Earnings Call Transcript - SPSC Q1 2023

Irmina Blaszczyk, Investor Relations

Thank you, Andrew. Good afternoon, everyone, and thank you for joining us on SPS Commerce First 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 reverse 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 at 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 our 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.

Archie Black, CEO

Thanks, Irmina, and welcome, everyone. The first quarter of 2023 marks a strong start to the year as macro and omnichannel dynamics continue to drive the need for efficiency across the retail industry. We continue to see strong momentum in fulfillment and analytics and achieved total revenue of $125.9 million. Both total revenue and recurring revenue grew 20%. Before I continue with my prepared remarks, I’d like to acknowledge the announcement we made in early March about my planned retirement. The Board is in the process of conducting a search for my successor and in the meantime, we continue to execute our strategy to be the world’s retail network. The expertise and knowledge we gained from working with over 115,000 trading partners worldwide uniquely positions us as a business adviser to existing and potential customers who are looking to improve efficiency and productivity. Over the past 3 years, retailers and suppliers have faced changing consumer behavior, growth in sales channels and volatility in the supply chain. Coupled with ongoing macroeconomic uncertainty, the strain on the retail industry has been substantial, uncovering inefficiencies among the trading partners of all sizes. SPS Commerce is proud to work with retailers and suppliers across different industries, helping growing businesses embrace automation and position them for success. We recently launched a community campaign for the True Value company, a wholesaler with over 4,500 independent retail locations worldwide and one of the largest distributors in the U.S. Our initial engagement to address specific EDI inefficiencies led to a full business assessment by SPS. Having recognized our ability to improve the quality and adoption of EDI within their vendor community, True Value decided to partner with SPS to standardize electronic order fulfillment with over 1,000 vendors. We believe this will result in improved order and inventory management, cost savings and trading partner performance across key metrics such as fill rates and ship timelines to deliver a better customer experience. SPS Commerce’s network model, our channel partner collaboration, EDI expertise and our suite of solutions are key differentiators and underscore our competitive advantage. Orveon, a private equity-backed collective of premium cosmetic brands was focused on long-term omnichannel success and was introduced to SPS during an ERP implementation. Making EDI a priority, Orveon became a fulfillment customer. And in an effort to optimize the omnichannel experience, they subscribe to analytics to gain visibility into inventory levels and sell-through across their various sales channels. Orveon is a prime example of a customer who is successfully navigating the omnichannel journey, leveraging SPS’ fulfillment and analytics solutions to work with trading partners that include Bloomingdale’s, Macy’s and Nordstrom. In summary, the ongoing expansion of our network is a reflection of SPS’ ability to help retailers, suppliers and emerging brands successfully and cost-effectively adapt to omnichannel retail while they future-proof their investments in supply chain automation. I believe our strategy and our people position SPS Commerce for continued success as we capitalize on the growth opportunities ahead of us. With that, I’ll turn it over to Kim to discuss our financial results.

Kim Nelson, CFO

Thanks, Archie. We had a great first quarter of 2023. Revenue was $125.9 million, a 20% increase over Q1 of last year and represented our 89th consecutive quarter of revenue growth. Recurring revenue this quarter also grew 20% year-over-year. The total number of recurring revenue customers increased 13% year-over-year to 42,750, and wallet share increased 7% to 11,050. For the quarter, adjusted EBITDA grew 16% to $37 million compared to $31.8 million in Q1 of last year. We ended the quarter with total cash and investments of approximately $233 million. Now turning to guidance. For the second quarter of 2023, we expect revenue to be in the range of $128 million to $128.8 million, which represents approximately 17% to 18% year-over-year growth. We expect adjusted EBITDA to be in the range of $36.4 million to $37 million. We expect fully diluted earnings per share to be in the range of $0.30 to $0.31 with fully diluted weighted average shares outstanding of approximately 37.5 million shares. We expect non-GAAP diluted income per share to be in the range of $0.62 to $0.63 with stock-based compensation expense of approximately $12.8 million, depreciation expense of approximately $5 million and amortization expense of approximately $3.9 million. For the year, we expect revenue to be in the range of $525.5 million to $527.6 million, representing approximately 17% growth over 2022. We expect adjusted EBITDA to be in the range of $154.2 million to $155.8 million, representing approximately 17% to 18% growth over 2022. We expect fully diluted earnings per share to be in the range of $1.55 to $1.58 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 $2.67 to $2.70, with stock-based compensation expense of approximately $45 million, depreciation expense of approximately $19.8 million and amortization expense for the year of approximately $15.6 million. For the remainder of the year, on a quarterly basis, investors should model approximately a 30% effective tax rate calculated on GAAP pretax net earnings. Beyond 2023, we maintain our annual revenue growth expectations 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, our history of strong financial performance and 89 consecutive quarters of revenue growth underscore the stability of our business model and our consistent execution. Despite ongoing macro dynamics, we believe we are better positioned than ever to deliver on our long-term targets and sustained profitable growth. And with that, I’d like to open the call to questions.

