Greetings, and welcome to the Vertex Second Quarter 2022 Earnings Conference Call. At this time all participants’ are in a listen-only mode. A breif question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Crivelli, Vice President of Investor Relations at Vertex. Please go ahead.

Good morning, everyone, and thanks for joining us for Vertex's conference call for the second quarter ended June 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. I'm proud to share our Q2 results with you today. We delivered another strong quarter of profitable growth. Total revenue was $119 million, up 14% year-over-year and exceeding the high end of our guidance. We saw solid growth across the key measures by which we monitor customer success. ARR grew in the quarter to $398 million, up over 18% year-over-year. NRR was 110%, up from 106% for the same period in 2021 and GRR was 96%, up from 94% and from the second quarter of last year. We continue to grow our top line and sustain strong EBITDA margins, while investing for the future. Throughout the quarter, we saw strong adoption from both new and existing customers, reflecting the strength of our brand, momentum with investments we are making and sustained demand and market opportunity despite challenging economic conditions. Historically, over the past 60-years, it has been shown that indirect taxes provide a more consistent method of government funding during adverse economic cycles relative to income and property tax, which are the other primary sources of funding. As a result, indirect tax revenues play a key part in the global economy and serve as a primary source of revenue for governments around the world. In fact, government revenue from indirect taxes is more than double that of income tax. And this will only continue to increase with expanding requirements for digital commerce and real-time reporting in a growing number of countries. All of this puts added pressure on companies of all sizes and market segments to automate indirect tax compliance to keep pace with changing requirements. Our company is still processing indirect taxes with homegrown systems, it's a matter of when, not if they will need to automate their…

Thanks, David, and good morning, everyone. I'll now review our second quarter financial results and provide third quarter and full-year guidance. In the second quarter, revenue was $119.3 million, up 13.7%, compared to last year's second quarter and exceeding the high end of our quarterly guidance by $1.8 million. Subscription revenues increased 12.8% period-over-period to $101.1 million, and services revenues grew at 18.6% period-over-period to $18.2 million. Annual recurring revenue or ARR, was $398.1 million in the quarter, representing approximately 18.4% growth over the comparable 2021 period. We've now lapped the Taxamo acquisition in last year's second quarter. Accordingly, on an organic basis, ARR grew at 18% as compared to 17.2% in Q1 2022. Net revenue retention, or NRR, remained strong at 110%. This was up from 106% in the comparable 2021 period and consistent with the first quarter of 2022. This metric continues to demonstrate our customers' ongoing commitment to our software and our solutions. Gross revenue retention or GRR, was 95.9% at quarter end. This is consistent with prior performance, which has the averaged 94% to 96%. Our returns processing Managed Services business generated recurring services revenues of over $10.3 million year-to-date through the second quarter of 2022 as compared to $8.4 million for the comparable period in the prior year. This service is a competitive differentiator and generates consistent recurring revenue, but is not included in our ARR. At June 30, we had 4,242 direct customers, consistent with last quarter. The inclusion of Vertex users that are sold and serviced by our one-to-many channel strategy would add 266 indirect customers to our customer count. So that investors have a full picture of our customer counts, including indirect small business customers sold in service by our channel partners, we have provided the most recent five quarters of data…

Thanks, John. When I look back at Q2 in the first half of the year, the common thread driving our strong financial results is people, which is why we continue to invest in our ecosystem and our team. I want to take a moment to thank our Vertex team around the world. It is your ongoing commitment to developing innovative solutions and an unmatched experience that allows us to deliver value for our customers and shareholders. I'd also like to thank our customers for putting your trust in Vertex and allowing us to be part of your business success and growth. As you've heard time and again in my comments today, our partner ecosystem and the strength of the relationships we have built are a true differentiator for Vertex. Our end-to-end platform, our robust global tax content, our trusted partner ecosystem and our talented Vertex team create a winning combination that continues to drive our growth. Now let's pause for your questions.

Thank you. We will now be conducting a question-and-aswer session. [Operator Instructions] Your first question comes from Josh Reilly with Needham.

