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Edited Transcript of AVLR.N earnings conference call or presentation 7-May-20 9:00pm GMT

Q1 2020 Avalara Inc Earnings Call

SEATTLE Jun 14, 2020 (Thomson StreetEvents) -- Edited Transcript of Avalara Inc earnings conference call or presentation Thursday, May 7, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ross Tennenbaum

Avalara, Inc. - CFO & Treasurer

* Scott M. McFarlane

Avalara, Inc. - Co-Founder, Chairman & CEO

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Conference Call Participants

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* Alexander James Sklar

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Bradley Hartwell Sills

BofA Merrill Lynch, Research Division - VP

* Brent Alan Bracelin

Piper Sandler & Co., Research Division - MD & Senior Research Analyst

* Christopher David Merwin

Goldman Sachs Group Inc., Research Division - Research Analyst

* Daniel William Jester

Citigroup Inc, Research Division - VP

* Joseph P. Goodwin

JMP Securities LLC, Research Division - Analyst

* Joshua Christopher Reilly

Needham & Company, LLC, Research Division - Associate

* Lucas Lincoln Morison

Canaccord Genuity Corp., Research Division - Associate

* Matthew Alan Stotler

William Blair & Company L.L.C., Research Division - Analyst

* Sitikantha Panigrahi

Mizuho Securities USA LLC, Research Division - MD

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Gregory Ryan McDowell

ICR, LLC - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Avalara's First Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your speaker today, Greg McDowell, Investor Relations. Thank you. Please go ahead, sir.

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Gregory Ryan McDowell, ICR, LLC - MD [2]

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Good afternoon, and welcome to Avalara's First Quarter 2020 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; and CFO, 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, the impacts of COVID-19 on our business and global economic conditions, our expected future business and financial performance and financial condition and our guidance for the second 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, 2020, 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.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [3]

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Thanks, Greg, and welcome to everyone joining our Q1 2020 earnings call. Q1 was another good quarter for Avalara. Our revenue was $111.4 million, up 31% year-over-year, with subscription and returns revenue up 35% year-over-year. Overall, our execution was solid. We experienced strong new sales in January and February that met our internal expectations. In March, our new sales were impacted by the COVID-19 crisis, and this impact continued in April. We believe we can emerge from this crisis even stronger than before. Not all SaaS businesses enjoy the structural advantages we have. We benefit from having market tailwinds at our backs. We help businesses become more efficient. We have a strong and sticky customer base. We believe we are well positioned to grow within our customer segments that are doing well in the current environment. And that we are relatively insulated from the risk represented by our customer segments that are struggling. Businesses have been forced to pivot to remote workforces, now have tangible evidence of the advantage of moving to the cloud, which helps many SaaS providers including us.

Many e-commerce businesses along with marketplaces and e-commerce platforms that enable them are benefiting from the current environment. And we see it in our data where around half of our transaction volume comes from e-commerce. And our revenue from customers experiencing meaningful increased transaction volume is currently on par with our revenue from customers experiencing decreases. We believe this crisis will accelerate businesses move to the cloud and e-commerce, and we will be there alongside our partners to help businesses succeed in their journey. We partner with leading marketplace and e-commerce platform providers, who are all open for business with many continuing to thrive.

When the COVID-19 crisis began, we quickly increased our engagement with existing and prospective marketplace and e-commerce platform partners, reinforcing the message that their compliance obligations continue and reminding them that our solution puts them in a position of strength to press forward in this time. I'm happy to say that the intensity of our conversation with these important partners has increased as a result. And we expect to announce exciting new and expanded relationships in 2020. We also believe our customer base is relatively well insulated from the negative consequences of this crisis. While our customer base includes small businesses, more than 80% of our revenue comes from our core customers, and we did not see a meaningful increase in gross revenue churn in March.

While the crisis has changed the landscape, our vision and our plan remain the same. We are here to accelerate the inevitable. The move to compliance automation, and we are unwavering in our goal to alleviate the burden of government-mandated compliance requirements. Avalara supports all types and sizes of businesses. Regardless of the size or type, we believe all businesses will look for efficiencies as they prioritize and optimize spend. The pain of manual tax compliance will not diminish in the months to come. In fact, it may become more acute as everyday complexities are multiplied by a patchwork of new rules, payment deadlines, relief offers and short-term rate changes. Every business will be compelled to navigate the new environment, and we will be there for those who haven't yet automated.

No doubt we will feel the impacts from the crisis. But I believe our compelling ROI story and the resilient business model may insulate Avalara from some of the difficulties, other companies are facing. Even before COVID, as a compliance company, we've been building and testing a system that our customers can trust and, today, that is on display. Nearly 100% of our global employees are working from home, and our employee productivity remains high. As a SaaS company and a global business, we have been using cloud-based collaboration tools for videoconferencing, project management and other functions for many years. These technologies allow us to bridge geographic distance, so it's been a seamless shift for us to recalibrate for the current reality.

Many investors have asked us how we are selling, and I just want to remind everybody that we have a high-velocity inside sales force. Many of whom were remote employees before the crisis. Because we don't have long sales cycles or high ASPs, our sales reps rarely have to get on a plane to visit prospects. The crisis has put some of our teams into overdrive. As global tax authorities use rates and deadlines as mechanisms to provide business relief, our compliance, support and marketing teams have generated numerous resources for businesses to help them understand and respond to the options available. These resources include updates on legislative changes worldwide, educational assets that help businesses pivot effectively to new models, the ability of customers to defer payments to states based on new legislation, and promotional pricing alongside our partners. Capturing and simplifying changing tax rules has always been our specialty. Because understanding tax compliance complexities can be overwhelming to companies navigating the crisis. We have made that expertise more openly available on our website. We believe this will strengthen our existing customer relationships and attract new businesses, who want an expert help navigate new realities going forward.

Many investors understandably have questions about the mechanics of our business and how it works. First of all, our business model is designed to be stable. While we certainly enjoy positive business cycles driven by external forces like Wayfair, we haven't suffered as much as many other businesses during previous economic upheavals. A simple framework is to think about our business in 2 parts: One is tied to calculations, and the other is tied to compliance. Let's talk about both in more detail.

