Q2 2023 SPS Commerce Inc Earnings Call
Participants
Archie C. Black; CEO & Director; SPS Commerce, Inc.
Kimberly K. Nelson; Executive VP & CFO; SPS Commerce, Inc.
Jeffrey Van Rhee; Partner of Institutional Research & Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Jeffrey Parker Lane; Associate; Stifel, Nicolaus & Company, Incorporated, Research Division
Joseph D. Vruwink; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Mark William Schappel; MD; Loop Capital Markets LLC, Research Division
Matthew Charles Pfau; Analyst; William Blair & Company L.L.C., Research Division
Nehal Sushil Chokshi; MD & Senior Research Analyst; Northland Capital Markets, Research Division
Scott Randolph Berg; Senior Analyst; Needham & Company, LLC, Research Division
Irmina Blaszczyk; MD; The Blueshirt Group, LLC
Presentation
Operator
Good day, and welcome to the SPS Commerce Second Quarter 2023 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Irmina Blaszczyk, Investor Relations for SPS Commerce. Please go ahead.
Irmina Blaszczyk
Thank you, Drew. Good afternoon, everyone, and thank you for joining us on SPS Commerce Second 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 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 for a more detailed description of the risk factors that may affect our results. These documents are available on our website, spscommerce.com, and at the SEC's website, sec.gov. In addition, we are providing a historical data sheet for easy reference on the 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 C. Black
Thank you, Irmina, and welcome, everyone. Before I proceed with my prepared remarks, I'd like to mention the CEO announcement we made earlier this month. In October, I will transition to the role of Executive Chair of the Board as we welcome our new CEO, Chad Collins. Given Chad's leadership and industry experience, I believe he is uniquely qualified to lead SPS through its next chapter of growth and innovation, capitalizing on omnichannel retail dynamics. We look forward to introducing Chad to you all on our third quarter earnings conference call.
Turning to our second quarter performance. We continue to see investments in organizations across retail, fueling ongoing demand for SPS fulfillment and analytics products. Total revenue of $130.4 million grew 19% in the quarter, while recurring revenue grew 20%. In today's omnichannel world, the average consumer expects to purchase exactly what they want from where they want, looking for a consistent experience across all channels. They are pushing the limits of retailers operations and forcing suppliers to embrace an omnichannel strategy. Since the pandemic, the increased pace and complexity of fulfillment exposed inefficiencies which are now forcing suppliers to revitalize their supply chain.
According to the 2022 MHI annual industry report, a survey of over 1,000 supply chain and manufacturing leaders, 74% of respondents plan on investing in inventory and network optimization tools over the next year. For example, Moose Toys, a large manufacturer in Australia has been an SPS fulfillment customer since 2016, expanding their network across Asia Pacific, North America and Europe. To effectively manage their inventory, they use sell-through data from retailers for forecasting and planning.
However, they were receiving the data in many different formats and had to process it manually, which caused delays in their ability to extract meaningful insights. SPS' analytics was the right solution for Moose Toys to begin aggregating, normalizing and integrating the vast amount of data feeds from their many trading partners. They can now leverage the strategic insights derived from the data to capitalize on significant growth opportunities around the world.
As trading partners strive for automation, ERP integration is another key component to solving supply chain challenges. For example, our partnership with Microsoft has been mutually beneficial over the years, and Microsoft has recently chosen to highlight SPS Commerce as the featured solution on their app store.
Microsoft has been focused on migrating their customers to the cloud. And with their strong presence in retail, distribution and manufacturing, the need for fully automated and scalable supply chain operations is a pivotal factor of these ERP migrations. SPS Commerce's deep Microsoft integration technology, multi-tenant cloud-based retail network and full-service model is allowing Microsoft sellers and VARs to leverage best-of-breed technologies when trying to migrate customers and win new business.
Just as retailers and suppliers are investing in new technologies to optimize their supply chain, SPS Commerce remains committed to delivering world-class products and excellent customer experience. By capitalizing on artificial intelligence technologies, we are already driving efficiencies throughout our organization to serve our customers and improve our product offerings.
