What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-05-13 compared with 2020-11-13 · 228 added, 380 removed, 284 unchanged (68% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties.

Our actual results and the timing of events could differ materially from those discussed in the forward-looking statements.

Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the section titled “Risk Factors” in Part II, Item 1A.

Vertex delivers comprehensive tax solutions that enable global businesses to transact, comply and grow with confidence.

Companies with complex tax operations rely on Vertex to automate their end-to-end indirect tax processes.

Indirect tax is the largest corporate tax category, encompassing sales tax, sellers use tax, consumer use tax and value added tax (“VAT”), among others.

Indirect tax accounts for more than $3.5 trillion of annual tax revenue, which is 2.5 times the amount of corporate income taxes, according to the 2019 OECD Tax Database.

Our software, content and services address the increasing complexities of global commerce and compliance by reducing friction, enhancing transparency and enabling greater confidence in meeting indirect tax obligations.

As a result, our software is ubiquitous within our customers’ business systems, touching nearly every line item of every transaction that an enterprise can conduct.

Vertex is a leading global provider of indirect tax software and solutions.

Our mission is to deliver the most trusted tax technology enabling global businesses to transact, comply and grow with confidence.

Vertex provides cloud-based and on-premise solutions that can be tailored to specific industries for every major line of indirect tax, including sales and consumer use, value added and payroll.

Headquartered in North America, and with offices in South America and Europe, Vertex employs over 1,200 professionals and serves companies across the globe.

We have pioneered tax technology for over 40 years.

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We bill almost all of our customers annually in advance of the subscription period.

We have over 4,000 customers, including the majority of the Fortune 500, as well as a majority of the top 10 companies by revenue in multiple industries such as retail, technology and manufacturing, in addition to leading marketplaces.

At September 30, 2020, we had over 4,000 customers and our Annual Recurring Revenue (“ARR”) per customer was over $75,000, while at September 30, 2019, we had over 4,000 customers and our ARR per customer was over $65,000.

Our customers include a majority of the Fortune 500, as well as a majority of the top 10 companies by revenue in multiple industries such as retail, technology and manufacturing, in addition to leading marketplaces.

As our customers expand geographically and pursue omnichannel business models, their tax determination and compliance requirements increase and become more complex, providing sustainable organic growth opportunities for our business.

Our pricing model is aligned with our customers’ objectives by adjusting with their growth over time.

Our flexible, tiered transaction-based pricing model also results in our customers growing their spend with us as they grow and continue to use our solutions.

We principally price our solutions based on a customer’s revenue base, in addition to a number of other factors.

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Cloud-based subscription sales to new customers have grown at a significantly faster rate than on-premise software subscription sales, which is a trend that we expect to continue over time.

We generated 28.7% and 21.0% of software subscription revenue from cloud-based subscriptions during the three months ended September 30, 2020 and 2019, respectively, and 26.6% and 18.7% for the nine months ended September 30, 2020 and 2019, respectively.

While our on-premise software subscription revenue comprises 73.4% of our 2020 software subscription revenue, we anticipate that it will decrease as a percentage of total software subscription revenue as cloud-based subscriptions accelerate.

We sell our solutions primarily through our direct sales force, which focuses on selling to qualified leads provided by our marketing efforts, and through our network of referral partners.

We generated 32.3% and 25.1% of software subscription revenue

from cloud-based subscriptions during the three months ended March 31, 2021 and 2020, respectively.

While our on-premise software subscription revenue comprises 67.7% of our 2021 software subscription revenue, it continues to decrease as a percentage of total software subscription revenue as cloud-based subscriptions accelerate.

We license our solutions primarily through our direct sales force, which focuses on selling to qualified leads provided by our marketing efforts, and through our network of referral partners.

We also utilize indirect sales to a lesser extent to efficiently grow and scale our enterprise and mid-market revenues.

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We believe that global commerce and the compliance environment provides durable and accelerating growth opportunities for our business.

We generated revenue of $82.4 million and $94.6 million for the three months ended September 30, 2019 and 2020, respectively.

We generated revenue of $235.4 million and $275.1 million for the nine months ended September 30, 2019 and 2020, respectively.

We had net income of $11.9 million and a net loss of $21.0 million for the three months ended September 30, 2019 and 2020, respectively.

We had net income of $26.3 million and a net loss of $79.2 million for the nine months ended September 30, 2019 and 2020, respectively.

Adjusted EBITDA was $19.6 million and $22.5 million for the three months ended September 30, 2019 and 2020, respectively.

Adjusted EBITDA was $50.8 million and $59.3 million for the nine months ended September 30, 2019 and 2020, respectively.

Additionally, we generated net cash provided by operating activities of $45.8 million and $20.0 million in the nine months ended September 30, 2019 and 2020, respectively.

Our free cash flow was $3.7 million and $15.8 million in the three months ended September 30, 2019 and 2020, respectively.

Our free cash flow was $20.1 million and $18.7 million in the nine months ended September 30, 2019 and 2020, respectively.

Adjusted EBITDA and free cash flow are non-GAAP financial measures.

We generated revenue of $98.2 million and $89.2 million for the three months ended March 31, 2021 and 2020, respectively.

We had net income of $2.3 million and a net loss of $29.1 million for the three months ended March 31, 2021 and 2020, respectively.

Adjusted EBITDA was $18.2 million and $15.3 million for the three months ended March 31, 2021 and 2020, respectively.

Adjusted EBITDA is a non-GAAP financial measure.

Refer to “ Use and Reconciliation of Non-GAAP Financial Measures ” for further discussion of non-GAAP financial measures and their comparison to GAAP financial measures.

Recent Developments

Initial Public Offering

On July 31, 2020, we completed our initial public offering (“IPO”) in which we sold 23,812,216 shares of our Class A common stock, and certain selling stockholders sold an additional 510,284 shares of Class A common stock, at a public offering price of $19.00 per share.

We received proceeds of approximately $423.0 million, after deducting underwriting discounts and commissions, from sales of our shares in the IPO.

We did not receive any of the proceeds from the sale of shares by the selling stockholders.

Taxamo Acquisition

On May 12, 2021, we acquired EVAT Solutions Limited and its subsidiaries, doing business as Taxamo (collectively “Taxamo”), a cloud-based pioneer in tax and payment automation for global e-commerce and marketplaces for approximately $200.0 million in cash on hand.

This acquisition supports and accelerates our growth strategies across ecommerce platforms and marketplaces in the enterprise and mid-market in Europe and North America, and among our existing global customers.

Impact of COVID-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic.

The COVID-19 pandemic is having widespread, rapidly evolving and unpredictable impacts on global society, economies, financial markets and business practices.

Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes and closure of non-essential businesses.

To protect the health and well-being of our employees and customers, we have made substantial modifications to employee travel policies, closed our offices as employees are advised to work from home and cancelled or shifted our conferences and other marketing events to virtual-

The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers and partners, and there is substantial uncertainty in the nature and degree of its continued effects over time.

During the first half of 2020, the COVID-19 pandemic had minimal impact on our revenue or results of operations, as we continue to derive the significant majority of our revenue from our existing software subscriptions.

During 2020, the COVID-19 pandemic had minimal impact on our revenues and results of operations, as we continue to derive the significant majority of our revenues from our existing software subscriptions.

As we principally price our solutions based on our customers’ revenues within certain revenue bands, elongated declines in our existing customers’ revenues may impact our ability to grow our existing customer revenues.

We did not experience an abnormal number of non-renewals in the first half of 2020, nor any material declines in revenue associated with declines in our customers’ revenues, and we currently expect our existing customer base to remain largely stable, as it did through the recession in 2008 and 2009.

However, significant decreases in non-renewals or concessions to renewal customers would have a material impact on our revenues and cash flows.

We did see a decline in new software subscription billings at the end of the first quarter of 2020.

It is important to note that our sales metrics are assessed quarterly, and given the size and complexity of our sales process we often see variances from month to month due to legal or procurement processes.

In the case of the first quarter of 2020 we achieved our new software billings targets as several deals were completed earlier in the quarter.

For the third quarter of 2020, new software billings exceeded our original third quarter of 2020 forecasts.

We have seen some delays due to prospects shifting to working remotely, and some due to economic uncertainty.

We expect that the uncertainty caused by the COVID-19 pandemic could continue to impact our billings to new customers for the remainder of 2020, and it may also negatively impact our efforts to expand revenues from our existing customers as they continue to evaluate certain long-term projects and budget constraints.

