Kim, you just want to test it out real quick?
Yeah.
All right, looks like you're on.
It's on, yeah.
All right, we'll get started here. Thanks, everyone, for joining us. My name is Scott Berg. I lead the enterprise software and SaaS research efforts here at Needham. I was just chuckling to myself, actually, so if you see my list of questions, I always write names up on the top just in case I forget it. Kim, I've been working with you for about 16 years now. I better not forget your name.
You better not.
Yeah, Chad, I've known you for, I think, 12 or 13 years. I better not know your name. But I was introducing my new associates to part of our sales team this morning, and the funny thing is I actually couldn't remember one of the salespersons on my team that I've worked with for 10 years. So this is why I write names, just because in the heat of the moment, when you're busy, it happens. But anyways, today with us, we have SPS Commerce, currently my longest covered company under my coverage. We have Chad Collins, the company CEO, and Kim Nelson, the company CFO. I guess for maybe the one or two people in the room that is unfamiliar with SPS. How about a brief overview of what the company does?
Yeah, sure. At SPS, we operate a network in the cloud that helps connect retailers with all of their suppliers, primarily merchandise suppliers, so they can digitally exchange supply chain documents across our network and really helps facilitate the collaboration on the supply chain processes between retailers and suppliers.
Okay. So I'm going to start with the, I think, the question you probably have as topic 1A coming off your conference or after your third quarter call, because it's the first question I get in almost any call I have on you guys lately is, let's talk about the revenue recovery business. The company's made two acquisitions in the space, SupplyPike predominantly on the 1P side and Carbon6, which does both 1P and 3P suppliers. I guess for investors that might be new to your story, at least maybe haven't seen this product area, what's the difference between 1P and 3P, and how do the core customer demographics maybe differ across the two solutions?
Yeah, sure. So let me even go maybe one step back and just, what is this revenue recovery thing anyway, right? So in retail and distribution, the buying organizations, so the retailers or the distributors, typically have a set of rules for their supply chain that they enforce with their suppliers, that you have to follow these rules. And they're really complex. They're everything from these digital signals that we send back and forth, all the way to where you should put the label on the box, to what transportation carriers you use, and also all the way down to the payment terms that'll go back and forth. And so for a supplier, if you violate one of the rules that the retailers have, the way that they try to drive enforcement of these rule books is if you have that violation, they charge you a penalty.
And the way that they charge that penalty is they just short pay your invoice and give you a very mysterious code that says, here's your penalty. And oftentimes, it's very complex for suppliers. They don't know what they did wrong oftentimes. And in some cases, the error that caused the penalty was actually driven by the retailer, not the supplier. And so if you dispute it, you can get your money back. So that's sort of the business problem that our supplier customers are dealing with. And this revenue recovery set of solutions provides a SaaS platform that allows the suppliers to understand when they get these penalties, one, what was the root cause problem in their supply chain so they can go fix it and have it not happen again.
And if the error was on the retailer side, how do they dispute that penalty and get their money back? So that's what these solutions do. We were hearing from our customers quite a bit about a lot of challenges that they were having dealing with these chargebacks or penalties and how to manage those. Most of them were doing it in a very manual way. And that's really what led us to the revenue recovery area and thought that we could get into that space the fastest and add the most value for our customers by acquiring in this area. So that led us to SupplyPike and Carbon6. And just now, your specific question on the 1P, 3P.
The 1P model refers to the wholesale model, so where you have a supplier to a retailer who's selling the goods wholesale to the retailer or distributor, and then they're going to resell them to the end consumer. The 3P model is more of the marketplace model. That's where you're going to list your products in a particular marketplace, Amazon in this case, and you actually own those products even though they're listed on the marketplace. In the case of Amazon, Amazon kind of also does the logistics service or the fulfillment service for you. This whole deal with revenue recovery can happen both in the 1P and the 3P. Most of our fulfillment customers are 1P, so kind of our 50,000 fulfillment customers are more in that 1P model.
