Vertex, Inc. (VERX) Q3 2022 Earnings Call Transcript

Good day, and welcome to the Vertex Incorporated Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. 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 for nine consecutive quarters since going public. And once again, we 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 scrutinizing their budgets more carefully and, in some cases, elongating sales cycles. We believe our third quarter results are 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 challenging economic times, governments rely on the enforcement of indirect taxes to sustain their revenues. This leads to additional audit pressures on corporate taxpayers, which in turn leads to demand for Vertex solutions. Our third quarter performance underscores the value Vertex brings to our customers every day and confidence in our solutions to manage compliance at scale for global enterprises. It also speaks to the strength and durability of our partnerships, with leading technology providers and accounting firms. In October, we held the Annual Vertex Exchange Conference in Las Vegas, where we welcomed a record number of customers, partners and industry thought leaders, representing the most dynamic businesses in the world. Attendees showed great interest in the new solutions we've introduced to the market and our recent acquisitions. There was positive sentiment for our approach for a single extensible global platform to deliver value to the business faster. With flexibility built-in, we can support our customers as their business evolves. It's a key reason why customers remain so loyal to Vertex as they require new compliance capability and migrate to the cloud. At the exchange, customers confirmed they need three things from Vertex's solutions: increased speed, improved compliance accuracy, and enhanced value from their technology investments. As an example, at a conversation at exchange with a new customer from the oil and gas vertical, who remarked, that since installing Vertex, he knows he has less audit risk; it has enhanced the efficiency of the team to work on other challenges. This was a tremendous validation in an industry where we have made a significant investment over the past several quarters. These conversations reinforce the value of our strategy and the investments we've been making to build on our best tax content database, deliver new solutions and expand go-to-market capacity. Now let me shift to a few business insights from the quarter. We had another strong quarter in Europe, where we are replicating our formula for enterprise market success by combining strong partnerships, fit-for-purpose solutions, and customer referenceability. We understand to drive continued success, we must think global but act local. Meaning that while companies are looking for global capabilities and solutions, it is still critical in these deals that we demonstrate a connection to an understanding of the local environment, and that is why we are investing in the growth of our teams and partnerships in the region. Our relationships with the world's leading technology platforms, consulting firms, and implementation partners often cement the decision just like Vertex in competitive deals. In Q3 we won the business of a leading European-based Fortune 500 company in the food and beverage industry. We won this in partnership with SAP and Grant Thornton. This customer needed a cohesive solution to support their global digital transformation. Their mission was clear: make it easier for the customers to do business with them. To get there, they are implementing the best-of-breed digital platforms for all their key business processes. Our certified connectors will allow them to seamlessly plug into the technologies they rely on each day, including SAP, Microsoft D365, and Salesforce. We are uniquely positioned with a solution that can support all their systems simultaneously. Our connectors enable Vertex to be integrated into the integral systems where transactions are occurring in the business today. This creates a seamless, intuitive, and intelligent experience for our customers. Throughout the year, we've been working closely with Microsoft to enhance our support for D365, and we recently released a new update with enhanced capabilities for e-commerce on this platform. We're seeing an uptick in interest and wins as a result. A great example in the third quarter was a leading diversified metals solutions provider, managing over 100 entities across the nation. The company was looking to consolidate their business on one ERP platform. They needed an enterprise-scale solution to replace their manual in-house processes for tax management. Our understanding of the specific challenges metals companies face and the industry-specific solutions they need to connect with enabled this win. Another key area of differentiation is our single multi-tax type platform. That helps our customers to meet their end-to-end global requirements across a multitude of systems and enables scale. Let me now highlight a competitive cloud takeaway. In this win, customer experience is job one for this point-of-sale solutions provider. The end-to-end solution they selected from Vertex includes global tax calculation with deployment on the edge and multi-system integrations to SAP, NetSuite, and their e-commerce platforms using Salesforce and their mobile app. The incumbent provider could not meet these requirements. This customer also selected our newly released TestSuite Tool. On that point, I'm really excited about the new tools we released in the third quarter. TestSuite, which is purpose-built for SAP, automates and expands the scope of testing for our customers. We also launched FLUX Builder in Q3. Both tools are part of our suite of offerings that improve end-to-end processes and user experience for our customers running on SAP. After only one month in the market, we're already seeing pipeline growth for these tools. This quarter, we had multiple six-figure installed-base deals tied to global expansion and cloud migration. A Global 500 healthcare company was one of them, moving from our on-premise solution to our cloud solution as part of their SAP S/4HANA initiative. Like most of our on-premise customers, they chose to stay with Vertex on their journey to the cloud, thanks to our strong connection to their ERP and procurement solutions, but also our ability to support their consumer's use tax requirements. Their years of proven confidence in the results our solution provides made the decision to stay with Vertex a no-brainer, because tax buyers value accuracy and risk avoidance far above their deployment choice of cloud or on-premise. Through this success, we continue to see how our end-to-end platform, robust global tax content, and trusted partner ecosystem are differentiating us in deals and delivering value for our customers. Our relentless commitment to deliver exceptional customer experience was recognized this quarter. Vertex was awarded IDC's 2022 SaaS CSAT award for tax. This award recognizes the industry's leading SaaS providers, and what makes it even more meaningful is that winners are determined based on a survey of over 2,000 global companies of all sizes, who were surveyed on 30 different metrics including brand, user experience, and value. In IDC's 2022 SaaSPath survey, Vertex received the highest rating among SaaS tax vendors for overall customer satisfaction. This is a testament to the hard work of the entire Vertex team. Now I'd like to hand it over to John for a deeper look at this quarter's numbers and then I'll make a few closing comments before we transition to Q&A.