We did not experience an abnormal number of non-renewals in 2020, nor any material declines in revenues associated with declines in our customers’ revenues, and we currently expect our existing customer base to remain largely stable, as it did through the recession in 2008 and 2009.

However, significant increases in non-renewals or concessions to renewal customers would have a material impact on our revenues and cash flows.

During 2020, we did see some delays in signing deals due to prospects shifting to working remotely, and some due to economic uncertainty.

We expect that the uncertainty caused by the COVID-19 pandemic could impact our billings to new customers beyond 2020 as the pandemic continues to generate economic uncertainty, and it may also negatively impact our efforts to maintain or expand revenues from our existing customers as they continue to evaluate certain long-term projects and budget constraints.

However, we do not anticipate that overall demand for our software and solutions, our ability to deliver such software and solutions, or our growth strategies will be materially impacted by the COVID-19 pandemic, as companies continue to rely on us for their indirect tax solutions.

In addition to the impacts on our sales, our cash collections from existing customers were lower than expected at the end of the first quarter of 2020.

During the second and third quarters of 2020, our collections exceeded our expectation as some of the procedural disruptions that customers experienced as they shifted to remote work in March had stabilized.

We believe that we may see delays in collections over the coming months.

Our cash collections for the year were consistent with our expectations as some of the procedural disruptions that customers experienced as they shifted to remote work early in the year stabilized by the end of 2020.

We believe that we may see delays in collections in 2021 as the pandemic continues to generate economic uncertainty.

However, we do not believe that these delays will materially impact our business;

we continue to expect that we will be able to collect amounts due under subscription contracts from customer experiencing issues as a result of the COVID-19 pandemic, and we have not recorded an additional allowance for doubtful accounts in connection with any delays.

we continue to expect that we will be able to collect amounts due under subscription contracts from customers experiencing issues as a result of the COVID-19 pandemic, and we have

not recorded additional credit losses associated with the allowance for doubtful accounts in connection with any delays.

Given that customers cannot forgo our monthly content updates, which are necessary to remain compliant with the most current regulations, we believe customers will continue to pay our renewal invoices in a timely, even if slightly elongated, manner.

We believe that we currently have ample liquidity and capital resources to continue to meet our operating needs, and our ability to continue to service our debt or other financial obligations is not currently impaired.

For a further description of our liquidity, including the New Credit Agreement entered into on March 31, 2020, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic;

For a further description of our liquidity, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors that cannot reliably be predicted, including the duration and scope of the pandemic;

governmental, business, and individuals’ actions in response to the pandemic;

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These factors may adversely impact consumer, business and government spending on technology as well as customers’ ability to pay for our products and services on an ongoing basis.

This uncertainty also affects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including estimated allowance for subscription cancellations, product life cycles and estimated lives of long-lived assets.

Key Business Metrics

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We derive the vast majority of our revenue from recurring software subscriptions.

We believe ARR provides us with visibility to our projected software subscription revenue in order to evaluate the health of our business.

We believe Annual Recurring Revenue (“ARR”) provides us with visibility to our projected software subscription revenue in order to evaluate the health of our business.

Because we recognize subscription revenue ratably, we believe investors can use ARR to measure our expansion of existing customer revenues, new customer activity, and as an indicator of future software subscription revenues.

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MRR only includes customers with MRR at the end of the last month of the measurement period.

(In millions)

Period-over-Period change

Three months ended

(Dollars in millions)

Year-Over-Year Change

Annual Recurring Revenue

ARR increased by $40.9 million or 15.4% for the twelve month period ended September 30, 2020, as compared to the same period in 2019.

The increase was primarily driven by $20.0 million of growth in revenues from existing customers through their expanded use of our solutions as well as price increases and $20.9 million of on premise and cloud-based subscription sales of our tax solutions to new customers.

ARR increased by $35.9 million or 12.6% for the three months ended March 31, 2021, as compared to the same period in 2020.

The increase was primarily driven by $14.7 million of growth in revenues from existing customers through their expanded use of our solutions as well as price increases and $21.2 million of on-premise and cloud-based subscriptions of our tax solutions to new customers.

Net Revenue Retention Rate.

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Our NRR refers to the ARR expansion during the 12 months of a reporting period for all customers who were part of our customer base at the beginning of the reporting period.

Our NRR calculation takes into account any revenue lost from departing customers or customers who have downgraded as well as any revenue expansion from upgrades, cross sells or upsells of our software.

Our NRR calculation takes into account any revenue lost from departing customers or customers who have downgraded or reduced usage, as well as any revenue expansion from migrations, new licenses for additional products or contractual and usage-based price changes.

Three months ended

Net Revenue Retention Rate

The NRR declined from 109% at September 30, 2019 to 108% at September 30, 2020 due primarily to a reduction in new sales to existing customers.

The 400 basis point decline in NRR from 109% for the three months ended March 31, 2020 to 105% for the same period in 2021 was primarily attributable to a reduction in sales growth to existing customers as compared to the prior year related to delays in signing deals due to their focus shifting to working remotely, and economic uncertainty in connection with the impact of the COVID-19 pandemic on their businesses.

Adjusted EBITDA and Adjusted EBITDA Margin.

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We believe that Adjusted EBITDA and Adjusted EBITDA margin are useful as supplemental measures to evaluate our overall operating performance as they measure business performance focusing on cash related charges and because they are important metrics to lenders under our New Credit Agreement.

We define Adjusted EBITDA as net income or loss before interest, taxes, depreciation, and amortization, as adjusted to exclude charges for asset impairments, share-based compensation expense, severance charges and offering transaction costs.

We define Adjusted EBITDA as net income or loss before interest, taxes, depreciation, and amortization, as adjusted to exclude charges for asset impairments, stock-based compensation expense, severance expense and transaction costs.

Adjusted EBITDA margin represents Adjusted EBITDA divided by total revenues for the same period.

For purposes of comparison, our net (loss) income was $(21.0) million and $11.9 million for the three months ended September 30, 2020 and 2019, respectively, while our net income margin was (22.2)% and 14.4% over the same periods, respectively.

Additionally, our net (loss) income was $(79.2) million and $26.3 million for the nine months ended

September 30, 2020 and 2019, respectively, while our net income margin was (28.8)% and 11.2% over the same periods, respectively.

For the three months ended

For the nine months ended

For purposes of comparison, our net income (loss) was $2.3 million and $(29.1) million for the three months ended March 31, 2021 and 2020, respectively, while our net income margin was 2.3% and (32.6%) over the same periods, respectively.

Three months ended

(Dollars in thousands)

Adjusted EBITDA:

Net (loss) income

Interest, net

Net income (loss)

Interest expense, net

Income tax (benefit) expense

Depreciation and amortization – cost of subscription revenues

Amortization of acquired intangibles - selling and marketing expense

Depreciation and amortization

Stock-based compensation

Severance charges

Depreciation and amortization - property and equipment

Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues

Amortization of acquired intangible assets - selling and marketing expense

Stock-based compensation expense

Severance expense

Transaction costs

Adjusted EBITDA

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Adjusted EBITDA margin

The increase in Adjusted EBITDA for the three months ended September 30, 2020 of $2.9 million over the comparable period in 2019 is primarily driven by an increase in gross profit, offset by an increase in operating expenses including additional sales and marketing and research and development investments.

Adjusted EBITDA margin remained consistent at 23.8% for the three months ended September 30, 2020 over the comparable period in 2019.

The increase in Adjusted EBITDA for the nine months ended September 30, 2020 of $8.6 million over the comparable period in 2019 is primarily driven by an increase in gross profit, offset by an increase in operating expenses including additional sales and marketing and research and development investments.

Adjusted EBITDA margin remained consistent at 21.6% for the nine months ended September 30, 2020 over the comparable period in 2019.

The increase in Adjusted EBITDA for the three months ended March 31, 2021 of $2.9 million over the comparable period in 2020 is primarily driven by an increase in net income of $31.4 million, offset by the decrease in stock-based compensation of $28.4 million.

Adjusted EBITDA margin increased to 18.5% for the three months ended March 31, 2021 compared to 17.1% for the comparable period in 2020.

Free Cash Flow and Free Cash Flow Margin.

Our management uses free cash flow as a critical measure in the evaluation of liquidity in conjunction with related GAAP amounts.

We use free cash flow as a critical measure in the evaluation of liquidity in conjunction with related GAAP amounts.

We also use this measure when considering available cash, including for decision making purposes related to dividends and discretionary investments.