For the revenue recovery, we manage that for a bunch of 1P customers and also have coverage on that through the Amazon marketplace for those 3P customers.
Okay. So a core part of the 1P's potential is the cross-selling of the solution into your fulfillment base, obviously, and on the 3P side, which formally launched in October, I guess. What customer sizes do you typically target with this solution? Does it really address all your customer base, or is there something that's a better fit?
Yeah, so if we look at our core fulfillment solution where most of our customers are, it really spans from a lot of very small customers through medium and large customers. Revenue recovery is going to be much more addressable for those medium and large customers that are doing enough volume with the retailers that justifies having a solution like this in place. So yeah, we see it much more addressable to our existing customers that, one, have the volume. And then, of course, you also have to be trading with one of the retailers that we support for the revenue recovery solution. We have almost all the retailers covered in our network for revenue recovery. Now, there's about a dozen retailers that we support.
And how does an existing customer use their data within the fulfillment solution for these? Because I think that's the interesting part of how you're bringing that revenue recovery into the SPS platform is you can kind of leverage that. But how is that important?
Yeah, so that's one of the things that we saw as a real benefit of building out in this revenue recovery space. A lot of the documents or information that you need to dispute one of these chargebacks is actually available already on our network. So when these Carbon6 and SupplyPike were standalone businesses, they had to go find other means to go get these documents to go dispute things and file the claims. What we're able to get is actual shipment data, sometimes transportation data right off our network, which really speeds up the process to handle these.
So really a benefit where, and this is a great thing I think about network businesses, if you have that core network and then you can add value-add applications on top, a lot of times those applications get a lot stronger by being plugged into the network and having access to that data on the network.
Okay. So you have 2,000 retailers. You mentioned there's about a dozen currently within your revenue recovery network, at least. Can all 2,000 plus of those retailers ultimately kind of fit within this, or is there a subset that's also probably a better fit?
Yeah, so it's really going to be the more mature and larger retailers and distributors, which will implement these chargeback or penalty programs. If you think about it, those are also the buying organizations that have a little bit more power over their suppliers so they can put these programs in place. So I think over time, we will see more and more retailers and distributors implement these penalty programs to drive the right supply chain behavior. But I would not expect that all of the retailers in our network, probably the small ones won't, and the large ones will.
Okay. So let's go back to the third quarter, specifically on the revenue recovery business. The first thing in the third quarter is in your, we'll call it 15-plus years as a public company. It was the first quarter that the company actually missed its guidance and our estimates for the quarter. I guess help us recap what happened in the quarter and how do you correct kind of your visibility and how you think about that business? Because the revenue recovery really was the driving force into the underperformance in the quarter.
Yeah, I can take that one. So to your point, it was really primarily driven by the revenue recovery. There were two aspects there. One, with the benefit of hindsight, as we looked back in the first half of the year, we were actually exceeding what our internal expectations were. We factored that Q2, really that beat and drivers of that into our back half guidance. We recognized in Q3 that there was some seasonality, particularly around Amazon Prime Day, that was impacting the Q2 numbers. So that part meant that our internal expectations for the back half of the year were lower than we had previously thought. Again, front half was higher. The year before we owned the acquisition, that company was growing very nicely. It still is growing, of course, but it masked some of that seasonality.
The second part of it had to do with a change that Amazon made as it related to how many months of inventory suppliers could ship in. These third-party suppliers could ship into Amazon. So there's a bit of a one-time effect of having to reduce that down to the lower inventory levels. That's not sort of an ongoing. Both of those were the drivers of where we were off in Q3. We made sure on our earnings call, we focused on explaining the why behind that and also the impact that that then had into Q4.
Okay. The one-time impact, Kim, that you just mentioned is around the, I'll call it right-sizing of inventory levels. Is that just a one-time impact on Q3? How do we think about that kind of flowing through maybe the next 12 quarters?