Hey, guys. Thanks for taking my questions and nice job on the another quarter of accelerating ARR growth. If you look at your exposure by vertical, within retail, obviously, we know you have some very large customers. I'm curious, what are you seeing in their trend in terms of in-store versus e-commerce transactions? And how are these customers renewing their revenue bands year-over-year? Are you seeing any down-sell because of lower e-commerce transaction volumes or is it just kind of stable?

Josh, thanks -- thank you for calling in, and I appreciate the question. To be honest, we don't have direct visibility on a quarter-by-quarter basis of what our clients are building through e-commerce or in-store to answer that question directly. The good news is in almost all of our retailers, we have both sides of that relationship. And so -- and then when you add in now the edge computing solution, we're actually seeing still expanded opportunities in the retail space because of the need for retailers to be more creative in serving the point of need, and that's what containerization and edge solutions allow them to do. So we're not -- I don't have that specific data. I will say, again, because of our license bands, the way we price our product, we don't see any material downward pressure. We've been through several, obviously, economic downturns in our 40-year history and have not experienced sort of any significant repricing of contracts, yes.

Got it. Okay. And then maybe one other way of kind of asking about business trends. If you look at your B2C customers versus some of your B2B customers, are you seeing any difference in terms of the underlying trends with those customers in terms of what their eagerness to upsell or cross-sell new additional products? And can you just remind us maybe roughly how much of your business is B2B versus B2C?

The great news is we're not seeing any elongation or slowdown in our pipeline across all our verticals. One of the beauties of our content databases, we actually have the opportunity sell across so many verticals. So if one vertical is slow, we're seeing now oil and gas do some really interesting things that we've added that content. So I haven't seen any real material issues there in the shift. I would say I don't have great data to answer your B2B versus B2C, but they are fairly balanced. I would just -- I would approximate.

Got it. Thank you guys.

Thanks, Josh.

Thanks, Josh.

Next question, Matt Stotler with William Blair.

Hi, there. Thanks for taking the questions. Maybe just start off with one on cloud. Obviously, cloud deployments continue to be the majority of your new customer wins here. But I'd be interested if you're seeing any update in kind of the shift in the installed base, right? I mean whether there's been any move or acceleration of transition in that installed on-premise space towards cloud? Or what that path looks like in expectations there going forward?

Yes. Matt, I appreciate. We really look at cloud in 3 dimensions. It's the new logos, which we continue to see exceptional success by our sales teams in delivering cloud as the primary. We see it in the cross-sells, and I'd say it's still holding at about 50% of all of our cross-sells are that. The migration base continues at the fairly annualized 3% to 4% we experience every year. Haven't seen a material shift in that. Obviously, as we monitor the ongoing evolution of OCI adoption of SAP S/4 adoption, we may see acceleration there, and it's certainly we're positioned well for that because of our content database and how well customers have relied on our content accuracy on-prem, when they're ready to make that migration to the cloud, it's a pretty seamless transition from their perspective because they want to get the same answer in the cloud that they were getting on-prem. And that's why we enjoy such high success rate on those migrations. But I would not say there's any unique acceleration.

Right. Got you. That's helpful. And a great segue into the next question, which is, I think Josh asked a couple of questions on the macro. Would be interested when you look specifically at the, I guess, adoption triggers, right? The trigger events that typically drive adoption of your solutions or moving to cloud or what have you, specifically momentum in the ERP implementation pipeline and the progress you're seeing in that pipeline. And then any other observations around significant adoption triggers that you're seeing here.

Yes. So we -- our adoption triggers are threefold. They are business model transitions as companies seek to create new revenue models, which obviously in challenging economic times is going to be an area of focus. And as they're doing that, that will create pressure on the in-house tax solution, which will create pain and, therefore, opportunities. You'll also see it in the regulatory environment in one or two ways. You'll see it either in increased regulations or you'll see it in audit pressure. And we've seen through tough economic times, both things showing up. So that's another trigger. And then lastly, as you note, it's the system change. It could be a best-of-breed like I'm adopting a Coupa or an e-commerce platform like Adobe Magento or it could be ERP. And I would say right now, we're seeing demand across all 3 of those segments. We haven't seen any material slowdown in the work that we're doing across those platforms -- across those drivers at this point.

Very helpful. Thanks again.

Sure.

Next question, Brad Reback with Stifel.