SPS is the world's largest retail cloud network, which gives us access to the depth and breadth of data necessary to leverage AI and reduce the requirements for suppliers to connect to retailers, making it much easier to implement trading partner connections. We see many opportunities to enhance our products in the future as we use AI to increase the intelligence of SPS' network, which, in turn, will make joining and operating within the network, increasingly more efficient.
We also continue to expand our portfolio and global footprint. And yesterday, we announced our planned acquisition of TIE Kinetix. We believe TIE's e-invoicing capabilities will enable us to capitalize on the opportunity presented by mandatory e-invoicing regulations in Europe, while expanding our European presence to serve our growing network with access to international markets.
In summary, increasing complexity in omnichannel retail is fueling investment in supply chain revitalization. SPS is well positioned to capitalize on new technologies such as AI, which are proving necessary for automation and optimization of trading partner relationships and amplify our ability to bring our network to more retailers and suppliers faster and easier.
With that, I'll turn it over to Kim to discuss our financial results.
Kimberly K. Nelson
Thanks, Archie. We had a great second quarter of 2023. Revenue was $130.4 million, a 19% increase over Q2 of last year and represented our 90th consecutive quarter of revenue growth. Recurring revenue this quarter grew 20% year-over-year. The total number of recurring revenue customers increased 11% year-over-year to 43,000 and wallet share increased 8% to 11,350. For the quarter, adjusted EBITDA grew 24% to $38.2 million compared to $30.9 million in Q2 of last year. We ended the quarter with total cash and investments of approximately $270 million.
Now turning to guidance. The following third quarter and full year 2023 revenue and adjusted EBITDA guidance does not include the impact from the pending acquisition of TIE Kinetix. For the third quarter of 2023, we expect revenue to be in the range of $133.6 million to $134.4 million, which represents approximately 17% year-over-year growth. We expect adjusted EBITDA to be in the range of $39.3 million to $40 million. We expect fully diluted earnings per share to be in the range of $0.37 to $0.38 with fully diluted weighted average shares outstanding of approximately 37.6 million shares.
We expect non-GAAP diluted income per share to be in the range of $0.65 to $0.67 with stock-based compensation expense of approximately $11.7 million, depreciation expense of approximately $4.9 million and amortization expense of approximately $3.7 million. For the full year, we expect revenue to be in the range of $528.5 million to $530 million, representing approximately 17% to 18% growth over 2022. We expect adjusted EBITDA to be in the range of $155.8 million to $156.9 million, representing growth of approximately 18% to 19%.
We expect fully diluted earnings per share to be in the range of $1.60 to $1.63 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 $2.69 to $2.72, with stock-based compensation expense of approximately $46.2 million, depreciation expense of approximately $19.4 million and amortization expense for the year of approximately $14.7 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. As noted in our press release announcing the planned acquisition of TIE Kinetix, we expect it to have a nominal impact on Q3 financial results with the exception of approximately $1 million of certain onetime deal-related costs. In the fourth quarter, we expect TIE Kinetix to contribute approximately $3.9 million of revenue and expect adjusted EBITDA of the acquired business to be approximately negative $500,000.
Beyond 2023, we maintain our annual revenue growth expectation 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, ongoing investments across the retail industry continue to present tremendous opportunities for SPS. With the only full-service EDI solution, we are well positioned to help our customers optimize their network as we capitalize on a multibillion dollar addressable market to deliver sustained profitable growth.
With that, I'd like to open the call to questions.
Question and Answer Session
Operator
(Operator Instructions) The first question comes from Matt Pfau with William Blair.
Matthew Charles Pfau
First, I wanted to ask on the TIE Kinetix acquisition. Can you just better help us understand what this brings to the table, is this e-invoicing product different than what you currently have? And how does it help you gain more traction in Europe?