Yes, no, great question. So by one-time meaning, it's not an ongoing. But to your point, when you have over 8,000 suppliers, it did not work all the way through in Q3. So we have that factored as well into Q4 of knowing there's a period of time where it's going to take to work through the system. But when we put together our updated expectations for 2025, we did take into account in that guidance the fact that there still would be some working through the system.
Okay. Fair enough. And then probably my last question on revenue recovery is Amazon made a number of changes to their program and how they work with, I think it was more on the 3P side in the beginning of the year with those suppliers. I think some have thought that will reduce your opportunity to work with them in this revenue recovery segment. But I know in my discussions with you, you've been very optimistic about that opportunity kind of in general. Is what you saw out of Amazon, not just this one-time inventory item, but maybe the bigger changes they made last year, is that a real headwind to the business, or is that maybe overstated by what some investors think?
Yeah, so I think it's important to understand that the majority of our revenue recovery business aligns with all of our fulfillment business, which is in this 1P area, and we have seen these policy changes, but they have been exclusive to the Amazon third-party area, and so while some of these policy changes have been a headwind, what we're not seeing is in the more strategic part, which is really the 1P part and really the focus of our strategy overall, building out revenue recovery, because that's the most addressable part to our other customers. We've not seen these headwinds, so overall, our thesis around that revenue recovery would be very addressable to our customers, that there'd be a lot of demand for this solution overall. All those things have very much held true, and especially on the 1P side.
Mainly on the 3P side, a few more headwinds than we might have expected.
Okay. All right, let's move to product a little bit. You held an Investor Day at the end of September. Your office is there in Minneapolis. I thought you presented a really interesting chart on the opportunity for software within the supply chain kind of ecosystem where you all play. As we think about your future innovation, whether it's organic or inorganic, should most of your net new functionality come from what that chart depicted, or are you starting to see some opportunities outside of that? Because I thought you did a really good job of showing what you addressed today and what the white space was in that ecosystem.
Yeah, yeah, and I think in that Investor Day, we specifically showed that chart for our supplier customer. I mean, we're really servicing three main market segments, and most of the revenue is with that supplier segment, but equally important to us is the retail customer we serve, as well as the third-party logistics provider. And so when we think about product strategy, that exact chart is something we use in forming our product strategy, and we have one of those charts for each, so for retailers, suppliers, and 3PLs, really look at it in their whole business process. What are the areas of that business process where we have solutions for them and they're utilizing our technology today? And then what else is very close or somewhat even involved in that business process where we're not helping them today?
And then we look at that and say, "Hey, would it make sense for us to provide that solution to the customer? Would we be a better provider of that solution for whatever they have today?" And if the answer is yes, then we work that into our product strategy. Most of the times, that results in some kind of feature or capability that will build and enhance our own products. But sometimes that's a partnership opportunity, and sometimes it's an acquisition opportunity.
The company has been very acquisitive since its IPO. It's maybe not very modestly acquisitive. Do you expect that pace of acquisitions to change and maybe shift more towards organic innovation, or should the mix that we've seen be kind of held true, do you think?
Yeah, so I'd say over the mid- to long-term, we do view that M&A can be a great lever for us to continue to build out the right set of solutions for our customers and grow the business. Kind of looking at that in three different areas. One is continued consolidation of the EDI market. Those work very well where you have small players that would like to sell their business. They can come on. Usually, that's a big benefit for their customers because those customers immediately get the benefit when they come onto our much broader, larger network. Also, additional solution areas like what we've done with revenue recovery, where we have high conviction that we'll be able to cross-sell this new product category into our customers.
And then geographically, I think if we have some early but positive signs in our development as we build out the business in Europe, could see some geographic M&A as well to further build out, especially in Europe should we continue to have traction in Europe. So that's more of the mid to long term. I'd say in the near term, we are still working through the build-out of this revenue recovery business and kind of all the integrations of that business. In addition to that, there's a little bit different revenue model. Some of that business is done on a take-rate basis versus subscription. And we want to make sure all those things are stabilized and we're fully through the post-merger integration on those things. And so I'd say the M&A, while we're always building M&A pipeline, probably more a medium to long-term focus.
