Vertex, Inc. (VERX) Q3 2024 Earnings Call Transcript

Good day, and welcome to the Vertex Inc. Third Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Joe Crivelli, Vice President, Investor Relations. Please go ahead.

Hello, and thanks for joining us to discuss Vertex's third quarter financial results. I'm Joe Crivelli, Vice President, Investor Relations. David DeStefano, our President and CEO; and John Schwab, our CFO are with us also today. During this call, we may make forward-looking statements about expected future results. 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. In our remarks today, we will also refer to non-GAAP financial metrics. A reconciliation of these metrics to GAAP is provided in today's press release. The call is being recorded and will be available for replay on our Investor Relations website. I'll now turn the call over to David.

Welcome, everyone, and thank you for joining us. In the third quarter of 2024, Vertex delivered very strong financial results while advancing our long-term strategic and financial priorities. From a financial standpoint, we delivered strong revenue growth, adjusted EBITDA, and free cash flow, and we were GAAP earnings positive for the fourth quarter in a row. In addition, we achieved a significant strategic goal in late August when we completed our announced acquisition of ecosio, a fast-growing EDI and e-invoicing company based in Austria. We are very excited to have ecosio as part of the Vertex family. We believe our combined solution will be a springboard for sustained growth in international markets where value-added tax is the main source of indirect tax revenue for governments. Our combined Vertex e-invoicing solution is powered by our global tax content and built on our data platform. This allows our customers to effectively manage the entire indirect tax workflow from tax determination and compliance to planning and audit defense through a single platform. This creates tremendous value for our Vertex community. At a customer event in Germany in September, we previewed our offering with 40 key customers and prospects as well as representatives from our partner ecosystem. The excitement was clear with one of our largest customers telling us we have changed the competitive landscape. This was then topped by the experience I had at our annual customer conference last week. At this event, we enjoyed record customer and partner attendance. We previewed several exciting new AI capabilities, including our recently released Copilot and our soon-to-be-released smart categorization offering. We also highlighted ways we are enhancing our support offerings based on customer input and unveiled significant enhancements to our global partner enablement program. The strong relationships we maintain drive our ongoing success, and we never forget that our customers' total experience matters. That shows up at customer events throughout the year. I left both events extremely energized and convinced that we have the right strategy to help our enterprise customers and prospects tackle the compliance challenges of today and tomorrow. Now turning to the financials, revenue was $170.4 million in the second quarter, up 17.5% year-over-year. Software subscription growth was 20.6% and cloud revenue growth was 29.9%. This includes a $1 million revenue contribution from ecosio. John will discuss the organic financial results in a moment. The earnings power of our financial model is demonstrated by adjusted EBITDA of $38.6 million in the third quarter, which represents an adjusted EBITDA margin of 22.7%. Adjusted EBITDA margin has expanded in every single quarter since we completed our multi-year growth investment program in mid-2023. Demonstrating the quality of our earnings, free cash flow was $18.4 million in the third quarter. In addition, GAAP net income was $7.2 million or $0.04 per diluted share. I'll now share some additional key performance indicators. Note that these figures are only and do not include the impact of Systax or ecosio, which John will cover in a moment. NRR was 111%, which is up from 110% in the second quarter and equal to 111% in last year's third quarter. GRR was 95% in the third quarter, which maintains our targeted best-in-class range of 94% to 96%. Annual recurring revenue was $563 million, up 16.1% from last year's third quarter. Cloud revenue growth was 28.5% in line with our stated target for the year. Scaled customer count, which represents customers delivering annual revenue over $100,000, grew 13% year-over-year, and average revenue per customer was $131,400, up 16.6% from $112,690 in last year's third quarter. My leadership team and I are laser-focused on executing our strategy as we believe we have room to continue to grow revenue, further improve profitability and free cash flow and build on our market-leading customer metrics. This is because we are in a unique segment of the software market. Indirect taxes are incredibly complex. For example, we now maintain over 1 billion effective rates and rules in our differentiated tax content database. This content fuels all our solutions. Indirect taxes impact every single transaction and every single company in every jurisdiction around the world, and yet so many enterprises are still calculating and reporting indirect taxes based on legacy internally developed software and systems that were built decades ago. For these companies, things like ERP conversions, mergers, and acquisitions, and audit pressure from taxing authorities caused their legacy systems to be inadequate to support their increasingly complex and sophisticated business. This, in turn, makes switching to an expert provider like Vertex an absolute necessity. In addition, we have two multi-year tailwinds coming our way that will accelerate the migration from homegrown to our cloud solutions. The first of these has received a lot of attention from Wall Street lately, the coming super cycle of ERP conversions that is partly driven by legacy ERP systems that will be end-of-life by leaders in the space. And the second is the reason we bought ecosio last quarter, the coming wave of e-invoicing regulations that will make countries with VAT regimes for indirect tax fertile hunting ground for Vertex's global indirect tax