Sps Commerce Inc Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the SPS Commerce Q1 2020 Earnings Call. At this time, all participant lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded. I would now like to hand the conference over to your speaker today, Irmina Blaszczyk. You may begin.

Thank you, Blue. Good afternoon everyone and thank you for joining us on SPS Commerce First Quarter 2020 Conference Call. We will make certain statements and projections 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 and projections are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially. We know in particular that uncertainty regarding the impact of the COVID-19 pandemic on our performance could cause actual results to differ materially from our projections. 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 we furnished Form 8-K to the SEC earlier today 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 datasheet for easy reference on our Investor Relations section of our website, spscommerce.com. During our call today, we will discuss adjusted EBITDA financial measures and non-GAAP earnings per share. In our press release and our filings with the SEC, each of which is posted on our website, we will find additional disclosures regarding these non-GAAP and adjusted EBITDA measures, including reconciliations of these measures with comparable GAAP measures. And with that, I will turn the call over to Archie.

Thanks, Irmina, and welcome everyone. First and foremost, we hope you're all staying safe and well and our thoughts are with everyone affected by the coronavirus pandemic. The health and safety of our employees, customers and partners is a top priority and we remain fully committed to support the suppliers and retailers that serve our communities in these challenging times. SPS Commerce Services are absolutely critical to our customers to ensure they are able to deliver the day to day essentials we all need. We are a cloud-native company and the investments we have made over the years, and our tools systems and processes enable us to deliver uninterrupted and secure service anywhere in the world often with nothing more than a web browser. Due to the nature of the SaaS business model, we are able to operate remotely providing a full-service experience to existing customers and promptly onboarding new suppliers as needed. For the first quarter, revenue grew 11% to $74.2 million. Recurring revenue grew 12% and adjusted EBITDA grew 24% to $20.4 million. SPS Commerce provides a mission-critical service to suppliers and retailers at a time when e-commerce has become central to their business. We recently engaged with US Foods, a leading foodservice distributor about leveraging EDI and automating their supply chain. As COVID-19 started to disrupt operations in the food industry, US Foods realized that electronic processes are critical to maintain effective business operations. They identified EDI as a crucial component in this process requiring all of their suppliers to move to electronic order fulfillment. In a matter of four weeks, SPS Commerce has signed on more suppliers to transact EDI with US Foods than they have on their own over the last 10 years. US Foods has also formed grocery sector partnerships, enabling it to deliver product directly to our retailers' distribution center or stores. These new partnerships further emphasize the need for supply chain efficiencies to help retailers across the United States maintain inventory and meet increasing consumer demand. Many of the retailers we work with are expanding on their multi-channel sourcing strategy to meet increasing demand. Costco, for example, has regularly been using SPS for same-day vendor setup, and has relied on us over the past few weeks to add approximately 200 new vendors to their network and ensure they are up and running to fill Costco's orders within hours. We have also been working with Walgreens, onboarding new critical suppliers of essential products such as face masks. With our full-service, same day onboarding capabilities, SPS was able to increase speed to market for a variety of critical products from new suppliers. Stay-at-home government directives have also caused an abrupt decline in brick-and-mortar retail sales and a shift to online shopping. E-commerce is now an integral and sometimes necessary part of our lives, prompting retailers to evaluate their operational efficiencies and quickly adapt to stay relevant. As part of SPS Commerce fulfillment, we launched carrier service to help suppliers manage drop-ship orders, helping them save time with functionality like batch processing and reduce costs with rate shopping capability for all major carriers in the US and Canada. Carrier service, which was just launched in March is being used by our customers to fulfill orders for Amazon, Costco, Home Depot, Bed Bath & Beyond and Target. We are pleased with the product's acceptance to date as we strive to support our trading community in this challenging environment. We expect the current dynamics impacting retailers and suppliers will continue to amplify the need for process automation. And SPS Commerce has committed to support and improve trading partner relationships in every way we can. We are also mindful of the economic impacts of the COVID-19 pandemic and the uncertainty around its implications across the retail landscape. SPS Commerce has a very large network of trading partners across various industries and we see retailers and suppliers adapting and implementing e-commerce capabilities to serve rapidly evolving consumer demand. Across our network and diverse end markets, we have seen a steady volume of transaction since March, with approximately half of our network seeing increased volume, while some have experienced a decline. The dynamics of the situation continue to evolve. At this time, we are seeing increased demand for automation from retailers embracing e-commerce and implementing drop-ship capabilities. Our exposure to the grocery supply chain has resulted in an increase in onboarding of new suppliers for retailers as well as foodservice and grocery distributors. These are the dynamics that drive demand for SPS Commerce solutions, and we are optimistic about the long-term opportunities as we continue to support our growing network of over 31,000 trading partners. As we look at the rest of 2020, this uncertainty around the duration and the magnitude of the pandemic and its growing impact on the economy, we are factoring in the possibility of continued pressure on retailers, a decline in demand for our solutions such as analytics and a push-out in enterprise ERP implementations. All of which would negatively impact our business. These are dynamics we cannot predict or control, but with our cloud-native operational model we are well-positioned to provide support to our customers, partners and our community. In summary, SPS continues to be a mission-critical aspect of the global supply chain. Our vision to be the world's retail network is being realized. Our retail supply chain solutions are keeping trading partners connected, especially now during this time of crisis and disruption. The work we do is vital and I would like to thank all of our employees for the ongoing commitment to supporting our customers and ensuring business and supply continuity for our communities. We achieved our 10th year as a public company in April, and based on our history of consistent execution and ongoing focus on our customers' needs, we believe SPS Commerce will emerge from this crisis stronger than ever. With that, I'll turn it over to Kim, to discuss our financial results.