We consider free cash flow to be an important measure for investors because it measures the amount of cash we generate from our operations after our capital expenditures and capitalization of software development costs.

development costs.

In addition, we base certain of our forward-looking estimates and budgets on free cash flow and free cash flow margin.

We define free cash flow as the total of net cash provided by operating activities, adjusted for the redemption of stock appreciation rights (“SARs”) in 2020 in connection with the Offering reflected as a reduction of cash provided by operating activities, less purchases of property and equipment and capitalized software.

We define free cash flow as the total of net cash provided by operating activities, adjusted for the redemption of stock appreciation rights (“SARs”) in 2020 in connection with our initial public offering (the “Offering”) reflected as a reduction of cash provided by operating activities, less purchases of property and equipment and capitalized software.

We define free cash flow margin as free cash flow divided by total revenues for the same period.

Our net cash provided by operating activities was $20.0 million and $45.8 million for the nine months ended September 30, 2020 and 2019, respectively, while our operating cash flow margin was 7% and 19% over the same periods, respectively.

Net cash used in investing activities was $36.5 million and $25.7 million for the nine months ended September 30, 2020 and 2019, respectively.

Net cash provided

by (used in) financing activities was $212.4 million and $(25.5) million for the nine months ended September 30, 2020 and September 30, 2019, respectively.

Nine months ended

Our net cash used in operating activities was $(3.0) million and $(6.4) million for the three months ended March 31, 2021 and 2020, respectively, while our operating cash flow margin was (3.0%) and (7.2%) over the same periods, respectively.

Net cash used in investing activities was $(14.5) million and $(21.7) million for the three months ended March 31, 2021 and 2020, respectively.

Net cash (used in) provided by financing activities was $(8.1) million and $103.7 million for the three months ended March 31, 2021 and March 31, 2020, respectively.

Three months ended

(Dollars in thousands)

Free Cash Flow:

Cash provided by operating activities

Redemption of Converted SARs

Cash used in operating activities

Property and equipment additions

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Free cash flow margin

Free cash flow decreased by $1.4 million for the nine months ended September 30, 2020 as compared to the same period in 2019, driven primarily by a decrease in cash from operating activities of $25.8 million due to a $22.9 million payment for redemption of converted SARs in connection with the IPO, a reduction in cash provided by changes in operating assets and liabilities of $9.4 million, partially offset by an increase in non-cash operating activity resulting from increases in depreciation and amortization of $5.4 million and the write-off of deferred financing fees of $1.4 million.

The $22.9 million payment for redemption of converted SARs pertain to SARs converted to stock options and immediately redeemed for cash upon the IPO.

The reduction in operating assets and liabilities of $9.4 million was primarily due to a reduction in deferred revenue of $9.3 million.

Deferred revenue decreased due to a $5.6 million decrease in nonrecurring extended product support fees billed in the first half of 2019 related to older versions of software subscription solutions retired during 2019.

The balance of the deferred revenue reduction of $3.7 million is due primarily to modifications to billing frequencies requested by customers, primarily to align all the annual subscription billings for their subscription licenses to the same period.

Such billing frequency modification results in a short-term reduction in deferred revenue, but no impact to revenue.

The increase in depreciation and amortization of $5.4 million was due to increased development costs related to the release of O Series 9.0 and internal automation projects.

The write-off of deferred financing fees of $1.4 million was a result of the redemption of debt during the nine months ended September 30, 2020.

Free cash flow increased by $4.4 million for the three months ended March 31, 2021 as compared to the same period in 2020.

This increase was primarily driven by an increase in net income of $31.4 million, offset by the decrease in stock-based compensation of $28.4 million.

Historically, our cash flows in the first quarter are lower than the remaining calendar quarters as they are heavily influenced by annual employee bonus and other variable compensation payments.

Components of Our Results of Operations

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Our on-premise software subscription prices in the initial subscription year are higher than standard renewal prices.

The excess initial year price over the renewal price is a material right that provides customers with the right to this reduced renewal price.

The excess initial year price over the renewal price is a material right that provides customers with the right to this reduced

renewal price.

We recognize revenue associated with this material right over the estimated period of benefit to the customer, which is generally three years.

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Terminations of cloud-based subscriptions prior to the end of the subscription term have occurred infrequently and the impact has been immaterial.

The allowance for subscription and non-renewal cancellations reflects an estimate of the amount of such cancellations and non-renewals based upon our historical experience.

The allowance for subscription and non-renewal cancellations reflects an estimate of the amount of such cancellations and non-renewals based on past experience, current information and forward-looking economic considerations.

Services Revenue

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Fluctuations in services revenue are directly correlated to fluctuations in our subscription revenues with respect to implementation and training services as we have historically experienced an attachment rate to subscription sales for these services in excess of 60%.

Our managed services offering has recently experienced increased revenue associated with returns processing volume increases attributable to regulatory changes, as customers expanded their tax filings into more jurisdictions.

However, demand for services in 2020 exceeded historical levels as certain customers migrated to a newer version of the software which is not expected to be a significant driver of our services revenues growth in 2021.

In addition, our managed services offering has continued to experience increased revenues associated with returns processing volume increases attributable to regulatory changes, as customers expanded their tax filings into more jurisdictions.

Cost of Revenue

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In addition, cost of revenue includes direct costs associated with information technology, such as data center and software hosting costs, and tax content maintenance.

Cost of revenue also includes amortization associated with direct labor and related expenses for capitalized internal-use software and developed software for new products and enhancements to existing products and cloud-based subscription solutions.

Cost of revenue also includes amortization associated with direct labor and related expenses for capitalized internal-use software for cloud-based subscription solutions and software developed for sale for new products and enhancements to existing products, and costs associated with the amortization of acquired intangible assets.

We plan to continue to significantly expand our infrastructure and personnel to support our future growth and increases in transaction volumes of our cloud-based solutions, including through acquisitions.

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Research and development costs, other than software development expenses qualifying for capitalization, are expensed as incurred.

For the nine months ended September 30, 2020 and 2019, $9.2 million and $12.3 million of software development costs were capitalized, respectively.

For the three months ended March 31, 2021 and 2020, $2.2 million and $3.7 million of software development costs were capitalized, respectively.

Capitalized software development costs consist primarily of employee-related and third-party labor costs.

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These costs include salaries, benefits, bonuses and stock-based compensation.

In addition, selling expense includes costs related to advertising and promotion efforts, branding costs, partner-based commissions, costs associated with our annual customer conferences and amortization of acquired intangibles.

We intend to continue to invest in our sales and marketing capabilities in the future to continue to increase our brand awareness and expect these costs to increase on an absolute dollar basis as we grow our business and continue to expand our market and partner ecosystem penetration.

Sales and marketing expense in absolute dollars and as a percentage of total revenue may fluctuate from period-to-period based on total revenue levels and the timing of our investments in our sales and marketing functions as these investments may vary in scope and scale over future periods.

In addition, travel restrictions due to COVID-19 continue to result in reductions in travel and external marketing events.

These costs are expected to increase once travel and conference restrictions are lifted, although it is uncertain whether they will return to their historical levels experienced pre-COVID-19.

General and Administrative

General and administrative expenses consist primarily of personnel and related expenses for administrative, finance, information technology, legal, risk management, facilities and human resources staffing, including salaries, benefits, bonuses, severance, stock-based compensation, professional fees, insurance premiums, facility costs and other internal support costs.

We expect our general and administrative expenses to increase in absolute dollars as we continue to expand our operations, hire additional personnel, integrate future acquisitions and incur additional costs associated with becoming a publicly listed company.

As a public company, we expect to incur increased expenses related to accounting, tax and auditing activities, legal, insurance, SEC compliance and internal control compliance.

publicly listed company.

As a public company, we expect to incur increased expenses related to accounting, tax and auditing activities, legal, insurance, SEC compliance and internal control compliance, including the design, implementation and testing of increasingly formalized systems of internal control over financial reporting.

Depreciation and Amortization

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Depreciation and amortization will fluctuate in correlation with our ongoing investment in internal infrastructure costs to support our growth.

Interest Income

Interest income reflects earnings on investments of our cash on hand and on funds held for customers related to our managed outsourcing services.

Interest income will vary as a result of fluctuations in the future level of funds available for investment and the rate of return available in the market on such funds.

Interest Expense

Interest expense consists primarily of interest payments and other financing costs on our debt facility.

Interest expense includes write downs of deferred financing costs upon redemption of debt.

Interest Expense, net

Interest expense, net reflects the amount of our interest expense that exceeds interest income over the same period.

