Vertex, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; financial statements are unaudited. Unless noted otherwise, amounts below are in U.S. dollars. Comparisons are with Q1 2022 or December 31, 2022, as applicable.
Business context
Vertex provides indirect-tax software and related services, including cloud and on-premise subscriptions, implementation, training, and managed tax-return services. It operates as one reportable segment. Subscription revenue is generally recognized over the contract term, and many customers are billed annually in advance.
Financial results and key metrics
| Metric | Q1 2023 | Q1 2022 / comparator |
|---|---|---|
| Revenue | $132.8 million | $115.0 million; up 15.5% |
| Software subscriptions | $111.0 million; up 14.3% | $97.1 million |
| Services | $21.7 million; up 21.8% | $17.9 million |
| Gross profit / margin | $81.0 million / 61.0% | $70.1 million / 61.0% |
| Operating loss / margin | $(8.9) million / (6.6)% | Operating income of $0.5 million / 0.4% |
| Net loss / margin | $(18.1) million / (13.7)% | $(0.3) million / (0.3)% |
| Adjusted EBITDA / margin (non-GAAP) | $20.2 million / 15.2% | $19.1 million / 16.6% |
| Operating cash flow | $6.8 million | $2.6 million |
| Free cash flow / margin (non-GAAP) | $(10.6) million / (8.0)% | $(14.2) million / (12.3)% |
| Cash and cash equivalents at period end | $68.6 million | $91.8 million at Dec. 31, 2022 |
| Available-for-sale investments at period end | $11.5 million | $11.2 million at Dec. 31, 2022 |
| Debt at period end | $48.6 million, net of financing costs | $48.9 million at Dec. 31, 2022 |
Gross margin was unchanged year over year, while operating costs grew faster than revenue. Research and development rose 64.7%, selling and marketing 30.2%, and general and administrative expense 19.3%. Stock-based compensation increased to $11.4 million from $4.9 million.
ARR was $446.5 million at March 31, up 17.3% year over year. Net revenue retention was 110% and gross revenue retention was 96%, both unchanged from the prior-year measures. Cloud represented 43% of software subscription revenue, compared with 39% a year earlier. The company reported 4,278 subscription customers and AARPC of approximately $104,370.
Material changes and cash, debt, and liquidity
- Revenue growth was attributed primarily to expanded use and price increases among existing customers, as well as services growth. Management cited $40.0 million of ARR growth from existing customers and $25.9 million from new customers.
- Operating expenses increased $20.3 million year over year, exceeding the $10.9 million increase in gross profit. Management attributed spending growth to hiring and product development, marketing and brand investment, and technology, process, and public-company infrastructure investments.
- Operating cash flow improved by $4.2 million year over year, but capital expenditure and capitalized software development resulted in negative free cash flow of $10.6 million. Investing activities used $17.6 million; financing activities used $1.5 million. Cash, cash equivalents, and restricted cash declined by $12.1 million during the quarter.
- The company had a $200 million revolving credit facility with no borrowings and a $50 million term loan. It reported $48.6 million of bank debt, net of financing costs. Variable borrowing rates were 8.00% based on the base rate or 5.72% based on SOFR, plus the applicable margin, as described in the filing.
- Funds held for customers were $26.0 million and are restricted for customer tax remittances; they should not be treated as freely available operating cash. Related customer-funds obligations were $23.1 million.
Outlook, commentary, risks, and unusual items
- The filing provides no specific numerical revenue, earnings, or cash-flow guidance. Management said existing cash resources and the undrawn credit line should be sufficient for operating and capital needs, and described liquidity as ample.
- Management expects continued investment and absolute-dollar cost growth in areas including cloud infrastructure, personnel, research and development, and sales and marketing. It noted that product development spending may not achieve market acceptance and could result in impairment of capitalized development costs.
- The GAAP effective tax rate was an expense of 111.4%. The $9.6 million tax expense despite a pretax loss reflected state and foreign tax effects, limits on certain compensation deductions, and a valuation allowance on certain foreign deferred tax assets.
- Foreign currency, variable interest rates, customer renewal and expansion, competition, cybersecurity and data privacy, system or service-provider failures, and the ability to execute growth plans are among the cited risks. A 100-basis-point increase in base or SOFR rates was estimated to increase annual interest expense by $0.5 million on the relevant borrowing exposure.
- Vertex’s lawsuit against Avalara alleges unfair competition, interference with contractual relations, and trade-secret misappropriation. The matter remained in jurisdictional discovery; the company said the outcome and potential impact are uncertain. Management reported no other legal proceedings it believed would have a material adverse effect.
- Other notable items include $0.2 million of increased Tellutax contingent consideration expense and $11.4 million in stock-based compensation. The company said there were no material changes to its risk factors, no defaults on senior securities, and disclosure controls were effective at a reasonable-assurance level.
Important facts for investors to verify
- Whether subscription and ARR growth, retention rates, and the shift toward cloud continue, and how much growth comes from existing versus new customers.
- Whether operating expenses and stock-based compensation moderate relative to revenue growth, given the decline in adjusted EBITDA margin and GAAP operating loss.
- Cash conversion and investment needs: operating cash flow improved, but free cash flow remained negative after property, equipment, and software spending.
- Available liquidity after distinguishing unrestricted cash from customer funds, and the terms, variable rates, and covenant capacity of the debt facilities.
- The drivers and sustainability of the unusually high tax expense, including the foreign deferred-tax-asset valuation allowance.
- Developments in the Avalara litigation, contingent acquisition obligations, and currency and interest-rate exposures.