Thanks David and good morning, everyone. I'll now review our third quarter financial results and provide fourth 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 service is 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 number of customers generating greater than $100,000 of ARR grew into the low to mid-teens both on a year-over-year and on an annualized sequential basis. It is also noteworthy that our average annual revenue per customer or AARPC has steadily increased and was $97,300 in the third quarter, up from $93,850 in the second quarter. Note that AARPC is based on the direct customer count only. We continue to see strong growth in our cloud-based solutions among both existing and new customers. Revenues from cloud-based solutions grew to $43.8 million, an increase of 31.3% over the prior year comparable quarter. As I've discussed in the remainder of the income statement, please note that unless otherwise stated, all references to our expenses, operating results, and per share results are on a non-GAAP basis. All non-GAAP financial measures are detailed and reconciled to our GAAP results in the earnings press release that was issued this morning. Gross profit for the third quarter was $87.6 million and our gross margin was 69.4%. This compares with gross profit of $78.9 million and a 71.3% gross margin in the same period last year. As a reminder to investors, in 2022, operating expenses are being impacted by investments that we're making for continued growth, including R&D, sales, marketing, and IT infrastructure. Accordingly, in the third quarter our research and development expense was $9.8 million or 7.7% of revenues compared to $9 million or 8.1% of revenues in last year's third quarter. Our total R&D spend, which includes capitalized costs, is up $4.3 million year-over-year in the quarter and $8.4 million year-over-year for the nine-month period. Selling and marketing expense was $27.9 million or 22.1% of total revenues, an increase of $4.8 million and approximately 20.5% from the prior year period. General and administrative expense was $29.3 million or 23.2% of total revenues, an increase of $4.4 million from the prior year period. Our growth investments, in turn, impacted the year-over-year comps for our earnings metrics. Adjusted EBITDA was $20.7 million for the third quarter of 2022, a decrease of $600,000 over the prior year comparable period. And adjusted EBITDA margin for the third quarter of 2022 was 16.4%, down 29 basis points from last year. Turning to the balance sheet, we ended the third quarter with $72.4 million of unrestricted cash and cash equivalents. Total bank debt was $49.2 million and investment securities totaled $6.1 million. For additional liquidity, we also have $200 million of unused availability under our line-of-credit. Turning now to guidance. For the full-year 2022, we are increasing our guidance for both revenue and adjusted EBITDA. Accordingly, we now expect total revenue in the range of $484.5 to $487.5 million, representing annual growth of 14% to 15%. Adjusted EBITDA in the range of $73 million to $77 million. And we continue to expect that cloud revenue will grow by approximately 33% in 2022. The full-year guidance translates to fourth quarter revenues in the range of $124 million to $127 million, representing year-over-year growth of 11% to 14%. And fourth quarter adjusted EBITDA in the range of $15.4 million to $19.4 million. This takes into consideration that our performance exceeded our third quarter guidance, due in part to certain expenses moving to the fourth quarter. Accordingly, our adjusted EBITDA will be lower on a sequential basis. In closing, we are pleased with the third quarter financial results, up and down the P&L and balance sheet the numbers were solid and we delivered these results while continuing to invest in our business to unlock incremental growth opportunities. Our guidance reflects our optimism as we have increased our outlook for both revenue and adjusted EBITDA for the full-year of 2022. We will provide additional color on our outlook for fiscal 2023 when we announce the fourth quarter results in early March. David will now make some closing comments before we open for Q&A.