platform. Net-net, we believe the opportunities that are in front of us are sizable and will fuel revenue growth and profitability for years to come. I'll now highlight some notable wins in the quarter. It was an exciting quarter on the new business front with new logos. So I'll start there. We landed a very high-profile new logo deal with a major electric vehicle manufacturer. This new scaled customer moved to Vertex from a competitive solution that didn't support their business effectively. This customer's operating environment is unique in that they use a custom homegrown ERP system. In turn, this introduces a level of complexity and customization that gives Vertex a major edge over competitors. The result was nearly seven figures of new recurring revenue for Vertex across a comprehensive solution set including sales, use, and VAT tax calculation, sales tax returns, address cleansing, and exemption certificate management. As an example of a company that's switched from a homegrown solution in the third quarter, we won a mid six-figure new contract with one of the largest fast food restaurant chains in the world. This company decided to move to a vended solution due to an Oracle cloud transformation. We had several exciting wins in Europe during the quarter as well. Our integrated Vertex ecosio solution won the day for an e-invoicing opportunity with a SaaS software company based in Germany. This customer wanted to get ahead of the upcoming e-invoicing mandate in Germany and conducted an RFP, evaluating several competitors in the space. While this was a modest five-figure new business win, it evidenced the strength of our e-invoicing solution as we prevailed over several of the most formidable competitors in the space. We won a six-figure new logo deal for VAT calculation and compliance with a leading Swiss agricultural company. This customer previously used a homegrown tax calculation solution, but the level of complexity of their business, as well as an upgrade to their commodities trading platform, moved them to look at vended solutions. Vertex prevailed with a global solution, including capabilities for Brazil. And we won a six-figure deal with an international materials manufacturer based in Austria. This company is planning for an SAP S/4HANA migration in 2025. This company selected Vertex in part due to Systax as they have extensive operations in Brazil. In addition, we had a strong referral from one of our top accounting partners. Now turning to wins with existing customers. One of the largest technology companies in the world expanded its entitlements with Vertex in the third quarter. This led to an annual entitlement increase across a comprehensive solution, including sales, use, and value-added taxes, communications, tax content, retail tools, and SAP accelerators. This was the largest entitlement ever done in our 46-year history, and increased well into the seven figures that was necessitated by the growth of our customers' business. A cloud transformation project led a global pharmaceutical company to expand its relationship with Vertex. The company purchased additional entitlements for the areas of the business that we did not previously serve across a very comprehensive solution that includes calculation for sales, use, and VAT tax, as well as Vertex tools, SAP Accelerator, exemption certificate manager, address cleansing, and other add-ons. The net result was high six figures of new revenue for Vertex, nearly doubling our cloud business with this long-standing customer. An international industrial manufacturer expanded with Vertex to consolidate systems and become more efficient. The company, which had grown through acquisition, was using Vertex for sales tax calculation and compliance in certain segments of its business as well as competitors and manual processes in others. By standardizing on Vertex, the company can improve accuracy and efficiency. As a result, we now provide the customer with a comprehensive solution set including tax mapping tools, address cleansing, and exemption certificate management alongside the original sales tax calculation and compliance solution. The last two customer expansions are very notable because they demonstrate the reality that when we land a new logo, it's very unlikely that the company is implementing our solutions across all the operating units of its business. Whether they only have challenges in one part of the business initially or they subsequently make acquisitions, there are always opportunities to expand our software footprint as we prove out our capabilities and earn their confidence. This is an essential element of our long-term success. I really appreciate how excited investors are about the upcoming transition in the SAP ecosystem from ECC to S/4HANA could mean for Vertex. In the third quarter, an existing customer that is a global manufacturer of semiconductor equipment executed an enterprise-wide transformation. As part of this process, they expanded their use of Vertex O Series globally to support VAT compliance obligations that previously have been managed natively within their ERP. And while I don't think this example is necessarily typical of what we will see across our customer base for this customer, the transition led to mid-six figures of new revenue. A more than ten-fold year-over-year increase across increased entitlements for sales tax, the addition of consumer use tax, and the licensing of a cross-section of SAP tools. And finally, I will highlight that one of the world's largest equipment rental companies expanded with Vertex in conjunction with a company-wide cloud transformation project. The customer moved from a legacy on-prem offering to our O Series cloud offering and selected us for best-of-breed leasing, sales tax, and consumer use tax capabilities. This resulted in mid-six figures of new revenue for Vertex, a four-fold year-over-year increase with this customer. In closing, it was a great quarter for Vertex with strong financial results, positive momentum on the new business front with both new and existing customers. Our business is executing as we expected. And best of all, we have plenty of runway to continue to drive revenue growth and earnings leverage. John will now take you through the financials. John?

