Vertex, Inc. (NASDAQ:VERX) Q3 2023 Earnings Call Transcript

Vertex, Inc. (NASDAQ:VERX) Q3 2023 Earnings Call Transcript November 9, 2023

Vertex, Inc. beats earnings expectations. Reported EPS is $0.1, expectations were $0.08.

Operator: Hello, good morning and greetings. Welcome to Vertex’s Third Quarter 2023 Earnings Conference Call. Please note this conference is being recorded. At this time, all participants are in listen-only mode. And at this time I will 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 third quarter financial results. I’m Joe Crivelli, Vice President, Investor Relations. David DeStefano, our President and CEO; and John Schwab our CFO, are on the call with us today. As a reminder, during this call, we may make forward-looking statements about expected future results. Our 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. Please note that our remarks today will also include references to non-GAAP financial measures. A reconciliation of these non-GAAP metrics to GAAP is also provided in today’s press release. This conference call is being recorded and will be available for replay via webcast 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. Once again in the third quarter Vertex delivered excellent financial results, driven by consistent strong execution. Revenue in the third quarter was $145 million, up 15% year-over-year. Adjusted EBITDA was $26.6 million, up 30% compared to last year’s third quarter. This represents an EBITDA margin of 18.4%. In addition, in the third quarter we delivered 18% year-over-year growth in ARR consistent GRR at a SaaS best-in-class level of 96%, NRR of 111% for the second quarter in a row. Average annual revenue per customer of nearly $113,000, up 16% year-over-year. And growth in scaled customer count, representing customers with annual revenues greater than $100,000, up 15% year-over-year for the fourth quarter in a row.

This reflects our ongoing success in the underpenetrated enterprise market. I’m very proud of these results which demonstrate the outstanding effort of our global teams and the pay-off of our multiyear growth investment that began in 2020 and largely wrapped up in the second quarter with the launch of our new ERP system. The result is continued strong revenue growth and now accelerating earnings leverage, something we expect to continue in the fourth quarter and beyond. By investing earnings back into the business over the past three years, we are now selling into new markets and have built a growth engine that we believe will propel us to $1 billion of revenue and beyond. In addition to modernizing our corporate infrastructure, our investment in additional R&D and strategic acquisitions allows us to bring new capabilities and products to market faster than ever.

The expansion of our go-to-market channels has enhanced our revenue opportunity with both new and existing customers. And while these investments impacted Vertex’s bottom line from mid-2020 through the first half of 2023, they have now positioned us for growth in the top line margins and shareholder value. I’m extremely confident in where we are as a company. Indirect tax remains the largest form of corporate tax worldwide. And with increasing governmental debt and more diverse forms of commerce, indirect tax is only becoming more complex for global businesses. As such, more and more enterprise and upper middle market companies need trusted solutions like those provided by Vertex. I’d like to now share notable wins from the third quarter that show how we are delivering solutions and a differentiated experience for our customers.

Let’s start with some key wins in the SAP ecosystem. We believe the SAP’s decision to move from ECC and encourage customers to move to S/4HANA by 2027 will provide a multiyear tailwind for Vertex. Several of our growth investments were focused on furthering our lead in the SAP ecosystem and we continue to accelerate momentum through our joint go-to-market efforts and the most differentiated solutions for SAP customers. This was evident in the sales process with a global pharmaceutical company. Our customer is consolidating multiple deployments of SAP ECC across its enterprise to a single global instance of S/4HANA. As part of this process the customer wanted to standardize how they handled indirect tax. Vertex won this eight-figure deal because of the array of tools we have introduced over the past several years to support the SAP platform including our industry-leading SAP Connector.

References from other customers gave this customer confidence in our ability to support their success. We also won a major piece of new business with a customer in the defense industry. This customer was also undergoing a massive multiyear move to S/4HANA and adding SAP Ariba for purchasing across the enterprise. As part of the process, the customer wanted to standardize on Vertex as they were operating with a mix of Vertex, homegrown and competitive solutions. All-in-all this represented a seven-figure revenue uplift over the life of the 5-year contract for Vertex. It’s interesting to note that as a defense contractor, the customer is subject to strict data sovereignty requirements that preclude the use of cloud in certain areas of its business.