Archie C. Black
Yes. Thanks for the question, Matt. A number of things. One, the company is a roughly 60% European revenue and 40% U.S. revenue. So -- and those businesses are relatively separate as far as go-to-market, et cetera. The U.S. business, think of that as much more consistent with a customer acquisition play. So meaningful revenue there, put them on our platform, they can have more offerings so we can upsell the customers like we've done in the past. .
The European business, I think gives us a couple of things. One, it gives us a larger platform to go after fulfillment and really just think about learning about the market, we're in the market on a much smaller basis. We're in the market in analytics, but not much there. And then the e-invoicing product is -- think of it as in Europe, it's a government reporting almost regulatory compliance where you need to report that tax, et cetera. So in order to do business in Europe, you have that. We partnered in the past for those capabilities. It's applicable in Europe and also we use some of it in Mexico, but don't anticipate using it in the U.S. just because it's not really utilized here. So we do not have an e-invoicing platform as we speak. So that's capabilities and customer acquisition.
Matthew Charles Pfau
And just one quick follow-up on that. The -- Kim, I know you said that the revenue from the acquisition, isn't included in the updated guidance that you provided in the earnings press release. But the $1 million of additional expenses in Q3, is that factored into the guidance?
Kimberly K. Nelson
No. The guidance we provided excludes anything related to the acquisition we announced of TIE Kinetix. And the reason for that is we announced it, but it has not yet closed. So all the numbers exclude, but we have separately in a press release about TIE Kinetix as well as on this earnings call, reiterated the numbers that we believe they will be in 2023. So that $1 million of really deal-related costs in Q3 is not factored into the SPS Commerce guidance we provided today.
Operator
The next question comes from Scott Berg with Needham.
Scott Randolph Berg
Congrats on a good quarter. I guess a couple things here. Starting with the acquisition, Archie, I'm certainly familiar with the VAT reporting requirements there. There are some nuances, I think kind of developing over the next couple of years around real-time reporting for that for different vendors. Can that be a catalyst to maybe drive some outsized growth from that segment going forward, knowing that a lot of these countries are kind of trying to get to more of this real-time almost straight through processing for that reporting?
Archie C. Black
Well, I think the e-invoicing has an opportunity to grow and it has an opportunity. Right now, it's fairly small, but pretty optimistic that it can be a bit of a catalyst into the future. But I wouldn't put a lot of weight on to it as we look at '24 and clearly not '23. But having those capabilities will be a positive. And for us, more importantly, we really get to learn that market by being in it. So I think that's a nice size deal that puts us in the market, we can really see more firsthand what is happening and what the real opportunity is.
Scott Randolph Berg
Got it. Helpful. And then on business trends in the quarter, it looks like the company added roughly 250 net new customers, knowing the second quarter is usually a seasonally strong period for customer acquisitions. That's actually lighter, not just during the pandemic, but during several years before that. Anything to read through necessarily on a single quarter snapshot on customer acquisition trends?
Kimberly K. Nelson
Sure. So when we think about the community enablement activity in the quarter, it was quite a strong quarter. But what we saw is more skewed towards existing customers that we were able to upsell versus the amount of net new customers. We don't think that, that is at all a trend. It just so happened this quarter that the mix was a bit more on our existing customers versus new.
Operator
The next question comes from Parker Lane with Stifel.
Jeffrey Parker Lane
Kim, I know it's early to be talking about 2024. But as far as it relates to TIE Kinetix, you talked about a $16 million revenue benefit for next year. And I noticed that I think they did $8 million of total revenue in their first half of their year. Can you just give us a better sense of what your assumptions are as you look forward to '24, '25 on any interesting dynamics to that revenue growth in that business?
Kimberly K. Nelson
Sure. So obviously, we have not yet acquired the business, but that is our -- obviously, our intent, which we do believe will close later in Q3. As it relates to our expectations for 2024, of the approximately the $16 million that we did mention. That is primarily based on our view of what we see as the opportunity. Do also keep in mind that there is -- a fair portion of their business is in Europe. It is subject to fluctuations from FX rates as well. But overall, it's our best view...
Operator
Excuse me, there has been an interruption. Just one moment. Ms. Nelson, please continue.
