Vertex, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; interim financial statements are unaudited. Unless noted otherwise, dollar amounts below are in millions.
Business context and reporting period
Vertex sells indirect-tax compliance software and related services, including cloud and on-premise subscriptions, implementation, and managed tax-return services. It reported one operating segment and more than 4,000 customers. The quarter included the company’s transition from an S corporation to a C corporation and its July 2020 initial public offering (IPO).
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $94.6 | $82.4 | $275.1 | $235.4 |
| Gross profit | $46.6 | $55.0 | $145.9 | $155.3 |
| Gross margin | 49.3% | 66.7% | 53.1% | 66.0% |
| Operating income (loss) | $(50.0) | $12.3 | $(107.3) | $27.8 |
| Net income (loss) | $(21.0) | $11.9 | $(79.2) | $26.3 |
| Adjusted EBITDA | $22.5 | $19.6 | $59.3 | $50.8 |
| Adjusted EBITDA margin | 23.8% | 23.8% | 21.6% | 21.6% |
- Q3 subscription revenue rose 12.3% and services revenue rose 30.1% year over year. For the nine-month period, subscription revenue increased 14.9% and services revenue increased 29.1%.
- GAAP operating and net results were heavily affected by stock-based compensation: expense was $64.3 million in Q3 and $140.9 million for the nine months, compared with $1.3 million and $3.9 million, respectively, in 2019. Management attributed the increase principally to the IPO-related treatment and valuation of stock awards.
- Q3 income-tax benefit was $30.8 million; the company recorded a $32.4 million deferred tax asset in connection with its C-corporation conversion. The filing’s pro forma, tax-adjusted net loss per share was $0.28 for Q3 and $0.65 for the nine-month period.
- Nine-month operating cash flow was $20.0 million, down from $45.8 million. Free cash flow, a company-defined non-GAAP measure, was $18.7 million versus $20.1 million; it adds back $22.9 million of IPO-related SAR redemptions before capital expenditures and capitalized software.
- Cash and cash equivalents were $270.3 million at September 30; an additional $8.7 million was held for customers and restricted for customer tax remittances. Current assets were $361.8 million and current liabilities $263.5 million. Deferred revenue totaled $197.5 million, down from $205.8 million at year-end 2019.
- The company reported no bank debt at quarter-end and had a $100 million revolving credit facility with no borrowings. Balance-sheet debt of approximately $1.5 million primarily reflected capital leases. The facility matures in 2025, is secured by certain assets, and includes covenants; Vertex reported compliance at September 30.
Material changes versus prior periods
- Revenue grew, but GAAP gross margin fell to 49.3% in Q3 from 66.7%, largely reflecting the substantial increase in stock-based compensation recorded in cost of revenue. Management’s non-GAAP gross margin, which excludes specified expenses, was 71.4% versus 71.6%.
- ARR increased 15.4% year over year to $306.5 million. Net revenue retention declined slightly, to 108% from 109%, primarily due to reduced new sales to existing customers.
- Vertex completed its IPO, receiving approximately $423.0 million net of underwriting discounts and commissions from its own shares. It used $175.0 million of proceeds to repay the term loan. The company also paid $146.1 million in stockholder distributions during the first nine months, primarily before the S-corporation election ended.
- In January 2020, Vertex acquired a 60% controlling interest in Brazilian tax-software provider Systax for $12.4 million cash. It recorded preliminary goodwill of $26.1 million at acquisition, subsequently reduced to $18.7 million, including foreign-currency translation effects. The company has a commitment to acquire the remaining 40% incrementally through 2024; the recorded future acquisition commitment was $10.3 million at September 30.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management said it expects sufficient cash and available credit to fund operations for at least 12 months and described ongoing investment in sales, marketing, research and development, infrastructure, and public-company capabilities.
- COVID-19 had not caused significant reductions in sales, revenue, or collections through September 30. Q3 new software billings exceeded management’s original forecast, but management cautioned that pandemic-related uncertainty could affect new-customer billings, expansion sales, and collection timing for the rest of 2020.
- IPO-related stock-award accounting, the tax-status conversion, debt repayment and financing-cost write-offs, and the Systax acquisition materially affect comparability. Adjusted EBITDA and free cash flow are non-GAAP measures; their definitions and exclusions differ from GAAP results.
- Management concluded disclosure controls and procedures were not effective at September 30 because of previously identified material weaknesses involving revenue-recognition review, software capitalization and impairment, and access controls/segregation of duties. Remediation was underway but had not been demonstrated effective for a sufficient period. Management said additional procedures supported fair presentation of the interim statements.
- The company reported no known legal proceedings believed likely to have a material adverse effect and no material changes to the risk factors reported in its prior quarterly filing. Risks include COVID-19, customer renewals and growth, cybersecurity and service-provider disruptions, tax compliance, and international and currency exposure.
Important facts for investors to verify
- How much of the GAAP loss and margin decline reflects IPO-related stock compensation, and what recurring expense and dilution may follow from unrecognized awards?
- Whether ARR growth, 108% net revenue retention, and cloud-subscription growth continue, particularly if customer budgets or new-customer billings weaken.
- Cash generation after accounting for the SAR redemption, changes in deferred revenue, and ongoing investment; also confirm the availability and covenant terms of the unused revolver.
- The final Systax purchase-price allocation and future payments for the remaining ownership interest, which depend partly on performance and exchange rates.
- Progress in remediating the disclosed internal-control material weaknesses, and the eventual balance-sheet effect of adopting lease accounting in 2021.
- The voting implications of the dual-class structure: Class B shares carry ten votes per share, compared with one vote for Class A shares.