Sps Commerce Inc Q2 FY2020 Earnings Call

Thank you for joining us for the SPS Commerce Q2 2020 Earnings Call. All participant lines are currently muted for listening. Following the presentation, we will have a question-and-answer session. I will now turn the conference over to your speaker, Irmina Blaszczyk. Please proceed.

Thank you, everyone, and thank you for joining us on SPS Commerce's Second 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 note 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 via 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 at 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. 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, you 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. Before I review our second-quarter performance, I would like to address two important topics. First, I would like to reflect on the tragedy that took place two months ago in our hometown of Minneapolis and the senseless murder of George Floyd while in police custody. My sympathy and condolences are with George Floyd's family, friends, and communities. My heart goes out to everyone that has been impacted and affected by the violent riots that followed this tragic event. It is time to stop turning a blind eye and ignoring the systemic issues that plague our society. I would like to thank all SPS Commerce employees for their commitment to be part of the solution, as we all take action against racial bias, injustice, and inequity. SPS has always embraced diversity, but we recognize that more needs to be done, and we began with the following steps. During the past two months, I hosted discussions with employees and listened intently to their feedback on how we move forward as a company and community. I also formed an advisory group that meets regularly to discuss how SPS can make an impact. In recognition of Juneteenth, all SPS employees received $100 each towards supporting their local black-owned businesses. Together with more than 80 members of the Minnesota business partnership, I signed a letter urging lawmakers to pass policing reform in a special session. We are working with Federal Reserve President Neel Kashkari and Justice Page to amend Minnesota’s Constitution to give all children a right to quality education. I am personally committed to addressing the inequities in Minnesota's education system. And as an immediate step, SPS Commerce has started the process to establish a scholarship program for students of color wishing to pursue a career in technology. The systemic injustice in our country underscores the need for change. The real work is ahead of us, making sure we don't return to what was considered normal. SPS is focused on making that change. The second issue we continue to face is the ongoing pandemic. And SPS Commerce remains committed to customers to ensure they're able to deliver everyday essentials we all need. The dynamics impacting the retail industry, which we outlined on our last earnings call, continue to play out as we expected. Across our large network of trading partners across diverse end markets, we continue to see a steady volume of transactions. Enablement campaigns are driving ongoing momentum in fulfillment, which was offset by softness in analytics. For the second quarter, revenue grew 10% to $75.6 million, recurring revenue grew 11%, and adjusted EBITDA grew 25% to $20.4 million. The current situation requires retailers to navigate the retail industry's new normal. The COVID-19 crisis means a shift from common brick-and-mortar stores, with many shoppers nervous about purchasing products in-store. We're seeing a significant shift to e-commerce sales, with many e-commerce businesses experiencing sizeable growth. To help the brands that ship on behalf of retailers and their e-commerce retail stores, SPS Commerce joined forces with our partner Shipfusion. We believe that the right partner can make or break a retailer's logistics, customer service, and repeat purchases. Shipfusion has multiple fully managed and operated fulfillment centers across the U.S. and Canada, giving brands the best tools possible for building a successful e-commerce operation. Both retailers and suppliers are seeing the need for increased efficiency and automation, underscoring the mission-critical nature of the service we provide. For example, Drakes Supermarkets, a leading grocery retailer in Australia pivoted from being supplied by a wholesaler to directly supply its 40 stores. Drakes partnered with SPS Commerce to deploy an EDI strategy and electronically connect with their suppliers through vendor onboarding. EDI provided Drakes with the order and inventory visibility they needed to manage a diverse vendor community and keep their shelves stocked. In addition to supply chain automation, EDI improves order fulfillment accuracy, which avoids shipment delays and additional costs associated with inaccurate data entry. Earlier this year, SPS surveyed nearly 200 third-party providers about data accuracy. The responses showed a direct correlation between timely and accurate data from customers and their ability to ship accurately and on time. Suppliers use third-party logistics (3PL) to take on the logistics and fulfillment aspects of their businesses and without proper data, the 3PL cannot perform the task it was hired to do in the most efficient manner. SPS asked 3PLs what was the one thing they would be doing in 2020 to address 3PL order accuracy. The responses focused on automation, moving clients to EDI, or working with customers to increase their use of EDI. As the world's retail network, SPS solutions are responsible for keeping products moving along the retail supply chain for more than 90,000 businesses. We empower retailers, suppliers, and logistics firms to embrace today's latest retail trends. Our solutions have received numerous awards, and we have recently been ranked #1 Twin Cities largest software development firm by the Minneapolis St. Paul Business Journal. I am honored to have our local tech teams recognized for all they do. They lead the pack not just in numbers, but also in talent and passion. In summary, the challenges we have endured this year have impacted our communities, our businesses, and our lives. I would like to thank SPS Commerce employees for their ongoing dedication to our customers and our communities. We remain committed to taking action and making progress in the years ahead. With that, I'll turn it over to Kim to discuss our financial results.

