Good day, and welcome to the Vertex Incorporated Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Joe Crivelli, Vice President of Investor Relations. Please go ahead.

Good morning, everyone, and thanks for joining us for Vertex's conference call for the third quarter ended September 30, 2022. I'm Joe Crivelli, Vice President Investor Relations; David DeStefano, our CEO; and John Schwab, our CFO, joined me on the call today. As a reminder, this call including the Q&A portion of the call may include forward-looking statements related to our 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 will be available for replay via webcast on our Investor Relations website. And with that, I'll now turn the call over to David.

Thank you, Joe. Welcome everyone and thank you for joining us. The Vertex value proposition of delivering end-to-end indirect tax determination and compliance capabilities was on full display in the third quarter. Total revenue was a record $126.2 million, up 14% compared to, last year's third quarter and, $2 million above the high-end of our third quarter guidance. We have now delivered double-digit growth and outperformed our revenue guidance. Nine consecutive quarters since going public. And once again delivered strong profitability. Adjusted EBITDA was $20.7 million, which also exceeded the high-end of our third quarter guidance by over $2 million. Finally, we saw solid growth across the key measures by which we monitor success in the market. ARR grew in the quarter to, $411 million, up nearly 17% year-over-year. NRR was at 109%, up from 106% for the same-period in 2021. And GRR held steady at 96%, up from 95% in the same-period last year. We achieved these strong results in what was a challenging environment for most tech companies, with economic uncertainty technology decision makers are scrutinizing their budgets more carefully and, in some cases, elongating sales cycles. We believe our third quarter results our proof of the durable, consistent and profitable growth that Vertex has delivered for over 40 years and our ability to weather adverse economic cycles. It also reflects the inherent benefits of being the leading provider in the enterprise market, which is far more stable in recessionary times than the SMB segment. This is because our solutions are not just a nice-to-have, they are a must-have, especially for companies focused on business diversification and global expansion. Every time a customer adds new products or services and every new way of buying and selling they adopt creates additional tax impacts to the business. In addition, during…

Thanks David and good, morning, everyone. I'll now review our third quarter financial results and provide four quarter and full-year guidance. In the third quarter revenue was $126.2 million, up 14% compared to, last year's third quarter. Our subscription revenues increased 15.3% period-over-period to $106.4 million and services revenue grew 7.7% period-over-period to, $19.9 million. Annual recurring revenue or ARR was $411.5 million in the quarter, representing 16.6% growth over the comparable 2021 period. Net revenue retention or NRR remains strong at 109%, this was up from 106% in the comparable 2021 period. This metric continues to demonstrate our customers' ongoing commitment to our software and solutions. Gross revenue retention or GRR was 96% at quarter-end. This is consistent with the second quarter and, an increase from 95% in the third quarter of 2021. Our returns processing Managed Services business generated recurring revenues of over $18 million year-to-date through the third quarter of 2022, as compared to, $15.3 million for the comparable period in the prior year. The services a competitive differentiator and generates consistent recurring revenue but it's not included in our ARR. At September 30th, we had 4,230 direct customers and 268 indirect customers, for a total customer count of 4,498. While this is slightly down from 4,508 total customers at the end-of-the second quarter. I want to, provide some additional context. As noted in previous calls most of our customer turnover is in the small business segment of the market. For example, the average ARR for customers that churned in the quarter was less than $10,000 per year. This is in-part driven by our ongoing strategy to move small business customers into our indirect channel. By contrast, we continue to see very healthy growth in the enterprise segment of the market where we focus. By example, our…

Thanks, John. In closing it was a great quarter for Vertex. In reviewing our third quarter results, I believe investors can see the durability of our business model and the value we deliver for our customers. As I said earlier, Vertex indirect tax solutions are not a nice to have, they are mission-critical. In today's global economy, tax automation is a must-have. Tax complexity continues to increase and homegrown solutions can no longer keep pace. This makes up 80% of our TAM by our estimates and represent sustained opportunity for Vertex as companies change their business models and evolve their technology platforms. We are investing to accelerate and maximize our growth opportunity, and we are seeing positive results. Vertex has the product set that customers need on their global commerce journey, and our end-to-end platform grows more comprehensive as our R&D investments bear fruit. We have a highly experienced team to help complex businesses make sense of indirect tax regulations and connect their disparate technology systems to remain compliant wherever and however they do business. And underpinning it all is the industry's most comprehensive tax content database, which is a clear competitive strength. We continue to expand our relationships with existing customers while onboarding new ones. And we meet our customers where they are with solutions that work for them and their IT infrastructure. This allows us to deliver shareholder value through dependable, durable top line growth and strong profitability. As you can tell, I'm proud of what we built, which wouldn't have been possible without every one of my Vertex teammates. I thank you all for your hard work. Now let's pause for your questions.

