the company.

Yes, I mean, everybody knows how sort of excited I am and I think the company is for that. And Bill has talked about this in the past.

It's really a growing area for us. It's a strong, strong growing area for us.

It's just growing on a small base. And the good news is, is that the big base is growing pretty fast as well.

It's just hard to get out in front of that big number. But it is a one of our really good growth areas.

And and we're pleased with where we are.

Thanks for taking the question top of the hour here. I guess I'll echo the well wishes for Bill's retirement here.

First question is for Scott here, and I have a follow-up for Bill and Ross. Scott tax regulation has and continues to be a tailwind to the business, tailwind to kind of automating the complexity.

The latest kind of regulation was the marketplace facilitator law that kind of went to place in Q4. What did you learn in the quarter around that new regulation?

And what are some of the – what's been some of the early feedback from some of those marketplace facilitators? And again, one quick follow-up for the CFO team here.

Hey, Brent. Thanks a bunch.

I mean, I think what we're seeing in the Marketplace act. I mean, what – I think it's a reflection of what's just happening in tax around the world.

It's, I mean, Wayfair, marketplace, all of the efforts that the rest of the world is putting into VAT reporting, live reporting, those are all just fantastic awareness tailwinds for us. But what I think I've learned about this is much, it's, that they are always there and they are always creating complexity.

And in this one case, complexity is our friend. And it's not one thing, it's the culmination of all of those things that I think are driving to what I've always said that this is inevitable.

And I mean specifically around marketplaces it became easier in one sense, but way more complex for the customers because if they're doing something on their own eCommerce site, then then they have to report everything just as if nothing changed. And so deciphering what they have to report and what they don't have to report because it's already been done is really, actually more difficult than what they had before.

And so we're starting – I mean we see that in conversations throughout – our discussions throughout the chain around marketplaces, the marketplaces themselves, the customers that they're dealing with. So it's hard to say which one is exactly pushing them along.

But the whole concept of sales tax, I mean, I think, everybody is getting more and more aware of what they have to do and the difficulty around it.

Got it, helpful color. And then as I think Bill and Ross, as I just think about the two components of the business, the core customer cohort, that's a $300 million business growing pretty consistently in that low 30% range.

The remaining cohort are kind of non-core, smaller customer cohort that smaller 20% of the business, $76 million business, but growing much faster over 80% growth year-over-year this year. As you think about that cohort, that faster growing court, I assume these are smaller kind of deal revenue sizes.

Is there an opportunity to kind of upsell those smaller customers, convert them into core customer cohorts? Walk me through just the puts and takes the growth levers in that smaller but fast growing part of the business today.

Sure, Brad, I don't want to kind of reconcile your math. But we see a lot of opportunity, as I've always described, in the mid-market in the United States, we identify historic 400,000, 500,000 mid market customers.

But in that fewer than 20 employees segment of the marketplace, which are the smaller merchants, there's over five million registered businesses in the United States. And so to your point this long tail of smaller merchants we think – while further out us is very, very significant.

I know we've got some great executives here, like Amit, and Jay and others that are very familiar with that marketplace from their days at PayPal and other companies. And so, in terms of upsell, and add on, and so on and so forth, again, the core customer metric as you know this $3,000 number if we sign up a new customer at $3,600 a year, well, they're not a core customer until month-10.

But if we sign up a new customer at $36,000 a year, they are a core customer in month one. And so we're going after both segments very aggressively.

We're obviously very, I believe I’d like I say we've been successful with kind of the mid market segment of which there's still hundreds of thousands of potential customers out there. But in the smaller segment of which the volume is much larger, we're going to do lots of things and we're making very significant investments in that area to approach those.

But it kind of goes to something Scott said that that needs to be much more automated, it needs to be much more self-served, it needs to be much lower friction. And again back to kind of my premise about we're so early in the adoption cycle here we think as we solve those speed bumps, or friction points, or hurdles, we think that will open up opportunities for us in this large smaller customer segment.

Not only to get them to use our service, but then to sell them more things.

Hey guys, a nice job and thanks for taking my question. Really last one here.

So I'll give you a brief. I just want to talk to the competitive environment, any changes from the lower-end players or the higher-end players?

And then just really as you think about the idea of automation, you might took someone like a [indiscernible]. There's a lot of sort of manual stuff that's done there, integration, process flow, et cetera, workflow for the large customers.

