Irmina Blaszczyk - Investor Relations Archie Black - President and Chief Executive Officer Kim Nelson - Executive Vice President and Chief Financial Officer.

Matt Pfau - William Blair Monika Garg - KeyBanc Scott Berg - Needham David Hynes - Canaccord Koji Ikeda - Oppenheimer Tom Roderick - Stifel Tim Klasell - Northland Securities Jeff Van Rhee - Craig Hallum Mark Chapelle - Benchmark Mathew Spencer - JMP Securities.

Good day, ladies and gentlemen and welcome to the SPS Commerce Q2 2018 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 maybe recorded.

I would now like to introduce your host for today’s conference, Ms. Irmina Blaszczyk. Ma’am, you may begin..

Thank you, Crystal and good afternoon everyone and thank you for joining us on SPS Commerce second quarter 2018 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 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 datasheet 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 will turn the call over to Archie..

Thanks, Irmina and welcome everyone. SPS Commerce continues to deliver on its financial targets as it strengthens its competitive position and the retail market that continues to evolve to address the demands of today’s consumers. We posted a strong second quarter of 2018.

Revenue grew 13% to $61.1 million, recurring revenue grew 13% and adjusted EBITDA grew 53% to $12.1 million. SPS has grown to be a leader in cloud-based supply chain management solutions by establishing and growing its network of strategic and consultative relationships with retailers and suppliers.

As consumers’ shopping habits and expectations continue to drive the need for retailers to evolve their omni-channel strategies, SPS leverages its platform and its network to deploy efficient and comprehensive solutions. As retailers continue to automate order management, suppliers must meet new compliance requirements.

During the second quarter, SPS ran a community enablement campaign with Walgreen suppliers based on updated order management requirements. Walgreens is just one example of many retailers to partner with SPS for new vendor on-boarding and to ensure existing vendors comply with new rulebook enhancements and specifications.

SPS’ vast network of retailers and suppliers is a testament to the relationship we establish and solutions we deliver. Along with our customer SIM supply we were recently honored by supply and demand chain executive, a business technology magazine to their top 100 supply chain projects for 2018.

The annual list showcases recent projects that advance the company supply chain to deliver growth and new efficiencies that position them for long-term success. When SIM supply experienced increased demand that created an urgent need for automation, they chose SPS based on a recommendation of one of its largest customers.

SPS has been pioneering innovative technology solutions that make retailer and supplier relationships more collaborative and profitable and we continue to advance our strategy to leverage the industry’s most broadly adopted retail cloud services platform.

We now power more than 350,000 trading partner partnerships making it easy for retailers, suppliers and logistics companies to work together.

Our newly redesigned website highlights how SPS can help our customers work more effectively, collaboratively and profitably with our network of trading partners underscoring how uniquely we are positioned to address their business challenges.

As retailers progress along their journey to become EDI and API capable, SPS can support them in the supply chain in streamlining fulfillment and shipping and inventory management.

As the industry’s only provider with an end-to-end solution, we are excited about the many opportunities ahead of us, which represents a multibillion dollar market opportunity. With that, I will turn it over to Kim to discuss our financial results..

Thanks, Archie. We had a great second quarter. Revenue for the quarter was $61.1 million, a 13% increase over Q2 of last year and represented our 70th consecutive quarter of revenue growth. Recurring revenue this quarter grew 13% year-over-year.

The total number of recurring revenue customers increased 4% year-over-year to approximately 26,200 and wallet share increased 8% year-over-year to approximately 8,700. For the quarter, adjusted EBITDA was $12.1 million compared to $7.9 million in Q2 of last year.

We ended the quarter with total cash and marketable securities of approximately $178 million and we repurchased approximately $6 million of SPS shares. Now, turning to guidance, for the third quarter of 2018, we expect revenue to be in the range of $61.2 million to $61.7 million.

We expect adjusted EBITDA to be in the range of $12.2 million to $12.7 million. We expect fully diluted earnings per share to be approximately $0.22 to $0.24 with fully diluted weighted average shares outstanding of approximate 17.6 million shares.

