EngageSmart, Inc. (NYSE:ESMT) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Good morning. Thank you for attending today’s EngageSmart First Quarter 2023 Earnings Call. My name is Todd, and I will be your moderator today [Operator Instructions]. Please note, this call will be recorded, and I will be standing by if you should need any assistance. I’ll now turn the call over to Josh Schmidt of EngageSmart. Josh?

Josh Schmidt: Thank you. Good morning, and welcome to our first quarter 2023 earnings call. With me on the call today are Bob Bennett, Chief Executive Officer; and Cassandra Hudson, Chief Financial Officer. Our earnings press release, supplemental presentation and associated Form 8-K can be found at investor.engagesmart.com. During this call, we will be discussing certain forward-looking information. Actual results could differ materially from those contemplated by these forward-looking statements. Please refer to the Risk Factors section of our annual report on Form 10-K and other SEC filings for more information on the risks regarding these forward-looking statements and risk factors associated with our business. All metrics discussed during this call are non-GAAP unless otherwise noted.

A reconciliation of non-GAAP metrics to the nearest GAAP metric as well as statements regarding why management believes these measures provide useful information can be found in our earnings press release and supplemental presentation, both of which are available on the Investor Relations section of our website. This call is being webcast live and will be available for replay on our website at investor.engagesmart.com. I would now like to turn the call over to our CEO, Bob Bennett.

Bob Bennett: Thanks, Josh. Good morning, everyone, and thank you for joining us on our first quarter 2023 earnings call today. We are thrilled to kick off the new year with an excellent first quarter that showcases the strength and resilience of our business model. EngageSmart delivered our seventh consecutive quarter of record revenue, which is $88.4 million, representing 31% year-over-year growth, all organic, and record adjusted EBITDA of $17.3 million, which is an adjusted EBITDA margin of 19.6%. Our teammates’ hard work and unwavering dedication to excellence have been instrumental in driving our success and enabling us to deliver exceptional value for our customers. Throughout the first quarter, we continued to see sustained demand and favorable secular trends across both segments of our business.

We also continued to make progress in driving product innovation, further solidifying our market position. As we move forward in 2023, our focus on simplifying customer and client engagement is paying off, and we continue to expand our reach across all verticals. Before Cassandra dives deeper into the details of our financial performance and our outlook for 2023, I’d like to share some first quarter highlights. The high demand for mental health care and the shortage of professionals presents a unique opportunity for our SMB segment to make a meaningful and positive impact, Driven by new customer adds and favorable transaction revenue, SMB achieved revenue growth of 36% in the first quarter. Our Enterprise segment is well positioned to capitalize on the long-term trend of organizations digitizing their operations, providing a steady tailwind for growth.

Enterprise delivered revenue growth of 25%, fueled by strength in digital payments and paperless adoption and continued customer go-lives this quarter. Our growth strategy in SMB has two main elements and is showing great traction. The first element of our strategy centers on our core mental health vertical, where we see a growing need for care due to the prevalence of mental health disorders. According to the American Psychological Association, 45% of psychologists agreed or strongly agreed that they felt burnt out in 2022, highlighting the strain on the industry. SimplePractice presents a unique opportunity to address this challenge. By streamlining administrative functions, SimplePractice gives practitioners time to focus on what they care most about, treating their patients.

The second element of our strategy targets group practices, which we see as a significant growth opportunity. We continued to see traction with this area in Q1, particularly among small group practices. These are an excellent fit for us given our track record of helping solo practitioners expand their businesses with our comprehensive solution. We continue to invest in developing new features and functionality to cater to the needs of both small and large group practices and are encouraged by our progress with both. Additionally, we continue to see strong market expansion growth, particularly with speech language pathologists and occupational therapists. One of the keys to SimplePractice’s success is its ability to build and foster a community around its platform.

Our customers don’t just need a software solution, but also a supportive community that can help them succeed in their practices. We’ve taken this approach to heart and are investing to create resources that bring our customers together. In a recent survey of over 900 practitioners, we found that 75% say that mentorship is a critical aspect to their career success, but only 25% currently have a mentor. With our vast network of over 169,000 mental health and wellness practitioners, we are uniquely positioned to address this gap and connect practitioners with peer support. In March, we launched a pilot 50-member mentorship program, and the interest we saw was enormous. In fact, we received over 10x the number of applicants than we had room for.

We are excited about initiatives like this as they help us expand our community, bring new practitioners into SimplePractice, and enable us to grow our brand. We are committed to making mental health care more accessible. Our newest offering, SimplePractice Enterprise is an extension of that mission. We believe our practitioner network has the potential to be particularly valuable for employee assistance programs or EAPs and managed care organizations, or MCOs, which often struggle to find therapists for their network. By providing easy scheduling with our existing practitioners, SimplePractice Enterprise can address systemic issues regarding therapist supply while also improving efficiency. SimplePractice Enterprise also strengthens our flywheel by expanding our in-network practitioner base and growing our patient and practitioner community.

