Vertex, Inc. (NASDAQ:VERX) Q4 2022 Earnings Call Transcript

Vertex, Inc. (NASDAQ:VERX) Q4 2022 Earnings Call Transcript March 8, 2023

Operator: Greetings. Welcome to Vertex’s Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I’ll now turn the conference over to Joe Crivelli, Vice President, Investor Relations. Mr. Crivelli, you may now begin.

Joe Crivelli: Hello and thanks for joining us to discuss Vertex’s financial results for the fourth quarter and full ended December 31st, 2022. I’m Joe Crivelli, Vice President, Investor Relations. With me on the call today are David DeStefano, Vertex’s President and CEO; and our CFO, John Schwab. As a reminder, during this call we may make forward-looking statements related to expected future results. Our actual results may differ materially from our projections due to risks and uncertainties. These risks and uncertainties are described in our earnings release and filings with the Securities and Exchange Commission. Today’s remarks will also include references to non-GAAP financial measures. Additional information, including reconciliation between non-GAAP financial information to the GAAP financial information is provided in the press release.

This conference call is being recorded and will be available for replay via webcast on our Investor Relations website. With that, I’ll now turn the call over to David.

David DeStefano: Thank you, Joe. Welcome everyone and thank you for joining us. I’m pleased to speak with you today about Vertex’s financial results. Businesses today face immense regulatory change and indirect tax complexity. These challenges intensify as they expand into new regions, diversify offerings, and accelerate e-commerce growth and that’s why we continue to see tax technology growing in both value and demand. Our company’s vision to accelerate global commerce has never been more relevant. Our solutions give enterprise and mid-market businesses alike the confidence to manage tax compliance at scale in over 20,000 jurisdictions around the world. Against this backdrop, Vertex executed extremely well in 2022, finishing on a high note with our best quarter of the year.

Revenues in the quarter reached a record $131.1 million, up 17.4% from Q4 2021. This is the highest year-over-year revenue growth that we have delivered as a public company and we closed the fourth quarter with adjusted EBITDA of $20.8 million, up 8% from last year. Our strong performance in an uncertain economic environment reinforces the durability of our business, the financial strength of our customer base, and our ability to sustain profitable growth. Free cash flow in the quarter was $24 million, which helped us deliver positive free cash flow for the full year, while making a multimillion dollar growth investment. We are seeing benefits from our strategic acquisition and the targeted investments we are making in R&D, go-to-market, and ecosystem expansion.

These investments are helping us further penetrate the $22 billion addressable market for tax automation solutions. Our investments are focused in four key areas; first, expanding our installed base through accelerated go-to-market investment to drive customer success and high-value new logos within our target markets. Second, broadening and deepening our strategic partnerships; third, strengthening our global presence with a spotlight on Europe. And finally, driving new product innovation with heavy investments in emerging technologies and tax content to have the power to transform our industry. And we are seeing adoption from both new and existing customers evidenced by strong performance across all our key performance indicators for customer success in the fourth quarter.

ARR was $431 million, up 16.5% year-over-year. NRR was 110%, up from 108% last year. GRR was 96%, up slightly from 95% last year and average annual revenue per customer increased 16% from last year’s fourth quarter and exceeded $100,000 for the first time in our history. On the technology front, we continue to advance our next-generation cloud solution to offer even greater scale and elasticity. We are enabling tax calculation at the point of transaction with the latest edge computing technology and we are accelerating our use of intelligent automation to help our customers increase efficiency, reducing the friction between commerce and compliance. Vertex also continues to make significant investments in our tools and technology to enable our tax professional’s business operations through intelligent automation, data and analytic tools and robotic process automation we are driving operational efficiencies and adding more content faster than ever before.

We’re proud to help the most dynamic and discerning businesses on the planet stay compliant with our tax content database, which has more than 700 million effective rates and rules. And our performance in 2022 confirms for me that we are just getting started. We have only scratched the surface of our addressable market, given the multiple trends triggering the need for tax automation. This gives me confidence that, we can continue to grow both our top and bottom lines as these tailwinds take hold and accelerate. I’d like to share a few business highlights from the quarter, illustrating these trends. Today, a significant segment of enterprise markets still relies on homegrown solutions or manual processes to address indirect taxes. This means incredible growth potential still exists within this highly valued segment of the addressable market, where we are the clear market leader.