Operator, Operator

The first question comes from Scott Berg with Needham & Company.

Scott Berg, Analyst

Congrats on the great quarter. I guess, I got 2. Let’s start with the revenue outperformance in the quarter. It was roughly double what it was in Q1 a year ago. What went better in the quarter than maybe you expected? Or was this more of a case of, I guess, a change in guidance philosophy or you’re maybe a little bit more conservative on your guidance this year, just given what the macro backdrop is like.

Kim Nelson, CFO

Scott, I’ll take that one. As it relates to the outperformance, it was really across the board. So we had solid execution on the fulfillment as well as our analytics product. We also, in this quarter, did have higher than typical one-time revenue as well. That is not something that you would anticipate or we would expect to continue going forward. That was really a mix of some of the community activity and a little bit of other one-time revenue.

Scott Berg, Analyst

Got it, helpful. And then as we think about the macro a little bit, I know we’ve had a chance to discuss this, I think a lot over the last 3 or 4 quarters, but if you break down by geographic region on where your presences are, maybe it’s Asia Pacific, obviously, with your foothold out of Australia, U.S. and Europe. Are you seeing any changes there that are kind of noteworthy or anything that might be different than your expectations 6 to 12 months ago?

Archie Black, CEO

Yes, Scott, thank you for the question. We are not really observing significant changes. The primary theme in retail, aside from omnichannel strategies and meeting consumer expectations, is the difficulty retailers and suppliers face in forecasting their business due to the lack of comparables. When you look at last year's first quarter or even the years 2021 and 2020, each year presents unique challenges. This continues to be the primary concern. Consequently, everyone is understandably cautious. In Europe, the focus is heavily on analytics, and we continue to see strong momentum there. Australia operates as a comprehensive ecosystem, and we are also experiencing strong momentum in that region. Lastly, in Asia, we are primarily supporting customers in the North American supply chain, but we aren’t encountering many significant changes there either.

Scott Berg, Analyst

Archie, just a quick follow-up on that. I know China has opened up over the last 90 to 120 days more from a travel perspective than a supply chain perspective necessarily. But does that kind of loosening of some of their restrictions, and I guess, borders, does that create an opportunity at all for you maybe as a minor tailwind for the business? Or is it really kind of a non-event for you all?

Archie Black, CEO

Frankly, it’s somewhat of a non-event. It really comes down to the suppliers. And typically, it’s the manufacturing that is in China. So where that manufacturing takes place. At the end of the day, it really doesn’t affect us and doesn’t really create an opportunity or a threat for us.

Operator, Operator

The next question comes from Parker Lane with Stifel. Archie Black, CEO, mentioned that it’s somewhat of a non-event. It mainly depends on the suppliers, and typically, the manufacturing occurs in China. Therefore, the location of that manufacturing does not significantly impact them or present an opportunity or threat.

Parker Lane, Analyst

Congrats on the quarter. Kim, I noticed that wallet share was down a touch quarter-over-quarter. Wondering if you could dive into the dynamics of that? I know it’s not a terribly large decline. And then just give us a reminder on the balance of wallet share and net new customer additions that you expect in the growth algorithm this year.

Kim Nelson, CFO

Sure, Parker. So from a year-over-year perspective, it grew about 7%. But to your point, if you look at the absolute dollars, Q4 to Q1, there was a slight sequential decline. That’s driven from an acquisition we made in Q4 of InterTrade. As a reminder, when we made that acquisition, we said that would add about 2,500 customers. But their average revenue per customer is much smaller than ours, roughly around $3,000. And so that is why you see that sequential decline because Q1 is the first full quarter where we have all of that InterTrade revenue. Also, just of note, that has occurred in some other acquisitions as well. So if you were to look back at Q4 2021 compared to Q1 2022 based on an acquisition we made in Q4 2021, you saw a similar type of dynamic.

