VERX - NASDAQ

Greetings. Welcome to Vertex's Fourth Quarter 2023 Earnings Conference Call. Please note this conference is being recorded. At this time, all participants are in listen-only mode. I will turn the conference over to Joe Crivelli, Vice President of Investor Relations. Mr. Crivelli, you may now begin.

Hello, and thanks for joining us to discuss Vertex's fourth quarter financial results. I'm Joe Crivelli, Vice President, Investor Relations. David DeStefano, our President and CEO; and John Schwab our CFO, are also with us today. During this call, we may make forward-looking statements about expected future results. Our actual financial results may differ due to risks and uncertainties. These risks and uncertainties are described in our filings with the Securities and Exchange Commission. Please note that our remarks today will also include references to non-GAAP financial measures. A reconciliation of these non-GAAP metrics to GAAP is also provided in today's press release. This conference call is being recorded and will be available for replay on our Investor Relations website. I'll now turn the call over to David.

Thanks, Joe. Welcome everyone and thank you for joining us. The fourth quarter was our strongest quarter of 2023, wrapping up a year of outstanding execution across all areas of the business. I'm extremely proud of the entire Vertex team. Our employees' focus and commitment underpin our market-leading solutions and customer value. This in turn enabled our strong performance this year. Revenue in the fourth quarter was $154.9 million, up 18.1% year-over-year. This exceeds the high end of our fourth quarter revenue guidance by $7.9 million. Our adjusted EBITDA was $32 million, up more than 50% compared to last year's fourth quarter. This represents an EBITDA margin of 20.7%, our highest EBITDA margin in over three years. In addition, this quarter ARR exceeded $500 million for the first time in our history, growing nearly 19% to $512.5 million. NRR was a record 113% up two full percentage points from the third quarter. Average annual revenue per customer increased 19% year-over-year to nearly $119,000. Growth in scaled customer count was 13% year-over-year. As a reminder, this number represents our customers with annual revenues greater than $100,000 and demonstrates our ongoing success in the underpenetrated enterprise market. GRR was 95% in the fourth quarter within our target best-in-class range of 94% to 96%. Our strong financial results in 2023 were not unexpected. We launched a strategic investment program in 2020 to pursue our vision to accelerate global commerce and fuel our growth to $1 billion in revenue and beyond. Since then, we have broadened our go-to-market team, we enhanced our longstanding partnerships with Oracle and SAP, while expanding into the Microsoft, NetSuite, Salesforce and Workday ecosystems. We accelerated the breadth and depth of our market-leading tax content database. We increased the pace of new product launches by investing in research and development on our cloud platform. We built a customer success team from a standing start that is now a major contributor of our consistent growth in NRR. We completed several technology and tax content-focused acquisitions and we also built the corporate infrastructure to support a large more efficient organization. With this investment program largely complete in mid-2023, we saw accelerating revenue growth and strengthening profit margins in the second half of the year, but we believe we are just getting started. This is because most enterprises and large middle market companies are still handling indirect tax with either a web of spreadsheets or an in-house built software program that was purpose-built when the company was less complex and kept running with the exceptional efforts of a number of in-house programmers. It may come as a surprise, but some of the most recognizable, respected and sophisticated companies in the world still handle indirect tax in this fashion. For these companies, it's not a matter of if, but when their in-house solution becomes insufficient to manage the business and they need to implement a third-party software solution. This decision is most frequently driven by one of three factors. First, business model changes or expansion. This could be an adoption of new ways of doing business such as multi-channel sales strategies or mergers and acquisitions that necessitate a more scalable approach to indirect taxes. Second, audit and reporting requirements demonstrate that an in-house solution is not delivering sufficiently accurate tax compliance. These situations quickly get the attention of everyone from the tax department to the C-suite and even the Board of Directors to deploy the necessary resources to fix the problem. Third, the company embarks on a digital transformation or system upgrade to the cloud. In these cases, it's typically not even financially feasible to refactor the