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 Total Addressable Market 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've 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.

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 one-time 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 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, three or four 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?

I believe there are two main factors contributing to this. First, since going public, we've significantly increased our investment in R&D, which has allowed us to enhance the capabilities of our end-to-end solutions. This expansion creates more opportunities for our sales team to provide increased value to our customers. The second factor is the growth of our customer success management function, which we are actively developing. We're observing positive engagement with this function, enabling our sales teams to concentrate more on acquiring new clients while our customer success management works to increase revenue per customer. Both of these elements are crucial drivers of our success. Additionally, we're continuing to grow within ecosystems like Microsoft, where we're seeing strong demand for our premium offerings, further contributing to revenue growth 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 the competitive wins you're seeing. Could you talk a little bit about how win rates have been evolving and how you weigh the catalysts 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. 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 in the mid and upper end of the market, it's Thomson Reuters, who we compete with, and that remains consistent. Outside the U.S., we certainly see Thomson and Sovos being our primary competitors, and that really has not changed.

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. 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. 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 stop in the back half of '23. 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 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. Taxamo is really a global solution. It's not just Europe. What we're seeing now with some of the marketplaces we've been winning is we're realizing great opportunity from that investment. It's starting to show up in more and more situations where we can expand share of wallet with 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 have been well received in the market.

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, that's a great question. We appreciate it. We're observing customer shifts, and while there is some decline as they explore other solutions, our focus has shifted to smaller customers through the indirect channel. Building this up is taking some time. Overall, I don't expect any significant fluctuations in our margins that would affect them in the long run. However, it's essential for us to stay committed, ensuring our solutions are presented effectively. We believe that the indirect channel is the right approach.

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. Can you elaborate on the differences in the markets and regions, specifically what's happening in Europe compared to the U.S.? Additionally, which sectors are performing better than others?

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. 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. That is really taking hold, and we're doing a lot of work with the direct SAP sales teams. I think so we're delivering more customer value in those conversations, which is secure. 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. 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. With over 40 years in the enterprise market, we are very confident in our position. If you examine our Gross Revenue Retention over the past six quarters, it has consistently grown and remained strong each quarter. Our entry into the lower end of the market was a strategic move with the launch of our cloud product as a proof point, allowing us to avoid risking our brand at the higher end. We intentionally engaged a variety of smaller customers. It’s no surprise that now, as we have refined our offerings, we are recognized as one of the leading SaaS solutions in the industry. We are focused on the mid and enterprise markets. Regarding the churn at the lower end, I’m not surprised, as this segment is not part of our core strategy, so it does not impact 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, I appreciate the question. Our goal is to focus on specific ecosystems where we recognize significant customer challenges and opportunities, rather than attempting to build numerous connectors and broadly invest in the market, which might not yield returns. The team is following a disciplined strategy to deeply engage in unique areas and provide valuable offerings specifically in the mid-market, helping to manage our risk.

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. Those revenue bands give each customer a broad range, both up and down before they would change ranges. Having been through the '08, '09 recession and what happened in '01, I'm comfortable feeling like those bands are well apportioned to minimize any exposure that short-term downside affects one customer but not really affect our overall revenue strength.

That's great. Now, shifting focus, the growth in ARR has slowed a bit sequentially after being at a higher range over the past few quarters. What should we consider as the reasons for this? Additionally, how should we view this growth rate moving forward? Thanks.