Okay. So, random off-script product question because I got this yesterday again, but I've had this question a lot over the last 10 years, is only because you just mentioned kind of EDI and some of the consolidation that you've done in that space. Do you feel that the SPS technology platform is modern enough as customers, your suppliers, move from traditional EDI connectivity to something more API-based, etc.? I think there's a misnomer that you can't handle that type of technology today.
Yeah, we get this question a lot about EDI versus API. And to us, it really doesn't make a difference. Our network can speak both EDI and API, in some cases just file formats. They're just different kind of endpoints on our network. And typically, how I explain this EDI versus API, it kind of is when the stuff was invented by the retailer, right? So these wholesale or ship-to-store models have been in place for years and years. That tends to be more EDI. The more modern things we're seeing in omnichannel, like marketplaces that were invented more recently, they elected to use APIs as the communication mechanism. For us, it doesn't really matter what that endpoint is. And actually, what we find with customers is the APIs actually tend to be more complex for them.
So using a network like ours that takes that complexity out of the equation, actually the value proposition might be stronger for the API approach versus the EDI approach.
Moving to go-to-market a little bit. One of the things that you all talked about at your Investor Day is customer segments. You had a new breakdown or newer breakdown of customer segments and what our approved growth looked like in those three different segments. But what do you think the greatest near-term opportunity is kind of within those three customers? Because the business is very different today than when I first started looking at it 15-plus years ago.
Yeah, yeah. By far, our greatest opportunity with existing customers is to drive more trading partner connections on our network for those customers. So the majority of new customers that come to us come to us through one of our retail enablement programs. And most often, if they come in that way, they only add that single retailer that we're running the program for. But if they add that retailer, they may be doing business with another five, 10, 15, 20 different retailers. And so we've always had this land and expand model. I think what you'll see is us get more focused on making sure we're fully penetrating and getting all the trading partners of a given customer. And that's by far the largest opportunity for us.
You've seen the company over time be able to move from very small customers kind of up-market as we've done more and more ERP integrations and added that to our portfolio so we can service large customers. I think that that will continue, and in the higher end of the medium and really the enterprise segment, there is a nice replacement opportunity. The challenge with replacement is there's fewer of those companies and you do have to wait for the replacement cycle, but I think that up-market trajectory over the medium to long term will continue in the business.
When you replace the integration networks with those mid to large-sized customers, how dependent upon the swap out of an ERP system is that kind of sales process for you all?
That's the most common way that we get them. So they're already looking at modernizing their technology, still often moving from an on-premise ERP system with an on-premise EDI tool. They're going to the cloud. They want a modern ERP system in the cloud. They'll go to a modern B2B connection tool like SPS in the cloud. But we also do see where companies just, they don't want to still have the manual EDI department where they have to go in and maintain all these maps themselves. And they're really seeing the value of plugging into a network like ours that is more managed on their behalf. So it really can come in both ways, but ERP change-out is still a big driver.
Okay. I think an interesting change, or maybe not change, expansion of your go-to-market strategy this year was you landed your first retailer to join you in the enablement campaign kind of programs. I guess, what have you learned initially from that? I don't know if they've actually launched their first program yet, but how does an enablement campaign maybe differ with a European-based retailer versus U.S.? And any of those learnings, I think, would be helpful.
Yeah, absolutely. So we have gotten the one and one other smaller one now as well. So the momentum is good in terms of running enablement campaigns in Europe. A couple of things that we've noticed. One, the retailers in Europe in general are smaller than the retailers are in the U.S. Kind of makes sense. They're covering typically a country or a region in Europe, which has a smaller GDP. So the power dynamics between the retailers and suppliers are different. So we have to be appreciative of that. Sometimes when we're calling in on behalf of a retailer in the U.S., that's a very powerful position that retailers in with their suppliers. The dynamics can be a little bit different in Europe. And then just operationally, we're doing that and reaching out to suppliers all across Europe, right? So we have different languages. We have different business cultures.
