SPS Commerce, Inc.

Good day and welcome to the SPS Commerce second quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ermina Blaszczyk, Investor Relations for SPS Commerce. Please go ahead.

Thank you, Drew. Good afternoon, everyone, and thank you for joining us on SPS Commerce second quarter 2023 conference call. We will make certain statements today, including with respect to our expected financial results, go-to-market strategy and efforts designed to increase our traction and penetration with retailers and other customers. These statements are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially. Please note that these forward-looking statements reflect our opinions only as of the date of this call and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Please refer to our SEC filings, specifically our Form 10-K, as well as our financial results press release for a more detailed description of the risk factors that may affect our results. These documents are available on our website, spscommerce.com, and at the SEC's website, sec.gov. In addition, we are providing a historical data sheet for easy reference on the investor relations section of our website, spscommerce.com. During our call today, we will discuss adjusted EBITDA financial measures and non-GAAP income per share. In our press release and our filings with the SEC, each of which is posted on our website, you will find additional disclosures regarding these non-GAAP financial measures, including reconciliations of these measures with comparable GAAP measures. And with that, I will turn the call over to Archie.

Thank you, Romina, and welcome, everyone. Before I proceed with my prepared remarks, I'd like to mention the CEO announcement we made earlier this month. In October, I will transition to the role of Executive Chair of the Board as we welcome our new CEO, Chad Collins. Given Chad's leadership and industry experience, I believe he is uniquely qualified to lead SPS through its next chapter of growth and innovation, capitalizing on omnichannel retail dynamics. We look forward to introducing Chad to you all on our third quarter earnings conference call. Turning to our second quarter performance, we continue to see investments in organizations across retail, fueling ongoing demand for SPS fulfillment and analytics products. Total revenue of $130.4 million grew 19% in the quarter, while recurring revenue grew 20%. In today's omni-channel world, the average consumer expects to purchase exactly what they want from where they want, looking for a consistent experience across all channels. they are pushing the limits of retailers' operations and forcing suppliers to embrace an omnichannel strategy. Since the pandemic, the increased pace and complexity of fulfillment exposed inefficiencies, which are now forcing suppliers to revitalize their supply chain. According to the 2022 MHI Annual Industry Report, a survey of over 1,000 supply chain and manufacturing leaders, 74% of respondents plan on investing in inventory and network optimization tools over the next year. For example, Moose Toys, a large manufacturer in Australia, has been an SPS fulfillment customer since 2016, expanding their network across Asia Pacific, North America, and Europe. To effectively manage their inventory, they use sell-through data from retailers for forecasting and planning. However, they were receiving the data in many different formats and had to process it manually, which caused delays in their ability to extract meaningful insights. SPS's analytics was the right solution for Moose Toys to begin aggregating, normalizing, and integrating the vast amount of data feeds from their many trading partners. They can now leverage the strategic insights derived from the data to capitalize on significant growth opportunities around the world. As trading partners strive for automation, ERP integration is another key component to solving supply chain challenges. For example, our partnership with Microsoft has been mutually beneficial over the years, and Microsoft has recently chosen to highlight SPS Commerce as the featured solution on their app store. Microsoft has been focused on migrating their customers to the cloud, and with their strong presence in retail, distribution, and manufacturing, The need for fully automated and scalable supply chain operations is a pivotal factor of these ERP migrations. SPS Commerce's deep Microsoft integration technology, multi-tenant cloud-based retail network, and full-service model is allowing Microsoft sellers and VARs to leverage best-of-breed technologies when trying to migrate customers and win new business. Just as retailers and suppliers are investing in new technologies to optimize their supply chain, SPS Commerce remains committed to delivering world-class products and excellent customer experience. By capitalizing on artificial intelligence technologies, we're already driving efficiencies throughout our organization to serve our customers and improve our product offerings. SPS is the world's largest retail cloud network, which gives us access to the depth and breadth of data necessary to leverage AI and reduce the requirements for suppliers to connect to retailers. making it much easier to implement trading partner connections. We see many opportunities to enhance our products in the future as we use AI to increase the intelligence of SPS's network, which in turn will make joining and operating within the network increasingly more efficient. We also continue to expand our portfolio and global footprint, and yesterday we announced our planned acquisition of Tye Kinetics. We believe Tye's e-invoicing capabilities will enable us to capitalize on the opportunity presented by mandatory e-invoicing regulations in Europe, while expanding our European presence to serve our growing network with access to international markets. In summary, increasing complexity in omnichannel retail is fueling investment in supply chain revitalization. SPS is well positioned to capitalize on new technologies such as AI, which are proving necessary for automation and optimization of trading partner relationships, and amplify our ability to bring our network to more retailers and suppliers faster and easier. With that, I'll turn it over to Kim to discuss our financial results.