[Operator Instructions] The first question today comes from Joshua Reilly with Needham. Please go ahead.

All right. Well, thanks for taking my questions and nice job on the quarter here, guys, in a tough climate. We all know you guys made a lot of sales investments here over the last 18 months. How much of these greater resources in the field, combined with ERP migration project remaining on track, maybe a little bit better than what you would expect in the current macro, offsetting just the more general difficult macro consumer trends that we're seeing out there?

Thanks, Josh, for the question. I think, in particular, when I think about the ROI we're seeing from our growth in Europe, the expansion of our go-to-market teams in Europe, and the customer success management function, two key areas of our go-to-market investments. I think that it's a direct result of the increased capacity, the quality of the people we've been able to hire and starting to build a true engine around both of those areas. So I think those are really the drivers of the success that we saw more than anything that I would say is offset by the economy.

Okay. Got it. And then maybe we can get some more color on the expenses that moved to Q4 from Q3. Are some of these expenses onetime in nature? Or will they be more in the ongoing run rate of the business?

I think, Josh, it's a little more kind of stuff that we're looking for from an investment standpoint. There are some investment things we wanted to get after in the third quarter that some of those projects didn't necessarily get completed. They'll push into the fourth quarter. And again, it's all part of that investment, kind of envelope that we've been talking about that we're heavy in here in 2022. So some will continue, but the majority of that stuff is really investment related that will really start bearing fruit in the next year.

The next question comes from Matt Stotler with William Blair. Please go ahead.

Good morning. Thank you for taking the questions. Maybe just one to double-click on what you're seeing from a macro environment. Obviously, still executing above expectations. You talked about some of the resilience of the business but would love to maybe get some more granularity on the kind of puts and takes there. Any particular places you're seeing strength versus weakness and how you're thinking about those dynamics heading forward?

Thanks for the question, Matt. Yes, I think like a lot of tech companies, we're seeing a little bit of more discipline from customers in their buying decisions. We've been fortunate. We haven't seen too many elongated sales cycles, but it is something we're carefully monitoring to make sure we've got our fingers on the pulse of what decisions are being made. I think because of the fact that our software is so mission-critical to what businesses need as they're going through either expansions in the new jurisdictions or technology refreshes as part of their digital transformation, we remain on the critical path of something they have to buy anyways. And so we've not seen material shift there.

Got it. That's helpful. And maybe just one follow-up on the average revenue per customer, pretty impressive growth there, 3 or 4 points sequentially, a little over 17% year-over-year growth in AARPC. Could you just dig into what's driving that expansion of that metric and kind of the sustainability of that growth rate going forward?

Matt, I think there's two distinct drivers of what's causing that. If you think about -- since we've gone public, we've investing a lot more in R&D. And so we are increasing the number of capabilities we're delivering in the end-to-end solutions we're providing. And so by doing that, we're creating more opportunities for our sales team to deliver more value to customers. And then the second reason is the customer success management function is we're really starting to build out that capability. We're seeing good uptick and embracing of that, allowing our sales teams to focus more on new logos and our customers success management function to drive more revenue per customer. I think both of those are key drivers. And then the last piece I would add is we continue to expand in some of the ecosystems like Microsoft, we're seeing good adoption of some of our -- of the upper end of the middle market. And I think that continues to drive new revenue growth for us per customer.

Very helpful. Thanks again.

The next question comes from Adam Hotchkiss with Goldman Sachs. Please go ahead.

