Vertex, Inc. (NASDAQ:VERX) Q1 2024 Earnings Call Transcript

Vertex, Inc. (NASDAQ:VERX) Q1 2024 Earnings Call Transcript May 8, 2024

Vertex, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to Vertex’s First Quarter 2024 Earnings Conference Call. Please note this conference is being recorded. At this time, all participants are in a listen-only mode. And now, I’ll turn the conference over to Joe Crivelli, Vice President of Investor Relations. Mr. Crivelli, you may now begin.

Joe Crivelli: Hello. And thanks for joining us to discuss Vertex’s first quarter financial results. I’m Joe Crivelli, Vice President, Investor Relations. David DeStefano, our President and CEO; and John Schwab, our CFO, are also with us today. During this call, we may make forward-looking statements about expected future results. Actual financial results may differ due to risks and uncertainties. These risks and uncertainties are described in our filings with the Securities and Exchange Commission. In our remarks today, we will also refer to non-GAAP financial metrics. A reconciliation of these metrics to GAAP is provided in today’s press release. This conference call is being recorded and will be available for replay on our Investor Relations website. I’ll now turn the call over to David.

David DeStefano: Thanks, Joe. Welcome everyone and thank you for joining us. 2024 is off to a very good start as shown in the first quarter results. Once again we exceeded the high end of our financial guidance for revenue and adjusted EBITDA. Our consistently solid performance is the result of being crystal clear on where we are going as a company and then being laser focused on executing our plans to get there. At Vertex, we have a bold vision to accelerate global commerce. To achieve this, we have built a consistent execution engine that continues to perform quarter-after-quarter. We deliver end-to-end capabilities for indirect tax to seamlessly connect systems, solutions and data. This unified approach empowers our customers to confidently navigate indirect tax complexity and manage their need for a continuous compliance process.

We’re able to support our customers throughout their entire digital transformation journey, wherever they run their business, locally, fully in the cloud, or somewhere in between. We provide value-added services that help them efficiently integrate their indirect tax into their infrastructure and stay in compliance. And behind the scenes, we have a world-class team dedicated to our customer success at every touchpoint. This is what enables us to keep delivering differentiated value to our customers and great results for investors. Revenue traction remains strong. Total revenue was up 18.1% in the first quarter and software subscription growth was 18.8%. In addition, cloud revenue growth was 28.3%, which is slightly ahead of our target for the full year.

Earnings leverage continues to build as expected. Adjusted EBITDA was $36.5 million, or 23.3% of revenue. This is up 80% from last year’s first quarter. I’ll also note that we delivered positive free cash flow in the first quarter, which is typically our lowest quarter of the year from a cash flow standpoint. This bodes well for cash production for the rest of the year. In addition, this quarter ARR was $525 million, up 17.5% year-over-year. NRR was 112%, up two full percentage points compared to last year’s first quarter. Average annual revenue per customer increased 17% year-over-year to $121,720. Scaled customer count which represents customers delivering annual revenue of over $100,000, grew 13% year-over-year and GRR was 95% in the first quarter, which falls within our targeted best-in-class range of 94% to 96%.

I’m incredibly proud that Vertex’s leadership in the indirect tax technology space was recognized by the financial markets last month when we raised $345 million of convertible debt that we can invest in our business. Convertible debt investors were extremely enthusiastic about Vertex, our business strategy and our growth prospects. They appreciate our consistent high-teens revenue growth as well as our ability to operate profitably and deliver positive adjusted EBITDA and free cash flow. This capital will enable us to be agile, proactive and decisive in seizing growth opportunities, whether through organic investments or acquisitions. Our financial flexibility and our balance sheet has never been stronger. Now, turning to notable wins in the quarter, our results confirm that the market for indirect tax software is underpenetrated and many companies are still handling their indirect tax needs with homegrown solutions.

