UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2020

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from to

 

Commission File Number: 333-239644

 

 

 

VERTEX, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware     23-2081753

(State or other jurisdiction of

incorporation or organization)

   

(I.R.S. Employer

Identification No.)

       
2301 Renaissance Blvd
King of Prussia, Pennsylvania
    19406
(Address of principal executive offices)     (Zip Code)

 

Registrant’s telephone number, including area code: (800) 355-3500

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading symbol Name of each exchange on which registered
Class A Common Stock, Par Value $0.001 Per Share VERX NASDAQ

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      No  

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer     Accelerated filer  
Non-accelerated filer        Small reporting company  
    Emerging growth company    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

 

As of August 31, 2020, the registrant had 26,359,623 shares of Class A common stock, $0.001 par value per share, and 120,417,000 shares of Class B common stock, $0.001 par value per share, outstanding.

 

 

 

 

 

 

TABLE OF CONTENTS

 
    Page
  Part I - Financial Information   
Item 1. Financial Statements  
  Condensed Consolidated Balance Sheets as of December 31, 2019 and June 30, 2020 (unaudited) 2
  Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2019 and 2020 (unaudited) 3
  Condensed Consolidated Statements of Changes in Equity for the Six Months Ended June 30, 2019 and 2020 (unaudited) 4
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2020 (unaudited) 5
  Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosures about Market Risk 51
Item 4. Controls and Procedures 52
  Part II - Other Information 54
Item 1. Legal Proceedings 54
Item 1A. Risk Factors 54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 70
Item 3. Defaults Upon Senior Securities 70
Item 4. Mine Safety Disclosures 71
Item 5. Other Information 71
Item 6. Exhibits 71
  Signatures 73

 

 

 

 

Cautionary Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), that involve substantial risks and uncertainties. All statements made in this Quarterly Report on Form 10-Q that are not statements of historical fact, including statements about our beliefs and expectations and regarding future events or our future results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management, are forward-looking statements and should be evaluated as such. These statements often include words such as “anticipate,” “believe,” “expect,” “suggests,” “plan,” “believe,” “intend,” “estimates,” “targets,” “projects,” “should,” “could,” “would,” “may,” “will,” “forecast” and other similar expressions or the negatives of those terms. We base these forward-looking statements on our current expectations, plans and assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances at such time. As you read and consider this prospectus, you should understand that these statements are not guarantees of future performance or results. The forward-looking statements are subject to and involve risks, uncertainties and assumptions, and you should not place undue reliance on these forward-looking statements. Although we believe that these forward-looking statements are based on reasonable assumptions at the time they are made, you should be aware that many factors could affect our actual results or results of operations and could cause actual results to differ materially from those expressed in the forward-looking statements. Important factors that may materially affect such forward-looking statements include, but are not limited to:

 

·the potential effects on our business of the current novel coronavirus (“COVID-19”) pandemic;
·our ability to attract new customers on a cost-effective basis and the extent to which existing customers renew and upgrade their subscriptions;
·our ability to sustain and expand revenues, maintain profitability, and to effectively manage our anticipated growth;
·the timing of our introduction of new solutions or updates to existing solutions
·our ability to successfully diversify our solutions by developing or introducing new solutions or acquiring and integrating additional businesses, products, services or content;
·our ability to maintain and expand our strategic relationships with third parties;
·risks related to our expanding international operations;
·our ability to deliver our solutions to customers without disruption or delay;
·our exposure to liability from errors, delays, fraud or system failures, which may not be covered by insurance;
·risks related to our determinations of customers’ transaction tax and tax payments;
·risks related to changes in tax laws and regulations or their interpretation or enforcement;
·our ability to manage cybersecurity and data privacy risks;
·risks related to failures in information technology, infrastructure and third party service providers;
·our ability to effectively protect, maintain and enhance our brand;
·global economic weakness and uncertainties, and disruption in the capital and credit markets;
·business disruptions related to natural disasters, epidemic outbreaks, terrorist acts, political events or other events outside of our control;
·our ability to comply with anti-corruption, anti-bribery and similar laws;
·changes in interest rates, security ratings and market perceptions of the industry in which we operate, or our ability to obtain capital on commercially reasonable terms or at all;
·any statements of belief and any statements of assumptions underlying any of the foregoing;
·other factors beyond our control; and
·other factors discussed in other sections of this Quarterly Report on Form 10-Q, including the sections titled “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and under Part II, Item 1A. “Risk Factors.”

 

 

 

 

You should not place undue reliance on our forward-looking statements and you should not rely on forward-looking statements as predictions of future events. The results, events, and circumstances reflected in the forward- looking statements may not be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements. The forward-looking statements made in this Quarterly Report on Form 10-Q speak only as of the date of this report. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

 

 

 

 

PART I - FINANCIAL INFORMATION 

Item 1. Financial Statements.

Vertex, Inc.

Condensed Consolidated Balance Sheets

As of December 31, 2019 and June 30, 2020 (unaudited)

(Amounts in thousands)

 

  

June 30,

2020

  

December 31, 

2019

 
     (unaudited)      
Assets          
Current assets:          
Cash and cash equivalents  $47,295   $75,903 
Funds held for customers   9,988    7,592 
Accounts receivable, net of allowance of $7,669 (unaudited), and $7,515, respectively   63,739    70,367 
Advances to stockholders   230    283 
Prepaid expenses and other current assets   13,119    11,412 
Total current assets   134,371    165,557 
Property and equipment, net of accumulated depreciation   55,657    54,727 
Capitalized software, net of accumulated amortization   33,761    32,075 
Goodwill   19,355     
Deferred commissions   10,390    11,196 
Deposits and other assets   4,956    1,068 
Total assets  $258,490   $264,623 
Liabilities and Equity          
Current liabilities:          
Current portion of long-term debt  $649   $50,804 
Accounts payable   13,769    10,729 
Accrued expenses   11,961    13,308 
Distributions payable       13,183 
Customer funds obligations   10,175    7,553 
Accrued salaries and benefits   19,825    15,195 
Accrued variable compensation   11,025    22,237 
Deferred compensation, current   22,349    8,935 
Deferred revenue   187,041    191,745 
Deferred rent and other   917    840 
Future acquisition commitment, current   808     
Total current liabilities   278,519    334,529 
Deferred compensation, net of current portion   77,505    18,530 
Deferred revenue, net of current portion   11,396    14,046 
Long-term debt, net of current portion   173,361    682 
Future acquisition commitment, net of current portion   9,831     
Deferred other liabilities   8,865    9,268 
Total liabilities   559,477    377,055 
Commitments and contingencies (Note 12)          
Options for redeemable shares   47,223    17,344 
Stockholders’ deficit (*):          
Class A voting common stock, $0.001 par value, 600 shares authorized, 300 shares issued, 147 shares outstanding        
Class B non-voting common stock, $0.001 par value, 299,400 shares authorized, 162,470 (unaudited), and 162,297 shares issued, respectively, 120,443 (unaudited) and 120,270 shares outstanding, respectively   54    54 
Accumulated deficit   (305,861)   (90,701)
Accumulated other comprehensive loss   (3,765)   (491)
Treasury stock   (38,638)   (38,638)
Total stockholders’ deficit   (348,210)   (129,776)
Total liabilities and equity  $258,490   $264,623 

 

(*) The number of shares of common stock have been retrospectively restated to reflect the three-for-one forward stock split which was effective July 28, 2020. See Note 13.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

- 2 -

 

 

 

Vertex, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

For the three and six months ended June 30, 2019 and 2020 (unaudited)

(Amounts in thousands, except per share data)

 

                 
   Three months
 ended June 30,
  

Six months

ended June 30,

 
   2020   2019   2020   2019 
   (unaudited)   (unaudited) 
Revenues:                
Software subscriptions  $77,306   $67,267   $153,066   $131,651 
Services   13,965    11,108    27,450    21,338 
Total revenues   91,271    78,375    180,516    152,989 
Cost of revenues:                    
Software subscriptions   26,001    19,417    50,685    37,843 
Services   15,744    7,692    30,522    14,830 
Total cost of revenues   41,745    27,109    81,207    52,673 
Gross profit   49,526    51,266    99,309    100,316 
Operating expenses:                    
Research and development   13,617    7,205    26,696    14,778 
Selling and marketing   24,544    17,287    48,877    33.334 
General and administrative   37,758    16,647    75,394    32,095 
Depreciation and amortization   2,505    2,172    5,374    4,217 
Other operating expense, net   103    305    214    468 
Total operating expenses   78,527    43,616    156,555    84,892 
Income (loss) from operations   (29,001)   7,650    (57,246)   15,424 
Other (income) expense:                    
Interest income   (101)   (232)   (456)   (524)
Interest expense   1,160    539    2,084    1,076 
Total other expense, net   1,059    307    1,628    552 
Income (loss) before income taxes   (30,060)   7,343    (58,874)   14,872 
Income tax (benefit) expense   (985)   221    (735)   425 
Net income (loss)   (29,075)   7,122    (58,139)   14,447 
Other comprehensive loss from foreign currency translation adjustments and revaluations, net of tax   276    23    3,274    2 
Total comprehensive income (loss)  $(29,351)  $7,099   $(61,413)  $14,445 
Net income (loss) attributable to Class A stockholders  $(35)  $9   $(70)  $18 
Net income (loss) per Class A share, basic and diluted (*)  $(0.24)  $0.06   $(0.48)  $0.12 
Weighted average Class A common stock, basic and diluted (*)   147    147    147    147 
Net income (loss) attributable to Class B stockholders  $(29,040)  $7,113   (58,069)  $14,429 
Net income (loss) per Class B share, basic (*)  $(0.24)  $0.06   $(0.48)  $0.12 
Weighted average common Class B stock, basic (*)   120,402    120,443    120,336    120,357 
Net income (loss) per Class B share, diluted (*)  $(0.24)  $0.06   $(0.48)  $0.12 
Weighted average common Class B stock, diluted (*)   120,402    124,158    120,336    124,169 
Loss before income taxes  $​(30,060)        $(58,874)     
Pro forma provision for income tax benefit   (7,605)        (14,895)     
Pro forma net loss  $(22,455)       $(43,979)     
Pro forma net loss attributable to Class A stockholders (*)  $(28)       $(54)     
Weighted average Class A common stock, basic and diluted   147         147      
Pro forma net loss per Class A share, basic and diluted (*)  $(0.19)       $(0.37)     
Pro forma net loss attributable to Class B stockholders (*)  $(22,427)       $(43,925)     
Weighted average Class B common stock, basic and diluted   120,402         120,336      
Pro forma net loss per Class B share, basic and diluted  (*)  $(0.19)       $(0.37)     

 

(*) The number of shares of common stock and the calculation of net income (loss) per share have been retrospectively restated to reflect the three-for-one forward stock split which was effective July 28, 2020. See Note 13.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

- 3 -

 

 

Vertex, Inc.

Condensed Consolidated Statements of Changes in Equity

For the six months ended June 30, 2019 and 2020 (unaudited)

(Amounts in thousands)

 

   Outstanding
Class A
Shares (*)
   Class A
Common
Stock
   Outstanding
Class B
Shares (*)
   Class B
Common
Stock
   Accumulated
Deficit
   Accumulated
Other
Comprehensive
Loss
   Treasury
Shares
Issued (*)
   Treasury
Stock
   Total
Stockholders’
Deficit
   Options for
Redeemable
Shares
 
Balance, January 1, 2019   147   $    120,270   $54   $(88,038)   $(496)   41,685   $(37,797)  $(126,277)  $14,581 
Remeasurement of options for redeemable shares                   (607)               (607)   607 
Distributions declared                   (5,255)               (5,255)    
Foreign currency translation adjustments and revaluations       —                —                21            21     
Net income                   7,325                7,325     
                                                   
Balance, March 31, 2019   147        120,270    54    (86,575)   (475)   41,685    (37,797)   (124,793)   15,188 
Remeasurement of options for redeemable shares                   424                424    (424)
Exercise of stock options, net           225        (116)               (116)    
Distributions declared                   (6,105)               (6,105)    
Foreign currency translation adjustments and revaluations                       (23)           (23)    
Net income                   7,122                7,122     
Balance, June 30, 2019   147   $    120,495   $54   $(85,250)  $(498)   41,685   $(37,797)  $(123,491)  $14,764 
                                         
Balance, January 1, 2020   147   $    120,270   $54   $(90,701)  $(491)   41,910   $(38,638)  $(129,776)  $17,344 
Remeasurement of options for redeemable shares                   (15,242)               (15,242)   15,242 
Distributions declared                   (4,010)               (4,010)    
Foreign currency translation adjustments and revaluations                       (2,998)           (2,998)    
Net loss                   (29,064)               (29,064    
                                        
Balance, March 31, 2020   147        120,270    54    (139,017)   (3,489)   41,910    (38,638)   (181,090)   32,586 
Remeasurement of options for redeemable shares                   (14,637)               (14,637)   14,637 
Exercise of stock options, net           173        53                53     
Distributions declared                   (123,185)               (123,185)    
Foreign currency translation adjustments and revaluations                       (276)           (276)    
Net loss                   (29,075)               (29,075)    
Balance, June 30, 2020   147   $    120,443   $54   $(305,861)  $(3,765)   41,910    $(38,638)   $(348,210)  $47,223 

 

(*) The number of shares of common stock and treasury stock have been retrospectively restated to reflect the three-for-one forward stock split which was effective July 28, 2020. See Note 13.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

- 4 -

 

 

 

Vertex, Inc.

