SPS Commerce, Inc. (SPSC) Q3 2012 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the SPS Commerce Third Quarter 2012 Earnings Call. [Operator Instructions] As a reminder this call is being recorded. I would now like to introduce your host for today's conference Ms. Stacie Bosinoff, with investor relations.

Good afternoon everyone,, and thank you for joining us on SPS Commerce's Third Quarter 2012 Conference Call. Joining me on the call today is CEO and President Archie Black; and CFO, Kim Nelson. Before turning the call over to the company, I’ll read our Safe Harbor statement. 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 this 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 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 EBTDA 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 EBTDA measures including reconciliations of these measures with comparable GAAP measures. And with that I’ll turn the call over to Archie.

Thanks Stacie,, and welcome everyone. We had another great quarter with both revenue and adjusted EBTDA ahead of guidance. We saw continued momentum in the business and expanded our market leadership even further with the acquisition of Edifice, a leader in retail point-of-sales analytics. Additionally, we completed a successful follow-on offering, raising $58 million and strengthening our balance sheet. Revenue for the quarter increased 31% to $20.3 million and adjusted EBTDA was $2.2 million. Recurring revenue grew at 35%. We also continued to expand our customer base and captured more wallet share from our existing customers. As we continue to invest in growing the business, we remain focused on both metrics, as they represent our underlying fundamental growth strategy. Over the last year, we’ve been talking about the ongoing evolution in the supply chain market that’s providing a tailwind to our growth. The pressures of ring incremental sales and cost efficiencies are causing retailers and suppliers to seek store-level visibility to match demand with inventory as precisely as possible. Emerging challenges in the supply chain such as new distribution demands of retailers and the rise of e-commerce is causing retailers and suppliers to look for efficiency within their networks. And consumer expectations continue to increase. We see greater use of social media conversations driving awareness and creating demand for new and existing items, coupled with real-time requirements like expedited shipping and instant delivery notifications. These new technologies are creating opportunity for driving EDI strategies that lend itself well to a SAS platform. Simply put, our leading SAS ecosystem of trading partners positions us well to take advantage of the new market dynamics. At the heart of the evolution is real-time data analytics which is not only becoming necessary for success but also necessary for survival. Real-time analytics is a key theme across many verticals and software markets and supply chain management is no different. This big data capability to turn point-of-sale data into actionable intelligence is quickly becoming a strategic advantage for both suppliers and retailers. Not only does it give precise information on consumer actions, but it helps improve relationships within the network and maximizes business efficiencies. To further our capabilities in this area we acquired Edifice, which enables trading partners to more efficiently and productively share point-of-sale data to help manage supply chains. Together, SPS Commerce and Edifice have the industry’s most comprehensive set of point-of-sale data, enabling the combined customer base to have access to a better and broader set of data and an expedited suite of solutions and supply chain performance insight. Edifice's customer base is also important for two reasons. One, it creates more opportunities to grow our recurring revenue per customer. And two, Edifice serves large brand named customers who immediately help extend our leadership. We believe analytics is in early stages of development and brand-named customers will prove to be a significant competitive advantage for us. From an integration standpoint, the acquisition is going well and we are pleased with the progress we have made over the past 2 months. Our goal is to preserve the Edifice customer experience. Our sales force has already started working with the Edifice team to understand their customer needs and where we will have opportunity to expand our presence with those customers. In summary, we are very pleased with our results and are looking forward to a strong finish to the year. We saw continued execution and momentum in the business and extended our market leadership with Edifice. The successful completion of our follow-on allows us to continue to look for strategic acquisitions and we'll continue to make investments in sales and marketing. We see our market opportunity growing every day and I believe that combining solid execution with smart acquisitions will help us build greater momentum in our business. With that, I’ll turn it over to Kim to discuss our financial results.