Thanks, Archie. We delivered a solid second quarter of 2020. Revenue was $75.6 million, a 10% increase over Q2 of last year and represented our 78th consecutive quarter of revenue growth. Recurring revenue this quarter grew 11% year-over-year. The total number of recurring revenue customers increased 5% year-over-year to approximately 31,500. For Q2, while its share was up 5% year-over-year at approximately $9,100. For the quarter adjusted EBITDA was $20.4 million, compared to $16.4 million in Q2 of last year. We ended the quarter with total cash and investments of approximately $233 million. We also repurchased $7 million of SPS shares in the quarter. Now turning to guidance. For the third quarter of 2020, we expect revenue to be in the range of $76.6 million to $77.1 million. We expect adjusted EBITDA to be in the range of $20.5 million to $21 million. We expect fully diluted earnings per share to be approximately $0.19 to $0.20 with fully diluted weighted average shares outstanding of approximately 36.3 million shares. We expect non-GAAP diluted earnings per share to be approximately $0.32 to $0.33 with 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 Archie mentioned earlier, the dynamics of the current situation continue to impact our business. We continue to monitor the uncertainties around the duration and magnitude of the pandemic and the impact that a second wave of infections may have on economic activity. We're also taking into account the possibility of continued pressure on retailers, prolonged store closures, and bankruptcies, all of which could negatively impact our business. For the remainder of the year, we expect to see continued softness in analytics. However, the ongoing need for automation across our network continues to drive momentum in fulfillment. As a result, given these dynamics and with two quarters remaining in the year, we are reinstating our annual guidance for 2020. For the full year, we expect revenue to be in the range of $304.1 million to $305.3 million, representing approximately 9% growth over 2019. We expect adjusted EBITDA to be in the range of $82.4 million to $83.5 million, representing 18% to 20% growth over 2019. We expect fully diluted earnings per share to be approximately $0.99 to $1, with fully diluted weighted average shares outstanding of approximately 36.1 million shares. We expect non-GAAP diluted earnings per share to be approximately $1.41 to $1.42, with stock-based compensation expense of approximately $19.6 million, depreciation expense of approximately $13.4 million, and amortization expense of approximately $5.5 million. 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. Given our history of strong operating leverage, and the resilience of our SaaS business model, we remain confident in our ability to achieve our long-term adjusted EBITDA target of 35%. In summary, we cannot predict the duration and magnitude of the pandemic and its growing impact on the economy. But the challenges the retail industry faces underscore the need for EDI and supply chain automation. With our cloud-native operational model, SPS Commerce is well-positioned to continue to provide mission-critical solutions and support our customers, our partners, and our community. With that, I'd like to open the call to questions.

Thank you. Our first question comes from Matt Pfau with William Blair. Your line is open.

Thank you for taking my question. Congratulations on a strong quarter in a tough environment. I wanted to ask about your performance this quarter, which exceeded your guidance, and your decision to reinstate your 2020 guidance. Can you share what factors are contributing to your confidence in providing the updated guidance? Additionally, with three more months of data since your last earnings release, could you elaborate on what you observed in those data points that contributes to your positive outlook for 2020?

Sure, Matt. To your point, we do have three more months of data than from our last earnings call. And you may recall a quarter ago, we gave some commentary around different puts and takes. We have said that community enablement campaigns on the fulfillment side, that's an area that we were seeing more occurring there, as retailers were working to become more electronic in what they are doing as well as trying to source products from different suppliers and moving more online. And we did see that carry forward in the past quarter. We also said that we anticipated that analytics would be a bit softer, and that did also carry forward. You may recall we also talked about the potential for bankruptcies and churn. That was something that we didn't know what was going to happen there. I would say on that last one, we're still in and we don't know what's going to happen, but we did not see an increase in churn or bankruptcies in the quarter. However, that is something that still may happen in the future, depending on the magnitude or duration of the pandemic and what that means for store closures. Knowing that we're now less than six months left of the year, we have nice visibility into this quarter. And then you're really only predicting for the next 90 days after that point. Because of that, we felt like there was enough color in the results that we've seen and our belief of what's in the pipeline and the opportunities that we felt comfortable being able to restate the annual guidance as well as give guidance for the next quarter.