Condensed Consolidated Statements of Cash Flows

For the six months ended June 30, 2019 and 2020 (unaudited)

(Amounts in thousands)

 

    Six Months Ended June 30,  
    2020     2019  
    (unaudited)  
Cash flows from operating activities:                
Net income (loss)   $ (58,139 )   $ 14,447  
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:                
Depreciation and amortization     15,416       12,154  
Provision for subscription cancellations and non-renewals     154       (682 )
Amortization of deferred financing costs     428       133  
Stock-based compensation expense     76,596       2,620  
Other     14       44  
Changes in operating assets and liabilities:                
Accounts receivable     7,093       14,626  
Advances to stockholders     53       79  
Prepaid expenses and other current assets     (1,717 )     (1,583 )
Deferred commissions     807       71  
Accounts payable     2,911       (767 )
Accrued expenses     (1,481 )     445  
Accrued and deferred compensation     (10,804 )     (9,084 )
Deferred revenue     (7,353 )     647  
Other     (3,222 )     590  
           
Net cash provided by operating activities     20,756       32,850  
Cash flows from investing activities:                
Acquisition of business, net of cash acquired     (12,318 )      
Property and equipment additions     (10,565 )     (8,271 )
Capitalized software additions     (7,264 )     (8,101 )
           
Net cash used in investing activities     (30,147 )     (16,372 )
Cash flows from financing activities:                
Net increase in customer funds obligations     2,622       702  
Proceeds from line of credit     12,500        
Principal payments on line of credit     (12,500 )      
Proceeds from long-term debt     175,000        
Principal payments on long-term debt     (51,009 )     (3,112 )
Payments for deferred financing costs     (2,904 )      
Proceeds from exercise of stock options     52       68  
Distributions to stockholders     (140,378 )     (22,252 )
           
Net cash used in financing activities     (16,617 )     (24,594 )
Effect of exchange rate changes on cash, cash equivalents and restricted cash     (204 )     (2 )
Net decrease in cash, cash equivalents and restricted cash     (26,212 )     (8,118 )
Cash, cash equivalents and restricted cash, beginning of period     83,495       59,174  
Cash, cash equivalents and restricted cash, end of period   $ 57,283     $ 51,056  
           
Reconciliation of cash, cash equivalents and restricted cash to the Consolidated Balance Sheets, end of period:                
Cash and cash equivalents   $ 47,295     $ 47,018  
Restricted cash—funds held for customers     9,988       4,038  
           
Total cash, cash equivalents and restricted cash, end of period   $ 57,283     $ 51,056  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

- 5 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

(Amounts in thousands, except per share data)

 

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

Vertex, Inc. (“Vertex”) and its direct and indirect wholly-owned subsidiaries (collectively, the “Company”) operate as solutions providers of state, local and value added tax calculation, compliance and analytics, offering software products which are sold through software license and software as a service (“cloud”) subscriptions. The Company also provides implementation and training services in connection with its software license and cloud subscriptions, transaction tax returns outsourcing, and other tax-related services. The Company sells to customers located throughout the United States of America (“U.S.”) and internationally.

 

Effective January 7, 2020, the Company acquired a 60% controlling interest in Systax Sistemas Fiscais LTDA (“Systax”), a provider of Brazilian transaction tax content and software. Systax is considered a Variable Interest Entity (“VIE”) and its accounts have been included in the consolidated financial statements from the acquisition date. Systax was determined to be a VIE as the Company is the primary beneficiary of the equity interests in Systax and participates significantly in the variability in the fair value of Systax’s net assets. Although the Company does not have full decision-making authority as it is shared with the minority interest owners, as the minority interest owners are considered a related party, the Company is considered the most closely associated party to Systax and is required to consolidate. Systax’s assets may only be used to settle its own obligations and this will continue until such time as the Company owns 100% of the VIE. As of June 30, 2020, the net assets of Systax were $19,555 (unaudited). The Company is at risk to the extent of its current 60% ownership of Systax, which risk will increase over time in proportion to increases in percentage ownership as the Company exercises its future share purchase commitment through 2024. See Note 2.

 

Registration of Company Stock

 

The Company’s Registration Statement on Form S-1 (the “S-1”) with the Securities and Exchange Commission (“SEC”) was declared effective on July 28, 2020, resulting in newly issued Class A common stock being registered and available for trading on the NASDAQ exchange (the “Offering”). Refer to Note 13 for further description of the impacts of this and other events which occurred in connection with the Offering.

 

Unaudited Interim Financial Information

 

The accompanying unaudited condensed consolidated balance sheet as of December 31, 2019, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC for interim financial information and include the accounts of the Company. All intercompany transactions have been eliminated in consolidation. Certain information and disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) have been condensed or omitted. Accordingly, these consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes for the year ended December 31, 2019 included in the Company’s final prospectus dated July 28, 2020 and filed with the SEC pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, (the “Securities Act”), on July 30, 2020 (the “Prospectus”). The accompanying interim condensed consolidated balance sheet as of June 30, 2020, the interim condensed consolidated statements of comprehensive income (loss) and changes in equity for the three and six months ended June 30, 2020 and 2019, and the interim condensed consolidated statements of cash flows for the six months ended June 30, 2020 and 2019, are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on a basis consistent with that used to prepare the annual audited consolidated financial statements and include, in the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the consolidated financial statements. The operating results for the three and six months ended June 30, 2020 and 2019 are not necessarily indicative of the results expected for the full year periods ending December 31, 2020 and 2019, respectively.

 

Segments

 

The Company operates its business as one operating segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker (“CODM”), the Company’s Chief Executive Officer, in deciding how to allocate resources and assess performance. The Company’s CODM allocates resources and assesses performance based upon discrete financial information at the consolidated level. For the three and six months ended June 30, 2020 and 2019, approximately 3% of the Company’s revenues were generated outside of the United States in each respective period. As of December 31, 2019, none of the Company’s long-lived assets were held outside of the U.S. As of June 30, 2020, 18%, or $19,471, of the Company’s long-lived assets were held outside of the U.S. (unaudited) and consists primarily of goodwill of $19,355 (unaudited) at June 30, 2020 related to the acquisition of the controlling interest in Systax, which is located in Brazil. See Note 2.

 

- 6 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Fair Value of Financial Instruments

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, funds held for customers, accounts receivable, accounts payable, accrued expenses and debt approximate their related fair values.

 

Use of Estimates

 

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity, revenues and expenses during the reporting period. Significant estimates used in preparing these consolidated financial statements include: (i) the estimated allowance for subscription cancellations, (ii) the reserve for self-insurance, (iii) assumptions related to achievement of technological feasibility for software developed for sale, (iv) product life cycles, (v) estimated useful lives and potential impairment of long-lived assets, intangible assets and goodwill, (vi) determination of the fair value of tangible and intangible assets acquired, liabilities assumed and consideration transferred in an acquisition, (vii) amortization period of material rights and deferred commissions (viii) valuation for the Company’s stock used for stock-based compensation, and (ix) the potential outcome of future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Actual results may differ from these estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments purchased with an initial maturity date of three months or less to be cash equivalents.

 

Funds Held for Customers

 

Funds held for customers in the consolidated balance sheets represents customer funds advanced for transaction tax returns outsourcing. Funds held for customers are restricted for the sole purpose of remitting such funds to satisfy obligations on behalf of such customers and are deposited at FDIC-insured institutions. Customer funds obligations are included in current liabilities in the consolidated balance sheets, as the obligations are expected to be settled within one year.

 

Property and Equipment

 

Property and equipment are stated at cost or fair value when acquired in a business combination and presented net of accumulated depreciation. Normal maintenance and repairs are charged to expense, while major renewals and betterments are capitalized. Assets under capital leases are recorded at the lower of the present value of the minimum lease payments or the fair value of the assets and are depreciated over the shorter of the asset’s useful life or lease term. Depreciation and amortization are computed straight-line over the estimated useful lives of the assets, as follows:

 

Leasehold improvements  1 - 12 years
Equipment  3 - 10 years
Computer software  3 - 7 years
Internal-use software developed  3 - 5 years
Furniture and fixtures  7 - 10 years
Automobiles  5 years

 

- 7 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Software Development Costs

 

Internal-Use Software

 

The Company follows Accounting Standard Codification (“ASC”) 350-40, Goodwill and Other, Internal-Use Software, to account for development costs incurred for the costs of computer software developed or obtained for internal use. ASC 350-40 requires such costs to be capitalized once certain criteria are met. Capitalized internal-use software costs are primarily comprised of direct labor, related expenses and initial software licenses. ASC 350-40 includes specific guidance on costs not to be capitalized, such as overhead, general and administrative and training costs. Internal-use software includes software utilized for cloud-based solutions as well as software for internal systems and tools. Costs are capitalized once the project is defined, funding is committed and it is confirmed the software will be used for its intended purpose. Capitalization of these costs concludes once the project is substantially complete and the software is ready for its intended purpose. Post-configuration training and maintenance costs are expensed as incurred. Internal-use software is included in internal-use software developed in property and equipment in the consolidated balance sheets once available for its intended use and is depreciated over periods between 3 to 5 years. Depreciation expense for internal-use software utilized for cloud-based solutions and for software for internal systems and tools is included in cost of revenues, software subscriptions and depreciation expense, respectively, in the consolidated statements of comprehensive income (loss).

 

Software Developed for Sale

 

The costs incurred for the development of computer software to be sold, leased, or otherwise marketed are capitalized in accordance with ASC 985-20, Costs of Software to be Sold, Leased or Marketed, when technological feasibility has been established. Technological feasibility generally occurs when all planning, design, coding and testing activities are completed that are necessary to establish that the product can be produced to meet its design specifications, including functions, features and technical performance requirements. The establishment of technological feasibility is an ongoing assessment of judgment by management with respect to certain external factors, including, but not limited to, anticipated future revenues, estimated economic life and changes in technology. Capitalized software includes direct labor and related expenses for software development for new products and enhancements to existing products and acquired software.

 

Amortization of capitalized software development costs begins when the product is available for general release. Amortization is provided on a product-by-product basis using the straight-line method over periods between 3 to 5 years. Unamortized capitalized software development costs determined to be in excess of the net realizable value of the product are expensed immediately.

 

Capitalized software costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in software technologies. At each balance sheet date, unamortized capitalized software costs are compared to the net realizable value of the related product. The carrying value of the related assets are written down to the net realizable value to the extent the unamortized capitalized costs exceed such value. The net realizable value is the estimated future gross revenues from the related product reduced by the estimated future costs of completing and disposing of such product, including the costs of providing related maintenance and customer support.

 

Assessment of Long-Lived Assets

 

The Company reviews the carrying value of long-lived assets, including internal-use software, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Whenever such events or circumstances are present, an impairment loss equal to the excess of the asset carrying value over its fair value, if any, is recorded.

 

Business Combinations

 

Upon acquisition of a company, the Company determines if the transaction is a business combination, which is accounted for using the acquisition method of accounting. Under the acquisition method, once control is obtained of a business, the assets acquired, liabilities assumed, consideration transferred and amounts attributed to noncontrolling interests, are recorded at fair value. The Company uses its best estimates and assumptions to assign fair value to the tangible and intangible assets acquired, liabilities assumed, consideration transferred, and amounts attributed to noncontrolling interests at the acquisition date. One of the most significant estimates relates to the determination of the fair value of these amounts. The determination of the fair values is based on estimates and judgments made by management. The Company’s estimates of fair value are based upon assumptions it believes to be reasonable, but which are inherently uncertain and unpredictable. Measurement period adjustments to these values as of the acquisition date are reflected at the time identified, up through the conclusion of the measurement period, which is the time at which all information for determination of the values of assets acquired, liabilities assumed, consideration transferred and noncontrolling interests is received, and is not to exceed one year from the acquisition date (the “Measurement Period”). Thus the Company may record adjustments to the fair value of these tangible and intangible assets acquired, liabilities assumed, consideration transferred and noncontrolling interests, with the corresponding offset to goodwill during this Measurement Period. Additionally, uncertain tax positions and tax-related valuation allowances are initially recorded in connection with a business combination as of the acquisition date. The Company continues to collect information and reevaluate these estimates and assumptions periodically and record any adjustments to preliminary estimates to goodwill, provided the Company is within the Measurement Period with any adjustments to amortization of new or previously recorded identifiable intangibles being recorded to the consolidated statements of comprehensive income (loss) in the period in which they arise. In addition, if outside of the Measurement Period, any subsequent adjustments to the acquisition date fair values are recorded to the consolidated statements of comprehensive income (loss) in the period in which they arise.