Great. Good morning and thanks very much for the questions. To start, David, I would love to just dig in on some of the drivers behind competitive wins you're seeing. Could you talk a little bit about how win rates have been evolving and how you weigh the catalyst behind that between your content database and things you're doing on the tech innovation side? When you talk to customers, how important are some of the innovations you're doing like containerization, flux builder and some of these other things in driving incremental adoption? And then I just had a quick follow-up.

Sure, Adam. I would say that continuing to add new capabilities by listening to our customers and really allowing them to co-design some of the solutions we bring to market is really a valuable part of the success we're enjoying and from a competitive perspective because the customers know they have a voice in how we're bringing things to market and solving the problems they have. From a competitive perspective, there hasn't been too much of a change from what we consistently see pretty much in the mid and upper end of the market, it's Thomson Reuters, who we compete with and that remains consistent. And outside the U.S., we certainly see Thompson and Sovos being our primary competitors, and that really has not changed. Adam?

The next question comes from Daniel Jester with BMO Capital Markets. Please go ahead.

Good morning, everybody. Thanks for taking my question. David, maybe could you just remind everybody where we are on this investment cycle? Obviously, you've been investing very deeply in the business since the IPO, which has pressured margins and cash flow. Are we going to start to harvest some of this in 2023? Is 2023 still going to be an investment year, love sort of a sense of where we are in this journey.

Yes. Dan, thank you for the question. Consistent with the plan, we have been investing heavily in go-to-market tax content database and our R&D on new products. And I think that's been the drivers of the ARR growth and the revenue growth that we've enjoyed. We absolutely have seen it impact free cash flow. But I think we are coming to the end of some of that as we move into '23. I think you'll start to see the true ROI from that and cash flow from that stope in the back half of '23. And certainly, we'll be watching the economic environment to make sure our pipeline remains strong. We're fortunate being an enterprise player. We have good visibility into our pipeline. And so -- but that will also give us the metrics we need if we need to slow down any of those investments.

Got you. And then just a follow-up on Taxamo, maybe an update on how that is progressing, the integration and getting that out to clients in Europe.

Yes. And Taxamo is really a global solution. It's not just Europe. And I think what we're seeing now with some of the marketplaces we've been winning is we're realizing great opportunity from that investment. And it's starting to show up in more and more situations where we can expand share of wallet with the existing customers as they're looking to continue to diversify their businesses with their own private marketplaces and all that the Taxamo resources have been -- and capabilities has been well received in the market.

Great. Thanks very much.

The next question comes from Andrew DeGasperi with Berenberg. Please go ahead.

Good morning. Just wanted to ask a question on the customer count, specifically. I think you mentioned the lower end customers are transitioning to indirect. I was just wondering, first of all, is there a lag between that transition. And then as those customers move to the indirect channel, is it likely that you could benefit from a margin perspective longer term?

Yes. Andrew, great question. Thanks. We appreciate it. I think we are seeing the customers move. Again, they're moving -- we are seeing some degradation as they move and find other solutions. I think as we've transitioned our go-to-market focus, our go-to-market focus is on looking at those smaller customers through the indirect channel. So it is taking some time to build that up. I think from an overall standpoint, I think I don't anticipate any big wild swings in our margins and how that would impact our margins over the longer term. But it's something that we really feel like we need to stay after, continue to have a solution that's out there and make sure that it's being put forth in the best possible way, and we think that indirect is the way to go there.

Got it. And I guess that means that you would spend less resources with those customers that are generating under 10,000 a year I just want to confirm that?

Yes.

That makes sense. Right. And then I guess on the -- just broadly speaking, trying to get a pulse on the different end markets and geographies. Can you maybe elaborate what's going on in Europe versus U.S.? And maybe what verticals are stronger versus others?

So from a Europe perspective, I realize it's bucking a little against the trend that a lot of tech companies are seeing. We continue to see good activity and had a good quarter relative to our expectations. And I think it's because of a few things. I've spoken in the past about the importance of our partnerships with SAP and the alliances. And that is really -- is really taking hold, and we're doing a lot of work with the direct SAP sales teams. And I think so we're delivering more customer value in those conversations, which is secure. And then the other piece is the referenceability. Talked about for a number of quarters now, the importance of having marquee customers who are referenceable to their peers as you go to expand in a geo. And we have really begun to build some marquee customers in Europe that are giving us strong references that plays very well at the enterprise market. It's a playbook we've run in North America for years, and we're seeing it start to bear fruit with our go-to-market investments in Europe. The other piece relative to vertical I'm thrilled with the investment we made in oil and gas, and our team has done a great job of learning and really building some expertise in that discipline, and we're seeing good uptick there. While not a vertical, the edge solution that we've advanced this year is really getting some nice traction, and we're seeing some considerable opportunities to expand that as we move into '23.

