Vertex, Inc. (VERX) Q3 2023 Earnings Call Transcript

Hello, good morning and greetings. Welcome to Vertex's Third Quarter 2023 Earnings Conference Call. Please note this conference is being recorded. At this time, all participants are in listen-only mode. And at this time, I will turn the conference over to Joe Crivelli, Vice President of Investor Relations. Mr. Crivelli, you may now begin.

Hello, and thanks for joining us to discuss Vertex's third quarter financial results. I'm Joe Crivelli, Vice President of Investor Relations. David DeStefano, our President and CEO; and John Schwab, our CFO, are on the call with us today. As a reminder, during this call, we may make forward-looking statements about expected future results. Our actual financial results may differ due to risks and uncertainties. These risks and uncertainties are described in our filings with the Securities and Exchange Commission. Please note that our remarks today will also include references to non-GAAP financial measures. A reconciliation of these non-GAAP metrics to GAAP is also provided in today's press release. This conference call is being recorded and will be available for replay via webcast on our Investor Relations website. I'll now turn the call over to David.

Thank you, Joe. Welcome everyone and thank you for joining us. Once again, in the third quarter, Vertex delivered excellent financial results, driven by consistent strong execution. Revenue in the third quarter was $145 million, up 15% year-over-year. Adjusted EBITDA was $26.6 million, up 30% compared to last year's third quarter, representing an EBITDA margin of 18.4%. Additionally, we achieved 18% year-over-year growth in annual recurring revenue with a consistent gross revenue retention rate at a best-in-class level of 96% and a net revenue retention rate of 111% for the second consecutive quarter. The average annual revenue per customer was nearly $113,000, a 16% increase year-over-year, and we saw a 15% increase year-over-year in the scaled customer count, which includes customers with annual revenues exceeding $100,000, marking the fourth consecutive quarter of growth. These results reflect our ongoing success in the underpenetrated enterprise market. I'm very proud of these achievements, which illustrate the incredible efforts of our global teams and the benefits of our multi-year growth investment initiated in 2020, which culminated in the second quarter with the launch of our new ERP system. This groundwork has led to continued strong revenue growth and growing earnings leverage, which we anticipate will continue into the fourth quarter and beyond. By reinvesting earnings back into the business over the past three years, we are now entering new markets and have developed a growth engine that we believe will drive us to $1 billion in revenue and beyond. In addition to modernizing our corporate infrastructure, our commitment to research and development and strategic acquisitions enables us to deliver new capabilities and products to market faster than ever. The expansion of our go-to-market channels has improved our revenue potential with both new and existing customers. Although these investments affected Vertex's bottom line from mid-2020 through the first half of 2023, we are now positioned for growth in revenue, margins, and shareholder value. I have strong confidence in our current position as a company. Indirect tax is the largest category of corporate tax globally, and as governmental debt rises and commerce diversifies, the complexity of indirect tax is increasing for global businesses. Consequently, more enterprise and upper middle market companies are seeking trusted solutions like those offered by Vertex. I'd now like to highlight some key successes from the third quarter that illustrate how we are providing solutions and a unique experience for our customers. Let’s begin with some significant wins in the SAP ecosystem. We believe SAP's move from ECC and its encouragement for customers to transition to S/4HANA by 2027 will create a multi-year advantage for Vertex. Many of our growth investments have focused on solidifying our leadership in the SAP ecosystem, and we continue to gain momentum through joint go-to-market efforts and our unique solutions for SAP clients. This was evidenced by a sales process with a global pharmaceutical company that is consolidating various SAP ECC deployments into a singular global S/4HANA instance. As part of this change, they aimed to standardize their handling of indirect tax. Vertex secured this eight-figure contract due to the range of tools we've developed for the SAP platform, including our leading SAP Connector. References from other customers instilled confidence in our capability to support their success. We also secured a substantial new contract with a defense industry client undergoing a comprehensive transition