homegrown software solution to run-in the new environment. We are confident that, all three of these tailwinds will drive Vertex's growth for the foreseeable future. Business changes such as mergers and acquisitions are constant, especially in the market segments where we focus. Audit pressure is only going to increase as governments grapple with ways to plug spending deficits and deal with the massive amounts of debt that must be serviced and indirect tax is an important part of this equation as governments generate 3.5 times more revenue from indirect tax than they do from corporate income tax. In addition, increasingly complex rules around digital businesses and marketplaces are driving new reporting and revenue transparency requirements. And we consistently see our ERP partners driving their customers to move to cloud-based solutions. For example, Oracle is encouraging customers to move to Oracle Cloud. SAP is ending mainstream support for ECC in 2027, prompting customers to migrate to S/4HANA and businesses are also advancing digital transformation initiatives organically. So, to summarize, the fourth quarter results were excellent and I'm very confident in how our business is positioned for consistent execution in the quarters years to come. Now turning to notable wins in the quarter, one of the biggest sources of new revenue for Vertex and a sustainable driver of NRR growth is increased business with our existing customers. In the fourth quarter, we expanded our relationship with one of our longstanding customers, a large international conglomerate. We have been on a multiyear journey with them as they consolidate and transition their systems to the cloud. The customer increased their usage tiers for their existing subscriptions, expanded their use of Vertex solutions into additional global markets and licensed additional products including Chain Flow Accelerator. This resulted in high six figures of additional recurring revenue for Vertex. It's noteworthy that, this company has been a customer for over a decade and uses a wide array of Vertex offerings including sales tax, consumers use tax and VAT tax calculation, premium oil and gas content, certificate center, the SAP ecosystem tools we acquired with LCR-Dixon and our tax return managed service among others. This shows the growth potential of our existing enterprise customer base even with a customer that has a comprehensive and longstanding relationship with Vertex. With another customer, a leader in global digital imaging solutions, a cloud-first strategy implemented by new leadership drove a transition to our cloud solution in the fourth quarter. This resulted in a new five-year contract with mid six figures of additional annual revenue for Vertex. The partnership we have built over the past 12 years plus the value they have experienced over the years provided us with the opportunity to win the business without having to compete in an RFP. We are currently working with them to move their self-hosted tax solution to the cloud seamlessly with tight connections to their Oracle ERP and other key systems. Similarly, another existing customer, one of the largest online marketplaces in the world expanded their usage with us in the fourth quarter. During their renewal process, the customer consolidated several licenses, added new geographies and increased its usage tiers. This resulted in high six figures of new revenue for Vertex. RSM, a top-ten accounting firm partnered with us on this implementation. As I mentioned, ERP conversions are one of the primary factors for companies to reevaluate how they are handling indirect tax. One example in the fourth quarter resulted in a high five-figure new contract with a global consumer products company. This company moved to Oracle Cloud and in doing so, re-bid their indirect tax solution as they were unhappy with their existing provider, one of our competitors. Vertex won this deal because of our ability to operate in a one-to-many environment and seamlessly integrate with both their ERP provider Oracle Cloud, and their global instance of Salesforce commerce. The customer also had peace of mind moving their tax engine to Vertex based on the valued experience one of their entities has had with our returns outsourcing service. In the SAP ecosystem, we had a notable win with a global provider of equipment and services to the oil and gas industry. For this customer, an S/4HANA transformation drove a company-wide initiative to centralize global tax compliance. This led to seven figures of additional revenue for Vertex. The support of our partners at SAP as well as Deloitte were also keys to this new business win. In the Microsoft ecosystem, a global manufacturer of nutritional supplements selected Vertex to support its migration to Dynamics 365. In the Workday ecosystem, we won several new deals including one of the major stock exchanges, a regional healthcare system and a provider of financial software for