Thanks, David, and good morning, everyone. I'll now review our third quarter financial results and provide guidance for the fourth quarter full year of 2024. In the third quarter, revenue was $170.4 million, up 17.5% year-over-year. Ecosio contributed $1 million of revenue during the quarter after it was acquired at the end of August. Accordingly, on an organic basis, revenue was $169.4 million and revenue growth was 16.8%, exceeding the high end of our revenue guidance for the quarter. True-up revenue, which represents a catch-up payment typically billed as part of the renewal process when customers exceed their entitlements, was about $2 million higher than expected in the third quarter. This is a benefit to having large and growing customers that are seeing value from our software, and true-up revenue positively impacts ARR growth when the renewal process is completed. Subscription revenue increased 20.6% period-over-period to $146.3 million. Services revenue grew 1.8% to $24.2 million. The slower services revenue growth this quarter reflects the impact of our previously discussed effort to direct more implementation opportunities to our channel partners who are an important referral source for new software opportunities. In essence, we are trading near-term implementation services revenue for longer-term recurring software revenue. Cloud revenue was $71 million in the third quarter, up 29.9% from last year's third quarter and ahead of our guidance for the year. Ecosio added about 1 point to cloud revenue growth. Annual recurring revenue, or ARR, was $576.8 million at quarter end. Ecosio added $8.1 million to ARR, and Systax added $5.9 million. Excluding these amounts, organic ARR was at 16.1%. Net revenue retention, or NRR, was 111%, up 1 point sequentially and equal to last year's third quarter. Our gross revenue retention, or GRR, remained at 95% at quarter end, within our targeted range of 94% to 96%. Our average annual revenue per customer, or AARPC, for Vertex standalone was $132,422, up 17.5% from last year's third quarter. Including the impact of ecosio and Systax, AARPC was $118,800. For the remainder of the income statement discussion, I will be referring to non-GAAP metrics. These non-GAAP metrics are reconciled to our GAAP results in this morning's earnings press release. Gross profit for the third quarter was $126.2 million, and gross margin was 74%. This compares with gross profit of $103.4 million and a 71.3% gross margin in the same period last year. Gross margin on subscription software revenue was 80.5% compared to 78.3% in last year's third quarter and 80.4% in the second quarter of 2024. And gross margin on services revenue was 35% compared to 35.3% in last year's third quarter and 36.8% in the second quarter of 2024. Turning now to operating expenses. In the third quarter, research and development expense was $12.9 million compared to $15.4 million last year. With capitalized software spend included, R&D spend was $30.1 million in the third quarter, which represents 17.7% of revenue. Selling and marketing expense was $38.5 million, or 22.6% of total revenues, an increase of $7.5 million and approximately 24.1% from the prior year period. Our general and administrative expense was $35.8 million, up $4.9 million from last year. This was about $5 million higher than both the second quarter of 2024 and the year-ago quarter due to timing of expenses that shifted from the first half to the second half of 2024. Adjusted EBITDA was $38.6 million, an increase of $12 million or 45.1% year-over-year and exceeding the high end of our quarterly guidance by $3.6 million. In the third quarter, operating cash flow was $41.4 million, and free cash flow was $18.4 million. We believe that we can continue to deliver strong positive free cash flow on an ongoing basis. I'll note that the fourth quarter is historically our strongest free cash flow quarter of the year. On a trailing 12-month basis, we have generated $88.7 million of free cash flow for an EBITDA to free cash flow conversion rate of 60.8%. We believe over the long term, we can increase this to 65% to 70%. Our trailing 12-month free cash flow margin was 13.8%, the highest level since the fourth quarter of 2020. We ended the third quarter with over $279 million of unrestricted cash and cash equivalents and investment securities totaling $7.5 million. For additional liquidity, we also have $300 million of unused availability under our recently amended line of credit. Now, turning to guidance, all of which now includes our expectations for ecosio. For the fourth quarter of 2024, we expect total revenue in the range of $175 million to $178 million, which would represent 13.9% year-over-year growth at the midpoint. Ecosio is expected to contribute approximately $3 million to the fourth quarter revenue, and services revenue growth is expected to be flat in the fourth quarter, reflecting our strategy of directing additional services opportunities to our implementation partners. And adjusted EBITDA is expected to be in the range of $33 million to $37 million, which would represent a year-over-year increase of approximately $3 million at the midpoint. This results in full-year 2024 guidance of total revenue in the range of $663.3 million to $666.3 million, representing annual revenue growth of 16.1% at the midpoint, and adjusted EBITDA in the range of $146.8 million to $150.8 million, representing a year-over-year increase of $48 million at the midpoint and a full-year adjusted EBITDA margin of 22.4%. Full-year cloud revenue growth is expected to be 28%. To assist you in forward modeling, ecosio's 12-month revenue for 2025 is expected to be approximately $16 million. In addition, ecosio is expected to be dilutive through adjusted EBITDA by approximately $3 million to $4 million per quarter through 2025. David will now make some closing comments before we open up for Q&A.

