Cabot Small-Cap Confidential Issue: February 2, 2023

The Big Idea

Small and mid-sized businesses (SMBs) play a crucial role in the global economy, generating the bulk of businesses and employment in the U.S. and other developed countries.

Yet that small size often leads to challenges specific to SMBs. For example, many still struggle with manual and inefficient processes for managing repetitive, back-office functions.

Expense management is one of these tasks. It involves the collection, processing, auditing, and reimbursement of employee expenses.

Ugh.

Unfortunately, many employees are still required to physically submit receipts and manually track expenses, leading to inefficiencies and errors in the process. It’s just a pain in the neck for everybody.

As SMBs seek to modernize their operations, they’re gravitating toward technologies that are easy to implement and use.

At the same time, individual employees are becoming a powerful source of change as they want to bring their own choice of technology into the workplace. After all, these are the people on the front lines of expense reporting. It needs to work for them!

Today we’re looking at a small company with a disruptive solution to expense management.

The company was founded about fifteen years ago on the belief that making the experience easy for everyday employees was critical to their organization’s success.

By automating the entire expense journey, this small company has eliminated the need for manual tracking and storage of receipts.

The platform has expanded over the years and now includes features for managing corporate credit cards, invoicing, bill payment, travel booking and payroll, all accessible through a single, easy-to-use mobile application.

After a massive growth spurt during the pandemic expected revenue growth is likely to be in the mid-teens for the next few years. But management says they’re sticking to their long-term growth goal of 25% to 35%, implying market expectations may be low.

Unlike many small software companies, this one is profitable and generates positive free cash flow. It’s focused on long-term growth, which I like.

It’s one of many small software companies that suffered a painful share price correction in 2022 but which looks poised to deliver massive gains in the years ahead, for investors that can stomach the risks.

The Company

Expensify (EXFY) is a financial services software company offering an expense management platform that simplifies the process of managing and submitting expense receipts, and billing and invoicing customers.

The company’s integrated mobile platform is designed to make members’ lives easier, is simple enough for freelancers and small businesses to use and yet still powerful enough for large enterprises with tens of thousands of employees.

Expensify also offers an Expensify Card, primarily distributed to large corporate customers in the U.S. The card provides real-time control over employee spending and compliance with spending limits.

New products are hitting the market took, including a Chat solution and a Payroll solution.

Every day, people from all walks of life in organizations around the world use Expensify to scan and reimburse receipts from flights, hotels, coffee shops, office supplies and ride shares.

One of the key differentiators of the platform is that it’s powered by Bedrock, a blockchain database. This makes Expensify one of the first publicly traded software companies offering blockchain-based solutions.

The platform integrates with a range of third-party accounting applications, including QuickBooks, Xero, NetSuite, Intacct, Sage and Microsoft Dynamics.

Expensify is based in San Francisco, CA and about 91% of revenue comes from the U.S. It’s market cap is just under $900 million.

Since the company was founded in 2008, Expensify has added over 10 million members. It has processed and automated over 1.2 billion expense transactions, freeing people to spend less time managing expenses and more time doing the things they love.

Platform & Solutions

Expensify’s AI-driven, mobile-first, cloud-based platform makes it easy for small businesses to handle financial tasks more efficiently and move away from crumpled receipts, paper notes, and excel spreadsheets.

Here is a brief overview of parts of the platform.

Expense Management: Expenses have a weirdly complex pre-accounting workflow, even for a very small business. But it almost always comes down to one three-step process; capture, approve, then pay. Expensify’s platform has technologies that cover all steps of the process.

Expensify Card: Many corporate cards are a pain to use since they lack real-time receipt capture and transaction visibility. Expensify launched the Expensify Card to address this pain point while also expanding its market. Its card can be used alongside existing expense policies, or as a separate corporate card program on the Expensify platform. It includes a cashback rewards program based on volume and SaaS subscription tier.

Invoicing & Bill Pay: A relatively new addition, Expensify’s invoicing and bill payment features make it easy to complete credit/debit card, ACH, check, Venmo and PayPal payments. Bills are automatically SmartScanned (an Expensify scanning technology) and both parties can communicate on the platform in real time if there are any questions.

Payment Plans

Expensify payment plans are designed to be self-service, payable by credit card, and both flexible and transparent for individuals up to large enterprise customers. Members chose the plan with the features they need and don’t need to deal with a sales rep, or hidden costs for implementation, maintenance, or support.

Free Plans: Expensify offers a free Track plan which comes with SmartScan receipt scanning and is typically used by individuals and sole proprietors for receipt and mileage tracking. The free Submit plan is similar but adds in the ability to automatically submit expense reports to anybody for reimbursement. A free plan allows a member to roll out a corporate card program with the Expensify Card.

Paid Plans: The paid Collect plan lets members integrate with popular small business accounting systems, create simple expense report workflows, and pay employees, contractors and volunteers via direct deposit. The paid Control plan includes everything in Collect and adds rules-based approval workflows, integrates with financial, travel, HR and other internal systems often used by mid-sized and enterprise-scale companies. Control is the most popular plan.

How Does a Viral Growth Model Work?

Expensify adoption in an organization typically starts with an individual employee who downloads the mobile app or signs up on the website. They start with a free version and can easily submit expenses to their manager with a few taps.

After the employee realizes the benefits of the platform, they become a fan of Expensify and often spread the word to other employees. They see how the platform can be configured and used by everyone in the organization, not just decision-makers or managers.