the healthcare industry. During the quarter, we also saw good examples of how audit pressure and compliance risk are driving business our way. As an example, we won a new deal with a mid-market business solutions company that was using its homegrown billing system, as a platform to calculate indirect tax liabilities. The company's tax department was manually entering tax rates into this system. Inevitably, this approach led to inaccuracies for the customer, which in turn led to audit pressure and liability for back taxes and penalties. The company's tax department worked quickly to get the technology needed to update its systems and Vertex prevailed in the results in RFP, in part, due to our leading tax content database and ability to handle the vagaries of tax calculations across a product list with more than 5 million separate SKUs. As we noted in our annual sales tax Rates and Rules Report last month, U.S. sales tax rate changes reached a 10-year high in 2023 in addition to hundreds of new taxes that were imposed. With over 20,000 taxing jurisdictions globally, keeping up with these regulatory changes and the escalating complexity of the tax environment both domestically and internationally is a massive tax for any tax department. Now I'd like to highlight a couple of the wins on the international front that I'm very proud of. We won a high-profile new logo in the fourth quarter with a major luxury brand in the jewelry industry. This customer launched an online marketplace so its customers could have a secondary market in which they buy, sell and trade its products, many of which have long waiting lists at retail stores. This customer quickly acknowledged that, tax complexity for a global marketplace was beyond their internal capabilities as well as the compliance risk that this represented. This led to a search for a third-party provider. Thanks to the trusted relationship we have built with the U.S. division of the company, we added this prestigious new client to our customer base. Additionally, Vertex was selected by one of the fastest-growing middle-market providers of software for the office of the CFO. Internal system changes to its billing platform resulted in an evaluation of its existing solution. Vertex won based on the ability to operate seamlessly in the company's new IT environment, while providing the expertise to smoothly execute the migration process. In addition, the customer determined that Vertex's tax content was more thorough and accurate than the competition. We are excited about this win, because this new customer is owned by a private equity firm that also owns a competitor of ours that was included in the RFP process. Even so, the competitor could not successfully compete in solving the tax complexity of the portfolio company. They also did not enjoy the high level of confidence and trust to deliver that Vertex received from the advisory community that influenced our win. As I look to 2024, I'm extremely confident in the momentum we continue to build. I'm excited about the rapidly growing pipeline from our recent partnership with Shopify and their move upmarket. And I am seeing tangible progress to drive margin improvements with our ongoing investments in generative AI to support tax content expansion, software development and creation of new customer experience tools. Finally, let me say a few words about our Pagero tender offer. From the outset, we were well advised on the nuances of Swedish law for tender offers, which open the potential for additional parties to join in the bidding. We were prepared for what unfolded and determined to stay true to our disciplined investment philosophy. With our differentiated approach of combining our VAT compliance solution with e-invoicing capabilities through a single portal, we are solving highly-valued challenge for tax departments. We have been clear the e-invoicing component could be solved via partnership or acquisition and when Pagero presented us with both options, we pursued it at the right price. Currently, our multiyear partnership agreement with Pagero that we announced last October remains in place. We are comfortable with the strength of the terms of that agreement, so in the near-term that is how we will continue to handle e-invoicing opportunities. At the same time, we have considerable options with other e-invoicing companies that are attracted to our highly sought-after customer base and with recent legislation delaying the implementation of e-invoicing in France and Poland, we will remain strategic in our actions. I look forward to sharing more about our plans for this market opportunity in the future. In conclusion, I remain very confident in the path ahead. The fundamentals of our business are strong and we are well-positioned to capitalize on the significant market opportunity in today's increasingly complex tax landscape. John will now take you through the financials for 2023 and our guidance for 2024. John?

