Irmina Blaszczyk - IR, Blueshirt Group Archie Black - President, CEO & Director Kim Nelson - Executive VP & CFO.

Tom Roderick - Stifel Jeffrey Van Rhee - Craig-Hallum Koji Ikeda - Oppenheimer Pat Walravens - JMP Group Tim Klasell - Northland Securities Peter Levine - Needham & Company.

Good afternoon, and welcome to the SPS Commerce Q3 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Ms. Irmina Blaszczyk at Blueshirt Group..

Thank you, Tanya. Good afternoon, everyone, and thank you for joining us on SPS Commerce's Third Quarter 2017 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, 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 as well as our financial results press release for 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 the 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 will turn the call over to Archie..

revenue growth and margin improvement. During a time when market dynamics are moderating revenue growth, we will drive stronger bottom line results. This will allow us to invest at an appropriate level in the business relative to the current market disruption, while continuing to lay the foundation for increasing future revenue growth.

In summary, SPS Commerce is the largest retail platform to enable fully orchestrated retailing across all channels, platform architected for today's complex omnichannel environment, which includes brick-and-mortar, e-commerce and drop-ship.

We have a multibillion dollar global opportunity in front of us, and we will continue to grow our market leadership even further. With that, I'll turn it over to Kim to discuss our financial results..

Thanks, Archie. We had a great quarter. Revenue for the quarter was $56.2 million, a 14% increase over Q3 of last year and represented our 67th consecutive quarter of revenue growth. Recurring revenue this quarter grew 15% year-over-year. In Q3, the total number of recurring revenue customers increased 3% year-over-year to approximately 25,400.

For Q3, wallet share increased 11% year-over-year to approximately $8,200. For the quarter, adjusted EBITDA was $8 million compared to $7.4 million in Q3 of last year. We ended the quarter with total cash and marketable securities of approximately $166 million. We ended the quarter with approximately 290 quota-carrying sales headcounts.

Now turning to guidance. For the fourth quarter of 2017, we expect revenue to be in the range of $57.2 million to $57.7 million, which represents 12% to 13% growth. We expect adjusted EBITDA to be in the range of $7.9 million to $8.4 million.

We expect fully diluted earnings per share to be approximately $0.07 to $0.09 with fully diluted weighted average shares outstanding of approximately 17.5 million shares.

We expect non-GAAP diluted earnings per share to be approximately $0.20 to $0.21, with stock-based compensation expense of approximately $2.5 million, depreciation expense of approximately $2.2 million and amortization expense of approximately $1.2 million. For the year, we expect revenue to be in the range of $219.6 million to $220.1 million.

We expect adjusted EBITDA to be in the range of $32 million to $32.5 million. We expect fully diluted earnings per share to be in the range of $0.45 to $0.47. We expect fully diluted weighted average shares outstanding of approximately 17.4 million shares.

We expect non-GAAP diluted earnings per share to be in the range of $0.91 to $0.92, with stock-based compensation expense of approximately $9.3 million. We expect depreciation expense of approximately $7.5 million, and we expect amortization expense for the year to be approximately $4.7 million.

For the forecast, you should model approximately 40% effective tax rate calculated on GAAP pre-tax net earnings. Our strategy of balanced growth is designed to invest in the business at an appropriate level to capitalize on market dynamics and fuel future revenue growth.

While market dynamics are tempering revenue growth, we do expect our adjusted EBITDA dollars to grow 20% or greater on an annual basis for the foreseeable future. As we specifically look ahead to 2018, we expect our 2018 revenue growth rate to be lower than our guided Q4 2017 revenue growth rate.

This is driven by retailers in transition and the market dynamics we discussed earlier as well as an impact of about 1% from a customer loss due to retail consolidation. Despite bankruptcies in the retail space and the headwinds Archie laid out that affect our industry and our business, we believe we are executing well to our business model.

The sales reorganization we completed heading into this year is working and gives us increased confidence in our ability to drive future results and extend our leadership position. With that, I'd like to open the call to questions.

