SPS Commerce, Inc. (SPSC) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SPS Commerce first quarter 2016 earnings conference call. [Operator Instructions] I would now like to turn the conference over to Nicole Gunderson, Investor Relations. Please begin.

Good afternoon, everyone, and thank you for joining us on SPS Commerce's first quarter 2016 conference call. We will make certain statements today including with respect to our expected financial results, go-to-market strategy and efforts designed to increase our traction and penetration with retailers and other customers. These statements are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially. Please note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Please refer to 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 on our website spscommerce.com and at the SEC's website SEC.gov. In addition we are providing 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 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'll turn the call over to Archie.

Thanks, Nicole, and welcome, everyone. We had a strong start to the year. Total revenue grew 23% to $45.6 million, recurring revenue grew 25% and adjusted EBITDA was $6 million. We experienced solid business momentum, as the team executed across all fronts and the pipeline remained strong. Our business success continues to be driven by the ever-expanding adoption of omni-channel strategies, as we work as a strategic advisor to both retailers and suppliers to help them grow their businesses and stay ahead of the competitive curve. Retailers are increasingly focused on growing their digital channels and rethinking the role of the story to align with their e-commerce initiatives, as today's consumers expect a nearly endless selection of product across all channels. This pressure has left many retailers scrambling to keep up with the pace of assortment expansion. Our recent industry survey highlighted that 75% of retailers listed e-commerce growth as their top priority in the coming year. Additionally, 80% of suppliers indicated streamline fulfillment as their number one priority. Our broad-based network places us at the center of the retail ecosystem and enables us to work as a trusted advisor to both retailers and suppliers, as they adapt to the needs of today's consumer. A recent example of this is the community program we ran with ICONIC, a high-growth leading online fashion retailer in Australia and New Zealand. The company is setting the standard for Australian online retail by offering same day delivery and overnight shipping to customers, and chose SPS to help them implement a new supply chain strategy. Using our fulfillment product, the company has streamlined and ordering, receiving an invoicing process with suppliers. By partnering with SPS, THE ICONIC was able to move their suppliers to electronic order fulfillment, resulting in end-to-end visibility and agility they need to meet the consumers expectations. Today, the only way to meet the demands of the consumer and build their loyalty is through a more agile supply chain. In order to align their organizations with the needs of the digital consumers, retailers must deploy e-commerce strategies such as drop ship and buy online, pick up and store. It is imperative that retailers work with suppliers to enable rapid fulfillment to consumers to remain competitive and maintain the integrity of their brand. SPS Commerce enable suppliers and retailers to quickly adapt and collaborate to address consumer demands and remain competitive, while growing their brands. An example of our work with customers on these initiatives is Shop.com. Shop.com is one of the world's top 100 internet retailers, providing robust product selections and comparison shopping from over 2,000 retailers, such as BestBuy, GAP, Macy's and Overstock. As increasingly price-sensitive customers came to its website looking for the best deals, Shop.com found itself becoming more of a retailer aggregator than a household name, often sending consumers to other retailer's sites. They quickly realized that they needed to increase their own brand awareness in order to continue to grow. Since Shop.com does not carry inventory and warehouses, this meant accelerating drop ship capabilities to broaden their product selection across strategic categories. Shop.com turned to SPS to tap into a large network of suppliers and identify new suppliers who are willing to ship directly to consumers, while providing a seamless brand experience. In partnership with SPS, Shop.com has deployed a successful drop ship program from the ground up. Overall orders and revenue jumped 45%, since launching with SPS, demonstrating the power of SPS retail network. Collaboration between suppliers and retailers further enables trading partners to address consumer needs and drives growth and efficiency. Through analytics, suppliers can provide strategic suggestions on inventory to improve margins and sell-through, driving growth and efficiencies for both retailers and suppliers. As SPS Commerce grows, we continue to invest in building a world-class management team to go after the multibillion dollar market opportunity in front of us. Last month we announced the hiring of Dan Juckniess as our Chief Sales Officer. In this newly created position, he will manage the sales strategy for all SPS Commerce products across the full spectrum of customers in the SPS retail network. Dan brings deep varied experience in enterprise cloud sales at high growth companies. As we discussed on our last call, we have expanded our sales hiring efforts and added recruiting resources. During the quarter we added 10 net new sales reps and are tracking to our plan of adding 25 to 35 new sales people in 2016. We are confident in our ability to continue to grow the sales organizations to attack the large global market opportunity in front of us. In summary, I am pleased to report a great start to 2016. We continue to execute on all fronts. SPS remains a primary beneficiary of omni-channel trend and we remain well-positioned to extend our market leadership. With that, I'll turn it over to Kim to discuss our financial results.