Thanks, David, and good morning, everyone. I'll now review our results in detail and provide financial guidance for the first quarter and full year of 2024. In the fourth quarter, revenue was $154.9 million, up 18.1% compared to last year's fourth quarter and for the full year, total revenue was $572.4 million, up 16. 4% from 2022. As David mentioned, this exceeded the high end of both our fourth quarter and full-year revenue guidance by $7.9 million. Note that, in the fourth quarter, contract renewals with several major customers resulted in usage tier true-ups of approximately $3 million to $4 million. For comparison sake, last year's fourth quarter usage tier true-ups were in the $1 million to $2 million range. Subscription revenue in the fourth quarter increased 17.9% over last year's fourth quarter to $130.7 million. Full-year subscription revenue was $480.8 million, up 15.7% year-over-year. Services revenue in the Q4 grew 19.7% over last year's fourth quarter to $24.2 million. Full-year services revenue was $91.6 million up 20.2% year-over-year. Cloud revenue was $60.6 million, up 29.9% from last year's fourth quarter. Full-year cloud revenue was $214.6 million, up 27.1% year-over-year and exceeding our full-year guidance. The higher-than-expected full-year growth was in part due to the usage tier true-up revenue, which contributed about 0.5% point to the full-year cloud revenue growth rate. Annual recurring revenue or ARR was $512.5 million at the end of the year, representing 18.9% year-over-year growth. Net revenue retention or NRR, remains strong at 113%. This was up from 110% in the comparable 2022 period and up from 111% in the third quarter. Gross revenue retention, or GRR, was 95% at quarter end, within our targeted range of 94% to 96%. Average annual revenue per customer or AARPC, which is based on our direct customer count was $118,910 in the fourth quarter, up from $112,690 in the third quarter of 2023. For the remainder of the income statement discussion, I will be referring to non-GAAP metrics. These non-GAAP metrics are reconciled to GAAP results in the earnings press release that was issued this morning. Gross profit for the fourth quarter was $109.6 million and gross margin was 70.7%. This compares with gross profit of $94.4 million and a 72% gross margin in the same period last year. Gross margin on subscription software revenue was 76.8% compared to 78.4% in last year's fourth quarter and 78.3% in the third quarter of 2023. The decrease in gross margins was driven by increased cloud and hosting support customers in the multi-cloud environments. Services gross margin was 38.2% compared to 36.8% in last year's fourth quarter and 35.3% in the third quarter of 2023. Turning to operating expenses. In the fourth quarter, research and development expense was $11.3 million compared to $11 million last year. For the full year, R&D was $52.2 million with capitalized software spend included, R&D spend was $23.5 million for the fourth quarter and $100.7 million for the full year, which represents 15.2% of revenue for the fourth quarter and 17.6% of revenue for the full year. Selling and marketing expense was $34.4 million up 3.5% from last year's fourth quarter. For the year, selling and marketing expense was $129.2 million up 12.1% from last year. And general and administrative expense were $31.4 million up $2.6 million from last year. For the full year, general and administrative expense was $124.9 million compared to $112.7 million last year. Both fourth quarter and full-year adjusted EBITDA exceeded the upper end of our guidance. With our growth investment program largely completed in mid-2023, we are seeing improved earnings leverage, which was apparent in the fourth quarter. Adjusted EBITDA was $32 million an increase of $11 million or over 52% year-over-year. In addition, the fourth quarter adjusted EBITDA margin was 20.7%. For the full year, adjusted EBITDA was $100.8 million, up $22.2 million from last year. As you may recall, our ERP conversion in the second quarter resulted in short-term to disruptions to billings, which in turn impacted our cash flow in the second and third quarters. This was largely resolved by the end of the fourth quarter as we deliver $28.8 million of free cash flow. Note that DSO remained at elevated levels in the fourth quarter, but we expect to resolve this by end of the first half of 2024. For the full year, free cash flow was $6.1 million, compared to $3.4 million last year. We ended the fourth quarter with over $68.2 million in unrestricted cash and cash equivalents. Total bank debt was $46.9 million and investment securities totaled $9.5 million. For additional liquidity, we also have $200 million of unused availability under our line of credit. With Vertex's strong execution, we have built a foundation for growth and profitability that we expect to be a shareholder value-creating engine for years to come. The growth investments we've made position us to deliver consistent revenue growth in the mid to high teens, which we in turn expect to drive earnings leverage and expanding adjusted EBITDA margins. Reflecting this confidence, we are guiding above-consensus for 2024. Accordingly, for the first quarter of 2024, we expect total revenue in the range of $152 million to $156 million, which would represent 16% year-over-year growth at the midpoint and adjusted EBITDA in a range of $29 million to $31 million which would represent an increase of approximately $8 million or 45% at the midpoint. For the full year 2024, we expect total revenue in the range of $650 million to $660 million representing annual revenue growth of 14% at the midpoint. While the full year revenue growth embedded in our guidance is slightly lower than what we delivered for the full year of 2023, this is due to two factors. First, over the last two years, we have deliberately increased our focus and commitment to enabling and supporting our global alliance partners, who implement our software and help to drive software subscription revenue to our business. As a result of this shift of focus, you are seeing and will continue to see a reduced growth rate for our Services business. We expect Services revenue to grow in the mid to single-digits on a percentage basis in 2024. Secondly, we do not expect the high level of fourth quarter usage tier true-up revenue that I mentioned earlier to reoccur in the fourth quarter of 2024. Offsetting this, in 2024, we expect cloud revenue growth to accelerate to approximately 28% and software subscription revenue to accelerate to more than 16%. For the full year of 2024 we expect adjusted EBITDA in the range of $130 million to $135 million, representing an increase of $32 million or 31% at the midpoint and a full-year adjusted EBITDA margin of just over 20%. David will now make some closing before we open up for Q&A. David?