 

- 8 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Goodwill

 

Goodwill represents the excess of the purchase price over the fair value of net tangible and intangible assets acquired in a business combination. The Company evaluates goodwill for impairment annually at December 31 and whenever events or circumstances make it more likely than not that impairment may have occurred. The Company has determined that its business comprises one reporting unit. The Company has the option to first assess qualitative factors to determine whether events or circumstances indicate it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, in which case a quantitative impairment test is not required.

 

The quantitative goodwill impairment test is performed by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not impaired. An impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the fair value up to the amount of goodwill allocated to the reporting unit. Income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit are considered when measuring the goodwill impairment loss, if applicable.

 

Deferred Financing Costs

 

The Company capitalizes costs related to obtaining, renewing or extending loan agreements and amortizes these costs on a straight-line basis, which approximates the interest method, over the life of the loan. Deferred financing costs related to outstanding borrowings under bank debt are reflected as a reduction of current portion of long-term debt and long-term debt, net of current portion. Deferred financing costs related to undrawn debt are reflected in deposits and other assets in the consolidated balance sheets in accordance with ASC 835-30, Interest—Imputation of Interest.

 

Accounting for Stock-Based Compensation

 

The Company applies the provisions of ASC 718, Compensation—Stock Compensation, for the award of equity-based instruments. The provisions of ASC 718 require a company to measure the fair value of stock-based compensation as of the grant date of the award. The Company has stock options and stock appreciation rights (“SAR(s)”) (collectively, the “awards”) outstanding that are subject to guidance set forth in ASC 718. The Company’s Board of Directors (the “Board”) intends all awards granted to be exercisable at a price per share not less than the per share fair value of the Company’s common stock underlying such awards on the date of grant. Stock-based compensation expense reflects the cost of employee services received in exchange for the awards.

 

SARs are accounted for as liabilities under ASC 718 and, as such, the Company recognizes stock-based compensation expense by remeasuring the SARs at the end of each reporting period and accruing the portion of the requisite service rendered at that date. As a nonpublic entity for all periods presented, the Company elected to measure SARs based on their intrinsic values. Management measures the intrinsic value of the SARs as the difference between the fair value of the Company’s Class B common stock less the grant date fair value of the underlying shares as this is the value the SAR participant can derive from exercise of the SAR award. The fair value of the Company’s common stock is determined periodically by the Board with the assistance of management and a third-party valuation firm. Management continued to record changes in the intrinsic value of the SARs in 2020 up to the date on which the Company became a public entity. Upon becoming a public entity and up to the effective date of the Offering, Management will remeasure SARs using the fair value-based method under ASC 718. See Note 13 for discussion of the impact of the resulting change in accounting policy. Outstanding SARs are included in deferred compensation, current and deferred compensation, net of current portion in the consolidated balance sheets.

 

- 9 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Due to the option holders having the right to require the Company to repurchase shares issued in connection with option exercises after six months of share issuance, the options are classified as temporary equity and reflected in options for redeemable shares on the consolidated balance sheets at their redemption value, which equals the options’ intrinsic value, as of the end of each balance sheet measurement period. Changes as a result of remeasurement of the redemption value of options for redeemable shares are recorded as adjustments to accumulated deficit. The options were exchanged for new options in connection with the Offering. See Note 7.

 

The fair value of the common stock underlying the awards is determined by the Board with assistance from management and an independent third-party valuation firm. The determination of value uses the market and income approaches, with an adjustment for marketability discount pertinent to private company entities in arriving at the per share fair value (the “valuation methodology”). Under the market approach, the guideline public company method is used, which estimates the fair value of the Company based on market prices of stock of guideline public companies. The income approach involves projecting the future benefits of owning an asset and estimating the present value of those future benefits by discounting them based upon the time value of money and the investment risks associated with ownership. At the end of 2019, due to the consideration by the Board of pursuing the Offering, the valuation methodology began to consider the impact of such an event on the value of the Company’s common stock underlying the awards. As the Company approached the Offering effective date, this resulted in increases in the intrinsic value of the awards which resulted in corresponding increases to compensation expense for the three and six months ended June 30, 2020 which exceed historical results. See Note 10. Management expects the SAR value increases to continue and to exceed historical results. See Note 13.

 

Operating Leases and Deferred Rent

 

Rent expense for operating leases is recognized on a straight-line basis over the period of the related lease. For lease agreements that include future specific rent increases, rent concessions and/or tenant improvement allowances, the difference between the rent payments and the straight-line rent expense is included in deferred rent liability in the consolidated balance sheets.

 

Self-insurance

 

The Company is self-insured for the majority of its health insurance costs, including medical claims subject to certain stop-loss provisions. Management periodically reviews the adequacy of the Company’s stop-loss insurance coverage. The Company records an estimate of claims incurred but not reported, based on management’s judgment and historical experience. Self-insurance accruals are $1,473 and $1,980 at December 31, 2019 and June 30, 2020 (unaudited), respectively, and are reflected in accrued salaries and benefits in the consolidated balance sheets. Material differences may result in the amount and timing of insurance expense if actual experience differs significantly from management’s estimates.

 

Revenue Recognition

 

Revenue from contracts with customers

 

The Company recognizes revenue in accordance with Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, (“ASC 606”). 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. The Company enters into contracts that can 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, which are subsequently remitted to governmental authorities.

 

- 10 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Nature of goods and services

 

Licenses for on-premise software subscriptions 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 (collectively “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, the Company has 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. The Company’s 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 (“new sale premium”) is a material right that provides customers with the right to this reduced renewal price. The Company recognizes revenue associated with this material right over the estimated period of benefit to the customer, which is generally three years.

 

Cloud-based subscriptions allow customers to use Company-hosted software over the contract period without taking possession of the software. The cloud-based offerings also include related updates and support. Cloud-based contracts consistently provide a benefit to the customer during the subscription period, thus the associated revenue is recognized ratably over the related 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 from deliverable-based services is recognized as services are delivered. Revenue from fixed fee services is recognized as services are performed using the percentage of completion input method.

 

The Company has elected the “right to invoice” practical expedient for revenue related to services that are billed on an hourly basis, which enables revenue to be recognized as the services are performed.

 

The Company has determined that the methods applied to measuring its progress toward complete satisfaction of performance obligations recognized over time are a faithful depiction of the transfer of control of software subscriptions and services to customers.

 

Significant Judgments

 

Contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Identification of the amortization periods of material rights and contract costs requires significant judgement by management.

 

Disaggregation of revenue

 

The table reflects revenue by major source for the following periods:

 

   For the three months ended
June 30,
   For the six months ended
June 30,
 
   2020   2019   2020   2019 
   (unaudited)   (unaudited) 
Sources of revenue:                    
Software subscriptions  $77,306   $67,267   $153,066   $131,651 
Services   13,965    11,108    27,450    21,338 
Total revenue  $91,271   $78,375   $180,516   $152,989 

 

Contract balances

 

Timing of revenue recognition may differ from the timing of invoicing customers. A receivable is recorded in the consolidated balance sheets when customers are billed related to revenue to be collected and recognized for subscription agreements as there is an unconditional right to invoice and receive payment in the future related to these subscriptions. A receivable and related revenue may also be recorded in advance of billings to the extent services have been performed and the Company has a right under the contract to bill and collect for such performance. Subscription-based customers are generally invoiced annually at the beginning of each annual subscription period. Accounts receivable is presented net of an allowance for potentially uncollectible accounts and estimated cancellations of software license and cloud-based subscriptions (the “allowance”) of $7,515 and $7,669 at December 31, 2019 and June 30, 2020 (unaudited), respectively. The allowance is based on management’s assessment of uncollectible accounts on a specific identification basis, with the estimate of potential cancellations being determined based on management’s review of historical cancellation rates.

 

- 11 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

The beginning and ending balances of accounts receivable, net of allowance, are as follows:

 

   For the year ended
December 31,
   For the six months ended
June 30,
 
   2019   2020 
       (unaudited) 
Balance, beginning of period  $62,235   $70,367 
Balance, end of period   70,367    63,739 
Increase (decrease), net  $8,132   $(6,628)

 

A contract liability is recorded as deferred revenue on the consolidated balance sheets when customers are billed in advance of performance obligations being satisfied, and revenue is recognized after invoicing ratably over the subscription period or over the amortization period of material rights. Deferred revenue is reflected net of a related deferred allowance for subscription cancellations (the “deferred allowance”) of $5,614 and $5,335 at December 31, 2019 and June 30, 2020 (unaudited), respectively. The deferred allowance represents the portion of the allowance for subscription cancellations associated with deferred revenue.

 

The beginning and ending balances of and changes to the allowance and the deferred allowance are as follows:

 

   For the three months ended
June 30, 2020
 
   (unaudited) 
   Balance   Net Change 
Allowance balance. April 1  $(7,476)    
Allowance balance, June 30   (7,669)    
Change in allowance       $193 
Deferred allowance balance, April 1   5,118      
Deferred allowance balance, June 30   5,335      
Change in deferred allowance        (217)
Net amount charged to revenue       $(24)

 

   For the three months ended
June 30, 2019
 
   (unaudited) 
   Balance   Net Change 
Allowance balance. April 1  $(4,703)    
Allowance balance, June 30   (4,845)    
Change in allowance       $142 
Deferred allowance balance, April 1   3,901      
Deferred allowance balance, June 30   3,719      
Change in deferred allowance        182 
Net amount charged to revenue       $324 

 

   For the six months ended
June 30, 2020
 
   (unaudited) 
   Balance   Net Change 
Allowance balance. January 1  $(7,515)    
Allowance balance, June 30   (7,669)    
Change in allowance       $154 
Deferred allowance balance, January 1   5,614      
Deferred allowance balance, June 30   5,335      
Change in deferred allowance        279 
Net amount charged to revenue       $433 

 

- 12 -

 

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

   For the six months ended
June 30, 2019
 
   (unaudited) 
   Balance   Net Change 
Allowance balance. January 1  $(5,527)     
Allowance balance, June 30   (4,845)     
Change in allowance       $(682)
Deferred allowance balance, January 1   4,858      
Deferred allowance balance, June 30   3,719      
Change in deferred allowance        1,139 
Net amount charged to revenue       $457 

 

The table provides information about the balances of and changes to deferred revenue for the following periods:

 

  

As of

December 31, 2019

  

As of

June 30, 2020

 
         (unaudited) 
Deferred revenue, current  $191,745   $187,041 
Deferred revenue, non-current   14,046    11,396 
Total  $205,791   $198,437 

 

   For the three months ended
June 30,
   For the six months
ended June 30,
 
   2020   2019   2020   2019 
   (unaudited) 
Changes to deferred revenue:                    
Beginning balance  $201,484   $181,957   $205,791   $178,703 
Additional amounts deferred   88,224    75,769    173,162    153,637 
Revenue recognized   (91,271)   (78,375)   (180,516)   (152,989)
Ending balance  $198,437   $179,351   $198,437   $179,351 

 

Contract costs

 

Deferred sales commissions earned by the Company’s sales force and certain sales incentive programs and vendor referral agreements are considered incremental and recoverable costs of obtaining a contract with a customer. An asset is recognized for these incremental contract costs and reflected as deferred commissions in the consolidated balance sheets. These contract costs are amortized on a straight-line basis over a period consistent with the transfer of the associated product and services to the customer, which is generally three years. Amortization of these costs are included in selling and marketing expense in the consolidated statements of comprehensive income (loss). The Company periodically reviews these contract assets to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these assets. There were no impairment losses recorded for the periods presented.

 

- 13 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

The table provides information about the changes to contract cost balances as of and for the following periods:

 

   For the three months ended
June 30,
   For the six months
ended June 30,
 
   2020   2019   2020   2019 
   (unaudited) 
Deferred commissions:                    
Beginning balance  $10,563   $8,239   $11,196   $8,830 
Additions   1,630    1,605    2,694    3,066 
Amortization   (1,803)   (1,084)   (3,500)   (3,136)
Ending balance  $10,390   $8,760   $10,390   $8,760 

 

Payment terms

 

Payment terms and conditions vary by contract, although the Company’s terms generally include a requirement of payment within 30 days. In instances where the timing of revenue recognition differs from the timing of payment, the Company has determined that its contracts do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing products and services, not to receive financing from customers or to provide customers with financing.

 

Cost of Revenues

 

Cost of revenues, software subscriptions includes the direct cost to develop, host and distribute software products, the direct cost to provide customer support, and amortization of costs capitalized for software developed for sale and for internal-use software utilized for cloud-based subscriptions. Cost of revenues, services includes the direct costs of implementation, training, transaction tax returns outsourcing and other tax-related services.

 

Reimbursable Costs

 

Reimbursable costs passed through and invoiced to customers of the Company are recorded as services revenues with the associated expenses recorded as cost of revenues, services in the consolidated statements of comprehensive income (loss).

 

Research and Development

 

Research and development costs consist primarily of personnel and related expenses for research and development activities including salaries, benefits and other compensation. Research and development costs are expensed as incurred in accordance with ASC 730, Research and Development, and are included in the consolidated statements of comprehensive income (loss).

