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Small-Cap Confidential
Undiscovered stocks that can make you rich

Cabot Small-Cap Confidential Special Bulletin

Three more portfolio stocks report good earnings.

Avalara (AVLR), Rapid7 (RPD) and Inspire (INSP) Weigh in. (Hint: all look good)

Avalara (AVLR) reported yesterday with a quarter that should get the stock moving in the right direction again. Revenue was up 41% to $98.5 million and beat by $5.4 million while adjusted EPS of -$0.01 beat by $0.08. Management also guided for full-year 2019 revenue of around $375 million, which is about $5 million ahead of consensus and implies 39% growth.

On the conference call, and the reason the stock is probably not up double digits today, management gave preliminary 2020 revenue growth guidance of around 25% and noted that it has tough comparison numbers in 2019 given the big outperformance this year. You may not recall, but in my original research report on AVLR back in February (just nine months ago) I stated that analysts were looking for 2019 growth of 19%. The company grew more than twice as fast!

Suffice to say, management is now trying to temper expectations and give room to beat. And many investors that aren’t aware of the real trends here aren’t digging deeper. That’s where we have an information edge. Avalara should surpass expectations next year by a wide margin and I think the stock will ultimately break out to new highs in 2020, implying at least 25% upside from here. There are no guarantees of course and my bullishness reflects improving sentiment toward growth stocks, and cloud software in particular, over the past two weeks. That could change. Nevertheless, taking it all in, AVLR is moving back to Buy today.

Big picture, management said that the international opportunity (under 10% of revenue today) remains huge and it will be doing a lot to broaden its offerings of cross-border solutions. When asked about competition, management basically said, yes, it’s out there, but nobody is remotely as well positioned as Avalara and it doesn’t see any major competitive threats in the near term. Typical management answer.

In terms of other initiatives, the big one is working with partners to try and broaden the scope of companies that Avalara can reach. And management talked about how crucial it is to work with marketplaces and platforms. Examples are its work with Amazon and Poshmark, among others, where many sellers come together and benefit from the tax compliance solutions Avalara delivers to the marketplace. I thought this was an interesting example because it shows how one marketplace deal can dramatically increase payment volume as compared to one more retailer, for example. Bottom line: I like this stock and think it’s going higher. BUY.

Rapid7 (RPD) also reported yesterday and results beat expectations on the top and bottom lines. Revenue was up 33% to $83.2 million, beating by $3 million, while adjusted EPS of $0.01 beat by $0.04. Management raised full-year revenue growth guidance to 32% to 33% (vs. 31% prior) and guided to full-year profitability from breakeven. We also saw average recurring revenue (ARR) jump by 43%, which suggests customers are still prioritizing spend on Rapid7’s core offerings around vulnerability management, analytics, app security and orchestration.

We’ve been watching to see if management can add new customers. With the sales team incentivized to do this very thing, they’ve been successful. Customer count goes to 8,600 from 7,400, a 17% increase. At the same time, average recurring revenue per customer goes up 22% to $36,000 showing that bigger customers/larger deals are being landed. There was a little slippage in net revenue retention given that salespeople aren’t as focused on retention, but we’ll give them a little leeway here (for now).

Stepping back, it seems that management is content to keep their foot on the gas to grow the business, which could mean profit margins are pressured in 2020. That said, we’ll just have to see what happens and this team has far exceeded expectations for several quarters now so we’re not going to assume they can’t pull it off. One concern is how the market will react should ARR growth decelerate in 2020, which wouldn’t be surprising given that the transition to subscriptions here is well underway and it will be hard to sustain 40%+ ARR growth through another year.

That said, Rapid7 has more products to offer now and as we’ve seen with other successful cloud software vendors, once you have happy customers and they see you have another module or two that can help them, it’s not hard to grow within the existing customer base.

In terms of the stock, for now I’m content to keep Rapid7 at Hold and see how shares digest the report. They’ve been a little wobbly over the last two days so in my view there’s no urgency to buy, or sell, this minute. HOLD.

Inspire Medical (INSP) reported after the bell yesterday and shares of the company, which sells an implantable device to treat obstructive sleep apnea (OSA), are trading up nicely today and will remain at buy. Revenue was up 60% to $20.9 million, beating by $1.7 million, while adjusted EPS of -$0.34 beat by $0.07. Management also increased full-year revenue guidance by roughly $5 million (way more than the $1.7 million beat) to $78.5 million (at the midpoint), implying 55% growth. Consensus is at $60 million. Management also said it now sees 15 to 17 new medical centers opened this year, versus 12 to 14 previously.

Breaking things down by region, U.S. was up by 60% while Europe was up 27% and now accounts for 10.5% of revenue. The average sales price in the U.S. went up $700 to $23,900, helped by the introduction of the new sensing lead, which hit the market in February. Average sales price in Europe went down $1,000, to $21,700, due to lower foreign currency exchange rates. Total gross margin goes to 83.4% from 81.1%.

Management talked about how things are getting a little easier now that it has more reimbursement and doesn’t need to lead patients through the appeals process. That opens the door to more direct-to-consumer and television sales efforts, which are being tested in six markets currently (versus three previously). Management was also asked about the increase in full-year guidance, which was bigger than the revenue beat. And the answer was that, again, commercial approvals, mainly with United Healthcare, is just greasing the wheels and making it easier to gain approvals at the first request, rather than after an appeals process. This takes the average time for approval down to just 25 days. That’s a big deal. Medicare approvals still take longer and this will be an initiative to work on in 2020.

The obvious question was asked by Wells Fargo analyst, Tim Hebert. He wondered, with growth accelerating now, why would growth conceivably slow in 2020? Management’s answer was that, essentially, it wants to put out conservative guidance that it feels confident in surpassing. Smart answer. Also, it does have some work to do with Medicare, and Anthem, a big commercial payer, isn’t yet onboard. There is also not yet a formal agreement in Japan on pricing, so that’s a potential upside growth driver.

Finally, Inspire isn’t yet approved for kids with Down syndrome. But management is working on it and the data looks good so far. Management would like to get the technology into the market in 2020 and plans to update us in Q1 2020. All in all, things look good and Inspire remains a Buy. BUY.