Thanks, John. As I said at the top of the call, I'm very pleased with our execution in 2023. By any measure, it was a terrific year for Vertex. Vertex has always been a consistent, durable, profitable grower even back to our days as a privately held, family run business. But the growth investments we made from 2020 through mid-2023 have further energized the company from top-to-bottom. Accordingly, with continued strong execution, we see plenty of runway and opportunity to continue the standard of performance we set in 2023 in the years to come. With that, we will take your questions.

[Operator Instructions]. Our first question comes from Chris Quintero of Morgan Stanley. Please go ahead.

Congrats on the outstanding results here. Really, really impressive. You all are clearly seeing the benefits of this long investment cycle that you just concluded. Just taking a step back, as you look back on that journey and all of the areas that you invested in, from your perspective, what have been the key kind of one to two needle movers for you that have really made the most impact today?

Thanks, Chris. I would say that our investment in our partner ecosystem and alliances has really strengthened our growth vectors. When you couple that with the new products we brought to market around our customer success function, really enabling the customer success function to drive those new offerings and the products we acquired through acquisition. I would say, the combination of those two things has really fueled and been additive to our consistent growth story.

Got it. That's really helpful. And then really great to see that cloud growth guide of 28% for next year. What gives you the confidence in that guide and where do you expect to see more of the growth to come from? Is it more migrations from the on-prem version or just a testament to that really strong new logo growth that you're seeing?

I think the tailwinds of our business, if you think about the consistent regulatory pressure that our customers are facing, we had a record year in compliance changes last year, and you couple that with the ongoing digital transformations that are going on across the industry. Both of those two things I think are going to play out strongly in '24 and beyond. I think that really is where we're going to see, why we're so confident in our cloud growth. I don't see any fundamental shift in the migration process. I think that will continue to be a smaller part. Again, remember with our cross-sells, Chris, a lot of our cross-sells are customers who might have self-hosted software and now want to go to cloud software for the next offering. I think with that cross-sell motion and the NRR motion that we're enjoying, I think you'll see cloud growth there. I think that's really the drivers of that cloud success in 2024.

The next question comes from Matt Stotler of William Blair. Please go ahead.

Great. Thanks for taking my questions and great results guys. I wanted to follow-up on the commentary related to e-invoicing and Pagero. I think given the bidding war that perspired there, there's a view that Pagero was a very unique asset in addressing e-invoicing. But based on your comments, it makes it seem like even if the Pagero partnership doesn't work out, there's other potential partnerships or perhaps acquisition options out there. Is that correct? And any more detail you can provide on how you're thinking about addressing that opportunity longer-term?

Yes, Matt. Thank you. I definitely believe that, Pagero at the right price was an interesting asset for us, but the e-invoicing solution without the single portal combined with that compliance is not as high a value. Clearly, what makes it -- what's the differentiated value is our customer base combined with the way we've married up our VAT compliance solution and an e-invoice provider is really how we're going to differentiate in the market. I'm very comfortable and confident that, given the invoicing volume of our customer base, we have a lot of options about how we're going to solve for that other piece. Pagero at the right price was a wonderful asset, but it is clearly not the only game in town by any means.

Great. Just a follow-up on the e-invoicing. I wanted to also clarify the comments around the timeline for implementation of that regulation in some countries. It seems like perhaps, we're still a few years out from that opportunity becoming a more material driver, so you all have some time here to sort of formulate your strategy. Is that correct? Just wanted to confirm those comments.

Yes. There's certainly activity in the market now that's opportunity that we want to get after. We did it. But some of the bigger economies that are looking at it have pushed out their dates, which just again affords us the ability to be very strategic and disciplined in what we do, which is something we've always tried to do to drive long-term shareholder value. I see it playing out strongly again in this scenario.