Interest expense consists primarily of interest payments and other financing costs on our bank credit facility.

Interest expense includes amortization of deferred financing fees over the term of the credit facility or write-downs of such costs upon redemption of debt.

Interest expense will vary as a result of fluctuations in the level of debt outstanding as well as interest rates on such debt.

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dollars and which do not qualify for hedge accounting.

In addition, changes in the settlement value of the future payment obligation for the Systax acquisition will be recorded as interest expense, as described further in “Note 2—Acquisition” to our interim consolidated financial statements included in this Quarterly Report on Form 10-Q.

Provision for Taxes

Prior to July 27, 2020, we have been taxed as an S-corporation for U.S.

federal income tax purposes and for income tax purposes in most states.

As a result, net income or loss prior to this date has been allocated to our stockholders and included on their individual income tax returns.

In certain states, we have been taxed at the corporate level going forward.

In addition, changes in the settlement value of the future payment obligation for the Systax Sistemas Fiscais Limited (“Systax”) acquisition will be recorded as interest expense.

Interest income reflects earnings on investments of our cash on hand and on funds held for customers related to our managed outsourcing services.

Interest income will vary as a result of fluctuations in the future level of funds available for investment and the rate of return available in the market on such funds.

Provision for Income Taxes

Prior to July 27, 2020, Vertex was taxed as an S-corporation for U.S.

federal and certain state income tax purposes.

As a result, net income or loss prior to this date has been allocated to and included on the income tax returns of the S-Corporation stockholders.

Vertex was taxed at the corporate level in certain states where the S-Corporation status was not recognized or where the state imposed a tax on S-Corporations.

Accordingly, the income tax provision or benefit for such periods was based on taxable income allocated to those states.

In certain foreign jurisdictions, our subsidiaries were taxed at the corporate level.

Similar to states, the income tax provision or benefit is based on taxable income sourced to these foreign jurisdictions.

Effective as of July 27, 2020, we converted to a C-corporation, which will result in net income of the Company being taxed at the corporate level.

As such, our provision for taxes will increase.

Upon conversion to a C-corporation, we expect a pro forma entity level estimated effective tax rate of approximately 25%, inclusive of all applicable U.S.

federal, state, local and foreign income taxes.

We recorded a tax benefit of $30.5 million upon such conversion, which is included in the condensed consolidated statement of comprehensive income (loss) for the three months ended September 30, 2020 included in Part 1 – Financial Information in this Quarterly Report on Form 10-Q.

In certain foreign jurisdictions, our subsidiaries were taxed at the corporate level, and the income tax provision or benefit is based on taxable income sourced to these foreign jurisdictions.

Effective as of July 27, 2020, Vertex converted to a C-Corporation, which resulted in our net income being taxed at the corporate level.

As such, our provision for income taxes has increased since we are now subject to U.S.

federal and state corporate income taxes.

Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Prospectus filed with the SEC on July 30, 2020.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, our consolidated financial statements and the notes with our Annual Report on Form 10-K filed with the SEC on March 15, 2021, and our Prospectus filed with the SEC on July 30, 2020.

The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.

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(Dollars in thousands) (unaudited)

Period-over-Period change

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Period-Over-Period Change

Software subscriptions

Total revenue

Cost of Revenue:

Total revenues

Cost of revenues:

Software subscriptions (1)

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Depreciation and amortization

Other operating expense

Other operating (income) expense, net

Total operating expenses

Income (loss) from operations

Other (income) expense:

Interest income

Interest expense

Total other expense, net

Interest expense, net

Income (loss) before income taxes

Income tax (benefit) expense

Net (loss) income

Other comprehensive loss from foreign currency translations

Net income (loss)

Other comprehensive loss from foreign currency translations and revaluations, net of tax

Total comprehensive income (loss)

(1) Includes stock-based compensation expenses as follows in the table below.

For more details, see “Seasonality and Quarterly Trends.”

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(In thousands)

Stock-based compensation expense:

Cost of revenues, software subscriptions

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General and administrative

Total stock-based compensation

Total stock-based compensation expense

The following table sets forth our results of operations as a percentage of our total revenue for the periods presented.

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Software subscriptions

Total revenue

Cost of Revenue:

Total revenues

Cost of Revenues:

Software subscriptions

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Depreciation and amortization

Other operating expense, net

Other operating (income) expense, net

Total operating expenses

Income (loss) from operations

Other (income) expense:

Interest income

Interest expense

Total other expense, net

Interest expense, net

Income (loss) before income taxes

Income tax (benefit) expense

Net (loss) income

Other comprehensive loss from foreign currency translations

Net income (loss)

Other comprehensive loss from foreign currency translations, net of tax

Total comprehensive income (loss)

Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

Three months ended

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Software subscriptions

Total revenue

Revenue increased $12.2 million, or 14.8%, to $94.6 million for the three months ended September 30, 2020 compared to $82.4 million for the three months ended September 30, 2019.

The increase in software subscriptions revenue of $8.7 million, or 12.3%, was primarily driven by $7.7 million in revenue growth derived from our existing customers and $1.0 million of revenue growth from new customers.

Total revenues

Revenue increased $9.0 million, or 10.1%, to $98.2 million for the three months ended March 31, 2021 compared to $89.2 million for the three months ended March 31, 2020.

The increase in software subscriptions revenue of $7.5 million, or 9.9%, was primarily driven by and increase of $7.3 million in revenues derived from our existing customers and a year over year increase of $0.2 million in revenues derived from new customers.

Software subscriptions revenue derived from new customers averaged 7.5% of total software subscriptions revenue in both periods.

The $1.5 million increase in services revenue is primarily driven by an increase of $1.0 million in software subscription related services associated with the growth in subscription revenues, which includes new customers implementing our solutions and existing customers upgrading to newer versions of our solutions.

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Period-over-Period change

Cost of software subscription revenue

Cost of software subscriptions revenue increased $10.5 million, or 56.4%, to $29.2 million for the three months ended September 30, 2020 compared to $18.6 million for the three months ended September 30, 2019.

Of this increase, 59.1% is due to an increase in stock-based compensation of $6.3 million for the three months ended September 30, 2020 over the same period in 2019.

After excluding the impact of stock-based compensation there is a remaining increase of $4.2 million.

Of this increase, $0.6 million is due primarily to increased amortization expense associated with late Q3 2019 release of O Series 9.0.

The remaining $3.6 million variance is associated with increased costs of personnel supporting year-over-year growth of sales and customers and ongoing infrastructure investments to support expansion of customer transaction volumes for our cloud-based subscription customers.

As a percentage of total revenue, the cost of software subscriptions revenue increased to 30.8% for the three months ended September 30, 2020 compared to 22.6% in September 30, 2019.

Adjusting for the increase in stock-based compensation in 2020, cost of software subscriptions as a percentage of total revenue would have been 24.1% for the three months ended September 30, 2020.

Cost of software subscription revenues

Cost of software subscriptions revenue increased $0.9 million, or 3.7%, to $25.6 million for the three months ended March 31, 2021 compared to $24.7 million for the three months ended March 31, 2020.

This is primarily driven by a $3.8 million increase in costs of personnel supporting year-over-year growth of sales and customers and ongoing infrastructure investments to support expansion of customer transaction volumes for our cloud-based subscription customers.

This increase is partially offset by a $2.9 million decrease in stock-based compensation for the three months ended March 31, 2021 over the same period in 2020.

As a percentage of total revenue, the cost of software subscriptions revenue decreased to 26.0% for the three months ended March 31, 2021 compared to 27.7% for the same period in 2020.

After excluding stock-based compensation expense, as a percentage of total revenue, cost of software subscriptions revenue increased to 25.5% in 2021 compared to 23.7% in 2020.

Cost of Services Revenue

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Period-over-Period change

Cost of services revenue

Cost of services revenue increased $10.0 million, or 114.1%, to $18.8 million for the three months ended September 30, 2020 compared to $8.8 million for the three months ended September 30, 2019.

Of this increase, 90.1% is due to an increase in stock-based compensation of $9.2 million for the three months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $0.8 million is primarily due to headcount growth in the service delivery areas to support revenue growth in software subscription related services and our managed services offering.

As a percentage of total revenue, cost of services revenue increased to 19.9% in 2020 compared to 10.7% in 2019.

Adjusting for the increase

in stock-based compensation in 2020, cost of services revenue as a percentage of total revenue would have been 10.1% for the three months ended September 30, 2020.