Thanks, Archie. We had a great second quarter of 2023. Revenue was $130.4 million, a 19% increase over Q2 of last year, and represented our 90th consecutive quarter of revenue growth. Recurring revenue this quarter grew 20% year over year. The total number of recurring revenue customers increased 11% year-over-year to 43,000, and wallet share increased 8% to 11,350. For the quarter, adjusted EBITDA grew 24% to $38.2 million compared to $30.9 million in Q2 of last year. We ended the quarter with total cash and investments of approximately $270 million. Now, turning to Guidance. The following third quarter and full year 2023 revenue and adjusted EBITDA guidance does not include the impact from the pending acquisition of Thai Kinetics. For the third quarter of 2023, we expect revenue to be in the range of $133.6 million to $134.4 million, which represents approximately 17% year-over-year growth. We expect adjusted EBITDA to be in the range of $39.3 million to $40 million. We expect fully diluted earnings per share to be in the range of 37 cents to 38 cents, with fully diluted weighted average shares outstanding of approximately 37.6 million shares. We expect non-GAAP diluted income per share to be in the range of 65 to 67 cents, with stock-based compensation expense of approximately 11.7 million, depreciation expense of approximately 4.9 million, and amortization expense of approximately $3.7 million. For the full year, we expect revenue to be in the range of $528.5 million to $530 million, representing approximately 17% to 18% growth over 2022. We expect adjusted EBITDA to be in the range of $155.8 million to $156.9 million, representing growth of approximately 18% to 19%. We expect fully diluted earnings per share to be in the range of $1.60 to $1.63, with fully diluted weighted average shares outstanding of approximately 37.4 million shares. We expect non-GAAP diluted income per share to be in the range of 269 to 272, with stock-based compensation expense of approximately $46.2 million, depreciation expense of approximately $19.4 million, and amortization expense for the year of approximately $14.7 million. For the remainder of the year, on a quarterly basis, investors should model approximately a 30% effective tax rate calculated on GAAP pre-tax net earnings. As noted in our press release announcing the planned acquisition of Thai Kinetics, we expect it to have a nominal impact on Q3 financial results, with the exception of approximately $1 million of certain one-time deal-related costs. In the fourth quarter, we expect Thai Kinetics to contribute approximately $3.9 million of revenue and expect adjusted EBITDA of the acquired business to be approximately negative $500,000. Beyond 2023, we maintain our annual revenue growth expectation of 15% or greater as we expand our network through community enablement campaigns and acquisitions. We continue to expect adjusted EBITDA dollar growth of 15% to 25% as we invest in the business to capitalize on market dynamics and support current and future growth. In the long term, we maintain our target model for adjusted EBITDA margin of 35%. In summary, ongoing investments across the retail industry continue to present tremendous opportunities for SPF. With the only full service EDI solution, we are well positioned to help our customers optimize their network as we capitalize on a multi-billion dollar adjustable market to deliver sustained profitable growth. With that, I'd like to open the call to questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Matt Bob with William Blair. Please go ahead.

Hey, Greg. Thanks for taking my questions. First, I wanted to ask on the Thai Kinetics acquisition, just better help us understand what this brings to the table. Is this e-invoicing product different than what you currently have, and how does it help you gain more traction in Europe? Thanks.