The tax complexity grows, compliance becomes unmanageable, triggering a need for change. As an example, one of the leading global commodities trading companies in Europe reached a tipping point when new regulatory requirements for near and real-time reporting pressure tested manual processes and their ability to maintain compliance. The time was right to automate tax determination in the cloud and our ability to win this competitive six-figure deal was based on three things: the technical capabilities of our cloud solution to support data accuracy in every global jurisdiction, with tight integration into their SAP platform. The reference ability of current customers who represent some of the most influential and complex businesses in Europe and the expertise demonstrated by our in-region Vertex team.

This is a differentiated value that allowed us to achieve record growth in our business in Europe in 2022. When we speak with prospective customers, our ability to uniquely connect disparate systems to a single tax platform is another clear differentiator. This led to a significant six-figure ARR win this quarter. We were selected by one of the largest consumer insurance companies in the United States as their provider of choice for indirect tax automation. This significant new logo opportunity was driven by the company’s implementation of Coupa for procurement. As they integrated Coupa into their Oracle infrastructure, it was the ideal time to transition from their homegrown indirect tax system, which could no longer keep pace with their compliance needs in today’s modern cloud ecosystem.

Another area of investment that I touched on earlier, centers on new product innovation. We had a notable win the quarter that highlights how our continued portfolio enhancement to better support the SAP ecosystem makes Vertex the clear choice for tax technology in that space. After being spun off from their parent company, our cloud solution was selected by a well-known consumer products brand to manage sales tax compliance. The company was familiar with our industry-recognized customer experience and the strength of our solutions, having previously used our managed services offering. As an independent company, they needed a tax engine that connects seamlessly to SAP. They also licensed our plus tools that launched in 2022 with the acquisition of LCR-Dixon.

This deal reflects the value we are receiving from this strategic investment and gives us an edge with the most complete and differentiated tax automation solution for SAP. Each quarter, I highlight how trusted relationships across the partner ecosystem create value for our joint customers and differentiate us in competitive deals. Across the board, we continue to enhance our integrations globally with our strategic partners and actively engaged with their sales teams. Additionally, we are working closely with our alliance partners to focus on key ecosystems where we share strength and differentiation. Together, we deliver a better overall experience for our customers. In the mid-market, we continue to work closely with Microsoft Dynamics team and strengthen our technical integrations and go-to-market motions together.

In the quarter, we had multiple deals where we were able to drive value for Microsoft customers. As an example, our solutions allowed a premium retailer in the US to consolidate tax and billing systems as part of a larger financial systems transformation on Microsoft Dynamics 365. Our unique ability to integrate into multiple financial systems for accurate tax calculation allowed us to win this new logo. This retailer now has a trusted tax partner that is supporting their long-term omnichannel strategy. This was a highly competitive deal as the customer was using solutions from two of our competitors in other areas of their business. Another powerful example of how our multisystems integrations and partner relationships are setting Vertex apart from the competition involved a national restaurant chain looking to streamline their tax processes.

Their systems integrator, top block brought us into the opportunity, the fact that we named a preferred ISV and premier partner for their Workday financial environment was key to earning their confidence. The strength of our tax content for the food and beverage industry reinforce that Vertex is the right choice to help them manage tax compliance. Looking forward, I’m excited to build on our preferred position within Workday in 2023 and beyond. Across all our highlighted wins this quarter, the breadth and depth of our tax content database is clear advantage for us time and again. The expansion of our vertical specific tax content is another example of how investments we are making are quickly delivering value to our customer and shareholders.

B2B marketplaces are growing at a rapid pace and emerging regulations seek to ensure governments get their fair share of the revenue on these new platforms. This creates increased complexity for businesses using this e-commerce channel. Because of this, marketplaces continue to be a focal point of our growth efforts. And we continue to leverage the acquisitions of Taxamo and its integration with our other products to strengthen our partnerships with marketplace operators. A great example of this was how we expanded our relationship with Mirakl, in the fourth quarter. Mirakl is a leading enterprise SaaS platform that powers over 300 online marketplaces. We initially announced our strategic partnership in 2021 and with an integration to help their customers comply with emerging VAT e-commerce regulations.