We have different ways decisions are made inside these companies. And so just working through all of those different dynamics, whether they're the power dynamics or the business culture dynamics, but early signs are positive that there is certainly a need for these types of enablement campaigns. And the other thing I'll say about Europe is the e-invoicing product that we got with the TIE Kinetix acquisition has worked out very well. The e-invoicing mandates that are coming out across Europe are really gaining some traction now. And what we see a lot of companies is they're looking at now they're required to implement e-invoicing. They're looking at how they do all the potential supply chain documents electronically as well.
So some of these, even though it's just the mandate for the invoice, a lot of companies are looking at, "Hey, how can I digitize all of my supply chain as long as I'm doing it for the invoice?" And so that's been a positive thing that we've seen in Europe.
I know in Europe, the VAT compliance e-invoicing kind of rules and regulations or compliance of that is it's had some fits and starts, right, over the last couple of years. And I think probably more stops than starts as, I don't know, the governments are trying to still figure out the right ways to actually report and remit some of the data that's here. But it doesn't sound like that's impacting any of the customer interest in it. It sounds like they're probably trying to get ahead of it a little bit.
I would say they're much more interested in the countries like Belgium that are actually mandating it now. And there have been a lot of fits and starts. But I think that because some countries are really getting traction with it now, Germany's just underway now as well. I think that other countries, and if you're doing business cross-EU, you're kind of mandated to do it once one country does it. It has been slow, but I see it really building momentum now.
Okay. On the go-to-market side, you've had a change in your chief customer officer, chief revenue officer, depending on the title for you guys. It's chief commercial officer, at least with Eduardo coming in. He's got kind of a really unique background with some of your partners in the space. I guess it's early. I knew Dan for a long time. But how do you think your go-to-market maybe evolves or changes a little bit with Eduardo coming in, if at all?
Yeah, yeah. So I mean, first off, Dan was our long-time Chief Revenue Officer, did a fantastic job growing the company, but did retire, and so we were able to do some thoughtful succession planning there and have Eduardo ready to go, and so a few things that we were looking for when we filled this role of Chief Commercial Officer. One, we wanted somebody who'd operated at a scale a little bit larger than us as we continued to grow and grow into bigger scales. Just having that background of operating larger go-to-market organizations was something that we were looking for.
We also wanted a real strong go-to-market thinker, especially as it related to the customer treatment strategies and how to maximize upsell and cross-sell with the existing customers, which we've been quite clear that we think there's both growth that will come on new customers, but probably the growth percentage will be higher on the ARPU growth, which really mandates us really building out those muscles around upsell, cross-sell. We wanted somebody who had operated internationally as well. Eduardo has operated in every major commercial area of the world. And then what we also got with Eduardo is somebody who had a background in ERP. And so our channel go-to-market, where we work a lot with ERP providers, he knows that ecosystem very well. And I think it would be very, very beneficial for helping us out there in the channels as well.
Yeah, he came from two different ERPs and worked at Microsoft. So certainly he's been around that partner type of ecosystem extensively. Probably two more questions for me, then happy to open it up to any questions from the audience. Kim, your initial 2026 guidance calls for, we'll call it 7 to 8% organic growth. You already talked about the revenue recovery kind of conservatism in the year, or at least accounting for some of those changes. Are you feeling any other headwinds in the business? I get the question frequently relative to a couple of years ago, you're still growing organically 15%, and we've seen some slowdown. But any other headwinds you can kind of summarize, I guess?
Sure. So I'll take us back to our Q2 earnings call. On our Q2 earnings call, we took an opportunity to update our, call it more medium-term view of how we're looking at growth on the top line, as well as how we're looking at margin expansion on the bottom line. Prior to that, we had a view back from, call it 2021, as it related to a top-line growth of 15% that included M&A. And we'd heard a lot from investors, their desire to have a view of, "Hey, what could that top line look like if you did not do future M&A?" Meaning M&A would be on top of it or additive to it. So in Q2, we took the opportunity to provide that updated view, which was high single digits, excluding M&A.