Thanks Archie. As Archie mentioned, we had a great third quarter. Revenue for the quarter was $20.3 million, a 31% increase over Q3 of last year. The increase in revenues is a result of an increase in recurring revenue customers and an increase in what we refer to as wallet share, which is the annualized average recurring revenue per recurring revenue customer. Recurring revenue this quarter grew 35% year-over-year. Keep in mind that in Q3 we lacked the Direct EDI acquisition from 1 year ago and we’ve a partial quarter of the Edifice acquisition. The total number of recurring revenue customers increased 11% year-over-year to over 17,700. This includes approximately 300 Edifice customers. For Q3, annualized wallet share increased 21% to $4,101. Excluding the Edifice acquisition wallet share would have increased 10% year-over-year. As you look at these 2 metrics it’s important to remember that they work in concert with each other and it’s really the mix of the 2 metrics together that we focus on. Total operating expenses for the quarter were $14.2 million and represented 70% of revenue. Looking at the individual line items, sales and marketing was $7.8 million, G&A expenses were $3.7 million, R&D was $2.1 million and operating profit was $138,000. I want to point out that we had two benefits affecting the tax line this quarter totaling $175,000. Breaking this out $75,000 was related to the Edifice acquisition and $100,000 was related to a true-up from our 2011 taxes. For the quarter, adjusted EBTDA was $2.2 million compared to $1.5 million in Q3 of last year. As Archie mentioned, in September we completed a follow-on offering of 1.84 million shares, which included the full exercise of the greenshoe. SPS Commerce received net proceeds of approximately $58 million. We ended the quarter with total cash of approximately $70 million. Now turning to guidance. For the fourth quarter of 2012, we expect revenue to be in the range of $21.7 million to $22 million. We expect fully diluted loss per share to be in the range of -$0.01 to -$0.02, reflective of the additional share count. Fully diluted weighted average shares outstanding are expected to be approximately 15.6 million shares. We expect non-GAAP diluted earnings per share to be in the range of $0.08 to $0.09, with stock-based compensation expense of approximately $800,000 and amortization expense of approximately $760,000. We expect adjusted EBTDA to be in the range of $2.1 million to $2.3 million. For the full year, I’m pleased to announce that we are increasing our guidance. We expect revenue to be in the range of $76.3 million to $76.6 million. We expect fully diluted earnings per share to be in the range of $0.04 to $0.05, with fully diluted weighted average shares outstanding of approximately 13.9 million shares. We expect non-GAAP diluted earnings per share to be in range of $0.38 to $0.39, with stock-based compensation expense of approximately $2.9 million. We expect the amortization expense for the year to be approximately $1.8 million. We expect adjusted EBTDA to be in the range of $8.5 million to $8.7 million. Although we are not giving detailed 2013 guidance at this time, for modeling purposes SPS Commerce expects to have an adjusted EBTDA margin of approximately 13% in 2013. In summary, we had a great quarter. We continue to deliver profitable topline growth while incrementally increasing our adjusted EBTDA margin. We continue to execute and focus on our unique viral platform that gives us the competitive advantage in the supply chain world. With that I’d like to open the call up to questions.

[Operator Instructions] Our first question comes from the line of Laura Lederman with William Blair.

Can you give us a sense of the organic recurring revenue growth? And the organic total revenue growth? I realize that you only had the acquisition for a part of the quarter but always like to put the organic numbers in a model. And then I’ll come back with one after that.

Sure. The organic numbers for the quarter. Organic recovering revenue was 22%, organic GAAP revenue was 19%. And just from a definitional, the only thing that is different between the reported revenue and the organic is Edifice, since we’ve already lacked the Direct EDI acquisition.

Could you talk a little bit about why the recovering revenue growth is so down? You had been growing in the mid-20s. And I guess a related question is, what would you expect the revenue growth to be going forward for the long-term? And I realize you’re not giving out '13 guidance, but to give us a sense.

Sure. As it relates specific within the quarter, keep in mind that we are lapping -- we have a difficult compare from Q3 of last year. It’s the first quarter that we are, in essence, lapping the Direct EDI acquisition. That now goes into the organic number, prior to that it was not. Q3 of last year also was a large enablent campaign quarter that we are lapping. Relative to how we did, organically relative to guidance, we actually exceeded the guidance we gave on both an organic and a reported basis.

Once again, without giving guidance for '13, what do you think kind of the sustainable long-term growth rate is? An inner range is fine, too, if you’re comfortable with that, between blank and blank.

Yes. Laura, I think when we look at our business there is no change in what we see as the long-term opportunity in front of us and I think we will continue to invest aggressively in the business and we think we have a significantly large long-term opportunity.

Our next question comes from the line of Tom Roderick with Stifel, Nicolaus.

So I’m thinking about the integration of Edifice and I recognize it’s very early in the game on that, but maybe you could go back and just refresh us, what the average price looks like for Edifice? And if you’ve got any anecdotal evidence in terms of cross-sell, upsell capabilities thus far, I mean it would be great to hear about anything anecdotally. But more broadly, when do you expect that cross-sell, upsell effort to begin in more earnest?

Tom, when we first made the first acquisition our first goal was really to make sure that 1 plus 1 equals 2 and that the Edifice customers continue to have a positive experience in the customer base. I spent, and the management teams have spent, a lot of time together. We’ve spent time with customers. I think in general there’s been a very positive reception from the Edifice customers and we’ve achieved our goals and feel very good about where we’re going on it. These are larger customers and the cross-sell opportunities are going to be longer sell cycles but I think we’ve begun that. But I would not expect any short-term, significant upsell/cross-sell opportunities.

Okay. And Archie, just thinking about the channel, I might have missed it, but can you give us a sense or just an update as to what percentage of new bookings are coming from the channel and any particular partners that you are generating a lot of traction with there?