to S/4HANA and integrating SAP Ariba for enterprise purchasing. In this transition, they chose to standardize on Vertex, as they had previously used a combination of Vertex and other solutions. This deal represents a seven-figure revenue increase over the five-year contract. Notably, as a defense contractor, this client is subject to stringent data sovereignty regulations that restrict cloud usage in certain business areas. Thus, we won this contract partly because we are the only provider in the indirect tax software space that fully supports on-premise installations. A global manufacturer of heavy equipment selected Vertex for their SAP ERP transformation project in North America, attributed to the advanced capabilities we've expanded in the SAP arena, including our pre-built certified integration and SAP Plus functionalities acquired from LCR-Dixon. Furthermore, we secured a major US gas pipeline operator in the third quarter, who turned to Vertex after facing continuous difficulties with a competitor’s tax solution. The strength of our SAP integration encouraged the customer to replace their existing mid-contract solution. Additionally, our technical capabilities and industry-specific content library were crucial in winning this new logo. This is just a snapshot of our Q3 wins in the SAP ecosystem. We have invested significantly to enhance our long-standing relationship and strengthen our alignment with SAP's go-to-market teams. In July, Vertex O Series Cloud was recognized as an SAP Endorsed App for North America, a premium certification now reflected in the SAP store. SAP sales professionals are achieving wins with Vertex, earning commissions and quota credit for joint selling, which is boosting our pipeline with SAP. In 2023, we've observed nearly a five-fold increase in leads from the SAP channel in North America, which is promising as it indicates potential new business wins. On that note, year-over-year victories from deals referred by the SEB channel have more than doubled thus far in 2023. Moving to the Oracle ecosystem, in the third quarter, a long-term customer from the oil field services sector migrated to the cloud as part of an Oracle OCI cloud conversion, showcasing two key differentiators for Vertex. First, our capability to support flexible deployment options allows customers to transition seamlessly along their digital transformation journey. As soon as this customer was ready, we helped them transition from their server-based solution to the cloud without disruption. The second differentiator revealed through this deal is the strength of our partnerships. We have been closely collaborating with our tech and consulting partners to create a combined offering for our clients. This project leveraged our coordinated go-to-market efforts with Oracle and PwC, bringing us into the customer's process five to six months earlier, speeding up the value realization for our joint clients. We also secured a new contract with a global property maintenance service provider implementing Oracle Cloud and Coupa. I'm thrilled that we are applying the same successful strategy from the Oracle and SAP ecosystems with mid-market ERP providers, leveraging our strengths to enhance our presence in the NetSuite ecosystem. For instance, we won contracts with a North American specialty retailer and a North American employee benefit insurance provider, both integrating NetSuite. In the Microsoft Dynamics ecosystem, we won a contract with a leading plumbing supplies manufacturer due to their implementation of big commerce for e-commerce. In many cases, when our customers experience business changes, particularly mergers and acquisitions or new e-commerce channels, it leads to new opportunities for Vertex. Several customers increased their entitlements in the third quarter following acquisitions, including a major US electric supplies distributor that acquired a competitor and a large international conglomerate that took on a new subsidiary. Our customer success organization, a key focus of our growth investments, is dedicated to identifying new opportunities with existing customers and driving net revenue retention growth. For instance, a longstanding customer in the automotive sector added premium resilient content to its Vertex subscription, while one in the grocery industry expanded entitlements to incorporate additional subsidiaries under the Vertex umbrella and added Edge to enhance its e-commerce functions. Now, regarding Europe, since 2020, we’ve evolved from a minimal presence to a robust go-to-market team equipped with a complete suite of products tailored for European enterprise clients and an impressive lineup of reference customers to advocate for Vertex. Despite the sluggish European economy in 2023, we have developed our presence, which we expect will yield benefits in the long run, not just in the