Cost of services revenuess

Cost of services revenue decreased $3.4 million, or 23.2%, to $11.3 million for the three months ended March 31, 2021 compared to $14.8 million for the three months ended March 31, 2020.

This decline is primarily driven by a stock-based compensation decrease of $4.6 million for the three months ended March 31, 2021 over the same period in 2020.

After adjusting for the decline in stock-based compensation expense, cost of services revenue is increasing $1.2 million primarily driven by an increase in costs of personnel supporting the service delivery areas to support revenue growth in software subscription related services and our managed services offering.

As a percentage of total revenue, cost of services revenue decreased to 11.5% in 2021 compared to 16.6% for the same period in 2020.

After excluding stock-based compensation expense, as a percentage of total revenue, cost of services revenue increased to 10.9% in 2021 compared to 10.7% in 2020.

Research and Development

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Research and development

Research and development expenses increased $9.2 million, or 126.9%, to $16.5 million for the three months ended September 30, 2020 compared to $7.3 million for the three months ended September 30, 2019.

Of this increase, 67.3% is due to an increase in stock-based compensation of $6.3 million for the three months ended September 30, 2020 over the same period in 2019 for personnel that participate in the Company’s stock-based compensation plans.

The balance of the increase of $2.9 million is primarily due to costs associated with increased development activity associated with nascent technologies and new solutions to address end-to-end data analysis and compliance needs of our customers.

As a percentage of total revenue, research and development expenses increased to 17.4% for the three months ended September 30, 2020 compared to 8.8% for the three months ended September 30, 2019, driven in part by our expanded investment in developing our global compliance reporting solution.

Adjusting for the increase in stock-based compensation in 2020, research and development expenses as a percentage of total revenue would have been 10.7% for the three months ended September 30, 2020.

Research and development expenses decreased $1.6 million, or 12.4%, to $11.5 million for the three months ended March 31, 2021 compared to $13.1 million for the three months ended March 31, 2020.

However, this decline is primarily driven by a stock-based compensation decrease of $2.9 million for the three months ended March 31, 2021 over the same period in 2020.

After adjusting for the decline in stock-based compensation expense, research and development expenses are increasing $1.3 million primarily driven by an increase in costs associated with increased development activity associated with nascent technologies and new solutions to address end-to-end data analysis and compliance needs of our customers.

As a percentage of total revenue, research and development expenses decreased to 11.7% for the three months ended March 31, 2021 compared to 14.7% for the three months ended March 31, 2020.

After excluding stock-based compensation expense, as a percentage of total revenue, research and development expenses increased to 11.1% in 2021 compared to 10.7% in 2020.

Research and development expense excludes those costs that have been capitalized for solutions that have met our capitalization policy.

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Selling and marketing

Selling and marketing expenses increased $13.6 million, or 85.9%, to $29.4 million for the three months ended September 30, 2020 compared to $15.8 million for the same period in 2019.

Of this increase, 92.4% is due to an increase in stock-based compensation of $12.8 million for the three months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $0.8 million is primarily due to an increase in payroll and related expenses associated with the growth in year-over-year subscription sales and services revenue and expansion of our partner and channel management programs..

As a percentage of total revenue, selling and marketing expenses increased to 31.1% for the three months ended September 30, 2020 compared to 19.2% for the same period in 2019.

Adjusting for the increase in stock-based compensation in 2020, selling and marketing expenses as a percentage of total revenue would have been 17.5% for the three months ended September 30, 2020.

Selling and marketing expenses decreased $4.2 million, or 17.2%, to $20.2 million for the three months ended March 31, 2021 compared to $24.3 million for the same period in 2020.

However, this decline is primarily driven by a stock-based compensation decrease of $5.7 million for the three months ended March 31, 2021 over the same period in 2020.

After adjusting for the decline in stock-based compensation expense, selling and marketing expenses are increasing $1.5 million primarily driven by an increase in payroll and related expenses associated with the growth in year-over-year subscription sales and services revenue and expansion of our partner and channel management programs.

As a percentage of total revenue, selling and marketing expenses decreased to 20.5% for the three months ended March 31, 2021 compared to 27.3% for the same period in 2020.

After excluding stock-based compensation expense, as a percentage of total revenue, selling and marketing expenses decreased to 19.2% in 2021 compared to 19.4% in 2020.

General and Administrative

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General and administrative

General and administrative expenses increased $30.8 million, or 178.3%, to $48.0 million for the three months ended September 30, 2020 compared to $17.3 million for the same period in 2019.

Of this increase, 94.1% is due to an increase in stock-based compensation of $29.6 million for the three months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $1.2 million is primarily due to planned strategic investments in information technology infrastructure, business process reengineering and other initiatives to drive future operating leverage, as well as investments in employees and other systems and resources in support of our growth.

Due to these factors, as a percentage

of total revenue, general and administrative expenses increased to 50.8% for the three months ended September 30, 2020 compared to 20.9% for the same period in 2019.

Adjusting for the increase in stock-based compensation in 2020, general and administrative expenses as a percentage of total revenue would have been 19.5% for the three months ended September 30, 2020.

Depreciation and Amortization

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Period-over-Period change

Depreciation and amortization

Depreciation and amortization increased $0.4 million, or 18.3%, to $2.7 million for the three months ended September 30, 2020 compared to $2.3 million for the same period in 2019.

The increase was primarily due to the impact of infrastructure and technology purchases placed in service in 2019 and other capitalized infrastructure costs to support our growth.

As a percentage of revenue, depreciation expense was relative consistent at 2.9% for the three months ended September 30, 2020 compared to 2.8% for the same period in 2019.

Interest Income

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Period-over-Period change

Interest income

Interest income for the three months ended September 30, 2020 decreased $0.2 million or 56.5% due primarily to a significant decline in money market investment yields as compared to the same period in 2019.

Interest Expense

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Period-over-Period change

Interest expense

Interest expense increased $1.4 million, or 272.8%, to $1.9 million for the three months ended September 30, 2020 compared to $0.5 million for the same period in 2019.

The increase is primarily due to the writedown of deferred financing fees of $1.4 million in connection with the July 2020 payoff of the New Term Loan with a portion of the proceeds from the IPO.

This is offset by reductions in interest expense of $0.1 million due to the Company having no outstanding debt during the three months ended September 30, 2020 after this payoff, as compared to $51.6 million in outstanding debt for the same period in 2019.

General and administrative expenses decreased $12.8 million, or 34.0%, to $24.9 million for the three months ended March 31, 2021 compared to $37.6 million for the same period in 2020.

However, this decline is primarily driven by a stock-based compensation decrease of $12.2 million for the three months ended March 31, 2021 over the same period in 2020.

After adjusting for the decline in stock-based compensation expense, general and administrative expenses are decreasing an additional $0.6 million primarily driven by a decrease in travel costs due to COVID-19 travel restrictions and an increase in capitalized costs associated with internal optimization efforts, partially offset by increased costs associated with public company status.

As a percentage of total revenue, general and administrative expenses decreased to 25.3% for the three months ended March 31, 2021 compared to 42.2% for the same period in 2020.

After excluding stock-based compensation expense, as a percentage of total revenue, general and administrative expenses decreased to 21.7% in 2021 compared to 24.6% in 2020.

Provision for Taxes

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Period-over-Period change

Income tax (benefit)

Income tax expense decreased $30.9 million, or 17,684.6%, to a $(30.8) million income tax benefit for the three months ended September 30, 2020 compared to $0.2 million of income tax expense for the same period in 2019.

The decrease was primarily due to a pretax loss resulting from an increase in stock-based compensation in 2020.

As a percentage of revenue, income tax benefit increased to (32.5)% for the three months ended September 30, 2020 compared to expense of 0.2% for the same period in 2019 due to a pretax loss in 2020 resulting from an increase in stock-based compensation.

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019

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Period-over-Period change

Software subscriptions

Total revenue

Revenue increased $39.7 million, or 16.9%, to $275.1 million for the nine months ended September 30, 2020 compared to $235.4 million for the nine months ended September 30, 2019.

The increase in software subscriptions revenue of $30.2 million, or 14.9%, was primarily driven by $27.1 million in revenue growth derived from our existing customers and $3.1 million of revenue from new customers.

The $9.5 million increase in services revenue is primarily driven by an increase of $7.7 million in software subscription-related services associated with the growth in subscription revenues, which includes new customers implementing our solutions and existing customers upgrading to newer versions of our solutions.