[Operator Instructions] Your first question comes from the line of Tom Roderick from Stifel. Your line is open..

I want to start with the -- I'll work a little bit backwards from Kim's commentary on the '18 guidance, and this has been a continuing theme not just with yourselves but with everybody sort of facing the retail industry which is it's getting tougher out there. We've heard it all year.

But if we think about the components of your business, sort of 3% customer growth, and then ARPU has actually been accelerating here a little bit, curious how you might encourage us to think about the dynamics on customer growth as you look at -- for the foreseeable future.

Should they stay down kind of in this low single-digit level in so far as retailers don't start ramping up their enablement campaigns? Are there other drivers that you'd look at to sort of reinvigorate customer growth? Or is that just a function of those enablement campaigns and what you're seeing with the retailers themselves? So, I guess it's a broader question of, without knowing how long these headwinds will persist, how do you think about the inputs on the customer growth side of the equation?.

The biggest driver as it relates to the quantity of new customers is highly correlated to the community enablement campaigns which you mentioned, Tom. As you think about size of customers, so as we continue to get some larger than average customer size, that impact will show up more on ARPU.

But specific to the customer growth, that is in the lower single digits at this point. The reason that growth rate is lower, for example, than 2016 is directly correlated to the quantity of community enablement campaigns. That concept of correlation to number of community enablement campaigns, we would expect to continue going forward..

Yes, got it. Okay. And then, taking the other side of that equation, which is ARPU actually accelerated a little bit this quarter, and you're talking about being pretty satisfied with the sales force reorg that you put in place earlier this year. That suggests that you are, in fact, having some success with larger deals and more strategic deals.

Can you talk a bit about the construction of the sales force as you see it today? Would you like to see more higher end sales reps going after bigger deals and could that mean longer sales cycles down the line? Just take a shot at the mix of revenues between traditional SMB suppliers and a little bit of a move upstream for more strategic larger deals?.

Sure, Tom. Obviously, we've had a long history of expanding upstream to larger and larger deals. Fulfillment as a whole, as a product is doing fairly well, although it's being hurt by the community enablement campaigns. So, we are seeing success at the mid and larger deals.

Again, our larger deals still aren't the monster deals, so we continue to see success there. Analytics is, the growth is more tempered there. It's hard to become a top priority with the retailers. But we feel pretty good about the bigger deals and our product and our product positioning on fulfillment, so I think we'll continue to have success there.

There are parts of our business that are doing quite well. And as I said, fulfillment is doing fairly well and, I would say it's being tempered by the community enablement. In other words, the really small businesses, we're not seeing as much activity.

But I want to remind people, we are still seeing a significant number leads coming from retailers each and every day. It's just not at the pace we'd like to see..

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

So, I guess, as you looked, 2 questions around the, I guess, the churn that you talked about. You had a customer loss that you referenced as part of why growth rates will decelerate.

So just to be clear, that was a Q3 loss that you're referencing there for the compare?.

Yes..

That was specific, that comment, Jeff, was specific as it relates to 2018. So that 1% customer loss due to consolidation is effective January 1, 2018..

Okay. Starts 2018, January, okay. And, I guess, as you look at the rest of your book of business, how do you go through it and set some expectations and get a handle on what is a reasonable level of churn/bankruptcy? I imagine that's an incredibly tough task, so that's one.

And then two, just to be clear, I think the guide for Q4 is 12% to 13%, and you said you see it lower than that. You didn't comment to how much lower.

Do you still generally see, although, I understand it's not from guidance, double-digit growth as the likely scenario for '18?.

Sure. So, the guidance for Q4, you are correct, that's a 12% to 13% growth. We aren't specifically giving a number with guidance for next year. We'll give the detailed guidance on our February earnings call. But the color that we gave is that our expectation in 2018 is that, that growth rate will be lower than our Q4 guided, which is 12% and 13%.

And the 2 reasons we mentioned associated with that had to do with a lot of the retailers in transition and the dynamics we talked about there as well as the fact that there is a customer approximately 1% that we lost effective January 1 due to a consolidation.