immediate term. I previously mentioned our European achievement within the pharmaceutical industry. Additionally, we secured the largest VAT compliance deal in our history with a European publisher, prompted by a customer’s need to improve controls and mitigate risk in VAT compliance across 24 countries. We won this contract partly due to the reference accounts we provided in Germany, as we were the only competitor able to furnish credible references in that market. Traditionally, VAT was straightforward and easy to calculate, but European VAT tax regulations are becoming increasingly complex, particularly with the global rise of e-invoicing mandates. E-invoicing is a growing global trend that is rapidly accelerating, with over 50 countries having enacted different reporting requirements, and several major economies, including France and Germany, poised to follow suit. Simply stated, e-invoicing necessitates companies to report sales and corresponding VAT calculations in real-time during transactions, aiding governments in narrowing the VAT gap— the shortfall between expected and actual collections. To capitalize on the e-invoicing trend, in October at Vertex Exchange, our North American user conference, we announced our partnership with Pagero, with their CEO joining me on stage before over 1,000 attendees. This partnership combines Pagero’s e-invoicing cloud network with Vertex’s tax compliance portfolio, providing our customers with a comprehensive set of tools for adhering to the latest e-invoicing and continuous transaction control regulations globally. Throughout the conference, we met jointly with clients to discuss how our unified cloud platform facilitates ongoing compliance for e-invoicing, VAT, and sales and use tax, establishing a true global compliance solution. Customers expressed strong support for the integrated offering, leading us to exit the conference with several shared opportunities. Excitingly, we also announced a partnership with Shopify this week, becoming the first global tax technology provider to join their Tax Partner program. This collaboration will enable Shopify's customers to automate tax calculation and compliance on a global scale. We are enthusiastic about this association with a major e-commerce infrastructure provider that opens doors to an entirely new ecosystem of potential clients for Vertex. Reflecting on all we achieved in the third quarter, it is centered around a commitment to providing exceptional customer experiences through powerful solutions and reliable relationships, which drives our success. During the Exchange event, I was thrilled to announce that Vertex has once again earned IDC's SaaS Customer Satisfaction Award for Tax for overall customer satisfaction. This recognition is profoundly significant to me and the Vertex team, especially as we are the only indirect tax technology firm to receive it, and it stems from direct feedback from our customers. This acknowledgment confirms our unwavering dedication to delivering an outstanding customer experience, which we do not take for granted and is vital for our leadership in the middle and enterprise markets. Finally, I'd like to share some insights on a topic that is currently a priority for numerous businesses: artificial intelligence. Let me briefly highlight the implications of AI for our business and our strategy to leverage the vast opportunities it offers. At Vertex, we've incorporated AI and machine learning for years, and we are now venturing into generative AI and large language models that can create new solutions from existing content. We believe that generative AI has the potential to transform our approach to indirect tax software. By merging human creativity with generative AI capabilities, we can optimize workflows and enhance user experiences. Our R&D spending related to generative AI focuses on three key areas: content curation, customer experience, and customer data insights. We will be integrating generative AI copilots in our user interfaces to assist customers with tasks such as product categorization, system configuration, and accessing product knowledge quickly and easily. Furthermore, we are launching tools designed to help our customers extract additional insights from tax data for informed business decisions. This area presents a huge opportunity for Vertex, given that our software possesses insights into nearly every transaction our clients execute, down to specific SKUs and precise geographic locations. This aspect was very well-received during our keynote at Vertex Exchange, and several customers and partners have since come forward as potential product design collaborators in these investment areas, which aligns with how Vertex secures early adopters and ultimately established its leading position in the enterprise market. John will now walk you through the financials. John?