As the persistent tailwinds of business expansion, regulatory pressures and digital transformations continue to pressure tax departments, we believe that the opportunity to deliver our tax solutions to the market will grow. I will highlight some key new logo wins which pays this off. In the first quarter, we won a mid six-figure deal with a global provider of power management solutions. This particular deal highlights two growth pillars for Vertex, the anticipated wave of ERP conversions that will happen as a result of SAP’s decision to end mainstream support for ECC in 2027, as well as the sales partnership we have built with the SAP direct sales force. In this case, the customer was migrating to S/4HANA as part of their digital transformation project.

This was a catalyst for them to evaluate indirect tax and determine it was time to replace their homegrown solution as they were previously manually updating rules and regulations in their purchasing system. As we have discussed, one of our growth investments was building a more tightly aligned partnership with SAP on the go-to-market front and we are seeing ongoing traction from this investment. This deal is an example of how that partnership is bringing new customers to Vertex, as we were referred in by the SAP sales team. In addition to the credibility boost that we enjoy in this case, the SAP referral enabled us to get an early look at the customer’s infrastructure and tailor our solution accordingly. Another new logo we won in the first quarter was a global risk management consulting firm that had grown through hundreds of acquisitions over the past several decades.

They were using a homegrown indirect tax calculation and compliance system, but recent audit pressure had made it clear that the company outgrew its old ways of doing things and needed a more sophisticated solution. Due to the acquisitions, the customer systems environment was extremely complex, which competitively gave us an advantage due to our experience connecting multiple platforms to a single tax solution. In this case, we integrated with multiple systems including Oracle, Workday, Salesforce and JD Edwards, as well as the customers’ homegrown billing systems. We had a great win in the quarter with a cloud native cybersecurity company. After being acquired, our customer underwent a transformation initiative to move their tax solution to the cloud.

Even though the new parent currently uses one of our competitors, our cloud solution was chosen because the team was familiar with our proven track record and we were able to meet their accelerated timeline. We also won a mid six-figure deal with a new customer as a manufacturer of industrial machinery. It’s another case where S/4HANA transformation led the company to reevaluate how it was handling indirect tax. The company selected Vertex solutions for tax calculation as well as compliance and reporting solutions for both North America and Europe. They also licensed Vertex PLUS Tools for SAP and our certificate center. One of the biggest sources of new revenue for Vertex and a sustainable driver of NRR growth is increased business with our existing customers, the expand part of land and expand equation.

A customer in the consumer product space fueled our Q1 growth with a mid six-figure revenue addition. Their SAP infrastructure upgrade presented an ideal opportunity to move their Vertex solution to the cloud and expand entitlements by $15 billion. They also saw the value of our tax accelerator and Vertex PLUS Tools for SAP. While they evaluated competitive options as part of their process, our unmatched SAP expertise and solution set ultimately differentiated Vertex. Our unique capabilities delivered a lower total cost of implementation and ownership while minimizing risk. To further optimize their tax processes, our consulting team is collaborating with them to streamline current indirect tax calculations and compliance. Also in the first quarter, we expanded our relationship with a longtime customer in the medical diagnostics industry.

They advanced their corporate cloud strategy by migrating two of our legacy solutions to our modern cloud offering. This in turn consolidated their tax operations onto a single platform, seamlessly integrating with Salesforce Commerce Cloud, PeopleSoft and their internal billing systems. Other fundamental business changes such as M&A divestitures and adoption of new modes of commerce can also drive new business for Vertex. In the first quarter, we landed a new customer in the contract research industry that was being spun out by its parent. In this case, the company needed an indirect tax solution to pair with its implementation of Workday Financials. The Big Four accounting firm conducted an RFP and Vertex prevailed. Similarly, in the security industry, we want to deal with a company that was being sold to a private equity firm.