Our next question comes from Steve Enders of Citi. Please go ahead.

Hi. Thanks for taking the questions. This is George on for Steve. Maybe just first to start, you guys laid out this investment plan that obviously reaping the rewards of that. When you think about the success that you're seeing, this acceleration of growth across a number of metrics. Does that bring you back to the drawing table to maybe reconsider a more aggressive reinvestment posture going to 2024?

George, thanks for the question. I will tell you that, we continue to invest heavily in our R&D function to bring new products to market. The investment strategy we embarked on over the last three years was really to build out a much more mature go-to-market approach across Europe, U.S., middle market, advancing our ecosystem profile, also that we had more tentacles into the market to deliver value as we brought either bought companies, acquired companies or added new products to our portfolio. I don't see any slowdown in the R&D function at all. We can be much more tactical now when we add in the go-to-market areas, because we've got the base and the quality of talent and team ready to execute on that. And so, I think that's really -- and then I would want to highlight the back-office efforts we've put in place around our ERP system really give us the scalable infrastructure to really drive margin over time through our G&A operations.

Super helpful. And then the record high NRR was great to see. Maybe you could just talk a little bit about, break that down a little bit, what's been resonating? Is there any CPI component to that? Is there any CPI component baked into '24 that might look a little different? Just kind of any help on breaking apart NRR.

There's basically, George, there's three components to what drives our NRR. About 50% of it comes from the cross-sells of new offerings into our install base. About 25% comes from selling more of an existing product to the customer. We call them entitlements, where they're going through revenue bands and we end up -- it costs them more. And then the last 25% comes from price increases. I think the execution in fourth quarter really reflects consistent performance across all three with a little bit of uptick in the cross-sell and entitlements area, but nothing unique in the price area. We're pretty disciplined in our price increases. That's really not fueling the bulk of this at this point.

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

Thanks for taking the questions. And David, you mentioned some of the new logo wins in Europe. I'm curious how you view the competitive environment there, given it seems there's a lot of interest across the Office of the CFO, to get involved with some of the new e-invoicing regulations. Are your go-to-market teams seeing any of this and RFPs companies looking to get ahead of this today? Or do you think there's going a little bit more of a reactionary type of focus from companies in Europe given some of the delays in regulation? Appreciate it.

Thank you, Adam, for the question. The beauty and the benefit of and the pain of working in the indirect tax space is unless there is true pain, there is not advanced budget for it. One of the things we've learned over the years is, you want to have the right solution just in time to solve the problem, but getting there too soon doesn't always generate additional revenue because there's not a lot of discretionary spend. I think we see that consistently playing out here and that's why I feel like we can be very strategic with our decision-making as we move forward here. Our Europe team has done a great job of building a very strong customer reference base, which is essential in the indirect tax community. Certainly, with some of the offerings we brought forward like Chain Flow Accelerator, which is really differentiated in the SAP space. And if you think about again, one of our larger ecosystems along with Oracle is SAP and we're enjoying some really nice positioning inside of the SAP customer environment right now. I still feel like we're very well-positioned in that space.

Great. That's really helpful color. And then John on margins, just curious if there's anything you're contemplating this year from an incremental investment perspective, given the evolving, e-invoicing environment around, Pagero or those considerations would be beyond this year?

Yes. I think from a margin perspective, again, we talked a little bit about where we stand and kind of what we feel about the future. I don't anticipate anything significant coming that's not already contemplated in our guidance. I think we feel good about the increases we have made here in R&D and kind of bringing things together and I think we feel like we're going to stay that path and continue to work with the partners that we've kind of been talking to certainly from an e-invoicing standpoint. But we've got real good momentum and traction regarding some of the R&D efforts and some of the other areas for additional new products and things going forward. I don't anticipate a big wholesale change in terms of how we're thinking about investment to get after additional spend.

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

Hi. Good morning. Thanks for taking my questions and congrats on the great numbers. First one, maybe John for you, if I just look, you guys have seen growth get much, much stronger, but OpEx has been very, very limited in terms of expansion since December of 2022. Should we think about the company being kind of at the right level of OpEx? How should we think about maybe that's going forward? I know you've given margin guidance, but just philosophically help us to understand if we're at the right place in terms of headcount and maybe where expenses should trend? And then I have a follow-up for you, David.

