Vertex, Inc. — Q2 2020 Form 10-Q
Period: Three and six months ended June 30, 2020; unaudited. Unless noted, amounts are in millions of dollars. Vertex provides indirect-tax software subscriptions and related services. It reported as one operating segment.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $91.3 | $78.4 | $180.5 | $153.0 |
| Revenue growth | 16.5% | — | 18.0% | — |
| Gross profit / GAAP gross margin | $49.5 / 54.3% | $51.3 / 65.4% | $99.3 / 55.0% | $100.3 / 65.6% |
| Operating income (loss) | $(29.0) | $7.7 | $(57.2) | $15.4 |
| Net income (loss) | $(29.1) | $7.1 | $(58.1) | $14.4 |
| Adjusted EBITDA / margin | $21.5 / 23.6% | $15.5 / 19.8% | $36.8 / 20.4% | $31.1 / 20.4% |
| Operating cash flow | Not separately stated | Not separately stated | $20.8 | $32.9 |
| Free cash flow | $18.7 | $14.7 | $2.9 | $16.5 |
Revenue growth came from subscriptions and services: Q2 subscription revenue rose 14.9% and services revenue 25.7% year over year. Six-month increases were 16.3% and 28.6%, respectively. Management attributed subscription growth primarily to existing customers. ARR was $294.6 million at June 30, up 16.4% year over year; net revenue retention was 108%, unchanged from 2019.
Liquidity, debt, and balance sheet
- At June 30, cash and cash equivalents were $47.3 million; an additional $10.0 million was held for customers and restricted for tax remittances. Current assets were $134.4 million and current liabilities $278.5 million.
- Long-term debt was $173.4 million, with $0.6 million current debt; the company also had a $100 million undrawn credit line. The $175 million term loan was repaid on July 31 using IPO proceeds. Vertex said it had no outstanding bank debt after repayment.
- Six-month cash declined by $26.2 million to $57.3 million, including restricted customer funds. Investing used $30.1 million, including $12.3 million for Systax; financing used $16.6 million and included $140.4 million of stockholder distributions.
- Free cash flow fell year over year for the half-year, largely reflecting lower operating cash flow and billing-timing changes requested by customers, which management said reduced deferred revenue temporarily without affecting revenue.
Material changes and unusual items
- Stock-based compensation rose to $41.7 million in Q2 and $76.6 million in the first half, from $1.3 million and $2.6 million, respectively. Management linked the sharp increase primarily to remeasurement of stock appreciation rights as the company approached its IPO. This materially affected GAAP expenses, gross margin, and reported losses.
- Vertex acquired a 60% controlling interest in Brazilian tax-software provider Systax in January for cash consideration of $12.4 million. It recorded a preliminary $14.3 million liability for future purchases of the remaining interest, which are scheduled through 2024; settlement amounts depend on Systax performance.
- On July 31, Vertex completed its IPO, selling 23.8 million shares at $19 per share and receiving approximately $423.0 million net of underwriting fees. It used part of the proceeds to repay the term loan; remaining proceeds were designated for working capital and general corporate purposes.
- The S corporation election ended July 27, and Vertex became a C corporation. Management projected an effective tax rate of about 25% going forward and estimated a $27.2 million tax benefit in Q3 2020. The filing presents pro forma Q2 and first-half 2020 net losses of $22.5 million and $44.0 million, respectively, reflecting corporate-level taxes.
- Management estimated approximately $57 million of additional compensation expense for vested converted SARs through the IPO date, with approximately $44 million related to unvested awards to be recognized over service periods through 2025. These are estimates disclosed in the filing, not Q2 reported expenses.
Outlook, risks, and controls
No formal revenue or earnings guidance is provided. Management said COVID-19 had minimally affected first-half revenue and results; Q2 new software billings exceeded its original forecast. It cautioned that pandemic-related uncertainty could affect new-customer billings, customer expansion, and collections for the remainder of 2020. Management reported ample liquidity and expected resources to meet operating needs.
Management expects continued investment in research and development, sales and marketing, infrastructure, and public-company compliance. Key risks include customer renewals and expansion, competition, changing tax rules, cybersecurity and service interruptions, international and currency exposure, and acquisition integration. The Systax purchase commitment adds exposure to Brazilian real fluctuations; Vertex reported forward contracts hedging about 40% of that exposure.
Disclosure controls were deemed ineffective as of June 30 due to previously identified material weaknesses in revenue-recognition review, software-cost capitalization and impairment controls, and user-access segregation. Remediation was underway but not yet demonstrated effective. Management stated that additional analyses and procedures supported fair presentation of the interim financial statements. No material adverse legal proceeding was identified. Management expected adoption of the lease standard in 2021 to materially increase assets and liabilities, with no material income-statement or cash-flow impact expected.
Important facts for investors to verify
- How much of the reported loss and margin deterioration reflects IPO-related SAR remeasurement, and what compensation expense will follow the IPO?
- Whether revenue growth, ARR expansion, and 108% retention continue as COVID-19 affects new sales, customer budgets, and collections.
- How operating cash flow and free cash flow develop as billing schedules normalize, deferred revenue changes, and investment spending continues.
- The final Systax purchase commitment, its performance-based valuation, and foreign-exchange exposure.
- Progress in remediating material weaknesses and the timing and effects of C-corporation taxation and lease-standard adoption.