Thanks, Archie. We delivered a solid first quarter of 2020. Revenue was $74.2 million, an 11% increase over Q1 of last year and represented our 77th consecutive quarter of revenue growth. Recurring revenue this quarter grew 12% year-over-year. The total number of recurring revenue customers increased 5% year-over-year to approximately 31,000. For Q1, wallet share was up 6% year-over-year at approximately 9,100. For the quarter, adjusted EBITDA was $20.4 million compared to $16.5 million in Q1 of last year. We ended the quarter with total cash and marketable securities of approximately $215 million. We also repurchased $12 million of SPS shares in the quarter. Now turning to guidance. For the second quarter of 2020, we expect revenue to be in the range of $73.8 million to $74.8 million. We expect adjusted EBITDA to be in the range of $19 million to $20 million. We expect fully diluted earnings per share to be approximately $0.17 to $0.19 with fully diluted weighted average shares outstanding of approximately 36.2 million shares. We expect non-GAAP diluted earnings per share to be approximately $0.29 to $0.31 with a stock-based compensation expense of approximately $5.1 million, depreciation expense of approximately $3.5 million and amortization expense of approximately $1.4 million. As a result of the government-mandated office closures and reduced travel, we are recognizing savings and we'll continue to manage discretionary spending accordingly, given ongoing uncertainties resulting from the pandemic. However, we're in a unique position to expand our market presence, and we will continue to invest in product innovation to advance our technology leadership and continue to deliver the best customer experience. We are withdrawing 2020 annual guidance due to uncertainty related to the macroeconomic impact of the pandemic and the lack of visibility into the magnitude of the impact on our retail network. Dynamics that may negatively impact our business include prolonged store closures, bankruptcies, reduced demand for our analytics product and potential push out in ERP migration. Dynamics that may positively impact our business include increased enablement campaign activity driven by current e-commerce trends including demand for our drop-ship product. We will continue to monitor the macroeconomic impact on retail dynamics and reassess our visibility for the full year at the end of the second quarter. However, given our history of strong operating leverage and the resilience of our SaaS business model, we remain confident in our ability to expand adjusted EBITDA margin in 2020 and achieve our long-term adjusted EBITDA margin target of 35%. Although we are withdrawing guidance for the year, we are providing the following information for modeling purposes. We expect stock-based compensation expense for the year of approximately $19.7 million, depreciation expense of approximately $13.8 million and amortization expense of approximately $5.6 million. Also, for the remainder of the year on a quarterly basis, investors should model a 30% effective tax rate calculated on GAAP pre-tax net earnings. In summary, we expect that the current supply chain dynamics will amplify the need for e-commerce and EDI solutions in the long-term. And we believe SPS Commerce is uniquely positioned to capitalize on that opportunity. We are pleased with our ability to continue to provide mission-critical solutions to retailers and suppliers, and we'd like to thank all our employees for their unyielding effort and dedication to support the SPS Commerce network in these challenging times. With that, I'd like to open the call to questions.

