EngageSmart, Inc. (NYSE:ESMT) Q2 2023 Earnings Call Transcript

EngageSmart, Inc. (NYSE:ESMT) Q2 2023 Earnings Call Transcript August 6, 2023

Operator: Good morning. Thank you for attending today’s EngageSmart Second Quarter 2023 Earnings Call. My name is Chelsea, and I will be your moderator today. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note, this call is being recorded and that 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 second 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 investors.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 investors.engagesmart.com. I would now like to turn the call over to our CEO, Bob Bennett.

Robert Bennett: Thanks, Josh. Good morning, everyone, and thank you for joining us on our second quarter 2023 earnings call today. Building upon our proven track record of success, we achieved another remarkable quarter, delivering record revenue of $94.4 million and adjusted EBITDA of $19.4 million. This represents 28% revenue growth and 20.5% adjusted EBITDA margin. Our results demonstrate our ability to balance sustainable top line growth and strong profitability and they underscore the durability of our business model. With our teammates’ relentless execution and our attractive market position in defensive verticals, we are well-positioned for continued success. Before diving deeper into the details of our second quarter performance and outlook for 2023, I’d like to address the two strategic accomplishments that we announced today, the Luminello deal and the sale of our HealthPay24 solution.

We have entered into an agreement to acquire strategic assets of Luminello, an electronic medical record and practice management platform for mental health prescribers, predominantly psychiatrists. Like SimplePractice, Luminello was founded by practitioners to create a practical and intuitive solution that empowers private practices to run a simpler business and deliver better patient experiences. Both businesses share a commitment to removing administrative burdens for practitioners and enable them to focus on what they care most about, treating patients. We believe the Luminello deal offers four key strategic benefits. First, we believe it will expand our market share and growth potential in psychiatry. Luminello’s customer base complements SimplePractice’s growing community of mental health practitioners and enables us to better address the high-value prescriber market.

Second, Luminello has a compelling market position and offers distinct features and functionality, including e-prescribe. With both Luminello and SimplePractice, we will be able to offer a greater range of functionality and drive higher value for all practitioners. Third, the deal would unlock greater possibilities for serving multidisciplinary group practices. To solve more complex and acute mental health diagnoses, a growing number of group practices include both prescribers and non-prescribers, and Luminello’s strong background in serving prescribers adds to SimplePractice’s deep expertise in mental health. Fourth, it will increase the value we bring to employee assistance programs and managed care organizations. Our growing psychiatrist community enables us to better support health care organizations in simplifying access to quality care, particularly for patients whose conditions require medication.

We look forward to leveraging the collective experience and strength that Luminello and SimplePractice bring to practitioners. On Healthpay24, after careful considerations, we have entered into a definitive agreement and simultaneously have closed on the sale of our Healthpay24 solution to Waystar. We are proud to have developed Healthpay24 to become a premier enterprise patient payment platform that both patients and providers trust. We are confident that Waystar is the right owner to unlock Healthpay24’s full potential moving forward as we focus our investments and innovations on enhancing our offerings. We believe that this strategic move creates a more streamlined business and enables us to focus on the solutions which have the highest growth potential for us.

Now turning to our second quarter highlights. Driven by strong new customer adds in mental health and expansion with existing customers, our SMB segment achieved revenue growth of 30% in the second quarter. The high demand for mental health care, coupled with the shortage of professionals, continues to be a strong tailwind for our SMB segment, where we now serve nearly 110,000 customers and more than 178,000 practitioners. Notably, we have seen an acceleration of gross customer adds in that market. We are also excited about the ongoing traction beyond mental health. We continue to increase awareness for SimplePractice in specialties like speech-language pathology and occupational therapy and are encouraged by the growth in new customers this quarter.

In addition, we continue to make progress with group practices. The majority of new group acquisitions are made up of smaller businesses with up to 10 practitioners. These practices are an excellent fit for us, given our track record of helping solo practitioners grow their businesses. We also continue to see expansion in our existing customer base and are excited about this momentum. As we discussed last quarter, we have several long-term initiatives underway in our SMB segment intended to drive new growth, including SimplePractice Enterprise and Revenue Cycle Management, or RCM. Our SimplePractice Enterprise offering is an extension of our efforts to improve outcomes for patients. A recent survey from America’s health insurance plans found that nearly half of the insurance plans in America cover mental health services and 83% assist their plan members in finding providers and making mental health appointments.