Yes. From an update standpoint we give, I think annually we give precise numbers on channel. It continues to be a very strong part of our business. And as we look out, there has been no change in our long-term view that the channels will continue to be a more significant part of our business going forward and our key to us becoming -- really reaching our long-term goals as a business.

Okay. Kim last one for me. You talk about 13% EBTDA margins for next year which would be a little bit up from here. But can you just give us a sense just as to what -- how we ought to think of gross margins in light of the recent quarter and over the next kind of four or five quarters? Should they be flattish with where they were this quarter or kind of more in line with the historical normal around 73%? And then just as you look at the leverage that drives you to 13%, any particular 1 line item that we ought to get that from? Should that come from sales and marketing?

Sure. As it relates to gross margins, you did see this quarter a slight lower amount of gross margins than what you had seen previously. That’s really -- as we now have incorporated Edifice and the blended average between the 2, the Edifice business had a lower gross margin than the stand-alone SPS Commerce business did. So I think if you look at the quarter, that’s probably more reflective of the blended mix between the 2. As it relates to, for 2013 how we get to that adjusted EBTDA margin of 13%, we aren’t guiding line by line. We are committing to that improvement on the bottom line. We'll take the opportunity to reinvest as much dollars as we can back into sales and marketing as long as we are able to still hit that goal of approximately 13% adjusted EBTDA margin. So we’ll look at ways to become more efficient in scale across all line items with the opportunity to reinvest back in sales and marketing.

Our next question comes from the line of Richard Davis with Canaccord.

Archie, as you guys kind of move upmarket, the core of the selling effort has been in-house sales. At what point -- is it 1 year, 2 years, I don’t even know, do you start to have to adjust the sales model? Do you get to the point where you actually would ever conceive of having “a caring people” trooping around? I know some people go out of the office but most of it is in-house. How do you think about the evolution of the sales methodology and process?

Yes, I think when you look at our sales force as it relates at least to the supplier sales group, it has been a continued evolution and we have different levels of sales executives within the supplier sales and we have already addressed that. So there is a group that is doing that, where they are working with the larger accounts. As we’ve been talking over the last 2 years, we are seeing more larger and larger deals. It is an evolution and we are seeing that happen and that has happened over the last 12 months. And that’s really a great way -- place to put our more experienced sales reps.

Our next question comes from the line of Patrick Walravens with JMP.

Archie, on Edifice, from an integration point of view, what have you done already and what remains to be done?

So when you look at the Edifice product offering, first off, we had a point-of-sales product offering before. And really we look at the Edifice product offering as the offering for the top end of the market or a -- really, an enterprise-wide solution. Very much like we have in the integration product. What we have begun doing is the data acquisition is starting to be combined and then the back end of the solution set, not the front facing to the customers, the back end is becoming combined. The sales forces are starting to become trained on each other’s product offerings, so that’s combined. And we envision over really the next 1 to 2 years for that to continue to evolve.

Okay. And Kim, pretty basic question here, but what is it about Edifice that makes the gross margin lower?

So if you think about the Edifice business that has larger customers, if you think about the activities to get that customer up and going, since it is a little more customized, meaning it’s for a larger accounts, there's a little bit more activity and work that's done. The way our business models work is all of the implementation costs all go into cost-of-goods sold and have a direct impact into gross margin.

Our next question comes from the line of Scott Berg with Northland Capital Markets.

A couple of quick questions. First of all on your EPS guidance. A little bit lower than where I was at for the fourth quarter, and I think the Street as well. But yet out-performance in the third quarter. Is that reflective of some costs that were pulled forward or some additional integration costs relative to the Edifice acquisition?

So I would look at that as, first, the share count went up. So we did our follow-on after we had given previous guidance. With a higher share count that has a direct impact relative to EPS. So that would be your primary driver. Only other change is as it relates to Edifice. But the biggest change is really going to be the number of shares in which you are calculating your EPS off of.

Got it. And then, with regards to costs from the Edifice acquisition now that you have the asset in hand, are there any near-term costs that could likely be pulled out of that in the fourth quarter as we look to model the fourth quarter?

The fourth quarter guidance takes into account the combined business. If you go back from when we announced the Edifice, you had sort of our old guidance. Our updated guidance with Edifice. If you look at what that is from the adjusted EBITDA, you'll see that those numbers are actually very consistent with before. Before we had an implied Q4 adjusted EBITDA of between $2 million to $2.3 million. Our revised guidance is between $2.1 million to $2.3 million. So the bottom end is up slightly, the top end has remained the same.

Great. And then the last question from me. Can you talk about organic ARPU in the quarter? If we strip out Edifice? Trying to compare this historical business on a apple-to-apples basis.