As you guys do more and more automation, does that move up market become just more natural and obvious or is there a limit to what you think because of the deep strategic relationships, some of the strategic guys might have there that that sort of limits you in that market. Thanks.

Bhavan thank you. Your last part of the question, I think, is probably the more difficult aspect of it.

And I guess that's what I'll probably focus is really because our competition really hasn't changed. I mean in the beginning it's always status quo.

I mean that's what we're fighting against. And I would say the only that we've had there is, are the tailwinds that we've talked about, I think, are beneficial for awareness.

And I think that is changing and the more things that happen is pushing us along. But the competition that's out there at the low end.

And at the higher end they're doing what they're doing and they would love to trade places with Avalara and the moat that we've created around content and around our partner relationships. But because of things like adding cross border and all of the things that we do internationally just makes it exceedingly difficult for people to break into that moat.

But they are definitely pushing, and the tailwinds help – raises all boats, right. So they're out there.

But like I said, the last part of your question, streamlining workflow and all of that, it goes to actually what I was saying in my opening comments. Yes, we started out in calculation and yes, we're doing returns, but there are, a great deal of things that you can do beyond that.

And which ones those are not going to comment on now, but as we move up market in the enterprise space, I mean, there'll be lots of opportunity for us to add products around workflow and the things like that. I mean it'll just be natural for us to do that.

But having said that, our big focus is that mid-market. I mean, we are moving upstream, you see it all the time, we're protecting the low end, but the mid market is what we're really focused on.

So most of our effort is going to be into doing – into be doing products and initiatives around the mid market, which would not include some of the things that you were talking about, we’ll let [indiscernible] continue to do that.

I appreciate the color. Thank you, guys.

Nice job. Thanks for take my question.

You bet.

Hey, good afternoon. Congratulations Bill.

It's been a pleasure working with you. But one question for Scott about – Scott, you've talked about automation and how it's benefiting your customer base.

I'm wondering if you are seeing any signs on a state-by-state or municipal level of any signs of automation for states to crack down on noncompliant remote sellers. If there's any technologies that’s either using themselves, coordinating with each other to speed the compliance and the actual filing of returns.

Terry thanks. I've made mention to this in the past and I think it's notable.

So the direct answer to your question is no, they're not that sophisticated yet. But yes, they want to be that sophisticated and they will do it.

And they will start using digital methodologies, like looking at customers’ ecommerce transactions and credit card, I mean, credit card transactions. So they may not know what's happening in retail when cash is done, they may not know what's happening when checks are done, but when credit cards are done, they can get that information just like everybody else.

And they'll start to look at customers as to what are they doing and are they over their thresholds. And so already you're starting to see some states being organized around trying to find that data and then send out notices to customers to saying, hey, you are approaching the threshold, or we see you go over the threshold you need to take a look at that.

But that's all that they're doing right now. They haven't been able to get that okay from here this is what you need to do.

And I mean, for me it would be fantastic because they said let's contact Avalara, get you registered and collected and the like. But we still haven't gotten there yet, but don't think we're not trying.

Great. Thank you.

Siti Panigrahi. Okay, Bill pleasure working with you and Ross.

Congratulation and looking forward to working with you. Just a pull up to that marketplace facilitator law, last quarter, I think, you guys talked about 16 partners from a potential of 200 marketplace.

Just wondering any update on that on having more partners. And the second one on that, I guess, I the marketplace facilitator law that went effective last quarter and eBay talked about this six months impact to their GMV due to collecting sales taxes.

So I’m wandering they are one of their partner and I guess we should help – I'm wondering, is that some 2020, – any update on that will be great.

It's a good question. And don't think that we talk about partners each and every call, but our business development team, for us it’s the pointy end of the sphere.

And that's been sort of Avalara's bread and butter. I mean, that's what we're really good at going out and doing.

And the team is out talking to everyone that you mentioned on that list, trying to get – trying to help them solve this problem. And I mean it is driving lots of conversations.

And as they become more and more firm, we'll be able to report on that. But what I can report on it is a big initiative for us in 2020 to continue to drive our partnerships deep into the marketplaces, both domestically and internationally.

Sure. Thank you.

I want to close by saying thank you to our employees, customers and partners for what was an ambitious and exciting 2019. With renewed commitment to our goals and expanded vision I'm excited about the work ahead of us in 2020 and beyond.

Thank you for your interest in Avalara and we look forward to our next call with you all. And congratulations to Bill, it's been a fantastic journey.

Couldn't have done it without you. And Ross really excited to work with you in the future.

Thank you all.