We believe that SimplePractice’s network of over 178,000 practitioners is particularly valuable to these health care organizations because they frequently struggle to find therapists for their customers in a timely manner. We are seeing great traction with the pilot that we initiated a couple of months ago and are particularly excited about successfully expanding our program. For example, one large national managed care organization that was initially piloting the program in one state is now in over 40 states with SimplePractice Enterprise. Notably, this particular organization has over 100,000 practitioners in its network that are not yet using our practice management solution. We believe SimplePractice Enterprise represents a strong opportunity for us to drive top-of-funnel, expand our in-network practitioner base and grow our patient and practitioner community.

In addition, we continue to sign and onboard new health care organizations and are encouraged by the positive feedback from both practitioners and patients. MCO and EAP customers are most excited about the reduction in time to appointment for their members. The national average for time to appointment is 48 days. With SimplePractice Enterprise, we have reduced that period to six days on average for our MCOs and EAPs. I think we can all appreciate the positive impact this improvement in speed to care can have on patients and their families. We also continue to invest in RCM to address the challenges practitioners face when dealing with insurance. Many health and wellness practitioners don’t accept insurance today due to the difficult credentialing processes, long payment periods and high administrative costs and that’s where SimplePractice can help.

Our goal is to reduce the friction and administrative burden for providers, maximize their reimbursement rates and ultimately enable them to manage insurance at scale. So, early in our journey, we have gathered relevant customer feedback from the pilot and are excited about our progress. Across all customers participating in the pilot, our RCM solution automated approximately 80% of revenue from submitted insurance claims. Additionally, we recently completed a third-party analysis to size the RCM opportunity and gain further customer insights. Based on that analysis, we believe RCM has the potential to expand our behavioral health total addressable market by approximately $700 million. We have learned that most behavioral health customers prefer functionalities like RCM to be bundled with their practice management solution.

They indicated that RCM was one of the top 3 features that they are likely to adopt as an add-on over the next three years, demonstrating the industry’s shift towards improving mental health care, affordability and access. We believe RCM represents a significant opportunity for us and can enable us to capture higher wallet share from current customers and better serve group practice customers that already accept insurance today. Now turning to our Enterprise segment. Our dedication to creating streamlined and user-centric experiences that drive higher digital adoption continues to resonate well with our customers. Fueled by steady customer go-lives and record digital adoption, Enterprise delivered revenue growth of 25% in the second quarter.

We continue to see strong go-lives across verticals. In utilities, for example, we went live with several new customers, including the City of Independence, Missouri. Once we go live with our customers, our solution drives superior rates of digital and paperless adoption. Mount Pleasant Waterworks, a water and wastewater utility in South Carolina, for example, has reported a 72% increase in electronic payment adoption since first implementing InvoiceCloud in December of 2017. As of March 2023, the utility also reported a 46% increase in paperless enrollment. Another key differentiator is our ability to increase AutoPay adoption. Georgia Farm Bureau Mutual Insurance Company, for example, reported a 35% increase in AutoPay adoption and realized a 30% decrease in billing and payment related calls.

And this was just in the first 8 months after going live on the InvoiceCloud platform. Our ability to quickly drive results and time savings for our billers is why new customers like Southern Farm Bureau Casualty in Mississippi chose to partner with InvoiceCloud. Our new customer growth continues to be driven by our strategic alliances. Forming new strategic alliances and strengthening existing relationships remains important to us as they open new markets, add to our top of funnel and accelerate sales and implementation cycles once they’re onboarded. We are excited about our continued collaboration with Oracle and recently signed another Oracle customer, Nationwide Energy Partners. Finally, we continue to focus on developing innovative functionalities that remove friction and enhance the customer experience.

Most recently, we launched key enhancements to our online bank direct functionality to simplify payment reconciliation and limit money movement for billers. With the launch of our proprietary smart-match intelligence technology, billers now only receive match payments, ultimately speeding up their payment processing. For payments that do not automatically match, billers can take advantage of InvoiceCloud’s easy-to-use interface to match payments to invoices with just one click. Our machine learning technology then remembers that match for the future. In addition, billers now have the ability to receive single consolidated deposit and deposits sorted by invoice type. In summary, we’ve had a great second quarter, fueled by persistent customer demand in the markets we serve, adoption by our payers and outstanding customer retention rate.