Accordingly, we won this major contract in part because we’re the only player in the indirect tax software space that will fully support an on-premise installation. A global manufacturer of heavy equipment selected Vertex to support their SAP ERP transformation project in North America. Vertex was chosen thanks to the expanded capabilities we have built in the SAP space including our pre-built certified integration and SAP Plus tools that we acquired from LCR-Dixon. We also landed a major US gas pipeline operator in the third quarter. This customer turned to Vertex due to persistent challenges with a competitive tax solution. The strength of our integration with SAP drove the customer’s willingness to replace the incumbent mid-contract. In addition, our technical capabilities our industry-specific content library was a critical component for this new logo.

This is just a sampling of our wins in Q3 within the SAP ecosystem. We’ve invested heavily to deepen our decades-long relationship and strengthen our alignment with SAP’s go-to-market team. In July, Vertex O Series Cloud earned a distinction as an SAP Endorsed App for North America. This premium certification is now reflected in the SAP store. SAP sales professionals are getting wins on the board with Vertex earning commissions and quota credit for co-selling our solution and evangelizing Vertex in their accounts and with their teammates. Accordingly, our pipeline with SAP is building steadily. In 2023, we’ve seen nearly a five-fold increase in the number of leads from the SAP channel in North America which is extremely exciting as it is a precursor to new additional business wins.

On that point, year-over-year wins on deals referred by the SEB channel have more than doubled so far in 2023. Turning to the Oracle ecosystem. In the third quarter a long-standing customer in the oil field services business moved to the cloud as part of an Oracle OCI cloud conversion. This deal exemplifies two key differentiators for Vertex. The first is our ability to support optionality when it comes to deployment. As I often talk about we can meet our customers where they are in their digital transformation journey. In this case as soon as they were ready we were able to help the customer move from their server-based solution to the cloud seamlessly. The second differentiator this deal demonstrated is the strength and influence of our partnerships.

We have been working closely with our tech and consulting partners to build a combined bill of materials for our customers. In this deal, the triangulation of our go-to-market efforts with Oracle and PwC brought us into the process five to six months earlier. This approach speeds time to value for our joint customers. We also won a new contract with a global provider of property maintenance services that was implementing Oracle Cloud and Coupa. I’m really excited, we are running the same playbook that made us successful in Oracle and SAP ecosystems with middle-market ERP providers and leveraging our strength in Oracle to grow our presence in the NetSuite ecosystem. For example, we won a North American specialty retailer and a North American provider of employee benefit insurance both of which were implementing NetSuite.

In the Microsoft Dynamics ecosystem, we won a deal with a leading manufacturer of plumbing supplies due to their implementation of big commerce for e-commerce. Let me give you more context on how we are driving our consistent improvement in our — when our customers have a change in their business, especially M&A or implementation of new commerce channels it typically leads to new opportunities for Vertex. We had several customers increase their entitlements in the third quarter due to acquisitions, including a major US supplier of electric supplies that acquired one of its competitors and a major international conglomerate that acquired a new subsidiary. And our customer success organization, which is one of the key focal points of our growth investments is charged with finding new opportunities with existing customers and driving NRR growth.

In the third quarter, a long-standing customer in the automotive industry added premium resilient content to its Vertex subscription. And a customer in the grocery industry increased entitlements to bring additional subsidiaries under the Vertex umbrella and also added Edge to support its e-commerce channels. Now, turning to Europe. Since 2020, we’ve gone from having a small presence on the continent to having a fully fleshed-out go-to-market team a full array of products laser-focused on European enterprise customers and an impressive slate of reference customers ready to rise to the occasion and evangelize on Vertex’s behalf. And even though the European economy has been slow in 2023, we have built our presence there to pay dividends for years to come not just in the short term.

I already highlighted the European deal we won in the pharmaceutical industry. But we also won the largest VAT compliance deal in our history with a European publisher. This deal was driven by a customer desire to improve controls and reduced risk in VAT compliance across 24 different countries. We won this business in part because of the reference accounts we were able to provide in Germany. In fact, we were the only competitor that could provide viable references in that market. In the past, that was a very simple and easy to calculate tax. The European VAT tax regulations were nothing like the 12,000 different jurisdictions we deal with in the US. Generally speaking, there is one VAT rate per country. But that is getting more complex and the global expansion of e-invoicing regulations will only exacerbate it.