This quarter, we launched an enhanced connector to enable full service global support for Miracle expansion into North America. Interestingly enough, Mirakl also became a new customer of Vertex in Q4, which is very common with many of our tech partners. They are customers as well as go-to-market partner, which I think speaks volumes about our leadership in the industry. Before I turn the call to John, I want to thank the entire global Vertex team who have worked hard to get us to this inflection point. Their relentless commitment to deliver an exceptional customer experience was once again recognized this quarter by Help Desk Institute. Vertex achieved HDI support center certification which is an internationally recognized standard for best practices in customer support and the highest level of recognition for customer experience.

And quite frankly, that is something enterprise customers deeply value and we consistently differentiate on. We are the only tax technology provider to earn this level of certification. And we’ve now done it twice I could not be prouder of our team. When you work with the best customers and partners in the industry, you also attract top talent. We have continued to invest in and grow the Vertex team. Among the new additions to our team in 2022, we welcome Brad Cameron as Senior Vice President of Software Engineering. I could not be more excited to have Brad join us from Salesforce to lead our world-class engineering team in the development of our next generation of solutions and continue to advance technical innovation. Since we went public, we have been laser-focused on increasing our product and tax content leadership expanding our go-to-market capabilities and making and monetizing targeted strategic acquisitions and reflecting on our performance in quarter and all of 2022 and our team is executing well across every area of our business in direct alignment with that strategy.

John, I will now hand the call over to you to provide additional details on the quarterly results.

John Schwab: Thanks, David. And good morning, everyone. I’ll now review our results in detail and provide financial guidance for the first quarter and year. In the fourth quarter, revenue was $131.1 million, up 17.4% compared to last year’s fourth quarter. And for the full year, total revenue was $491.6 million, up 15.5% from 2021. This exceeded the high end of both our fourth quarter and full year revenue guidance by $4.1 million. Annual recurring revenue, or ARR, was $431.1 million at the end of the year, representing 16.5% year-over-year growth. Net revenue retention, or NRR, remained strong at 110%. This was up from 108% in the comparable 2021 period and up a point from 109% in the third quarter. Gross Revenue Retention or GRR, was 96% at quarter end, consistent with prior quarters and within our targeted range of 94% to 96%.

These metrics continue to demonstrate the stickiness of our solutions as well as the strength of our customer relationships. Our returns processing Managed Services business generated recurring service revenue of over $24.4 million for the full year compared to $20.8 million for the comparable prior year period. We also processed over $13 billion of tax payments for our customers and earned over $1 million of cash from the float on the funds. Customer count increased in the fourth quarter. At December 31, we had 4,559 total customers, up by 61 from 4,498 at the end of the third quarter. As we’ve discussed with investors previously, customers with ARR greater than $100,000 or scaled customers is a better metric than gross customer count to gauge our sales performance in the enterprise space and upper middle market where we focus.

Accordingly, in the fourth quarter, scaled customers grew 15% compared to the prior year and 17% on an annualized sequential basis. Our average annual revenue per customer or AARPC continues to steadily increase and was $100,500 in the fourth quarter, up from $97,300 in the third quarter. Note that AARPC is based on the direct customer count, which is disclosed in the press release. Cloud revenue was $46.6 million in the fourth quarter, up 34.4% compared to the fourth quarter of 2021. This was also up $2.8 million from $43.8 million in the third quarter. Full year cloud revenue was $168.9 million, up 33% year-over-year and in line with our guidance. 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 fourth quarter was $94.4 million and our gross margin was 72%. This compares with a gross profit of $79 million and 70.7% gross margin in the same period last year. Gross margin on subscription software was 78.4% and compared to 76.9% in last year’s fourth quarter and 76.5% in the third quarter of 2022. Gross margin on services revenues was 36.8% compared to 39.2% in last year’s fourth quarter and 31.3% in the third quarter of 2022. Turning to operating expenses. In the fourth quarter, research and development expense was $11 million compared to $10.1 million last year. For the full year, R&D was $40.1 million.

With capitalized software spend included, R&D spend was $22.5 million for the fourth quarter and $83.9 million for the full year, which represents 17% of revenues for each period, reflecting our ongoing investments in new product development and enhancing existing products to address customer needs. Selling and marketing expense was $33.2 million, up 25% from last year’s fourth quarter. For the year, selling and marketing expense was $115.3 million, up 26% from last year. The quarterly and year-over-year increase was a result of the expansion of our go-to-market and customer success organizations in 2022. Our general and administrative expense was $28.8 million, up $5.7 million from last year. For the full year, our general and administrative expense was $112.7 million, compared to $89.5 million last year.

