Vertex, Inc. (NASDAQ:VERX) Q4 2023 Earnings Call Transcript
Vertex, Inc. (NASDAQ:VERX) Q4 2023 Earnings Call Transcript February 29, 2024
Vertex, Inc. beats earnings expectations. Reported EPS is $0.13, expectations were $0.11. VERX 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. Welcome to Vertex's Fourth Quarter 2023 Earnings Conference Call. Please note this conference is being recorded. At this time, all participants are in listen-only mode. 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 fourth 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. 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 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. The fourth quarter was our strongest quarter of 2023, wrapping up a year of outstanding execution across all areas of the business. I'm extremely proud of the entire Vertex team. Our employees' focus and commitment underpin our market-leading solutions and customer value. This in turn enabled our strong performance this year. Revenue in the fourth quarter was $154.9 million, up 18.1% year-over-year. This exceeds the high end of our fourth quarter revenue guidance by $7.9 million. Our adjusted EBITDA was $32 million, up more than 50% compared to last year's fourth quarter. This represents an EBITDA margin of 20.7%, our highest EBITDA margin in over three years.
In addition, this quarter ARR exceeded $500 million for the first time in our history, growing nearly 19% to $512.5 million. NRR was a record 113% up two full percentage points from the third quarter. Average annual revenue per customer increased 19% year-over-year to nearly $119,000. Growth in scaled customer count was 13% year-over-year. As a reminder, this number represents our customers with annual revenues greater than $100,000 and demonstrates our ongoing success in the underpenetrated enterprise market. GRR was 95% in the fourth quarter within our target best-in-class range of 94% to 96%. Our strong financial results in 2023 were not unexpected. We launched a strategic investment program in 2020 to pursue our vision to accelerate global commerce and fuel our growth to $1 billion in revenue and beyond.
Since then, we have broadened our go-to-market team, we enhanced our longstanding partnerships with Oracle and SAP, while expanding into the Microsoft, NetSuite, Salesforce and Workday ecosystems. We accelerated the breadth and depth of our market-leading tax content database. We increased the pace of new product launches by investing in research and development on our cloud platform. We built a customer success team from a standing start that is now a major contributor of our consistent growth in NRR. We completed several technology and tax content-focused acquisitions and we also built the corporate infrastructure to support a large more efficient organization. With this investment program largely complete in mid-2023, we saw accelerating revenue growth and strengthening profit margins in the second half of the year, but we believe we are just getting started.
This is because most enterprises and large middle market companies are still handling indirect tax with either a web of spreadsheets or an in-house built software program that was purpose-built when the company was less complex and kept running with the exceptional efforts of a number of in-house programmers. It may come as a surprise, but some of the most recognizable, respected and sophisticated companies in the world still handle indirect tax in this fashion. For these companies, it's not a matter of if, but when their in-house solution becomes insufficient to manage the business and they need to implement a third-party software solution. This decision is most frequently driven by one of three factors. First, business model changes or expansion.
This could be an adoption of new ways of doing business such as multi-channel sales strategies or mergers and acquisitions that necessitate a more scalable approach to indirect taxes. Second, audit and reporting requirements demonstrate that an in-house solution is not delivering sufficiently accurate tax compliance. These situations quickly get the attention of everyone from the tax department to the C-suite and even the Board of Directors to deploy the necessary resources to fix the problem. Third, the company embarks on a digital transformation or system upgrade to the cloud. In these cases, it's typically not even financially feasible to refactor the homegrown software solution to run-in the new environment. We are confident that, all three of these tailwinds will drive Vertex's growth for the foreseeable future.
Business changes such as mergers and acquisitions are constant, especially in the market segments where we focus. Audit pressure is only going to increase as governments grapple with ways to plug spending deficits and deal with the massive amounts of debt that must be serviced and indirect tax is an important part of this equation as governments generate 3.5 times more revenue from indirect tax than they do from corporate income tax. In addition, increasingly complex rules around digital businesses and marketplaces are driving new reporting and revenue transparency requirements. And we consistently see our ERP partners driving their customers to move to cloud-based solutions. For example, Oracle is encouraging customers to move to Oracle Cloud.