Kimberly K. Nelson
Great. Apologies for that. Parker, I don't know exactly where I cut off, but you were asking as it relates to our expectations for 2024. As the acquisition, we believe, will close at the end of Q3. And at this point, we put together our best view of what we see as that opportunity in 2024 based on where that company is on its journey to moving over to a SaaS fulfillment model as well as the opportunities that we see in Europe.
Jeffrey Parker Lane
Understood. Okay. And then on the gross margin side of things, it's been a few quarters now. They're relatively in the same place. And I know you've talked about low 70s being the long-term target in this business. As we march up towards that low 70s target, are there things you're doing internally to actually get there? Or is this just going to be a matter of the business achieving some additional scale and that naturally flows through there?
Kimberly K. Nelson
Sure. So the biggest way that, that gross margin will move from where it is now up to the lower 70s is really primarily around efficiencies and scalings. So you may recall that in prior conference calls and years, we've talked about investments that we've made in the overall customer experience. In some years, those investments have been larger from a growth perspective than our revenue or similar in line with the growth as our revenue. Thus, you have not seen that improvement from a gross margin perspective.
As our business continues to grow, we believe we will be able to grow into some of those investments. We'll still obviously continue to add resources, but we shouldn't need to do those at the same level that we have historically. We also, as Archie mentioned, we'll be looking at AI. There's many things we're already doing on the artificial intelligence side, but we certainly do see opportunities on the customer success side as well, where we'll be able to leverage some of those tools and capabilities to help out with efficiency.
Operator
The next question comes from Jeff Van Rhee with Craig Hallum.
Jeffrey Van Rhee
So a couple for me. I guess, just high level, I guess, Archie, as you look at the suppliers that are not yet on the platform, what are the characteristics? I mean, you've been at this for a while. Just talk about the people that haven't jumped yet and sort of the defining characteristics.
Archie C. Black
Well, I think that is segmented into 2 different areas. The first I assume we're talking about the fulfillment product. The first is really people that just haven't -- are doing things more manually, e-mail, mail and just the retailers have not forced them to do it, they're small and they're just not there yet. So those are different solutions that we typically get those through our retail enablement campaigns, pretty high success rate there. I would say the other is where they have bought legacy software. And if they haven't moved ERPs and their business isn't moving very fast.
Then they're in the spot where they're in legacy software. It's working. They might have 5, 10, 20 retailers, it's working. If those retailers' environment isn't changing much. It's hard to get them to move. Once you see -- start seeing more change in their environment or they start growing or making acquisitions, that's the bigger -- that is the biggest opportunity with them or just simply some of these guys as we work with the retailers, we're helping the retailers effectively become dynamic in their supply chains, which is putting more pressure on the suppliers.
Jeffrey Van Rhee
Yes. And then along the lines of the enablement campaigns, if you look at the enablement campaigns, what are you seeing that might be the enablement campaign pipeline? What are you seeing that's different with respect to potentially the size of the campaigns, and specifically, as you're implementing the rate at which people are just testing versus signing?
Archie C. Black
The testing versus signing is really just depending on the mix and where we are and the type of retailer. I would say what we are seeing is consistent is automation of warehouse management. So we're seeing more ASN programs, advanced ship notes where if you purchased Manhattan Associates or trying to more fully utilize their capabilities.
In order to do that, you need to receive a document called an advanced ship notice so that you know what's being shipped and when it's going to be received and then to be able to receive that product into the distribution center with a barcode label that is scanned. So we're seeing more of those programs. Sometimes those will be a little heavier testing because it's a massive change for the retailer.
But for the supplier, it's adding a couple of documents, which are complex. We are seeing -- we continue to see it's amazing multibillion-dollar organizations that are, for the most part, manual still, and they're getting into the game because they need to have visibility. The advanced ship notice and the warehouse management systems and everything, that is -- a lot of that is about inventory visibility, which is becoming a hotter and hotter topic is I don't want to have too much inventory, and I need solid visibility into the inventory.