Your first question comes from the line of Matt Pfau from William Blair.

Hey guys, thanks for taking my questions, and hope you're all doing well. Wanted to ask on the new product you introduced on the carrier service. Maybe you can just tell us about how the monetization model for that works and is there an opportunity to expand that to more retailers?

Yes, so the product is an add-on product for fulfillment. And it's a modest monthly fee and it does two things: one, it greatly simplifies the whole process of tying your ASN to your shipping documents and also rate shopping. So it just simplifies that process and decreases the amount of manual effort which is of great value. So I think there's two big parts of it: one, it's a potential add-on for our customers so we can get more revenue, but it's also a retention tool in the fact that, obviously, the more value we can generate for our suppliers, the more likely they are to stay with us and makes it very difficult for them to go somewhere else. And yes, we continue to build out the network and we're building out the network as fast as people need the solution. Again, it's a new solution and we expect to have it available to basically our entire retail network.

Right. And then, I guess just generally, there are going to be a lot of supply chain-related changes coming out of the pandemic. So how do you think about that in terms of creating additional opportunities for more products to be created for your portfolio?

I believe we are very well positioned with our product. As usage increases, so do the opportunities. We've noticed a significant rise in drop-ship activities, with some retailers experiencing increases of 200% and others seeing growth of 1,000%. Overall, we're observing many more drop-ship opportunities among the 350 retailers that utilize our services. Reflecting on 2009, which was a tough year for retail, our community product still saw increased sales, leading us to go public based on those numbers. The demand for efficient electronic supply chains is clearer than ever now. Simple actions, like needing to go into the office for mail or avoiding packing slips on boxes delivered to distribution centers to minimize contact, highlight this need. We remain optimistic about these efficiencies and believe we will continue to adapt and grow in this area.

Great. Thanks for taking my questions, guys.

Your next question comes from the line of Scott Berg from Needham.

Hi, Archie and Kim. Congrats on a good quarter, and thanks for taking my questions. I guess a couple here, Archie. You started touching on it in the last question a little bit, some differences between the great recession and the current environment that we're in. What else is different for the business today? Obviously, you are in more of a hyper-growth mode than still very early in the fulfillment as the cloud kind of stage. Today, 12 years later, certainly more mature, you have a much different position in the ecosystem. Yes, what are the, maybe, puts and pulls that are kind of different or other positives that you're looking at today?

There are a few key differences to note. In 2008-2009, there wasn't a health crisis or an emotional climate that called for empathy, which makes this situation quite distinct. At that time, everyone was working in the office, unlike now with 1,500 people remotely across the globe. There are both advantages and disadvantages to this setup. Similar to 2008 and 2009, we are uncertain about how long the current economic conditions will persist, and we don't know how this situation will unfold. Is it going to be a V-shaped or W-shaped recovery? It's unclear. Our business landscape is very different now. Back in 2009, we primarily engaged with small suppliers and focused on community, where we noticed a significant increase in community needs, although we were somewhat unprepared for it. We observed a rise in bankruptcies that impacted our revenue modestly. However, 2009 was still a year marked by growth. At that time, we lacked analytics and didn't have any enterprise accounts linked to ERP systems, which are crucial for our current operations. Therefore, we lack a historical precedent to predict future outcomes. Our sales pipelines appear healthy, but we are uncertain about their responsiveness. Will things proceed normally as we approach quarter-end, or will there be delays? This uncertainty, along with concerns about bankruptcies and the timing of store openings, remains critical for us.