We expect non-GAAP diluted earnings per share to be approximately $0.39 to $0.41 with stock-based compensation expense of approximately $3.3 million, depreciation expense of approximately $2.4 million and amortization expense of approximately $1.1 million.

But for the full year, we expect revenue to be in the range of $243.7 million to $245.1 million, representing 11% growth over 2017. We expect adjusted EBITDA to be in the range of $47.4 million to $48.5 million representing 39% to 42% growth over 2017. We expect fully diluted earnings per share to be in the range of $0.94 to $0.98.

We expect fully diluted weighted average shares outstanding of approximately 17.5 million shares.

We expect non-GAAP diluted earnings per share to be in the range of $1.65 to $1.69 with stock-based compensation expense of approximately $12.7 million, depreciation expense of approximate $9.5 million and amortization expense for the year to be approximately $4.4 million.

For the remainder of the year on a quarterly basis, investors should model a 30% effective tax rate calculated on GAAP pre-tax net earnings. In summary, we are well on our way to reaching our 2020 goals proving efficiency in our business model, while continually evolving and executing our go-to-market strategy.

We look forward to expanding our market leadership and remain confident in our ability to achieve our long-term financial targets. With that, I’d like to open the call to questions..

Thank you. [Operator Instructions] And our first question comes from Matt Pfau from William Blair. Your line is open..

Hey, guys. Nice quarter and thanks for taking my questions. First, just wanted to start off with the revenue guidance for the back half of the year and so it looks like for the first half year, we have come in at over 13% revenue growth, but the guidance kind of implies a deceleration into the back half.

So was there anything that you are seeing that would make you cautious in the back half or I guess how should we think about that back half guidance for 2018?.

Sure, Matt. So when we think about the guidance, you will see that we have increased the annual guidance both bottom line as well as top line over $1 million reflective of the results that we saw in Q2.

However keep in mind as we establish guidance for the beginning of the year from a revenue perspective there is still a lot of uncertainty in the retail space and our guidance for the back half of the year remains consistent with what our expectations were at the beginning of the year.

In other words, we are really not seeing a lot of change relative to the retail environment and we think there is still a lot of volatility there..

Got it. That makes sense, okay. And then another question in terms of the guidance, if I look at the high end of revenue was brought up by about $1 million for the full year, but EBITDA was increased more at about $3.5 million. So obviously, EBITDA increased by more than just the revenue drop-through.

So what areas in terms of leverages on expenses are you getting that are maybe better than you had anticipated when you originally gave guidance for the year?.

Sure. So, when you look at the annual EBITDA guidance, you are correct, it takes into account not only what we have seen in the front half of the year, but also our expectations in the back half of the year.

Now, our absolute spend in dollars of course will increase in the back part of the year, but we are able to spend at a rate lower than the implied revenue growth in the back half of the year. Part of that is benefits of investments we have made in prior years and some of the efficiencies and savings we are seeing associated with that.

We also have evaluated what we believe is the appropriate spend for this year as well as investments we are making into the future and all of that has been taken into account in our guidance..

Great. That’s it for me, guys. Thanks for taking my questions..

Thank you. Our next question comes from Monika Garg from KeyBanc. Your line is open..

Hi, thanks for taking my questions. My first question is I think couple of quarters back you had given us like kind of a 2020 view exiting 2020 view on the EBITDA margins and lower revenue side too.

Given we are seeing a pretty significant EBITDA margin improving 2018, can you update us on that, how you are looking at the margins next 2, 3 years?.

Sure. So, you are correct that we did establish expectations for 2020 earlier this year. And as I mentioned in my prepared remarks, we are well on our way in achieving those expectations for 2020 as well as the longer term financial expectations.

The only update we have made at this point is as it relates to the year, where we have had the opportunity to take up both the top line as well as the bottom line profit..

Then how can you talk about multibillion opportunity ahead of you in your comments, how are you thinking about the growth for next 2, 3 years?.

