Vertex, Inc. (NASDAQ:VERX) Q1 2023 Earnings Call Transcript May 14, 2023

Operator: Greetings. Welcome to Vertex’s First Quarter 2023 Earnings Conference Call. Please note, this conference is being recorded. At this time, all participants are in listen-only mode. [Operator Instructions] At this time, I’ll now 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 financial results for the first quarter ended March 31, 2023. I’m Joe Crivelli, Vice President, Investor Relations. David DeStefano, Vertex’s President and CEO; and John Schwab our CFO, are also on the call today. 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 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. I’ll now turn the call over to David.

David DeStefano: Thanks, Joe. Welcome everyone, and thank you for joining us. 2023 is off to an exciting start. Through the focused efforts of our global team, we delivered great execution across all areas of the business. In the first quarter, we saw widespread contribution of our revenue growth balanced across new logos and cross-sells, as well as software and services in-spite of the uncertain macro environment. We also saw continued positive momentum in the metrics we use to track our success. Annual recurring revenue grew 17.3% in the quarter, GRR and NRR remain at consistently healthy levels of 96% and 110%, respectively. Average annual revenue per customer was $104,370 at the end of the first quarter, up 16.4% year-over-year, and the number of scaled customers are those generating over $100,000 of annual revenue grew 13%.

This resulted in revenue of $132.8 million, and adjusted EBITDA of $20.2 million. We accomplished this while continuing to execute on our multi-year growth strategy with focused investments in R&D, go-to-market, customer success, and corporate infrastructure. With these investments beginning to taper off, we are optimistic about the opportunity for earning leverage in the back half of 2023. We still see opportunity and demand as company’s continued tax transformation efforts in response to changes within their business and growing compliance requirements. Governments often look to indirect tax as a source of additional funding in challenging economic times, they lean into the enforcement of tax codes to replace lost revenue. As audit pressure builds, so does the need for companies to reevaluate how they calculate and remit taxes.

And while they’ve been playing catch-up with the accelerated pace of digital transformation, governments are now putting new rules and legislation in place to ensure that cross-border digital commerce is taxed fairly, and this has sweeping impact as most businesses today have an online presence. Growing revenue, doing business in new places and delivering a seamless omnichannel experience, all add a layer of complexity that makes automation critical to managing compliance at scale for global enterprises. This, in turn, meets the demand for Vertex solutions. Our notable strength in the enterprise market was evident again this quarter. Our unified platform, multi-cloud strategy, and deep partnerships continue to drive strong win rates for our sales and partner teams.

These same differentiators are also empowering mid-market businesses as they expand their business models, drive global omnichannel strategies, and continue their digital transformations. This quarter, with our focused investment in building our go-to-market ecosystem with Microsoft, Workday, and Salesforce, we saw nice traction with mid-market customers. And we continue to see a steady stream of customers expanding their usage of the existing solutions they licensed with us. Beyond the technical strength of our solutions, it’s the trust and experiences we deliver that gives our customers the confidence to grow with us and invest in additional solutions. We don’t talk a lot about our services business on these calls, but I believe the steady growth that continues in both revenue and new business activity reflects how businesses continue to invest in their tax technology.

We had a strong quarter in our services business and have a healthy backlog of [SOWs] [ph] that should enable continued growth in services revenue. I’d like to share a few highlights that really reflect how pervasive tailwinds contributed to the strength of the quarter. An existing customer, one of the largest social networks in the world, significantly expanded its business with Vertex in the first quarter. The customer manages an online marketplace where goods are bought, sold, and traded. As part of this aspect of their business, they are seeing more and more products that are subject to sales and use tax liability. Accordingly, they tripled the revenue tier of their entitlements, resulting in 7 figures of new ARR for Vertex. This company is not alone in the challenge to manage the growing tax complexities of operating a marketplace.

Vertex released a global research study in Q1 that revealed that 81% of responding businesses are taking advantage of marketplaces to attract new customers and sell into more countries. Both marketplace operators and sellers need to feel confident that their chosen platforms will enable them to meet growing compliance requirements, while maintaining top performance. This was a driving factor in a 6-figure new customer win with another leading e-commerce platform. We won this business due to our Edge product, our industry-leading customer support and for more consistent and predictable pricing. Perhaps the biggest reason for selecting Vertex was that the downtime and performance of their existing solution was unacceptable in an industry that requires near perfect uptime.