E-invoicing is a global trend that is accelerating and there are no signs of it slowing down. Over 50 countries have already adopted different forms of reporting requirements and several other major economies, including France and Germany have indicated they will soon follow suit. Simply put e-invoicing requires companies to remit information on sales and the associated VAT calculation in real time, at the point of purchase so governments can reduce the VAT gap, which is the difference between what they expect to collect and what they actually collect. To address, the e-invoicing opportunity in October at Vertex Exchange, our North American user conference, we formally announced our partnership with Pagero as the CEO joined me on stage in front of over 1,000 attendees.

Our partnership with Pagero adds their e-invoicing cloud network to Vertex’s tax compliance portfolio, providing our customers with a seamless set of tools for compliance with the latest e-invoicing and continuous transaction control regulations globally. Throughout the conference, we jointly met with customers and discussed how our differentiated single cloud platform helps companies manage continuous compliance for e-invoicing VAT and sales and use tax providing a true global compliance solution. Customers voiced their enthusiastic support for the integrated solution and we came away from the conference with several joint opportunities. Equally exciting, this week we announced a new partnership with Shopify, in which we became the first global tax technology provider to join the Shopify Tax Partner program.

This partnership will enable Shopify’s customers to automate tax calculation and compliance on a global scale. We are excited about this partnership with one of the major providers of Internet infrastructure for e-commerce which provides access to entirely new ecosystem of prospects for Vertex. When I think about all we accomplished in the third quarter, it all comes down to a focus on delivering great customer experiences with powerful solutions and trusted relationships and this is what drives our success. At Exchange, I was excited to share that once again Vertex has been recognized with IDC’s SaaS Customer Satisfaction Award for Tax for overall customer satisfaction. This award is incredibly meaningful to me and the Vertex team, not only because we are the only indirect tax technology company to be recognized but because it is based on the direct feedback of customers.

It is the recognition of our relentless commitment to deliver an exceptional customer experience. This is something we do not take for granted and it is essential to be the leader in the middle and enterprise markets. Finally, I’d like to share a few thoughts on the topic that is top of mind for most businesses today: artificial intelligence. Let me quickly highlight what AI means for our business and how we plan to capitalize on the enormous opportunity they present. At Vertex, we’ve been using AI machine learning for years and now we’re moving into generative AI and large language models, which can generate new solutions from existing content. We believe Gen AI has the power to revolutionize how we approach indirect tax software. By combining human ingenuity with Gen AI capabilities we can optimize workflows and elevate user experiences.

Our Gen AI related R&D spend is focus on three main areas: content curation, customer experience and customer data insights. We will be enabling Gen AI copilots within our user interfaces to assist our customers with processes like product categorization or system configuration or to access product knowledge quickly and easily. And on the new product front, we are delivering tools that will help our customers gain additional insights from tax data to make smart business decisions. This is perhaps the biggest area of opportunity for Vertex, because our software has insight into literally every transaction the company executes down to specific SKUs and precise geo-location. This was very well received element of our keynote at the Vertex Exchange and several customers and partners have since stepped forward to be product design partners in these areas of investment, which is consistent with how Vertex secures early adopters and ultimately built its leading position in enterprise market.

John will now take you through the financials. John?

John Schwab: Thanks David and good morning, everyone. Today I’m going to review our third quarter financial results and provide guidance for the fourth quarter and full year of 2023. Total third quarter revenues grew 14.9% year-over-year to $145 million, exceeding the upper end of our quarterly guidance by approximately $2 million. Subscription revenues increased 14% period-over-period to $121.3 million. Our services revenues grew 19.5% to $23.7 million. And cloud revenue was $54.6 million in the third quarter, up 24.8% from last year. As David mentioned, our customer metrics remained solid. ARR was up 17.8% year-over-year. NRR was 111% and GRR was 96% in the third quarter. And AARPC, which is based on our direct customer count was $112,690 in the third quarter up from $109,170 in the second quarter of 2023.

Non-GAAP gross profit for the third quarter was $103.4 million, representing a gross margin of 71.3%. This compares with $87.6 million and 69.4%, respectively in the same period last year. Non-GAAP gross margin on subscription software revenue was 78.3% and non-GAAP gross margin on services revenue was 35.3%. Turning to non-GAAP operating expenses. In the third quarter, research and development expense was $15.4 million compared to $9.8 million last year. With capitalized software spend included, total R&D spend was $28.4 million for the third quarter, which represents 19.6% of revenue as compared to 15% of revenue in the prior year period. Our selling and marketing expense was $31 million or 21.4% of total revenues. This is the fourth consecutive quarter that selling and marketing expense has been relatively steady in the low $30 million range, reflecting the moderation of our investments in the go-to-market over the past year.