Yeah. Thanks for the question, Matt. A number of things. The company is at roughly 60% European revenue and 40% U.S. revenue. And those businesses are relatively separate as far as go-to-market, et cetera. The U.S. business, think of that as much more consistent with a customer acquisition play. So, you know, meaningful revenue there. Put them on our platform. They can have more offerings that we can upsell the customers like we've done in the past. The European business, I think, gives us a couple things. One, it gives us a larger platform to go after fulfillment and really just think about learning about the market. We're in the market on a much smaller basis. We're in the market in analytics, but not much there. And then the e-invoicing product is, think of it as, in Europe, it's a government reporting, almost regulatory reporting. Compliance where you need to report VAT tax etc. So in order to do business in Europe you have that we partnered in the past for those capabilities It's applicable in Europe and also we use some of it in Mexico But don't anticipate using it in the US just because it's it's not really utilized here. So we do not have an e-invoicing platform as we speak so So that's current capabilities and customer acquisition.

And just one quick follow-up on that. Kim, I know you said that the revenue from the acquisition isn't included in the updated guidance that you provided in the earnings press release, but the $1 million of additional expenses in Q3, is that factored into the guidance?

No, the guidance we provided excludes anything related to the acquisition we announced of Thai Kinetics. And the reason for that is we announced it, but it is not yet closed. So all the numbers exclude, but we have separately in a press release about Thai Kinetics, as well as on this earnings call, reiterated the numbers that we believe they will be in 2023. So that $1 million of really deal-related costs in Q3 is not factored into the SPS commerce guidance we provided today.

Okay. Got it. Thank you very much.

The next question comes from Scott Berg with Needham. Please go ahead.

Hi, Archie and Kim. Congrats on the good quarter and thanks for taking my questions. I guess a couple things here. Starting with the acquisition, Archie, I'm certainly familiar with the VAT reporting requirements there. There's some nuances, I think, kind of developing over the next couple of years around real-time reporting for VAT for different vendors. Can that be a catalyst to maybe drive some outsized growth from that segment going forward, knowing that a lot of these countries are kind of trying to get to more of this real-time, almost straight-through processing for VAT reporting?

Well, I think the EE invoicing has an opportunity to grow and, you know, it has an opportunity. Right now it's fairly small, but pretty optimistic that it can be a bit of a catalyst into the future. But, you know, I wouldn't put a lot of weight onto it as we look at 24 and clearly not 23, but having those capabilities will be a positive. And, you know, for us, more importantly, we really get to learn that market by being in it. So I think that's a nice size deal that puts us in the market. We can really see more firsthand what is happening and what the real opportunity is.

Got it. Helpful. And then on business trends in the quarter, it looks like the company added roughly 250 net new customers. Knowing the second quarter is usually a seasonally strong period for customer acquisitions. That's actually later, not just during the pandemic, but during several years before that. Anything to read through necessarily on a single quarter snapshot on customer acquisition trends?

Sure. So when we think about the community enablement activity in the quarter, it was quite a strong quarter. But what we saw is more skewed towards existing customers that we were able to upsell versus the amount of net new customers. We don't think that that is at all a trend. It just so happened this quarter that the mix was a bit more on our existing customers versus new.

Got it. Helpful. I'll jump back in the queue. Congrats again.

The next question comes from Parker Lane with Speedful. Please go ahead.

Hi, Kim. Hi, Archie. Thanks for taking the questions here. Kim, I know it's early to be talking about 2024, but as far as it relates to Tye Kinetics, you talked about a $16 million revenue benefit for next year. And I noticed that, you know, I think they did $8 million of total revenue in their first half of their year. Can you just give us a better sense of what your assumptions are as you look forward to 2024, 2025 on, you know, any interesting dynamics to, you know, that revenue growth in that business?

Sure. So obviously we have not yet acquired the business, but that is obviously our intent, which we do believe will close later in Q3. As it relates to our expectations for 2024 of the approximately, you know, the $16 million that we did mention, that is primarily based on our view of what we see as the opportunity. Do also keep in mind that there is as a fair portion of their business is in Europe, it is subject to fluctuations from FX rates as well. But overall, it's our best view.