A customer selected Vertex for indirect tax to integrate Microsoft D365. Finally, on the international front, we had a nice win with a growing marketplace provider. When the customer first looked for an indirect tax solution, they went with a competitor. But over the course of their journey, things didn’t go well. They didn’t get the support they needed. Our competitor’s transaction based pricing model led to massive cost overruns. Ultimately, after 18 months of frustration, the customer changed direction and came back to Vertex. A quick word on how we are addressing e-invoicing. We remain committed to our strategy of delivering a continuous compliance solution, which provides for a single cloud portal to address the e-invoicing through to compliance process, of which e-invoicing is just one piece.

As we noted last quarter after we opted out of the bidding war in the near-term, we continue to utilize Pagero as a partner in alignment with our commercial agreement. However, we are also evaluating our options in developing partnerships with additional players in the space. We will have more to share on this in the coming quarters. As I look back on the strategic growth investments we made from 2020 through 2023 and how they are helping us better serve our customers, I am thrilled with our position in the market and the opportunity in front of us. Our product portfolio, tax content database, go-to-market expertise and scalable infrastructure has us well positioned for a nice run of revenue growth, increasing profitability and solid cash flow to reward our investors.

John will now take you through the financials. John?

John Schwab: Thanks, David and good morning, everyone. I’ll now review our first quarter financial results and provide guidance for the second quarter and full year of 2024. In the first quarter, revenue was $156.8 million, up 18.1% compared to last year’s first quarter and exceeding the upper end of our quarterly guidance. Subscription revenue increased 18.8% period over period to $131.8 million. Our services revenue grew at 14.8% to $25 million and cloud revenue was $61.8 million in the first quarter. This represents 28.3% year-over-year growth, which is slightly ahead of our guidance for the full year. Annual recurring revenue or ARR was $524.5 million at quarter end. This is up 17.5% year-over-year. Net revenue retention or NRR remains strong at 112%, up 2 full percentage points compared to last year.

Gross revenue retention or GRR was 95% at quarter end, within our targeted range of 94% to 96%. And our average annual revenue per customer or AARPC, which is based on our direct customer account was $121,720 in the first quarter of 2024, up from $118,910 in the fourth quarter of 2023. For the remainder of the income statement discussion I will be referring to non-GAAP metrics. All of these non-GAAP metrics are reconciled to GAAP results in the earnings press release that was issued this morning. Gross profit for the first quarter was $113.7 million and gross margin was 72.5%. This compares with gross profit of $95.3 million and a 71.8% gross margin in the same period last year. Gross margin on our subscription revenue was 78.6% compared to 78.4% in last year’s first quarter and 76.8% in the fourth quarter of 2023.

Gross margin on services revenue was 40.5% compared to 37.9% in last year’s first quarter and 38.2% in the fourth quarter of 2023. Turning to operating expenses. In the first quarter, research and development expense was $13.5 million compared to $13.6 million last year. With capitalized software spend included R&D expense was $28.8 million for the first quarter, which represents 18.4% of revenue as compared to 17.9% of revenue in the prior year period. Selling and marketing expense was $35.7 million or 22.8% of total revenues, an increase of $3.6 million and approximately 11.2% from the prior year period. And our general and administrative expense was $27.6 million, down $1.7 million from last year. Adjusted EBITDA was $36.7 million, an increase of $16.5 million or 82% year-over-year and exceeding our quarterly guidance.

As we noted in April when we launched our convertible debt offering, approximately $2 million of the adjusted EBITDA outperformance was driven by expenses that were delayed from the first quarter to future quarters in 2024 and another $2 million was driven by higher percentage of capitalized R&D costs compared to expensed R&D costs in the first quarter. But even excluding these items, adjusted EBITDA would have exceeded the high end of our first quarter guidance. We saw a positive year-over-year improvement in cash flow. Our operating cash flow was $24.6 million in the first quarter, a $21.1 million improvement compared to last year’s first quarter. And free cash flow was a positive $4.5 million in the first quarter compared to a negative free cash flow of $10.6 million in last year’s first quarter.