We recognize revenue from our calculation product, AvaTax. And our pricing model provides some insulation against economic downturns. AvaTax price plans are based on the number of transactions over the subscription term. Our customers pay for an annual subscription base on transaction volume, and a large majority of our customers pay upfront. Unused transactions are not carried over to the next subscription term. Furthermore, our transaction bands are generally quite wide. So a customer would have to see a significant degradation in transaction volumes in order to downgrade to a different band. And even if they chose to downgrade at renewal, the impact to revenue on a percentage basis is meaningfully less than the percentage decline in transaction volume.

We also recognized revenue from a number of compliance products: sales tax returns, VAT compliance returns, exemption certificate management and others. These products are not tied to transaction volumes or our customers' revenues. For example, our returns processing services are primarily charged on a subscription basis for an allotted number of returns to process within a given time period. Tax authorities around the world are offering flexibility to impacted businesses. For some, tax returns must be filed on existing schedules with the option to defer payments. And for others, both the return and the payment may be submitted at a later date. Ultimately, these returns and payments must be submitted and will provide these compliance services to our customers. We are adding value to our customers as we help them remain in compliance and understand and react to a rapidly evolving and complex environment. We have not seen a meaningful impact on our churn rate. In fact, our gross revenue churn in Q1 remained meaningfully below 4%. We believe it would be difficult, costly and frankly crazy for our customers to rip out our solutions and go back to manual processes, especially in this time when efficiency is so critical for so many businesses. Of course, there's a risk that churn will increase if macro conditions further deteriorate, but we believe churn would likely be concentrated among small businesses, which is the lower end of the market for Avalara and, therefore, should have a lesser impact on our revenue churn rate.

I would like to now share where we've been impacted by the crisis. As I said earlier, like many companies, our new business activity has been impacted by COVID-19. We don't have significant customer or industry concentration. Where we have customers in more heavily impacted industries, specifically lodging and fuel, I want to point out that these 2 industries each represent a low single-digit percentage of our total revenue, and they are heavily weighted to compliance products that are not tied to customers' revenue or transaction volumes. Our cross-border business is also being impacted. As a reminder, Avalara item classification makes it easier for customers to sell anywhere in the world through our offering that identifies and maps tariff codes to customers' products. Because global B2C trade has been down meaningfully, that part of our business has suffered. Professional services, which represents 5% of our total revenue in Q1, saw a year-over-year decline due to a very strong comparable in Q1 '19 and lower engagement from the customers for our Professional services as a result of COVID-19.

Regarding the impact on opportunity generation, the crisis has wiped out the trade show environment, and it's unclear when that type of gathering will regain its footing. Historically, Avalara has used trade shows to market alongside our partners and reach their customers. In 2020, we had planned to do more than 350 events with 100 of those already being canceled. We are working closer than ever with our partners to find new and different models to reach their customers.

To summarize my thinking on the COVID-19 crisis, I believe Avalara is well positioned to succeed in the long term. Today, we are experiencing economic uncertainty as businesses move quickly to new normal operations. Regardless of the impact, every business will be considering the efficiency and ROI of their investments, and it just makes sense to adopt a cloud-first philosophy when considering new tools, technology and processes. As cash flow has tightened and teams are forced to slow headcount growth and further control costs, Avalara's cloud technology cost effectively automates mandatory compliance processes. This return on investment for any business is appealing, especially in times of ambiguity. This has been Avalara's value proposition for many years and we serve thousands and thousands of customers today who rely on us to make their teams more efficient and processes more seamless. Just like many other companies that are focused on driving internal efficiency, we remain vigilant about improvements in this area for ourselves.

In our last earnings call, we discussed efforts to drive efficiency within our business, including the application of machine learning to our tax and product content to enable new product and customer growth. Today, I want to touch on 2 additional programs that are driving new efficiencies for Avalara teams and our customers. First is the migration of our return service platforms. Previously, our core sales and use tax returns team required 2 separate tools to process and file returns. Now in a single sales and use platform, our compliance team has a more streamlined platform that will enable us to process more returns per employee per month. And we plan to integrate our other tax types like communications and excise into this tool. We have made meaningful progress in deflecting many types of support cases through better self-service tools. This effort includes major projects like AvaTax calculation review, which shows customers a detailed breakdown of exactly how a sales tax rate calculation was determined, a very common inbound request.

As I introduced in Q4, this quarter, we launched the beta of AvaTax tax code mapping for customer onboarding. By deploying advanced technology in this process, we give new customers and implementation teams the ability to quickly and more accurately map product libraries to tax codes through a decision tree tool. With broader use, this tool will get more accurate, and further reduce this aspect of manual implementation work. Our efficiency efforts are global. Our European team has moved much of the exchange of materials and documents for registrations and filing services from e-mail to a web-based portal, enabling our compliance agents to handle more accounts, moving seamlessly among them and avoiding manual data transfer tasks. These types of improvements reflect a relentless effort by our product and engineering teams, from which our employees, customers and partners all stand to benefit.

Wrapping up, we announced last month that Justin Sadrian, a Managing Director at Warburg Pincus, will be leaving the Board of Directors when his current term ends in June 2020. Justin's contribution to Avalara since joining the Board in 2014 has been invaluable. I'm grateful for the positive impact he has made on our business. I would also like to welcome Brian Sharples to the Board. Brian is co-founder and former CEO of HomeAway and an accomplished leader on other public company Boards, such as Yelp, GoDaddy and Ally Financial.

I will now turn the call over to Ross to talk through our financial results.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [4]

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Thank you, Scott. Our first quarter results were highlighted by a continued increase in market demand with strong sales execution in January and February; and as Scott noted, softness in March. For the first quarter, total revenue was $111.4 million, up 31% on a year-over-year basis. Subscription and returns revenue grew 35% year-over-year to $105.5 million, which represented 95% of our total revenue. Professional services revenue was $5.9 million, down 12% year-over-year. The year-over-year decline in Professional services revenue was attributable to the COVID-19 crisis and a difficult comparable as our Q1 2019 Professional services revenue grew 92% year-over-year. Our core customer count increased by 750 to approximately 12,710 at the end of Q1 2020, a year-over-year increase of 31%. Our net revenue retention rate was 109%, up from 107% in Q1 2019, resulting in a 111% 4-quarter average, which is equal to the 4-quarter average we reported in Q4.