So unfortunately, there isn't more color to be able to give you there on that number other than what we've stated there.

But I'd also remind you that we also did give color as it relates to how to think about EBITDA for next year and that we provided the information that said we expect that the EBITDA to be able to grow at least that 20% year-over-year growth..

Got it. And I guess, just lastly then, as you look at these -- the retailer and supplier base that you serve, how have you seen them reallocating dollars? In particular, I think you commented within specifically your exposure to them, less interest in analytics, not a priority for them. Just any other observations there.

I'd be curious what you've seen, really lean into and be willing to invest in and things they seem to be walking away from?.

Yes, I think each different segment is a little bit different. From the retailer standpoint, again, there's a broad brush, there's people in all aspects of this. But they're really focusing on major transformations as far as how do I play in the omnichannel brick-and-mortar, e-commerce and drop-ship world.

And a lot of times, what's happening in the retailers is they haven't overinvested in technology over the last decade. So, a lot of times, they have to redo their entire infrastructure. It's not just an add-on, now I got to add capabilities, because their core capabilities are weak at best. So that becomes a significant process.

We talked about a Walgreens, a big transformational process which, as opposed to being a 4-month deal, it's going to be a 3-year, that's going to take to roll off their revenue. From the supplier standpoint, I would say, obviously, the very small suppliers (inaudible) community enablement campaigns, and that's being -- those are slower.

From a larger supplier standpoint, I think they're seeing the challenges of how do I work with the retailers. And they don't have a choice. They need to do EDI. They need to integrate to their retailers, their e-commerce providers and whatnot. So that continues to be a strength for us.

And again, the positive thing is that we can service those suppliers because we do have a brick-and-mortar solution, we do have an e-commerce solution, and we do have a drop-ship solution. So that's still driving. And that piece is not nearly as affected, other than some bankruptcies and consolidations..

Your next question comes from the line of Koji Ikeda from Oppenheimer..

I just have a question on the community enablement programs, wanted to dig into that a little bit more here. The way I understand it, community enablement programs can come both from the supplier side and the retail side of the network equation.

I was wondering if you could maybe talk a little bit about each side of that, maybe one of those sides is doing a little bit better in community enablement programs right now or how are those tracking to plan.

And are you going to be investing in maybe one of the size that isn't coming to plan as much as you thought year-to-date?.

Yes, the vast majority is from the retail industrial distributor, food services, e-commerce, it's from the buy side. There are supplier-side enablement campaigns where they're going back into their suppliers. There's a limited number of suppliers that are going to have that opportunity.

They need to be extremely large, and they have to have a fair number of suppliers because, really, a community enablement campaign, if you have half a dozen suppliers, it's just not the economics of it. So, we focus the vast majority of our time on the retailers.

And as we're seeing retail more challenged, we're putting more focus on industrial distribution and food services and other segments that may not quite have as much impact in today's world as we look out..

Got and thank you for that. And a quick question, quick follow-up question on sales capacity and how that's shaping out for 2018. I think at the beginning of this year, you've kind of laid out 15 quota-carrying reps is kind of the target for this year, and it looks like you've hit that target this quarter.

Are you -- is the capacity done for the rest of the year? And what's the right way of thinking about sales capacity going into '18? Are 15 kinds of the right number to think about for sales capacity or hiring trends in 2018?.

Sure. So, to your point, we exited or where we're currently at is around that 290 which is our goal that we stated for the year. So, we feel very good about our ability to deliver that goal. We will continue to hire sales resources as we continue this year and into next year.

As it relates to a particular number or how to think about 2018, we would be providing color on that on our February earnings call.

But what I'd tell you is sort of 3 quarters in to after the sales org change that we made, we feel really good about where we're at and that the existing sales team as well as the hires that we've been able to make thus far through this year are adding capacity. And we really feel great about how that will help us achieve our 2018 goals..

Thank you for that color. I’ll hop back in the queue..

Your next question comes from the line of Pat Walravens from JMP Group..