Thanks David and good morning, everyone. Today I'm going to review our third quarter financial results and provide guidance for the fourth quarter and full year of 2023. Total third quarter revenues grew 14.9% year-over-year to $145 million, exceeding the upper end of our quarterly guidance by approximately $2 million. Subscription revenues increased 14% period-over-period to $121.3 million. Our services revenues grew 19.5% to $23.7 million. And cloud revenue was $54.6 million in the third quarter, up 24.8% from last year. As David mentioned, our customer metrics remained solid. ARR was up 17.8% year-over-year. NRR was 111% and GRR was 96% in the third quarter. And AARPC, which is based on our direct customer count was $112,690 in the third quarter, up from $109,170 in the second quarter of 2023. Non-GAAP gross profit for the third quarter was $103.4 million, representing a gross margin of 71.3%. This compares with $87.6 million and 69.4%, respectively in the same period last year. Non-GAAP gross margin on subscription software revenue was 78.3%, and non-GAAP gross margin on services revenue was 35.3%. Turning to non-GAAP operating expenses. In the third quarter, research and development expense was $15.4 million compared to $9.8 million last year. With capitalized software spend included, total R&D spend was $28.4 million for the third quarter, which represents 19.6% of revenue as compared to 15% of revenue in the prior year period. Our selling and marketing expense was $31 million or 21.4% of total revenues. This is the fourth consecutive quarter that selling and marketing expense has been relatively steady in the low $30 million range, reflecting the moderation of our investments in the go-to-market over the past year. General and administrative expense was $31 million or 21.3% of total revenues. This is down approximately $2.3 million sequentially as some of the consulting expenses related to our second quarter ERP conversion did not recur in the third quarter. We expect relative stability in G&A expense on a dollar basis going forward, reflecting the conclusion of our heavy growth investment period. Adjusted EBITDA was $26.6 million in the third quarter of 2023, an increase of $5.9 million year-over-year and exceeding the upper end of our quarterly guidance. Operating cash flow was $27.6 million and free cash flow was $9.1 million in the third quarter. As the fourth quarter is usually our strongest cash flow quarter for the year, we expect positive operating and free cash flow for the full year 2023. We ended the third quarter with $49.5 million in unrestricted cash and cash equivalents. Total bank debt was $47.4 million, and our investment securities totaled $8.3 million. For additional liquidity, we also have $200 million of unused availability under our line of credit. Turning to guidance. In the fourth quarter of 2023, we expect total revenue in the range of $145 million to $147 million, which would represent 11.4% year-over-year growth at the midpoint and adjusted EBITDA in the range of $27.5 million to $29.5 million, which would represent a year-over-year increase of approximately $7.5 million at the midpoint. This results in an increase to our full year financial guidance as follows. We now expect total revenue for the year to be in the range of $562.5 million to $564.5 million, which represents 15% full year growth at the midpoint, up from 14% at the midpoint in our prior guidance. We are also increasing our full year adjusted EBITDA outlook to a range of $96.3 million to $98.3 million. Our new adjusted EBITDA guidance represents a year-over-year increase of $18.6 million at the midpoint, an increase of over $2 million compared to our prior guidance. We now expect cloud revenue growth of approximately 25% for the full year compared to 27% previously. This is due to a slight mix shift in the business to higher-margin on-prem software revenue. As a reminder for new deals, we are price-agnostic between cloud and on-prem deployments.