SAP is ending mainstream support for ECC in 2027, prompting customers to migrate to S/4HANA and businesses are also advancing digital transformation initiatives organically. So, to summarize, the fourth quarter results were excellent and I'm very confident in how our business is positioned for consistent execution in the quarters years to come. Now turning to notable wins in the quarter, one of the biggest sources of new revenue for Vertex and a sustainable driver of NRR growth is increased business with our existing customers. In the fourth quarter, we expanded our relationship with one of our longstanding customers, a large international conglomerate. We have been on a multiyear journey with them as they consolidate and transition their systems to the cloud.
The customer increased their usage tiers for their existing subscriptions, expanded their use of Vertex solutions into additional global markets and licensed additional products including Chain Flow Accelerator. This resulted in high six figures of additional recurring revenue for Vertex. It's noteworthy that, this company has been a customer for over a decade and uses a wide array of Vertex offerings including sales tax, consumers use tax and VAT tax calculation, premium oil and gas content, certificate center, the SAP ecosystem tools we acquired with LCR-Dixon and our tax return managed service among others. This shows the growth potential of our existing enterprise customer base even with a customer that has a comprehensive and longstanding relationship with Vertex.
With another customer, a leader in global digital imaging solutions, a cloud-first strategy implemented by new leadership drove a transition to our cloud solution in the fourth quarter. This resulted in a new five-year contract with mid six figures of additional annual revenue for Vertex. The partnership we have built over the past 12 years plus the value they have experienced over the years provided us with the opportunity to win the business without having to compete in an RFP. We are currently working with them to move their self-hosted tax solution to the cloud seamlessly with tight connections to their Oracle ERP and other key systems. Similarly, another existing customer, one of the largest online marketplaces in the world expanded their usage with us in the fourth quarter.
During their renewal process, the customer consolidated several licenses, added new geographies and increased its usage tiers. This resulted in high six figures of new revenue for Vertex. RSM, a top-ten accounting firm partnered with us on this implementation. As I mentioned, ERP conversions are one of the primary factors for companies to reevaluate how they are handling indirect tax. One example in the fourth quarter resulted in a high five-figure new contract with a global consumer products company. This company moved to Oracle Cloud and in doing so, re-bid their indirect tax solution as they were unhappy with their existing provider, one of our competitors. Vertex won this deal because of our ability to operate in a one-to-many environment and seamlessly integrate with both their ERP provider Oracle Cloud, and their global instance of Salesforce commerce.
The customer also had peace of mind moving their tax engine to Vertex based on the valued experience one of their entities has had with our returns outsourcing service. In the SAP ecosystem, we had a notable win with a global provider of equipment and services to the oil and gas industry. For this customer, an S/4HANA transformation drove a company-wide initiative to centralize global tax compliance. This led to seven figures of additional revenue for Vertex. The support of our partners at SAP as well as Deloitte were also keys to this new business win. In the Microsoft ecosystem, a global manufacturer of nutritional supplements selected Vertex to support its migration to Dynamics 365. In the Workday ecosystem, we won several new deals including one of the major stock exchanges, a regional healthcare system and a provider of financial software for the healthcare industry.
During the quarter, we also saw good examples of how audit pressure and compliance risk are driving business our way. As an example, we won a new deal with a mid-market business solutions company that was using its homegrown billing system, as a platform to calculate indirect tax liabilities. The company's tax department was manually entering tax rates into this system. Inevitably, this approach led to inaccuracies for the customer, which in turn led to audit pressure and liability for back taxes and penalties. The company's tax department worked quickly to get the technology needed to update its systems and Vertex prevailed in the results in RFP, in part, due to our leading tax content database and ability to handle the vagaries of tax calculations across a product list with more than 5 million separate SKUs. As we noted in our annual sales tax Rates and Rules Report last month, U.S. sales tax rate changes reached a 10-year high in 2023 in addition to hundreds of new taxes that were imposed.
With over 20,000 taxing jurisdictions globally, keeping up with these regulatory changes and the escalating complexity of the tax environment both domestically and internationally is a massive tax for any tax department. Now I'd like to highlight a couple of the wins on the international front that I'm very proud of. We won a high-profile new logo in the fourth quarter with a major luxury brand in the jewelry industry. This customer launched an online marketplace so its customers could have a secondary market in which they buy, sell and trade its products, many of which have long waiting lists at retail stores. This customer quickly acknowledged that, tax complexity for a global marketplace was beyond their internal capabilities as well as the compliance risk that this represented.