Great. Thanks very much. High level, guys, without getting specific on guidance for next year, but do you see margins bottoming this year?

Yes. This is John, Brad. Thanks for the question. I think we do. I think we've talked about that we really see this year as a big investment year for us. I mean we are making significant investment both in external facing through sales and marketing as well as through some of the R&D activity that we're doing to develop some of those new products. And we have always expected this was going to be our heaviest year of investing and that we would start to see ourselves move out of it into the back part of next year for sure.

And just sort of following on there, free cash flow this year, will it be positive?

We anticipate that it will. We don't guide to that, Brad. But from a free cash flow standpoint, we had a couple of big drivers in the current quarter when we think about some of the changes that took place. The biggest areas in ARR. We had a couple of real big ARR collections back in Q2 of 2022 that really drove in, and it was a lot of kind of pent-up stuff from the pandemic. And then -- and that was -- sorry, and that was in 2021. In 2022, what we did see is the timing of certain of the renewals and certain of the new sales that we had in the quarter were a little bit differently time than last year. And so I think the cash flow from those things just flops period. So I think we'll see that come back. We believe that's going to be -- that's certainly going to be positive, but we feel good about our opportunity to continue to generate cash flow and move it forward. Our aging continues to be in great shape. And again, because of the investment year from a cash flow standpoint, the PP&E and some of those spends are continuing to be very strong as we drive those product development activities.

That’s great. Thanks very much.

You bet.

Next question Samad Samana with Jefferies.

Hey, good morning, Joe. Maybe first, just going back to the organic ARR that was a pretty strong sequential increase and good particularly in dollars added for 2Q. So John or David, either one of you could answer this question, but I'm curious, how would you think about that better than normal seasonal strength? Is that more of a function of sales execution, the timing of go lives, maybe switching from 1Q to 2Q? Or just better-than-expected demand. Just how should we think about that given how seasonally strong that was?

I think I would say a couple of things there. I would say one is we've been investing continually in our sales and marketing, it takes -- there's a lead time before you actually are going to get return on that. And so we're seeing, I think, some of the growth because of the investments we've made there in both customer success and sales and marketing that is driving continued improvement. I do think traditionally, in our business, Q1 is a little slower than Q2 in general. So that's not unusual for us. And then the last thing, I think the investments we've been making with our ecosystem partners and the relationships that we -- that I've called out about SAP and Oracle are really critical to our success, and they continue to be important levers that we're digging into.

Understood. And then just as I think about, David, your comments on several large European wins, that just kind of stands a little bit in contrast to some maybe other software companies that are calling out Europe being a little bit of a tougher market right now. What do you think is driving your customers or your wins there beyond your distribution efforts? Is it just that the problems around tax rules has gotten too complex and they have no choice? Or is it just your vertical exposure that's still long you have success in Europe? Just maybe help us understand why that's a little bit different than maybe what some other software companies are seeing in the market?

Sure. So I'd start with our product suite. I'm really proud of what our team has built with that chain flow accelerator now our global compliance solution as those are maturing in the market. I think gaining referenceability around those is growing. The European market, as I've mentioned in the past, is very much a community with referenceability, anything in the enterprise market, but Europe, in particular, where referenceability matters. And so I think combination of the great work our team has done in the product suite, the referenceability we're gaining. We enjoy strong relationships with the alliance partners and consulting partners in the U.S. That is translating more and more into Europe because of their global organization as well. And then obviously, the strength of our SAP offerings, the whole suite of SAP capabilities we bring to bear with the LCR-Dixon acquisition we made last year, the relationships we enjoy with SAP. When you put those together, I think that's what's generating the type of results that we're excited about.

Great. Apprecxiate taking my questions and good to see the solid results.

Thank you.

[Operator Instructions] Next question comes from Daniel Jester with BMO.

Thanks for taking my question. Good morning, everyone. Appreciate the additional color on the indirect client growth. Maybe if you could just spend a minute and help us think about sort of how additive that could be in the future, what's driving that, et cetera? Thank you.