We are now in the process of bringing live additional EAPs and MCOs that we previously signed and look forward to updating you on our progress. Beyond SimplePractice Enterprise, we continue to invest in revenue cycle management or RCM to address the challenges practitioners face when dealing with insurance. Accepting insurance can be complicated and time-consuming, particularly for solo practitioners and small group practices that lack the necessary resources or expertise. As a result, they often rely on third parties to understand the various policies, submit accurate claims, and deal with denied claims or payment delays. Or they choose not to accept insurance at all. We believe SimplePractice has the potential to improve access to mental healthcare by transforming how solo practitioners and small group practices manage insurance.

We are developing an innovative ecosystem that is designed to help practitioners accept insurance at scale and maximize reimbursement rates, so they can focus on what they love most, treating patients. With a pilot program underway, we are making great progress in gathering valuable insurance insights, understanding customer expectations, and determining the most effective ways to add value to our SimplePractice solution. We are excited about the initial feedback, and we’ll keep you updated on our progress as we advance our solution with the goal of achieving strong product market fit. Now turning to our Enterprise segment, Enterprise continued to perform well, driven by steady wins throughout the quarter and ongoing digital and paperless adoption of our solutions.

The industries we cater to, utilities, financial services, government, healthcare and giving, rely heavily on outdated software that lacks modern features and capabilities. However, whether it’s shopping online or paying bills, consumers in today’s digital age demand a convenient, user-friendly and seamless experience. In these legacy industries, businesses often fall short in providing even basic functionalities such as mobile access, online payments or automated reminders and notifications. At InvoiceCloud, we have addressed this challenge by creating tight integrations and adding new features on top of existing systems. Our approach enables our customers to deliver a modern experience without the need for expensive overhauls. Once implemented, we partner with our billers to drive digital adoption with them, and that’s why we win.

We continued to see robust customer go-lives in the first quarter of 2023. In insurance, for example, we went live with our largest customer to date. In utilities, we went live with several customers, including Chugach Electric in Alaska, Charter Township of Canton, Michigan, and Vigo County, Indiana. In addition, we achieved new records of digital and paperless adoption. Notably, we are seeing an acceleration of adoption with recent cohorts, a testament to evolving customer preferences and our ability to drive superior rates of digital adoption for our billers. Our first quarter was also a strong bookings quarter for InvoiceCloud, fueled by consistency in the mid-market. In utilities, we recently signed the town of East Hampton, Connecticut and the City of Quincy, Illinois.

And in insurance, we won Luba Workers’ Comp. In tax, we signed several new customers in North Carolina where we benefit from tailwinds rooted in recent customer wins and strategic alliances. Forming new strategic alliances and strengthening existing relationships remain important growth drivers as they open new markets, add to our top of funnel, and accelerate sales and implementation cycles once they’re onboarded. Additionally, our network often enables us to move upmarket more quickly. One of our key initiatives is to expand our network and further accelerate our strategic move upmarket through industry conferences. For example, in the first quarter, we participated in the invitation-only Oracle Energy and Water Customer Edge Conference in San Diego.

InvoiceCloud was one of 6 companies that presented in the event’s innovation showcase, a forum that enables forward-thinking technology companies to share solutions that shape the future of energy and water. In the past, we have also worked with Oracle Energy and Water customer service and billing technologies to provide real-time integrations, new digital engagement efficiencies, and increased customer satisfaction to utility customers like the City of Escondido, California. We are excited about potential opportunities to collaborate with Oracle in the future. In addition, InvoiceCloud has joined the Oracle Industry Lab as a technology collaborator. Another key success driver is innovation. We are always striving to be at the forefront of product development and thought leadership to meet and exceed our customers’ expectations.

Most recently, we joined the Utility 2030 Collaborative. The collaborative focus is on helping customer-facing and operations-focused departments improved their impact on customers and employees. We look forward to sharing critical insights on customer preferences and how our solution helps utilities keep revenue streams consistent while assisting payment challenged customers. In summary, we’ve had a strong start to fiscal 2023, delivering yet another quarter of record revenue with expanded EBITDA margins. We continue to drive market adoption of solutions that help save costs, improve operational efficiencies, and elevate customer satisfaction. Our suite of vertically tailored SaaS solutions delivered outstanding outcomes fueled by persistent customer demand, platform adoption by payers, and excellent customer retention rates.

This demonstrates the strength of our business model and our position as leaders in customer engagement software with integrated payments. With that, I’ll hand the call over to our CFO, Cassandra Hudson. Cassandra?