In addition, our managed services offering experienced a $1.8 million increase in recurring services revenue over the prior year due to returns processing volume increases related to regulatory changes as customers expanded their tax filings into more jurisdictions.

Cost of Software Subscriptions Revenue

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Period-over-Period change

Cost of software subscription revenue

Cost of software subscriptions revenue increased $23.4 million, or 41.3%, to $79.8 million for the nine months ended September 30, 2020 compared to $56.5 million for the nine months ended September 30, 2019.

Of this increase, 58.3% is due to an increase in stock-based compensation of $14.0 million for the nine months ended September 30, 2020 over the same period in 2019.

After excluding the impact of stock-based compensation there is a remaining increase of $9.4 million.

Of this increase, $1.8 million is due primarily to increased amortization expense associated with the late Q3 2019 release of O Series 9.0.

The remaining $7.6 million variance is associated with increased costs of personnel supporting year-over-year growth of sales and customers and ongoing infrastructure investments to support expansion of customer transaction volumes for our cloud-based subscription customers.

As a percentage of total revenue, the cost of software subscriptions revenue increased to 29.0% for the nine months ended September 30, 2020 compared to 24.0% in September 30, 2019.

Adjusting for the increase in stock-based compensation in 2020, cost of software subscriptions as a percentage of total revenue would have been 23.9% for the nine months ended September 30, 2020.

Cost of Services Revenue

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Period-over-Period change

Cost of services revenue

Cost of services revenue increased $25.7 million, or 108.9%, to $49.3 million for the nine months ended September 30, 2020 compared to $23.6 million for the nine months ended September 30, 2019.

Of this increase, 78.3% is due to an increase in stock-based compensation of $20.7 million for the nine months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $5.0 million is primarily due to headcount growth in the service delivery areas to support revenue growth in software subscription related services and our managed services offering.

As a percentage of

total revenue, cost of services revenue increased to 17.9% in 2020 compared to 10.0% in 2019.

Adjusting for the increase in stock-based compensation in 2020, cost of services revenue as a percentage of total revenue would have been 12.8% for the nine months ended September 30, 2020.

Research and Development

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Period-over-Period change

Research and development

Research and development expenses increased $21.1 million, or 95.9%, to $43.2 million for the nine months ended September 30, 2020 compared to $22.0 million for the nine months ended September 30, 2019.

Of this increase, 64.3% is due to an increase in stock-based compensation of $14.0 million for the nine months ended September 30, 2020 over the same period in 2019 for personnel that participate in the Company’s stock-based compensation plans.

The balance of the increase of $7.1 million is primarily due to costs associated with increased development activity associated with nascent technologies and new solutions to address end-to-end data analysis and compliance needs of our customers.

As a percentage of total revenue, research and development expenses increased to 15.7% for the nine months ended September 30, 2020 compared to 9.4% for the nine months ended September 30, 2019, driven in part by our expanded investment in developing our global compliance reporting solution.

Adjusting for the increase in stock-based compensation in 2020, research and development expenses as a percentage of total revenue would have been 10.6% for the nine months ended September 30, 2020.

Research and development expense excludes those costs that have been capitalized for solutions that have met our capitalization policy.

Selling and Marketing

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Period-over-Period change

Selling and marketing

Selling and marketing expenses increased $29.1 million, or 59.3%, to $78.3 million for the nine months ended September 30, 2020 compared to $49.2 million for the same period in 2019.

Of this increase, 93.9% is due to an increase in stock-based compensation of $28.1 million for the nine months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $1.0 million is primarily due to an increase in payroll and related expenses associated with the growth in year-over-year subscription sales and services revenue and expansion of our partner and channel management programs.

In addition, increases in advertising and promotional spending and expanded brand awareness efforts contributed to this increase.

As a percentage of total revenue, selling and marketing expenses increased to 28.5% for the nine months ended September 30, 2020 compared to 20.9% for the same period in 2019.

Adjusting for the increase in stock-based compensation in 2020, selling and marketing expenses as a percentage of total revenue would have been 18.2% for the nine months ended September 30, 2020.

General and Administrative

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Period-over-Period change

General and administrative

General and administrative expenses increased $74.1 million, or 150.1%, to $123.4 million for the nine months ended September 30, 2020 compared to $49.4 million for the same period in 2019.

Of this increase, 84.0% is due to an increase in stock-based compensation of $64.0 million for the nine months ended September 30, 2020 over the same period in 2019.

The balance of the increase of $10.1 million is primarily due to planned strategic investments in information technology infrastructure, business process reengineering and other initiatives to drive future operating leverage, as well as investments in employees and other systems and resources in support of our growth.

Due to these factors, as a percentage of total revenue, general and administrative expenses increased to 44.9% for the nine months ended September 30, 2020 compared to 21.0% for the same period in 2019.

Adjusting for the increase in stock-based compensation in 2020, general and administrative expenses as a percentage of total revenue would have been 21.6% for the nine months ended September 30, 2020.

Depreciation and Amortization

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Period-over-Period change

Depreciation and amortization

Depreciation and amortization increased $1.6 million, or 24.2%, to $8.1 million for the nine months ended September 30, 2020 compared to $6.5 million for the same period in 2019.

The increase was primarily due to the impact of infrastructure and technology purchases placed in service in 2019 and other capitalized infrastructure costs to support our growth.

As a percentage of revenue, depreciation expense was relatively consistent at 2.9% for the nine months ended September 30, 2020 compared to 2.8% for the same period in 2019.

Interest Income

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Period-over-Period change

Interest income

Interest income for the nine months ended September 30, 2020 decreased $0.2 million or 56.5% due primarily to a decline in money market investment yields as compared to the same period in 2019.

Interest Expense

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Period-over-Period change

Interest expense

Interest expense increased $2.4 million, or 150.7%, to $4.0 million for the nine months ended September 30, 2020 compared to $1.6 million for the same period in 2019.

The increase includes the writedown of deferred financing fees of $1.4 million in connection with the July 2020 payoff of the New Term Loan with a portion of the proceeds from the IPO.

The increase also includes interest expense of $0.4 million related to an overall increase of $41.0 million in the average balance of debt outstanding during the nine months ended September 30, 2020 due primarily to the New Term Loan of $175.0 million being outstanding for approximately four months in 2020.

Provision for Taxes

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Period-over-Period change

Income tax (benefit) expense

Income tax expense decreased $32.1 million, or 5,351.3%, to a $(31.5) million income tax benefit for the nine months ended September 30, 2020 compared to $0.6 million of income tax expense for the same period in 2019.

The decrease was primarily due to a pre-tax loss resulting from an increase in stock-based compensation in 2020.

As a percentage of revenue,

income tax benefit increased to (11.5)% for the nine months ended September 30, 2020 compared to expense of 0.3% for the same period in 2019 due to a pre-tax loss in 2020 resulting from an increase in stock-based compensation.

Income tax expense decreased $0.9 million, or 371.6%, to $(0.7) million of income tax benefit for the three months ended March 31, 2021 compared to $0.3 million of income tax expense for the same period in 2020.

The decrease was primarily due to a pretax loss resulting from an increase in stock-based compensation in 2020 compared to the benefit for U.S.

federal and state income taxes in 2021 now that we are taxed as a C-Corporation.

The income tax benefit in the three months ended March 31, 2021 is primarily driven by exercises of stock options partially offset by the unfavorable impact of limitations on deductions of certain employees’ compensation under Internal Revenue Code Section 162(m).

Liquidity and Capital Resources

As of September 30, 2020, we had cash and cash equivalents of $270.3 million and retained earnings of $21.7 million.

As of March 31, 2021, we had cash and cash equivalents of $277.7 million and retained earnings of $24.7 million.

Our primary sources of capital to date have been from sales of our solutions, and proceeds from bank lending facilities.

On July 31, 2020, we received $423.0 million in proceeds, net of underwriting fees and commissions, from the sale of 23,812,216 shares of Class A common stock and used a portion of the proceeds to pay off the $175.0 million term loan under the New Credit Agreement.

As a result, we have no outstanding bank debt after such redemption.

The net proceeds remaining after payment of IPO costs will be used for working capital and other corporate purposes as described in the Prospectus.

In addition, on July 31, 2020, we received $423.0 million in proceeds from the Offering, net of underwriting fees and commissions, from the sale of 23,812,216 shares of Class A common stock and used a portion of the proceeds to pay off the $175.0 million term loan under the bank credit agreement.

As a result, we have no outstanding bank debt after such redemption and at March 31, 2021.

The net proceeds remaining after payment of Offering costs will be used for working capital and other corporate purposes as described in the Prospectus.