Thanks, John. I continue to be very pleased with the performance of the entire Vertex team. 2024 has been a tough year for many SaaS companies, but Vertex continues to execute on our opportunity and deliver extremely strong financial results. I love where Vertex is positioned right now. We believe we are the undisputed market leader in the enterprise sector. We are proud to serve large sophisticated companies that expand, make acquisitions, enter new markets and ultimately grow their business with us. We maintain long-standing trusted relationships with the best technology providers, implementers, and accounting and consulting firms in the business. We provide a world-class customer experience so that we retain these customers year after year. This is reflected in our best-in-class gross revenue retention. Our recent HDI certification and TrustRadius recognition further reaffirm our commitment to continuously enhancing the quality of support provided. And we have a financial model that delivers mid to high teens revenue growth year in and year out, along with strong profitability and free cash flow. Most importantly, we have multiple tailwinds in our business that we believe will propel us to new heights in the coming years. If you haven't already done so, please mark your calendars for our upcoming Investor Day on March 19, 2025, in Center City, Philadelphia. During the event, we will provide an update on our long-term financial targets, as well as a deep dive on our strategic plan. I'm also excited to give investors exposure to other members of the Vertex leadership team, a group of experts that I'm extremely proud of and who are the ones piloting this business to the great financial results you've seen since we went public in 2020. With that, operator, please open the call for questions.

We will now start the question-and-answer session. The first question is from Joshua Reilly with Needham. Please go ahead.

Thanks for taking my questions and great execution in the quarter. There's been a lot of discussion about the super cycle of ERP migration projects. Can you describe the current projects driving your business today compared to a few years ago? Are you noticing an acceleration in these migration projects, or do you expect to see an increase in leads for 2025?

Yeah, Josh, thanks for the question. I think as we raised our guidance in the second half of the year, it was because we had visibility to good activity for both Q3 and Q4. If you go back to Q2 call, a lot of it was driven by activity we're seeing in both Oracle, OCI and SAP's migration programs. I will say that that continues to be a source of our success. I also believe that the regulatory pressures that we're seeing around the world are continuing to drive demand for us. So I think both of those will continue to play out in 2025.

Got it. Regarding the e-invoicing opportunity, is there a specific country in 2025 that we should be aware of that will be enacting a mandate? Does this create a sense of urgency for you in terms of the integration process or from a sales perspective in specific countries in Europe? Thank you.

Yeah. I'm thrilled with our partnership that we had started months before the acquisition that we actually launched our solutions. So we are integrated from a go-to-market activity already. We have a solution that we're actively selling. So from that perspective, I think we're well-prepared for all the mandates. Those countries move, Josh, on a regular basis. France and Germany are both in the queue, and it's something we're going to be watching as we get into 2025 in terms of the adoption going forward with mandates that they have in place. But our go-to-market activity is full force here as we're starting in Q1 of 2025.

The next question comes from Steve Enders with Citi. Please go ahead.

Great. Thanks for taking the questions this morning. I guess, I want to follow-up on the SAP ecosystem question. I understand that cycle is coming or kind of tight here. But some like last quarter, maybe it was a little bit slower than expected and just would be great to get your view on how you expect that migration cycle to play out from here and how you're thinking about that becoming a contributor to net new moving forward?

Thank you for the question, Steve. You're correct that we highlighted in the first half of the year that things played out a bit slower. According to various third-party reports, including Gartner, the current adoption and migrations have progressed more slowly than some vendors anticipated. This will likely lead to increased demand as we head into 2025 and 2026. Midsized companies tend to move quicker, while large enterprises often take longer. They may start earlier, but there are fewer of them. This pattern has been evident in our demand cycle, which has been solid. I'm optimistic about our growth potential in '25 and beyond, as we expect more activity moving forward. In the U.S., there appears to be more urgency around adopting sales tax engines, which is clear from our observations. In Europe, the situation is slightly different due to the maturity of the markets for determination engines.

Got you. Okay. That's helpful context around that. And then, I want to ask on the partner ecosystem, and I guess, beyond SAP and Oracle. Just kind of what are you seeing with those other partnerships that you've been focusing on broadening out and …

Yeah.

...kind of be giving an update there?

Yeah. Sorry, I did mean to interrupt you there, Steve. The Microsoft and Workday activity, Shopify would be the three I'd highlight on some really nice work with all three of them seeing good activity. The Microsoft team has been phenomenal to work with, and we've really seen some interesting things there. Workday stepped up in some nice ways as well. So I think activity across all those remains solid. Our team is really focused on execution, making sure we're delivering quality solutions and have the right go-to-market motion with their teams.