This led to a search for a third-party provider. Thanks to the trusted relationship we have built with the U.S. division of the company, we added this prestigious new client to our customer base. Additionally, Vertex was selected by one of the fastest-growing middle-market providers of software for the office of the CFO. Internal system changes to its billing platform resulted in an evaluation of its existing solution. Vertex won based on the ability to operate seamlessly in the company's new IT environment, while providing the expertise to smoothly execute the migration process. In addition, the customer determined that Vertex's tax content was more thorough and accurate than the competition. We are excited about this win, because this new customer is owned by a private equity firm that also owns a competitor of ours that was included in the RFP process.
Even so, the competitor could not successfully compete in solving the tax complexity of the portfolio company. They also did not enjoy the high level of confidence and trust to deliver that Vertex received from the advisory community that influenced our win. As I look to 2024, I'm extremely confident in the momentum we continue to build. I'm excited about the rapidly growing pipeline from our recent partnership with Shopify and their move upmarket. And I am seeing tangible progress to drive margin improvements with our ongoing investments in generative AI to support tax content expansion, software development and creation of new customer experience tools. Finally, let me say a few words about our Pagero tender offer. From the outset, we were well advised on the nuances of Swedish law for tender offers, which open the potential for additional parties to join in the bidding.
We were prepared for what unfolded and determined to stay true to our disciplined investment philosophy. With our differentiated approach of combining our VAT compliance solution with e-invoicing capabilities through a single portal, we are solving highly-valued challenge for tax departments. We have been clear the e-invoicing component could be solved via partnership or acquisition and when Pagero presented us with both options, we pursued it at the right price. Currently, our multiyear partnership agreement with Pagero that we announced last October remains in place. We are comfortable with the strength of the terms of that agreement, so in the near-term that is how we will continue to handle e-invoicing opportunities. At the same time, we have considerable options with other e-invoicing companies that are attracted to our highly sought-after customer base and with recent legislation delaying the implementation of e-invoicing in France and Poland, we will remain strategic in our actions.
I look forward to sharing more about our plans for this market opportunity in the future. In conclusion, I remain very confident in the path ahead. The fundamentals of our business are strong and we are well-positioned to capitalize on the significant market opportunity in today's increasingly complex tax landscape. John will now take you through the financials for 2023 and our guidance for 2024. John?
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 full year of 2024. In the fourth quarter, revenue was $154.9 million, up 18.1% compared to last year's fourth quarter and for the full year, total revenue was $572.4 million, up 16. 4% from 2022. As David mentioned, this exceeded the high end of both our fourth quarter and full-year revenue guidance by $7.9 million. Note that, in the fourth quarter, contract renewals with several major customers resulted in usage tier true-ups of approximately $3 million to $4 million. For comparison sake, last year's fourth quarter usage tier true-ups were in the $1 million to $2 million range.
Subscription revenue in the fourth quarter increased 17.9% over last year's fourth quarter to $130.7 million. Full-year subscription revenue was $480.8 million, up 15.7% year-over-year. Services revenue in the Q4 grew 19.7% over last year's fourth quarter to $24.2 million. Full-year services revenue was $91.6 million up 20.2% year-over-year. Cloud revenue was $60.6 million, up 29.9% from last year's fourth quarter. Full-year cloud revenue was $214.6 million, up 27.1% year-over-year and exceeding our full-year guidance. The higher-than-expected full-year growth was in part due to the usage tier true-up revenue, which contributed about 0.5% point to the full-year cloud revenue growth rate. Annual recurring revenue or ARR was $512.5 million at the end of the year, representing 18.9% year-over-year growth.
Net revenue retention or NRR, remains strong at 113%. This was up from 110% in the comparable 2022 period and up from 111% in the third quarter. Gross revenue retention, or GRR, was 95% at quarter end, within our targeted range of 94% to 96%. Average annual revenue per customer or AARPC, which is based on our direct customer count was $118,910 in the fourth quarter, up from $112,690 in the third quarter of 2023. For the remainder of the income statement discussion, I will be referring to non-GAAP metrics. 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 $109.6 million and gross margin was 70.7%. This compares with gross profit of $94.4 million and a 72% gross margin in the same period last year.