On May 12, 2021, we used approximately $200.0 million of our cash and cash equivalents to acquire Taxamo, a cloud-based pioneer in tax and payment automation for global e-commerce and marketplaces.

We believe that our existing cash resources and our bank line of credit will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months.

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The following table presents a summary of our cash flows for the periods indicated:

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(In thousands)

Net cash provided by operating activities

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Period-Over-Period Change

Net cash used in operating activities

Net cash used in investing activities

Net cash used in financing activities

Net cash (used in) provided by financing activities

Effect of foreign exchange rate changes

Net increase (decrease) in cash, cash equivalents and restricted cash

Net (decrease) increase in cash, cash equivalents and restricted cash

Operating Activities.

Cash provided by operating activities was $20.0 million for the nine months ended September 30, 2020 compared to $45.8 million for the same period in 2019, a decrease of $25.8 million.

The decrease in cash from operating activities was driven primarily by a $22.9 million payment for redemption of converted SARs in connection with the IPO, a reduction in cash provided by changes in operating assets and liabilities of $9.4 million, partially offset by an increase in non-cash operating activity resulting from increases in depreciation and amortization of $5.4 million and the write-off of deferred financing fees of $1.4 million.

The $22.9 million payment for redemption of converted SARs pertain to SARs converted to stock options and immediately redeemed for cash upon the IPO.

The reduction in operating assets and liabilities of $9.4 million was primarily due to a reduction in deferred revenue of $9.3 million.

Such billing frequency modification results in a short-term reduction in deferred revenue, but no impact to revenue.

The increase in depreciation and amortization of $5.4 million was due to increased development costs related to the release of O Series 9.0 and internal automation projects.

The write-off of deferred financing fees of $1.4 million were a result of the redemption of debt during the nine months ended September 30, 2020.

Net cash used in operating activities was $3.0 million for the three months ended March 31, 2021 compared to $6.4 million for the same period in 2020, a decrease of $3.5 million.

The decrease in the use of cash from operating activities was driven primarily by an increase in net income of $31.4 million offset by a decrease in stock-based compensation of $28.4 million.

Historically, our cash flows from operating activities are lower in the first quarter than the remaining calendar quarters as they are heavily influenced by annual employee bonus and other variable compensation payments made in the first quarter of each year.

Investing Activities.

Cash used in investing activities was $36.5 million for the nine months ended September 30, 2020 compared to $25.7 million for the same period in 2019, an increase of $10.9 million.

This increase was primarily related to the acquisition of a controlling interest in Systax, a Brazilian transaction tax software and content subscription

provider, for cash paid of $12.3 million during the three months ended March 31, 2020.

For additional information, see “Note 2 to the Interim Condensed Consolidated Financial Statements (unaudited) —Acquisition.”

Cash used in investing activities was $14.5 million for the three months ended March 31, 2021 compared to $21.7 million for the same period in 2020, an decrease of $7.1 million.

This decrease was primarily due to a decrease in cash paid for acquisitions of $6.2 million period over period.

We acquired a controlling interest in Systax, a Brazilian transaction tax software and content subscription provider, for cash of $12.3 million during the three months ended March 31, 2020, partially offset by the acquisition of Tellutax, an Oregon-based computing edge technology company, for cash paid of $6.1 million during the three months ended March 31, 2021.

For additional information on the Tellutax acquisition, see “Note 3 to the Interim Condensed Consolidated Financial Statements (unaudited) —Acquisition.”

Financing Activities.

Cash provided by (used in) financing activities was $212.4 million for the nine months ended September 30, 2020 compared to $(25.5) million used for the same period in 2019, an increase of $215.0 million.

This change was due primarily to the $423.0 million in proceeds received from the IPO, offset by the payoff of the $175.0 million term loan under the New Credit Agreement.

As of September 30, 2020, we had a $100 million line of credit with no outstanding borrowings.

Interest on outstanding borrowings accrue at a Base Rate plus an applicable margin (3.75% as of September 30, 2020) or London Interbank Offered Rate (“LIBOR”) plus an applicable margin (2.5% as of September 30, 2020).

As of September 30, 2020, the interest rate on the term loan was 2.50%.

The Company has no outstanding bank debt at September 30, 2020.

Cash (used in) provided by financing activities was $(8.1) million for the three months ended March 31, 2021 compared to $103.7 million for the same period in 2020, a decrease of $111.8 million.

The three months ended March 31, 2020 included net borrowings under the bank credit agreement of $121.1 million, offset by distributions to stockholders of $17.2 million.

None of this activity recurred in the comparable period in 2021.

The three months ended

March 31, 2021 included $7.2 million in payments for taxes in connection with the exercise of stock options whereby the award holders returned shares to us to satisfy their tax obligations.

As of March 31, 2021, we had a $100 million line of credit with no outstanding borrowings.

Interest on outstanding borrowings accrue at a Base Rate plus an applicable margin (3.25% as of March 31, 2021) or the London Interbank Offered Rate (“LIBOR”) plus an applicable margin (2.00% as of March 31, 2021).

We have no outstanding bank debt at March 31, 2021.

Funds Held for Customers and Customer Funds Obligations

9 unchanged sentences

Contractual Obligations and Commitments

Other than the redemption of our outstanding debt through use of a portion of the Offering proceeds, there have been no material updates or changes to our contractual obligations and commitments compared to contractual obligations and commitments described in our Quarterly Report on Form 10-Q for the period ended June 30, 2020.

Other than the redemption of our outstanding debt through use of a portion of the Offering proceeds, there have been no material updates or changes to our contractual obligations and commitments compared to contractual obligations and commitments described in our Annual Report on Form 10-K for the year ended December 31, 2020.

Use and Reconciliation of Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we have calculated non-GAAP cost of revenues, non-GAAP gross profit, non-GAAP gross margin, non-GAAP research and development expense, non-GAAP sales and marketing expense, non-GAAP general and administrative expense, non-GAAP operating income, non-GAAP net income, and free cash flow, which are each non-GAAP financial measures.

In addition to our results determined in accordance with GAAP, we have calculated non-GAAP cost of revenues, non-GAAP gross profit, non-GAAP gross margin, non-GAAP research and development expense, non-GAAP selling and marketing expense, non-GAAP general and administrative expense, non-GAAP operating income, non-GAAP net income, Adjusted EBITDA, Adjusted EBITDA margin, free cash flow and free cash flow margin, which are each non-GAAP financial measures.

We have provided tabular reconciliations of each of these non-GAAP financial measures to its most directly comparable GAAP financial measure.

Management uses these non-GAAP financial measures to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, and to evaluate financial performance and liquidity.

Our non-GAAP financial measures are presented as supplemental disclosure as we believe they provide useful information to investors and others in understanding and evaluating our results, prospects, and liquidity period-over-period without the impact of certain items that do not directly correlate to our performance and that may vary significantly from period to period for reasons unrelated to our operating performance, as well as comparing our financial results to those of other companies.

We use these non-GAAP financial measures to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, and to evaluate financial performance and liquidity.

Our non-GAAP financial measures are presented as supplemental disclosure as we believe they provide useful information to investors and others in understanding and evaluating our results, prospects, and liquidity period-over-period without the impact of certain items that do not directly correlate to our operating performance and that may vary significantly from period to period for reasons unrelated to our operating performance, as well as comparing our financial results to those of other companies.

Our definitions of these non-GAAP financial measures may differ from similarly titled measures presented by other companies and therefore comparability may be limited.

In addition, other companies may not publish these or similar metrics.

Thus, our non-GAAP financial measures should be considered in addition to, not as a substitute for, or in isolation from, the financial information

prepared in accordance with GAAP measures, and should be read in conjunction with the financial statements included elsewhere in this Quarterly Report on Form 10-Q and the Prospectus.

Thus, our non-GAAP financial measures should be considered in addition to, not as a substitute for, or in isolation from, the financial information prepared in accordance with GAAP financial measures, and should be read in conjunction with the consolidated financial statements included in this Quarterly Report on Form 10-Q.

We calculate these non-GAAP financial measures as follows:

● Non-GAAP cost of revenues is determined by adding back to GAAP cost of revenue the stock-based compensation expense and the depreciation and amortization of capitalized software costs included in cost of revenue for the respective periods.

● Non-GAAP gross profit is determined by adding back to GAAP gross profit the stock-based compensation expense and the depreciation and amortization of capitalized software costs included in cost of revenue for the respective periods.