Thanks, Archie. We had a great first quarter. Revenue for the quarter was $45.6 million, a 23% increase over Q1 of last year and represented our 61 consecutive quarter of revenue growth. Recurring revenue this quarter grew 25% year-over-year and 20% organically. The total number of recurring revenue customers increased 6% year-over-year to approximately 23,800. For Q1, wallet share increased 17% year-over-year to approximately $7,000. For the quarter adjusted EBITDA was $6 million compared to $4.7 million in Q1 of last year. We ended the quarter with total cash and marketable securities of approximately $133 million. Now, turning to guidance. For the second quarter of 2016, we expect revenue to be in the range of $46.7 million to $47.2 million. We expect adjusted EBITDA to be in the range of $5.1 million to $5.6 million. We expect fully diluted earnings per share to be approximately breakeven, with fully diluted weighted average shares outstanding of approximately 17.3 million shares. We expect non-GAAP diluted earnings per share to be approximately $0.19 to $0.20, with stock-based compensation expense of approximately $2.2 million, depreciation expense of approximately $1.9 million and amortization expense of approximately $1.2 million. For the full year, we expect revenue to be in the range of $192.1 million to $193.6 million. We expect adjusted EBITDA to be in the range of $25.7 million to $26.5 million. We expect fully diluted earnings per share to be in the range of $0.18 to $0.21. We expect fully diluted weighted average shares outstanding of approximately 17.3 million shares. We expect non-GAAP diluted earnings per share to be in the range of $0.93 to $0.95, with stock-based compensation expense of approximately $8.5 million, we expect depreciation expense of approximately $7.5 million and we expect amortization expense for the year to be approximately $4.8 million. For the year you should model approximately 40% effective tax rate calculated on GAAP pre-tax net earnings. We expect to pay nominal cash taxes in 2016 due to our NOLs. In summary, we had a strong first quarter. Looking to the rest of the year, our new business pipeline remains robust, as the retail industry increasingly adopts omni-channel strategies. We look forward to expanding our market leadership and we are confident in our ability to achieve our long-term targets. With that, I'd like to open the call to questions.

[Operator Instructions] The first question is from Tom Roderick of Stifel.

I know you've been getting questions all quarter on the sort of sales hiring plan and the retention and you added 10 in the quarter. So a good start to the year. Can you talk a little bit more about some of the changes you put in place from a retention standpoint? How you feel those are impacting? What you're doing to keep folks around there? And as we get into sort of the heart of, call it, graduation and then the recruiting season, maybe talk a little bit more about how much you're putting in way of additional resources towards recruiting, that's supposed to how you might have treated it last year?

Yes, we made significant changes over the last three months as far as compensation. And then we've also really looked who we're hiring in our hiring processes. And I will tell you that the first quarter, its one quarter, so you got to take it in perspective our hiring. We've clearly added recruiting capacity. So our hiring was up and our retention was at historical levels, what we've experienced in the past. So feel very good about all fronts. We will be going into the season of college graduation, we'll hire -- I would expect hiring to be strong then, and it sometimes is in Q2, sometimes in Q3. So depending on when we decide to have them start will affect that. Again, we're trying to reiterate to people is that we're taking a long-term view and that we think we'll be back to the historical levels of 25 to 35. And I think the first quarter was a good start to the year on that front.

Another follow-up question. Another topic I suppose you're probably getting a lot of questions on is just the idea of the addressable market and where the market might be in its evolution of maturity and penetration. How do you guys look at that TAM today? And what are the metrics that you track that gives you a sense that it's still well underpenetrated? I don't know if that's lead, lead-gen, conversion rates. But maybe you could share with us some of the metrics that you track to give us a sense that the market sort of remain as healthy and as open as you've conveyed in the past?

So as it relates to the TAM, we still believe it's a multibillion dollar opportunity. We conservatively put that at about $4 billion total addressable market relative to where we will be this year. There is obviously -- we saw ample of opportunity and runway in front of that. The way I look at it is there's really is two component, there is a customer aspect to it and then there is the revenue per customer aspect to it. And when we look at how we determine the TAM, we believe globally the customer side of that's about 200,000, of which through the first quarter we have a little over 23,000. So still lots of opportunity to add customers. As it relates to the revenue per customer, we believe that TAM is about 20,000, of which through Q1 we're at about 7,000. So on both of those metrics, still lots of opportunity for us to go after that. The way we have conservatively look at the TAM, it's really focused on two products, the fulfillment product and the analytic product. And as it relates to our approach to go after that, we really believe we have that in place. We have two very strong lead generation sales engines and we have a very large direct sales force that helps convert those new sales either with a new customer or upselling an existing customer. So we believe we have what is necessary in place to go after that TAM.