Excuse me, there has been an interruption. Just one moment, please. Thank you. Thank you. Just one moment. Miss Nelson, please continue. Thank you.

Great. Apologies for that. Parker, I don't know exactly where I cut off, but you were asking as it relates to our expectations for 2024. The acquisition, we believe, will close at the end of Q3. And at this point, we put together our best view of what we see as that opportunity in 2024 based on where that company is on its journey to moving over to a SaaS fulfillment model as well as the opportunities that we see in Europe.

Understood. Okay. And then on the gross margin side of things, it's been a few quarters now. They're relatively in the same place. And I know you've talked about low 70s being the long-term target in this business. As we march up towards that low 70s target, are there things you're doing internally to actually get there, or is this just going to be a matter of the business achieving some additional scale and that naturally flows through there?

Sure. So the biggest way that that gross margin will move from where it is now up to the lower 70s is really primarily around efficiencies and scalings. So you may recall that in prior conference calls and years, we've talked about investments that we've made in the overall customer experience. In some years, those investments have been larger from a growth perspective than our revenue or similar in line for the growth as our revenue. Thus, you have not seen that improvement from a gross margin perspective. As our business continues to grow, we believe we will be able to grow into some of those investments. We'll still obviously continue to add resources, but we shouldn't need to do those at the same level that we have historically. We also, as Archie mentioned, will be looking at AI. There's many things we're already doing on the artificial intelligence side, but we certainly do see opportunities on the customer success side as well, where we'll be able to leverage some of those tools and capabilities to help out with efficiency.

Understood. Thanks again for taking the questions here.

The next question comes from Jeff Van Ree with Craig Hallam. Please go ahead.

Great. Thanks. Hi, guys. Thanks for taking the question. So a couple for me, I guess just high level, I guess, Archie, as you look at the suppliers that are not yet on the platform, what are the characteristics? I mean, you've been at this for a while. Just talk about the people that haven't jumped yet and sort of the defining characteristics.

Well, I think that it's segmented into two different areas. The first, I assume we're talking about the fulfillment product. The first is really people that just are doing things more manually, email, mail, and just the retailers have not forced them to do it. They're small, and they're just not there yet. So those are different solutions that we typically get those through our retail enablement campaigns, pretty high success rate there. I would say the other is where they have bought legacy software And if they haven't moved ERPs and their business isn't moving very fast, then they're in the spot where they're in legacy software. It's working. They might have 5, 10, 20 retailers. It's working. If those retailers' environment isn't changing much, it's hard to get them to move. Once you start seeing more change in their environment or they start growing or making acquisitions, That's the bigger up. That is the biggest opportunity with them. Or just simply some of these guys, as we work with the retailers, we're helping the retailers effectively become dynamic in their supply chains, which is putting more pressure on the suppliers.

And then along the lines of the enablement campaigns, if you look at the enablement campaigns, what are you seeing that might be the enablement campaign pipeline? What are you seeing that's different? with respect to potentially the size of the campaigns, and specifically as you're implementing, the rate at which people are just testing versus signing?

You know, the testing versus signing is really just dependent on the mix and where we are and the type of retailer. I would say, you know, what we are seeing as consistent is automation of warehouse management, so we're seeing more ASN programs, Advanced Ship Notice, where you know, if you purchased Manhattan Associates or are trying to more fully utilize their capabilities, in order to do that, you need to receive a document called an advanced ship notice so that you know what's being shipped and when it's going to be received, and then to be able to receive that product into the distribution center with a barcode label that is scanned. So we're seeing more of those programs. Sometimes those will be a little heavier testing because it's a massive change for the retailer But for the suppliers, it's adding a couple documents which are complex We are seeing You know, we continue to see it's amazing multi-billion dollar organizations that are for the most part manual still And they're getting into the game because they need to they need to have visibility the advanced ship notice and the warehouse management systems and everything A lot of that is about inventory visibility, which is becoming a hotter and hotter topic. I don't want to have too much inventory, and I need solid visibility into the inventory.

