Item 2. Management’s Discussion and Analysis
Item 2.
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 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 “Special Note Regarding Forward-Looking Statements” above.
Overview
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. We first began electronic delivery of tax rules in the early 1980s and we first sold transaction tax processing software in 1982. Today, our software enables tax determination, compliance and reporting, tax data management and document management with powerful pre-built integrations to core business applications used by most companies, particularly those applications that have a significant impact on global commerce. Our software is fueled by over 300 million data-driven effective tax rules and supports indirect tax compliance in more than 19,000 jurisdictions worldwide. In order to maintain the quality of our content, our team includes many global tax and regulatory experts from industry and the public sector, who deliver monthly updates to our tax content, which are then incorporated directly into our software. Our solutions can be deployed on-premise, in the cloud, or both, with implementation services available to enable optimal customer outcomes and satisfy their unique business requirements.
We have accumulated industry-specific tax knowledge for over four decades and our customers leverage our in-depth content through their use of our software. This allows our customers to comply with the dynamic regulatory landscape in real time and mitigates our customers’ risk exposure. As our customers expand their global footprint and business models, we are actively supporting their expansion by continuously strengthening our content offering and allowing for additional jurisdiction-specific tax compliance.
We derive the majority of our revenue from software subscriptions. These subscriptions include use of our software and ongoing monthly content updates. Our software is offered on a subscription basis to our customers, regardless of their deployment preferences. On-premise subscriptions are typically sold through one-year contracts and cloud-based subscriptions are typically sold through one- to three-year contracts. We bill almost all of our customers annually in advance of the subscription period.
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 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.
We employ a hybrid deployment model to align to our customers’ technology preferences for their core financial management software across on premise, cloud deployments or any combination of these models. Over time, we expect both existing and newly acquired customers to continue to shift towards cloud deployment models. 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 32.3% and 25.1% of software subscription revenue
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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.
Our partner ecosystem is a differentiating, competitive strength in both our software development and our sales and marketing activities. We integrate with key technology partners that span ERP, CRM, procurement, billing, POS and eCommerce. These partners include Adobe/Magento, Coupa, Microsoft Dynamics, NetSuite, Oracle, Salesforce, SAP, SAP Ariba, Workday and Zuora. We also collaborate with numerous accounting firms who have built implementation practices around our software to serve their customer base.
We believe that global commerce and the compliance environment provides durable and accelerating growth opportunities for our business. 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
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
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 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.
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 customers experiencing issues as a result of the COVID-19 pandemic, and we have
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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, 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; and the impact on economic activity, including the possibility of recession or financial market instability. 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 useful lives and potential impairment of long-lived assets, intangible assets and goodwill.
Key Business Metrics
We regularly review the metrics identified below to evaluate growth trends, measure our performance, formulate financial projections and make strategic decisions.
Annual Recurring Revenue.
We derive the vast majority of our revenue from recurring software subscriptions. 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. ARR is based on monthly recurring revenue (“MRR”) from software subscriptions for the most recent month at period end, multiplied by twelve. MRR is calculated by dividing the software subscription price, inclusive of discounts, by the number of subscription covered months. MRR only includes customers with MRR at the end of the last month of the measurement period.
Three months ended
March 31,
(Dollars in millions)
2021
2020
Year-Over-Year Change
Annual Recurring Revenue
$
320.1
$
284.2
$
35.9
12.6
%
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.
We believe that our Net Revenue Retention Rate (“NRR”) provides insight into our ability to retain and grow revenue from our customers, as well as their potential long-term value to us. We also believe it demonstrates to investors our ability to expand existing customer revenues, which is one of our key growth strategies. 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 or reduced usage, as well as any revenue expansion from migrations, new licenses for additional products or contractual and usage-based price changes.
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Three months ended
March 31,
2021
2020
Net Revenue Retention Rate
105
%
109
%
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.