This increase is due to the infrastructure investments we are making to support long-term growth. Adjusted EBITDA was $21 million in the fourth quarter, an increase of $1.8 million year-over-year. And for the full year, our adjusted EBITDA was $78.7 million, up $700,000 from last year. Now turning to cash flow, we delivered $23.7 million of free cash flow in the fourth quarter. This enabled us to deliver positive free cash flow for the full year, despite the significant growth investments we made in 2022. And accordingly, for the full year, our free cash flow was a positive $3.4 million. We ended the fourth quarter with $91.8 million in unrestricted cash and cash equivalents. Total bank debt was $48.9 million and investment securities totaled $11.2 million.

For additional liquidity, we also have $200 million of unused availability under our line of credit. Vertex has demonstrated throughout our history as a public company that we are thoughtful about our approach to guidance and strive to deliver on these promises consistently. Given the current economic uncertainty, we have been mindful with our 2023 expectations. Accordingly, for the first quarter of 2023, we expect total revenue in the range of $131 million to $133 million, which would represent 15% year-over-year growth at the midpoint and adjusted EBITDA in the range of $19 million to $21 million, which would represent an increase of approximately $1 million at the midpoint. And for the full year 2023, we expect total revenue in the range of $550 million to $556 million, representing annual revenue growth of 12.5% at the midpoint.

Adjusted EBITDA in the range of $92 million to $96 million, representing an increase of more than $15 million at the midpoint and we believe that cloud revenue will grow by approximately 27% in 2023. This guidance reflects our view of the business in the early going of 2023. As we have mentioned, we believe Vertex’s revenue base will be resilient even if the economy does turn downward. David will now make some closing comments before we open up to Q&A. David?

David DeStefano: Thanks, John. A few points to leave you with before we open the call for questions, first, I’m very pleased with our performance in the fourth quarter and in 2022 as a whole. It’s clear to me the investments we’ve made are helping us attack the significant growth opportunity in front of us. This is showing up in our double-digit growth, strong profitability and positive cash flow in the fourth quarter. We are where we had expected to be when we began our investment strategy two years ago. Second, while we continue to invest in our strategy and growth intentions, we are nearing the point we’re no longer intending to accelerate investments. In the back half of 2023, these should taper off and the growth trends will start to be even more visible to our investors.

And finally, we will continue to take prudent steps to invest wisely and strengthen our financial position, as we have throughout our 40-year history. During economic downturns, taxing authorities rely heavily on revenues from indirect taxes to fund budgets and enterprise customers still invest for the future. This drives ongoing demand for our solutions and allows us to continue to grow even in recessionary times. Our team is executing well, and we are energized about 2023 and beyond. With that, we’ll take your questions. Operator, please go ahead.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. Thank you. Our first question today is coming from the line of Matt Stotler with William Blair. Please proceed with your questions.

Matt Stotler: Hi, there. Appreciate you guys taking the questions. Maybe just to start off with one on the macro, obviously, some interesting commentary, it seems like you guys are obviously not seeing particular difficulties and talked about the criticality of the task compliance here. We love to just double-click on some of the observations that you’re seeing within the business, how customers are coping. If there’s any changes in usage and there’s just kind of stability based on the pricing structure that you guys have put in place. If you’re seeing any differences in deal cycles, what have you? I would love to just double-click on your observations there?

David DeStefano: Sure, Matt. So fundamentally, no usage concerns. The product is exceptionally sticky. We have pretty strong price uptake relative to our GRR and our installed base, that we’re not seeing any downward pressure there at all. I think on the deal cycle, I think customers remain thoughtful. The value prop of our software and our solutions continues to show through versus our competitors and that customers continue to drive both digital transformations, and this is really what enterprise customers are focused on digital transformation, ERP upgrades and other system upgrades to get €“ drive more efficiency in their business. And both of those things continue to serve us well. We do see occasional deals that will miss by a month of when we expect them, but we have not seen material push off, or we’re canceling budget on this project. We’ve not experienced that yet.

Matt Stotler: Got it. That’s helpful. And then maybe one kind of looking forward, I mean, you mentioned emerging tech and some of your investments in Emerging Tech there. I would love to kind of get your view on where you’re focused on in terms of additional kind of capabilities there and what you’re most excited about in the R&D pipeline at this point?