Normally, our cash flows in the first quarter are seasonally lower than they are in the remaining calendar quarters due to annual bonus payments, payroll taxes and sales and marketing expenses that are typically elevated to start the New Year. We are encouraged by the performance and anticipate that our free cash flow will follow our standard seasonality trends. We ended the first quarter with $56.1 million in unrestricted cash and cash equivalents. Our total bank debt was $46.3 million and investment securities totaled $9.1 million. I’ll note that with the proceeds of our convertible debt offering, our cash and investment balances now stand at approximately $350 million. For additional liquidity, we also have $200 million of unused availability under our existing line of credit.

And now turning to guidance. For the second quarter of 2024, we expect total revenue in the range of $159 million to $162 million, which would represent a solid 15% year-over-year growth at the midpoint and adjusted EBITDA in the range of $31 million to $33 million at the midpoint would represent an increase of approximately $10 million or 45% over the prior year. This would also represent our third quarter in a row with adjusted EBITDA margins over 20% and will fuel ongoing cash flow improvement to further strengthen our balance sheet. As in the past years, we have not changed our full year guidance based on our first quarter results and accordingly, for the full year, we continue to expect total revenue in the range of $650 million to $660 million, representing annual revenue growth of 14% at the midpoint.

Adjusted EBITDA in the range of $130 million to $135 million, representing an increase of $32 million at the midpoint and we believe that cloud growth will accelerate to approximately 28% in 2024. We expect to reevaluate our full year guidance in August when we announce our second quarter results. David will now make some closing comments before we open up for Q&A. David?

David DeStefano: Thanks, John. I want to reiterate that I’m very pleased with our performance in the first quarter. Vertex went public in mid-2020, and we have now been a public company for 15 quarters. We are proud that during that time, our strong base of recurring revenue has enabled us to provide financial guidance that investors can depend on. The first quarter of 2024 was the 14th time we exceeded the high end of our revenue guidance and the 11th time we exceeded the high end of our adjusted EBITDA guidance, and this was achieved during a time when many other SaaS companies struggled. The growth investments we made from 2020 through 2023 are only helping us to build on that track record. Our customer success organization is now mature and driving great results with the expansion of existing customer accounts.

Our broader and deeper go-to-market team, including our fully developed partner channel are finding new opportunities for us to add customers in the largely underpenetrated enterprise space. And the new products we launched over the past several years are gaining traction, differentiating Vertex when we compete for new business. With those investments behind us, job one is execution. And with the world class team we have in place all throughout the organization, I’m confident we have our eye on the ball and can continue to deliver great results for shareholders again in 2024. With that operator, please go ahead and open the call for questions.

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Q&A Session

Operator: And we are going to start the Q&A session now. [Operator Instructions] Our first question comes from Chris Quintero from Morgan Stanley. Chris, please go ahead.

Chris Quintero: Great. Hey guys, thanks for taking the questions here. Maybe for you, David. I wanted to ask about the pipeline conversion rates within the SAP channel. You mentioned that you haven’t benefited yet from some of the ECC migration efforts that will occur over the next three years, and now you’ve got SAP recently with seemingly greater willingness to push those migrations through. So just curious what you’re seeing with that large pipeline bringing into closed deals here.

David DeStefano: Yes, sure, Chris. I think what we’re seeing is, which is pretty typical for other migrations we’ve seen over the years. The largest companies go first because they’ve got the longest timeline that they’re going to need to evolve their ERP infrastructure and smaller companies will continue to push for as long as they can delay before they’ll go and then there’ll be sort of a flood of activity and we’re really seeing that behavior play out.

Chris Quintero: Got it. That’s super helpful. And then for John, I wanted to ask about free cash flow conversion and how we should think about that for the rest of the year, given that Q1 is usually that low point that you mentioned. And then do you have any thoughts on, like the long-term conversion rate and if there are any blockers for you to get there?