We believe that Adjusted EBITDA is a measure widely used by securities analysts and investors to evaluate the financial performance of our company and other companies. 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, 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 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
March 31
(Dollars in thousands)
2021
2020
Adjusted EBITDA:
Net income (loss)
$
2,288
$
(29,064)
Interest expense, net
535
569
Income tax (benefit) expense
(679)
250
Depreciation and amortization - property and equipment
2,827
2,869
Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues
5,905
4,567
Amortization of acquired intangible assets - selling and marketing expense
84
—
Stock-based compensation expense
6,543
34,920
Severance expense
531
1,183
Transaction costs
150
—
Adjusted EBITDA
$
18,184
$
15,294
Adjusted EBITDA Margin:
Total revenues
$
98,236
$
89,245
Adjusted EBITDA margin
18.5
%
17.1
%
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.
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
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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 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 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
March 31,
(Dollars in thousands)
2021
2020
Free Cash Flow:
Cash used in operating activities
$
(2,965)
$
(6,417)
Property and equipment additions
(6,195)
(5,632)
Capitalized software additions
(2,221)
(3,706)
Free cash flow
$
(11,381)
$
(15,755)
Free Cash Flow Margin:
Total revenues
$
98,236
$
89,245
Free cash flow margin
(11.6)
%
(17.7)
%
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
Revenue
We generate revenue from software subscriptions and services.
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration expected to be received in exchange for those products or services. We enter into contracts that include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowance for subscription and non-renewal cancellations and any taxes collected from customers that are subsequently remitted to governmental authorities.
Software Subscriptions
Licenses for on-premise software subscriptions, which are generally one year, provide the customer with a right to use the software as it exists when made available to the customer. Customers purchase a subscription to these licenses, which includes the related software and tax content updates and product support. The updates and support, which are part of the subscription agreement, are essential to the continued utility of the software; therefore, we have determined the software and the related updates and support to be a single performance obligation. Accordingly, when on-premise software is licensed, the revenue associated with this combined performance obligation is recognized ratably over the license term as these subscriptions are provided for the duration of the license term. Revenue recognition begins on the later of the beginning of the subscription period or the date the software is made available to the customer to download. 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
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renewal price. We recognize revenue associated with this material right over the estimated period of benefit to the customer, which is generally three years.
Our cloud-based subscriptions allow customers to use Vertex-hosted software over the contract period without taking possession of the software. The contracts are generally for one to three years and are generally billed annually in advance of the subscription period. Our cloud-based offerings also include related updates and support. All services within the cloud-based contracts consistently provide a benefit to the customer during the subscription period, thus the associated revenue is recognized ratably over the subscription period. Revenue recognition begins on the later of the beginning of the subscription period or the date the customer is provided access to the cloud-based solutions.
Revenue is impacted by the timing of sales and our customers’ growth or contractions resulting in their need to expand or contract their subscription usage, the purchase of new solutions or the non-renewal of existing solutions. In addition, revenue will fluctuate with the cessation of extended product support fees charged for older versions of our software subscription solutions when they are retired and these fees are no longer charged. Contracts for on-premise licenses permit cancellations at the end of the license term, which is generally one year. Legacy cloud-based subscription contracts for multi-year periods previously provided customers the right to terminate their contract for services prior to the end of the subscription period at a significant penalty. This penalty requires the payment of a percentage of the remaining months of the then current contract term. Current cloud-based contracts do not contain such termination rights. 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 on past experience, current information and forward-looking economic considerations.
Services Revenue
We generate services revenue primarily in support of our customers’ needs associated with our software and to enable them to realize the full benefit of our solutions. These software subscription-related services include configuration, data migration and implementation, and premium support and training. In addition, we generate services revenue through our managed services offering which allows customers to outsource all or a portion of their indirect tax operations to us. These services include indirect tax return preparation, filing and tax payment and notice management. We generally bill for services on a per-transaction or time and materials basis, and we recognize revenue from deliverable-based professional services as services are performed.
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%. 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
Software Subscriptions
Cost of software subscriptions revenue consists of costs related to providing and supporting our software subscriptions and includes personnel and related expenses, including salaries, benefits, bonuses and stock-based compensation. 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 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. We expect growth in our business will result in an increase in cost of revenue in absolute dollars.