Yes. I think it's part of our strategy to be efficient in accessing a market that otherwise we don't think is very efficient to access on a direct sale basis. And so I think as we continue to advance, and again, I think referenceability will Matt, as we continue to add new partners into that equation, it will be -- it builds over time, though. It will be an additive, but I don't want to confuse you -- confuse anyone that our focus is the enterprise market and the upper end of the mid-market. These are unique opportunities where we'd see growth but it's clearly not the primary focus of this business. Primary focus is complex mid-market and enterprise customers where we lead.

Great. And then maybe two quick ones for John. First, I don't know if you've mentioned it, but did you say what organic cloud revenue growth was in the quarter? And was there any FX impacts on the second quarter or in the guide? Thank you.

Yes. Thanks, Dan. Appreciate it. There was virtually minimal impact from an FX standpoint. Generally speaking, the majority of our revenue comes in U.S. denominated and even our European contracts. Some of those are denominated in U.S. So we do not have a big impact on exposure to FX from that standpoint. And from a cloud revenue standpoint, I think we talked a little bit about the growth there in terms of kind of what that's come through cloud revenue was the 25% growth that we reported out. And then on a pro forma basis, excluding the $2.1 million item from last year, that gets back up to 34%.

All right. Thank you very much.

You bet. Thank you.

Next question, Pat Walravens with JMP Securities.

Great. And let me add my congratulations. So it's just kind of interesting is the change in the competitive landscape with Vista and Avalara. So David, could you just maybe remind us how often and when you compete against them? And what impact you think this might have on your business going forward?

Yes. So I think we see them primarily in the mid-market. That's our -- that's been sort of the middle ground between them coming up market and us moving down market as more demand is showed up in the mid-market, and that's really where we see them. We don't really see them and I wouldn't have not seen any material change in our competitive win rates through our competitive dynamics, quite frankly, at the enterprise market. That's really Vertex and Thomson Reuters. I don't want to speculate on what this is going to do. I certainly think it validates the space in the industry that we play in. And the reality is we've seen a lot of M&A deals in our industry over time. Thomson bought Sabrix, ADP and Vista have both owned what is now HG's tax wear business and now -- so that became Sovos, and you had strike by tax charge. So we've seen a lot of industry transition. It really hasn't affected our brand, our market leadership or our strategy in any material way.

Thank you.

Next question comes from Keith Weiss with Morgan Stanley.

Hi, this is [indiscernible] on for Keith. Thanks again for taking my question. So I just wanted to touch on kind of the growth that you're seeing in Europe. And maybe can you provide any additional color sort of on your investments in Europe and how they're paying off and what differences you're seeing between the U.S. and European market in this environment? And then maybe also you spoke a little bit to the catalyst for customers to move to the cloud. So if you can maybe zoom into particularly the in Europe, which one of these catalysts is really driving the strong cross-sell deals that you noted? And how do you expect that sort of going forward?

Yes. So the European -- thanks for the question. The European -- the European growth -- I think you have to focus on the product suite. We have built products that are uniquely aligned to the SAP ecosystem. They are certified within SAP, which is really important to the end user to experience it the way they experience the rest of the SAP capability and the recipe offerings and -- so I think in doing that, that has created a differentiation for us in the market. When you add in some of the acquisitions we made like LCR-Dixon, which has a wonderful tool set of capabilities for SAP. It really gives us a broader approach to market than what we're seeing -- what we've seen in competitive environment. And so I think that's why we've enjoyed the success we have. As far as looking forward, I think we're going to continue to invest in areas of Europe that are where demand is being driven. So that would be around things like we're seeing e-invoicing becoming a growing demand point. We're seeing regulatory change that is making it more complex for the native functionality of VAT, and that has -- that continues to be an opportunity area for us. And then again, I can't emphasize enough referenceability matters. In the enterprise market, and so part of the reason I think we're gaining some traction there is we have been fortunate to secure some of the largest companies in Europe. And in doing so, that will attract other tax buyers who are struggling with some of the issues on regulations to look for who else is doing this well. And because Vertex is now developing brand over there, I think that is why we're gaining the traction we are.

Excellent. Thank you.

[Operator Instructions] There are no further questions. I would like to turn the floor over to David DeStefano for closing remarks.

Great. Thank you for joining us today. We look forward to speaking with you next quarter. If you have any questions, please don't hesitate to reach out. Have a great rest of your day.

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.