Parker Lane, Analyst

Got it. I appreciate that. And can you talk a little bit about gross margin leverage in this model longer term and just the impact that some of the recent acquisitions have had on gross margins where you expect the long-term model to shake out on that front?

Kim Nelson, CFO

Sure. So if you think about where we’re at from a gross margin, we’re at, call it, sort of that mid-ish to maybe a little bit above mid-ish 60s from a gross margin perspective. Longer term, we believe that can be in the low 70s. The biggest driver of how that will change over time to get us to the low 70s is really primarily going to be around scaling. Cost of goods sold is an area we’ve made a lot of investments in, in the overall customer experience. And over time, we believe we’ll be able to grow into a lot of those investments. For any acquisitions we’ve made where the asset that we’ve acquired has lower gross margins than we do, we do believe that there is nothing that would make them not equal our gross margins over time. So nothing has changed from our belief in the ability to have gross margins in the low 70s in the future and that would align with when we’re at, call it, that sort of mid-30s from an adjusted EBITDA margin perspective.

Operator, Operator

The next question comes from Jeff Van Rhee with Craig-Hallum.

Jeff Van Rhee, Analyst

Congrats on another great quarter. I have a couple of questions. I would like to hear more about the True Value opportunity. Specifically, what do they currently have? What are they using? What are you replacing? How did they find you? I’d appreciate some additional context on how you reached this point.

Archie Black, CEO

Yes, there are many manual processes typical for a retailer. While some documents are automated, it's not uniform across all of them. This company operates somewhat differently, but their enablement campaign is quite standard. They act as a distributor between themselves and the retailers. We will support their suppliers by conducting a typical campaign that includes recording a webcast, collaborating with their team, making calls, and allowing suppliers to use our solution or test and certify with a competitor's solution. We will coordinate closely with True Value, and while there are a considerable number of suppliers involved, we believe they represent a standard type of retailer. Ultimately, they function more as a distributor than a traditional retailer since they serve independent stores.

Jeff Van Rhee, Analyst

On the acquisition front, just any update on sort of pricing, pricing expectations from potential sellers, pipeline of future deals that you’re looking at or how it’s changing?

Archie Black, CEO

Yes, we remain very active. However, it is quite challenging. If companies have raised funds in the last two years, many have unrealistic valuation expectations. We are not going to pay valuations that were normal 18 months ago but are outdated today. This creates some headwind, but over time, many of these valuations tend to align more closely with reality. Additionally, for those companies funded by investors, we are seeing a shift towards profitability. Many were burning a lot of cash, which poses problems for us, and we prefer to avoid that. Some companies are starting to get their operations in order. We will continue to be aggressive and actively seek opportunities, but we will remain disciplined.

Jeff Van Rhee, Analyst

Last for me, in terms of the most recent, call it, last 12 months, give or take, a cohort of suppliers coming on to the network, any observations about how this cohort might be behaving differently with respect to the number of connections, the frequency or pace at which they start to add new connections, the size that they come in. Any notable differences about the most recent cohort that stands out.

Archie Black, CEO

That’s a good question. We examine this regularly, and it tends to be quite typical. Over time, particularly with the committee enablement campaign, we see great upsell opportunities with those suppliers. It does take time, but there’s nothing unusual about the last 12 months specifically.

Operator, Operator

The next question comes from Joe Vruwink with Robert W. Baird & Company.

Joe Vruwink, Analyst

Yes, I guess similar to the last question, maybe similar on just the macro topic with a retailer bankruptcy now in the news. Is there any change in just how suppliers currently on the network kind of absorb information like that? Like is there a certain immediacy where that connection, that particular connection just goes away? Or are there sometimes opportunities to actually use it as a reengaging event and kind of reeducate on what the platform can bring. And so you don’t end up losing a lot of business? How would you kind of approach that proposition these days?