We also had a very exciting new logo win with one of the largest SaaS companies in the world, which also selected Vertex as their indirect tax platform in the first quarter. The customer is experiencing significant growth, both organically and through acquisitions, which increases the number of source systems the tax department needs to pull data from, for their clients. Our ability to effectively manage data across multiple systems and integration points into a single-cloud solution allowed us to earn their business. This 7-figure deal includes complex integrations with the customer CRM, ERP, and accounts payable systems. The strength of our ecosystem also played a significant role in this competitive takeaway as we partner with PwC and Accenture.

This is a common scenario as most companies today are managing applications and workloads across fragmented environments. Our approach wins because we offer a single platform for all indirect tax types with interfaces to the multitude of systems our customers rely on each and every day. I can’t emphasize enough how important it is for a tax professional to have confidence and consistency in their tax outcomes across all their systems, particularly as we see audit pressure intensify. One of the major food delivery companies became a customer this quarter when audit pressure opened their eyes to the importance of tax calculation accuracy to support their fast-growing business. This is a segment we have come to lead in the past few years. It’s an industry where complexity rains and in-house solutions and manual process are simply not enough for tax management.

Sales tax for food delivery can be impacted by hundreds of esoteric factors such as location of the restaurant, location of the end customer, how the food is prepared and even the ingredients in the food, making it one of the most complex industries we serve. Our robust tax content database, which today covers more than 700 million effective rates and rules along with our geo locator capabilities that delivers pinpoint tax area ID assignment gives our customers more precise tax calculation accuracy. And finally, let me share an example that highlights how we are winning in the middle market, a provider of industrial parts and accessories based in Europe selected Vertex in conjunction with an Oracle ERP cloud transformation. As this company grew the complexity of their needs changed, they outgrew an incumbent competitor.

Our ability to handle a complex ERP integration was an important winning factor for Vertex. I’m proud of the success our teams are having on the go-to-market front, the combination of our investments in expanding the go-to-market team, as well as delivering new products and services has really helped to differentiate Vertex with customers and prospects. We are pleased with our progress in using intelligent automation to monitor for tax code changes and keep our tax content database up to date. We are also leveraging it within our solutions to help streamline workflows and ensure that our customers remain compliant with the various tax laws that impact their business. Our growing pipeline of organic and inorganic opportunities and ability to keep that momentum going on the sales front gives me confidence for the quarters ahead and in our overall strategic position in the market.

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

John Schwab: Thanks, David, and good morning, everyone. Today, I’m going to review our first quarter financial results and provide guidance for the second quarter and full-year of 2023. Total first quarter revenue grew at 15.5% year-over-year to $132.8 million, reaching the upper end of our quarterly guidance. Our subscription revenues increased 14.3% period-over-period to $111 million, and average services revenues grew 21.8% to $21.7 million. Annual recurring revenue or ARR, was $446.5 million at quarter end. This is up 17.3% year-over-year and 14.3% on an annualized sequential basis. Net revenue retention, or NRR, remained strong at 110% and was consistent on both a year-over-year and sequential basis. Gross revenue retention or GRR, was 96% at quarter-end, consistent with our prior quarters and within our historical 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 revenues of $7.4 million in the first quarter of 2023, up from $6 million in the comparable prior year period. Our average annual revenue per customer or AARPC, continues to steadily increase and was at $104,370 in the first quarter, up from $100,500 in the fourth quarter of 2022. Note that AARPC is based on the direct customer count, which is disclosed in the earnings press release that was issued this morning. Cloud revenue was $48.2 million in the first quarter, up 26% from last year. And for the remainder of the income statement discussion, I will be referring to non-GAAP metrics.

Gross profit for the first quarter was $95.3 million and gross margin was 71.8%. This compares with gross profit of $80.7 million and 70.2% gross margin in the same period last year. Gross margin on subscription software revenue was 78.4%, compared to 76.6% in last year’s first quarter, and 78.4% in the fourth quarter of 2022. Gross margin on services revenues was 37.9%, compared to 35.3% in last year’s first quarter and 36.8% in the fourth quarter of 2022. Turning to operating expenses. In the first quarter, research and development expense was $13.6 million compared to $9.5 million last year. With capitalized software spend included, R&D was $23.8 million for the first quarter, which represents 17.9% of revenue as compared to 17.2% of revenue in the prior year period.