As the number of employees using Expensify grows and managers begin to see the value of simplified and efficient workflows, a decision-maker purchases a subscription to Expensify and becomes a paying customer with a few members.

Usage within the organization grows as the company adds members and adopts new features, such as the Expensify Card or Bill Pay. As members within this organization interact with those in other organizations, who also see the benefit of Expensify’s platform, more members are brought into the fold.

This Freemium business model is efficient and means the product is available to every single person out there. That can made adoption far easier than a product that needs to be approved by upper management.

Growth Initiatives

Expand Beyond Expense Management: Expensify is doing more than just streamlining expense reports, which are only used by a subset of employees. The company is building out the platform to include things like invoicing and bill pay. The Chat and Payroll solutions are just rolling out (Payroll is live in 47 states). Expect more solutions and features over time.

Expensify Card: Launched in 2019 the Expensify Card generates about 5.5% of total revenue now and could grow to around 10% of revenue within a couple of years while helping to better monetize the free user base. Card growth was 115% in the last quarter.

Corporate Travel: Business travel is coming back, driving higher demand for the types of solutions Expensify sells.

Convert Free Users to Paid: About 10% of Expensify’s user base are paying customers. Initiatives that increase conversion of free to paid could move the needle.

Converting to Subscription: Management is hiring account managers to help convert pay-per-use users (about a third of all users) to subscribers. This should increase revenue visibility for the company and likely help the stock.

International Expansion: Less than 10% of revenue currently comes from outside the U.S. There is a big opportunity out there for the company to go after.

The Business Model

Expensify generates revenue from subscription fees based on platform usage, including monthly active members and level of service. Contracts are either pay-as-you-go or annual. The company’s employee-focused sales strategy drives a viral adoption cycle that begins with a single employee and spreads throughout the organization, and beyond. This “freemium” model brings in free users, then converts them to paying users over time.

The Bottom Line

Expensify enjoyed a great 2021 as the pandemic drove users to the platform. Revenue rose 62% to $142.8 million, and EPS jumped to $0.33 from a loss of two cents in 2020.

Things have slowed down in 2022 but the company is still growing. In Q3 2022 an average of 761,000 paid members (+14%) across 200 countries and territories used Expensify. Revenue grew by 13% to $42.5 million, driven by growth in paid members and reimbursement activity. The return of business travel has helped. Gross margin expanded to 61% (from 51%).

The company is on track to grow revenue by 19% this year, to $170 million. EPS should be around $0.28.

In 2023 analysts are currently expecting Expensify to grow revenue by 12% to $190 million and to grow EPS by 14% to $0.32. However, there are a number of factors that could cause those estimates to change, hopefully for the better. On the Q3 conference call management repeated its goal of 25% to 35% average revenue growth over the long-term, implying current expectations may be low.

Expensify raised $57.5 million from its November 2021 IPO. The company is free cash flow positive($4.7 million in Q3). The cash and cash equivalent balance was $106 million at the end of September. It has a $44.5 million loan (CIBC, matures 9/2026) and $15 million outstanding on a line of credit.

Risk

Competition: Heightened business-to-business (B2B) payments and/or corporate card competition could challenge Expensify’s growth trajectory and drive higher-than-expected customer acquisition costs.

Viral Marketing Approach: Businesses that grow virally are great, until word-of-mouth stops working. While Expensify’s viral growth model is supported by large-scale brand advertising, at some point it may need to ramp up its marketing efforts to keep growth alive.

Recession Risk: A downbeat economy could pressure small business activity and hurt Expensify. On the other hand, efficiency solutions shine when companies are trying to streamline operations.

New Product Failures: Expected contributions from bill pay, invoicing and the Expensify Card fail to materialize.

Interchange Fee/Card Changes: Expensify is cleaning up financial reporting with Marqeta (MQ) related to handling of interchange fees. A new treatment is accepted by auditors, etc. but is not yet 100% finalized. When it is the company will send out new Cards to all users. Expect an update on this on the Q4 call. It’s a near-term risk, but also should provide a boost to the stock once resolved.

Competition

There are numerous companies, both large and small, offering some form of expense management, bill payment and/or back-office software. Just a few examples include Bill.com (BILL), Mitek (MITK), Coupa (COUP), Quickbooks, Certify and Rydoo. But Expensify’s biggest competition is just the old, manual way of doing things.

The Stock

Trading Volume: EXFY trades an average of 385,000 shares daily, around $4.1 million. We could have a modest impact on the share price.

Historical Price: EXFY came public at 27 on November 10, 2021, and shot up 52% the first day. It enjoyed a few good weeks and hit an all-time high of 51.1 on November 26 before broad-market blues began to dull its shine. The stock trended down through April of 2022 and was near 13.5 just after lockup expiration. The Q1 2022 report catalyzed a rally into the low-20s and EXFY looked better through most of the summer, ultimately peaking at 25.4 in early August. But the broad market weakened and EXFY headed south once again. It looks like the low of 8.0 was hit on January 6 (hopefully). The stock is up about 30% since and has been trading above its 50-day line for a couple of weeks.

Valuation: EXFY trades with an EV/Forward Revenue multiple of 4.2. If things go well valuation could double.

Buy Range: Expect to buy between 9.3 (level of 50-day line) and 13 (rough level of overhead resistance from November) over the next two weeks.

The Next Event: We do not yet have a date for the Q4 2022 earnings report, but I expect that to be the next big event.

Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for March 2, 2023.