Okay, makes sense.

Thanks so much. The next question comes from Nihal Chokshi with Northland Capital Markets. Please go ahead.

Yeah, thank you. Nice quarter here. Kim, you mentioned earlier that some of this upside was driven by strong upsell. Was this new SKUs or expanding connections?

This would be expanding connections. So when we run a community enablement campaign, where we will end up seeing that impact us is really going to be in three places. Customer ads, testers, or existing customers that are now adding that connection. And in this quarter, the mix just happened to skew a bit more on the existing customers adding a connection versus adding new customers. We still, of course, did add new customers, but the quantity of new customers was a bit lower in this quarter than what you would typically see from us with community activity.

Got it. Okay. And then you guys also talked about one of the unique capabilities that Tye Kinetics brings is the e-invoicing.

what's the value of this capability relative to your typical ARR that you're able to get from your customers? Or maybe talk about the ASP of invoicing for a given customer size relative to the rest of your product suite that you're offering.

Yeah, so first off, we're not going to be using it in the U.S. because it's not a concept of VAT reporting, tax reporting, compliance reporting. So it's you know, it's not applicable to that business. It really is a European, and then we see that in Mexico as well. It's really more of a, you have to have it. It's like a document type, you have to have it to be able to play. We have done that through partnering, and our fulfillment business in Europe is relatively small. As we've discussed in the past, we've really attacked Europe more with the analytics product, which we're seeing success in, and, you know, being able to now with those analytics products, have a more robust fulfillment product and having the fulfillment customers from Tide Kinetics to be able to have an analytics product, we think over time will also add value. But I think of it more as a capability you just have to have as opposed to an upsell. To get into the game, you have to have it.

Great. Thank you for taking my question.

The next question comes from Mark Chappell with Loop Capital. Please go ahead.

Hi, thank you for taking my question. Just a couple of follow-up questions on Kinekinetics, such as how fast was it growing? How many employees did they have? Do they have certain target industries that they focus on?

Sure. So about 100 employees. And they were growing, if you sort of look at things from sort of a constant currency perspective, because they obviously have a U.S. business plus a European business, they were growing in about the single digits when you're adjusting for, again, for a constant currency.

Okay, great. And then, you know, given that they have more of a European focus, could you just remind us what percent of SPS stocks SPS's revenue today comes from international sources?

Sure. So when you look at our overall revenue, think of it as approximately 85% of the revenue is in more U.S., so non-international. But do keep in mind that our Asia business, which is heavily there to support the supply chain of our North American suppliers, that does show up as U.S. revenue because it's the paying company. is in the United States.

Great. Thank you.

That's all for me.

Again, if you have a question, please press star then 1. The next question comes from Joe Brewink with Baird. Please go ahead.

Great. Hi, Archie and Kim. Maybe just one follow up on the customer account ads this quarter and maybe a revenue question as well. Was there any impact from retailer bankruptcies on kind of revenue and the number of connections that might have went away in response to a retailer bankruptcy?

No, there was not. There was nothing unusual as it relates to the bankruptcies that we saw in the quarter.

Okay, thank you. And then, Archie, I wanted to go back to that tidbit you shared at the very beginning. I think it was 74% of a surveyed customer base planning to invest in inventory and networking solutions. Do you have a number for current levels of either electronic fulfillment or EDI Just to kind of relate the two, I'm wondering if we could compare 74% to whatever that adoption rate happens to be to get kind of a sense of what the market might be growing at at this point.

I don't. Unfortunately, that data was not broken out is what I understand. And what we see is the more – it's been the same story all along. The more change in the environment for suppliers – Kind of back to an earlier question from Jeff as far as the people that are sticking with their old software, the more change they have in the environment, that tends to serve us well. So the fact that people are going to be changing environments, investing, and looking to do things on the supplier side is a positive for SPS Commerce. So that's kind of the point. How much of that is going to be on our fulfillment side, don't know. But I know if it's on ERP, warehouse management, all those things tend to be a positive for us.

Okay. Thank you very much.

I'm showing no further questions in the queue. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day.