David DeStefano: Yeah. So we continue to expand on our edge and edge solutions and cloud platform. I continue to think that, that is a strength for us that will be a differentiator looking forward, we’ve had a number of healthy discussions about data, data transformation, data intelligence, and we see some opportunities there. And then we’re always staying close to driving ML and AI and thinking about more automation, both in our business and in our solutions. And so those are areas that I think will continue to push forward in 2023 and beyond.

Matt Stotler: Great. Thanks, again.

David DeStefano: Thank you, Matt.

Operator: Our next question is from the line of Joshua Reilly with Needham & Company. Please proceed with your question.

Joshua Reilly: Hey, guys. Thanks for taking my questions. Nice job on the quarter here. I think, if you look at in-store retail, I think it continued to be stronger in Q4 than maybe what people expected. Can you just discuss your exposure to in-store retail versus e-commerce? And how is the edge cloud solution, which I think has been out now for roughly a year, how that’s either helping you win net new customers or retain customers you have and migrate them to the cloud?

David DeStefano: Sure. Josh, I think the great news is our customer base is really well-balanced across both e-commerce and in-store. So, it’s sort of like left pocket, right pocket. We’ve enjoyed success on both sides. So, when the pandemic hit and we saw people start shifting heavily to e-commerce we were running omnichannel for our customer base. And so we enjoyed sort of an uptick there. And now we’re seeing it more on the in-store side. And I think that’s the benefit of our position with the enterprise customer base. We’re on both sides, and edge is really furthering that experience. It’s really getting uptake across not only retail, but we’re seeing other deployments where customers really want to containerize their solutions, and they’re seeing value in what we’re doing there. So, it is — we’re seeing good uptake there.

Joshua Reilly: Got it. That’s helpful. And then if you look at your Q4 subscription revenue, I guess, a couple of quick questions there. Was there any overages in the quarter there can note in the subscription revenue line item? And then as you look at how customers are buying based on revenue bands for 2023, would you say that people are being cautious with their expectations around revenue growth, or are the buying patterns normal?

John Schwab: Yes, Josh, thanks for the question. First, on overages, there wasn’t anything in the fourth quarter that was notable in terms of — to call out in terms of what — if there’s anything that was above normal. So, I would say there’s really nothing there. And then we think about kind of new opportunities and what people are buying from a band level. I wouldn’t say that there’s anything there that’s driving us causing for change. We’re not seeing people taking anything down or buying less than they normally would in anticipation of something in the future. So, again, that stuff does get trued up, so it really gets caught up. But we’re not seeing people we’re not seeing people buy anything lower. There’s really nothing meaningful in the numbers yet that are indicating any kind of a pullback there.

Joshua Reilly: Got it. Super helpful. Thanks guys.

David DeStefano: You bet.

Operator: Our next question is from the line of Daniel Jester with BMO Capital Markets. Please proceed with your question.

Daniel Jester: Hey, good morning everyone. Thanks for taking my question. Maybe first to start off on the guidance for 2023, 27% growth in the cloud. If I have my math right, implies maybe 5% growth in the rest of the business. So, can you just provide a little bit more context about Beyond the Cloud? What your growth expectations for the different other parts of the business are this year?

John Schwab: Yes. Thanks for the question, Dan. Much appreciate it. Again, as we think about growth, again, you called out cloud, and we feel pretty good about where that’s going to come in. Again, as we’ve talked about, the on-prem business is going to continue to be there and be something that our customers use and those that have it may continue to add on to that. But we’ve seen a nice split between people adding additional cloud under their existing on-prem infrastructure as well as adding some on-prem activity if they need it. So, we’re seeing some modest growth that’s going to come out of that. And then from a services standpoint, we’re going to see that increase a little bit over last year in terms of kind of what our growth expectations are. My guess is that’s going to be in that kind of 13%-ish kind of zone kind of year-over-year basis. So, that’s kind of how we break that out.

David DeStefano: We’re always mindful Dan to work closely with our ecosystem partners because we really — there’s a nice symbiotic relationship between our organizations and theirs, and we gone mindful about the growth there versus our relationships.

Daniel Jester: Got you. That’s helpful context. Thank you. And then on the free cash flow, certainly, a big improvement in the fourth quarter. As I think to 2023 in your comments that we’re sorting to nth investments, how should we think about the EBITDA to free cash flow conversion? Can that tighten up into later this year into 2024? I know that’s a long way out, but just how should we be thinking about that? Thank you.