● Non-GAAP gross margin is determined by adding back to GAAP gross margin the impact of stock-based compensation expense and depreciation and amortization of capitalized software costs included in cost of revenues as a percentage of revenue for the respective periods.

● Non-GAAP research and development expense, non-GAAP selling and marketing expense, and non-GAAP general and administrative expense are determined by adding back to GAAP research and development expense, GAAP selling and marketing expense, and GAAP general and administrative expense, the stock-based compensation expense and severance expense included in the applicable expense categories for the respective periods.

● Non-GAAP operating income is determined by adding back to GAAP operating income (loss) the stock-based compensation expense, depreciation and amortization of capitalized software costs and acquired intangibles, and severance costs included for the respective periods.

● Non-GAAP net income is determined by adding back to GAAP net (loss) income amortization of capitalized software costs and acquired intangibles, stock-based compensation expense,the impact of converting from an S- to a C-corporation, and severance costs included for the respective periods.

● Adjusted EBITDA is determined by adding back to GAAP net (loss) income the net interest expense, taxes, depreciation and amortization of property and equipment, capitalized software costs and acquired intangibles, stock-based compensation expense and severance cost included for the respective periods.

● Non-GAAP cost of revenues, software subscriptions is determined by adding back to GAAP cost of revenues, software subscriptions, the stock-based compensation expense, and depreciation and amortization of capitalized software costs and acquired intangible assets included in cost of revenues for the respective periods.

● Non-GAAP cost of revenues, services is determined by adding back to GAAP cost of revenues, services, the stock-based compensation expense included in cost of revenues for the respective periods.

● Non-GAAP gross profit is determined by adding back to GAAP gross profit the stock-based compensation expense, and depreciation and amortization of capitalized software costs and acquired intangible assets included in cost of revenues for the respective periods.

● Non-GAAP gross margin is determined by adding back to GAAP gross margin the impact of stock-based compensation expense, and depreciation and amortization of capitalized software costs and acquired intangible assets included in cost of revenues as a percentage of revenues for the respective periods.

● Non-GAAP research and development expense and non-GAAP general and administrative expenses are determined by adding back to GAAP research and development expense and GAAP general and administrative expense the stock-based compensation expense and severance expense included in the applicable expense categories for the respective periods.

● Non-GAAP selling and marketing expense is determined by adding back to GAAP selling and marketing expense the stock-based compensation expense and the amortization of acquired intangible assets included in selling and marketing expense for the respective periods.

● Non-GAAP operating income is determined by adding back to GAAP operating income or loss the stock-based compensation expense, depreciation and amortization of capitalized software costs and acquired intangible assets, and severance expense included in GAAP operating income or loss for the respective periods.

● Non-GAAP net income is determined by adding back to GAAP income or loss before income taxes the stock-based compensation expense, depreciation and amortization of capitalized software costs and acquired intangible assets – cost of subscription revenues, amortization of acquired intangible assets – selling and marketing expense, and severance expense included in GAAP income or loss before income taxes for the respective periods to determine non-GAAP income or loss before income taxes.

Non-GAAP income or loss before income taxes is then adjusted for income taxes calculated using the respective statutory tax rates for applicable jurisdictions, which for purposes of this determination were assumed to be 25.5% and 2.0% for the 2021 and 2020 periods, respectively.

● Adjusted EBITDA is determined by adding back to GAAP net income or loss the net interest income or expense, income taxes, depreciation and amortization of property and equipment, depreciation and amortization of capitalized software costs and acquired intangible assets – cost of subscription revenues, amortization of acquired intangible assets – selling and marketing expense, asset impairments, stock-based compensation expense, severance expense and transaction costs included in GAAP net income or loss for the respective periods .

● Adjusted EBITDA margin is determined by dividing Adjusted EBITDA by total revenues for the respective periods.

● Free cash flow is determined by adjusting net cash provided by (used in) operating activities by adding back cash used for the redemption of SARs redeemed in connection with the IPO and reducing it for purchases of property and equipment and capitalized software additions for the respective periods.

● Free cash flow is determined by net cash provided by (used in) operating activities and reducing it for purchases of property and equipment and capitalized software additions for the respective periods.

● Free cash flow margin is determined by dividing free cash flow by total revenues for the respective periods.

2 unchanged sentences

Refer to “Item 2.

Management’s Discussion and Analysis of Financial Condition

and Results of Operations - Key Business Metrics” for further discussion and reconciliation of Adjusted EBITDA, Adjusted EBITDA margin, free cash flow and free cash flow margin to the related GAAP financial measures.

For the three months ended

For the nine months ended

(in thousands)

Management’s Discussion and Analysis of Financial Condition and Results of Operations - Key Business Metrics” for further discussion and reconciliation of Adjusted EBITDA, Adjusted EBITDA margin, free cash flow and free cash flow margin to the related GAAP financial measures.

Three months ended

(Dollars in thousands)

Non-GAAP cost of revenues, software subscriptions

7 unchanged sentences

Non-GAAP net income

For the three months ended

For the nine months ended

(in thousands)

Non-GAAP Cost of Revenue:

Three months ended

(Dollars in thousands)

Non-GAAP Cost of Revenues, Software Subscriptions:

Cost of revenues, software subscriptions

Stock-based compensation

Depreciation and amortization - cost of subscription revenues

Stock-based compensation expense

Depreciation and amortization of capitalized software and acquired intangible assets – cost of subscription revenues

Non-GAAP cost of revenues, software subscriptions

Non-GAAP Cost of Revenues, Services:

Cost of revenues, services

Stock-based compensation

Stock-based compensation expense

Non-GAAP cost of revenues, services

Non-GAAP Gross Profit:

Stock-based compensation

Depreciation and amortization of capitalized software

Stock-based compensation expense

Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues

Non-GAAP gross profit

Non-GAAP Gross Margin:

Stock-based compensation as a percentage of revenue

Depreciation and amortization - cost of subscription revenues as a percentage of revenue

Stock-based compensation expense as a percentage of revenues

Depreciation and amortization of capitalized software and acquired intangible assets – cost of subscription revenues as a percentage of revenues

Non-GAAP gross margin

Non-GAAP Research and Development Expense:

Research and development

Stock-based compensation

Research and development expense

Stock-based compensation expense

Non-GAAP research and development expense

Non-GAAP Selling and Marketing Expense:

Selling and marketing

Amortization of acquired intangibles - selling and marketing expense

Stock-based compensation

Non-GAAP selling and marketing

Selling and marketing expense

Stock-based compensation expense

Amortization of acquired intangible assets – selling and marketing expense

Non-GAAP selling and marketing expense

Non-GAAP General and Administrative Expense:

General and administrative

Stock-based compensation

Severance charges

Non-GAAP general and administrative

General and administrative expense

Stock-based compensation expense

Severance expense

Transaction costs

Non-GAAP general and administrative expense

Non-GAAP Operating Income:

Income (loss) from operations

Stock-based compensation

Stock-based compensation expense

Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues

Amortization of acquired intangible assets – selling and marketing expense

Severance expense

Amortization of acquired intangibles - selling and marketing expense

Depreciation and amortization - cost of subscription revenues

Transaction costs

Non-GAAP operating income

Reconciliation of Non-GAAP Net Income:

Net (loss) income

Stock-based compensation

Severance charges

Amortization of acquired intangibles - selling and marketing expense

Depreciation and amortization - cost of subscription revenues

Impact of S- to C-corporation conversion

Non-GAAP Net Income:

Income (loss) before income taxes

Stock-based compensation expense

Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues

Amortization of acquired intangible assets – selling and marketing expense

Severance expense

Transaction costs

Non-GAAP income before income taxes

Income tax adjustment at statutory rate

Non-GAAP net income

Critical Accounting Policies and Estimates

The critical accounting policies that reflect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements include software development costs, goodwill, accounting for stock-based compensation, revenue recognition, and income taxes, which are described in “Note 1—Summary of Significant Accounting Policies” in Part I, Item 1 of this Quarterly Report on Form 10-Q.

There have been no material updates or changes to our critical accounting policies and estimates compared to the critical accounting policies and estimates described in our Quarterly Report on Form 10-Q for the period ended June 30, 2020.

There have been no material updates or changes to our critical accounting policies and estimates compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the period ended December 31, 2020.

Recent Accounting Pronouncements

For further information on recent accounting pronouncements, refer to Note 1 in the consolidated financial statements contained within this Quarterly Report on Form 10-Q.

For further information on recent accounting pronouncements, refer to Note 1 in the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis