EngageSmart, Inc. (NYSE:ESMT) Q4 2022 Earnings Call Transcript

EngageSmart, Inc. (NYSE:ESMT) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Good morning. Thank you for attending today’s EngageSmart Fourth Quarter and Fiscal Year 2022 Earnings Call. My name is Todd, and I will be your moderator today. It is now my pleasure to turn the conference over to Josh Schmidt of EngageSmart. Josh?

Josh Schmidt: Thank you. Good morning. And welcome to our fourth quarter and fiscal 2022 earnings call. With me on today’s call 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.

Bob Bennett: Thanks, Josh. Good morning everyone. And thank you for joining us on our fourth quarter and fiscal 2022 earnings call today. Fiscal 2022 was truly a phenomenal year for EngageSmart. We delivered record annual revenue of $303.9 million, representing 41% year-over-year growth, all organic. We also reported record annual adjusted EBITDA of $49.3 million or 16.2% of revenue for the year. Our excellent results reflect the strength of EngageSmart’s business model, which is characterized by our which is characterized by our proven customer-led strategy, our deep vertical expertise, our strategic alliances, and our highly motivated team. I’d like to thank our teammates for their strong passion and outstanding work throughout 2022, never wavering from their commitment to excellence for our customers.

The fourth quarter and fiscal 2022 were marked by robust demand, favorable secular trends, and continued execution across our business segments as we drove product innovation and extended our market leadership. We entered 2023 from a position of strength, our dedication to simplifying customer and client engagement is resonating with the market, our products are gaining market share and we are expanding our footprint 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 2022 highlights. Our SMB segment is uniquely positioned to help address the shortage of mental health professionals and the high demand for care. SMB achieved outstanding revenue growth of 52% in 2022, driven by new customer adds, a favorable mix in subscriptions, the successful pricing and packaging changes that we implemented in Q1 of 2022 and our strength and transactions processed.

We continue to see strong traction in mental health and are excited about our opportunity to drive growth and expand with group practices in 2023. Our Enterprise segment benefits from systemic, long-term, tailwinds, stemming from the need for organizations to digitize their operations. Enterprise delivered annual revenue growth of 29% fueled by customer go-lives and high digital and paperless adoption with existing customers. To provide more color on our strong results in the SMB segment, we continue to experience high demand for our SimplePractice solution, particularly in our core mental health vertical. The mental health market is characterized by a shortage of professionals coupled with an increasing demand for care due to a high prevalence of mental health disorders.

SimplePractice designed to simplify administrative functions addresses those challenges by enabling practitioners to focus on what is most important to them, treating more patients with a network of over 160,000 mental health and wellness practitioners, SimplePractice helps many therapy seekers take their critical first steps, find the best provider, get in contact with that provider and successfully book an appointment, and we continuously evolve our offering with new features and functionalities that add value for our customers. Most recently, we launched our new Client app, which allows our practitioners to use their smartphone for scheduling, note taking, messaging, billing, and more. Monarch and SimplePractice Enterprise are extensions of our efforts to make care more accessible and to enable our practitioners to focus on what they do best, treating patients.

Both Monarch and SimplePractice Enterprise, leverage our extensive customer base of over 160,000 practitioners. Monarch is a consumer facing website found at meetmonarch.com that enables a digital method for practitioners and patients to connect. It simplifies the process of finding and accepting new patients. It also builds the foundation for SimplePractice Enterprise, our B2B offering for employee assistance programs, EAPs and managed care organizations, MCOs. Our network of practitioners is particularly valuable to these organizations as they frequently struggle to match patients to therapists in a timely fashion. By enabling easy scheduling with SimplePractice for providers who are already within an EAP or MCO network, we help speed up that process.

We recently signed our largest SimplePractice enterprise deal to date and have a robust pipeline of opportunities. We look forward to exploring the potential contribution to our SimplePractice flywheel as we partner with EAPs and MCOs to capture in-network providers who do not yet use SimplePractice In mental health we are excited also about the opportunity with group practices. In 2023 we are prioritizing this market segment with our product roadmap to expand on the efficiency SimplePractice creates for groups. By further enhancing the value we bring to groups, we believe we can attract new practices and enable our customers to grow their practices by adding more practitioners. Revenue cycle management is also an opportunity for SimplePractice.

Insurance billing is difficult to manage for small practices and getting paid is a key challenge for our practitioners. This complexity is often a deterrent to our customers accepting insurance, which can lead to access and affordability issues for patients. We are prioritizing roadmap items to accommodate revenue cycle management and believe we can support our customers in better managing collections and maximizing reimbursement rates. Ultimately, we hope to increase financial transparency for our customers by helping simplify yet another administrative task. Finally, we continue to see a large addressable market opportunity with new verticals and plan to enhance specific features and functionality in the future to continue to drive value for our customers.

In addition to product innovation, we continue to invest in marketing to drive a conflict. Word of mouth referrals are our most efficient marketing channel, particularly as we rapidly grow our referral base each quarter. At the same time, we are seeing great traction with our investments in digital marketing, which enables us to broaden our brand awareness beyond existing customers and their network. Now turning to our Enterprise segment, our strong results are driven by customer go-lives across all verticals, fueled by our partner-assisted selling motion, as well as record digital adoption with existing customers. Our verticals, Utilities, Financial Services, Government, Enterprise Healthcare and Giving are characterized by broad usage of legacy systems, many of which are outdated, expensive to maintain and time consuming to update.

That’s why many billers struggle with high operating costs, fail to meet consumer demand for digital experiences and often resist the idea of implementing new systems that is until they meet with us. Our core value proposition is driving superior rates of digital adoption by enabling a modern user experience, a wide variety of payment methods and omnichannel capabilities, ultimately increasing cost saving behaviors. We combine a modern commerce experience with engagement capabilities that are specific to the needs of our customers. Automated reminders, emails, text messages, and personalized bill pay capabilities, and we achieve all that through tight integrations with our billers, customer information systems or CISs. Our approach allows our billers to offer a modern billing and payments platform without the time consuming process to upgrade the CIS, while extending the useful life of their original solutions, and that’s why we win.

In the fourth quarter and throughout 2022, we saw great momentum in all verticals as we continue to realize efficiencies in deals where we have existing integration. We recorded several notable customer launches and utilities, including the City of Port St. Lucie Florida. In insurance we launched Phase 1 of the go-live process with our largest insurance client. And in tax we went live with several new clients including Union County, North Carolina. In addition, we drove record adoption with existing customers in all verticals. Our ability to quickly achieve results is highly valued by our new billers such as Truckee Meadows Water Authority in Nevada and EmPRO, a medical professional insurance carrier based in New York. Within a year of implementing InvoiceCloud, Truckee Meadows increased AutoPay adoption by 22%, decreased mail-in payments by 20% and achieved $175,000 in annual operational efficiencies.

EmPRO saw a 211% increase in electronic payment adoption in the first year as well as a 7x increase in AutoPay adoption. Increasing AutoPay adoption is a key value proposition for our insurance clients as more customers automatically renew their policies. We focus not only on driving digital adoption, but also paperless adoption. In the fourth quarter, we had record levels of paperless adoption and achieved a significant milestone. Approximately half of our customers invoice are sent by us by email, a key step in reducing the use of paper and cost for billers. Soquel Creek Water District in California, for example, recorded a 33% increase in paperless enrollment within one year. The fourth quarter was also a phenomenal bookings quarter for Enterprise.

Historically, we have seen an ebb and flow in new bookings due to fluctuations on big deals. In the fourth quarter, we achieved a records booking quarter driven by consistency in the mid-market and several large deals. Notably, we signed two of the four largest deals of 2022 in Q4. Our new customer growth continues to be driven by our strategic alliance go-to-market strategy. In Q4, we formed several new partnerships across verticals and strengthened existing alliances that contribute to our pipeline and extend our market share. In utilities, for example, we launched our FREY Municipal Software alliance, which further opens the mid-size market for us in 27 states. In our high growth insurance vertical, we signed several new customers, including another Guidewire customer, Franklin Mutual Insurance based in New Jersey.

And in tax we finalized the integration with DevNet opening county tax markets in Illinois, Missouri and North Carolina. Additionally, we finalized a government procurement partnership that streamlines the buying process for local and county governments. Product innovation remains incredibly important to us as we continue to drive higher value for our customers. Most recently, we launched outbound payments for insurance customers. Approximately half of the payments and insurance are outbound, representing a large opportunity for us and we are quickly gaining traction. In Q4 we closed six outbound payment deals. In summary, we’ve had a strong fourth quarter and a great year. We continue to drive traction in the market for products that help save labor costs, increased operational efficiency and drive customer satisfaction.

We delivered solid results across our vertically tailored SaaS solutions driven by continued customer demand, payer adoption on our platform, and great customer retention. We believe that this is a testament to the strength of our business model and our market leadership position 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 fourth quarter results again exceeded our revenue and profitability guidance capping off an outstanding year in which we delivered record revenue, net income and adjusted EBITDA. Revenue in 2022 was $303.9 million, representing 41% growth from 2021 and adjusted EBITDA was $49.3 million or 16.2% of revenue. Delivering more than $300 million in revenue as well as a 210 basis point expansion in our adjusted EBITDA margin were important milestones that we achieved in 2022. In 2023, we are focused on driving continued growth in both segments and making product and go-to-market investments that are intended to help us achieve our next midterm milestone of $500 million in revenue, while we continue to expand our margins.

For the full year, we expect revenue to be in the range of $380 million and $384 million or revenue growth of approximately 26%. Our revenue guidance implies roughly 30% growth in SMB and 20% growth in enterprise. The drivers of which I will cover in a few moments. For adjusted EBITDA; for the full year we expect to be in the range of $66.5 million and $69 million, which represents an adjusted EBITDA margin of roughly 17.7% or a 150 basis point improvement over fiscal year 2022. While we plan to continue investing in sales and marketing to drive top line growth and R&D to maintain product leadership, we are also committed to expanding margins as we continue to make progress toward our long-term adjusting EBITDA margin goal of 30% or higher.

As a result of the outperformance of our business model in 2022, our guidance for revenue and profitability for 2023 is well ahead of our initial expectations from our September 2021 initial public offering. For Q1 of 2023, we expect revenue in the range of $86 million to $87 million, which implies 28% growth year-over-year at the midpoint of our range. We expect adjusted EBITDA in the range of $13.5 million and $14 million, which represents an adjusted EBITDA margin of 15.9% at the midpoint. We continue to see strong cash flow generation with free cash flow of $45.8 million in 2022, taking our cash balance to $311.8 million as of December 31, 2022. In 2023, we expected adjusted EBITDA to free cash flow conversion to moderate to approximately 50% due to higher cash taxes associated with the capitalization of R&D expenses, which is now required for tax purposes under IRC Section 174 coupled with significant utilization of our remaining NOLs in 2022.

As you think about 2023, please keep the following in mind. Regarding SMB, we expect to see continued high demand for our SimplePractice Solution in our core mental health vertical fueled by a shortage of practitioners coupled with an increasing need for care. As our practitioners grow their practices and add more SimplePractice seats, they use additional features, purchase higher price packages, and process more payments through our solution. We are excited about the opportunity we see with group practices and our prioritizing features that will make it even easier for our customers to manage multiple practitioners this year. As you recall, we successfully launched our new three tiered pricing and packaging halfway through Q1 of last year.

Due to customers migrating earlier than expected and more customers electing our plus package, we exceeded our expectations and drove growth of more than 50% in SimplePractice in 2023. In late Q1 of 2023, we will be increasing the price of our integrated payment processing solution by 20 basis points. This increase will help to offset the higher payment processing and infrastructure costs that we have been incurring and allow us to continue to provide and invest in the seamless experience our customers expect. Now, turning to enterprise. As we move into 2023, we remain highly focused on continued sales and implementation execution to fuel new customer growth. We are beginning to focus on larger deals and believe moving up market is a critical aspect of our future growth.

Enterprise delivered strong growth in 2022, driven in part by consistency in the mid-market in the timing of several large go-live at the end of 2021 and the beginning of 2022. While the ebb and flow associated with the timing of go-live will result in moderating revenue growth in 2023. We remain confident in the long-term durability of our enterprise segments, driven by our record bookings quarter and Q4, and a robust pipeline that we believe will continue to fuel strong growth. We are excited about our success interaction in our newer insurance and tax verticals. In 2022 we invested in strategic alliances and signed clients in new states that we believe create long-term tailwinds for additional targets. Our DonorDrive solution is more susceptible to macroeconomic disruption and our guidance assumes a slowdown in revenue growth from fundraising events this year.

In terms of seasonality, we expect to see a small step down in Q1 revenue on a sequential basis due to the timing of transactions in Q4 2022 associated with tax billing and invoice cloud, and the concentration of large fundraising events for DonorDrive. Beyond new customer growth, we continue to focus on product innovation and customer experience that enables us to drive superior rates of digital and paperless adoption. We are investing in further simplifying the customer experience by adding functionality that removes friction to drive higher value for our customers. Now, turning to Q4 and full year 2022 results. Total revenue for Q4 was $83.9 million, representing 36% year-over-year growth fueled by growth in customer count and transactions processed.

As of the end of Q4 2022, our total customer count surpassed 100,000 to 102,700, a significant milestone for EngageSmart and an increase of 24% 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 Q4 we processed 38.9 million transactions, up from 31.2 million in the year ago quarter, representing 25% growth. We also saw continued strength in our net revenue retention rate, which was 117% for 2022, driven by the pricing and packaging changes in our SMB segment and strong digital payment adoption in our enterprise segment. Our SMB segment continues to perform exceptionally well with fourth quarter revenue coming in at $45.2 million, representing 45% growth year-over-year.

Subscription revenue of $33.5 million, grew 58% year-over-year driven by new customer ads and the impact of pricing and packaging changes. Transaction and usage based revenue of $11.5 million grew 21% year-over-year as more transactions were processed on our platform. Our enterprise segment also delivered strong results with reported revenue of $38.7 million, representing 27% year-over-year growth driven by new customer ads and strong digital payment and paperless adoption. Our adjusted gross margin for Q4 of 2022 increased to 79.5% from 77.8% in Q4 of 2021, primarily driven by the results of our SMB pricing and packaging changes. Sales and marketing expenses were $27.5 million, up $6 million. In SMB we continue to test new digital marketing channels to drive new customer acquisition and broaden our brand to create awareness for our solutions in all of the verticals we serve today in enterprise, our investments continue to be on our partner relationships as well as sales headcount to fuel pipeline and bookings growth.

R&D expenses came in at $13.8 million, up $4.5 million. In our SMB segment we’re investing in features for group practices and revenue cycle management. In our enterprise segment we’re investing in features and functionality to continuously improve the experience for our billers and their payers and to accelerate digital adoption in all of our verticals. G&A costs were $12.6 million, up $1.1 million driven by an increase in headcount to support our business growth. Net income was $4.9 million for the quarter compared to a net loss of $0.9 million in the fourth quarter of 2021. Adjusted EBITDA was $13.6 million for the quarter, representing 16.2% margin compared to $6.3 million or 10.2% margin in the fourth quarter of 2021. In summary, we continue to believe we operate in defensive verticals that should remain attractive and vibrant even in an economic downturn.

Regarding SMB, the unmet need for mental health treatment is large and widespread. Periods of economic uncertainty can further increase that need for care. In our Enterprise segment the majority of bills are non-discretionary in nature, and the secular trend of digitization remains strong. Overall we believe we are well positioned and remain confident in our ability to continue to deliver profitable growth. I’ll now turn the call back over to Bob for closing comments.

Bob Bennett: Cassandra, tremendous results again, feels a little like Groundhog Day. We founded EngageSmart because activities like paying bills, scheduling appointments, onboarding new patients and client communications shouldn’t be that hard. It’s great to see our team’s efforts bear fruit. Our success is driven by three simple factors: first, our proven customer focused playbook driven by a) players. We are committed to recruiting, retaining and developing top talent. Our momentum is driven by their tremendous work and relentless pursuit of customer satisfaction. Second, product leadership is measured by adoption and retention. We leverage our top talent with deep vertical expertise to put our customers at the center of our decision making, ultimately delivering innovative market leading solutions.

Third, our large market and runway. We address a $28 billion U.S. market across all zip codes and have captured about 1% of market share. We continue to invest in our solutions to unlock EngageSmart’s full potential and look forward to expanding our footprint across all of our verticals. We remain focused on delighting our customers, growing our business, and creating shareholder value while we make a positive impact in the world. We appreciate you all joining us on this call this morning. Before we begin Q&A, I’d like to take a moment to thank our investors and analysts for the time and insights they provide us as we further EngageSmart and its potential. Your input is incredibly important to us as we work to build long-term shareholder value for this growth company.