Our strong results are a testament to our product suite of vertically tailored SaaS solutions and position us as leaders in customer engagement software with integrated payments. In addition, we are proud of the two strategic accomplishments we achieved. The Luminello deal as well as the sale of HealthPay24 reinforce our commitment to enhance our offerings and deliver exceptional value to our customers. With that, I’ll hand the call over to our CFO, Cassandra Hudson. Cassandra?

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Cassandra Hudson: Thank you, Bob. We had an excellent second quarter that underscores our ability to achieve strong revenue growth, while continuously expanding our EBITDA. We delivered revenue growth of 28% in the quarter as well as record adjusted EBITDA of $19.4 million, which represents an adjusted EBITDA margin of 20.5%. And as Bob discussed, we announced the Luminello deal and the sale of HealthPay24 this morning. As a result, we are updating our 2023 guidance, the details of which I will discuss in a few moments. As for second quarter results, revenue growth for Q2 was fueled by growth in customer count and transactions processed. As of the end of Q2 2023, our total customer count was 113,200, an increase of 22% over the prior year.

Our customer growth continues to be mainly driven by new customer additions from our digital marketing programs and word-of-mouth referrals in our SMB segment. We also delivered strong growth in transactions processed. In Q2, we processed 43.8 million transactions, up from 36.1 million in the year ago quarter, representing 22% growth. Driven by strong secular tailwinds in mental health, our SMB segment delivered revenue of $53.1 million, representing 30% growth year-over-year. Subscription revenue of $36.6 million grew 25% year-over-year, driven by high trial volume and strong conversion. As a reminder, we lapped last year’s pricing and packaging changes halfway through the first quarter of 2023. The second quarter now marks the first full compare, and as anticipated, subscription revenue growth moderated from previous levels.

Transaction and usage-based revenue of $16.2 million grew 44% year-over-year, fueled 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 that we implemented in late Q1 of 2023. Our Enterprise segment also performed well, with reported revenue of $41.3 million, representing 25% year-over-year growth, marked by steady go-lives and continued digital adoption of our solutions. Notably, we continue to see high demand for our InvoiceCloud solution in our core verticals; utilities, insurance and tax. Our adjusted gross margin for Q2 of 2023 increased to 79.2%, up from 78.2% in Q2 of 2022, primarily driven by economies of scale, the price increase of our integrated payment processing solution and the timing of hardware revenue in the year-ago quarter.

Sales and marketing expenses were $29.4 million, up $6.3 million as we continue to invest in digital marketing channels to drive new customer acquisition in SMB and broaden our brand to create awareness for our solution. In Enterprise, our investments continue to be in support of our strategic alliances as well as sales headcount to fuel pipeline and bookings growth. R&D expenses came in at $15.6 million, up $4.9 million. In our SMB segment, we’re investing in new features and functionality for group practices, such as measurement-based care, our SimplePractice Enterprise offering as well as revenue cycle management. In Enterprise, we’re investing in features and functionality for our InvoiceCloud solution, such as the recent online bank direct enhancement.

Features like these continuously improve the experience for our billers and their payers and help accelerate digital adoption in all of our verticals. G&A costs were $11.4 million, down $1.3 million. We continue to realize efficiencies in G&A, driven by lower insurance premiums this year and leverage across many of our back-office functions. Net income was $4.3 million for the quarter compared to $6.9 million in the second quarter of 2022. The decrease is primarily due to higher income tax expense associated with the Section 174 tax code changes, partially offset by operating efficiencies and interest income. Adjusted EBITDA was $19.4 million for the quarter, representing 20.5% margin compared to $12 million or 16.2% margin in the second quarter of 2022.

The expanded EBITDA margin was primarily driven by economies of scale and efficiencies in G&A, partially offset by higher investments in R&D. Free cash flow was $13.8 million for the quarter, increasing our cash balance to $332.8 million as of June 30, 2023. 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 the majority of our remaining NOLs in 2022. Now, turning to our Q3 and full-year guidance. We are updating our 2023 guidance as follows. We now expect revenue in the range of $376.5 million to $379 million for the full-year or revenue growth of 24% at the midpoint. This updated guidance factors in our expectations for the continued strong performance across our business.