Yes. Thanks, Samad, for the question. I think, as we've talked about it before, a significant amount of our investments took place in the years leading up to 2023. Middle of the year of 2023, we did see an inflection point we felt with the go live of the ERP system in a number of the other areas really getting to the level that we had anticipated when we undertook the journey. I feel very good about where that is. I think we will continue to expand from a headcount standpoint, because again, there's growth opportunities and things that are out there that we'll get after. But we do anticipate and as you would see from our guidance, getting leverage out of our cost infrastructure. Again, we've talked about G&A, we've talked about some level of selling and marketing expense seeing that there. We're always being opportunistic from an R&D standpoint. We feel good about where we are now from a headcount standpoint, from an expense standpoint, but there is some level of growth built into it. But again, you'll start to see that leverage really come through now that those big investment dollars are past us.

Great. And then David, just on the partnership side, especially the big ones like SAP and Oracle, how are you seeing the joint go-to-market efforts there? Is it doing as you expected? Is it doing better-than-expected? And maybe how should we think about how partnerships will contribute to the strong 2024 cloud revenue growth?

Yes. Thank you, Samad. We continue to see really solid performance across the base there. I think you really have to marry it well with the alliance community, because it's the combination of the two that is really differentiated for us and supports the strong win rate we have. I think the pipeline of activity as we look forward, a lot of what the team accomplished in 2023 didn't even benefit from some of the ECC migration efforts that we think are going to play out in '24, '25 and '26. And so, I think the team has done a good job of positioning us inside of those ecosystems. And our conscious effort now to slow down our services growth to really reward our partner ecosystem further, I think is really aligned with what we want to envision growing this business as we go forward here.

Great. Appreciate you taking my questions. Thank you.

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

Thank you. David, you've talked about high teens growth and targeting upwards of kind of 20% growth in some of the recent quarters, you just delivered on 19% ARR growth. Has anything changed in terms of your belief on the organic opportunity ahead for Vertex?

Thanks, Alex. No, I see the -- I still see -- again, you have to look at the tailwinds, I really look at what are the macro events that are driving opportunities to us. And I think business model changes and mergers and acquisitions at the enterprise space continue to play out, the regulatory environment is only getting more complex and painful. And again, we're competing largely against in-house systems that ultimately need to be replaced. And so, I think when you take those two and add in ongoing digital transformations and ERP upgrades, the strength of what we've envisioned happening and what we embarked on over three years ago in our investment strategy is really playing out quite nicely. And I don't see that changing in the near term at all.

Okay. Great color there. And maybe one for you, John. Just in terms of guidance philosophy and how we should look at the 2024 outlook, I think in past years, you've spoken to not being kind of a huge embedded beat-and-raise cadence until you get later into the year. I'm just curious if anything changed in terms of how you approach the guidance this year.

It's a great question. No, I appreciate it very much, Alex. I think we are very consistent and thoughtful about our guidance methodology. And I think we expect that we'll continue with that same as we move forward. I think we feel it's -- it's done us well to kind of be thoughtful and conservative about how we set that. And then the way that we approach it is not anticipated to change.

Thank you, Alex.

Next question comes from Daniel Jester of BMO Capital Markets. Please go ahead.

Good morning, and thanks for taking my question. David, you gave us a little bit of update about your efforts around AI in the prepared remarks. I'd love if you could expand on the areas of opportunity in '24? And how are your customer conversations progressing along those lines?

Yes. So, thanks for the question, Dan. We continue to be really disciplined in our investment here. We've made a conscious effort to look at ways to improve productivity and drive more efficiency in our business and we're seeing some really good sprouts of opportunity. I think on the customer front, it's probably in the long run, more exciting because, obviously, I think we can drive more revenue from the business. One of the things our customers have always valued in our brand is around trust and it's trust that we can be more accurate than they can do on their own. And so, the conversations and the reason we're inviting our customers into the dialogue early in the process is to make sure they retain that confidence. And so, we set up a number of design programs and labs to sort of engage them in that journey to make sure we're meeting their expectations and not undermining trust in the process.