Operator
The next question comes from Nehal Chokshi with Northland Capital Markets.
Nehal Sushil Chokshi
Congrats on the nice quarter here. Kim, you mentioned earlier that some of the upside was driven by strong upsell, was this new SKUs or expanding connection?
Kimberly K. Nelson
This would be expanding connection. So when we run a community enablement campaign, where we will end up seeing that impact us is really going to be in 3 places. Customer adds, testers or existing customers that are now adding that connection. And in this quarter, the mix just happened to skew a bit more on the existing customers, adding a connection versus adding new customers. We still, of course, did add new customers, but the quantity of new customers was a bit lower in this quarter than what you would typically see from us with community activity.
Nehal Sushil Chokshi
Got it. Okay. And then you guys also talked about one of the unique capabilities that TIE Kinetix brings is the e-invoicing. What's the value of this capability relative to your typical ARR that you're able to get from your customers or maybe talk about the ASP of invoicing for a given customer size relative to the rest of your product suite that you're offering?
Archie C. Black
Yes. So first off, we're not going to be using it in the U.S. because it's not a concept of that reporting tax reporting compliance reporting. So it's not applicable to that business. It really is a European and then we see that in Mexico as well. It's really more about you have to have it. It's like a document type, you have to have it to be able to play. We have done that through partnering. And our fulfillment business in Europe is relatively small.
As we've discussed in the past, we've really attacked Europe more with the analytics product, which we're seeing success in being able to -- now with those analytics products have a more robust fulfillment product and having the fulfillment customers from TIE Kinetix to be able to have an analytics product, we think over time will also add value. But I think of it more as a capability you just have to have as opposed to an upsell to get into the game, you have to have it.
Operator
The next question comes from Mark Schappel with Loop Capital.
Mark William Schappel
Just a couple of follow-up questions on TIE Kinetix, such as how fast is it growing? How many employees do they have? Do they have certain target industries that they focus on?
Kimberly K. Nelson
Sure. So about 100 employees and on a -- they were growing, if you sort of look at things from sort of a constant currency perspective because they obviously have a U.S. business plus a European business. they were growing in about the single digits when you're adjusting for -- again, for a constant currency.
Mark William Schappel
Okay. Great. And then given that they have more of a European focus, could you just remind us what percent of SPS' revenue today comes from international sources?
Kimberly K. Nelson
Sure. So when you look at our overall revenue, think of it as approximately 85% of the revenue is in more U.S., so non-international. But do keep in mind that our Asia business, which is heavily there to support the supply chain of our North American suppliers that does show up as U.S. revenue because it's -- the paying company is in the United States. .
Operator
(Operator Instructions) The next question comes from Joe Vruwink with Baird.
Joseph D. Vruwink
Maybe just one follow-up on the customer account adds this quarter and maybe a revenue question as well. Was there any impact from retailer bankruptcies on kind of revenue and the number of connections that might have went away in response to a retailer bankruptcy?
Kimberly K. Nelson
No, there was not. There was nothing unusual as it relates to the bankruptcies that we saw in the quarter.
Joseph D. Vruwink
Okay. And then, Archie, I wanted to go back to that tidbit you shared at the very beginning. I think it was 74% of a survey customer base planning to invest in inventory and networking solutions. Do you have a number for current levels of either electronic fulfillment or EDI? Just to kind of relate the 2. I'm wondering if we could compare 74% to that -- whatever that adoption rate happens to be to get kind of a sense of what the market might be growing at this point?
Archie C. Black
I don't. Unfortunately, that data was not broken out is what I understand. And what we what we see is the more -- it's been the same story all along, the more change in the environment for suppliers kind of back to an earlier question from Jeff as far as the people that are sticking with their old software, the more change they have in the environment that tends to serve us well. So the fact that people are going to be changing environments, investing and looking to do things on the supplier side is a positive for SPS Commerce. So that's kind of the point, how much of that is going to be on our fulfillment side, I don't know. But I know if it's on the ERP, warehouse management, all those things tend to be a positive for us.
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.
