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Small-Cap Confidential
Undiscovered stocks that can make you rich

August 6, 2021

Avalara (AVLR) shares are rising today after the company beat expectations and gave a solid outlook for the rest of the year. Maintaining at buy.

Avalara (AVLR), Arena (ARNA) and Q2 Holdings (QTWO) Report
Avalara (AVLR) shares are rising today after the company beat expectations and gave a solid outlook for the rest of the year. Maintaining at buy.

Details: Q2 revenue rose 45.2% to $169.1 million (beating by $14.9 million) while adjusted EPS of $0.02 beat by $0.12. Full-year guidance of $672 - $676 million was increased by $22 million and is ahead of $652.5 million consensus. Billings growth accelerated by 1% to 38%, not a huge beat but very solid, especially when considering net revenue retention jumped from 113% to 116% (i.e. customers are growing their spend with Avalara). Demand is being driven by both new and existing customers, international markets and significant cross-selling across the growing product portfolio (VAT, business licenses, etc.). More new solutions are on the way with things like e-Invoicing 1099, W-9, property tax and more.

Trends are good here and there’s potential for management to exceed rising expectations, which currently call for 35% revenue growth this year and 25% to 26% in 2022 and 2023. Notably, Avalara also has potential to turn adjusted EPS profitable in 2022. I like it. BUY

Q2 Holdings (QTWO) is down after reporting Wednesday that revenue grew 26.5% to $123.5 million (beating by $800K) and that adjusted EPS of $0.09 beat by $0.01. I saw some media outlets misreport the EPS number, which implied an EPS miss. That was not the case. Management inched up full-year revenue guidance from $495 - $498 million to $497.5 - $499.5 million, which straddles consensus estimates. Bottom line, this stock will require patience, so moving to hold.

Big picture, the issue with this stock is that the company sells software to banks and this customer base delayed decision making during the pandemic. When deals are closed there is also an implementation timeline of around a year. So it’s not like a big bank signs a deal with Q2, clicks a few buttons to fire up the platform and then they’re off to the races. It’s just not that kind of software. What this means is that, because of the decision-making delays during Covid, there is a gap in Q2’s revenue growth trajectory. Whereas revenue grew by 31% in 2019 and by 28% in 2020, 2021 will likely bring revenue growth closer to 24%, followed by low-20% in 2022. Somewhat compounding this challenge is that gross margins are under pressure because a new banking-as-a-service solution is consistent with typical SAAS profit trajectories, which means low at first as costs are involved then improving over time as volumes pick up.

Add it all up and what we hear from management is that deal activity remains a little low but is getting better and should improve in the second half of this year, theoretically driving revenue growth in the second half of 2022. Management also believes that all the new products (built and acquired) added in recent years means Q2 is a much stronger company now than the last time a revenue gap occurred. This should mean a longer and stronger revenue ramp and share price gains once things turn. In short, investors will have to be patient but should be justly rewarded. When? The stock will start to move higher when deal flow picks up and before the revenue hits because investors familiar with Q2 will want to build positions ahead of the revenue ramp.

Conversely, if banks continue to delay decisions and Covid variants mess the world up again, shares will likely remain in a funk. Obviously, Q2 won’t be the only stock to suffer in that scenario.

We’ve stuck with QTWO for a while, and I’m inclined to continue to do so now. Ultimately, I expect to be compensated for our patience. That said, without more to go on right now I’m not champing at the bit to buy. Let’s move to hold and see how the next few weeks go. HOLD

Arena Pharmaceuticals (ARNA) is selling off today mainly because the timeline on a few studies has been pushed back. This is annoying, but the rationale for the delays are palatable and, big picture, nothing here changes the story. Like a lot of biotech stocks ARNA is more likely to jump (or fall) significantly when trial results are published. Given that we’re still expecting success on multiple fronts maintaining at buy for patient, risk-tolerant investors.

Details: The Phase 3 ELEVATE trial is still on target to deliver data in Q1 for both the 12-week and 52-week arms. This is the next big event and is one of the main reasons why we bought, and continue to hold, ARNA. Management is advancing pre-launch plans and is enrolling the GLADIATOR study to help gain data to help with payer access.

The Crohn’s Phase 2 (CULTIVATE) is being pushed back by two quarters, from the end of 2021 to Q2 2022, due to an increase in the patient population (from 50 to 70) and the strategic decision to capture more data to potentially allow a sub-study to transition to a registrational study. The upside is that this could slash the overall timeline of the program.

The data release data for the Phase 2 study for etrasimod in alopecia areata (AA) has also been pushed to Q2 2022 from end of 2021 to allow another dosing cohort to be added (3mg). If successful, this program could potentially transition directly into Phase 3.

Remember, a stock like this will bounce around on these news releases but it is gameday (trial data release) that really drives the action. BUY

Additional Thoughts

Yesterday Fiverr (FVRR) was crushed, and I moved to hold. Thinking through the situation I’m leaning toward thinking there are a lot of people on the platform (both buyers and sellers) that have raced out into the world to do whatever they can that’s not on a computer. How many of us does this describe? After all, Covid lockdowns stunk. This has been a summer to get out and do! But as is typical, people will gravitate back toward online activities in the fall and winter. I feel the sentiment toward Fiverr may be a little too bearish given the realities of the day. I’m not moving back to buy yet, but as we think about this stock over the next one- to-three-year timeframe I believe there’s a compelling case to be made for buying before the stock claws too high out of this trench. More to come later.