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Services
Cost of services revenue consists of direct costs of software subscription-related services and our managed services offering. These costs include personnel and related expenses, including salaries, benefits, bonuses, stock-based compensation and the cost of third-party contractors and other direct expenses. We plan to continue to expand our infrastructure and personnel as necessary to support our future growth and related increases in our service revenue. We expect growth in our business will result in an increase in the cost of services revenue in absolute dollars, but may decrease as a percentage of revenues as we scale our operations.
Research and Development
Research and development expenses consist primarily of personnel and related expenses for our research and development activities, including salaries, benefits, bonuses and stock-based compensation, and the cost of third-party developers and other contractors. Research and development costs, other than software development expenses qualifying for capitalization, are expensed as incurred. 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.
We devote substantial resources to developing new products and enhancing existing products, conducting quality assurance testing and improving our core technology. We believe continued investments in research and development are critical to attain our strategic objectives and expect research and development costs to increase in absolute dollars. These investments include enhancing our solution offerings to address changing customer needs to support their growth, as well as implementing changes required to keep pace with our partners’ technology to ensure the continued ability of our solutions to work together and deliver value to our customers. The market for our solutions is characterized by rapid technological change, frequent new product and service introductions and enhancements, changing customer demands and evolving industry standards. As a result, although we are making significant research and development expenditures, which may be incurred and certain of which may be capitalized, there is no guarantee these solutions will be accepted by the market. This could result in increased costs or an impairment of capitalized development costs with no resulting future revenue benefit.
Selling and Marketing Expenses
Selling expenses consist primarily of personnel and related expenses in support of sales and marketing efforts. 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 certain acquired intangible assets. 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
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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
Depreciation and amortization expense consists of the allocation of purchased and developed asset costs over the future periods benefitted by the use of these assets. These assets include leasehold improvements for our facilities, computers and equipment needed to support our customers and our internal infrastructure and capitalized internal-use software associated with our internal infrastructure and tools. Depreciation and amortization will fluctuate in correlation with our ongoing investment in internal infrastructure costs to support our growth.
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. In addition, interest expense will include adjustments to the fair value of contracts that may be entered into to hedge risks associated with currency fluctuations for cash receipts or cash payments denominated in currencies other than U.S. dollars and which do not qualify for hedge accounting. 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, 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 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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The following table sets forth our consolidated statements of comprehensive income (loss) for the periods indicated.
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-Over-Period Change
Revenues:
Software subscriptions
$
83,280
$
75,760
$
7,520
9.9
%
Services
14,956
13,485
1,471
10.9
%
Total revenues
98,236
89,245
8,991
10.1
%
Cost of revenues:
Software subscriptions (1)
25,590
24,684
906
3.7
%
Services (1)
11,343
14,778
(3,435)
(23.2)
%
Total cost of revenues
36,933
39,462
(2,529)
(6.4)
%
Gross profit
61,303
49,783
11,520
23.1
%
Operating expenses:
Research and development (1)
11,459
13,079
(1,620)
(12.4)
%
Selling and marketing (1)
20,150
24,333
(4,183)
(17.2)
%
General and administrative (1)
24,852
37,636
(12,784)
(34.0)
%
Depreciation and amortization
2,827
2,869
(42)
(1.5)
%
Other operating (income) expense, net
(129)
111
(240)
(216.2)
%
Total operating expenses
59,159
78,028
(18,869)
(24.2)
%
Income (loss) from operations
2,144
(28,245)
30,389
107.6
%
Interest expense, net
535
569
(34)
(6.0)
%
Income (loss) before income taxes
1,609
(28,814)
30,423
105.6
%
Income tax (benefit) expense
(679)
250
(929)
(371.6)
%
Net income (loss)
2,288
(29,064)
31,352
107.9
%
Other comprehensive loss from foreign currency translations and revaluations, net of tax
977
2,998
(2,021)
(67.4)
%
Total comprehensive income (loss)
$
1,311
$
(32,062)
$
33,373
104.1
%
(1) Includes stock-based compensation expenses as follows in the table below.