Got it, very helpful. And you just kind of touch on pipelines right now and how they behave. I know, second quarter is seasonally a very important quarter in terms of enablement campaigns to customer additions, obviously, as retailers and suppliers try to ramp for the holiday season in the second half. I assume that's what you're commenting on specifically on enablement campaigns and if not, is there maybe anything different in the comment?

I think the focus is on the entire pipeline related to analytics, channel sales, ERP systems, and more enterprise deals. It's important to remember that community programs within the retail sector are a strong component of our business model, but I can't predict whether they will speed up or slow down. The positive aspect is that a significant portion of our enablement campaigns consists of daily supplier ads for companies like Costco, Grainger, and Loblaw across various sectors. I feel less certain about how enterprise and analytics will perform during this time, particularly with store closures.

Great. That's all I have. I'll jump in the queue. Congrats again.

Thanks.

Your next question comes from the line of Tom Roderick from Stifel.

Hey, Archie. Hi, Kim. I guess I'll start by saying congratulations on a full 10 years as a public company. It's been a pretty wild ride coming out of the 2009 recession and now doing your 41st call, our 41st quarter and under the circumstances we're in so I'm glad you're safe and healthy and hopefully staying reasonably sane. I'd love to chat a little bit about just some of the state as you look at your customers and how they're weathering the storm. As we look at our average recurring revenue, at kind of $8,500, between $8,000 and $9,000 per customer per year, that sort of hints at the nature of a lot of small and mid-sized suppliers, yet your churn rate has always been quite low. So I guess it's an opportunity for you to perhaps reflect on what you saw happen with the churn rate in 2009 and how you think about it in the context of today where some of those suppliers might be getting choked off by supply chain challenges or some of the stores they're servicing are having challenges. Take us through how you think about the health of the installed base and how you're kind of stress testing the thoughts about churn right now?

We have approximately 31,000 recurring revenue customers, demonstrating broad engagement across our network. We see substantial penetration in almost all areas of retail, with no single customer contributing significantly to our overall revenue, which is a positive aspect. Regarding our fulfillment product, it plays a critical role for our suppliers. For instance, even if more sales are shifting online due to the pandemic, suppliers still need our offerings, and we are positioned to support them. As a result, while they may be utilizing the fulfillment product in a different manner—more focused on online sales rather than physical stores, many of which are temporarily closed—it's essential to recognize that our product remains mission-critical and very sticky. The real uncertainties lie in how long stores will remain closed and the potential impact on bankruptcy rates. As mentioned, during 2008-2009, we experienced an increase in bankruptcies. However, we have not yet observed a rise in bankruptcies or customer churn; in Q1, our annualized churn rate remains around 13%. While we haven't seen significant changes yet, the future may depend on the duration of store closures. Overall, our fulfillment product continues to be integral and valuable for our customers.

Yes, that's great. Archie, I have another question regarding the go-to-market strategy. You've consistently executed well with the low-touch sales model and your ability to convert customers quickly through inside sales. Many companies are now trying to adopt this channel due to the necessity of selling from home and online. Is this channel becoming more competitive? Is it becoming more difficult to stand out? How are you adapting your go-to-market approach considering that others are pursuing the model you've refined over the years?

One significant aspect of our model is that when our supplier sales representatives reach out to suppliers to promote our product, they have a major retailer behind them advocating for a response. This retailer has been known to suggest they may limit their business with those suppliers if they don't return calls, making this field less competitive. Our close rates for community deals range from 65% to 95%. While these deals are not always recurring revenue, they can include testing contracts or recurring revenue. Most businesses aim for a 1% to 2% close rate from their inside sales teams, which they would consider a strong outcome. It's important to note that our salespeople are true sales professionals and are not cold calling. Our sales team, working from home, has remained incredibly focused and effective. It’s worth mentioning that some suppliers are eager to begin the onboarding process immediately, and we are able to onboard suppliers within hours, sometimes even under an hour, whereas the industry standard typically takes weeks or months.