Kim last one for me, either of you guys can take this. But the number I thought that stood out in terms of exceeding expectations was probably on the recurring revenue per customer, up 17% year-on-year. And I was wondering if you could talk a little bit more what the drivers were in that's and what the role of analytics played within that up 17%?

For the 17%, that includes the ToolBox acquisition. So that's the reported number. The organic equivalent to that is 13%. So the customer at 6% and the organic revenue per customer is at 13%. So we continue to see nice strong revenue per customer in sort of that low double-digit. There isn't anything particular in the quarter that I would highlight different than, for example, the last couple of quarters as it relates to the organic growth and revenue per customer. It's a continuation of multiple products, size of customer and existing customers adding more trading partners and connections, and how they're doing business with us.

The next question is from Scott Berg of Needham & Company.

This is [technical difficulty] in for Scott. Just a couple of quick questions. I guess the first one is, can you talk about why gross margins fell down year-over-year?

So as it relates to gross margin that is directly related to the acquisition that we made at the beginning of this year, the gross margins associated with ToolBox, we're at a much lower gross margin than our business there, closer to a 50%-ish gross margin. So you'll see in the quarter and what the expectations would be for the remainder of this year, as there is pressure put on that gross margin. So all else being equal, the impact of the ToolBox acquisition into SPS Commerce puts pressure of about 1% on the gross margin in the short-term. The short-term is for this year in 2016.

So for 2017 that should normalize back to I guess 68.5% or 69% from last year?

Longer-term we believe our gross margins will be in the low-to-mid 70s, but that's a longer-term number. You'd expect once we have gotten through about 12 months of combining, the two entities, the expectations is you would see gross margin improve over time.

And then, with the new Chief of Sales, I guess, what is potentially different that he is bringing to the company now, kind of the impact you've seen or you plan on seeing in the next 12 to 18 months?

Well, yes, he's been here three weeks now. So obviously he's been well received by the company and the by the sales leadership. I think it's really a continued evolution of our executive management team. As we hired a Chief Marketing Officer in '12, a new CTO in 2013, a Head of Human Resources, Chief Human Resources Officer in '14, and then last year we hired a Chief Customer Success Officer. So it's really bringing the multiple sales groups together and help us drive for the next level.

And the next question is from Matt Pfau of William Blair.

The first one, Kim, I don't know if I missed it, but did you give out the organic recurring revenue growth?

Organic recurring revenue growth was 20%.

And then also had a follow-up on these sales hiring. What are you seeing out there in terms of the quality of the candidates that you've hired? Has that stayed within historical levels? And then also in terms of the compensation that you've been having to pay out to get new heads on board, has that also been around your historical levels?

Yes, it has been. The compensation has been around our historical levels. As far as seeing candidates, I think we're doing a better job on hiring, so I think we're getting better candidates. We have the recruiting capacity. I think the improvements in our whole recruiting process will result in better candidates. And obviously, it's low on employment, but there is a lot of great candidates out there, it's just a little bit hard to find them. And once we find them, we tend to be able to bring them and show them the vision of SPS Commerce, that we're a long-term high-growth business in a huge TAM. And that's a story to the sales team to be able to recruit them. And I think we're able to do that successfully. So we're seeing great candidates out there and feel better about the new crop of people that we're hiring than ever before.

And then when you guys made the ToolBox acquisition, it sort of gave you a bit of foothold into the grocery and drug store space. So was just wondering what sort of progress you've made there? And is there any update on sort on moving more into that sector?

So we've always been in that sector, but we made the acquisition 100 days ago. So far I think the transition has been extremely positive from a customer and a prospect standpoint. And we're very optimistic. I think we're executing, at least, for our original 12-month plan according to making progress just as we expected. And I expect this acquisition to be like the other acquisitions that it's going to be a very positive for SPS Commerce. So we're a 100 days in, and everything is positive, and the pipelines are building and there will be success there I'm pretty confident about.

The next question is from David Hynes of Canaccord.