Archie Black, CEO

Yes. When considering suppliers, some rely solely on SPS for a specific retailer, which puts us at risk of losing them. This risk is typically higher when we have a strong relationship with that retailer. In the case of Bed Bath & Beyond, we currently do not have many suppliers in that situation. Other suppliers might work with multiple retail partners, and it's common for them to adjust their trading partners over time. Larger suppliers may sometimes maintain around 50 retailers, but they frequently add and remove partners in the process. This illustrates the strength of our business model, and we don’t anticipate a significant impact from such changes. While we prefer not to lose any business, it remains the responsibility of our sales and marketing teams to keep all our suppliers informed about the benefits of SPS Commerce. There may be heightened efforts in response to events like Bed Bath & Beyond, but conversations with retailers indicate that this situation is more of a unique occurrence rather than indicative of a larger trend in retail.

Joe Vruwink, Analyst

Okay. That’s all helpful. And then just based on what one of your peers in the supply chain category had to say last night, it seems like kind of rejuvenated investments in the stores, brick-and-mortar stores is something that’s taking place. Is there maybe a lagged effect when you hear about retailers sinking investment into things like point of sale or inventory management. Could your analytics product ultimately benefit, but it may benefit after those commitments? Or is there not a relationship at all?

Archie Black, CEO

Yes, I think a couple of things. One, not all that surprised by the results last night. I assume you’re referring to Manhattan. And just one of the big themes we’re seeing in retail is they met the demand to the consumer in 2021 and 2022. And now they’re really trying to get the back-end systems. So there are different lag effects for us. For instance, if a retailer is automating their distribution center, so they’re going to start receiving product with a barcode label. That will typically, upon implementation, lead to a potential enablement campaign. And we have a partnership there. So there are different lagging or leading indicators for us that can be a positive; I don’t want to overblow it, but they can be a positive. If again, like if a retailer is buying Manhattan Associates, they need to get their suppliers to behave differently. They need to send an advanced ship notice, they need to send a barcode label, and that’s where we come in. We enable those suppliers; we do an enablement campaign for those documents. So a lot of those things are real positives and we are seeing investment from retailers because they have met the needs of the consumer, for the most part, but they’re not doing it efficiently, effectively or necessarily profitably. So there’s a big push.

Joe Vruwink, Analyst

And does that relationship hold with the store activity? I think you have like point-of-sale, just wanting to have more accurate placement of inventory if you’re a supplier, visibility into kind of final demand? Does that kind of follow along?

Archie Black, CEO

It does. Obviously, the point of sales is most valuable for the store activity, either the store for the consumer buying at the store or also one of the trends we’re seeing is stores are becoming distribution centers. So having inventory on hand at the stores, what’s selling. So those are positives for us. Again, I don’t want to overblow it, but they are positives for us.

Operator, Operator

The next question comes from an analyst with Northland Capital Markets.

Unidentified Analyst, Analyst

Congrats on the quarter. Just wondering if you could talk about a little bit more about the level of activity that you’re seeing from channel partners. Are you still seeing strong contributions from them? And are there any changes to that relative to maybe 2020 levels?

Kim Nelson, CFO

Sure. So channel sales in that lead generation engine still remains very important and robust for us. There are some nuances depending on which ERP system, but that still remains quite positive and quite robust.

Unidentified Analyst, Analyst

Got it. Very helpful. And then on the revenue guidance provided for Q2 and the full year, I believe there is a slight deceleration embedded for the second half of ‘23. Can you just walk us through how you’re thinking about that trajectory there? Was there maybe some pull forward that you saw in the first half or maybe a little bit more cautiousness baked into the guidance there?

Kim Nelson, CFO

Sure. So a couple of things I can point you to is, one, there were a couple of acquisitions that we made in the latter part of ‘22 that we lack in the latter part of ‘23. So that has been reflected into the guidance itself. Also, just as a reminder, the guidance that we just provided for our revenue expectations for the year at a midpoint is about $2 million higher than what we had anticipated just 90 days ago.

Unidentified Analyst, Analyst

Got it. Okay. And then final question for me would be on the Analytics piece of the business there. Did you guys see any acceleration this quarter? How did that part of the business perform?

Kim Nelson, CFO

Sure. So Analytics grew about 10% year-over-year. And our expectation would be that we would expect to see Analytics grow within a couple of percentage points similar to that 10% number. So stay basically at 10% or plus or minus 1% or 2%.

Operator, Operator

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. You may now disconnect.