Yes, got it. Fantastic. I'll jump back in the queue, but again, nice job and look forward to you all. Take care.

Your next question comes from the line of Joe Vruwink from Baird.

Great. Hello, everyone. You've kind of been touching on this, but I was wondering if you could characterize maybe where EDI is falling in the pecking order of broader retail IT projects. You know, when I think of how you provide, it's a lot of value for a fairly low price point. So I would imagine that's the type of thing that might actually have more interest in this type of environment, but I'd be curious for your thoughts.

Thank you. First, we are relatively new in the pandemic world, having only six weeks of data so far in what are usually longer sales cycles. The early signs are encouraging, and while I can't predict if we will see a similar trend to 2009, there are some parallels. In 2009, retailers were not investing heavily in capital projects like building new distribution centers or implementing new ERP systems. For our product sales to retailers, we require their commitment but not necessarily their financial investment. This has elevated our priority for retailers, which is what we expect to see now. The need for foundational systems has become apparent, especially with retailers managing their back office operations from home; the challenges of manual processes are now very clear. There's a pressing requirement for efficiency and automation in distribution centers due to spacing needs. I am very optimistic about this segment of our business, and we plan to focus on it. Additionally, when comparing us to our competitors, they do not have a similar go-to-market strategy, which positions us well to gain market share in the coming years with a highly successful approach that others lack.

That's great, then. And speaking of pain points, there are a lot of anecdotes right now in listening to some of your supplier customers and how they just like more visibility on sell-through or how tight is inventory getting at the point of final demand. And that specifically seems to be happening in the US so that begs the question on the analytics product, and I understand why as a category that might be something that it makes sense to be a little more cautious on just given the environment. But when you think about, again, the pay endpoint and what suppliers are now asking for, could that actually see a bit of benefits? One, let's say conditions return to normal and you get a shot, maybe make the analytics pitch again?

Yes, I believe that once we return to what we consider 'normal,' there is potential for improvement. Currently, we are worried about store closings because the point of sales data is not very useful when stores are shut. This situation creates pressure on our operations. Additionally, consumer spending is discretionary in this context, especially in relation to our Fulfillment Service with Costco. If a customer wants to discontinue our service, they simply need to stop their purchase orders from Costco or find an alternative, but they won't stop altogether. Thus, it represents a more discretionary type of spending. However, the value for suppliers and retailers remains significant, and I think it will continue to grow. We must be cautious and recognize that, in the short term, store closures and cost-saving measures are prevalent, making it harder to sell spending dollars to save significantly in the future.

Great, thank you very much.

Your next question comes from the line of Patrick Walravens from JMP.

Great, thank you. I also want to congratulate you on your 10-year public company anniversary. Interestingly, my model starts from 2008. So here’s what I’ve found, and please correct me if I'm mistaken, but in Q2 of 2008, recurring revenue grew by 27%, and then it slowed down over the next five quarters. The percentages were 27%, 25%, 20%, 19%, 17%, and 16%. Then in Q4 of 2009, it increased to 21%, and you were off to a strong start. Just as a reminder, the lowest point for economic growth was in Q4 of 2008 when it dropped by about 8%. So, it's a tough question, but is it reasonable for us to assume five quarters of deceleration?

In relation to the potential acquisition from 2008, we have visibility for Q2 and have shared our expectations for this quarter. However, we have withdrawn our annual guidance due to significant uncertainty regarding various factors we've discussed. There are pressures from issues like the timing of store closures, bankruptcies, and enterprise ERP analytics, but there are also positive aspects tied to community dynamics. Given this uncertainty, we are not providing a complete outlook at this time. By next quarter, we hope to offer more clarity. Currently, our guidance indicates revenue growth will be below Q1, but it’s challenging to predict how long this will continue and what it will ultimately look like. I believe it will be somewhat linked to the duration of store closures.

Your next question comes from the line of Jason Celino from KeyBanc Capital Markets.

Archie, Kim, thanks for taking my question. Really just one, kind of housekeeping type question. You've given the examples of kind of the grocery store businesses and the suppliers tied to that segment. But can you help us quantify how much of your business is that segment or how to think about it?