Kim, maybe just one on revenue growth composition. The last couple of quarters, it certainly skewed towards the wallet share side versus the customer count. And I think you've lapped pretty tough compares on the customer count growth. But as you look forward and you guys kind of think about modeling organic growth internally, how do you see that split between kind of customer count and ARPU? And do you think the growth in the customer count side could get back up in that high-single digit range or it this kind of mid-single digits the new norm?

So both aspects, the customer account growth as well as the revenue per customer, both are very meaningful to get us to what has historically been to about 20%-ish organic recurring revenue. And this quarter, no different, 20% organic recurring revenue. To your point, what you have seen more recently over the last couple of years is that the revenue per customer has grown faster than the customer count. So as it relates to specific to this year, there is still lots of drivers to that revenue per customer, so size of customer, multiple products, for example, those are things that continue to have more of a lever on that revenue per customer than on the number of customers. So the trend that you saw in Q1, where one of those metrics in the single-digits, one of those in the low-double digits, expectation would be that probably similar that the customer growth is in a single-digit and the revenue per customer in the low-double digits for this year. And then longer-term, I would expect that both of them still remain a very meaningful contributors to that overall 20% growth.

And then, Archie, maybe kind of more strategic question. Right now, I think you guys are just kind of a communication, fulfillment, analytics hub for suppliers working with their retailers. As you think about how this evolves, is there an opportunity for you to help suppliers go straight to consumers either through your marketplaces or the social channels, which are effectively becoming like retailers with buy buttons and all that sort of stuff. So how do you think that plays out? And is there an opportunity for SPS to kind of monetize that side of your supplier relationships?

I think we are able to monetize things as when there is a trading partner relationship involved in a process. If there is a trading partner relationship involved, I think that SPS Commerce ought to be involved; if there is not a trading partner relationship that feels like an ERP system. It feels like a NetSuite, an SAP, Demandware solution set, something that's sitting behind the firewall. So that's how we define our space. If there is a trading partner relationship involved, then we want to be in that space. If there is not a trading partner relationship involved, we don't want to participate. We think that's an add-on to an ERP. So I don't know if that gives you guidance, but that is a guiding principle for us.

The next question is from Patrick Walravens of JMP Securities.

So Archie, big picture question for you to start, so are you guys back on track?

I've never felled off track, Pat, but obviously, we had some issues on the sales front. But I think I'd reiterate, I think we have a large opportunity in front of us and I think we're going to take advantage of it over the next few years. And execution on some fronts, we're less than stellar in the second half of last year, but in a lot of parts of the business they were stellar. So I feel very, very confident about the future at SPS Commerce. And I feel like some of the sales issues, while you continue to keep an eye on, I think we're making great progress on them.

And, Kim, where should we expect the organic growth rate to bottom out this year?

So we provide guidance for total GAAP revenue. And from that you could back into implied organic growth based on our guidance range. But we do not guide down to the organic level. So my suggestion to you is if you just look out at the implied guidance, and that the guidance that we just provided here is about $600,000 higher than what the guidance was 90 days ago.

Will do that. And then lastly, I feel like there has been a fair amount of confusion in terms of competition between you guys and Commerce Hub, which is going to be a public company, in the not too distant future, when they get spun off. Archie, could you talk a little bit about where you compete, but then also how you guys are different, because I think in general you're pretty different?

Yes. I think there's components that are similar, there's components that are different. Let's start on the fulfillment side of the house. They are focused on the direct-to-consumer portion of e-commerce, so it's not a full suite of e-commerce. If the retail is bringing product into the distribution center or warehouse, then they are not involved. And the primary difference in their offering on the fulfillment side is they really offer an, what I consider to be, an order management system, which allows the retailer to determine where they're going to buy from. That is something that we believe belongs within an ERP, which is to my earlier comment does not involve trading partner relationships. But we do see them from time-to-time on the direct-to-consumer part of the e-commerce initiatives. We don't see them at all in analytics. And then they also purchased a company that looked a little bit like a channel advisor type marketplace company. I think they were in a distant second place to a channel advisor and we don't compete on that side. So there is a segment of their business we do compete on, but a lot of differences.

The next question is from Jeff Houston of Northland.

Looking at the Australian market, could you talk a bit about how the, I know it's newer for you compared with the U.S. market, but can you talk a bit about how the penetration differs both on a retailer and supplier basis?