David will now make a few closing comments before we open up for Q&A. David? Thanks, John. So to wrap it up, it was another great quarter for Vertex. We have built an execution engine that is delivering strong and durable financial results in what has been a challenging economy for many SaaS companies. We're fortunate that our offerings are a must-have, not a nice-to-have for our enterprise customers. Tax compliance is required in strong and challenging economic times. This is what makes our solution so sticky, and is the foundation of the consistency in our GRR and NRR. With the investments we've made and the results they are delivering, over the next few years we see a clear path to the Rule of 40 metric long-term revenue growth, in the mid- to upper teens and EBITDA margins in the low to mid-20s. Unlocking this kind of performance was the North Star of our growth investments. And from here on out, it's about delivering the same consistent execution that we have since we went public in mid-2020. I am confident the Vertex team is up to the task. With that, we'll take your questions. Operator, please go ahead.

Thank you very much. We'll begin the question-and-answer session. Our first question comes from Chris Quintero from Morgan Stanley. Chris, please go ahead.

Hi, guys. Good morning. Congrats on the strong set of results here. Net Menu adds came in kind of the highest for Q3 and maybe kind of full year so any sense of what the channel mix is of where this new customers are coming and we talked about continues to accelerate momentum with SAP and you mentioned some nice customer wins there. So just curious how big of a contributor maybe the partnership with SAP was in the quarter.

Yes, Chris, I appreciate the question. SAP, clearly, is a strong tailwind given all the investments we've made right now in new offerings in the SAP space, the LCR-Dixon acquisition and all the work we're doing with our go-to-market teams and our partners. Collectively, that has clearly started to improve our pipeline and it's creating a nice tailwind. But what's been really great is, we're able to leverage the playbook we've been running in SAP, and we're starting to improve execution in Microsoft, NetSuite, Workday, and we had some really nice wins. And so while AARPC did rise nicely, we actually saw a good diversification of wins across the different ecosystems we're focused on.

Got it. That's very helpful. And then on the fewer conversations around moving to the cloud, what's your sense? Do you think that's more kind of like macro-driven, more secular? And as more kind of existing customers stay on that on-prem version? Does that change your calculation and thinking around pricing between the two different versions?

As you know, we made the switch to have the same pricing for cloud that we do on-prem. So we're getting the same subscription revenue regardless of whether an existing customer is upping their – expanding their wallet share with us with another on-prem license or in unique stack patterns like the one we highlighted in the call where a defense industry, there are certain governors on where they can have their data and being able to support them where they're at has always been a key differentiator for us, Chris. And so I'm really pleased with the actual. We're able to sustain such strong cloud growth and yet grow AR even more. And margins picked up, as a result, because of that – it's obviously, more profitable for us when they're buying on-prem. So it's actually been a really nice shift in strategy that's working incredibly well for us.

Excellent. Thanks, David.

And our next question comes from Matt Stotler from William Blair. Matt, please go ahead.

Yes, great. Thanks for taking my question and nice results. Wanted to ask on the strong NRR number. I think it's the second quarter in a row of record level there. Is this sustainable? And perhaps is there even additional upside to this metric? Thanks.

Matt, a key part of our strategy was to invest in building out a customer success function over the last several years and combine it with the new product suite that we've been expanding and the acquisitions we made also that we could better serve our existing customers. And I think what you're seeing is the execution on that and the maturity of that strategy is playing out really nicely. We don't guide to NRR, but I'm certainly pleased with the progress the team is making to make sure we're delivering value across our entire customer base.

Great. And then just wanted to follow up on the commentary around fewer on-prem migrations. If you could just give a few more details on what's driving that? Thanks.

Yes. So we – one of the things we've always talked about, Matt, in our process is we meet the customer where they are in their digital transformation journey and support them as they're ready. And I think our GRR proves when they're ready, they are migrating with us because it's much more about the content than it is the underlying platform. And so we're I think it's just episodic to where customers are in their journey with migrations that ebb and flow a little bit. But fundamentally not seeing any change in GRR and the fundamental shift continues. I think it's also important to remember that 90% of all the new logos that we're winning are on the cloud. So we're still leading with cloud and it is where we see the bulk of our new logos. But we've got a wonderful installed base and some of those customers are just on their journey at different paces.

Perfect. Thank you. Appreciate it.

And we now have a question from Joshua Reilly from Needham. Joshua, you may proceed.

All right. Thanks for taking my questions. Nice job on the quarter here guys. What are you seeing in terms of customers allocating budget to your category of products maybe exiting 2023 versus a year ago? Are you seeing larger budget opportunities year-over-year, which it appears that's the case, given some of these large wins? And what, if any, macro risks do you see exiting the year that could maybe impact some of the spending to close out the year?