I believe the best way to consider this is that we operate in grocery, e-commerce, and brick-and-mortar industrial distribution, and we are likely not too distant from the overall retail landscape in North America. Grocery is a significant portion, and it can include companies like Costco, which has a substantial grocery segment. When we evaluate it, our grocery business aligns closely with the overall retail market, though some sectors are smaller. We may have a lesser share, but we are present across all categories, including grocery, e-commerce, and pet supplies, each with its unique characteristics.

Your next question comes from the line of Tyler Wood from Northland Securities.

Hey, thanks for taking our question. Just one for me. On the suppliers on the network, could you kind of give us a sense of the share of those that are kind of just tied to one retailer and could potentially leave the network if retail bankruptcy were to occur? And then sort of how are you preparing for that possibility when it comes to ensuring that suppliers don't churn in that scenario? Thanks.

Yes. Let me explain this. The average revenue is $9,100, but we have three significant types of customers. There is a distribution around that average, and we have a substantial number of customers. In terms of customer count, we have the highest number of customers, but from a revenue perspective, there's an important share of customers who engage with us for one or two retailers. Additionally, we have between 1,500 and 1,800 customers who generate over $20,000, reaching into the hundreds of thousands. The main issue arises when customers use us for only one connection; that’s when we tend to lose them, especially those who stop doing business with that single retailer. Our approach remains consistent: we aim to encourage them to adopt our product, particularly if they have another retailer that may compel them but recognizes the value of our services and attempts to engage us for more than one connection. This has always been the case, particularly with our smaller customers.

It's helpful. Thank you.

Your next question comes from the line of Mark Schappel from Benchmark.

Hey, thanks for taking my question. It's Chad on for Mark. With respect to M&A, there are several private EDI vendors in the marketplace today. Many of them are in the $5 million to $20 million range, and many of them are either breakeven or marginally profitable. Given the recent retail disruptions, do you see more of these vendors looking for an exit strategy through M&A?

This is purely speculation since we are only six weeks into this situation, and there hasn't been an immediate reaction. I believe the answer could be yes. If these companies can endure the current challenges, they may consider that their value will recover. This dynamic is likely common across all mergers and acquisitions. The key issue for many smaller EDI suppliers is whether they can sustain their operations financially. They must have a dependable cloud-based infrastructure that can cope with demand and an effective sales process. We think many of our competitors will struggle during this period and are not as well-prepared as SPS Commerce in terms of technology and finances. Therefore, we are focused on raising awareness of our capabilities, building relationships, and potentially acquiring them. Challenges are heightened right now, as exposure to various industries plays a crucial role in M&A discussions. If you are in the grocery sector, things look relatively positive at the moment. Conversely, companies in the high-priced fashion sector are facing difficulties. This situation likely requires additional due diligence for any M&A deal, but there may be opportunities ahead.

Okay, great. That's all I got.

Your next question comes from the line of Jeff Van Rhee from Craig-Hallum Capital Group.

Hey guys, this is Rudy on for Jeff. With the June guide, I mean, surely you guys took some caution on it. Which were the first areas you sort of haircut a little based on what you're seeing and then what do you think you will see throughout the rest of the quarter?

So, as it relates to the Q2 revenue guidance that we gave that was based on what we're seeing thus far in the quarter as well as the pipeline. So we'll look at our sort of existing customers as well as upsell opportunities and new customers and a lot of the new comes as we look at that community enablement activity in the quarter. So, we take all of that into account and then we provide what we believe is appropriate guidance based on what we see in the pipeline as well as with our existing customers.

Got it. If you could recall 2008-2009, I know that currently the customer churn is about 12% to 13%. Looking back at that time, do you have any details on what percentage of your customers went bankrupt or how much the customer churn increased?

Yes, customer churn was a couple of percentage points higher back then, at around 1%.

Got it. Great, very helpful. Okay, great. Thank you.

I'm showing no further questions at this time. This concludes today's conference call. Thank you for participating, and have a wonderful day. You may all disconnect.