Sure. As it relates to organic ARPU in the quarter it was 10%.

[Operator Instructions] Our next question comes from the line of Jeff Houston with Barrington Research.

My question's -- regarding the recurring revenue customer additions. How many of them outside of Edifice were what you would classify as larger suppliers?

As it relates to the net customer adds, we don’t really break out -- we show an absolute number. So outside of Edifice in the quarter, the net customer add was 369, reflective of the enablement activities within the quarter. We don’t really break out a specific number for the larger customers within there.

I’m just trying to get a sense of what your attraction is with the larger suppliers is. Is maybe another way to look at it is, has the percent mix increased from a few quarters ago or is it remaining about the same?

I think what you’re seeing, Jeff, is the continual evolution of the average new deal size, moving up over time. From a quarter-to-quarter you can get some anomalies. Again, one of the things that forces an anomaly is when you have high enablement activity and you have a lot of smaller accounts, so the blended average tends to look smaller. But I think what you’re seeing is a continued evolution of more larger deals being sold each quarter and that evolution continues.

Our next question comes from the line of Michael Huang with Needham & Co.

Just a few questions for you. So first of all, in terms of the customer adds. I know excluding Edifice it was down a little bit quarter-on-quarter despite what I believe was a really strong enablement campaign heading into the quarter. I was wondering if you could comment on what you’re seeing in terms of conversion rates on these enablement campaigns. Is it staying relatively steady with what you’ve seen historically? Are things getting any weaker given, just overall, kind of macro concerns out there and how should we think about enablement campaigns and conversion rates trending into Q4?

I think when you look back over the last several years, the conversion rates have been relatively consistent. Maybe slightly up but not significantly up. And that continues to be the case. So no major cases, either positive or negatively on conversion rates.

And as it relates to how you should think about it from our customer adds, we had mentioned on previous conference calls that Q2 was, we had anticipated and was the highest from an enablement campaign activity for this year in 2012. Q3 was certainly nice but Q2 was the highest for us within this particular year. From a seasonality perspective, Q4 is the lowest from a number of enablement campaigns and that really is directly related to many retailers focused on the holiday season. So from a modeling perspective, you can look back at our historical but what you will see there is that Q4 has historically been the lowest net-customer-add quarter.

Okay, great. And as I think about your push up market and certainly Edifice will help out that proposition. How do you envision that may ultimately tweak your revenue model if at all? Was wondering, are there more economics to be had, driven by these retailers as opposed to primarily just by suppliers?

I think the economics will primarily continue from the supplier side. That’s really our business model. Retailers are really a very important part from a lead-generation perspective. I don’t really see that changing. As we move upstream however, to larger suppliers, that will have a direct impact on the ASP. But our pricing model and our business model still is primarily focused on gaining the economics from the suppliers not the retailers.

Actually, one last question. How are the efforts going outside of North America? If you could just comment on kind of what you’re seeing out there, that would be great.

Yes, I look at 2 -- really, 2 different regions that we are focused on is Asia, and that continues to have very strong momentum. And again, our investments are relatively modest but you can make the statement it is the fastest parting geography in our business and it continues to be strong. And Europe, we continue to make progress, we continue to expand slowly and make sure that we have a footprint to be able to invest in the future. Again, the biggest challenge we have investing internationally is that there is so much investment to be had in North America and there is so much opportunity in North America that, that is still getting the lion’s share of our investment. But we want to make sure that we continue to invest in other areas so that we are set up for the long term.

Our next question comes from the line of Jeff Van Rhee with Craig-Hallum.

Just a couple left here. In terms of the Edifice and what you’ve learned, what have you found that the Edifice base is using on the EDI side?

Well because it is larger customers, for the most part they are using installed software. They do it do it yourself. They’ve typically been at EDI for a long period of time before there were really SAS solutions. So they built out a software system and internal resources.

And just one follow-on there before I move on. In terms of the Edifice and now that you’ve had a little bit of a chance to look at exactly what’s going on inside, what’s been the area of the greatest surprise pro or con?

I think two things. One, I think the skill-set of the Edifice team, I’m very, very impressed with them. More impressed as we’ve worked together with the Edifice team. And I guess how passionate their customers are about point-of-sales and how important and strategic it is to their business and how they are driving retailers to share more point-of-sales data and it is part of their roadmap and it is very, very strategic for them.

And then just lastly on the sales front. Where did you end on quota reps? How many were Edifice adds and how many native?

Sure, we ended the quarter with 150 sales people. That’s up from 133 last quarter. Of the 150, 5 were Edifice.

[Operator Instructions] I’m showing no questions. I’ll turn it back to management for closing remarks.

Again, thank you very much for attending today and look forward to talking to you all in the future.

Ladies and gentlemen this does conclude your conference. You all may disconnect and have a good day.