John Schwab: Pardon me. Thanks, Chris for the question. Let me take the last one first. What we saw when we were before the investment cycle started, as we were coming public, our cash flow conversion rate was about 65% to 70% from adjusted EBIT – free cash flow was 60% to 75% of adjusted EBITDA. We expect that we’ll certainly get back there over some time. We did have a very good quarter, as you pointed out, in terms of our free cash flow. We would generate – a generator of free cash flow in the first quarter, which is the first time in the last four years that we’ve done that. So very good and very positive in terms of how that goes. We expect that that will continue to ramp through the period, but it’ll still take us a couple of years to get to that kind of that 65%, 70% conversion rate.

So again, we feel like we’ve made real good strides. The investment cycle is behind us. And as you can see from the results, the cash is going to start to come into the business very significantly.

Chris Quintero: Excellent. Thanks so much, guys. Congrats.

Operator: Our next question comes from Daniel Jester from BMO Capital. Daniel, please go ahead.

Daniel Jester: Great. Thanks for taking my question. Maybe you called out that your typical process is to not raise the full year guidance or adjust the full year guidance at this point of the year. Maybe you can just kind of compare and contrast the pipeline and your visibility today to other periods, so we can get a sense of your confidence level in 2024.

David DeStefano: Yes. Thanks, Dan. I think the pipeline remains solid. I think the progress we’re seeing in some of our other markets, like Microsoft, other ERP focused Microsoft Workday, NetSuite remains really positive with the rollout of our TCS solution to Microsoft. I’m seeing traction there that’s very encouraging. And then again, the SAP and Oracle stuff is a very consistent way for us. We’ve got really nice differentiated solutions in the SAP space. Our win rates remain really strong there, and I think that’s going to be a consistent one that gives us confidence as we look forward for the rest of the year.

Daniel Jester: Great. And then you touched on this briefly in the prepared remarks, so maybe we can expand a little bit more about how you’re viewing inorganic opportunities today, maybe the landscape that you see, kind of areas that you’re interested in. An update there would be great. Thank you.

David DeStefano: Yes, sure. We want to continue to be strategic in our thinking there and disciplined in our approach. Obviously, the new source of funding we’ve raised gives us additional flexibility to be assertive where we need to be. But we’re not going to lose sight of being thoughtful with shareholder capital. Obviously, opportunistically in certain areas that we’re focused on in our strategy, like e-invoicing, we continue to watch for opportunities here. The good news is we’ve had a number of good acceleration in partnership discussions there. So I’m feeling very confident in our overall solution in that space with flexibility if the right opportunity comes forward.

Daniel Jester: Great. Thank you very much.

Operator: And our next question comes from Joshua Reilly from Needham. Joshua, please go ahead.

Joshua Reilly: All right. Thanks for taking my questions. So you’ve come out with a number of new products over the last 12 to 18 months. I think it would be good to get an update on how much are these new products helping you with net new customer growth, any anecdotes on competitive wins? And the stronger NRR, how much year-over-year? I think it was 2 points. How much can you attribute to that the product innovations versus just the normal course of business?

David DeStefano: Yes. Sure, Josh. So, Josh, the track record in new product rollouts is pretty much proven out over time. We’ve been doing this for 45 years and we roll out new products, it all follows the same pattern. You typically need to get your early adopters, they need to go live with the product, you need to get reference ability and then you see sort of that tail. It takes a couple years to do that, and we’re seeing that progress. So the products we released a couple of years ago are starting to show more of an uptick. The ones we’ve released in the last 12 to 18 months are following that same pattern. So I think I’m encouraged by what the team has brought forward. Like the edge solution, some of the SAP tools and the SAP accelerator have really been nicely embraced by the market.

As for the NRR growth, which we’re really pleased because it’s already put us in a good position for as we go forward for the rest of the year relative to where we started NRR in 2023, I would say it’s really a combination. It’s a combination of some of the new offerings. And I do want to emphasize the customer success organization. We’ve really focused investment there and we’re seeing nice throughput from that team.