Three months ended
March 31
(In thousands)
2021
2020
Stock-based compensation expense:
Cost of revenues, software subscriptions
$
560
$
3,492
Cost of revenues, services
594
5,238
Research and development
561
3,492
Selling and marketing
1,287
6,984
General and administrative
3,541
15,714
Total stock-based compensation expense
$
6,543
$
34,920
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The following table sets forth our results of operations as a percentage of our total revenue for the periods presented.
Three months ended
March 31
2021
2020
Revenues:
Software subscriptions
84.8
%
84.9
%
Services
15.2
%
15.1
%
Total revenues
100.0
%
100.0
%
Cost of Revenues:
Software subscriptions
26.0
%
27.7
%
Services
11.5
%
16.6
%
Total cost of revenues
37.5
%
44.3
%
Gross profit
62.5
%
55.7
%
Operating expenses:
Research and development
11.7
%
14.7
%
Selling and marketing
20.5
%
27.3
%
General and administrative
25.3
%
42.2
%
Depreciation and amortization
2.9
%
3.2
%
Other operating (income) expense, net
(0.1)
%
0.1
%
Total operating expenses
60.3
%
87.5
%
Income (loss) from operations
2.2
%
(31.8)
%
Interest expense, net
0.5
%
0.6
%
Income (loss) before income taxes
1.7
%
(32.4)
%
Income tax (benefit) expense
(0.7)
%
0.3
%
Net income (loss)
2.4
%
(32.7)
%
Other comprehensive loss from foreign currency translations, net of tax
1.0
%
3.4
%
Total comprehensive income (loss)
1.4
%
(36.1)
%
Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020
Revenue
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Revenues:
Software subscriptions
$
83,280
$
75,760
$
7,520
9.9
%
Services
14,956
13,485
1,471
10.9
%
Total revenues
$
98,236
$
89,245
$
8,991
10.1
%
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. In addition, our managed services offering experienced a $0.5 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.
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Cost of Software Subscriptions Revenue
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Cost of software subscription revenues
$
25,590
$
24,684
$
906
3.7
%
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
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Cost of services revenuess
$
11,343
$
14,778
$
(3,435)
(23.2)
%
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
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Research and development
$
11,459
$
13,079
$
(1,620)
(12.4)
%
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
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Selling and marketing
$
20,150
$
24,333
$
(4,183)
(17.2)
%
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
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
General and administrative
$
24,852
$
37,636
$
(12,784)
(34.0)
%
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
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-over-Period change
Income tax (benefit) expense
$
(679)
$
250
$
(929)
(371.6)
%
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).
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Liquidity and Capital Resources
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. 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. However, if these sources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Additional financing may not be available at all, or in amounts or on terms unacceptable to us.
The following table presents a summary of our cash flows for the periods indicated:
Three months ended
March 31,
(Dollars in thousands)
2021
2020
Period-Over-Period Change
Net cash used in operating activities
$
(2,965)
$
(6,417)
$
3,452
(53.8)
%
Net cash used in investing activities
(14,516)
(21,656)
7,140
(33.0)
%
Net cash (used in) provided by financing activities
(8,140)
103,654
(111,794)
(107.9)
%
Effect of foreign exchange rate changes
(226)
(249)
23
(9.2)
%
Net (decrease) increase in cash, cash equivalents and restricted cash
$
(25,847)
$
75,332
$
(101,179)
(134.3)
%
Operating Activities. 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 $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 (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
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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.
Debt . 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
We maintain trust accounts with financial institutions, which allows our customers to outsource their tax remittance functions to us. We have legal ownership over the accounts utilized for this purpose. Funds held for customers represents cash and cash equivalents that, based upon our intent, are restricted solely for satisfying the obligations to remit funds relating to our tax remittance services. Funds held for customers are not commingled with our operating funds.
Customer funds obligations represent our contractual obligations to remit collected funds to satisfy customer tax payments. Customer funds obligations are reported as a current liability on our consolidated balance sheets as the obligations are expected to be settled within one year. Cash flows related to changes in customer funds obligations liability are presented as cash flows from financing activities.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined by applicable regulations of the SEC, that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
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 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 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.
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 financial measures, and should be read in conjunction with the consolidated financial statements included in this Quarterly Report on Form 10-Q.