Great. Thank you.

The next question comes from Keith Weiss with Morgan Stanley. Please go ahead.

Hi, good morning. It's Jonathan on for Keith. Thanks for taking my question. You talked about churn at the low end of the market. What gives you confidence that this doesn't permit upward?

Yes. Well, I think 40-plus years in doing the business of the enterprise market, we're very confident that -- and in fact, if you look at our GRO over the last six quarters, it's grown consistently and been very solid every quarter. So I think we know it from that perspective. I think you have to understand, back to the history of where we got into that low end of the market. It was an introduction of our cloud product as a proof point. We didn't want to expose our brands at the upper end of the market, so we intentionally took on a myriad of smaller customers and not surprising as we've now perfected and now have the recognized as one of the leading SaaS solutions in the industry. We're focused on the enterprise -- the mid and enterprise market. And so that low end of the market, I'm not surprised at all we're seeing some of that churn, but it really is not part of our core strategy. So it doesn't affect me at all.

Thanks for the color there. And I want to dig into some of the questions on the investment side. How are you thinking about your investments in the mid-market, particularly given what you're seeing in the macro environment?

Yes. Great. I appreciate the question. I think what we're trying to do there is be really targeted into a few ecosystems that we know there is considerable customer pain and market opportunity as opposed to a broader -- let's build 100 connectors and just spray the market with a lot of investment that may not pay off. And so I think the team has got a very disciplined approach about the unique areas we're trying to go real deep and deliver value prop in a very -- in specific ecosystems in the mid-market to try to manage that risk.

Helpful. Thanks guys.

The next question comes from Brad Reback with Stifel. Please go ahead.

Great. Thanks very much. David, can you remind us how you guys get paid and so much as if your customers' business flows and they use you less, does that mean you get paid less? Or is it fully fixed?

Yes. No. So we have new bands in our licensing. And so those revenue bands give each customer a broad range, both up and down before they would change ranges and having been through the '08, '09 recession and what happened in '01. I'm pretty comfortable feeling like those bands are well apportioned to minimize any exposure that short-term downside affect one customer but not really affect our overall revenue strength.

That's great. And then switching gears, ARR growth decelerated a bit sequentially after being in a bit of a higher range the last few quarters. How should we think about the -- what should we think about the reasons for that? And then how should we think about that growth rate going forward? Thanks.

Yes. Very much appreciate the question, Brad. I think as we think about the 16.6, we feel very good about what that number is. We think it's strong and healthy growth. We're proud of how that result has come through. I think as we think about -- we look at the rest of our business, we look at some of the other metrics. They continue to be very strong. But again, I think -- when we think about moving forward and what that means as we go forward, we need to be mindful of last year, we had a very strong back half of the year. So we have to be attentive to that. And especially given some of the kind of economic considerations that are out there. We want to be very mindful and we were mindful when we set our guidance to ensure that we kind of took that into account as well. So we're trying to be thoughtful about that. But in terms of -- we don't necessarily guide to ARR, but again, I think we're mindful of kind of what the economic environment is looking like and how we're shaping up as it relates to that.

That's great. Thanks very much.

The next question comes from Steve Enders with Citi. Please go ahead.

I just have a quick housekeeping question. Was there just any FX impact in the quarter that impact either the ARR or revenue or billing side to call out?

No, nothing to speak of.

Okay. That's helpful. And then just higher level, I just wanted to dig in a little bit more on the mid-market investments you're making. It seems like having really good traction with the Microsoft ecosystem and NetSuite those routes kind of called out. But how are you kind of thinking about the opportunity and kind of the further investments you're making to kind of penetrate the mid-market ecosystem at this point?

Yes, Steve, I think, again, back to the point of discipline, I think what we've proven to ourselves over the years with the ecosystem we invest taking Oracle and SAP as examples by going really strong in the quality of our integrations the understanding of their customer base, working closely with the partner and the ecosystem around it. We've been able to deeply our win rates and all justify the success we have. And so I think we're applying the same playbook to a few select mid-market channels as opposed to a spray and pray build 100 connectors and hope we get uptake in the environment. And so I think that's still translating well. And so I think that you'll hear more of those successes in very staged ecosystems as opposed to just -- a broad base of that mid-market. And I think that discipline not only -- it also gives us a metering of our investment portfolio, which I think, again, in the current environment, is prudent.

Okay. And then just on the macro, I just want to clarify a little bit more. It doesn't seem like there's anything that's impacting the top of funnel and new pipeline build. But is there anything that you would call out that's either -- is there a slowing in terms of deals coming in or anything to call out that you are seeing anything, at least on the pipeline side?

In the law of large numbers, we saw a few sales cycles elongate, but nothing that I'm like overly concerned about at this point. It's something we're going to monitor very carefully as we get deeper into the fourth quarter, obviously. And we tried to -- we raised our guidance because we still have good visibility to our pipeline. I think that it's a reflection of the strength of our offerings and the mission criticality of what we do. But it will be something we monitor very carefully as we think about the rest of the year. We watch the rest of the year unfold and we think about 2023.

Okay, perfect. Thanks for taking my questions.

The next question comes from Patrick Walravens from JMP Securities. Please go ahead.

Great. Thanks. And let me add my congratulations. I have a couple. So first of all, John, the cloud looks like it accelerated. I mean I think you added $1.9 million in revenue and cloud revenue sequentially last quarter and this quarter, it's $3.6 million. So is that just -- what's the reason for that? Is something positive going on? Is it just the way the revenue gets recognized?

Yes. I mean, listen, I think as you well know, Pat, I mean, we've been focused on cloud first. I mean that's where all our development resources sources are going, that is where the sales team is focused. That's what we are going to market with. And I think that activity and the investments we've been making, as David talked about, are really starting to bear fruit, and we're starting to see a lot of the activity there. Again, 90 plus percent of the new logo opportunities that come in are looking for cloud, as you would expect, because that's the product that we've been really putting most of our effort behind in getting ready. So I think it's a lot to do with that, and it's a lot to do with that investment cycle that we've talked about.

Awesome. And then just another big picture one for you, John, and you've mentioned a couple of these things so far, but just clearly, you're not guiding yet for 2023, but what sort of key points would you want investors to keep in mind?

Yes. Listen, you're right. We don't give guidance out for 2023 as we sit here today. I think we feel that we've got a very strong business. The business has been growing nicely. We've had nice top line growth through 2022. Things have been going well. We've been able to -- we've been very thoughtful about the guidance that we put together throughout 2020 to since 2021 and 2022 and very mindful of that. So we're going to certainly proceed in a similar fashion with the prudence that we've done in the past. But again, as we think about next year, it's we're going to take a little bit more time to kind of evaluate some of those bigger macro things that I think are starting to play out a little bit more. But again, from the place where we sit with mission-critical software and the long sort of pipeline that sort of that we operate in because of the nature of the customers we have, we feel pretty good about what -- when we talk about visibility, we feel like we've got nice visibility as to what the future portends.

Great. And then, David, for you, are you guys hiring? I saw like 90 open jobs on the website when I just checked. Are you finding it easier to get talent given that not a lot of other people are hiring anymore?

We are still hiring. We've been fortunate. We still have opportunities for growth. And I think that it is something we'll obviously be very thoughtful about here, again, managing pipeline and opportunity with our hiring trend. But yes, we are actively still hiring. And our hiring environment has gotten a little easier. It's still, I think, for engineering talent and tax talent, it's still a tighter environment than maybe some others, but certainly that we all read some recent layoffs that might free up some wonderful capacity for us in the future.

Congratulations. Thanks guys.

The next question comes from Samad Samana with Jefferies. Please go ahead.