Great and just one quick follow-up on that. So on the churn side, obviously, the customer churns in the fourth quarter, it is a much less meaningful impact on the overall results for the year relative to the start of the year. But it sounds like you did perhaps account for some potential pickup in churn, or how did you think about that when you put together your guidance?

Sure. To your point, because of the way the recurring revenue works, should churn increase in, say, Q4, the impact is a relatively nominal impact in the quarter and would be a much larger, more significant impact in 2021. So when we established our expectations for the remainder of this year, we took into account what we're seeing in the pipeline as well as some uncertainties such as churn. So we would have taken that into account. But to your point, it's a relatively nominal impact this year compared to the impact that would be in the following year.

Okay, great. Thanks a lot, guys.

Thank you. Our next question comes from the line of Scott Berg with Needham & Company. Your line is open.

Hi, Archie and Kim, congrats on a good quarter here. I guess two questions for me. Archie, can you comment maybe a little bit about your drop ship business in particular? We know e-commerce is certainly taking a meaningful step-up here in the quarter given the current situation. Did you see any benefit there in terms of customers seeking to potentially employ your solution in that arena?

I think there are two areas to highlight, Scott. Our drop ship volume is currently two to three times what it was before the pandemic. It's not surprising to see a significant shift to e-commerce, and we believe a large portion of that will remain. Both retailers and suppliers are actively seeking drop ship solutions, and we've noticed this as a consistent trend. Additionally, from an analytics perspective, it has provided a favorable boost.

Got it, helpful. And then from a follow-up perspective, I know on the Q1 call, Archie, you had called out enablement campaigns in the month of April being strong, especially with Costco, I believe, was the customer example. But maybe a commentary on trends of enablement campaigns throughout the quarter, maybe what you saw in May and June, were they kind of in line with historical trends? Or were there meaningful differences?

Yeah, no, we had a relatively strong enablement quarter. Remember, that enablement campaigns that you roll out in a quarter were sold one or two quarters earlier. So there's a separation between closing enablement campaigns and the actual economic effects of them. But early in the quarter, we saw some customers who wanted to accelerate, and some who were a little bit deer in the headlights. As the pandemic, as we got into a rhythm after 30, 45 days, people realized we need to move forward. I think things are positive, and people are recognizing, again, what we had discussed previously, the need to automate the supply chain and that continues to be a trend. Then we're all trying to do enablement campaigns and those are longer-term sales cycles, but early indications are positive.

Great, congrats and thanks for taking the questions.

Thank you. Our next question comes from the line of Koji Ikeda with Oppenheimer. Your line is open.

This is Chad Schoening on for Koji. Thanks for taking the question. Wondering if you could touch on kind of the overall resilience of your technology today versus back in the 2008 period? Obviously, this is a pretty disruptive period. So curious to hear what has changed from a technology standpoint that could make your tech more strategic for a retailer now versus back then? Thank you.

Compared to 2008, 2009, when we were probably a $20 million business, just about everything has changed. Our tech was strong but we now have a world-class infrastructure team that is unbelievable. We are clearly best-in-class. I think it will show during periods of times like this, where we can do a number of things. One, keep everything going extremely smoothly, but we also have the ability, with our technology infrastructure, to scale up or down needed infrastructure literally within seconds. I think the reliability, dependency, and scalability of the solution is night and day. As suppliers are looking to ensure they have companies that can operate during these changing and challenging times, I think that becomes a more strategic advantage in the sales cycle.

Great, thank you.

Thank you. Our next question comes from the line of Tom Roderick with Stifel. Your line is open.

