SPS COMMERCE, INC.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

SPS Commerce is a cloud-based supply chain management software provider, connecting retailers, suppliers, distributors, and third-party logistics providers, primarily catering to the retail industry.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

SPS Commerce operates in the dynamic supply chain management software industry. Its primary business revolves around facilitating smooth, efficient, and transparent communication and transactions among various participants of the retail supply chain through their cloud-based platform. This platform automates processes such as order management, inventory, invoicing, and shipping. They aim to improve speed, accuracy, and visibility in retail-related business operations.

SPSC’s business model is based on recurring subscription revenue from retailers, suppliers, and third-party logistics providers for accessing their cloud-based platform and its various functionalities. They also generate revenue from professional services, which include implementation, training, and support, although the recurring revenue is much more prevalent and stable.

  • Revenue Streams: The company generates revenue primarily from three sources:
    • Subscription fees: Recurring revenue from access to their cloud-based platform and its services, constituting the majority of SPSC’s revenue.
    • Professional services: Revenue from implementation, training, and support services provided to clients.
    • Transaction-based fees: Smaller component of revenue, where a fee per transaction is charged for services executed through the platform.
  • Industry Trends:
    • Increased Demand for Transparency and Visibility: Businesses are increasingly seeking transparency and real-time visibility into their supply chains to enhance operational efficiency and quickly adapt to changing market conditions.
    • Evolving Technology and Analytics: Cloud-based solutions are becoming essential for streamlining supply chain operations. There is an increasing demand for sophisticated analytical tools that provide insights on various performance and supply chain metrics.
    • Global Supply Chain Complexity: Global supply chains are becoming more complex, emphasizing the need for unified and well-integrated solutions such as SPSC offers to help manage and coordinate across a diverse group of participants.
    • The Rise of AI and ML: Artificial Intelligence (AI) and Machine Learning (ML) solutions are becoming more prevalent in supply chain management, offering predictive capabilities that improve accuracy and efficiency.
  • Margins: SPSC boasts high gross margins due to the recurring software subscription model and low cost of goods sold. However, operating margins are lower due to high sales, marketing, technology and research and development expenditures.
  • Competitive Landscape:
    • The competitive landscape is fragmented, with many players offering supply chain management solutions.
    • SPSC’s primary competitors are traditional EDI (Electronic Data Interchange) network providers, large supply chain software vendors, and some small, specialty software firms.
    • Competition in this space is likely to increase as technology evolves and clients demand more customized solutions.
    • SPSC has to continually innovate and invest in new technology to maintain its market position and growth.
  • Differentiation:
    • SPS Commerce emphasizes its robust cloud-based platform, which allows easy and transparent connection and communication between various entities of the retail supply chain, setting it apart from many older, more legacy systems
    • SPSC has a massive network of suppliers and retailers, which provides significant network effects for the company’s growth.
    • SPSC has deep domain expertise in the retail industry, giving them a strong industry specific moat that they can utilize to create value for their partners.
    • SPSC is continually investing in new features, technology and software to keep its offerings relevant in the rapidly changing market landscape.

Financial Analysis:

The following analysis is done based on SPSC’s latest 10-Q filing for the period ended September 30, 2024, in comparison with previous results.

  • Revenue Growth: SPSC has reported consistent revenue growth, though it has slowed from 2022 to 2023 and again for the most recent nine-month period.
    • For the nine months ending September 30, 2024 revenues totalled $383.2 million, up 16.3% y/y. This however, is much slower than the growth in the previous year.
    • For the year ending December 31, 2023 the revenues grew by 19.2% to $498.9 million, while for the previous year they grew by 25% to $418.7 million, indicating a steady deceleration in revenue growth.
    • This trend suggests that while SPSC continues to grow, growth rates are slowing down, which could indicate some degree of saturation in their primary markets.
  • Profitability:
    • SPSC has high gross profits, mainly due to their business model. Gross profit for the nine months ending September 30, 2024 was $276.8 million, or about 72% of revenue, which is quite consistent YoY.
    • The non-GAAP profit also remains highly consistent in percentage terms, however due to heavy investments into sales, marketing and R&D, operating margins are much lower in range of 20-25%.
  • Expenses:
    • SPSC’s operating expenses have risen substantially year on year.
    • For the nine months ended September 30, 2024, selling and marketing expenses were $123.9 million. Research and Development expenses totaled $79.5 million, while General and Administrative expenses were $71.3 million. This demonstrates significant investment into expansion, innovation, and back office infrastructure.
  • Balance Sheet:
    • SPSC’s balance sheet shows strength in terms of liquidity and overall solvency.
    • Current Assets stand at $211.6 Million (including $133.9 Million in cash and cash equivalents), versus total liabilities of $178.8 Million, showing a healthy current ratio.
    • SPSC has no long-term debt and only some short term debt ($2.4 million), further bolstering its balance sheet health.
    • The company also has a cash position of $133.9 million (mentioned before) which provides ample dry powder for further growth and investment.
    • Goodwill stands at $423.1 Million, which is the sum of all previous acquisitions and should be monitored.

Moat:

SPS Commerce has a Narrow Moat (3/5) based on several aspects.

  • Network Effects: A big strength for SPSC is its established network with thousands of suppliers and retailers on its platform. As more entities join the network, the value of SPSC’s platform and service rises for all other partners making it difficult for a competitor to replicate such massive, diversified network.
  • The network effect is very hard to replicate without a huge amount of initial cash burn that would turn away many would-be competitors. This gives SPSC a substantial moat around the core business.
  • Switching Costs: There are considerable switching costs for customers on SPSC’s platform. Customers have already invested their time, money, and data into the SPSC ecosystem, making it very difficult to switch over to a competing product.
  • There is also the risk of loss of crucial information and integration issues with a new provider, which further disincentivizes a switch.
  • Intangible Assets: While not as strong as a brand like Coca-Cola, SPSC’s intellectual property related to its proprietary software and unique business knowledge also constitute an aspect of its competitive advantage that prevents competitors from rapidly replicating SPSC’s business model.
  • Limited Scalability of Certain Aspects of the Business: While certain aspects of the business are scalable (the platform itself), customer service and sales requires a lot of personal human interaction and specialized sales teams, making quick, scalable growth difficult.

Risks to the Moat:

While these factors contribute to the company’s moat, there are some risks.

  • Technological Disruption: Rapid advancement in cloud, AI and other tech can render SPSC’s core tech obsolete, or enable competitors to rapidly create a more valuable alternative platform. SPSC must constantly innovate and adapt to stay relevant.
  • Aggressive Competition: Larger tech companies, or well-funded competitors could invest heavily in similar solutions to compete with SPSC, or try to offer cheaper solutions, thus lowering SPSC’s ability to charge premiums.
  • Concentrated Customer Base: High reliance on a few key customers could be detrimental to SPSC if those clients choose to switch or reduce spending, hence a more diversified client base should be maintained by SPSC.
  • Cybersecurity Risks: The supply chain software market is an area that is prone to many cyber security attacks, hence, SPSC needs to keep up with the latest security systems to ensure that their data is secure.
  • Changing Regulations: The various new laws and regulations could materially affect SPSC and increase operational costs. SPSC needs to prepare and adapt to such changes.

Understandability:

Based on the complexities of the core products and services, and considering that certain business operations can be hard to grasp for the common retail investor, we rate SPSC’s understandability as a 2/5.

  • SPSC’s business model is not readily understandable by new investors since it operates in a niche software industry, and it takes some time to understand the importance of SPSC’s specific niche, and it’s market penetration.

Balance Sheet Health:

The company has a very strong balance sheet, with virtually no debt and plenty of cash. We rate the balance sheet health of SPSC as a 4/5.

  • The only thing we would rate them down slightly in this category is their heavy use of goodwill in the acquisitions column.

Recent Concerns and Controversies:

  • Slowing Growth: SPSC’s revenue growth rate is slowing, which may indicate that the company’s best growth years are behind them, or that competition is increasing.
    • The management, however, has emphasized that this is still a time of rapid growth and that there is a massive TAM (Total Addressable Market) for its products. They further believe that they can improve their future growth. They have also shown intentions to grow in new adjacent areas of their market.
  • Customer Concentration: SPSC may be vulnerable as it serves a small percentage of large and important clients. The company has emphasized that they have great relationships with their customers that have provided a consistent stream of income.
  • They have also been continuously growing their client base, and hence, revenue from smaller enterprises is also increasing.
  • Profitability Challenges: Although margins are consistently high, concerns have been raised about profitability due to high operating expenses.
    • Management acknowledges that margins might look high enough and that margins on net income are comparatively lower because the company is investing heavily into R&D, sales and new tech, which should lead to further growth in the future.

Conclusion:

SPS Commerce is a company operating in a crucial part of the retail ecosystem. While the slowing revenue growth is a bit of a concern, their business model is sound, and it does have an economic moat based on network effects and switching costs. Although SPSC’s operations are not readily understood, and its valuation might be a bit pricey for some investors, it remains a strong company with good long-term potential.