Yes, I really appreciate the question, Brad. Regarding the 16.6, we are very optimistic about that figure. We believe it's indicative of strong and healthy growth, and we are proud of the outcome. When we evaluate the other aspects of our business, we find that the metrics remain robust. As we look ahead, we must consider that last year we had a very solid second half. We're being careful in our guidance to ensure we factor that in. We're being thoughtful about our approach. While we don't specifically guide ARR, we remain aware of the current economic environment and how we are positioning ourselves in relation to it.

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 impacted 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 the further investments you're making to penetrate the mid-market ecosystem at this point?

Yes, Steve, I think, again, back to the point of discipline, what we've proven to ourselves over the years with the ecosystem we invest in taking Oracle and SAP as examples. By going really strong in the quality of our integrations, the understanding of their customer base, and working closely with the partner and the ecosystem around it, we've been able to deepen our win rates and all justify the success we have. We're applying the same playbook to a few select mid-market channels as opposed to spray and pray build 100 connectors and hope we get uptake in the environment. That discipline meter’s our investment portfolio, which I think, again, in the current environment, is prudent.

Okay. I would like to clarify something about the macro situation. It doesn't appear that there is anything affecting the top of the funnel and new pipeline growth. However, is there anything you would want to point out regarding a slowdown in incoming deals or any observations you have about the pipeline?

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. 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. 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 congratulations. I have a couple of questions. First, John, it seems like the cloud revenue has accelerated. Last quarter, you added $1.9 million in cloud revenue, and this quarter it's $3.6 million. What accounts for this increase? Is there something positive happening, or is it just how the revenue is recognized?

I mean, listen, I think as you well know, Pat, I mean, we've been focused on cloud first. That's where all our development resources are going; that is where the sales team is focused. That's what we are going to market with. I think that activity and the investments we've been making, as David talked about, are really starting to bear fruit. 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. 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?

We currently do not provide guidance for 2023. However, we believe we have a strong business that has been experiencing good growth. Our top line has seen positive growth throughout 2022, and overall, things are progressing well. We have approached our guidance carefully since 2020 through 2021 and 2022, and we will continue this cautious approach moving forward. As we look ahead to next year, we plan to take additional time to assess some of the larger macro trends that are developing. From our position with mission-critical software and our extensive pipeline, we feel optimistic about our visibility regarding future outcomes.

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 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 perhaps some others, but certainly that we all read some recent layoffs that might free up some wonderful capacity for us in the future.

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. Could you remind us, are you incentivizing your enterprise customers to switch from on-prem to cloud? And are you doing that through discounting or any feature incentives or anything like that?

No, we don't have programs to incentivize that. It’s important to note that our main focus is on engaging with tax directors and similar roles. The final decision regarding deployment usually rests with another portion of the company. While there are individuals involved in the decision-making process, it's a somewhat different choice. Generally, whether it pertains to cloud solutions or on-premise setups, it aligns with the overall technology cycle the companies are following. Although we would prefer to accelerate this transition, it tends to be part of a larger strategic shift. We observe that customers are migrating; it’s not merely about moving tax technology to the cloud. It’s more about a broader push towards digitization that they haven’t pursued previously.

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. It looks like part of that was working capital. 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?

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. When we look to the fourth quarter, it's 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. This year has been a big investment year. That certainly manifests itself and hits with a lot of cash and extra cash flow drain than in the prior years. This is part of the plan that David has outlined, and we're continuing to stick to that. We feel good about the investments we're making. We're starting to see the ROI show itself, and we hope to see more of that show up in 2023.

Great. Appreciate you 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? Then could you just remind us, as 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 the components that make that stuff up. So that's not been a real big driver. We feel pretty good about how that's going to play out as we move forward. In terms of kind of the prior slowdowns or downturns in the economy, overall, the company grew through those nicely. We feel very good about what that might mean to us. In terms of the componentry for NRR, again, it's a customer-by-customer specific thing. We may see some of those additional entitlements or those additional volumes with certain 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. There will continue to be customers certainly in the enterprise expanding their geographic footprint and doing things that they can do to bring tax into solutions like ours that 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 [email protected]. 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.