Hi, Kim and Archie, thanks for taking my question. Archie, I appreciate your thoughts on the social issues. In fact, your community, well done on taking some proactive measures to get involved. So thanks for that. I guess kind of taking a big-picture type of question. As we look at all the supply chain disruption and it's taking a lot longer to get things from manufacturing facilities, factories over to in-store fulfillment here, I would love to hear what your retail partners are doing in real time to pivot more towards, like you said, e-commerce and let's even just call it multichannel fulfillment. But when you're having your discussions with those retail partners, what are they doing proactively as opposed to, okay, now the orders are coming e-commerce, and we're just going to fulfill them in that regard? What are they doing in terms of their own supplier selection pivoting the way that they're working with their partners? And then how does that impact the way that you have the opportunity from a fulfillment basis to get ahead of it?

I think a number of things, Tom, some that affect us and some that don't. Remember, in many cases, the actions that the retailer takes can greatly affect the consumer experience, but it does not affect the way they operate with their supplier. For instance, delivering from stores doesn't affect how they do business with their suppliers. Curbside pickup, we're seeing more of that. That does not affect the way they work with their suppliers. We're seeing a lot of discussion around wanting to know inventory levels and trying to source in-country, as they're worried about the tax repercussions with China and other countries, and the speed and resiliency of that. Retailers are really trying to shift their inventory thinking more holistically, needing to consider inventory in their stores, distribution centers, and at their suppliers. This approach is driving increased adoption of drop shipping. This allows a retailer, perhaps not as profitably with drop shipping, but still maintains customer satisfaction, which is more front and center right now.

Yes, fantastic. And then just relative to some of the comments and concerns relative to the analytics sector. So still holding in there pretty well; it seems like this would be sort of the technology that you might worry a little bit more about churn if in-store retail doesn't recover, but perhaps you can kind of refresh us on how the traffic and point-of-sale analysis impacts your purchasing decisions and where those are coming from? Because, again, it sort of looks like analytics is holding in there relative to what you would worry about?

Yes, I think there are arguments that could be made to suppliers that this remains more strategic now than ever before. For those actively using analytics, that is absolutely the case. We're seeing that. The issues arise when businesses need to make cost adjustments; then, everything is placed under scrutiny. If they use analytics heavily, we feel good about retaining those customers. If they haven't operationalized the analytics product, the analytics team does a fantastic job tracking usage and ensuring customers are trained and maximizing the product's benefit. It is a discretionary spend. We believe it's a very strategic spend, but it's only strategic if you are actively using it. One thing we're finding in general is that customers are scrutinizing all their expenses in challenging times, and we do that at SPS Commerce as well.

Yes, one last quickly, just if you don't mind. A lot of companies are getting the question of, okay, second quarter was better than you had feared. But how does the outlook sort of shape up? In particular, how is the pipeline building coming along? I know you have a typically shorter sales cycle and a highly efficient sales model. But would love to hear what you're hearing for sort of top-of-the-funnel pipeline generation to refill the bucket?

Yes, we believe things are positive. Our community enablement campaigns remain highly competitive. The sales cycles are continuing to be comparable, if not improving. Demand generation through search engine optimization and paid search is noteworthy; while the number of leads has decreased, their quality has increased. People tend to search only when they are ready to make a purchase. This means we are engaging with fewer prospects to achieve the same results. Larger deals are beginning to return, and we are observing considerable activity in fulfillment, as retailers recognize the importance of automating their supply chains for greater efficiency.

Fantastic, really good. Appreciate it. Thanks, guys. Nice job.

Thank you. Our next question comes from the line of Pat Walravens with JMP Securities. Your line is open.

Oh, great, thank you. So two questions. First of all, if I look back to the factors that you pointed to on the negative side last quarter, Archie and Kim, you talked about closures, bankruptcies, analytics, and ERP migration. So we talked about bankruptcies and analytics, but I'm wondering about closures and ERP migrations, what's going on? In particular, your data on closures must be really interesting. Can you tell what percentage of the stores on your network have not been open for business?

We can analyze retailer by retailer, but I don't have an aggregate number for you, Pat. The biggest factor affecting us is if a retailer actually goes out of business. A retailer going from 500 stores to 200 stores has a relatively minimal impact unless their assortment goes down or they have many suppliers leaving. Depending on the category, if it's grocery — which we haven't seen closures — that would impact us more regionally, but that is not a significant impact on our results overall.

Great, and is there anything there that was worth calling out on ERP migrations?