Josh, always good to talk to you. I think fundamentally, there are three major tailwinds that affect our opportunity set. The one is business model changes M&A, and we highlighted a couple of things we saw in the quarter, where M&A deals were happening and we were getting expanded wallet share. You've got the regulatory environment, which is only getting more complex, as governments are taking on more debt and looking for new ways in the indirect space to raise revenue. And then lastly, the ongoing digital transformations that businesses are going through. And I think that diversification of business drivers has given us the consistency of performance. And I think it's much more about our execution against those drivers that's driven our numbers up so much this year. And certainly, we haven't guided anything for 2024, but those three factors work in a really nice balance for us, and I see that continuing as we move forward fundamentally.

Got it. You had a solid increase in operating income this quarter. John, can you help us understand the operating leverage moving forward without providing guidance for 2024? Should investors expect to continue benefiting from the investments you've made, or is there another cycle of spending anticipated in 2024? Thanks, everyone.

Yes, that's a great question. Thank you, Josh. When considering leverage and how we view it moving forward, we've mentioned before that general and administrative expenses are an area where we see potential for leverage. This will remain a key focus for us. With the ERP upgrade completed, we are optimistic about leveraging that as we move ahead. Additionally, you've likely noticed that selling and marketing expenses have remained relatively stable over the past few quarters. After the significant build period in 2021 and 2022, we are beginning to see some moderation in that area as well. These are a couple of areas where we feel confident about achieving leverage. Furthermore, we will always be cautious with our research and development spending, as it is crucial for our future success. We'll keep a close eye on it to determine what constitutes the appropriate level of investment. However, I hesitate to limit that area too much, considering the opportunities presented by our esteemed customer base.

And we'll proceed with the question from Steve Enders from Citi. Steve, go ahead.

Thanks for taking my question this morning. I would like to know more about the recent Shopify partnership. How did this relationship come about and develop? How do you see it affecting the customer base and your approach to targeting the mid-market in the future?

I'm really excited about this new opportunity. The team has put in a tremendous amount of effort. It all started when we noticed that some of our customers had made acquisitions and ended up with divisions using Shopify. They were concerned about the tax information they were receiving compared to what they had in their ERP systems. Our customers and team approached Shopify to discuss potential collaboration if they could open up their API. As Shopify adjusted their strategy to target the enterprise market, they recognized that working with us on tax solutions was a natural fit for their goals. Everything has aligned perfectly, and I see this as a chance to connect well with both the middle market and enterprise segments in line with Shopify's strategy.

Okay. Great to hear. And then John, I guess I just want to get a better sense for now that we're through the ERP implementation, did that have any impact on billings or cash collection in the quarter? And I guess what kind of recovery did you see from 2Q on that front and 3Q? And how should we think about that going into Q4 as well?

Yes, Steve, good call-out. On the last call, I did mention that we did see a little bit of a slowdown in some of the collections at the end of the second quarter. I think, as mentioned, we started to see that come back in the third quarter and feel very good about that Now as I think about look to the fourth quarter, fourth quarters are typically our largest kind of cash generation quarter. A lot of the billings go out; a lot of those year-end customers. And so we feel very good about the processes and where we stand with respect to the new ERP system. And so I don't know that there's any significant change with respect to what we should think from a result standpoint because of any of that because of the move to the new system.

Okay. Perfect. Thanks for taking the questions this morning.

Thanks very much, Steve.

From Adam Hotchkiss from Goldman Sachs. Please go ahead.

Great. Thanks for taking the question. David, I just wanted to follow-up on the partner front a lot new here with SAP Microsoft Workday and now Pagero and Shopify. I recognize there are idiosyncratic drivers of all of these. But if we take a step back is there any commonality in what is giving you guys the edge in each of these ecosystems and why things are inflecting now?

I believe the market we operate in is the most attractive, specifically the enterprise and upper mid-market sectors, where many players want to position themselves. With our strong brand and reputation, along with our partner ecosystem that includes system integrators and major firms, we are well-positioned to win these deals. This creates a mutually beneficial relationship; for instance, our collaboration with Shopify will help them secure enterprise contracts, which in turn allows us to expand our influence. Pagero also recognizes itself as a player in the enterprise and mid-market and will gain access to a wider customer base and higher invoice volumes, which is appealing for their growth. This aligns perfectly with our goals to support comprehensive compliance needs for our clients. This synergy is why we are attracting attention in the market.