 

Foreign Currency

 

The Company transacts business in various foreign currencies. Management has concluded that the local country’s currency is the functional currency of its foreign operations. Consequently, operating activities outside the U.S. are translated into U.S. Dollars using average exchange rates, while assets and liabilities of operations outside the U.S. are translated into U.S. Dollars using exchange rates at the balance sheet date. The effects of foreign currency translation adjustments are included in stockholders’ deficit as a component of accumulated other comprehensive loss in the consolidated balance sheets. Related periodic movements in exchange rates are included in other comprehensive income (loss) in the consolidated statements of comprehensive income (loss).

 

Income Taxes

 

Vertex is taxed as an S-corporation for U.S. federal income tax purposes and for most states. As a result, net income or loss is allocated to the stockholders and is included on their individual income tax returns. In certain states, Vertex is taxed at the corporate level. Accordingly, the income tax provision or benefit is based on taxable income allocated to these states. In certain foreign jurisdictions, Vertex subsidiaries are taxed at the corporate level. Similar to states, the income tax provision or benefit is based on taxable income sourced to these foreign jurisdictions.

 

- 14 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Certain direct and indirect wholly-owned subsidiaries are treated as disregarded entities for U.S. federal income tax purposes and most states under the Internal Revenue Service (“IRS”) “check-the-box” regulations. The income and loss from these disregarded entities are reported on the Company’s U.S. federal and most state income tax returns in addition to being reported on a foreign jurisdiction tax return if a foreign subsidiary. Other foreign subsidiaries in which we own greater than 50% of the equity by measure of vote or value are treated as controlled foreign companies (“CFCs”) for U.S. federal income tax purposes and most states under the IRS foreign tax regulations. The income and loss from these entities is reported on the Company’s U.S. federal and some state income tax returns when the foreign earnings are repatriated or deemed to be repatriated to the U.S.

 

The Company records deferred income taxes using the liability method. The Company recognizes deferred tax assets and liabilities for future tax consequences of events that have been previously recognized in the Company’s consolidated financial statements and tax returns. The measurement of deferred tax assets and liabilities is based on provisions of the enacted tax law. The effects of future changes in tax laws or rates are not anticipated.

 

The Company records uncertain tax positions in accordance with ASC 740, Income Taxes, on the basis of a two step process whereby: (i) management determines whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position, and (ii) for those tax positions that meet the more likely than not recognition threshold, management recognizes the largest amount of tax benefit that is greater than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The impact as a result of the application of ASC 740 is reflected in the consolidated financial statements.

 

On July 27, 2020, the S corporation election was terminated by the Company’s stockholders in connection with the Offering. See Note 13.

 

Total Comprehensive Income (Loss)

 

Total comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under U.S. GAAP are recorded as elements of stockholders’ deficit but are excluded from net income. Other comprehensive income (loss) is comprised of foreign currency translation adjustments and revaluations.

 

Earnings Per Share

 

The Company calculates basic and diluted net income per share attributable to common stockholders using the treasury stock method. The Company has Class A voting common stock (“Class A common stock”) and Class B non-voting common stock (“Class B common stock”) outstanding. Neither class of stock has any liquidity or dividend preferences and are both considered to be participating securities. The diluted net income per share attributable to common stockholders is computed by giving effect to all potential dilutive common stock equivalents outstanding for the period. For purposes of this calculation, options to purchase common stock are considered common stock equivalents.

 

Unaudited Pro Forma Income Taxes

 

Effective July 27, 2020, the Company converted to and will be taxed as a C corporation for U.S. income tax purposes (see Note 13). Accordingly, a pro forma income tax provision has been disclosed as if the Company was a taxable corporation for the three and six months ended June 30, 2020. The Company has computed pro forma entity level income tax expense using an estimated effective tax rate of approximately 25% for these periods, inclusive of all applicable U.S. federal, state, local and foreign income taxes.

 

- 15 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Unaudited Pro Forma Earnings Per Share

 

The Company has presented pro forma earnings per share for the three and six months ended June 30, 2020 to reflect the pro forma adjustment to income taxes resulting from the conversion to a C corporation effective July 27, 2020. See Note 13.

 

  

For the three months

ended June 30,

   For the six months
ended June 30,
 
Class A common stock:  2020   2020 
   (unaudited) 
Numerator:        
Pro forma net loss attributable to all stockholders  $(22,455)  $(43,979)
Class A stock as a percentage of total shares outstanding   0.12%   0.12%
Pro forma net loss attributable to Class A stockholders  $(28)  $(54)
        
Denominator:          
Weighted-average Class A stock outstanding—basic and diluted   147    147 
        
Pro forma net loss per Class A share, basic and diluted  $(0.19)  $(0.37)

 

  

For the three months

ended June 30,

   For the six months
ended June 30,
 
Class B common stock:  2020   2020 
   (unaudited) 
Numerator:        
Pro forma net loss attributable to all stockholders  $(22,455)  $(43,979)
Class B stock as a percentage of total shares outstanding   99.88%   99.88%
Pro forma net loss attributable to Class B stockholders  $(22,427)  $(43,925)
        
Denominator:          
Weighted-average Class B stock outstanding—basic and diluted   120,402    120,336 
        
Pro forma net loss per Class B share, basic and diluted  $(0.19)  $(0.37)

 

Supplemental Cash Flow Disclosures

 

Supplemental cash flow disclosures are as follows for the respective periods:

 

   For the six
months ended
June 30,
 
   2020   2019 
   (unaudited) 
Cash paid for:          
​ Interest  $​1,360   $​946  
​ Income taxes  $​490   $​471  
        
Non-cash investing and financing activities:          
Exercised options exchanged in lieu of income taxes  $​-   $​184  
Acquisition purchase commitment liability  $14,344   $​-  
Equipment acquired through capital leases  $​-   $​1,904  
​ Remeasurement of options for redeemable shares  $29,879   $183 

 

- 16 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Recently Issued Accounting Pronouncements

 

As an “emerging growth company,” the Jumpstart Our Business Startups Act (the “JOBS Act”) allows the Company to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. The Company has elected to delay adoption of certain new or revised accounting standards. As a result, the Company’s financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective date for new or revised accounting standards that are applicable to public companies.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases. This standard amends several of aspects of lease accounting, including requiring lessees to recognize operating leases with a term greater than one year on their balance sheet as a right-of-use asset, and a corresponding lease liability, measured at the present value of the future minimum lease payments. The standard is effective for public entities for fiscal years and interim periods beginning after December 15, 2018, and after December 15, 2020 for all other companies, with early adoption permitted. The Company intends to adopt this standard effective January 1, 2021 using the modified retrospective transition method and therefore will not restate comparative periods. The Company expects to elect the “package of three” practical expedients permitted under the transition guidance, which allows (i) a carry forward of the historical lease classification conclusions, (ii) management’s assessment on whether a contract is or contains a lease, and (iii) the initial direct costs for any leases that exist prior to adoption of the new standard. The Company is currently evaluating the impact this guidance will have on the Company’s consolidated financial statements. While the Company has not yet quantified the impact, resulting adjustments are expected to materially increase total assets and total liabilities relative to such amounts reported prior to adoption, but not have a material impact on the consolidated statements of comprehensive income (loss) or consolidated statements of cash flows.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, (“ASU 2016-13”) which replaces the existing incurred loss impairment model with an expected credit loss model and requires financial assets, including trade receivables, to be measured at amortized cost to be presented at the net amount expected to be collected. ASU 2016-13 is effective for annual periods, and interim periods within those years, beginning after December 15, 2019, for business entities that are public and meet the definition of an SEC filer (excluding smaller reporting companies), and after December 15, 2022 for all other entities. The Company has elected to delay adoption of this guidance until January 1, 2021. The implementation of ASC 2016-13 is not expected to have a material impact on the Company’s financial position.

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, (“ASU 2017-04”) to eliminate step two of the goodwill impairment test requiring a hypothetical purchase price allocation. Goodwill impairment, if any, is determined by comparing the reporting unit’s fair value to its carrying value. An impairment loss is recognized in an amount equal to the excess of the reporting unit’s carrying value over its fair value, up to the amount of goodwill allocated to the reporting unit. In addition, income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. ASU 2017-04 is effective for annual periods, and interim periods within those years, beginning after December 15, 2019, for business entities that are public and meet the definition of an SEC filer (excluding smaller reporting companies), and after December 15, 2022 for all other entities. The Company has adopted this guidance effective as of January 1, 2020.

 

In December 2019, the FASB issued ASU Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, (“ASU 2019-12”) which simplifies the accounting for income taxes. The guidance in ASU 2019-12 is required for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2020, for business entities that are public, and after December 15, 2021, including interim periods within those annual periods for all other entities, with early adoption permitted. The Company will adopt this guidance on January 1, 2021. The Company is currently evaluating the impact this guidance will have on the Company’s consolidated financial statements.

 

- 17 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Risks and Uncertainties

 

In December 2019, a novel strain of coronavirus (“COVID-19”) appeared. 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. To protect the health and well-being of Company employees and customers, substantial modifications were made to employee travel policies, our offices were closed and employees advised to work from home, and conferences and other marketing events were cancelled or shifted to virtual-only. The COVID-19 pandemic has impacted and may continue to impact Company operations, including employees, customers and partners, and there is substantial uncertainty in the nature and degree of its continued effects over time.

 

The Company did not experience any significant reductions in sales, revenues or collections through June 30, 2020 as a result of COVID-19. The uncertainty caused by the COVID-19 pandemic could, however, impact Company billings to new customers for the remainder of 2020, and may also negatively impact Company efforts to expand revenues from existing customers as they continue to evaluate certain long-term projects and budget constraints. In addition to the potential impact on sales, the Company may see delays in collections over the coming months. However, these delays are not expected to materially impact the business, and thus the Company has not recorded an additional allowance for doubtful accounts in connection with any delays. The Company believes it has ample liquidity and capital resources to continue to meet its operating needs, and to service debt and other financial obligations.

 

The extent to which the COVID-19 pandemic impacts the 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 Company 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.

 

2.ACQUISITION

 

On January 7, 2020, the Company acquired a 60% controlling interest in Systax, a provider of Brazilian transaction tax content and software. Cash consideration for the purchase was $12,374 and was funded through borrowings under the revolving line of credit (the “Line of Credit”). This acquisition provides the Company with full access to a sizeable database of Brazilian tax content that is critical to supporting its global multi-national customers’ business expansion into Brazil. The Company has a contractual purchase commitment to acquire the remaining 40% equity interest from the original Systax Quota holders incrementally between 2021 through 2024. Future purchase commitment payments for these incremental acquisition amounts are based on a multiple of Systax revenue and earnings before interest, depreciation, amortization and income taxes (“EBITDA”) performance at the end of 2020, 2022 and 2023, whereby the Company will have full ownership after the final payment in 2024. Management has determined these future purchase commitments to be a forward contract, resulting in the Company being required to estimate and record an estimated future purchase commitment amount (the “Purchase Commitment Liability”) in connection with recording the initial purchase. The Purchase Commitment Liability is estimated to be $14,344 at the acquisition date based on information currently available. This amount is reflected in future acquisition commitment in the consolidated balance sheet at June 30, 2020, and any adjustments to the acquisition date fair value of this commitment will be adjusted to goodwill during the Measurement Period. Adjustments to the settlement date value that arise as a result of remeasurement at future balance sheet dates will be recorded as interest expense in the consolidated statements of comprehensive income (loss) in the period the change is identified.

 

The acquisition was accounted for as a business combination and the total preliminary purchase price was allocated to the net tangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition date, with the excess being recorded as goodwill. The net tangible assets acquired and liabilities assumed were valued at their respective carrying amounts as of the acquisition date pending the receipt of additional information during the Measurement Period. The contractual value of accounts receivable was $867 at acquisition date. The excess of the purchase consideration over the net tangible assets is recorded as goodwill and primarily reflects the value of the tax content database, the assembled workforce and expected future synergies. Goodwill is deductible for tax purposes. The preliminary values recorded will be adjusted during the Measurement Period as more detailed analyses are performed and further information becomes available regarding the fair values of these amounts as of the acquisition date. Any such adjustments may be material. Subsequent adjustments to these values not associated with determination of their fair values on the acquisition date would be recorded in the consolidated statements of comprehensive income (loss) in the period the change is identified.

 

- 18 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

The following table presents the preliminary purchase price allocation recorded in the Company’s consolidated balance sheet as of the acquisition date (unaudited):

 

Net Assets and Assumed Liabilities  Initial Purchase
Price Allocation
 
    (unaudited) 
    (in thousands) 
Cash and cash equivalents  $56 
Accounts receivable   867 
Property and equipment   48 
Other assets   18 
Goodwill   26,124 
Accounts payable and accrued expenses   (228)
Accrued compensation   (162)
Other liabilities   (5)
Total consideration at acquisition date  $26,718 

 

The Company has included the financial results of Systax in the consolidated statement of comprehensive income (loss) from the date of acquisition in accordance with ASC 810 due to the Company having a controlling financial interest in Systax. Systax revenue and net loss for the three months ended June 30, 2020 (unaudited) reflected in the consolidated statement of comprehensive income (loss), after elimination of intercompany activity, were $944 and ($25), respectively. Systax revenue and net loss for the six months ended June 30, 2020 (unaudited) reflected in the consolidated statement of comprehensive income (loss), after elimination of intercompany activity, were $2,087 and ($281), respectively. As the Systax acquisition did not have a material impact on the Company’s reported revenue or net loss for the three and six months ended June 30, 2020, pro forma financial information has not been presented. The transaction costs associated with the acquisition were approximately $504 and were recorded in general and administrative expense in the year ending December 31, 2019.

 

3.PROPERTY AND EQUIPMENT

 

The major components of property and equipment are as follows:

 

   As of
December 31,
   As of
June 30,
 
   2019   2020 
       (unaudited) 
Leasehold improvements  $20,887   $21,028 
Equipment   40,598    40,698 
Computer software acquired   11,232    11,269 
Internal-use software developed          
Cloud-based services   51,442    54,689 
Internal systems and tools   23,957    24,584 
Furniture and fixtures   7,451    7,505 
Automobiles   27    60 
In-process internal-use software   809    5,587 
    156,403    165,420 
Less accumulated depreciation   (101,676)   (109,763)
Property and equipment, net  $54,727   $55,657 

 

- 19 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Depreciation expense for property and equipment, excluding all internal-use software and capital leases, was $1,773 and $1,371 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $3,948 and $2,788 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. Depreciation for property and equipment, excluding all internal-use software, is reflected in depreciation and amortization in the consolidated statements of comprehensive income (loss).

 

Assets under capital leases of $1,455 and $1,120, net of accumulated depreciation of $627 and $962, at December 31, 2019 and June 30, 2020 (unaudited), respectively, are included in property and equipment in the consolidated balance sheets. Depreciation expense for assets held under capital leases was $167 and $167 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $335 and $229 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. Depreciation expense for assets held under capital leases is included in depreciation and amortization expense in the consolidated statements of comprehensive income (loss).

 

The major components of internal-use software are as follows:

 

   As of December 31,   As of June 30, 
   2019   2020 
       (unaudited) 
Internal-use software developed  $75,399   $79,273 
Less accumulated depreciation   (53,852)   (59,051)
    21,547    20,222 
In-process internal-use software   809    5,587 
Internal-use software developed, net  $22,356   $25,809 

 

Amounts capitalized for internal-use software and included in property and equipment additions on the consolidated statements of cash flows are as follows:

 

   For the six months ended
June 30,
 
   2020   2019 
   (unaudited) 
Cloud-based solutions  $7,731   $4,594 
Internal systems and tools   939    1,622 
Total  $8,670   $6,216 

 

In-process internal-use software is not depreciated until it is available for its intended use. Depreciation expense for internal-use software used for cloud-based solutions for the three months ended June 30, 2020 and 2019 (unaudited) was $2,453 and $2,105, respectively, and $4,464 and $4,219 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. Depreciation expense for internal-use software used for cloud-based solutions is included in cost of revenues, software subscriptions in the consolidated statements of comprehensive income (loss).

 

Depreciation expense for internal-use software utilized for internal systems and tools for the three months ended June 30, 2020 and 2019 (unaudited) was $565 and $634, respectively, and $1,091 and $1,200 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. Depreciation expense for internal-use software utilized for internal systems and tools is included in depreciation and amortization in the consolidated statements of comprehensive income (loss).

 

Research and development costs associated with internal-use software were $240 and $211 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $735 and $398 for the six months ended June 30, 2020 and 2019 (unaudited), respectively.

 

- 20 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

4.CAPITALIZED SOFTWARE

 

Capitalized software includes acquired software and direct labor and related expenses for software developed for sale for new products and enhancements to existing products. Software development costs capitalized for the three months ended June 30, 2020 and 2019 (unaudited) were $3,558 and $4,186, respectively, and $7,264 and $8,101 for the six months ended June 30, 2020 and 2019 (audited), respectively.

 

The major components of capitalized software are as follows:

 

   As of December 31,   As of June 30, 
   2019   2020 
       (unaudited) 
Capitalized software  $47,862   $57,560 
Less accumulated amortization   20,281    25,859 
    27,581    31,701 
In-process capitalized software   4,494    2,060 
Capitalized software, net  $32,075   $33,761 

 

Capitalized software amortization expense for the three months ended June 30, 2020 and 2019 was $3,022 and $1,903, respectively, and $5,578 and $3,718 for the six months ended June 30, 2020 and 2019, respectively, and is included in cost of revenues, software subscriptions in the consolidated statements of comprehensive income (loss).

 

5.GOODWILL

 

The changes in the carrying amount of goodwill for the six months ended June 30, 2020 are as follows:

 

   2020 
   (unaudited) 
Balance, January 1  $ 
Acquisition of Systax, January   26,124 
Foreign currency translation adjustment for the three months ended March 30   (5,893)
Foreign currency translation adjustment for the three months ended June 30   (876)
Balance, June 30  $19,355 

 

6.DEBT

 

New Credit Agreement (unaudited)

 

On March 31, 2020, the Company entered into a new credit agreement with a bank, which was subsequently amended on April 3, 2020 to permit another bank to be a party to the agreement, consisting of a $175,000 term loan (the “New Term Loan”) and a $100,000 committed line of credit (the “New Line of Credit”) (collectively, the “New Credit Agreement”). Absent the occurrence of a triggering event, such as an initial public offering which requires immediate repayment of the New Term Loan, the New Term Loan matures in March 2023 and requires quarterly principal payments of $4,375 starting October 1, 2020, with a balloon payment on the payoff date. The Company was required to distribute not less than $110,000 and not more than $125,000 to stockholders within 90 days of the closing date of the New Credit Agreement or such amount must be repaid to the lender. Net proceeds from the New Term Loan after payment of financing fees of $2,904 and repayment of aggregate amounts outstanding at March 31, 2020 under the previous credit agreement term loan and line of credit of $61,656, were used to fund a portion of the $123,000 distribution made to the stockholders on May 29, 2020, thus satisfying this requirement. The New Term Loan was repaid on July 31, 2020 upon funding of the Offering (see Note 13). The outstanding balance of the New Term Loan of $175,000 was classified as long-term debt, net of current portion in the consolidated balance sheet at June 30, 2020 due to this amount being repaid on July 31, 2020 with a portion of the proceeds from the Offering.

 

- 21 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

The New Line of Credit matures in March 2025 and had no outstanding borrowings at closing. The Company has the option to select an applicable interest rate at either the bank base rate plus an applicable margin (the “New Base Rate Option”) or the LIBOR plus an applicable margin (the “New LIBOR Option”). The applicable margins are determined by certain financial covenant performance as defined in the New Credit Agreement. At June 30, 2020, the New Base Rate Option and New LIBOR Option were 3.75% and 2.50%, respectively. The New Credit Agreement is collateralized by certain assets of the Company. The New Credit Agreement contains financial and operating covenants. The Company was in compliance with these covenants at June 30, 2020.

 

Credit Agreement

 

At December 31, 2019, the Company had a credit agreement (the “Credit Agreement”) consisting of a term loan (the “Term Loan”) with an outstanding principal balance of $50,375 and a $40,000 committed line of credit (the “Line of Credit”) with no outstanding borrowings. The Company had the option to select an applicable interest rate at either the bank base rate plus an applicable margin (the “Base Rate Option”) or the London Interbank Offered Rate (“LIBOR”) plus an applicable margin (the “LIBOR Option”). The applicable margins were determined by certain financial covenant performance as defined in the Credit Agreement. At December 31, 2019, the Base Rate Option and LIBOR Option resulted in rates of 4.75% and 2.69%, respectively. The Credit Agreement was collateralized by certain assets of the Company. The Credit Agreement contained financial and operating covenants, which included limitations on the amount of dividends payable in a given period. The Company was in compliance with these covenants at December 31, 2019.

 

The Term Loan required quarterly principal payments over five years, with a balloon payment in November 2020. The interest rate on the Term Loan was 2.69% at December 31, 2019 as the Company selected the LIBOR Option. Term Loan outstanding amounts are reported in current portion of long-term debt and long-term debt, net of current portion, in the consolidated balance sheets. As a result of the Term Loan becoming due in November 2020, the balance outstanding of $50,375 was included in current portion of long-term debt on the consolidated balance sheet at December 31, 2019.

 

The Line of Credit was due to expire on November 1, 2020. The Company was required to pay a quarterly fee on the difference between the $40,000 maximum borrowings allowed under the Line of Credit and the unpaid principal balance outstanding under the line at an applicable rate. The applicable rate, determined by certain financial covenant performance as defined in the Credit Agreement, was 0.200%.

 

Unamortized deferred financing costs of $221 at December 31, 2019 are included as a reduction in current portion of long-term debt in the consolidated balance sheets. Amortization expense of deferred financing costs will be $221 in 2020 and will be included in interest expense in the consolidated statements of comprehensive income (loss).

 

Capital Leases

 

Capital lease obligations were $1,333 and $701 at December 31, 2019 and June 30, 2020 (unaudited), respectively, and are included in current portion of long-term debt and long-term debt, net of current portion in the consolidated balance sheets.

 

- 22 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

7.OPTIONS FOR REDEEMABLE SHARES

 

Prior to 2006, Vertex issued stock options under separate option agreements, not subject to an option plan, permitting certain key members of management and the Board to purchase shares of Class B common stock. At December 31, 2019 and June 30, 2020, 3,849 and 3,676 (unaudited) shares of Class B common stock, respectively, were reserved for issuance under these option agreements. The exercise price of the shares under these option agreements is equal to the fair value of the shares as of the grant date, as determined by the Board with assistance from management and an independent third-party valuation provider. No options have been issued since December 2005. All options are fully vested at December 31, 2019 and June 30, 2020.

 

The options are exercisable upon: (i) any time after the option holder is no longer an employee of the Company or a member of the Board; (ii) the Grantee’s death or disability; (iii) the occurrence of a Partial Triggering Event (as defined below); or (iv) the occurrence of a Triggering Event (as defined below). In addition, the option agreements provide employee option holders with the ability to exercise a portion of their options between April 15 and April 30 of each year based upon the fair value of the Class B common stock as of December 31 of the prior calendar year, provided that certain Company performance is achieved. At the election of the Company, the option agreements allow option holders to satisfy tax withholding obligations incurred in connection with the exercise by exchanging exercised options in lieu of payment of income taxes paid by the Company on their behalf. The fair value of exchanged exercised options is recorded as a reduction to stockholders’ deficit as part of the exercise of the related options, net of cash received.

 

Since these option agreements permit the option holders to put their exercised shares back to the Company for a price per share based upon the fair value of the Class B common stock determined six months after the holder exercised the options, they are classified as temporary equity and included in options for redeemable shares on the consolidated balance sheets. In addition, these option agreements permit the Company to call the shares based upon the fair value of the Class B common stock determined six months after the options were exercised. The Company has never exercised its right to call any shares issued from option exercises. In the event of the sale of at least 50% of the Company’s stock or all the assets of the Company (“Triggering Event”) in a single or multiple transactions, the option holders have the right to exercise their options and sell their related shares in connection with the transactions. Unexercised options expire after a Triggering Event. In the event of a sale of at least 25% of the Company’s assets to an unrelated third-party in a single or multiple transactions (“Partial Triggering Event”), the option holders have the right to exercise a portion of their options pro rata based on the sales price and sell their related shares in connection with the transaction. Unexercised options remaining after a Partial Triggering Event remain outstanding. In addition, in the event stockholders owning at least 51% of the outstanding stock of the Company (the “selling stockholders”) sell a portion of their stock to an unrelated third-party, the option holders have the right to exercise and sell an amount of options in the same proportion as the selling stockholders (a “tag-along right”). The option holders may also be required to exercise all their outstanding options and sell all related shares in the event the selling stockholders sell at least 51% of their ownership to an unrelated third-party (a “drag-along right”).

 

The table below reflects stock option activity for the following periods:

 

   Options   Intrinsic
values
   Per share
range of
option prices
  Per share
weighted average
option prices
 
Outstanding at January 1, 2019   4,125   $14,581   $0.15—$0.71  $0.20 
Exercised   (276)  $957   $0.15—$0.38  $0.25 
Outstanding at December 31, 2019   3,849   $17,344   $0.15—$0.71  $0.19 
Exercised (unaudited)   (173)  $759   $0.15—$0.38  $0.30 
Outstanding at June 30, 2020 (unaudited)   3,676   $47,223   $0.15—$0.71  $0.19 

 

Upon the effectiveness of the Offering on July 28, 2020 (see Note 13), outstanding options to purchase Class B common shares were exchanged for options to purchase an equivalent number of Class A shares at the same exercise price and vesting, subject to the terms of the 2020 Incentive Award Plan (the “2020 Plan”) except with respect to the expiration of the options which remain subject to the Trigger Event requirements of the original option agreements. The option holders’ ability to put the exercised option shares to the Company and the Company’s ability to call these shares expired as these shares are now eligible to sold on the NASDAQ exchange. As a result of the put right no longer being applicable, the options will no longer be considered temporary equity and will be reclassified to stockholders’ equity during the three months ended September 30, 2020.

 

- 23 -

 

 

Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

8.STOCKHOLDERS’ DEFICIT

 

Common Stock

 

There are no dividend or liquidation preference differences between the Class A common stock or Class B common stock.

 

In April 2020, Vertex issued 173 shares of Class B common stock in connection with the exercise of stock options by option holders for cash of $53. In April 2019, Vertex issued 225 shares of Class B common stock in connection with the exercise of stock options by option holders for cash of $68, net of 51 shares that were immediately returned to Vertex upon exercise in lieu of payment of income taxes payable by the option holders of $184.

 

At December 31, 2019 and June 30, 2020, repurchased shares (“Treasury Stock”) aggregating 41,910 for each period are carried at cost and included in Treasury Stock in the consolidated balance sheets. Treasury Stock includes 41,757 shares of Class B common stock and 153 shares of Class A common stock for both years.

 

The Board declared distributions of $4,010 ($0.03 per share) and $123,185 ($1.02 per share) during the three months ended March 31 and June 30, 2020, respectively, pro rata to stockholders of the Class A and Class B common stock.

 

The Board declared distributions of $5,255 ($0.04 per share) and $6,105 ($0.05 per share) during the three months ended March 31 and June 30, 2019, respectively, pro rata to stockholders of the Class A and Class B common stock.

 

9.EARNINGS PER SHARE

 

The table below illustrates the calculation of basic and diluted net income (loss) per common share for the Class A common stock and Class B common stock for the following periods:

 

  

For the three months ended
June 30,

   For the six months ended
June 30,
 
Class A common stock:  2020   2019   2020   2019 
   (unaudited) 
Numerator:                    
Net income (loss) attributable to all stockholders  $(29,075)  $7,122   $(58,139)  $14,447 
Class A stock as a percentage of total shares outstanding   0.12%   0.12%   0.12%   0.12%
Net income (loss) attributable to Class A stockholders  $(35)  $9   $(70)   18 
                
Denominator:                    
Weighted-average Class A stock outstanding—basic   147    147    147    147 
Dilutive effect of stock equivalents                
Weighted-average Class A stock outstanding—diluted   147    147    147    147 
                
Net income (loss) per Class A share, basic and diluted  $(0.24)  $0.06   $(0.48)   0.12 

 

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Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

   For the three months ended
June 30,
   For the six months ended
June 30,
 
Class B common stock:  2020   2019   2020   2019 
   (unaudited) 
Numerator:                    
Net income (loss) attributable to all stockholders  $(29,075)  $7,122   $(58,139)  $14,447 
Class B stock as a percentage of total stock outstanding   99.88%   99.88%   99.88%   99.88%
Net income (loss) attributable to Class B stockholders  $(29,040)  $7,113   $(58,069)  $14,429 
                
Denominator:                    
Weighted-average Class B stock outstanding—basic   120,402    120,443    120,336    120,357 
Dilutive effect of stock equivalents       3,715        3,812 
Weighted-average Class B stock outstanding—diluted   120,402    124,158    120,336    124,169 
                
Net income (loss) per Class B share, basic  $(0.24)  $0.06   $(0.48)  $0.12 
                
Net income (loss) per Class B share, diluted  $(0.24)  $0.06   $(0.48)  $0.12 

 

10.EMPLOYEE BENEFIT AND DEFERRED COMPENSATION PLANS

 

401(k) Plan

 

The Company maintains a 401(k) plan that covers eligible employees subject to certain age and length of service requirements. The Company matches up to 3% of eligible compensation during the period in which an eligible participant contributes to the plan. Matching contributions were $965 and $779 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $2,090 and $1,929 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. In addition, a discretionary profit-sharing contribution of 3% of eligible compensation for eligible employees was approved and aggregated $3,363 for the year ended December 31, 2019 and is reflected in accrued salaries and benefits in the consolidated balance sheet. Accrued salaries and benefits includes $981 and $1,942 for the three and six months ended June 30, 2020 (unaudited), respectively, for an estimated discretionary profit-sharing contribution for 2020.

 

Long-Term Rewards Plan

 

The Company has a long-term rewards (“LTR”) plan for certain key employees which provides for compensation related to growth in certain financial measures over a three-year period (the “Reward Performance Period”), subject to achieving an annual minimum net income target (the “Net Income Target”) during each year of the Reward Performance Period. Each year, eligible LTR plan participants receive an individual target award opportunity (“Award Opportunity”) for a new three-year Reward Performance Period (i.e. target award grant made in 2018 is for years 2018 through 2020). For Reward Performance Periods prior to 2018, compensation earned for growth in the financial measures over each Reward Performance Period is paid in cash in the year following the end of the respective Reward Performance Period, assuming the Net Income Target was achieved for each year of the respective Reward Performance Period. Starting in 2018, the Net Income Target is only required to be achieved in the final year of the Reward Performance Period. Estimated compensation is recorded during each year of a Reward Performance Period (“accrued LTR Award Opportunities”).

 

Compensation expense included $799 and $493 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $1,597 and $985 for the six months ended June 30, 2020 and 2019 (unaudited), respectively, for open Reward Performance Periods. Amounts paid to participants in 2020 for the Reward Performance Period starting in 2017 of $2,717 is reflected in deferred compensation, current in the consolidated balance sheet as of December 31, 2019. Amounts estimated to be paid in 2021 for performance through June 30, 2020 for the Reward Performance Period starting in 2018 of $1,707 (unaudited) is reflected in deferred compensation, current in the consolidated balance sheet as of June 30, 2020.The remaining balances of accrued LTR Award Opportunities for open Reward Performance Periods of $1,812 and $3,329 at December 31, 2019 and June 30, 2020 (unaudited) are reflected in deferred compensation, net of current portion, in the consolidated balance sheets.

 

SAR Plan

 

The Company has a SAR plan for the purpose of providing incentives to key members of management to contribute to the growth and financial success of the Company. SAR plan awards (“SAR Awards”) are represented as a fixed number of shares of Class B common stock (“SAR Units”). SAR Units outstanding aggregated 12,276 and 12,086 at December 31, 2019 and June 30, 2020 (unaudited), respectively. SAR Units are issued at the equivalent of the fair value of the equivalent number of shares of the Company’s Class B common stock on the grant date (“Base Value”), as determined by the Board with assistance from management and an independent third-party valuation provider, and compensation is based upon the appreciation of the SAR Units in excess of the Base Value over the service vesting period. SAR Awards are exercisable upon 50% vesting or upon the occurrence of a triggering event.

 

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Vested SAR units are redeemed upon the occurrence of a triggering event. Triggering events include: (i) expiration of the term of the SAR; (ii) a change of control of the Company whereby stockholders holding at least 50% of the voting stock of the company sell their shares; (iii) a merger of the Company with an unrelated third-party; (iv) an initial public offering; and (v) death, disability or retirement of a SAR participant.

 

SAR participants are limited to exercising no more than 25% of their vested SAR Units in any given year. SAR Awards generally vest 50% and 100% after two years and five years, respectively, from the grant date, or as determined by the Board. Maximum contractual terms range from ten years to term of employment of the participant. SAR Awards are settled in cash only, not through the issuance of shares. SAR Award exercises are limited each year to the proportion of the vested SAR units to the total units outstanding multiplied by adjusted net cash from operating activities (the “Liquidity Pool”), which is defined as cash from operating activities less cash paid for property and equipment and capitalized software for a given period.

 

The below table represents SAR activity for the following periods:

 

   Vested Units   Unvested Units   Total Units   Range of
Grant Values
 
Balance, January 1, 2019   5,889    4,782    10,671    $0.92–$3.17 
Granted   297    2,112    2,409    $3.73 
Exercised   (609)       (609)   $1.31–$2.50 
Forfeited       (195)   (195)   $2.13–$2.50 
Vested   630    (630)         
Balance, December 31, 2019   6,207    6,069    12,276    $0.92–$3.73 
Granted (unaudited)   21    681    702    $4.70 
Exercised (unaudited)   (829)       (829)   $1.31–$2.50 
Forfeited (unaudited)       (63)   (63)   $2.50 
Vested (unaudited)   1,410    (1,410)         
Balance June 30, 2020 (unaudited)   6,809    5,277    12,086    $0.92–$4.70 

 

The weighted average grant date intrinsic value of the SARs on grant date is zero as the Company’s Board grants all awards at a price per share not less than the per share fair value of the Company’s Class B common stock underlying such awards on the date of grant.

 

The Company recognized stock-based compensation cost in the consolidated statements of comprehensive income (loss) to reflect the appreciation in value of the vested portion of outstanding SAR Awards over the Base Value from the grant date as follows:

 

   For the three months ended
June 30,
  

For the six months ended

June 30,

 
   2020   2019   2020   2019 
   (unaudited) 
Cost of revenues, software subscriptions  $4,168   $131   $7,660   $262 
Cost of revenues, services   6,251    197    11,489    394 
Research and development   4,168    131    7,660    262 
Selling and marketing   8,335    262    15,319    523 
General and administrative   18,754    589    34,468    1,179 
Total stock-based compensation  $41,676   $1,310   $76,596   $2,620 

 

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Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Accrued SAR Awards of $5,790 and $20,582 at December 31, 2019 and June 30, 2020 (unaudited), respectively, representing SAR Units scheduled for redemption and 25% of the vested SAR Units eligible for exercise within 12-months of the balance sheet date are reflected in deferred compensation, current in the consolidated balance sheets. The remaining balances of accrued SAR Awards of $16,506 and $75,705 at December 31, 2019 and June 30, 2020 (unaudited), respectively, are reflected as deferred compensation, net of current portion, in the consolidated balance sheets. We had approximately $3,900 and $27,867 of total unrecognized compensation expense for unvested SAR Awards at December 31, 2019 and June 30, 2020 (unaudited), respectively, which we expect to recognize over the respective service periods of one to five years.

 

The SAR Awards were amended in connection with the Offering. See Note 13.

 

11.RELATED PARTIES

 

The Company advanced amounts to certain stockholders of the Company of $283 and $230 at December 31, 2019 and June 30, 2020 (unaudited), respectively. These amounts are non-interest bearing as they are short-term in nature and repaid within three months. These amounts are included in advances to stockholders in the consolidated balance sheets.

 

12.COMMITMENTS AND CONTINGENCIES

 

The Company leases office space under operating leases that expire at various dates through September 2028. Rent expense under all property operating leases was $1,754 and $1,574 for the three months ended June 30, 2020 and 2019 (unaudited), respectively, and $3,451 and $3,092 for the six months ended June 30, 2020 and 2019 (unaudited), respectively. These amounts are reflected in general and administrative expense in the consolidated statements of comprehensive income (loss).

 

The Company may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. The Company is not aware of any such legal proceedings or claims that management believes will have a material adverse effect on our business, financial condition, or operating results.

 

13.SUBSEQUENT EVENTS

 

Termination of S Corporation Filing Status

 

On July 27, 2020, the Company and its shareholders entered into an S corporation and Tax Sharing Agreement, pursuant to which the Company’s S corporation status for U.S. federal income tax purposes was terminated on July 27, 2020 and the Company will thereafter be taxed as C Corporation. As a result, the Company’s effective tax rate is projected to increase from approximately 2.5% to 25%. The Company estimates a tax benefit of approximately $27,200 (unaudited) upon such conversion in the quarter ended September 30, 2020.

 

Changes to Capital Structure

 

On July 28, 2020, the Company filed its amended and restated certificate of incorporation with the Delaware Secretary of State to effect a three-for-one forward stock split (the “Stock Split”), a share exchange, and to establish a new capital structure for the Company. The Stock Split resulted in each one share owned by a stockholder being exchanged for three shares of common stock, and the number of shares of the Company’s common stock issued and outstanding was increased proportionately based on the Stock Split. In addition, in connection with the Stock Split, stockholders of record exchanged their existing Class A and Class B common stock for newly created shares of Class A common stock (“Class A”) and Class B common stock (“Class B”) issued in connection with the new capital structure. The effect of the Stock Split was recognized retrospectively in the Consolidated Financial Statements.

 

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Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

In connection with the new capital structure, the Company authorized 450,000 shares of common stock, par value $0.001 per share, and 30,000 shares of preferred stock, par value $0.001 per share. Common stock is divided into two classes, Class A with one vote per share, and Class B with ten votes per share. The rights of the holders of Class A and Class B are identical, except with respect to voting, conversion and transfer rights. Following the Offering, authorized Class A will consist of 300,000 shares and authorized Class B will consist of 150,000 shares.