This is, of course, offset by the removal of $5 million in revenue from the back half of the year due to the divestiture of HealthPay24. We estimate that excluding the impact of this divestiture, our revenue growth rate for 2023 would increase by roughly 2 percentage points. For adjusted EBITDA for the full-year, we are updating our guidance to $69.5 million to $70.5 million, which represents an adjusted EBITDA margin of roughly 18.5% at the midpoint or a 230 basis point improvement over fiscal year 2022. Our adjusted EBITDA guidance assumes continued strong profitability, which is partially offset by the impact of the Luminello deal and the sale of HealthPay24. For Q3 of 2023, we expect revenue in the range of $95 million to $96 million, which implies 21% growth year-over-year at the midpoint of our range.

Our updated revenue range factors in a decrease of $2 million from the sale of HealthPay24. We estimate that excluding the impact of this divestiture, our revenue growth rate for Q3 2023 would increase by roughly 3 percentage points. We expect adjusted EBITDA in the range of $14.7 million and $15.2 million, which represents an adjusted EBITDA margin of 15.7% at the midpoint. This assumes a minor reduction in adjusted EBITDA as a result of both deals as well as the impact of one-time go-to-market investments we are planning to make in our Enterprise business. As you think about the next quarter and the remainder of 2023, please keep the following in mind. Regarding SMB, we continue to see strong new customer growth in mental health. The mental health market makes up the majority of our SMB revenue today and continues to grow at a steady pace.

Our solution remains in high demand with solo practitioners and small group practices, and we continue to invest in increasing awareness for our SimplePractice brand. Beyond new customer growth, we enable our practitioners to grow their practices with us. And as they expand, they typically purchase higher priced packages, add more seats, and process more payments through our solution. Additionally, we continue to invest in product innovation to enhance our solution and drive higher value for our practitioners. We remain excited about RCM and the TAM expansion opportunity it presents. We received positive feedback in our pilot program, and we will continue to invest in this growth area. As a reminder, we increased the pricing of our integrated payment processing solution by 20 basis points in late Q1 of 2023.

This increase helps to offset the higher payment processing and infrastructure costs that we have been incurring and allows us to continue to provide and invest in the seamless experience our customers expect. Finally, we are very excited about the strategic potential of the Luminello deal. However, our guidance assumes no material contribution from this deal in 2023. Now turning to Enterprise. We are seeing consistent demand for our solutions and have built a robust pipeline that we believe will continue to fuel steady customer growth. We are beginning to focus on larger deals and are excited about our top-of-funnel. In addition, we are encouraged by the continued traction in insurance and tax, both verticals are characterized by large white space where we see significant room for growth.

Our expansion into these verticals speaks to the versatility of our solution as well as our ability to replicate our success in other verticals. We continue to invest in strategic alliances that create long-term tailwinds for growth as well as in our solution to enhance features like the online bank direct functionality. In addition, we are planning the following strategic one-time Enterprise investments to create future margin expansion opportunities. First, we are in the process of renegotiating certain legacy partner arrangements. Related one-time expenses will impact margins in the second half but will enable us to further expand margins over the long-term. Second, we are conducting a comprehensive pricing analysis for our InvoiceCloud solution with the goal of better understanding and optimizing our pricing structure.

Our guidance factors in related consulting expenses that we expect to incur in the second half of 2023. As a reminder, our DonorDrive vertical is more susceptible to macroeconomic disruption and our guidance assumes a slowdown in revenue growth from fundraising events this year. Finally, our updated guidance for the third quarter and fiscal 2023 now excludes revenue and adjusted EBITDA from our Healthpay24 solution, whose sale we announced today. In summary, we believe we largely operate in defensive verticals that are characterized by attractive secular tailwinds. Regarding SMB, the unmet need for mental health treatment is large and widespread. In the coming quarters, we look forward to leveraging the expertise of SimplePractice and now Luminello to better serve practitioners in the mental health and wellness verticals.