I guess, Archie, it's been -- if you look back, it's been, I guess, a 9-quarter deceleration here, something like that. And we've been talking about this growth versus profitability tradeoff for a while. So why now? What was it that you saw in the quarter that finally led you to say, okay….

Well, I think we see continued challenges in the retail environment. And we had different reasons for different decelerations. And we had some things in '15 on execution. But I have to tell you, I think right now, through the sales reorganization, we have attrition levels at normal to slightly below normal levels.

So, I think people are working in their -- well in their new roles, embracing it. So, I feel like the sales team is working excellently in the things that we control, and we're just seeing a really tough environment. And there's times when you can pull the lever.

And it's just you know you can continue to throw resources at it and become very, very effective. And there's times when you can double the sales force. And if you do that, you can double the amount of sales. I think it's a more challenging environment today, and I don't think that would be the right thing to do.

So, I think that allows us to make sure that we have clarity on our profitability goals..

Okay, good. And then this is sort of similar, and I know you don't love this question at all, but I think people are going to ask.

So, I mean, under what circumstances would SPS Commerce consider strategic alternatives?.

So, the way I look at our company is we have a multibillion-dollar TAM. We believe we have the right go-to-market strategy, we have the right products, and we have the right team to be successful there. To Archie's point, some of the dynamics that we faced back in sort of the '15-time period on the sale side was more internal-driven.

We really feel like, from an internal execution, we are solidly set up very well. There's some dynamics that are happening with retailers in transition that we do not control, the timing of it as they work through that. However, we believe we are absolutely set up to have that business and win that business over time.

So, from our perspective, nothing's really changed relative to the market opportunity and our ability to go after that..

Okay.

And then last one for me is just what else can you tell us about the customer loss? [indiscernible] What can you tell us?.

Yes, I can tell you that it was a ToolBox retailer that we got in the ToolBox acquisition, that they were acquired by a substantially larger organization, substantially larger. That larger organization had built internal capabilities to more of a consulting type analytics company. And we were in a sales cycle to try to win the whole thing.

But you are in a significant underdog situation when the company that's 90% can continue doing what they're doing, and it's not as big a transformation for them. So, we lost that deal. And I think anytime you're part of the smaller organization, especially if it's significantly smaller, you're just in a significant underdog situation.

So, ToolBox analytics retailer..

Your next question comes from the line of David Hynes from Canaccord..

This is Mark on for DJ. First question on the enablement campaigns being pushed out.

What the sense you're getting in terms of the delay there? Are these being pushed out indefinitely at this point? Or is that, just what are you hearing from customers?.

Well, what we're hearing is they're part of, they're doing large transformational projects or they're deer in the headlights. There's a whole different sort of issues. We still believe in the TAM, so we believe they're out there. We continue to do enablement campaigns. So, I think there continues to be opportunity.

I think, but with the dynamic market that retail is right now, it's just a challenging, it's challenging to move to the priority space. In any sales cycle, you can convince somebody that they should do what you want them to do, but you have to move it up to top priority for them. And that's the biggest challenge today..

Yes. Okay, got it. And then looking at the ARPU line, I mean it was commented earlier that there's a bit of a tick-up in growth there.

Given the market that you're seeing, how sustainable is growth in and around this low double-digits or high single-digits level?.

Yes. So, if you look at the ARPU, you'll notice the last few years, it's been in that double-digits. And the driver for that really is multi-pronged. It's the longer customers with us, the more [indiscernible] we get from that customer just because they're using us more or differently than how they initially sign up.

So, you can think about that more as sort of a connections concept. Size of customers, I mentioned earlier, is going to impact that ARPU, a number greater than the number of customers and then multiple products. So those 3 legs of the stool have all contributed to the overall ARPU.

And it isn't something that really changes radically in one quarter versus another. You've seen that sort of trend over multiple years, and our expectation is we still have multiple levers on that ARPU going forward as well..

Okay. Thank you. .

[Operator Instructions]. Your next question comes from the line of Monika Garg from KeyBanc Capital Markets..