 

Each outstanding share of Class B is convertible at any time at the option of the holder into one share of Class A. Each share of Class B will convert automatically into one share of Class A upon any transfer, except for certain permitted transfers to other Class B stockholders or other members of the control group. Each share of Class B will convert automatically into one share of Class A if the voting power of all then-outstanding shares of Class B comes to represent less than ten percent of the combined voting power of all shares of the then-outstanding common stock. Once converted or transferred and converted into Class A, the Class B may not be reissued.

 

The Board is authorized to issue up to 30,000 shares of preferred stock in one or more series without stockholder approval. The Board of directors has the discretion to determine the rights, preferences, privileges and restrictions, including voting rights, dividend rights, conversion rights, redemption privileges and liquidation preferences, of each series of preferred stock. Upon closing of the Offering, there were no shares of preferred stock outstanding.

 

SAR Amendment

 

SAR participants were offered the option to either redeem their SARs upon the occurrence of the Offering or amend their SARs pursuant to which, upon effectiveness of the Company’s 2020 Plan to occur concurrent or shortly after the effective date of the Offering, such SARs will become options to purchase shares of new Class A common stock under the 2020 Plan. Effective July 13, 2020, this offer period ended and all SAR participants eligible to receive the offer accepted and will have their outstanding SARs converted to stock options with equivalent terms under the 2020 Plan (the “Converted SARs”). This is considered a modification of these SAR awards.

 

Converted SARs with either no expiration date or that expire during calendar year 2020 were converted to options and automatically exercised into shares (the “Auto Exercise New Options”) on July 28, 2020, the effective date of the Offering. Shares issued in connection with the Auto Exercise New Options were net of the number of shares of common stock necessary to satisfy the aggregate exercise price and the tax withholding obligation of such options. The Auto Exercise New Option participants also had the ability to require the Company to repurchase all or a portion of the shares remaining after this reduction on the Offering date for cash based on the Offering price, which aggregated $22,900 (unaudited).

 

Management continued to record changes in the intrinsic value of the SARs in 2020 up to July 2, 2020,the date on which Management determined the Company was considered to have become a public entity. Management will record the change in accounting policy of $2,421 in accordance with ASC 718 during the three months ended September 30, 2020, which includes $1,299 of vested Converted SARs which will be recognized as compensation expense during this period, with the remaining $1,122 of unvested Converted SARs being recognized as compensation expense over the remaining service period of one to five years through 2025. Any additional incremental increase in fair value of the Converted SARs after July 2, 2020 resulting from the modification will be recorded as compensation expense at the time of the exchange upon the Offering effective date. Upon modification, the Converted SARs will no longer be recorded as a liability under ASC 718 and the accumulated liability balance will be reclassified to stockholders’ equity. The unvested portion of the Converted SAR liability at the Offering date will be amortized over the remaining service period of the Converted SARs as compensation expense. At the Offering price of $19.00 management estimates the fair value of the Converted SARs at the Offering date to be approximately $197,000 (unaudited), of which approximately $153,000 (unaudited) is vested. At this value, management expects to record estimated additional compensation expense of approximately $57,000 (unaudited) for vested Converted SARs from July 1 to the Offering date, which includes the $1,299 impact of the change in accounting of vested Converted SARs. The remaining approximate $44,000 (unaudited) of unvested Converted SAR liability, which includes the $1,122 of unvested Converted SARs, will be recognized as compensation expense over the remaining service period of one to five years through 2025.

 

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Vertex, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited), continued

(Amounts in thousands, except per share data)

 

Registration of Company Stock

 

The Company’s Registration Statement filed with the SEC was declared effective on July 28, 2020, resulting in Class A being registered and available for trading on the NASDAQ exchange. Concurrent with the effectiveness of the S-1, the Company filed a form S-8 registration statement, which was also declared effective covering registration of shares issued or to be issued under the Company’s 2020 Plan and the Employee Stock Purchase Plan.

 

Debt Redemption

 

On July 31, 2020, the Company received $423,024 in proceeds, net of underwriting fees, from the sale of 23,812 shares of Class A and used a portion of the proceeds to pay off the $175,000 New Term Loan. The Company expects to record a write down of deferred financing costs associated with the New Term Loan of $1,174, which will be recorded as interest expense in the consolidated statement of comprehensive income for the three months ended September 30, 2020. The net proceeds remaining after payment of Offering costs will be used for working capital and other corporate purposes as described in the Prospectus.

 

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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 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.

 

Overview

 

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.

 

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.

 

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 June 30, 2020, we had over 4,000 customers and our Annual Recurring Revenue (“ARR”) per customer was over $72,000, while at June 30, 2019, we had over 3,900 customers and our ARR per customer was over $63,000. 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. We principally price our solutions based on a customer’s revenue base, in addition to a number of other factors.

 

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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 26% and 18% of software subscription revenue from cloud-based subscriptions during the three months ended June 30, 2020 and 2019, respectively, and 26% and 17% for the six months ended June 30, 2019 and 2020, respectively. While our on premise software subscription revenue comprises 74% 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 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 $78.4 million and $91.3 million for the three months ended June 30, 2019 and 2020, respectively. We generated revenue of $153.0 million and $180.5 million for the six months ended June 30, 2019 and 2020, respectively. We had net income of $7.1 million and a net loss of $(29.1) million for the three months ended June 30, 2019 and 2020, respectively. We had net income of $14.4 million and a net loss of $(58.1) million for the six months ended June 30, 2019 and 2020, respectively. Adjusted EBITDA was $15.9 million and $21.5 million for the three months ended June 30, 2019 and 2020, respectively. Adjusted EBITDA was $31.1 million and $36.8 million for the six months ended June 30, 2019 and 2020, respectively. Additionally, we generated net cash provided by operating activities of $32.9 million and $20.8 million in the six months ended June 30, 2019 and 2020, respectively. Our free cash flow was $14.7 million and $18.7 million in the three months ended June 30, 2019 and 2020, respectively. Our free cash flow was $16.5 million and $2.9 million in the six months ended June 30, 2019 and 2020, respectively. Adjusted EBITDA and free cash flow are non-GAAP financial measures. 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 any sale of shares by the selling stockholders.

 

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-only. 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.

 

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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. 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 second quarter of 2020, new software billings exceeded our original second 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. 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 to be materially impacted by the COVID-19 pandemic, as companies continue to rely on us for their indirect tax solutions. There is potential for an increase in demand for our products over the long-term considering the amount of state debt being accumulated during the pandemic, which may result in increases in taxes and revenue department audits which our products are positioned to address customer needs.

 

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 quarter 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. 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. 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; 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 lives of long lived assets.

 

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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 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.

 

   June 30   Period Over  
(In millions)  2020   2019   Period Change 
Annual Recurring Revenue  $294.6   $253.0   $41.6    16.4%

 

ARR increased by $41.6 million or 16.4% for the twelve month period ended June 30, 2020, as compared to the same period in 2019. The increase was primarily driven by $20.7 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. 

 

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 as well as any revenue expansion from upgrades, cross sells or upsells of our software. 

 

   June 30 
   2020   2019 
Net Revenue Retention Rate   108%   108%

 

The NRR remained consistent at June 30, 2020 with the same period in 2019 at 108%. 

 

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, share based compensation expense, severance charges and offering 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 $(29.1) million and $7.1 million for the three months ended June 30, 2020 and 2019, respectively, while our net income margin was –31.9% and 9.1% over the same periods, respectively. Additionally, our net income (loss) was $(58.1) million and $14.4 million for the six months ended June 30, 2020 and 2019, respectively, while our net income margin was –32.2% and 9.4% over the same periods, respectively.

 

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   For the Three Months
Ended June 30
   For the Six Months
Ended June 30
 
(dollars in thousands)   2020    2019    2020    2019 
Adjusted EBITDA:                    
Net income (loss)  $(29,075)  $7,122   $(58,139)  $14,447 
Interest, net   1,059    307    1,628    552 
Income tax (benefit) expense   (985)   221    (735)   425 
Depreciation and amortization – cost of subscription revenues   5,475    4,008    10,042    7,937 
Depreciation and amortization   2,505    2,172    5,374    4,217 
Stock-based compensation   41,676    1,310    76,596    2,620 
Severance charges   859    409    2,042    947 
Adjusted EBITDA   $21,514   $15,549   $36,808   $31,145 
Adjusted EBITDA Margin:                    
Total revenues  $91,271   $78,375   $180,516   $152,989 
Adjusted EBITDA margin    23.6%   19.8%   20.4%   20.4%

 

The increase in Adjusted EBITDA for the three months ended June 30, 2020 of $6.0 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 increased to 23.6% for the three months ended June 30, 2020 over the comparable period in 2019 margin of 19.8% primarily due to revenue increasing at a higher rate than operating expenses. The decrease in operating expenses as compared to the prior period was driven primarily by a reduction in travel and external marketing events in 2020 due to COVID-19 travel and conference restrictions. These costs are expected to increase once travel and conference restrictions are lifted, although it is uncertain whether these costs will return to their historical levels experienced pre-COVID-19.

 

The increase in Adjusted EBITDA for the six months ended June 30, 2020 of $5.7 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 was consistent at 20.4% for the six months ended June 30, 2020 over the comparable period in 2019 primarily due to revenue and operating expenses increasing at comparable rates.

 

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 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. 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 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 in operating activities was $20.8 million and $32.9 million for the six months ended June 30, 2020 and 2019, respectively, while our operating cash flow margin was 11.5% and 21.5% over the same periods, respectively. Net cash used in investing activities was $(30.1) million and $(16.4) million for the six months ended June 30, 2020 and 2019, respectively. Net cash used in financing activities was $(16.6) million and $(24.6) million for the six months ended June 30, 2020 and June 30, 2019, respectively.

 

   For the Six Months
Ended June 30
 
   2020   2019 
Free cash flow (in thousands)   $2,927   $16,478 
Free cash flow margin    2%   11%

 

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Free cash flow decreased by $13.6 million for the six months ended June 30, 2020 as compared to the same period in 2019, driven primarily by a decrease in cash from operating activities of $12.1 million due to a reduction in cash provided by changes in operating assets and liabilities of $17.8 million. This reduction was primarily due to decreases in accrued and deferred compensation of $1.7 million, a reduction in deferred revenue of $8.0 million and a reduction in accounts receivable of $7.5 million. Accrued and deferred compensation decreased by $1.7 million due to payments for variable compensation for the first half of 2020 increasing over the comparable quarter from the prior year by $0.3 million as a result of increases in headcount, and due to payments of $1.4 million for stock appreciation right redemptions in the first half of 2020 as compared to the same period of 2019. Deferred revenue decreased $8.0 million 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 $2.4 million, and the reduction in accounts receivable of $7.5 million are 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.

 

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 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 upon our historical experience.

 

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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%. 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.

 

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 and developed software for new products and enhancements to existing products and cloud-based subscription solutions. 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.

 

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 six months ended June 30, 2020 and 2019, $7.3 million and $8.1 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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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 and costs associated with our annual customer conferences. 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.

 

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, 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.

 

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 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 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 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.

 

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Provision for Taxes

 

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 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. Accordingly, the income tax provision or benefit is based on taxable income allocated to these 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. The Company estimates a tax benefit of approximately $27.2 million upon such conversion, which will be reflected in the three months ended September 30, 2020.

 

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

 

The following table sets forth our consolidated statements of comprehensive income (loss) for the periods indicated.

 

   Three Months
Ended June 30
           Six Months
Ended June 30
         
(Dollars in thousands) (unaudited)  2020   2019   Period-Over-Period Change   2020   2019   Period-Over-Period Change 
Revenue:                                        
Software subscriptions   $77,306   $67,267   $10,039    14.9%  $153,066   $131,651   $21,415    16.3%
Services    13,965    11,108    2,857    25.7%   27,450    21,338    6,112    28.6%
Total revenue    91,271    78,375    12,896    16.5%   180,516    152,989    27,527    18.0%
Cost of Revenue:                                        
Software subscriptions(1)    26,001    19,417    6,584    33.9%   50,685    37,843    12,842    33.9%
Services(1)    15,744    7,692    8,052    104.7%   30,522    14,830    15,692    105.8%
Total cost of revenues    41,745    27,109    14,636    54.0%   81,207    52,673    28,534    54.2%
Gross profit    49,526    51,266    1,740    3.4%   99,309    100,316    (1,007)   (1.0%)
Operating expenses:                                        
Research and development(1)    13,617    7,205    6,412    89.0%   26,696    14,778    11,918    80.6%
Selling and marketing(1)    24,544    17,287    7,257    42.0%   48,877    33,334    15,543    46.6%
General and administrative(1)    37,758    16,647    21,111    126.8%   75,394    32,095    43,299    134.9%
Depreciation and amortization    2,505    2,172    333    15.3%   5,374    4,217    1,157    27.4%
Other operating expense   103    305    (202)   66.2%   214    468    (254)   54.3%
Total operating expenses    78,527    43,616    34,911    80.0%   156,555    84,892    71,663    84.4%
Income (loss) from operations    (29,001)   7,650    (36,651)   479.1%   (57,246)   15,424    (72,670)   471.1%
Other (income) expense:                                        
Interest income    (101)   (232)   131    56.5%   (456)   (524)   68    13.0%
Interest expense    1,160    539    621    115.2%   2,084    1,076    1,008    93.7%
Total other expense, net    1,059    307    752    245.0%   1,628    552    1,076    194.9%
Income (loss) before income taxes    (30,060)   7,343    (37,403)   509.4%   (58,874)   14,872    (73,746)   495.9%
Income tax (benefit) expense    (985)   221    1,206    545.7%   (735)   425    1,160    272.9%
Net income (loss)    (29,075)   7,122    (36,197)   508.2%   (58,139)   14,447    (72,586)   502.4%
Other comprehensive loss from foreign currency translations    276    23    253    1100.0%   3,274    2    3,272    163600.0%
Total comprehensive income (loss)   $(29,351)  $7,099   $(36,450)   513.5%  $(61,413)  $14,445   $(75,858)   525.2%

  

(1)Includes stock-based compensation expenses as follows in the table below. For more details, see “Seasonality and Quarterly Trends.”