In our Enterprise segment, the majority of bills are nondiscretionary in nature, and the trend towards digitization remains strong. The sale of HealthPay24 enables us to focus on the Enterprise Solutions and markets with the highest growth potential for us. We remain committed to investing in our solution 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.

Robert Bennett: Hubba Bubba, Cassandra, that was one strong, busy quarter. 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 three simple factors. First, we have a proven playbook that revolves around customers and is guided by top talent. We are focused on recruiting, retaining and developing our teammates. Their exceptional work and dedication to customer satisfaction fuel our ongoing momentum. Second, our emphasis on product leadership is reflected in our high adoption and retention rates. Leveraging our deep expertise in vertical markets, we make customer-centric decisions and develop innovative industry-leading solutions.

Third, we operate in a vast and thriving market with immense potential for expansion. We have captured about 1% of our addressable U.S. market. We are eager to broaden our reach across all verticals and capitalize on new opportunities as they emerge. 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. Thank you very much.

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Q&A Session

Operator: [Operator Instructions] And our first question will come from Bhavin Shah with Deutsche Bank. Your line is open.

Bhavin Shah: Thanks for taking my question and great to see another strong quarter. Just on Luminello, given that there appears to be plenty of product and target market overlap, how should we think about the longer-term cost synergy opportunity here? Is there an ability to, over time, consolidate or integrate onto one platform?

Cassandra Hudson: Thanks, Bhavin. Yes, I mean, that certainly is our intent. So, we envision delivering an enhanced solution that basically provides the functionality for all of our customers, including the customers of Luminello. So we’re excited about that. And I think what you’ll see once we get on the other side of migrating to one platform that you’ll see a high degree of flow-through to the bottom line as a result.

Bhavin Shah: Got it. And then just – Cassandra, just following up on your fiscal year guidance. Even after we adjust for the HealthPay sale, it appears that you haven’t raised the full-year guidance despite the 2Q outperformance. Anything that you’re seeing in the business or kind of pipeline that has you a little bit more cautious or any kind of change to the guidance methodology we should think about?

Cassandra Hudson: No, I wouldn’t say we’re being more cautious. I mean, I think our performance has been up – has been very strong through the first half of the year. I think there certainly is noise given the HealthPay divestiture that’s masking things a bit. We did move up the midpoint of our range a bit excluding the impact of HealthPay, and I think that factors in the continued strong performance that we saw in the first half to continue in the second half. I think this year, our business is very predictable. So we’re pretty comfortable with the numbers that we put out, and I think that’s reflected in our guidance.

Bhavin Shah: Super helpful. Thanks for taking my question.

Operator: Thank you. Our next question will come from Bob Napoli with William Blair. Your line is open.

Robert Napoli: Thank you and good morning, Bob and Cassandra. Solid numbers, and I like the strategic moves. Just, I guess, on the RCM effort, I mean, it sounds like a really large opportunity. Maybe a little bit more color on the nuts and bolts of how – first of all, are you having success on cross-sell and what percentage of your clients already accept insurance? And then how are you – what is EngageSmart doing with their customers to enable that insurance business?

Robert Bennett: Hi Bob, it’s Bob. Yes, less than half of our customers accept insurance in SimplePractice or getting closer to half, I guess. And what we do is actually take over the burden, and ultimately, we see ourselves helping our clinicians with credentialing, with the claims management and we’re developing solutions and systems that automate the process of claims management so that we get a very high degree of automation that requires no human intervention for claims management. And so what we – and then we take, from a revenue standpoint, we take a percentage of the claim that flows through our solutions. So, as insurance continues to gain traction for mental health across the country, we continue to see strong demand from our clinicians for that. It’s been in pilot, really small percentage of our clinicians using it today, but we anticipate this generating material revenue in the future.

Robert Napoli: Great. And then, just on the pricing change and I’ll turn it over, lots of questions, a lot of it going on here. But the pricing change that you made, what is the response from your customers? How does your pricing compare, I think, to some of your competitors? And how important is that pricing on the payments piece to the overall customer relationship, the pricing on the payments part?

Cassandra Hudson: I guess, Bob, just to clarify, you’re talking about the SimplePractice pricing change, correct?

Robert Napoli: Yes, that’s right. I’m sorry. Yes.