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We calculate these non-GAAP financial measures as follows:
● 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 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.
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● Free cash flow margin is determined by dividing free cash flow by total revenues for the respective periods.
We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view these non-GAAP financial measures in conjunction with the related GAAP financial measures.
The following schedules reflect our non-GAAP financial measures and reconcile our non-GAAP financial measures to the related GAAP financial measures. 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.
Three months ended
March 31
(Dollars in thousands)
2021
2020
Non-GAAP cost of revenues, software subscriptions
$
19,125
$
16,625
Non-GAAP cost of revenues, services
$
10,749
$
9,540
Non-GAAP gross profit
$
68,362
$
63,080
Non-GAAP gross margin
69.7
%
70.6
%
Non-GAAP research and development expense
$
10,898
$
9,587
Non-GAAP selling and marketing expense
$
18,779
$
17,349
Non-GAAP general and administrative expense
$
20,630
$
20,739
Non-GAAP operating income
$
15,357
$
12,425
Non-GAAP net income
$
11,042
$
11,619
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Three months ended
March 31
(Dollars in thousands)
2021
2020
Non-GAAP Cost of Revenues, Software Subscriptions:
Cost of revenues, software subscriptions
$
25,590
$
24,684
Stock-based compensation expense
(560)
(3,492)
Depreciation and amortization of capitalized software and acquired intangible assets – cost of subscription revenues
(5,905)
(4,567)
Non-GAAP cost of revenues, software subscriptions
$
19,125
$
16,625
Non-GAAP Cost of Revenues, Services:
Cost of revenues, services
$
11,343
$
14,778
Stock-based compensation expense
(594)
(5,238)
Non-GAAP cost of revenues, services
$
10,749
$
9,540
Non-GAAP Gross Profit:
Gross profit
$
61,303
$
49,783
Stock-based compensation expense
1,154
8,730
Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues
5,905
4,567
Non-GAAP gross profit
$
68,362
$
63,080
Non-GAAP Gross Margin:
Gross margin
62.5
%
55.7
%
Stock-based compensation expense as a percentage of revenues
1.2
%
9.8
%
Depreciation and amortization of capitalized software and acquired intangible assets – cost of subscription revenues as a percentage of revenues
6.0
%
5.1
%
Non-GAAP gross margin
69.7
%
70.6
%
Non-GAAP Research and Development Expense:
Research and development expense
$
11,459
$
13,079
Stock-based compensation expense
(561)
(3,492)
Non-GAAP research and development expense
$
10,898
$
9,587
Non-GAAP Selling and Marketing Expense:
Selling and marketing expense
$
20,150
$
24,333
Stock-based compensation expense
(1,287)
(6,984)
Amortization of acquired intangible assets – selling and marketing expense
(84)
—
Non-GAAP selling and marketing expense
$
18,779
$
17,349
Non-GAAP General and Administrative Expense:
General and administrative expense
$
24,852
$
37,636
Stock-based compensation expense
(3,541)
(15,714)
Severance expense
(531)
(1,183)
Transaction costs
(150)
—
Non-GAAP general and administrative expense
$
20,630
$
20,739
Non-GAAP Operating Income:
Income (loss) from operations
$
2,144
$
(28,245)
Stock-based compensation expense
6,543
34,920
Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues
5,905
4,567
Amortization of acquired intangible assets – selling and marketing expense
84
—
Severance expense
531
1,183
Transaction costs
150
—
Non-GAAP operating income
$
15,357
$
12,425
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Non-GAAP Net Income:
Income (loss) before income taxes
$
1,609
$
(28,814)
Stock-based compensation expense
6,543
34,920
Depreciation and amortization of capitalized software and acquired intangible assets - cost of subscription revenues
5,905
4,567
Amortization of acquired intangible assets – selling and marketing expense
84
—
Severance expense
531
1,183
Transaction costs
150
—
Non-GAAP income before income taxes
14,822
11,856
Income tax adjustment at statutory rate
(3,780)
(237)
Non-GAAP net income
$
11,042
$
11,619
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 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 condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.