General and administrative expense was $31 million or 21.3% of total revenues. This is down approximately $2.3 million sequentially as some of the consulting expenses related to our second quarter ERP conversion did not recur in the third quarter. We expect relative stability in G&A expense on a dollar basis going forward, reflecting the conclusion of our heavy growth investment period. Adjusted EBITDA was $26.6 million in the third quarter of 2023, an increase of $5.9 million year-over-year and exceeding the upper end of our quarterly guidance. Operating cash flow was $27.6 million and free cash flow was $9.1 million in the third quarter. As the fourth quarter is usually our strongest cash flow quarter for the year, we expect positive operating and free cash flow for the full year 2023.

We ended the third quarter with $49.5 million in unrestricted cash and cash equivalents. Total bank debt was $47.4 million and our investment securities totaled $8.3 million. For additional liquidity, we also have $200 million of unused availability under our line of credit. Turning to guidance. In the fourth quarter of 2023, we expect total revenue in the range of $145 million to $147 million, which would represent 11.4% year-over-year growth at the midpoint and adjusted EBITDA in the range of $27.5 million to $29.5 million, which would represent a year-over-year increase of approximately $7.5 million at the midpoint. This results in an increase to our full year financial guidance as follows. We now expect total revenue for the year to be in the range of $562.5 million to $564.5 million, which represents 15% full year growth at the midpoint, up from 14% at the midpoint in our prior guidance.

We are also increasing our full year adjusted EBITDA outlook to a range of $96.3 million to $98.3 million. Our new adjusted EBITDA guidance represents a year-over-year increase of $18.6 million at the midpoint, an increase of over $2 million compared to our prior guidance. We now expect cloud revenue growth of approximately 25% for the full year compared to 27% previously. This is due to a slight mix shift in the business to higher-margin on-prem software revenue. As a reminder for new deals, we are price-agnostic between cloud and on-prem deployments. David, will now make a few closing comments before we open up for Q&A. David?

David DeStefano: Thanks, John. So to wrap it up, it was another great quarter for Vertex. We have built an execution engine that is delivering strong and durable financial results in what has been a challenging economy for many SaaS companies. We’re fortunate that our offerings are a must-have, not a nice-to-have for our enterprise customers. Tax compliance is required in strong and challenging economic time. This is what makes our solution so sticky, and is the foundation of the consistency in our GRR and NRR. With the investments we’ve made and the results they are delivering, over the next few years we see a clear path to the Rule of 40 metric long-term revenue growth, in the mid- to upper teens and EBITDA margins in the low to mid-20s.

Unlocking this kind of performance was the North Star of our growth investments. And from here on out, it’s about delivering the same consistent execution that we have since we went public in mid-2020. I am confident the Vertex team is up to the task With that we’ll take your questions. Operator, please go ahead.

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Q&A Session

Operator: Operator Thank you very much. We’ll begin the question-and-answer session [Operator Instructions] And our first question comes from Chris Quintero from Morgan Stanley. Chris, please go ahead.

Q – Chris Quintero: Hi, guys. Good morning. Congrats on the strong set of results here. Net Menu adds came in kind of the highest for Q3 and maybe kind of full year so any sense of what the channel mix is of where this new customers are coming and we talked about continues to accelerate momentum with SAP and you mentioned some nice customer wins there. So just curious how big of a contributor maybe the partnership with SAP was in the quarter.

David DeStefano: Yes, Chris, I appreciate the question. SAP clearly, is a strong tailwind given all the investments we’ve made right now in new offerings in the SAP space, the LCR-Dixon acquisition and all the work we’re doing with our go-to-market teams and our partners. Collectively, that has clearly started to improve our pipeline and it’s creating a nice tailwind. But what’s been really great is, we’re able to leverage the playbook we’ve been running in SAP and we’re starting to improve execution in Microsoft, NetSuite, Workday and we had some really nice wins. And so while AARPC did rise nicely, we actually saw a good diversification of wins across the different ecosystems we’re focused on.

Q – Chris Quintero: Got it. That’s very helpful. And then on the fewer conversations around moving to the cloud, what’s your sense? Do you think that’s more kind of like macro-driven, more secular? And as more kind of existing customers stay on that on-prem version? Does that change your calculation and thinking around pricing between the two different versions?

David DeStefano: As you know, we made the switch to have the same pricing for cloud that we do on-prem. So we’re getting the same subscription revenue regardless of whether an existing customer is upping their – expanding their wallet share with us with another on-prem license or in unique stack patterns like the one we highlighted in the call where a defense industry, there are certain governors on where they can have their data and being able to support them where they’re at has always been a key differentiator for us Chris. And so I’m really pleased with the actual. We’re able to sustain such strong cloud growth and yet grow AR even more. And margins picked up, as a result because of that – it’s obviously, more profitable for us when they’re buying on-prem. So it’s actually been a really nice shift in strategy that’s working incredibly well for us.

Chris Quintero: Excellent. Thanks, David.

Operator: And our next question comes from Matt Stotler from William Blair. Matt, please go ahead.

Matt Stotler: Yes, great. Thanks for taking my question and nice results. Wanted to ask on the strong NRR number. I think it’s the second quarter in a row of record level there. Is this sustainable? And perhaps is there even additional upside to this metric? Thanks.

David DeStefano: Matt, a key part of our strategy was to invest in building out a customer success function over the last several years and combine it with the new product suite that we’ve been expanding and the acquisitions we made also that we could better serve our existing customers. And I think what you’re seeing is the execution on that and the maturity of that strategy is playing out really nicely. We don’t guide to NRR, but I’m certainly pleased with the progress the team is making to make sure we’re delivering value across our entire customer base.

Matt Stotler: Great. And then just wanted to follow up on the commentary around fewer on-prem migrations. If you could just give a few more details on what’s driving that? Thanks.

David DeStefano: Yes. So we – one of the things we’ve always talked about Matt in our process is we meet the customer where they are in their digital transformation journey and support them as they’re ready. And I think our GRR proves when they’re ready, they are migrating with us because it’s much more about the content than it is the underlying platform. And so we’re I think it’s just episodic to where customers are in their journey with migrations that we – that that ebbs and flows a little bit. But fundamentally not seeing any change in GRR and the fundamental shift continues. I think it’s also important to remember that 90% of all the new logos that we’re winning are on the cloud. So we’re still leading with cloud and it is where we see the bulk of our new logos. But we’ve got a wonderful installed base and some of those customers are just on their journey at different paces.

Matt Stotler: Perfect. Thank you. Appreciate it.

Operator: And we now have a question from Joshua Reilly from Needham. Joshua, you may proceed.

Joshua Reilly: All right. Thanks for taking my questions. Nice job on the quarter here guys. What are you seeing in terms of customers allocating budget to your category of products maybe exiting 2023 versus a year ago? Are you seeing larger budget opportunities year-over-year which it appears that’s the case, given some of these large wins? And what if any macro risks do you see exiting the year that could maybe impact some of the spending to close out the year?

David DeStefano: Josh, always good to talk to you. I think fundamentally, there’s three major tailwinds that affect our opportunity set. The one is, business model changes M&A and we highlighted a couple of things we saw in the quarter, where M&A deals were happening and we were getting expanded wallet share. You’ve got the regulatory environment which is only getting more complex, as governments are taking on more debt and looking for new ways in the indirect space to raise revenue. And then lastly, the ongoing digital transformations that businesses are going through. And I think that diversification of business drivers has given us the consistency of performance. And I think it’s much more about our execution against those drivers that’s driven our numbers up so much this year. And certainly, we haven’t guided anything for 2024, but those three factors work in a really nice balance for us and I see that continuing as we move forward fundamentally.

Joshua Reilly: Got it. And then you had a nice beat on the operating income here in the quarter. John, can you help us think about the operating leverage going forward without guiding to 2024? Should investors — should we assume that we will continue to be in a period of harvesting the investments that you’ve made? Or should is there another cycle of spending maybe coming in 2024? Thanks guys.

John Schwab: Yes. Great question, Josh. Thank you. Yeah, as I think about leverage and kind of how we think about that moving across the — across the years again we’ve talked about G&A being an area we think there’s opportunity for leverage there. And that’s an area that we’ll continue to be focused on. Again having the ERP upgrade behind us and kind of moving forward with that, we feel very good about the opportunity to be able to leverage that going forward. And I think you’ve seen in our results the selling and marketing expense has been has been fairly flattish for the last handful of quarters. And so that’s another area that again after we got through the big build period in that 2021, 2022 time frame you’re starting to see a little bit of moderation in that area.