Great. That's great color. And then maybe one for you, John. If I look at deferred revenue on the balance sheet, in 2021 and 2022, that was kind of growing in the teens. But kind of exiting the year, we've kind of slipped to growth sort of in the mid-single digits. So, is there anything that we should be thinking about with regards to deferred revenue and the visibility you have on the growth algorithm for '24?

Yes. Thanks for the question, Dan. No, there's nothing that's changed with respect to our visibility or how we think about the business in terms of kind of our confidence and ability to read into deferred revenue and what's on the horizon. I would tell you that with the change back in 2021, we did change how we do some of our pricing for on-prem software. That's become a much smaller piece, but over time, that's come down. And so that's why you see a little bit of a change relating to the deferred revenue over time. So that migration was expected to take place and has. But no, from an overall standpoint, our ability to see into the future with our customers, the contract length and the way that that's manifesting itself in deferred revenue has been virtually unchanged.

Great. Thank you, very much.

Thanks, Dan.

The next question comes from Pat Walravens of Citizens JMP Securities. Please go ahead.

Great and let me add my congratulations on the Q4 results, fabulous. So, David, and part of this comes from questions I've gotten from investors. But prior to Pagero, I would not have expected Vertex to be willing to pay nearly $600 million for an asset and to partner with someone like Silver Lake to get the financing. So how should we think about Vertex's future appetite for M&A? How big a transaction are you willing to do? And should you maybe have more cash on the balance sheet to provide more flexibility around those kinds of things in the future?

Thanks, Pat. I think one of the things I enjoy with our Board is willing to do what's necessary to support the long-term strategy of the company and the confidence they have in management to execute on that. And I think what happened over the last three years is the company has continued to perform better than expected, beating our own budget and guidance expectations. We've completed that investment cycle. And the Board was supportive that there was an opportunity. And then at the right price, we would do what was necessary to make it happen. And so, I don't think that philosophy will change at all given the strength of our execution and the strength of the organization's performance. If the right opportunity presents itself and it serves our customers' long-term needs, our Board will support doing what's necessary to make it happen. What that is, the world will be informed as we go forward, but rest assured, there's strong confidence across from the board down through management on that.

Great. And I think everyone does appreciate how you stay disciplined on that.

Thank you.

[Operator Instructions]. Our next question comes from Brad Reback of Stifel. Please go ahead.

Great. Thanks, very much. Gentlemen, can you remind us with the true-ups how that impacts ARR both in the quarter and going forward?

Yes. Thanks for the question, Brad. The true-ups. The way that it works is the true-up is really periods that have passed. So, it's a direct impact to revenue for the prior overages that took place. But what's typically happening at the same time, Brad, is those same customers are renewing for a new contract going forward. And typically, that's coming in at a higher tier. So, you are getting -- you are getting benefit from that customer renewing at a higher tier. So, it's very similar to the amount that goes backwards, but ARR is the forward look. And so, the forward look typically has an increase in it when you come out of a customer entitlement upgrade like that.

Great. And then as the cloud business gets bigger and bigger, can you also remind us sort of what the impact is on gross margin longer term? Thanks.

Yes, that's a great question, Brad. Thank you. Now over time, what we have seen is that customers are moving. There is a migration toward the cloud. We have mentioned that our cloud revenue and our cloud margins, if you will, were a little bit lower than our on-prem margins. But a lot of that had to do with some of the leverage that we got. And as more uptake in the multi-tenant cloud starts to take place, we are seeing those margins increase. So, we feel very good about that. We feel that the margins, again, with the volume that we're getting that the margins will find themselves just under where the on-prem margins were, obviously, there's a cost there to host and keep the cloud costs going. But we feel very good that those margins will be able to kind of stay in that range of where they are right now.

Awesome. Thanks, very much.

Thank you, Brad.

Thanks, Brad.

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

Thanks, everybody, for joining us today. If you have any follow-up questions or if you'd like to schedule additional time with the team, please send me an e-mail at investors.vertex.com -- I'm sorry, [email protected]. Have a great rest of your day, and we look forward to speaking with you in the coming weeks.