We have seen ERP migrations slow down, but it seems more similar to the past. Now remember, we might get the deal right when they sign to go with a new ERP, but sometimes we are trailing. So we're not the best early indicator. It's when they start to migrate or are halfway through the implementation that we can gauge better how that affects us. We haven't seen a major change there yet. Whether they continue down this path, that's likely dependent on the ERP performance.

Well, surprisingly, they've actually been doing all right. So then my other question was just sort of practically, are you having people back in the office anywhere in the world, and is anything happening in person? Or is everything 100% remote for SPS Commerce?

Most of our offices are open because we are critical. We are fully work-from-home optional, and we've made it clear that this is truly work-from-home optional. I would tell you in the Minneapolis office, on any given day, an average of 2% to 4% of employees are in for some reason. Perhaps they have a big meeting, they need to print things, or just want a better work environment. It's pretty minimal. Obviously, our help desk, which has been phenomenal, has staff coming to help with laptop issues. So while there are a few people in, it's not a collaborative work environment.

Yeah. All right, great. Thank you, Archie. Thank you, Kim.

Thanks, Pat.

Thank you. Our next question comes from Joe Vruwink with Baird. Your line is open.

Great. Hello, everyone. I was curious, in thinking about the composition of your growth going forward. There's clearly a lot of interest in getting new suppliers qualified, and it seems like, I don't know if you agree, the end market commentary on that sort of thing seems to be broadening. Industrial distributors, grocery is less of a surprise, but a lot of end markets seem to be in the same boat. That would seem good for expanding the audience, perhaps. But I was wondering if that's good for customer counts up? As you look a few quarters out, would your expectation be that maybe the wallet share contribution begins to pick up as these new customers realize the virtue of the network? Specifically, in growing wallet with the fulfillment product, if you can, and obviously, with analytics, that's perhaps a different conversation, but just your thoughts there.

Sure, Joe. With our business model, we actually are fortunate in that we've been able to continue to add customers or grow our customer count, and grow what that wallet share is or that average recurring revenue per recurring revenue customer. This past quarter, both customer count and wallet share were up 5%, so they are equally weighted in our overall growth. In any quarter or year, this may vary by 1% or 2%, but both remain meaningful contributors to our overall recurring revenue growth. The biggest impact on customer count is highly correlated to community-enablement campaigns. When we have strong community-enablement campaigns in a quarter, you often see a higher increase in our net customer additions. For this quarter, for example, our customer additions were 458, which is an increase on both a sequential and absolute year-over-year basis. What tends to happen is that more customers we get from community-enablement campaigns tend to be smaller customers initially, some may not have been doing anything with EDI before, while others may just have been using a minimal amount. Over time, the revenue from those customers naturally grows. So what is positive about our model is that both customer count and wallet share are solid contributors to our overall recurring revenue. Our belief is that going forward, both factors will continue to contribute strongly.

And there's nothing about what you've seen over the last couple of months, or in thinking about how the second half is forecasted, that would indicate the basic structure of what you've outlined in the past is going to differ in the next quarters or two, just in terms of the composition of your growth?

There is nothing unique as it relates to any particular quarter or the back half of the year that would indicate an outlier. Significant increases in churn or bankruptcies would impact average revenue per customer and customer numbers, but as of now we do not see any signals for adjustments in that structure.

And if I can squeeze one more in. I did want to ask whether collection activity this quarter was better, worse, or about in line relative to your expectations? I see the reserves went up a bit sequentially, nothing alarming, but curious on your thoughts there.

Sure. The accounts receivable balance and the DSO did go up a little bit sequentially, as some of our customers just take a little longer to pay, but there's nothing of concern or alarm there.

Thank you. Our next question comes from the line of Jeff Van Rhee with Craig-Hallum. Your line is open.

This is Rudy on for Jeff. Most of my questions have been answered, but just wanted to circle back to the pipeline for a second. Curious if there's anything more you can share in terms of what you're seeing maybe upmarket, downmarket, verticals, just relative to where it was pre-COVID. Just curious what you could share on the pipeline.

I would say there's not a drastically different situation. The only differentiation is that there can be different dynamics within companies where they have so much business and activity that they don't have time to take a breath and may slow down. Conversely, some companies manage to remain agile and speed up their processes. However, I wouldn't say there is a drastic difference, other than the discussions we have had around fulfillment and analytics.

Great, thanks. That's it for me.

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