Okay. Perfect. Thanks for taking my questions.

Yeah. Sure.

The next question comes from Chris Quintero with Morgan Stanley. Please go ahead.

Hey David, Hey John, congrats on another standout quarter here. I wanted to follow-up on that whole ERP discussion. It's really interesting to see you kind of call that out here. So I wanted to ask really kind of about the timing? So when these migrations happen and your expectation around that, how long does that typically take before someone like a Vertex can get brought into those big transformational projects?

Yeah, Chris, that's a really good nuance question about our space. Obviously, when a business is making a decision to migrate to one of the larger, more modern cloud platforms, tax is not at the forefront of that. So it's going to be several quarters following a decision by the company to actually say, hey, we want to go live. We're going to start a migration process. They need to organize with their consulting partners and all. They will start with some of the largest parts of the business and how they need to move through that cycle. Tax is going to come in well before they go live because you have to prove out your invoice can work in every country you're doing business. So it's a mission-critical part of the implementation. So it does get brought in, but it's typically going to lag a few quarters, probably two quarters from when the customer starts the process. And those projects can be – for the large enterprises, they are like maybe a three-year go-live cycle. The good news is we get full contract value once they've adopted Vertex. Even if they haven't gone live with the new solution, because they're getting full value by testing it along the way to prove out the invoices will be valid in those new jurisdictions when they go live with the system. So it actually works quite well from that perspective. But you're always going to see a slight delay.

Got it. Yeah. No, that makes a ton of sense, really, really helpful color there. And then, I wanted to touch on a bit on AI. I know you made the Ryan Tech acquisition in June and you just launched a copilot offering at your conference. So I was wondering, what are some of those early use cases you're really targeting the technology for? And what are maybe some key ROI examples that customers are finding or you expect them to find by adopting this technology?

Yeah. I think from a smart categorization perspective, for an indirect tax department, one of the hardest projects they have to deal with is the constant mapping of products to tax categories as jurisdictions are changing rules. Their companies are launching new products, and again, in the enterprise market, the SKUs can be in the millions for some of these larger enterprises. They are always having to stay current to make sure they're going to be taxed effectively in every jurisdiction. So the ROI on creating a smart categorization tool that will help enable the customer to stay current and minimize future audit risk is going to be compelling. I think that's the one where we've worked really hard with customers to be our design partners. Customers and partners are actually a part of our design process, and we're doing that to build trust in the solution because if you think about it, AI is a probabilistic technology, and tax needs a deterministic answer. The importance of bringing them in as design partners is to build that confidence that the solution we're bringing is going to be validated by the market. I think we're getting some really good feedback there. Going deeper, I think as we start to think about the data that we touch, AI will be a compelling tool to bring data insights off of our data fabric and the data layer that we have on our cloud platform to help customers get more insights about their tax efficiency as well as their overall business with some of the transactional data that we get the benefit of touching.

Awesome. Super helpful, David. Thank you.

The next question comes from Alex Sklar with Raymond James. Please go ahead.

Great. Thank you. I had a two-part question first on the invoicing opportunity across your installed base. David, maybe can you just help frame what percentage of your customers are going to be impacted by the current and some of those near-term rules? Any sense for how many of those haven't really purchased any invoicing solution today where it's really greenfield for you, versus maybe having to rip out another solution? Thanks.

The good news is we work with multinationals, which means they're operating in many countries, with over 50 currently deploying or having mandates for e-invoicing. This will affect most of our customers, although the impact varies based on their operational locations. Major economies like France and Germany are starting to adopt e-invoicing, which will further influence our customer base. In regions just beginning this transition, it's a greenfield opportunity since companies haven't dealt with it before. In countries like Brazil, where mandates have been established for years, our customers have been addressing this issue locally. What's changed is that customers are now seeking a global solution. Instead of working with separate providers in different countries like Brazil, Argentina, Hungary, and Malaysia, they're looking for an enterprise solution that can manage all jurisdictions. We intend to introduce this with our acquisition of ecosio, combining it with our VAT compliance solution. This will create a seamless end-to-end capability, which is a significant value proposition for us. While there might be some disruption from local providers, like in Brazil where a single-solution provider is being replaced, we're offering customers much greater value in the process. Therefore, the conversation is quite straightforward for us.

Okay. Great color. And then, John, maybe just on ecosio follow-up for you. Just on the contribution, you called out the $8 million of ARR and the $16 million of next 12-month revenue. Is the implication there that you think ARR is kind of growth we should think about as north of 100%? Or is there a big services component there? Or there's kind of a volume component that maybe isn't captured in ARR? Just any color on that bridge. Thanks.