Well, we're much earlier there. So in general, I would consider the marketplace to be about 10% of the U.S. marketplace, maybe slightly little lower than the North America marketplace then. And so obviously, our revenues are substantially below that market. So we think we have a lot of room there. And then what's interesting about the marketplace, it looks very similar to the U.S. without as bigger pressure from Amazon, but there are people doing some phenomenal things, like THE ICONIC, who is going same-day delivery. And then there is some people that are lagging. So the marketplace feels a little bit behind the U.S. in the fact that there is not as big of an Amazon effect, not necessarily from how they do business if it not behind, but they don't feel as much pressure from the Amazon piece. But as some of these retailers like ICONIC and others ramp up there game, I think it's going to be more and more competitive. And so we're excited about the marketplace there, as 8% to 10% of our total market opportunity in North America.

And then building out the retailer distribution, supplier maps with the different retailers, I think you talked about in the U.S., you're at pretty much all the major retailers, how many of the Australian ones have you build out those maps for?

We've build them out to dozens of retailers there and we continue to build out that network. And the great thing is, we played this game before. It's a viral network, right. So as we add more suppliers in Australia, we are going to add more retailers. So we'll continue to build out that network. And that's never been an obstacle for us and we're ready to invest in building out that network.

And then looking at cash balances roughly $130 million, I know the focus has always been on organic, but you have done a number of acquisitions in the past. Could you talk about your current thoughts on what your appetite is for acquisitions? What the pricing is looking like in the private market, companies you're looking at, and as well as particular areas of interest?

So our M&A strategy has remained relatively consistent since 2010, and the fact that you're correct, we are focused primarily on organic growth. And we think we can build this significant meaningful business through organic growth. We continue to be active and look. We're going to be very selective. We are looking for either product expansion, customer acquisition or geographic expansion, our primary targets. And we're going to be very selective. We are not interested in buying companies that are broken, because we think the effort and time to turn them around is could be detrimental to our organic growth. So we're very conscious of that. From a marketplace standpoint, obviously, private companies, when SaaS multiples contract private companies tend to think they're immune to those contractions. And after it settles in for three to six months and reality tends to set in a little bit more. But frankly, we're going to continue to be selective and we have an appetite to do it if we can do the right deal.

The next question is from Jeff Van Rhee of Craig-Hallum.

And couple of questions. I guess, first, with respect to the enablement campaign pace, maybe can you just update us what's changed here, maybe last three, six months with respect to the size of the campaigns, the spaces, sub-segments where they're coming, maybe a taste of the number that are adopting your solution in those enablement campaigns versus the numbers that are testing. Just trying to get a sense of the flow of enablement campaigns, your ability to convert them and even to convert the follow-on testers, maybe with just a focus on the delta, seems that even if they're albeit small that you seem changing over the last three, six, nine months.

I think it's an evolution. Our close rates on enablement campaigns, the percentage of the testing as opposed to recurring revenue has not changed very significantly. It will bounce around from one quarter to another, but not significant changes. Obviously, the trend we've seen over the last four or five years is that we're able to get larger and larger customers. Some of those are the testers that over periods of time we convert and some of that is through channels. So that's really the only, over the last six months, it would be a reflection of frankly of what we've seen over the last three years, not drastic changes in closed rates. I think in some geographies like ICONIC had very high success rate, as we get confidence in the marketplace and are really able to sell our best practices, in community enablement, that really changes the game and I think we're better in that region. But I think in North America it's remained relatively constant as far as what we're seeing.

And then, Kim, just briefly on the model, with the sequential revenue guide built in, but EPS dip obviously added 10 reps having their chance to work through the model, but just the EPS dip sequentially, anything you can tell us about the driver there? I'm sure, I guess, that sales is part of it, but maybe filling in any of the gaps?

When you're talking about EPS sequential, are you talking about Q4 to Q1 or what's your time period?

The Q1 to Q2, so we just posted $0.22, I guess, Q1 and you're guiding $0.19 to $0.20.

Yes. As it relates to the sequential from Q1 to Q2, if you look at the EBITDA guide, you'll see that's really the driver. As it relates to that we established EBITDA dollars for the year. And then we work to make sure that we are investing appropriately back in the business, but still hitting our annual EBITDA guidance. Specific to how that flows through the year, Q2 is a quarter where there is more significant sales and marketing spend. One thing to keep in mind, we have our annual customer event in the quarter and the cost associated with that customer event hits in Q2. Also, we're going to continue to focus very much as it relates to our hiring in the sales space as well. So I really look at it as nothing is different for the year, but specific to Q2 there is a little bit more cost and investment that you see in Q2, but no change relative to what those expectations would be for the EPS or EBITDA for the year. End of Q&A

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day everyone.