Our new sales demand was meaningfully impacted in March and remained impacted in April. However, we saw some improvement in our opportunity funnel in April, though it's too early to know if this will sustain. Despite the current macro environment, our customers must still calculate taxes and file returns, and our business model and customer base so far has shown the resiliency we expect. To illustrate, I'd like to provide you with more details on both our logo and revenue churn as well as share some additional details on our customer composition. In Q1, the number of logos that churned out of our business was actually down year-over-year as a percentage of our renewal base with no meaningful uptick in March. Our gross revenue churn, which in the past, we have said has been lower than 4%, remained meaningfully below 4% in Q1 2020 and was on par with the rate we saw in Q1 '19. We define gross revenue churn as the annual revenue contribution associated with billing accounts that canceled all of their agreements with us in the last 4 quarters, divided by the total annual revenue recognized during the last 4 quarters. As a reminder, our gross revenue churn does not include downgrades, the value of which was not a significant percent of total revenue in Q1.

While our customer base does comprise small businesses, more than 80% of our revenue comes from our 12,710 core customers that paid us more than $3,000 in the trailing 12 months. Our 2019 average core customer revenue was approximately $30,000, calculated by taking our 2019 total core customer revenue and dividing by 10,515 average 2019 core customers. As a reminder, this does include larger marketplace and commerce platform customers that are aggregators of many of their own end customers.

Finally, as Scott discussed, a number of our e-commerce customers, along with the marketplaces and commerce platforms that enable them are benefiting from the current environment, providing us with opportunities to increase our penetration in this important channel. In discussing the remainder of the income statement, please note that unless otherwise stated, all references to our expenses, operating results and loss per share 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 $79.6 million for Q1 '20, representing a 71% gross margin. This compares with gross profit of $61.6 million and a 72% gross margin in the same period last year. Sales and marketing expense was $46.2 million in Q1 or 41% of total revenue, an improvement of over 150 basis points year-over-year. We made meaningful investments in Q4 '19 to increase our marketing and sales capacity to address a healthy demand environment. We continued those investments in January and February, but slowed investments in March and April as we began to see a slowdown in end customer demand for our products as the result of COVID-19. Q1 research and development expense was $23.5 million or 21% of revenue, up from 17% of revenue in Q1 '19. This increase was consistent with our expectations as we continue to invest in our global cloud platform, including in new products, content and features to drive sales growth and cost efficiency.

Q1 general and administrative expense was $18.1 million or 16% of revenue versus 15% of revenue in Q1 '19. Our Q1 '20 G&A expense includes unplanned charges totaling $1.6 million, primarily related to increasing legal reserves, increasing our estimate of foreign non-income tax accruals and higher bad debt expense. Q1 non-GAAP operating loss was $8.1 million, which was better than our previous guidance. Our non-GAAP operating loss reflects revenue upside and higher-margin subscription and returns revenue and lower-than-expected employee costs in the quarter, offset by lower-than-expected Professional services revenue and gross margin. Non-GAAP loss per share was $0.05 in the quarter based on 77.9 million shares outstanding.

Turning to our balance sheet and cash flow statement. Our cash and cash equivalents were $450.5 million at the end of Q1 '20, a decrease of $16.5 million from $467 million at the end of Q4 2019. Total deferred revenue as of Q1 '20 was $165.4 million, up 3% from $161.2 million at the end of Q4 '19. As a reminder, our fourth quarter is typically our strongest in terms of end customer demand and billing and, therefore, we would expect our first quarter deferred revenue to be flat decline as compared to our fourth quarter. 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 $116.7 million in Q1 '20, up 21% from $96.4 million in the same period last year. Calculated billings was impacted in Q1 by a write-down to total deferred revenue of approximately $1 million, primarily as a result of increasing our allowance for doubtful accounts balance amid the uncertainty of COVID-19.

Additionally, since our calculated billings metric includes total revenue, the calculated billings growth rate was also impacted by lower-than-expected Professional services revenue as previously discussed. Although we normally don't discuss billings linearity in the quarter, I would like to share a little more color with respect to the month-to-month fluctuation. In January and February, our year-over-year calculated billings growth was similar to our Q4 '19 year-over-year billings growth rate. However, in March, our calculated billings decelerated meaningfully due to the crisis. We saw an impact more in our new customer acquisition demand and, to a lesser extent, on upsell and cross-sell deals to our existing customers. Free cash flow consumption was $25.9 million, compared to consumption of $12.5 million in the same quarter last year. The increased cash consumption and level of spend in Q1 was expected and is largely driven by the payment of our annual corporate bonuses totaling $20.4 million, a large insurance renewal for $3.5 million and the renewal of various software licenses for $5 million. Free cash flow was also impacted by lighter than expected accounts receivable collections in the quarter. 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 and levels of our billings and expenses as well as our overall level of investment in the business.

I will now conclude the call by providing guidance on revenue and non-GAAP operating loss for Q2 and for the full year of 2020. We've expanded the range of our guidance due to the uncertainty surrounding the COVID-19 pandemic. Our guidance is also based on the assumption that the most significant headwinds will occur in the second quarter with a modest improvement of third quarter. We are further assuming that economic conditions will more broadly open up by the end of the year. Clearly, significant variation from these assumptions could cause us to modify our guidance higher or lower.

For Q2 2020, we expect total revenue to be in the range of $109 million to $111 million. Although not a standard practice for us to break out expected growth rates between subscription and returns and Professional services, for this quarter only, we would like to share that we expect year-over-year subscription and returns revenue growth in the low- to mid-20% area, while we expect Professional services revenue to modestly decline year-over-year. Management is focused on delivering efficient growth, and as such, we are being responsible about how we manage our expenditures and cash flow. In early March, we thoroughly reviewed our 2020 hiring plan and decided to slow hiring across the business. Additionally, we have been curtailing or delaying nonessential operating expenses. We expect our Q2 non-GAAP operating loss to be in the range of $8 million to $9 million. For the full year 2020, we are lowering our total revenue guidance from a range of $470 million to $474 million to a range of $455 million to $465 million. We expect some mix shift based on our assumption that 2020 Professional services revenue growth will be flattish year-over-year. We continue to expect our full year non-GAAP operating loss to be in the range of $18 million to $22 million.