Thanks for the question. Yeah, ecosio does have a services component of their business with the implementation and other activities that go on with some of the work that they do, not only in e-invoicing but in some of the EDI products that they have. So that is a little bit of the disparity between sort of the revenue amount and the ARR amount. That's kind of standard, and that's been in their business. So nothing unusual there. But no, we expect very good things from ecosio going forward.

Okay. Great. Thank you.

Thanks.

The next question comes from Daniel Jester with BMO Capital Markets. Please go ahead.

Great. Good morning, everyone. Thanks for taking the question. It was great to hear about the new logo win that you highlighted or some of them. As I think about the growth algorithm going forward with sort of the things that you mentioned around e-invoicing and sort of the ERP super cycle, how should we be thinking about the mix of new logo growth versus growth in your current customer base?

Yeah. I appreciate the question, Dan. So I think on e-invoicing, obviously, we have the good fortune from 40-plus years in being in business of working with the largest enterprises in the world. They're going to have the largest invoicing volume in the world. So job one is to ensure we are delivering high value to existing customers where we can expand wallet share. And again, that's a significant opportunity for us. From the e-invoicing side, that is clearly one of our priorities. It will no doubt, and we already have seen it help us land some new logos, but it's important to us that we serve our customers with that capability. The super cycle that you highlight is certainly a bigger opportunity to expand logos as well as some of the expansion we're doing with Microsoft and Shopify and Workday. We're already seeing some nice new logo wins in that space. So that's how I would kind of look at it from that perspective.

Great. Thank you. And then, John, maybe to you, impressive margin expansion over the last couple of quarters. As we think about 2025, I know you're probably not going to give us guidance today, but any sort of comments you would make about the trajectory of the margin profile of the business as we go into next year? Thank you.

Thank you for the question, Dan. We are pleased with the expansion we've experienced since concluding our significant growth phase following the IPO, which wrapped up around mid-last year. We have seen a positive margin expansion, and we are optimistic about it. In the third quarter, we made some investments that we previously discussed in the second quarter, and we intend to make further investments in the fourth quarter as we conclude the year. Regarding next year, I won't provide guidance at this time. However, I want to point out that while we are pleased with the growth in margin, the acquisition of ecosio will slightly impact our adjusted EBITDA. I mentioned this in my remarks. That's the only notable change from our typical operating performance. Thank you for your question.

Great. Thank you very much.

The next question comes from Samad Samana with Jefferies. Please go ahead.

Hey. Good morning. Thank you for taking my questions. So David and John, you guys are obviously experts and have done this for a long time. We've had a big election cycle year globally, not just in the US. Obviously, we capped it last night here. I'm just curious if you could remind us what you've seen in past post-election cycles, whatever regulatory change comes, I'm sure there's always change, but how quickly that reverberates and maybe what impact that's had on your business historically and how that's changed maybe decision-making timelines? Does it tend to create any type of air pocket, or does it accelerate decision-making? Just remind us what you've experienced in past cycles.

I appreciate your question, Samad, and it's certainly relevant given this morning's news. A federal election in the United States doesn't have a significant impact on Vertex. While it may influence the broader economy, it doesn't change the tax legislation we have to navigate. Our opportunities in the U.S. primarily come from the 10,000 state and local jurisdictions. Therefore, we don’t expect a major shift based on federal elections; it’s more about what’s happening locally. States are struggling for revenue in a fluctuating economy, and indirect taxes are their primary source of corporate revenue. Our tax research team is skilled at adapting our content database to changes in rules and regulations, so our response is more about updating content rather than making technological adjustments. We are leveraging advanced technologies to enhance our ability to process these changes swiftly. Looking globally, elections worldwide highlight the ongoing debt challenges jurisdictions face, leading them to utilize VAT and e-invoicing as key strategies to address financial deficits, which presents opportunities for us.

Great. John, regarding ecosio, I know you've received several questions about it already, but when you consider what you're projecting for 2025 as the base case, could you help us understand how much of that is based on expected revenue synergies in the first year? Is it mainly based on ecosio maintaining its current performance, with an expectation of increased synergies or growth in the second year? Please help us understand the progression of ecosio and what you anticipate in that initial guidance.

Yes. In the initial guidance, that assumes that ecosio's running at its normal pace with what it has. It assumes very little synergy activity going on from the work that we'll be doing with them together. We'll see how that plays out. But again, they have some real nice growth aspirations there in their business, and we're excited about that. But that's how we think about it. Again, we think the opportunity, as David more fully described, really is out there, and it really plays out late into next year and into the following years with the mandates coming and companies really looking for that end-to-end solution that we can offer.

Great. Appreciate it. Thanks guys.

Thanks, Samad.

The next question comes from Jake Roberge with William Blair. Please go ahead.

Yes. Thanks for taking my questions. And congrats on the great quarter. Yes, I just wanted to follow up on the ecosio deal as well. I know there are a few geographies that ecosio covers from an invoicing perspective today. So just kind of moving forward, I'd be curious how you're thinking of the building versus buying in that space to kind of get the fully covered solution.