This increase in R&D expense is driven by ongoing investments in innovation and expansion of our solution capabilities. Selling and marketing expense was $32.1 million or 24.2% of total revenues an increase of $6.4 million and approximately 25.1% from the prior year period. This increase was a result of the expansion of our go-to-market and customer success organizations in 2022. General and administrative expense was $29.3 million or 22.1% of total revenues, an increase of $3.1 million from the prior year period. This increase is due to the infrastructure investments we are making to support the long-term growth of the company. Adjusted EBITDA was $20.2 million in the first quarter of 2023, an increase of $1.1 million year-over-year. We saw positive year-over-year improvement in cash flow.

Our operating cash flow was $6.8 million in the first quarter, a $4.2 million improvement compared to last year’s first quarter. And free cash flow was negative $10.6 million in the first quarter, a $3.6 million improvement from last year’s first quarter. Historically, our cash flow in the first quarter are seasonally lower than the remaining calendar quarters, due to annual bonus payments, payroll taxes and sales and marketing expenses that are typically elevated at the start of the year. We do expect free cash flow to be positive for the full-year as our period of accelerated growth investment subsides, we expect Vertex to return to historic levels of free cash flow generation. We ended the first quarter with over $68.6 million in unrestricted cash and cash equivalents.

Total bank debt was $48.6 million and investment securities totaled $11.5 million. For additional liquidity, we also have $200 million of unused availability under our line of credit. Turning to guidance. In the second quarter of 2023, we expect total revenue in the range of $135 million to $137 million, which would represent 14% year-over-year growth at the midpoint. And adjusted EBITDA in the range of $21 million to $22 million, which would represent an increase of $3.7 million at the midpoint. And for the full-year of 2023, we continue to expect total revenue in the range of $550 million to $556 million, representing annual revenue growth of 12.5% at the midpoint. And 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. We are very pleased with the strong first quarter performance and believe we are off to a very good start to achieve our financial goals in 2023. David will now make a few closing comments before we open up for Q&A. David?

David DeStefano: Thanks, John. Year is off to an excellent start with our strong financial results in the first quarter and our outlook for the balance of the year is positive from both a revenue and earnings standpoint. We remain on track with our growth investments, and we expect to see earnings leverage in the second half of 2023. We’ve already seen some progress here as selling and marketing expenses leveled out in Q1, as we launch our new ERP system in Q2 spend associated with this project should also wind down. We continue to deliver exceptional and differentiating value to our customers, and we believe the winning formula we have put in place will continue to drive success with end-to-end solutions, the most complete and accurate content database in the industry, a scalable unified cloud platform across all major tax sites, seamless integration and consistent results across source systems, and partners and in-house experts who deliver rapid value in even the most complex environments.

In closing, I’d like to thank our employees for their continued dedication to our mission, our customers, and our partners. Your hard work makes all our success possible. With that, we will take your questions. Operator, please go ahead.

Q&A Session

Operator: Thank you. [Operator Instructions] Our question comes from Matt Stotler with William Blair. Please go ahead.

Operator: Our next question comes from Adam Hotchkiss with Goldman Sachs. Please go ahead.

Operator: Our next question comes from Joshua Rilley with Needham. Please go ahead.

Operator: Our next question comes from Daniel Jester with BMO Capital Markets. Please go ahead.

Operator: Our next question comes from Steve Enders with Citi. Please go ahead.

Operator: Our next question comes from Andrew DeGasperi with Berenberg. Please go ahead.

Operator: Our next question comes from Brad Sills with Bank of America. Please go ahead.

Operator: [Operator Instructions] Our next question comes from Alex Sklar with Raymond James. Please go ahead.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Joe Crivelli for any closing remarks.

Joe Crivelli: Thanks, everybody, for joining us today. If you have follow-up questions or if you’d like to schedule more time with the team, please reach out to me at ir@vertexinc.com. Thanks, and have a great day.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.