This is Jason on for Monika. Most of my questions have kind of been answered, so I kind of want to switch gears a little bit. So, you kind of talked about Lidl in the grocery sector.

And with Amazon buying Whole Foods, I mean, have you seen any change in the grocery vertical for any customers? And kind of how are you kind of thinking about that?.

We have not seen a substantial movement because of that sale, other than there's a lot of buzz and a lot of talk. But things don't move that quickly in the world. We're seeing companies like a Lidl. Lidl has 10,000 stores across 28 countries moving into the U.S.

So, grocery is also dynamic, it has a lot of different characteristics that we actually do like the grocery industry from a standpoint of industries that we think are right, not every grocer, but we haven't seen substantial changes there.

We're seeing changes more on the big box and sporting goods and other spaces, but probably less so on Whole Foods. But realistically, at this time, Amazon hasn't made drastic changes on how they deliver grocery. They made some price reductions. But when you actually read the analyst reports, they haven't really even made price reductions.

It's been pretty modest. So, I mean there's a lot of talk, but there hasn't been a lot of change on day 1..

Okay.

And then kind of with the analytics products, when we kind of think about it returning to higher growth in fulfillment, I mean, like what kind of needs to happen for that?.

Yes, I think we still believe in the product. We still believe in the TAM. And we still believe in the value that it brings. And we still like our positioning in this. I think the reality is right now, it's just -- it's more geared towards brick-and-mortar, not completely, but more geared towards brick-and-mortar, the store information.

And it's just not a priority right now for the retailers. At some point, it will become a priority. Now if you ask me when, I'm not going to be able to answer that because I don't know because we have a dynamic industry.

But I do believe that we need retailers to embrace it and say, we are going to start collaborating with data, with our suppliers, and we're going to make that a priority. That's what needs to happen..

Okay. Thanks for taking my questions. .

Your next question comes from the line of Tim Klasell from Northland Securities. Your line is open. .

Yes, just a quick question on if you take a look at your retail install base, it sounds like you sort of had a heads-up when you're in there bidding for this consolidation that -- where you lost the one major customer.

Are there other situations like that going on? Could we continue to see sort of a trend of this going into 2018 and 2019? Just give us a color of where you think maybe the bottom might be hitting for retailer consolidation?.

The retail consolidation we had -- we're caught in this one situation on analytics. There's not a lot of big dollar retailers like this for us. I'm actually more concerned about bankruptcies where they close down completely. And that's going to be more of the impact for us than consolidation.

Now consolidation on the supplier standpoint, I will tell you, it continues to happen. Sometimes we're on the high side of that, sometimes we're on the low side of that.

And the reality is when somebody comes and buys a company, if they're 10x bigger, when you're a service provider for the acquiring company, a lot of times you don't even get a bid, you don't get an audience. They just -- it's just -- it's day 1, they're coming in, which can work for us.

I mean, we've talked in the past about different companies where we've gone through divisions, and if they've been acquiring, we've been in a really good spot for that. So, there's wins and losses there. But from a retailer, there could continue to be consolidations.

I don't -- I'm not as concerned of as many of this magnitude, but it's a hard industry to predict right now..

Your next question comes from the line of Peter Levine from Needham & Company. Your line is open..

Great, this is terrific Scott, almost my questions have been answered, so just one quick one on the EBITDA guidance you provided.

I know you're not giving guidance for '18, but is there any high-level commentary you can provide us, just on some of those levers and how you plan on getting there?.

So, we continue to have a balanced approach between our top line and our bottom line. And to your point, the guidance that we gave, we'll give obviously more specific numbers as it relates to when we give guidance on our February earnings call.

But we are comfortable sharing that we are confident in our ability to deliver 20% or greater EBITDA dollar growth year-over-year. As a business, we continue to invest in both the short term, medium term and long term. But we also want to make sure we're tempering that relative to what we are seeing as it relates to the top line.

So, we will, again, invest appropriately, not just for today but for the future, but be conscious of or cognizant of that spend relative to the revenue expectations for next year..

I am showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may now disconnect..