Thank you very much.

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Q&A Session

Operator: Thank you. Our first question comes from Robert Napoli with William Blair.

Robert Napoli: Thank you and good morning. Congratulations on excellent first year as a public company. Good guidance. Just a question on.

Bob Bennett: Hey Bob. How are you?

Robert Napoli: I’m doing well, Bob. How about yourself?

Bob Bennett: Sound good.

Robert Napoli: The SMB segment, you do lap the price increase in the first quarter, the number of customers you’re adding, good trend as you get larger, some deceleration but you’re moving up market. Are you getting is the average guest clinicians per customer increasing? Do you expect that to increase or continue to increase?

Cassandra Hudson: Yes. I mean, we’ve continued to see growth in the average number of practitioners per practice, Bob, through 2022 as well and I think as you it’s kind of steadily moved up over the past few years. Certainly with our pricing and packaging changes, the opportunity with group practices was really highlighted for us, and that is why we are now prioritizing more features specifically for group practices on our roadmap. So, as we deploy those features we do continue to expect more traction there in the group practice segment for us.

Robert Napoli: Got it. Thank you and follow up. Just, I mean, you had mentioned a 20 basis point price increase, but just generally around margins, your margin guidance is solid. You have 30% target long-term margins. How do you think about incremental margins to get to that 30% long-term margin, and then any materiality you can get or the 20 basis point price increase, when is that and what does that mean to revenue? Thank you.

Cassandra Hudson: Sure. So just taking the pricing first, that will start to take effect in late Q1 here, so March timeframe. And so we’ll certainly start to see higher transaction revenue as a result of that leading into Q2. And then on the margin side of things, at least in the near term, a lot of the expansion you’re going to see is going to come specifically from G&A. We’re starting to really get leverage from our shared services model across all of EngageSmart and as we’ve made kind of incremental improvements in gross margin in 2023, and we expect that effectively that level of improvement to continue in the medium term as well. So those are the two big areas we’re still investing on the engineering side and also investing in our go-to-market market functions to drive long-term growth.

Robert Napoli: Thank you.

Operator: Thank you. Our next question will come from Will Nance with Goldman Sachs.

Will Nance: Hey guys. Good morning. Nice results this morning. I wanted to ask on the enterprise segment. You mentioned a handful. I think your largest booking quarter in history seems like very strong momentum in the fourth quarter. I guess I’m just trying to kind of marry those comments with the outlook for 20% revenue growth in 2023. Should we be thinking about this as sort of just like an air pocket and implementation timelines? And do you guys have kind of line of sight towards an acceleration of some of these large bookings kind of start to flow into revenue?

Cassandra Hudson: Thanks for the question, Will. You’re thinking about it exactly right? So we did have a really strong bookings quarter in Q4. We do have to implement those deals, so there’s a booking €“ a new booking cycle and an implementation cycle that we have to get through. So the ebb and flow that we see in go-live is really reflected in our guidance for this year. But as we continue to bring the record breaking bookings that we saw in Q4 live, we’ll start to see them really positively impact revenue in the future.

Will Nance: Got it. That’s super helpful. And then I just wondering if you could talk a little bit about penetration rates within just the mental health vertical and SimplePractice. You guys are talking about going up market into group practices. How do you kind of delineate the size of the market in each and kind of where you stand from a penetration perspective?

Cassandra Hudson: So I mean, we still look at the market holistically. So with SimplePractice still targeting $10 billion TAM with $5 billion of that more longer-term focused on medical specialties, $5 billion on the wellness market that we’re serving today. Within the behavioral health portion of the market, which we estimate to be at least $1.2 billion obviously there’s a huge concentration of solo practitioners, which we’ve been very successful at selling into. We’re really focused on is slowly moving upmarket, so selling to €“ still what I would characterize as small group practices, but that’s where we’ve been seeing the biggest traction to date and we’ll continue to kind of slowly progress up into larger and larger group practices over time. But, we’re not €“ we’re not actively targeting large group practices today, if you will. This is a slow movement upwards.

Will Nance: Understood. Appreciate you taking the questions. Nice results.

Bob Bennett: Thanks Will.

Cassandra Hudson: Thanks Will.