Turning to our views on cash flow for the year. We have implemented responsible solutions to manage cash flow. As AR collections began to slow as a result of the crisis, we increased our efforts to extend accounts payable terms with vendors and take advantage of other programs that will delay cash outflow including the deferral of employer payroll tax payments under the recently passed CARES Act. We continue to expect a modest level of cash burn in 2020 consistent with what we shared on our February 2020 earnings call; however, our cash burn may be slightly higher due to the potential impact to billings and increase in day sales outstanding.

In closing, I would like to emphasize a few points that Scott touched on in his prepared remarks. While our business is not immune from the COVID-19 crisis, we believe we are well positioned to grow within our customer segments that are doing well in the current environment and that we are relatively insulated from the risk represented by our customer segments that are struggling. And we enjoy some business model advantages that are appealing in these trying times, including: First, the vast majority of our sales team is inside sales. We expect our sales teams can be as productive at home is in the office. Second, our ASPs are modest compared to many software sales, and we typically don't have lengthy implementation projects or the need for people to be on site, so we can continue to take customers live on our products. And finally, we are in the compliance industry. Businesses still have to calculate taxes, file tax returns and remit payments. So we believe this function is still very important relative to other software purchases businesses may be making.

On June 23, we will be hosting a virtual Analyst Day for the investment community. A webcast of the event will be accessible on our IR website, and we will share additional details shortly.

At this point, we would like to open up the call for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Chris Merwin from Goldman Sachs.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [2]

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I just wanted to ask about trigger events. I know there's many of them that cause customers to become aware about Avalara. And in the past, ERP has been one of the bigger ones. I know point-of-sale replacements can -- it at least has been a big one as well. But obviously, we're dealing with a much different environment now. So wondering if you're seeing new trigger events causing customers to come through? Just what that has looked like more recently?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [3]

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Chris, this is Scott. So as you pointed out, there's probably 8 or 9 that we call -- 8 or 9 trigger events that we call out on a regular basis, anywhere from ERP, the audit, to change the CFO, to moving into a different product arena, a different geography. But I would actually have to say that over the years, the ERP has been our strongest one. When somebody says, "Hey, I am going to go change my ERP," that's the time to go solve a problem that everybody knows that they have, right? If you're out there talking to controllers and CFOs, they all know that they've probably got some work to do in the sales tax arena, and they take that opportunity of an ERP change or financial application change, POS change, whatever it is, business application change in order to do that. Now having said that, I mean having gone through the 2008 and 2009, sort of downturn that we had, we learned that probably the best trigger of them all is uncertainty. Our biggest competitor is status quo. And when they are forced with having to look at ROI decisions, efficiency decisions, this is what brings them to the fore. So I can actually make the case with the COVID environment, right, the one that we are in right now, where people are having to look at all of their inefficiencies or looking at efficiency measures in order to help the business, this is one of the strongest triggers that are out there.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [4]

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Great. And maybe just if I could ask one more. And apologies if I missed it in the prepared remarks, but just wondering if you called out what percent of customers are actually trading down to a lower-tier because of significant pressure on revenue. I know gross revenue churn, sounded like it was very strong at south of 4%. But just curious if you'd call it out the impact of that.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [5]

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We did -- I didn't call it out specifically, although that we're not seeing a meaningful change and anybody downgrading at this moment in time.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [6]

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Yes. And Chris, it's Ross. When we look at our transaction volumes, we see -- the base is very stable. We see volumes that are up. We see volumes that are down. But what Scott did say was when you look at those that are more meaningfully up versus those that are more meaningfully down on a dollar basis, they're offsetting each other. So on a dollar basis, the ones that are up are about equal to the ones that are declining.

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Operator [7]

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Your next question comes from Sterling Auty from JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [8]

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I apologize I've been bouncing between calls, so if you did cover this. But I'm curious in terms of when we look at some of the exposure to some of the smaller companies, so through the Wix, the BigCommerce, et cetera, what are you experiencing with that end of the spectrum? And is that a meaningful amount of revenue? So if you see variability, is it really going to move the needle much anyway?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [9]

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Well, I'll give you an overview, and then Ross can fill in some of the details, Sterling. But -- so that segment has not been a big sort of revenue area for us. It's been a big strategic area for us because if you recall, we sort of did our land and expand in the mid-market and then have been opportunistic upmarket. But down market, we wanted to protect ourselves through the big aggregators. And so we've done big volume deals in those areas with those customers. And then we'll be working overtime to monetize those relationships even more than we are today. But from an overall perspective, it does not have a meaningful impact on the business if that were to go south. Interestingly though, we're seeing a lot of businesses, I mean, small businesses actually want our services and are thinking about doing it because it's so -- of the efficiency -- the efficiency aspect of it. So there's a good and bad tail to that end of the market.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [10]

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Yes. And Sterling, how are you doing? Hope you are well. I would just add one thing to that. I think there's kind of 2 questions in there. One is on the commerce side, I think it's a great opportunity for us. And as COVID causes more of an acceleration to commerce, we stand to benefit from that, so that's a positive. I think the other part of your question was just small business exposure. And there's a few ways we think about it. I mean the core -- we said on the call, our 2019 average core customer revenue, which is 80% to 85% of our total revenue. The average is $30,000. So it skewed a little high from commerce and marketplace customers that are bigger, but it's still -- even when you net that out, that average, revenue from core customers is a pretty sizable number that doesn't look like something that comes from a small business. And then the other thing I would say is, when you think about just our gross churn, which we said is meaningfully below -- our gross dollar churn is meaningfully below 4%. When you just think about that and you think about, well, software companies that only serve small businesses have monthly churn that looks a lot like our annual churn. And so you say, well, why is that and why isn't ours higher? And I think that suggests that either we have fewer of those classic small businesses or the dollar contribution from them is just pretty insignificant with respect to our dollar churn. So that's a little more color on the composition.

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Operator [11]

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Your next question comes from Brad Sills from Bank of America Securities.