Yes, Jake, thank you for your question. Part of the investment that John mentioned will be directed towards building out our content coverage over the next couple of years. Our primary focus is on regulatory content, as it is central to our business and leverages technology for delivery. We have been successful in this area for many years. We recognize the gap between current coverage and what is needed, and we are committed to ensuring that the necessary investments are made to cover the countries where we currently lack presence. This is fundamentally a content issue, not something that requires acquisitions; we intend to harness our expertise in content development along with the ecosio team to expand into those additional countries.

Okay. Very helpful. And then to hear that you're starting to see some good momentum behind the SAP opportunity. Is there any sense of how much SAP migrations are actually impacting the model today from the new logos you're landing? Like, is that already having a meaningful impact on new logo growth or new logos still largely being driven by kind of how you've historically landed the new logos? Just trying to see if we're starting to see that migration ramp up more…

Yes, that's a very good question, and I appreciate it. I wish I had a straightforward answer, but it’s still early since the migration process began only a year ago with the end-of-life announcement in June 2023. We’re beginning to see some momentum, but I’m hesitant to provide specific data without having enough to back it up. However, I can say that the pipeline is definitely being influenced by it. The regulatory environment has been quite dynamic, especially with significant changes in sales tax rates in 2024, which has created new demand opportunities for us. That’s why I’m being cautious in my response, but it’s clear that it’s having a positive effect on our situation.

Yes, makes a lot of sense. Well, thank you for taking the questions and congrats on the results.

Yes. Great. Thank you. We’re really pleased.

The next question comes from Rob Oliver with Baird. Please go ahead.

Great. Good morning. Dave, I know you called out that semiconductor capital equipment deal at mid-six figures. And you noted you were hesitant to extrapolate that that would be sort of the forward leading indicator on all deals. However, the fact that you called it out, I'm just curious what you saw in that deal that drove such an appreciably higher contract value than is your norm and how you either drive the sales efforts or take the learnings from that sort of deal to hopefully repeat that in other kind of S/4HANA driven migrations?

Thank you for the question, Rob. You've touched on a complex issue. Typically, when customers engage with us, they are using our services for part of their business, and over a long-term partnership of possibly 10 to 20 years, we may end up covering their entire operation. During their migration, they mainly aim to replace and resolve the existing issues they face. The positive aspect is that they have confidence in our tax content on the current platform, making it a natural progression for them to transition to the new platform with us. In this particular case, the customer mentioned that while they were making this change, they wanted to explore other areas where they could utilize Vertex. This indicated a desire to expand our relationship. Our efforts in enhancing our customer success function and delivering proven products since their initial purchase have created an opportunity for us to present a broader value proposition. We plan to use what we’ve learned to target other accounts. However, I don’t currently have enough data to suggest that we will see a similar uplift across all of our existing ECC customers, which is why I wanted to clarify that point. Nonetheless, it was an exciting development, and we gained valuable insights that motivate us as we move forward.

Okay. That's very helpful. Thank you. And then, John, just a quick one for you. I think by our math, the lower ARR per direct customer would have been up organically, if not for the deal, but just wanted to make sure we weren't missing anything there? And then just a quick follow-up to that, just anything to call out relative to the Pagero deal unwind and any impact that might have on the model? Thank you.

Nothing significant to mention regarding the Pagero unwind. That was accounted for in the second quarter. I don't see any issues there. From the AARPC perspective, we are seeing that some of the new customers we are acquiring, particularly with Systax and ecosio, are typically starting with lower revenue compared to our traditional customers. This does have a slight effect on lowering the average a bit. Thanks for your question, Rob.

Very helpful. Thanks guys. Appreciate it.

The next question comes from Adam Hotchkiss with Goldman Sachs. Please go ahead.

Great. Thanks so much for taking the question. David, I guess just to take a step back, I know you talked a lot about tax complexity and breakage of more manual systems as a driver of businesses to vended tax solutions. I'm just curious, we talk a lot about e-invoicing and the ERP upgrade cycle, but could you just maybe flesh out any other notable accelerative tax complexity catalysts that you're watching? Or is it really just about the steady drumbeat of tax complexity increases we've talked about for a number of years?

Yes, it's really the latter. This is primarily a source of corporate revenue for governments, which are struggling to find ways to meet their budget needs. Raising rates politically may not be wise given the election cycle, so instead they implement more dynamic rules like bag fees and delivery fees in states such as Minnesota and Colorado. This creates significant jurisdictional pressure for businesses, which may find it increasingly difficult to keep pace with these complexities. Subsequently, businesses may experience audit pressure due to these regulatory changes, leading them to realize that their previous accuracy was insufficient. This realization often prompts a CFO or similar executive to reconsider the reserves set aside for settlements, as it ties up working capital. They may seek a reliable outside solution for these issues. The notable regulatory trend here is certainly the rise of e-invoicing, which introduces a completely new dynamic.