Okay. That's really helpful. And then I noticed you added Chirag Patel as CSO intra-quarter. Just what was the driver of making the change for that role? And what gaps are you looking to fill there?

Yes. Chirag brings an incredible resume, is a serial entrepreneur; was at EY; has had his own start-up businesses over the years, successfully transitioning those. Grew up his legacy in Oracle so he understands our space incredibly well. And as we think about innovation, John was highlighting R&D spend and the importance of that, we still see a lot of frontiers, so there's opportunities. And I think Chirag's going to bring a keen eye and a discipline that will help us be even more efficient and effective at driving new opportunities in the market. So, I'm really excited about bringing that kind of talent into Vertex.

Really helpful. Thanks, David.

And our next question comes from Alex Sklar from Raymond James. Alex, please proceed.

Great. Thank you. Dave, on the e-invoicing partnership with Pagero, can you just help frame what percentage of your 4,300 customers have international operations that e-invoicing is going to be relevant to? And then any rough range in terms of what an ACV for that solution might look like given you're working with the partner there?

Yes. I can say that many large multinational companies, especially in the enterprise and upper mid-market sectors, operate across multiple countries. This presents a unique opportunity as our customer base has been facing challenges that they've tried to solve with various individual solutions, but they are not satisfied. A significant part of our strategy has been to offer a comprehensive global solution through a single provider. We believe this is a substantial achievement. While we haven't disclosed any pricing publicly, considering the invoice volume associated with the types of customers we serve in these countries, we view this as a significant opportunity for our revenue growth as we head into 2024, 2025, and beyond, especially as customers transition to a more global approach for their e-invoicing needs.

Okay. That's great color. John, just following up on Steve's question regarding free cash flow. Outside of the billing timing and that's snapping back there, can you just give some added color on the right way to think about EBITDA to cash flow conversion? And if there's any way to quantify what may have been a nonrecurring component of CapEx this year as we think about 2024?

Yes. There are a couple of ways to consider that. From an EBITDA to cash flow perspective, we have mentioned that we expect to be free cash flow positive this year. Historically, the company has achieved around a 70% conversion from EBITDA to free cash flow. I anticipate that we will reach that level again as we navigate through our current investment cycle and find the right rhythm. We are optimistic about this. Regarding capital expenditures this year, I would estimate that about a high teens amount in millions will not recur next year. This relates to some of the infrastructure items discussed by David. That's the nonrecurring part I would highlight. However, we will continue to invest in capitalized software and other recurring areas, which will remain in our plans.

Okay. Perfect. Thank you, both for the answers.

Thank you.

And we'll proceed now with a question from Samad Samana from Jefferies. Samad, go ahead.

Hi guys. Thanks for taking my questions. This is Jeremy on for Samad. Follow-up on the net adds. It looks great all around. But I think the rest came in a lot higher than we expected given the emphasis on the indirect channel. Can you talk about what your strength there as well? And is there an opportunity for this to remain elevated?

I appreciate the great question. Our focus and strategy in NetSuite, Microsoft, and Workday are beginning to show the execution and branding we aim for, and we will continue to maintain that approach. The team has done well in securing new client wins. While we don't predict future outcomes, I'm pleased with our disciplined focus on a few ecosystems, and the teams are effectively engaging with partners and tech firms, which is evident in the results.

That's useful color. And useful color on some of the customer behavior on cloud versus on-prem. I guess, have you noticed any additional change from the close of the quarter through October and November, whether that's change in deal cycles or anything like that?