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Bradley Hartwell Sills, BofA Merrill Lynch, Research Division - VP [12]

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I wanted to ask a question about the comments earlier on the migration to the new platform for compliance. It sounds like that could be a catalyst for communications and excise tax, new categories. Could you just provide a little color on where you are in those 2 and how this new platform might enable that?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [13]

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Brad, Scott. I'm very excited about that move. I mean -- and I'm really proud of the team. I mean we've been working on this for a couple of years and we've been -- we had our new customers all going on the new platform. But to get everybody over to it, we had to make -- you have to make sure all of the features and everything is working properly. And so over the last 9 months, we've been migrating thousands of customers over to this new platform, and it's allowing us to deprecate one of the platforms that we've had for a while. So the efficiency of just going to 1 single platform that allows you to better service your customers, to help them onboard, to help our agents respond to customers and work with them easier. I mean it's just a great benefit for everybody. And then as you suggest, there are areas that we can use to drive more business better through a single, more sophisticated platform. So we're really excited about that. And it's something that I'm really proud of the team for getting done under the circumstances because they did the final migration of some of the biggest and toughest and many of the customers during the COVID crisis.

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Bradley Hartwell Sills, BofA Merrill Lynch, Research Division - VP [14]

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And then I wanted to ask about the comments made earlier on funnel improvement towards the latter part of April. Are you assuming if that is the case that reflected in your guidance that, that sustains? Or are you assuming more of kind of the environment that you saw prior on gross adds?

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [15]

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Yes, Brad... Go ahead, Scott.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [16]

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No, go ahead, Ross. Go on.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [17]

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I was going to say, March. We had some commentary around -- March was impacted as we hit COVID and April looked a lot like March. There were some improvements on the bookings side in some of the subcategories of bookings. And then we saw when we look at the overall opportunity funnel, we saw a nice improvement in April. And in the first week of May, we continue to see that hanging in there. So I would say we're being very cautious. We're not ready to call that a trend. They are just some observations we want to share that we're seeing some improvements. And so when we think about the guidance, as I mentioned on the prepared remarks, Q2, we see as being the most impaired. We kind of modeled several scenarios, and we're looking at something that's more like a U shape. So Q2 most impaired some improvement in Q3. And then, more broadly, opening up in Q4.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [18]

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I'll add quickly, Brad. I read real quickly to this. The -- when we saw the COVID crisis developing, having been through 2008 and '09, personally, and knowing what the message was, I got together with the team, and we rapidly switched to an ROI efficiency message. And the team responded really, really well to develop lots of digital assets, lots of things that we can do to drive business. And it took us that month of March to switch over. And I think April, May and June will prove out that they've done a pretty good job of making that transition. And the number of people we have coming to our webinars are at an all-time record, as you might expect. But it really is -- the new message really is driving new opportunities. So we're very hopeful that, that will continue throughout the year.

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Operator [19]

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Your next question comes from Pat Walravens from JMP Securities.

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Joseph P. Goodwin, JMP Securities LLC, Research Division - Analyst [20]

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This is Joey on for Pat. I was wondering if you could talk about the opportunity you see with marketplaces. And then how are you guys thinking about M&A at this time?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [21]

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Well, again, I'll start out, and Ross can jump in on the marketplaces, and then we'll go to M&A. But look, I mean this is -- we really believe in the marketplace in e-commerce. And I guess, I want to remind everybody, when we think about this space, I think of it a lot like how we got involved in the ERPs in the beginning. You get into the ERPs, you win those -- that business, you secure those partners as loyal partners to yourselves and then you work with them to develop and monetize those relationships. So for the last couple of years, we've been really focused on how we are working with the big aggregators in e-commerce and marketplaces, like Shopify, BigCommerce, Wix. And that's exactly what we've been doing. And coming along, I mean, seeing COVID, I mean what -- I mean, nobody saw that happening and just the demand that is being generated in that area right now and the number of transactions and the increases that people are having is really quite amazing. And we've been working with them to solidify our relationships to help them take advantage of the opportunity now, but it really is one of those kinds of things where you're just strategically getting them in place, making sure that it's all working and working with them, so you become a trusted partner and this will monetize itself over time. But no doubt, marketplaces are a strong driver in the market today. Ross, you want to jump in on that one?

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [22]

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Yes. No, I think it's great. I mean, it's a great opportunity. We've spent the last couple of years really developing these relationships with the important commerce platforms, marketplaces. We've expanded the team in 2019 to focus on those efforts and it's a really great long-term opportunity, and it's tied to what we think will be an acceleration of adoption of e-commerce given COVID. So we're excited about the opportunities. I would say the intensity of conversations in Q1 and then in April were very, very encouraging. Two-way conversations on where we can be helpful. But what I would say is this is a long-term game. This is a long-term opportunity for us that will play out. We're not a GMV model. We like to say we're lower beta. So in tough times, the base holds in and the good stuff will play out over the years. But we're not a GMV model where the revenue shows up immediately or goes away immediately. So as we have successes and growth out of the segment, it will come over time, but it's not -- don't look for it in Q2.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [23]

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Yes. What I have been really impressed with is that the number of strategic conversations that we're having. I mean, you could expect it could go either way, right? But for us, it really has been a big time when we are talking to lots of different players now, lots of marketplaces, lots of e-commerce businesses. And as I said in my prepared remarks, I think that we'll start announcing some of those things in the months and quarters to come. So it really is a good area for us.

And now for M&A, I mean, we're an acquisitive company, and we've had areas that we wanted to look at. We're always evaluating things on a build-and-buy process, build by partner. But we've got our -- we have identified some targets that we would like to look deeper at in the coming months and quarters. So we're going to continue to lean in when it comes to acquisitions.

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Operator [24]

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Your next question comes from Scott Berg from Needham.

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Joshua Christopher Reilly, Needham & Company, LLC, Research Division - Associate [25]

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This is Josh on for Scott. On the partner side, just curious, how impacted is ERP change events versus some of the other partner groups out there in generating leads? And have you seen any improvements specifically with ERP in the last few weeks? I know you touched on this a bit, but just wanted to get some more color.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [26]

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Yes. I mean, great question. And I think it goes to sort of the heart of Avalara and our partner model. I mean, interestingly -- and when everybody talks about ERPs, there -- I mean I think, people just assume that it's new business, right? I mean they're really -- it really boils down into 2 segments. You have new business, of which there's not just a lot of new ERPs in the United States that are being sold on an annual basis, and less so in a crisis like we're dealing with here. But the real part of the market that we're dealing with our ERP customers is working with them with those that have already, what we call, existing customers, right? Existing customers in the micro in the Dynamics world, the Sage world, the Epicor world. So we're working with those companies through our partner channel, our team of SAM, strategic account managers, we work with them in order to come up with programs that are driving their customers to implement a more efficient way to do sales tax or use tax. So it really is a moment where we can stop and focus on the existing customer bases of the ERPs, which is really a target-rich environment and drive that efficiency message.