Cassandra Hudson: Thank you, Bob. Our first quarter results again exceeded our expectations, showcasing the continued strength of our defensive verticals and our ability to deliver growth while expanding profitability. We’ve reported robust growth in revenue and delivered record-breaking adjusted EBITDA and adjusted EBITDA margin in the first quarter. As a result, we are making the following changes to our fiscal year 2023 guidance. For the full year, we continue to expect revenue to be in the range of $380 million and $384 million or revenue growth of approximately 26%. We are raising our guidance for adjusted EBITDA for the full year, and we now expect to be in the range of $69 million and $71 million, which represents an adjusted EBITDA margin of roughly 18.3% or a 210-basis point improvement over fiscal year 2022.

For Q2 of 2023, we expect revenue in the range of $92.5 million to $93.5 million, which implies 26% growth year-over-year at the midpoint of our range. We expect adjusted EBITDA in the range of $15 million and $15.5 million, which represents an adjusted EBITDA margin of 16.4% at the midpoint. We anticipate a sequential decrease in the adjusted EBITDA margin from Q1 to Q2 due to the timing and concentration of investments in Q2 of 2023. As you think about the next quarter and the remainder of 2023, please keep the following in mind. Regarding SMB, our SimplePractice solution remains in high demand within our core mental health vertical, driven by an increase in awareness and a growing demand for care. This trend has created opportunities for small practitioners to expand their practices and meet the needs of a growing patient population.

As our customers grow, they typically purchase higher-priced packages, add SimplePractice seats, and process more payments through our solution. We believe group practices represent a significant opportunity for us, and we are seeing continued traction. We remain focused on enhancing our platform to further strengthen our value proposition and accelerate our move upmarket. In late Q1 of 2023, we increased the pricing of our integrated payment processing solution by 20 basis points. This increase helps to offset higher payment processing and infrastructure costs and allows us to continue to provide and invest in the seamless experience our customers expect. As it relates to Enterprise, we are seeing consistent demand for our solution and have built a robust pipeline that we believe will continue to fuel steady growth.

We also remain highly focused on our sales and implementation execution, enabling us to move upmarket. We are excited about our top of funnel as this market segment is becoming a critical aspect of our growth strategy. In addition, we are seeing strong traction in our insurance and tax verticals. As Bob mentioned, we just went live with our largest insurance customer to date and are encouraged by our progress with several new tax customers in North Carolina, where we benefit from tailwinds rooted in recent customer wins and strategic alliances. Insurance and tax billers have traditionally relied heavily on slow, inefficient, and error-prone billing systems and represent a large opportunity for us. As you know, our pricing is customized based on individual customer needs.

In some cases, we charge a fixed fee per transaction and absorb costs. In other cases, we charge a percent of volume, which increases revenue as the average ticket increases. And in some cases, we charge a mix of both. We regularly assess and adjust our pricing structure for our customers to optimize revenue per transaction while absorbing higher costs. Finally, as I mentioned last quarter, we believe that our DonorDrive solution is more susceptible to macroeconomic disruption and our guidance assumes a slowdown in revenue growth from fundraising events in the second half of this year. Now turning to our first quarter results. Total revenue for Q1 was $88.4 million, representing 31% year-over-year growth, fueled by an increase in customer count and transactions processed.

As of the end of Q1 2023, our total customer count was 108,200, representing an increase of 23% over the prior year. Our customer growth continues to be primarily driven by new customer adds from our digital marketing programs and word-of-mouth referrals in our SMB segment. We also delivered strong growth in transactions processed. In Q1, we processed 42.6 million transactions, up from 34.3 million in the year ago quarter, representing 24% growth. Driven by strong secular tailwinds that have propelled demand for our SimplePractice solution in mental health, our SMB segment delivered revenue of $49.8 million, representing 36% growth year-over-year. Subscription revenue of $34.9 million grew 39% year-over-year, fueled by new customer adds and a partial uplift related to the pricing and packaging changes that we made in the first quarter of last year.

Transaction and usage-based revenue of $14.6 million grew 32% year-over-year, driven by a higher number of transactions processed on our platform as well as a higher transaction ARPU due to the 20-basis point price increase of our integrated payment processing solution. Our Enterprise segment continued to perform well with reported revenue of $38.6 million, representing 25% year-over-year growth, marked by consistent wins throughout the quarter and continued digital adoption of our solutions. As expected, we saw a small stepdown in revenue on a sequential basis due to the timing of transactions in Q4 2022 associated with tax billing in InvoiceCloud and the concentration of large fundraising events for DonorDrive. Our adjusted gross margin for Q1 of 2023 increased slightly to 78.7% from 78.6% in Q1 of 2022.