Obviously, M&A would then be additive to it, as well as expanding our EBITDA margin expectation to 200 basis points annually. And as the top line is more in that sort of high single digits, being a SaaS business model, very appropriate and well within our ability to drive higher margin expansion at that 200 basis points. So I start us there because when you compare that to what we said in Q3, in Q3, we took an opportunity to provide our preliminary view for 2026. As you well know, Scott, we typically do not talk about next year until our Q4 earnings call. But in light of how we're planning on exiting 2025 that we talked about on our Q3 earnings, we felt it was appropriate to provide a preliminary lens into 2026.
A way to think about that is on the lower end of high single digits specific to 2026. We also did reiterate that 200 basis points of EBITDA margin for 2026. And then we also then reiterated that longer medium-plus view of that high single digits with the 200 basis points. So really the one change, if you want to call it a change between Q2 and Q3, was we just honed in a little bit of what the expectations are specific to 2026. And that was really driven by how we're planning on exiting 2025 and the impact the way recurring revenue works, the impact that that then has into 2026.
Okay. My last question is around the 200 basis points of leverage. The business is already really profitable. You have a great adjusted EBITDA margin profile. Obviously, as you become more profitable, 200 basis points on an annual basis in the next couple of years becomes incrementally more difficult to take out of the business. Where is that all coming from? I know you've talked a little bit from gross margins, but is it primarily going to be gross margins or is there some operating expenses? Because the visibility in 200 basis points maybe seems a little less clear than what it was three or four years ago, but you're very confident in it.
Sure. Yep, so we have stated longer-term goals by line item of where we see opportunity to expand the margins. We're currently pointing investors primarily to gross margin, really based on a multi-year time period in which we made significant investment in the overall customer experience, and we're now beginning to grow into that. Simply stated, we don't need to add as many resources incrementally as we have historically based on all the investment that we've already made. You've started to see that roll through in the back half of 2024, and if you look at our implied guidance for 2025 and the implied EBITDA margin expansion in 2025, we have pointed investors to gross margin, and you've already seen that through the first three quarters of 2025. Longer term, we think gross margin. We've said low to mid-70s. We've been in the mid-60s for a long period of time.
Now we're creeping up a little bit closer to the upper 60s, but a lot of that's based on, again, being able to grow into various investments we've previously made. And of course, there's lots of efficiencies we can get through AI as well, so lots of reasons that gives us that optimism as it relates to gross margin expansion. That being said, there's certainly opportunities to continue to refine a bit on the sales and marketing spend now that we've already driven a lot of efficiencies there, and we're more in the lower 20s, but we've seen sort of high teens-lower 20s longer term, and G&A is an area for natural margin expansion as well over time. R&D less so. We think that's pretty appropriate, the spend that we have there.
Okay. With that, happy to take any questions from the audience. George.
So the revenue recovery business, is that a little bit more of a managed service business than the software business in that the pricing is not a monthly or annual fee and it's sort of more volume-based?
Yeah. So when we acquired SupplyPike and Carbon6, they each had a different revenue model. SupplyPike was more traditional SaaS, and then the users would have to provide all the administration of these claims back to the retailers. Carbon6 was a take-rate model, so more of a managed service in which whatever money was recovered, they participated in that. We found the need for both of those solutions in the market. So as we've combined the sales force and brought that together, I mean, first now we have one sales force that can offer all the retailers in revenue recovery. But they can offer both on a SaaS basis and a take-rate basis. And that take-rate basis is a little bit more of a white glove or managed service because we really help them administer those claims back to the retailer.
Any other questions? Well, with that, we'll give everyone a couple of minutes to go fight the elevators. Chad and Kim, I wanted to thank you so much for your time today.
All right.
Thank you so much.
Thanks, Scott. We'll see you next week.