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Joshua Christopher Reilly, Needham & Company, LLC, Research Division - Associate [27]

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Okay, great. And then just a follow-up. Given the shift in demand for some items, are you finding any products where you didn't have tax content built out previously, but are surging now at customers and you're redirecting the team to build that?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [28]

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That's a good question. That's a good question. I'd encourage everybody to go look at our blog on our website about some of the interesting things that we've seen around the COVID crisis. Survival goods are on the rise, right? Lots of things that you would expect. But we did have all that content. I've not heard of an area where it's just really off the charts that we did not have content for, but I'll have to go back and check on that one because I haven't heard that one.

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Operator [29]

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Your next question comes from DJ Hynes from Canaccord.

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Lucas Lincoln Morison, Canaccord Genuity Corp., Research Division - Associate [30]

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This is Luke on for DJ. So I was wondering, are there differences in the profiles of customers you're adding today versus pre-COVID? And that is, as in are they concentrated in certain verticals? Or are you seeing differences in geographies? And then also, are there discernible changes in the types of trigger events that are driving new bookings today and over the last couple of months that you've been able to identify?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [31]

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I have -- we have not noticed any discernible change in the kind of customers that we're getting. We hear this all the time. Some really large deals that we deal with, and they're like, no, this is a problem for us. We've got to step up. We've got to make it -- we've got to get this done regardless of what's going on. And we don't see it -- our customers coming in, in any different area or lack of an area, whether it be New York or Louisiana or Arkansas, some of the things that -- places that are hit harder. We haven't seen a meaningful change in the way customers are approaching us or buying the product. If anything, we see somebody says, "Hey, I can't make a decision this month. I want to push it off to another month." I mean, we see some of that. But for the most part, it really is business as usual, although the way we're talking to them around efficiency and ROI is different.

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Operator [32]

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Our next question comes from Brian Peterson from Raymond James.

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Alexander James Sklar, Raymond James & Associates, Inc., Research Division - Senior Research Associate [33]

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This is Alex Sklar on for Brian. Ross, I know you mentioned being more measured on hiring, but are there any -- have there been any other shifts in terms of the buckets you plan to invest in this year, whether it be international or product development, automation? Or is it just business as usual outside of the hiring?

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [34]

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It's largely business as usual. What I would say is, in early March, we went through all of the headcount. I mean we're fortunate as a high-growth tech company that we can slow our hiring to manage expenses. And we went through all the headcount across the whole company, and we looked at areas where we can slow hiring and take some costs out of Q2, and we're evaluating on a weekly basis as everything evolves in a very fluid dynamic situation, how we want to modulate hiring. So we got our fingers on the dials of the hiring pace. What I would say is that we still look at continuing our investments in product and engineering. We have a really attractive roadmap for delivery of some really exciting products this year, and we'll talk more about them on Analyst Day in June. But we've got some exciting products that are for long-term growth and for efficiency drivers. And so we really are doing great there, and we want to continue making those investments. So while we are slowing all areas of the business and the hiring, I think we'll be more normal in the R&D side. Sales and marketing, the good news is, as we commented on prior calls, we felt we were a little bit behind in our sales and marketing capacity as we exited 2019. So in Q4, we were ramping our capacity and that continued in January, so we got a lot of that behind us. And so we've modulated that further as COVID hit and we'll continue to look at that. And then on G&A, I think we did have some unexpected expenses in Q1, and I think we can get some leverage in there. So pretty much business as usual, but a little additional color right there.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [35]

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And probably -- we probably won't be quite as aggressive to expand internationally, this year. We'll just probably hunker down and focus on EMEA, Lat Am, and a little bit of growth in India. But we'll probably tone it down a little bit internationally.

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Alexander James Sklar, Raymond James & Associates, Inc., Research Division - Senior Research Associate [36]

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Got it. Scott, one other question for you. One of the things we've heard consistently is that handling of paper-based documentation has been one of the biggest challenges during the work-from-home environment. Have you seen any uptick in demand for some of your digitization products like CertCapture?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [37]

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You mean -- not as of yet, but we do believe that, that is a big tailwind for the business, right? I mean, the realization of what you have to do at home in something like this really is driving people to really contemplate how can I go online? How can we use a cloud-based product? We did see some -- one of our largest CertCapture deals that we've ever had happened in Q1. So people are looking at it. It is 1 of our top 3 product lines, but I haven't seen a huge switch to that in the last 45 days.

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Operator [38]

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Your next question comes from Brent Bracelin from Piper Sandler.

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Brent Alan Bracelin, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [39]

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A couple of questions here from me. Scott, maybe we'll start with you. Obviously, there's going to be some new EU VAT rules that go into effect here in January of 2021. I know Europe is small, international is small, but walk us through the opportunity you see as those rules go into place? Is that kind of a nice to have? Or can that be a change agent to accelerate growth in Europe? And then a couple more follow-ups.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [40]

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I mean it's a really good question. I mean, look, all that's going on in Europe and around the world, for that matter, is really -- I mean, playing into our strength and driving the business, right? The Brexit rules, all of the different -- all of different VAT changes that are happening, I mean, are certainly a tailwind for us. There's no -- I mean there's no question about that. And that's why we're sort of doubling down and investing in that area. And we're looking at other ways to be able to deal with the digitization and the like in EMEA. So I would say, yes, it will. But COVID has put a dampening effect on international for -- because it's just been so widespread there, hit really hard. So I mean nobody is really pushing a lot of the initiatives that we're driving things, and we'll see how it all -- we'll see how it all settles out. But for right now, we know it's a tailwind. We know it will be a driver of the business. One of the interesting things about that is that unlike sales tax, which is state, I mean, that is a federal tax. And so they're using that as a way to soften the blows and do some of the different things. So it's a political hot potato. And I think it will have to fall out in the coming quarters. We'll see how the fall out happens.