The next question comes from Brad Reback with Stifel. Please go ahead.

Great. Thanks very much. John, if I'm doing my math right, it seems like, I'll call it, core sustainable or repeatable Vertex grew about 18% on a subscription basis, which is a nice uptick sequentially. Should we think about this as the new go-forward or continued variability around that level?

Yes, Brad, that's a good question. I wouldn't say we're ready to set that as the standard for moving forward. However, we have observed solid performance recently and identified some promising opportunities. You mentioned poor operating results, but that might be because you didn't account for some of the adjustments we had this quarter, which is a reasonable perspective. Regarding our guidance for the fourth quarter, we did have a strong performance last year, so it will be a tougher comparison. Nevertheless, we are optimistic about the momentum in the business and our growth. The annual recurring revenue growth has been consistently around 16% this past quarter, and we are pleased with that. I wouldn't say I'm prepared to raise expectations to the high teens that you're suggesting.

That's great. And then, David, circling back to an earlier question around, sort of the growth algorithm and customer count. If I also do the kind of core Vertex over the last couple of quarters taking out ecosio and Systax, I get a fairly flat number, and I understand there's a transition going on in the base. Do you think that we see in the coming quarters or years of meaningful acceleration there? Or should we think about really ARPC being the predominant driver of subscription as that transition happens in that installed base to bigger customers? Thanks.

Brad, scaled customer growth is the number one priority for us, just being really direct on that. That's what we focus on because those are the customers that pay the bills today and they will buy more from us in the future. There is still some noise at the very bottom end of our market, that legacy cloud strategy that we talked about that's long since been set aside. I am excited about the opportunities we're growing in Microsoft, NetSuite, Workday, Salesforce, and now e-invoicing to bring us into new logos. I don't think we're giving guidance on any of that just yet. But there's no doubt that part of the strategy is to focus and broaden our tentacles into the right ecosystems that we can also expand new logos as well as continue to drive scaled customer growth. That remains the priority though.

And I'm sorry if I missed it. What was the scaled customer growth in the quarter?

13%.

The next question comes from Natalie Howe with Baird. Please go ahead.

Hey. This is Natalie Howe on for Brad. So I wanted to talk a little bit about your cross-selling deals. You mentioned some pretty big wins there. And if I remember correctly, back in 2Q, you mentioned you anticipate seeing that activity pick up in the second half of the year. I guess I wanted to see how that was tracking with your expectations and if you see any sort of change in that rate for the rest of the year?

Natalie, we appreciate the question. Yes, it did track consistently with what we thought we had good visibility on activity that was coming. Not unusual in our space, in the enterprise space, that tax departments get a budget that's more available to them in the second half of the year. So, it was a little slower. We called that out, honestly, in the first half of the year but had good visibility to that budget spend that was going to accelerate, and I think it's been baked into our guidance that we see that continuing solidly here in Q4.

The next question comes from Patrick Walravens with Citizens JMP Securities. Please go ahead.

Great. Thank you. And let me add my congratulations. So David, I have two questions about Ecosio. First, how does having a solution for European e-invoicing drive demand for your core tax engine in Europe? Secondly, can you elaborate on the data opportunity that Ecosio presents for Vertex regarding continuous transaction processing?

Sure. Thank you, Pat, for the question and the comment on the quarter. So yes, so what e-invoicing is, you're sending out invoice data, which is kind of like if you think about it, this almost makes it like a mini tax return. You're sending the government tax information at the point of the transaction. Normally, you didn't send them any tax information until the end of the quarter or the end of the month depending upon the filing process. Customers are starting to realize, 'I want to have more confidence in the accuracy of what I put on that invoice as the taxability that I'm going to owe because the governments are going to see it sooner than I'm used to.' Because that comes from master data, which is controlled upstream in the business where the tax department doesn't have as much influence, the determination engine gives them a way to have more confidence in that tax ability because they're leveraging our content and our tax assessment on the invoice itself. That's where I think we're seeing some interesting value prop conversations coming from, number one. Number two, relative to the data question, I think it's we're just going to be touching that much more data. One of the things we've been focused on our cloud platform is expanding our data layer to support the end-to-end process. What we have learned is that if tax departments have accuracy and transparency to their data throughout the end-to-end workflow, it's the best place for them to ensure the accuracy and compliance that they need. That's what really excites me about what we're doing in e-invoicing is going to fuel the quality of that data transparency to give us a new value prop to talk about with our customers.

Great. Thank you.

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

Thank you, everyone, for joining us today. As always, if you have follow-up questions or would like to schedule additional time with the team, please reach out to me at investors.vertexinc.com. Have a great rest of your day.

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