Well, we continue to invest in all areas of the business and obviously we are cautiously optimistic in the retail environment and we are just continuing to try to execute on what we have control over and continue to deliver best-in-class products to our customers..

Alright.

Do you think we could see acceleration in top line growth next couple of years?.

There is so much uncertainty that’s not our forecast at this time..

Alright, okay. Then just last question on the enablement campaigns in previous quarters, you kind of little bit talked about you had seen some delays in enablement campaigns, any update on those? Thanks..

No, I think in our viewpoint, the environment continues to be pretty much the same. I would say that I think a shot out to the retail team really had excellent execution over the last two quarters as you saw in the numbers, but we don’t see that as necessarily a change in the environment, so continued to monitor everything..

Thank you..

Thank you. And our next question comes from Scott Berg from Needham. Your line is open..

Hey, Archie and Kim, congrats on the great quarter. I guess I got two quick ones.

First of all, Kim, I think this was your largest revenue beat that I can remember in 8 years of covering the company, why such a big beat this quarter relative to prior performances?.

Yes, sure. So in the quarter, one of the large contributors to the beat had to do with our community enablement campaign and more specifically as it relates to Walgreens.

So, Archie talked a little bit about that in the prepared remarks, but in the quarter, we had an opportunity to reach out to all of Walgreens current supplier base as Walgreens was rolling out some new requirements as it relates to different documents order management etcetera and how that impacted us, it impacted us more in terms of one-time revenue associated with that as we are reaching out again to their existing supplier base, but that was highly correlated to the specific beat in the quarter..

Great. Thank you. Helpful.

And I guess the solid question is the incremental EBITDA for the year, trying to understand which line items do you expect to get that additional leverage from, you have made great strides on a year-over-year basis, but wondering if we should be modeling more leverage in sales and marketing versus R&D etcetera to drive that increase?.

Sure. So we guide in the year, we guide to both that revenue as well as EBITDA and not specific line by line.

You certainly have how we are performing across those different line items for the first half of the year and we have given some color as it relates to longer term of what expectations are, but specific to this year you have the first half of the year results and obviously in each quarter we will update you how that looks line by line, but our EBITDA we think is reflective of our expectations for the remainder of the year allowing us still to invest not just in the business for today, but also invest going forward in the future..

Great, helpful. Congrats, again..

Thank you. And our next question comes from David Hynes from Canaccord. Your line is open..

Hey, thanks a lot guys. Archie, I wanted to ask you, your prepared remarks you finished with a comment about helping customers be both EDI and API-enabled.

Can you just talk about kind of the difference there? Are you starting to see a change in the market and how does that evolve your solutions and what you need to be able to do for your customers?.

Yes. I think over time, it’s a very, very slow evolution. I think it’s a big opportunity for us over time.

If you think about EDI, it’s more batch, I am not as much real-time which in a lot of scenarios real-time isn’t of a lot of value as you get into more real-time, you get into drop-ship, you are seeing more on the ERP side of the integration and then on some of the drop-ship marketplaces etcetera, we use APIs to integrate to Shopify, for instance, you are seeing more and more of that.

I think that’s an opportunity for us in the fact that, that’s the way we are built. We are built as an integration company, not as a EDI company.

And I think over time, it’s going to evolve, which will force some tougher times as far as smaller competitors are capable of staying up with the times and also more likely for people to want to have somebody else do that for them, but we made the ice today, we are cold slowly seeing that evolve, but it’s just very, very small and I don’t think it’s going to be that big of a change over the next 1 or 2 years, but it could be, I mean, it would be a positive if it was, but I think it’s very slow evolution..

Okay, that makes sense. Good bit of helpful color.

And then second more strategically than in the numbers, if you think about kind of future requirements vis-à-vis the margin expansion targets you have out there right obviously we are taking a bit of a breather on sales hiring this year, I think it is reflected in the numbers, the marketing was flat year-over-year.

What are the gating factors you look at it, you start to think about next year right, there is demand support, the need for some new sales additions, are you taking more of a wait-and-see approach, how should we think about it?.