Sales and marketing expenses were $28.2 million, up $5.9 million as we continue to invest in digital marketing channels to create awareness for our SimplePractice solution and drive new customer acquisitions. In Enterprise, our investments continue to be primarily focused on our strategic alliances as well as sales headcount to fuel pipeline and bookings growth. R&D expenses came in at $13.9 million, up $4 million. In our SMB segment, we’re investing in additional features for group practices as well as the long-term opportunities we see with SimplePractice Enterprise and Revenue Cycle Management. In our Enterprise segment, we’re investing in functionality to continuously enhance the experience for our billers and their payers and to accelerate digital adoption in all of our verticals.

G&A costs were $11.3 million, up $200,000. We’ve seen significant efficiencies in G&A, driven by lower insurance premiums and leverage across many of our back-office functions. Net income was $4.1 million for the quarter compared to $2.1 million in the first quarter of 2022. Sequentially, net income decreased by $800,000, primarily due to an increase in income tax expense associated with the Section 174 tax code changes. Adjusted EBITDA was $17.3 million for the quarter, representing 19.6% margin compared to $10.6 million, a 390-basis point improvement from the first quarter of 2022. The expanded EBITDA margin was primarily driven by efficiencies in G&A, and to a lesser extent, sales and marketing as well as the timing of investments planned in fiscal year 2023.

Free cash flow was $6.4 million, increasing our cash balance to $318.3 million as of March 31, 2023. We typically see lower adjusted EBITDA to free cash flow conversion in the first quarter as a result of our annual bonus payments. As a reminder, we expect adjusted EBITDA to free cash flow conversion to moderate to approximately 50% in 2023 due to higher cash taxes associated with the Section 174 tax code changes and the utilization of our remaining NOLs in 2022. In summary, we believe we operate in defensive verticals that should remain attractive and vibrant even in times of economic uncertainty. In SMB, there is significant and widespread unmet need for mental health treatment that continues to fuel growth. In our Enterprise segment, the majority of bills are nondiscretionary in nature, and the trend towards digitization remains strong.

Looking ahead, we continue to invest in our solutions to further enhance our ability to serve the unique needs of both our SMB and enterprise customers. We are confident in our ability to drive profitable growth and create long-term value for our stakeholders as we execute our strategy and capitalize on the opportunities that lie ahead. I’ll now turn the call back over to Bob for closing comments.

Bob Bennett: Thank you, Cassandra. Wicked cool growth and profit expansion. We founded EngageSmart because activities like paying bills, scheduling appointments, onboarding new patients, and client communications shouldn’t be that hard. Our success is driven by a combination of 3 simple factors. First, we have a proven playbook that is centered on our customers and led by top-tier talent. We prioritize recruiting, retaining, and developing our teammates, whose exceptional work and unwavering focus on customer satisfaction keep our momentum going. Second, we have a strong focus on product leadership, as evidenced by our high adoption and retention rates. Our deep expertise in vertical markets allows us to make decisions that prioritize our customers, resulting in innovative industry-leading solutions.

Third, we operate in a large and growing market with significant potential for expansion. We have captured approximately 1% of market share of a $28 billion addressable U.S. market. We look forward to expanding our presence across all verticals and seizing new opportunities as they arise. We remain focused on delighting our customers, growing our business and creating stakeholder value while we make a positive impact in the world. We appreciate you all joining us on this call this morning, and thank you very much.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Bhavin Shah with Deutsche Bank.

Operator: Our next question comes from Jason Kupferberg with Bank of America.

Operator: Our next question comes from Tien-Tsin Huang with JPMorgan.

Operator: Thank you. Our next question comes from Terry Tillman with Truist Securities.

Operator: Our next question comes from John Davis with Raymond James.

Operator: Our next question comes from Scott Berg with Needham.

Operator: Our next question comes from Josh Beck with KeyBanc.

Operator: Our next question comes from Bob Napoli with William Blair.

Operator: Thank you. There are no additional questions registered at this time. I will now pass the floor back over to Bob Bennett for any additional or closing remarks.

Bob Bennett: Thank you. EngageSmart had a successful first quarter with strong execution. Both of our segments contributed to achieving record revenue and adjusted EBITDA results, reflecting the momentum and durability of our business. Our achievements were driven by several key factors, including robust customer growth, an increase in average revenue per customer, effective pricing and packaging changes, and exceptional customer retention. We remain bullish and well positioned to take advantage of the immense market opportunity in the U.S. and our compelling value proposition continues to resonate with customers. We look forward to speaking with you again later this quarter at J.P. Morgan’s 51st Annual Global Technology, Media and Communications Conference in Boston and William Blair’s 43rd Annual Stock Growth Conference in Chicago. Thank you very much.

Operator: Thank you. This concludes today’s EngageSmart First Quarter 2023 Earnings Call. You may disconnect at this time, and have a wonderful day.