Hi, everyone. This is Jordan Boretz on for Samad. Congrats on the impressive results, especially in light of the tough macro. I wanted to ask a quick follow-up to Pat's question for you, John. So obviously, cloud growth of 33% is pretty strong, and it implies that the net new revenue for cloud in the fourth quarter is about double that of last. So could you remind us, are you incentivizing your enterprise customers to switch from on-prem to cloud? And are you doing that discounting or any feature incentives or anything like that?

No, we don't have programs in to incent that. Again, you need to remember, as we talk a little bit through this, the primary the primary person that we are focused on spending time with and marketing to are the tax directors, et cetera. When it comes down to the decision making around deployment, typically that falls into some -- into another area of the company. Again, somebody that's involved in the decision and the process -- but really, it's a little bit of a different decision. And that decision many times, whether it's cloud or whether it's on-prem, is going to really follow whatever the path of the technology cycle that the companies are on. So while we would love to push that many times, it's part of a bigger wholesale move. And we see customers migrating it's not, hi, we're just taking our tax technology and moving it to the cloud. It's more things are getting moved or there's a push to digitization that they haven't had before.

Great. That's really, really helpful. And then a quick follow-up. Profitability was impressive, and you called out a push out in some expenses into the fourth quarter. Still free cash flow, maybe it was a bit lighter than we expected initially. And it looks like part of that was working capital. So were there any changes maybe to collections or anything working capital worth calling out? And how should we think about how working capital is going to trend ahead maybe in the fourth quarter and then through 2023?

Yes. There weren't any changes to anything that we've done with respect to working capital and how that has played out over the handful of quarters. I think what I would tell you is when we look to the fourth quarter, fourth quarter is typically when a lot of those year-end billings start rolling in. So it's usually a strong cash generative quarter for us historically. We anticipate to see, again, an uptick in the amount of cash that's coming in. So we expect to see that. But I think as we've talked about this year in 2022 has been a big investment year. That certainly manifests itself and hit with a lot of cash and extra cash flow drain than in the prior years. But I think this is part of the plan that David has outlined, and we're continuing to stick to that. We feel good about the investments that we're making. We're starting to see the ROI start to show itself, and we hope to see more of that show up in 2023.

Great. Appreciate for taking the questions.

The next question comes from Adam Hotchkiss with Goldman Sachs. Please go ahead.

Thanks for the follow-up guys. And apologies for the connection issues after my first question earlier. John, just wanted to dig in a little on how you're thinking about NRR going forward. Obviously, some real durability in gross retention. Could you just begin on the upsell side, what are you seeing customers prioritizing the current macro between incremental geos and products? Is that any different than what you would typically see? And then could you just remind us you think about prior slower macro environments like the global financial crisis, the impacts, if any, to volume down sell or holding steady at renewal for customers? And anything you're seeing there over the last couple of months? Thanks so much.

Sure. No, thanks, Adam. Appreciate it. In terms of kind of our NRR, again, the NRR continues to be very strong. We're pleased with the results that we're seeing there. I wouldn't say there's a real difference in the types of products or the geos or the areas that's really coming from. We haven't seen a big move there in terms of kind of the components that make that makes that stuff up. So that's not been a real big driver. And we feel pretty good about how that's going to play out -- how that will play out as we move forward. And the second part of your question, Adam, I just want to make sure I get that.

Yes. No, could you just remind us what -- when you look back at prior slower macro...

Yes, no problem. When we look back at the prior kind of the prior sort of slowdowns or turndowns in the economy, again, on an overall basis, the company grew through those nicely. And so we feel very good about sort of what that might mean to us. In terms of the componentry that makes up the NRR, again, it's a customer-by-customer specific thing. I think what we expect, we may see is that -- we may see some of that those additional entitlements or those additional volumes with certain of the customers starting to slow down a little bit, like so additional volume with existing products might not be as robust as it had been because the economy is slowing down, which makes sense. But again, there will continue to be customers certainly in the enterprise, expanding their geographic footprint and doing things that they can to bring tax into solutions like ours that are going to allow them for a global solution.

Great. Super helpful. Thanks for the follow-up.

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

Thanks, everybody, for joining us today. If you have follow-up questions or would like to schedule time with the team, please e-mail me at ir@vertexinc.com. And with that, thanks, and have a great day.

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