Yes, I mean, we continue to just monitor where we think we have demand and where we can effectively hire and add resources. I think there is still a lot of opportunity in the retail space and retailers many of them are behind I think there is a lot of opportunity.

So we will continue to invest in there, I think in channels, I think there continues to be opportunity and our focus on product is to make our product easier to use, easier to partnership, partner with more intuitive, which if you – as we deliver our world-class solution it does cost less to support typically.

So that’s all positive too and our investments are also not only helping us with creating a world class customer experience, but it actually helps us in our margin as well..

Yes.

And then maybe I guess speaking on one last quick one for Kim, deferred revenue pretty big sequential jump, any color on what drove that?.

No, the deferred revenue is just related to the new customers that were signed up in the quarter and the setup fees associated with that that goes on the balance sheet as deferred revenue and gets recognized ratably over 2 years on the financial statement.

And then for certain customers if pay us for more than 1 month at a time, there is a little difficult that goes in there, but nothing out of the ordinary in this quarter..

Okay, perfect. Thanks, guys..

Thank you. And our next question comes from Koji Ikeda from Oppenheimer. Your line is open..

Thanks for taking my questions and congrats on a great quarter, Archie and Kim.

I had a question on the net new recurring revenue customers metric in the quarter and according to my model, that was a pretty good metric this quarter and you highlighted that Walgreens in your prepared remarks and from Scott’s question too that Walgreens contributed to the beat in the revenue line item, but Kim, in your answer, you said that the Walgreens revenue came in as one-time revenue and I believe that means that that those customers aren’t considered recurring revenue customers yet that net new recurring customer count was pretty good this quarter still at over 300.

I was wondering if you could unpack maybe if there was any contribution from Walgreens in that metric and if you could maybe talk a bit about where else you are seeing community enablement campaign successes?.

Sure. So, as it relates to the customer count, you are right that was a nice contribution in the quarter, so we added roughly 300 compared to last quarter that was roughly 100 as an example. The quantity of the net new customer adds is correlated to community enablement campaigns.

The comment when I was talking about Walgreens as I was correlating that to the total revenue beat, more of that came in the form of one-time revenue specific on Walgreens.

That being said, we certainly are getting new business, new recurring revenue from the Walgreens campaigns, but just more percentage wise, if you look specific at that campaign came in the form of one-time revenue versus new, but overall, the healthy adds in the net customer count is correlated to the community enablement campaign activity in the quarter..

Got it, got it. Thank you for that clarification. And just one quick question, another question for you Kim on the tax, it came in a little bit lower than what we are modeling this quarter, could you walk us through the puts and takes on that tax line that resulted in that lower tax rate.

And I just wanted to clarify that you said that we should continue to model a 30% tax rate on a GAAP pre-tax earnings for the remainder of the year?.

That’s correct. Going forward, you should model approximately 30%, you are correct, in the quarter, the tax rate in the quarter was lower than that.

That’s really driven by a couple more one-time type items, one, as it relates to stock transactions that occurred in the quarter, another as it related to a provision to return true-up as we are finalizing our 2017 tax return, we are able to recognize a bit more tax credit in the form of R&D tax credit than we had originally anticipated and as we were completing our provision to return, we are able to take that benefit which gets recorded as an immediate one-time benefit to the tax expense..

Got it. Thanks for the clarification and congrats on a great quarter guys..

Thank you. And our next question comes from Tom Roderick from Stifel. Your line is open..

Hi, guys. Thanks for the question. So just following up, Kim, on the one-time benefits from this quarter, I don’t know if you want to quantify that or if you can help us think about that, but it’s the sort of best to think going forward that the mix kind of trends back to this 93% level that we have seen for most of the past few years.

So maybe I got point of benefit this quarter, how should we think about what that was in this quarter and where the mix goes back to next quarter?.

Sure. Yes, your point, if you look back over the past several quarters that the recurring revenue as a percent of total revenue has been around 93% to your point this quarter that was 92%.

That was correlated to the comments I made about that – specific to that Walgreens enablement campaign, so 93% tends to be the normal and what you would anticipate as it relates to recurring revenue as a percent of total revenue..