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Brent Alan Bracelin, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [41]

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Helpful color there. And then I guess, shifting to you, Ross. As you look at your customer base, 12,000 customers, there's a mix of those customers that are kind of offline, online, multichannel. We're clearly seeing acceleration to kind of the online opportunities. And I'm just wondering, where are you at in pivoting your go-to-market efforts to target more of the online businesses? And how quickly can you kind of pivot to capture what looks like a pretty sharp acceleration here that we're seeing at some of the other platforms out there? I get your marketplace partners, but are there things you can do to drive more opportunities top of funnel, specifically with some of the online activities happening now.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [42]

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Yes. I mean, to me, that hasn't really changed. We've been at that game for a while now. We said on the call, about 50% of our transaction volume comes from e-commerce. So this could be pure e-commerce or this could be the evolution of storefronts that have migrated in the mix models. And so we see that across our base. And I think as Scott talked about, it's not just marketplaces but also the commerce platform partners or the businesses that are doing it on their own, just doing commerce on their own. That's been a big growth area for our business in the past. It's something that is woven into the top track of our go-to-market model. And we have many customers that are pure commerce or mix model. And I think as we talked about before, we really laid the groundwork over the last couple of years of getting the partners and putting ourselves in the position to establish ourselves as a leader. And I think when you look at our platform and the ability to have sales tax, compliance, cross-border, international exemptions to be were coming in this multi-platform -- multiproduct platform company. And so in working with these customers that are inherently global as they become e-commerce and they have varying needs across the tax compliance journey. I just find that we're shining in our ability to deepen our partnerships and attract our customers. So again, it's a long-term opportunity, and I think we'll be advantaged by what I agree with what you said, which is the acceleration of the journey to e-commerce by potential customers out there.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [43]

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We saw -- sorry, we saw one of the most interesting things. We had a customer come here just recently. I mean it's very, very fast. A household name that we all know would know. I mean they've been selling almost exclusively retail in malls and stores all over. And in the 115 years, they've never sold any other way than that. And with our -- one of our partners, one of our new -- relatively new partners, Tulip retail. That's who they had selected, and they were using Avalara. We got them up and going and selling in just like record time. But it's a big brand, never gone online, and we do see business like that driving our way.

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Brent Alan Bracelin, Piper Sandler & Co., Research Division - MD & Senior Research Analyst [44]

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Very encouraging. Ross, really around the go-to-market -- or excuse me, the pro services business, you talked about kind of billings being pretty good in January, February, and then obviously, a step down. Obviously, part of that step down in billings, you talked about being tied to pro services, so what was the linearity of pro services? Are you pivoting more to a virtual implementation? Just trying to understand the drivers of pro services, the run rate kind of in margin, what it implies for Q2?

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [45]

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Yes. Good question. PS, I think one important thing about PS, first of all, we definitely saw an impact starting in February from some international PS and then meaningfully in March, including in the U.S. and our global PS business. And so that hit. And then we're looking at, I think PS grew 92% year-over-year in Q1 '19. So we're kind of facing that year-over-year comparison, which was difficult. But I think the important part that I want people to understand is that we don't view PS as a good leading indicator for our subscription business. What's most important in that business is that we continue to sell and add-on products -- expanding our existing customers and add on products to our existing customers, and we land new customers and take them live. And when we look at our go-lives in March, it was down from January and Feb, but it was at or above many of the months in 2019. And then in April, it was above March.

And so we're still doing a good job of bringing in customers and taking them live, and that's really what drives subscription. And so in PS, to give you a little more color, that PS is really comprised of things like nexus studies and voluntary disclosure agreements and registrations and even like customs brokerage support services. And so a little of the PS revenue for the core high velocity business comes from implementation. So the services are all very valuable to our customers. But I think right now, they're focused on their business, and they just want to get this tax headache, which I think has become more complex and it's going to continue to be more complex. They just want to get the taxes calculated and the returns filed and the payments made. And the other things, dealing with doc filings of EDA, I think they can put that on pause and come back to that later. And so that's the majority of the PS services, and that's, I think, where we see the impact. And in the guide, we've kind of given some color that we see it being flattish for the year. It's just difficult to see how -- when that comes back, and we had a strong year in the first half of the year. Last year, I think we did 52% growth year-over-year in Q2 '19 as well. But I think the important point is we don't look at it as a leading indicator of the subscription business.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [46]

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And I just want to point out to everybody on the call that it's -- we're very conflicted when it comes to Professional services because we do not want to be in competition with our partners. The people, who are bringing us business and doing the implementations, so we walk a very fine line in what we're doing with, how much we grow that business and how much we involve the partners. And we always want to be partner first.

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Operator [47]

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(Operator Instructions) Your next question will come from Matt Stotler from William Blair.

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Matthew Alan Stotler, William Blair & Company L.L.C., Research Division - Analyst [48]

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You've addressed most of them. Just a couple of quick ones for me. First of all, you talked about stable customer churn positive. It sounds like downgrades are pretty benign at this point. But outside of the kind of structured downgrades that you're seeing, are you seeing any requests from customers for flexibility in billings terms or ACV relief or anything like that?

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [49]

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Yes. We have seen customers ask for extended payment terms. So can we pay net-90 instead of net-45. We've seen some of that. It's -- we've seen elongation in our day sales outstanding, but it's a few million dollars. It's nothing too concerning at this point. And we haven't -- on the pricing side, really, customers haven't been as focused on increasing discounts for new sales, but they've been more interested in cash relief. And so I think that manifests itself in maybe giving them a net-90 or something longer. And also, we have seen some customers request instead of paying annual advance, can they pay quarterly or monthly. So we are getting some of those requests. It's not a significant portion yet, but I expect we'll see more of that.