 

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    Three months ended
June 30
  Six months ended
June 30
    2020  2019     2020     2019  
    (unaudited)
    (In thousands)
Cost of revenues, software subscriptions   $4,168  $131   $7,660  $262 
Cost of revenues, services    6,251   197    11,489   394 
Research and development    4,168   131    7,660   262 
Selling and marketing    8,335   262    15,319   523 
General and administrative    18,754   589    34,468   1,179 
              
Total stock-based compensation   $41,676  $1,310   $76,596  $2,620 

  

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

 

   Three months ended
June 30
   Six months ended
June 30
 
   2020   2019   2020   2019 
   (unaudited) 
Revenue:                
Software subscriptions   84.7%   85.8%   84.8%   86.1%
Services   15.3%   14.2%   15.2%   13.9%
Total revenue   100.0%   100.0%   100.0%   100.0%
Cost of Revenue:                    
Software subscriptions   28.5%   24.8%   28.1%   24.7%
Services   17.2%   9.8%   16.9%   9.7%
Total cost of revenues   45.7%   34.6%   45.0%   34.4%
Gross profit   54.3%   65.4%   55.0%   65.6%
Operating expenses:                    
Research and development   14.9%   9.2%   14.8%   9.7%
Selling and marketing   26.9%   22.1%   27.1%   21.8%
General and administrative   41.4%   21.2%   41.8%   21.0%
Depreciation and amortization   2.7%   2.8%   3.0%   2.8%
Other operating expense, net   0.1%   0.4%   0.1%   0.3%
Total operating expenses   86.0%   55.7%   86.8%   55.5%
Income (loss) from operations   (31.8)%   9.7%   (31.8)%   10.1%
Other (income) expense:                    
Interest income   0.1%   0.3%   0.3%   0.3%
Interest expense   (1.3)%   (0.7)%   (1.2)%   (0.7)%
Total other expense, net   (1.2)%   (0.4)%   (0.9)%   (0.4)%
Income (loss) before income taxes   (33.0)%   9.3%   (32.7)%   9.7%
Income tax (benefit) expense   1.1%   (0.3)%   0.4%   0.3%
Net income (loss)   (31.9)%   9.0%   (32.3)%   9.4%
Other comprehensive loss from foreign currency translations   (0.3)%   (0.0)%   (1.8)%   (0.0)%
Total comprehensive income (loss)   (32.2)%   9.0%   (34.1)%   9.4%

  

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

 

Revenue

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Revenue:                    
Software subscriptions   $77,306   $67,267   $10,039    14.9%
Services    13,965    11,108    2,857    25.7%
Total revenue   $91,271   $78,375   $12,896    16.5%

 

Revenue increased $12.9 million, or 16.5%, to $91.3 million for the three months ended June 30, 2020 compared to $78.4 million for the three months ended June 30, 2019. The increase in software subscriptions revenue of $10.0 million, or 14.9%, was primarily driven by $9.0 million in revenue growth derived from our existing customers and $1.0 million of revenue from new customers.

 

The $2.9 million increase in services revenue is primarily driven by an increase of $2.4 million in software subscription related services associated with the growth in subscription revenues, which includes new customers implementing our solutions and upgrading existing customers 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.

 

Cost of Software Subscriptions Revenue

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Cost of software subscription revenue  $26,001   $19,417   $6,584    33.9%

 

Cost of software subscriptions revenue increased $6.6 million, or 33.9%, to $26.0 million for the three months ended June 30, 2020 compared to $19.4 million for the three months ended June 30, 2019. Of this increase, 61.3% is due to an increase in stock-based compensation of $4.1 million for the three months ended June 30, 2020 over the same period in 2019. After excluding the impact of stock-based compensation there is a remaining increase of $2.5 million. Of this increase, $1.5 million is due primarily to increased amortization expense associated with late Q3 2019 release of O Series 9.0. The remaining $1.0 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 28.5% for the three months ended June 30, 2020 compared to 24.8% in June 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 June 30, 2020.

  

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Cost of Services Revenue

 

   Three Months
Ended June 30
     
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Cost of services revenue  $15,744   $7,692   $8,052    104.7%

 

Cost of services revenue increased $8.1 million, or 104.7%, to $15.7 million for the three months ended June 30, 2020 compared to $7.7 million for the three months ended June 30, 2019. Of this increase, 75.2% is due to an increase in stock-based compensation of $6.1 million for the three months ended June 30, 2020 over the same period in 2019. The balance of the increase of $2.0 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 17.2% in 2020 compared to 9.8% 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 10.6% for the three months ended June 30, 2020.

 

Research and Development

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Research and development  $13,617   $7,205   $6,412    89.0%

 

Research and development expenses increased $6.4 million, or 89.0%, to $13.6 million for the three months ended June 30, 2020 compared to $7.2 million for the three months ended June 30, 2019. Of this increase, 63.0% is due to an increase in stock-based compensation of $4.0 million for the three months ended June 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 $2.4 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 14.9% for the three months ended June 30, 2020 compared to 9.2% for the three months ended June 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 10.5% for the three months ended June 30, 2020.

 

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

 

Selling and Marketing

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Selling and marketing  $24,544   $17,287   $7,257    42.0%

 

Selling and marketing expenses increased $7.3 million, or 42.0%, to $24.6 million for the three months ended June 30, 2020 compared to $17.3 million for the same period in 2019. Of this increase, 111.3% is due to an increase in stock-based compensation of $8.1 million for the three months ended June 30, 2020 over the same period in 2019. The balance of the variance of $(0.8) million is primarily due to a reduction in travel and external marketing events due to COVID-19 travel and conference restrictions. These costs are expected to increase once travel and conference restrictions are lifted, although it is uncertain whether these costs will return to their historical levels experienced pre-COVID-19. As a percentage of total revenue, selling and marketing expenses increased to 26.9% for the three months ended June 30, 2020 compared to 22.1% 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 18.0% for the three months ended June 30, 2020.

 

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General and Administrative

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
General and administrative  $37,758   $16,647   $21,111    126.8%

 

General and administrative expenses increased $21.1 million, or 126.8%, to $37.8 million for the three months ended June 30, 2020 compared to $16.6 million for the same period in 2019. Of this increase, 86.0% is due to an increase in stock-based compensation of $18.2 million for the three months ended June 30, 2020 over the same period in 2019. The balance of the increase of $2.9 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 41.4% for the three months ended June 30, 2020 compared to 21.2% 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 21.5% for the three months ended June 30, 2020.

 

Depreciation and Amortization

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Depreciation and amortization  $2,505   $2,172   $333    15.3%

 

Depreciation and amortization increased $0.3 million, or 15.3%, to $2.5 million for the three months ended June 30, 2020 compared to $2.2 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 2.7% for the three months ended June 30, 2020 compared to 2.8% for the same period in 2019.

 

Interest Income

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Interest income  $(101)  $(232)  $131    56.5%

 

Interest income for the three months ended June 30, 2020 did not fluctuate significantly compared to the same period in 2019.

 

Interest Expense

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Interest expense  $1,160   $539   $621    115.2%

 

Interest expense increased $0.6 million, or 115.2%, to $1.2 million for the three months ended June 30, 2020 compared to $0.5 million for the same period in 2019. The increase is primarily due to interest of $0.6 million related to an increase in outstanding debt of $113.6 million over the first quarter of 2020 related to borrowings under the New Credit Agreement entered into on March 31, 2020.

 

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Provision for Taxes

 

   Three Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Income tax (benefit)  $(985)  $221   $1,206    545.7%

 

Income tax expense decreased $1.2 million, or 545.7%, to a $(1.0) million income tax benefit for the three months ended June 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 (1.1)% for the three months ended June 30, 2020 compared to expense of 0.3% for the same period in 2019 due to a pretax loss in 2020 resulting from an increase in stock-based compensation.

 

Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019

 

Revenue

 

    Six Months
Ended June 30
 
             
(Dollars in thousands)     2020       2019       Period-Over-Period Change  
Revenue:                                
Software subscriptions   $ 153,066     $ 131,651     $ 21,415       16.3 %
Services     27,450       21,338       6,112       28.6 %
Total revenue   $ 180,516     $ 152,989     $ 27,527       18.0 %

 

Revenue increased $27.5 million, or 18.0%, to $180.5 million for the six months ended June 30, 2020 compared to $153.0 million for the six months ended June 30, 2019. The increase in software subscriptions revenue of $21.4 million, or 16.3%, was primarily driven by $19.3 million in revenue growth derived from our existing customers and $2.1 million of revenue from new customers.

 

The $6.1 million increase in services revenue is primarily driven by an increase of $4.9 million in software subscription-related services associated with the growth in subscription revenues, which includes new customers implementing our solutions and upgrading existing customers to newer versions of our solutions. In addition, our managed services offering experienced a $0.4 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

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Cost of software subscription revenue  $50,685   $37,843   $12,842    33.9%

 

Cost of software subscriptions revenue increased $12.8 million, or 33.9%, to $50.7 million for the six months ended June 30, 2020 compared to $37.8 million for the six months ended June 30, 2019. Of this increase, 57.6% is due to an increase in stock-based compensation of $7.4 million for the six months ended June 30, 2020 over the same period in 2019. After excluding the impact of stock-based compensation there is a remaining increase of $5.4 million. Of this increase, $2.1 million is due primarily to increased amortization expense associated with the late Q3 2019 release of O Series 9.0. The remaining $3.3 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 28.1% for the six months ended June 30, 2020 compared to 24.7% in June 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 24.0% for the six months ended June 30, 2020.

 

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Cost of Services Revenue

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Cost of services revenue  $30,522   $14,830   $15,692    105.8%

 

Cost of services revenue increased $15.7 million, or 105.8%, to $30.5 million for the six months ended June 30, 2020 compared to $14.8 million for the six months ended June 30, 2019. Of this increase, 70.7% is due to an increase in stock-based compensation of $11.1 million for the six months ended June 30, 2020 over the same period in 2019. The balance of the increase of $4.6 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 16.9% in 2020 compared to 9.7% 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 10.8% for the three months ended June 30, 2020.

 

Research and Development

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Research and development  $26,696   $14,778   $11,918    80.6%

 

Research and development expenses increased $11.9 million, or 80.6%, to $26.7 million for the six months ended June 30, 2020 compared to $14.8 million for the six months ended June 30, 2019. Of this increase, 62.1% is due to an increase in stock-based compensation of $7.4 million for the six months ended June 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 $4.5 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 14.8% for the six months ended June 30, 2020 compared to 9.7% for the six months ended June 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 June 30, 2020.

 

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

 

Selling and Marketing

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Selling and marketing  $48,877   $33,334   $15,543    46.6%

 

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Selling and marketing expenses increased $15.5 million, or 46.6%, to $48.9 million for the six months ended June 30, 2020 compared to $33.3 million for the same period in 2019. Of this increase, 95.2% is due to an increase in stock-based compensation of $14.8 million for the six months ended June 30, 2020 over the same period in 2019. The balance of the increase of $0.7 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 27.1% for the six months ended June 30, 2020 compared to 21.8% 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 18.9% for the six months ended June 30, 2020.

 

General and Administrative

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
General and administrative  $75,394   $32,095   $43,299    134.9%

 

General and administrative expenses increased $43.3 million, or 134.9%, to $75.4 million for the six months ended June 30, 2020 compared to $32.1 million for the same period in 2019. Of this increase, 76.9% is due to an increase in stock-based compensation of $33.3 million for the six months ended June 30, 2020 over the same period in 2019. The balance of the increase of $10.0 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 41.8% for the six months ended June 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 23.3% for the six months ended June 30, 2020.

 

Depreciation and Amortization

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019   Period-Over-Period Change 
Depreciation and amortization  $5,374   $4,217   $1,157    27.4%

 

Depreciation and amortization increased $1.2 million, or 27.4%, to $5.4 million for the six months ended June 30, 2020 compared to $4.1 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 3.0% for the six months ended June 30, 2020 compared to 2.8% for the same period in 2019.

 

Interest Income

 

   Six Months
Ended June 30
         
(Dollars in thousands)  2020   2019