Great.

And Archie, how do you feel about sort of sales capacity distribution, oftentimes, you go through the process of trying to drive a little bit more leverage, you get 6 months down the road and say okay, we were shown the leverage and it’s like you guys are showing a lot more than we had expected, which is great, but do you still feel like you have got the necessary sort of sales capacity distribution to keep you on that path towards it’s still double-digit growth rate coming out the year 2020, how do you kind of manage that balance right now?.

Yes, Tom, we think we have the right people in the right spots at this time. It’s a day by day monitoring of that and we are very conscious as a business of building a long-term business.

So, we are going to do what’s right for the long-term both in our investments in our product and more importantly in our sales force to make sure that we are setup for a strong 2019, a strong 2020.

We are obviously looking at the demand out there in the retail environment trying to right-size it based on that, but right now, we think we have the right resources. Again, we have opened business here and there but – and there is monitoring in general pretty much the right capacity..

Okay, great.

Last quick one for you, I will let either you guys decide to get to answer this one, so looking at the average recurring revenue per recurring revenue customer, so kind of our proxy for pricing, which has been pretty steadily and sort of the 10%, 11% range of the last kind of 1 year, 1.5 years, it dipped down into 8% and sort of understanding that the emphasis is more on fulfillment and less on analytics or perhaps that maybe the direction where the demand is going, does that kind of drive sort of a natural drift towards maybe more revenue customer growth, but not as much ARPU growth, how does that play out and maybe you could talk a little bit if you don’t mind about that 8.5% number on the ARPU lift here this quarter?.

Sure. So as you think about those metrics, first, I take you back to the total which is the total recurring revenue growth of 13% and then to your point there is two components that we share that get to that 13%, one is customer and another is that average revenue per customer.

So in this particular quarter, you saw a nice healthy increase in the number of net customers, again correlated to community enablement campaigns.

What we tend to see is when there is a quarter, where there is more community enablement activity and therefore more net new customers that joined SPS Commerce, that tends to actually depress slightly from the revenue, average revenue per customer, because those customers from the large quantity of customers that we get from enablement campaigns they tend to be smaller than our average customer and then they grow with us over time.

In a quarter, where you have less or fewer community enablement campaigns, you tend to then see higher come in the form of ARPU as it’s relating to just more and more revenue we are getting from our existing customers as well as more SKU to the larger customers we get from channel sales, so sort of a longwinded way to try to answer your question, but specific in the quarter, you saw more of that growth come in the quantity of new customers, which slightly depresses than the average revenue per customer..

Outstanding. Really helpful. Thank you, guys. Nice job..

Thank you. And our next question comes from Tim Klasell from Northland Securities. Your line is open..

Yes, congrats on the quarter as well. My questions around the enablement campaigns now in Q1, you had a nice set going on there and obviously had Walgreens in Q2, how should we – what are your plans for the second half of the year, will it be continuing at the same pace or what should we be expecting there? Thank you..

Yes. I think as we have talked about this on a certain time and I think that we had two really good quarters of execution by this retail sales team and I think you need to be cautious on taking two data points and saying it’s a new trend, because we don’t see the overall environment a whole lot different than it’s been in the past..

Okay, great. And then just a real quick question on the sales and marketing line as we have mentioned earlier seems sort of flat, where are you getting the leverage, is it through the channel, is it through getting extra productivity as your direct sales force.

It seems like you guys are gaining some nice leverage, I don’t know if you can sort of point to one or two things that seems to be driving that? Thank you..

Yes, I think specific in the last two quarters as we have discussed, I don’t think we had a really good execution out of the retail team and that makes a lot of good things happen at SPS Commerce. So, I think it’s really based on that..

Okay, great. Thank you very much. Appreciate your time..

Thank you. And our next question comes from Jeff Van Rhee from Craig-Hallum. Your line is open..

Great, thanks. Several for me.