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Matthew Alan Stotler, William Blair & Company L.L.C., Research Division - Analyst [50]

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Right. Okay. That's helpful. And then the second one, just from a higher level. Obviously, you guys have over the past decade or so, built this massive library of content. You've expanded that both organically and through acquisitions. I was wondering, looking forward, what kind of priorities you have in terms of continuing to expand content and capabilities, whether that's geographically or in terms of different types of tax coverage?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [51]

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Yes. I mean, Ross actually addressed this when we talked a little bit about where we are going to take our investments going forward. And we've really tried really hard to protect in what we're doing around content, around development, R&D. So we can drive the new products that we're bringing out the efficiencies. And content is just one of those. And we've got, I think, a very strong roadmap around the content that we want to deliver to fill in holes in the U.S. and what we need to do internationally as well, and in particular, EMEA and Brazil. So we're going to stay on that game plan and fill in the holes that we've had. I've been saying all the way along the line, we don't have all the content that we need in the U.S., and we're going to continue to be relentless in making that happen either through our own efforts, through the index acquisition as we can start to point that AI service to get that done and as well as acquisitions when they come up. So I mean, we're going to be relentless in driving that forward.

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Operator [52]

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Your next question comes from Siti Panigrahi from Mizuho.

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Sitikantha Panigrahi, Mizuho Securities USA LLC, Research Division - MD [53]

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Glad to hear you guys doing well. Most of my questions were asked. Just a quick question. You talked about revised guidance lower. I'm just wondering where do you see the impact more between your calculation business versus compliance. You guys talked about the business model. Just wondering where the -- where you expect more impact.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [54]

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Yes. I mean I think, one, when we think about sort of roughly half of the subscription business is compliance, and so that's not really tied to transaction volume or anything like that. So we feel very well insulated. And then we've talked about how the other half is calculation. And we feel reasonably well insulated there because of how our pricing model, where we price in wide bands and so customers have to be meaningfully impaired and then have to -- meaningfully impaired to downgrade and in the way the pricing model is built. They're pretty wide, so it's hard to get downgraded. And then the impact on revenue to us is less than the impact of transaction volume. So there's really good reasons why we're insulated across the board. And as we talked about our churn and downgrades, that is looking good so far. Not sure how it will play out going forward. But so far, the base is really stable and the metrics look good.

When we think about guidance for 2020, I'd say we focused on 3 things, right. We modeled a few scenarios, V Shape, U Shape, L Shape. We kind of zeroed in on the U Shape. As we modeled those scenarios, we were able to get the boundaries high and low on what revenue can look like for the year, and we're able to get comfortable around those boundaries. And the 3 areas we looked at was just sort of that shape of the curve and how it will affect new bookings. And so Q2 being the hardest hit and then Q3 improving from there and Q4 opening up more broadly. And then the second part is churn. As I commented, it's just what do we think about churn. In March, it was good. April was on par with March. So far, we're really seeing a stable resilient base. It could uptick. We did model and assume some uptick. We expect it would. But so far, it's been holding in nicely. And then the third one is we've got a bunch of new products coming out this year. And some of them, we had projections for revenue in the back half of the year. We're still going to launch those products, and we still are going to focus on getting revenue from those products. But I think in this environment, that could dampen our expectations. It has dampened our expectations for what we expect out of those products. So kind of those 3 things and the scenario model I talked about is how we got our arms around the guidance.

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Operator [55]

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Your last question comes from Daniel Jester from Citi.

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Daniel William Jester, Citigroup Inc, Research Division - VP [56]

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Two really quick ones. First, on the growth opportunities. You talked about this a little bit earlier about being opportunistic going upmarket. I guess, how does that rank in your growth priorities given that going upmarket might be a little bit of a higher touch sale, which could be a little more difficult in the current environment? So that's the first question. And then the second question is, when state and local jurisdictions change up sort of the filing dates, does that -- how does that impact you, especially for the customers that aren't on a subscription for tax returns? Does that shift to revenue? Does that add any incremental costs on your side? Any insight there would be great.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [57]

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I'll take the -- Ross, do you want to take the last question first, and then we'll deal with the other one. Go ahead.

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Ross Tennenbaum, Avalara, Inc. - CFO & Treasurer [58]

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Yes. So we've -- we're monitoring and cataloging the changes that jurisdictions are making, allowing our customers to delay -- in some cases, you can delay your payment, but you have to file; some cases, you can delay filing as well. But what I would say is over the past few years, we've really moved the compliance business to mostly annual subscriptions paid upfront. And so the returns revenue is recognized ratably. There still are somewhat I call pay-as-you-file, so as we file, we bill and recognize the revenue. But it's become really the significant majority -- I mean, minority of compliance. So most of it is annual, recognized ratably. And so we could see that small minority. If you file a little later, it might shift some revenue, but we don't see that as a really meaningful impact into revenue.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [59]

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Daniel, can you repeat the first question?

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Daniel William Jester, Citigroup Inc, Research Division - VP [60]

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Sure. Just on going upmarket, it feels like in this kind of environment, it might be a little bit of a difficult high-touch sale. Kind of where does that rank in your priorities right now?

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [61]

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I mean, look at -- I mean, we're going to continue to be opportunistic in the enterprise space. I mean -- and when I say opportunistic, the thing that I really mean about opportunistic is that we don't change our sales motion. We don't -- the way we go after the upper end of the mid-market is the same way we go against an upmarket into the enterprise space. So for us, there really is no change in sales motion. And we're going to be as aggressive of doing those opportunistic changes -- I mean, opportunistic deals as we possibly can, and we do quite a number of those every quarter. What I would say is we're in the -- we're just in the process of having a limited availability of our custom rules. And that's really the biggest element that I've talked about in the past that we need to have as a feature in order to really go upmarket. And we've been driving towards getting that release and bringing that out over the coming quarters. And so yes, we have our sight set on continuing to be opportunistic and moving up. And hopefully, it will coincide with the loosening of all of the COVID issues. So yes, it could be really good timing for us.

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Operator [62]

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We have no further questions. I would like to turn the call back over to Scott McFarlane, Co-Founder and CEO, for closing remarks.

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Scott M. McFarlane, Avalara, Inc. - Co-Founder, Chairman & CEO [63]

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I want to close by saying thank you to Ross and congratulations on his first earnings call with Avalara and to all the employees for your adaptability, and to our customers and partners for your trust. We will navigate the coming months together, and I'm confident that Avalara will emerge from this crisis stronger as a team and as a valued technology to our customers and partners. Thank you all for your interest in Avalara, and we look forward to talking to you on the next call. Thank you very much.

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Operator [64]

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Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.