I don't have any specifics on changes in deal cycles this early in the quarter. However, fundamentally, everything we're doing is focused on the cloud. As I mentioned, I believe 90% of our new logos are cloud-based. We're also observing that existing customers who have on-premises solutions for one module are moving to the cloud for a new module. There are still significant opportunities in this area, and that's where our teams are leading, but there's no new shift in the mix. Additionally, with our new on-premises pricing, we are enhancing our gross margins when customers opt for that direction, as we are not incurring any of the on-premises costs. The hosting costs are actually working out strategically very well for us.

Got you. Thanks for taking my questions, guys.

And our next question comes from Pat Walravens from JMP Securities. Pat, please go ahead.

Oh, great. Thank you. Congratulations to you guys. It's great to see the performance here. All right, David, what is the most important thing for Vertex to get right in 2024?

In 2024? Execution focus that continues to drive operating leverage. That's what we're going to be. That's where we're really heads down. We've come through a big investment cycle for the last several years. We've put ourselves into place. And now it's about executing and reaping the margin performance that we expect as we look forward.

Awesome. If I could follow up, you mentioned that customers are increasing their entitlements with different customers, which I find very interesting. What is driving that, and how does the process work when they increase their entitlements?

Yes. Pat, this is John. I'll take that. I think what we're seeing is that we're seeing a number of different expansion opportunities with existing customers. And so what that typically means is they're using the same products, but they're expanding their use to different divisions, different areas, different geographies. And then when they do that they typically roll through a pricing tier that we've created. When they roll through that pricing tier then we have the opportunity to increase the annual amount that we charge. So that's the typical cadence that we see and the reasons for people breaking through.

If I could expand on that point, it's essential to recognize that when we address a problem for a large multinational, it's usually focused on just one division or area of their business. This creates a long-term value opportunity as we enhance our customer success function. They can then discuss potential expansions to other divisions that we previously covered in the initial division. What you're observing in this example is that companies are consolidating their units, moving away from competitors or on-premises solutions, and opting to standardize across more of their divisions with Vertex.

Great. Thank you.

And we will continue with a question from Daniel Jester from BMO Capital. Daniel, please go ahead.

Hey, this is Kyle Aberasturi on for Dan. Thanks for taking my question. Can you just dig a bit further into the Celera cloud migration? I guess, does this change any sales strategy in Q4? Or any changes there? How are you thinking about that? And then, I guess how you're preparing for 2024? Do you guys expect consistent trends heading into the New Year?

Yes, there is definitely no change in strategy. The main focus is on execution. We've worked hard to reach this point, and the team has done outstanding work. We've gone through the investment process to get here, and now it's all about execution. So, there is absolutely no shift in strategy. Regarding 2024, we haven't provided guidance yet, but we are seeing the positive factors we've mentioned, such as SAP and the regulatory environment, supporting the performance we anticipated when we began this strategy.

Great. Thank you. And one quick one for me. So I appreciate the color on Shopify. I guess how are you guys thinking about any more or any additional type of marketplace or e-com growth in the business? Thank you.

We continue to work on the platforms where our customers operate and are seeking new opportunities to expand our partnerships. We will remain disciplined in areas that present significant opportunities for customer base expansion where we can leverage our capabilities. Shopify clearly stands out as a partnership we are very excited about, and we will keep exploring similar opportunities. We have also seen great growth with other platforms like Miracle, among others. Our focus is on where our customers in the middle and enterprise markets are doing business, which is where we need to concentrate our efforts.

Terrific. I'd like to just add one thing unrelated to this matter. I just wanted to point out when Alex Sklar asked the question a bit back about nonrecurring CapEx spend, I answered the question with respect to the ERP spend that we had. That was the total amount of ERP spend. About 60% or 65% of that spend happened last year; the other portion happened this year. So I just wanted to draw a line of clarification there. That was the total cost not just the cost in the current period. So thank you very much.

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

Okay. Thanks everybody for joining us today. If you have follow-up questions or if you'd like to schedule additional time with the team please send me an e-mail at [email protected]. Have a great rest of your day and we look forward to speaking with you in the coming weeks.

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