Gross margin on subscription software revenue was 76.8% compared to 78.4% in last year's fourth quarter and 78.3% in the third quarter of 2023. The decrease in gross margins was driven by increased cloud and hosting support customers in the multi-cloud environments. Services gross margin was 38.2% compared to 36.8% in last year's fourth quarter and 35.3% in the third quarter of 2023. Turning to operating expenses. In the fourth quarter, research and development expense was $11.3 million compared to $11 million last year. For the full year, R&D was $52.2 million with capitalized software spend included, R&D spend was $23.5 million for the fourth quarter and $100.7 million for the full year, which represents 15.2% of revenue for the fourth quarter and 17.6% of revenue for the full year.
Selling and marketing expense was $34.4 million up 3.5% from last year's fourth quarter. For the year, selling and marketing expense was $129.2 million up 12.1% from last year. And general and administrative expense were $31.4 million up $2.6 million from last year. For the full year, general and administrative expense was $124.9 million compared to $112.7 million last year. Both fourth quarter and full-year adjusted EBITDA exceeded the upper end of our guidance. With our growth investment program largely completed in mid-2023, we are seeing improved earnings leverage, which was apparent in the fourth quarter. Adjusted EBITDA was $32 million an increase of $11 million or over 52% year-over-year. In addition, the fourth quarter adjusted EBITDA margin was 20.7%.
For the full year, adjusted EBITDA was $100.8 million, up $22.2 million from last year. As you may recall, our ERP conversion in the second quarter resulted in short-term to disruptions to billings, which in turn impacted our cash flow in the second and third quarters. This was largely resolved by the end of the fourth quarter as we deliver $28.8 million of free cash flow. Note that DSO remained at elevated levels in the fourth quarter, but we expect to resolve this by end of the first half of 2024. For the full year, free cash flow was $6.1 million, compared to $3.4 million last year. We ended the fourth quarter with over $68.2 million in unrestricted cash and cash equivalents. Total bank debt was $46.9 million and investment securities totaled $9.5 million.
For additional liquidity, we also have $200 million of unused availability under our line of credit. With Vertex's strong execution, we have built a foundation for growth and profitability that we expect to be a shareholder value-creating engine for years to come. The growth investments we've made position us to deliver consistent revenue growth in the mid to high teens, which we in turn expect to drive earnings leverage and expanding adjusted EBITDA margins. Reflecting this confidence, we are guiding above-consensus for 2024. Accordingly, for the first quarter of 2024, we expect total revenue in the range of $152 million to $156 million, which would represent 16% year-over-year growth at the midpoint and adjusted EBITDA in a range of $29 million to $31 million which would represent an increase of approximately $8 million or 45% at the midpoint.
For the full year 2024, we expect total revenue in the range of $650 million to $660 million representing annual revenue growth of 14% at the midpoint. While the full year revenue growth embedded in our guidance is slightly lower than what we delivered for the full year of 2023, this is due to two factors. First, over the last two years, we have deliberately increased our focus and commitment to enabling and supporting our global alliance partners, who implement our software and help to drive software subscription revenue to our business. As a result of this shift of focus, you are seeing and will continue to see a reduced growth rate for our Services business. We expect Services revenue to grow in the mid to single-digits on a percentage basis in 2024.
Secondly, we do not expect the high level of fourth quarter usage tier true-up revenue that I mentioned earlier to reoccur in the fourth quarter of 2024. Offsetting this, in 2024, we expect cloud revenue growth to accelerate to approximately 28% and software subscription revenue to accelerate to more than 16%. For the full year of 2024 we expect adjusted EBITDA in the range of $130 million to $135 million, representing an increase of $32 million or 31% at the midpoint and a full-year adjusted EBITDA margin of just over 20%. David will now make some closing before we open up for Q&A. David?
David DeStefano: Thanks, John. As I said at the top of the call, I'm very pleased with our execution in 2023. By any measure, it was a terrific year for Vertex. Vertex has always been a consistent, durable, profitable grower even back to our days as a privately held, family run business. But the growth investments we made from 2020 through mid-2023 have further energized the company from top-to-bottom. Accordingly, with continued strong execution, we see plenty of runway and opportunity to continue the standard of performance we set in 2023 in the years to come. With that, we will take your questions.
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