Just I guess back to that S&M question for a second, I think the last update you have given is that the expectation was you had lead the S&M headcount flat, just want to be clear is that where the head is right now and then where the thinking is right now? And then secondly just Archie, maybe back to that enablement campaign question, obviously good start to the year, just can you expand a little bit on what the pipeline looks like at this point, with respect to the enablement campaigns maybe versus where we might have been 6, 12 months ago?.

Yes, I think when we – obviously as we look to Q1 and Q2, they were exceptionally strong. We feel pretty good about the next three quarters, but I think we had two exceptional quarters there.

As far as headcount, obviously, we are not giving that, but you can see from our sales and marketing spend, we are making investments throughout the business as well. We are investing – we have invested in the past in customer success which is helping in different areas.

So again we think we are about the proper area to be able to deliver on our long-term profits..

Okay.

And then just two last for me then, has the ratio of those that test versus sign coming out of enablement campaigns changed?.

It has not, but in general, if you have a program like Walgreens where you are testing their larger suppliers and it’s really a change to their rulebook specifications. In a program like that, you are going to tend to have much higher testing. So in that, that’s going to be highly skewed towards testing.

As you get into the tail, if you are having a program where they are looking to onboard their last 300, 400, 500 suppliers that’s going to be a much higher new add or add-on recurring revenue customers. So in general, the answer is no, but it’s always been a program by program what’s the dynamics of the suppliers you are asking them to onboard..

Got it.

And then just lastly from me, the drop-ship impact obviously has been something you have mentioned on many, many occasions, what is the impact at this point of drop-ship versus when you look back 6 to 12 months, does it feel like it’s increasing as a driver of the overall business, decreasing sort of steady, how would you characterize that?.

Yes, I would say it’s probably market-driven, but it tends to get more and more headlines from the retailers. We obviously I think about a third of our suppliers now uses for some form of drop-ship. We do drop-ship with about 350 retailers.

So we think we are well positioned there and I think it’s just going to continue to be slowly become a bigger part of retail, but I don’t see it as a dominant piece of retail in the short-term or even long-term..

Okay, great. Thank you..

Thank you. And our next question comes from Mark Chapelle from Benchmark. Your line is open..

Hi, thank you for taking my question.

Archie, starting with you a quarter or two ago, you noted that your analytics product and the analytics in general was just on the backburner of most retailers and I was wondering if there has been any movement on that front?.

No, I think that’s continue to be consistent on that and I don’t want to see a change in that happening over the next 1 to 2 years, I just don’t see a big change in that..

Okay, good. Thanks.

And then with respect to your partnered channel, we haven’t heard much about any partner initiatives over the last quarter or two, I was just wondering if you could just give us a little color update on how that’s performing, was it directionally positive?.

Yes, I think that group continues to post nice results. I think they are in the integral part of our company, our solution, our selling, I think the relationships they build are extremely important, at least continue to be focused on our five main ERP system areas and also more and more in the larger global systems integrators.

So, I think it continues to be an extremely important part of our business and our strategic part of our business..

Okay, thank you.

And then Kim one question for you to the point that you can talk about it, where was the company with respect to customer churn, if I recall correctly, is around 13% around year end?.

Yes, so really no change. It’s approximately 13% annual customer churn..

Great, thank you. That’s all for me..

Thank you. [Operator Instructions] And our next question comes from Pat Walravens from JMP Securities. Your line is open..

Hi, this is Mathew Spencer on for Pat. Thank you for taking our question. What do you view as being the toughest challenge for retailers today and when do you think the retail environment will stabilize in the future? Thank you..

I think the hardest thing for the retailers today is the vast, vast majority of the business in the high 80% of their business is going to be in brick-and-mortar.

So, that’s an extremely important part of their business, but the future and the highest growth areas are e-commerce, so you have to do both extremely well and it’s blending more and more together. So it’s just changing.

And then I think with the Internet, not just Amazon, but the Internet pricing competitiveness in the marketplace is part of the new game..

Great. Thank you very much and congratulations..

Thank you. And I am showing no further questions from the phone line. Ladies and gentlemen, thank you for participating on today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day..