InnerWorkings, Inc. Q2 2010 Earnings Call Transcript

Aug. 5.10 | About: InnerWorkings, Inc. (INWK)

InnerWorkings Inc. (NASDAQ:INWK)

Q2 2010 Earnings Call

August 5, 2010; 05:30 pm ET

Management

Eric Belcher - Chief Executive Officer

Joe Busky - Chief Financial Officer

Analysts

George Sutton - Craig-Hallum Capital

Nate Brochmann - William Blair & Company, L.L.C

Vance Edelson - Morgan Stanley

Naved Khan - Jefferies & Company

Jeff Blaeser - Morgan Joseph

Operator

Good day, ladies and gentlemen and welcome to the InnerWorkings, Inc quarterly earnings call. (Operator Instructions)

I would now like to introduce our host for today’s conference, Joe Busky, Chief Financial Officer.

Joseph Busky

Thanks Juan. Good afternoon, everyone and thank you for joining us on our second quarter 2010 earnings call. This is Joe Busky and I am Chief Financial Officer at InnerWorkings. And as always, joining me on the call today is our Chief Executive Officer, Eric Belcher.

Before we begin, I would like to note that this call will include forward-looking statements related to future results that are made pursuant to the Safe Harbor provisions of the Federal Securities laws. These statements are subject to a variety of risks, uncertainties and assumptions that may cause actual results to differ materially from those stated or implied by the forward-looking statements.

Any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent date. Listeners to the call are advised to review our SEC filings, including the risk factors contained in our most recent Form 10-K.

In this call will discuss, among other financial performance measures, adjusted EBITDA, which is a non-GAAP financial performance measure. Please refer to the company’s second quarter earnings release issued earlier today for a reconciliation of adjusted GAAP to the nearest comparable GAAP measure. And also please note that this call is intended for investors and analysts, and may not be reproduced in the media in whole or in part without our prior consent.

And now at this time, I’ll spend a few minutes on our financial results, and then Eric will highlight some of the company’s key growth initiatives and then as usual we’ll finish up with your questions.

Our revenues for quarter two 2010 were $120.5 million, an increase of 20.4% compared with the second quarter of 2009. This up-tick was attributable to an $18.5 million or 18.5% new account organic growth, as well as same customer growth of 2%. And as Eric and I have discussed in several occasions, our expectation was that 2009 new enterprise wins, these are accounts such as Unilever, Pentair, IHG, SkyPark and others will deliver a new revenue in 2010 of at least $50 million.

The $18.5 million of new account growth in quarter two, combined with the $60 million earned in quarter one highlights the extent to which these accounts are successfully ramping the plan and generating substantial revenues.

We expect this trend to continue in the months and years ahead. Year-to-date revenue is $232.7 million, a $38.3 million or 20% increase versus the same period in 2009. This increase is driven primarily by the $34.5 million in new account growth.

In quarter two, we had strong dimension in the enterprise business as we added 60 enterprise clients bringing our total number of enterprise clients at the end of Q2 to 185, versus 159 at the end of Q2 last year. These new accounts added 5 FTEs for a growing roster of employees based onsite at client locations for a total of 89, and this figure now represents approximately 25% of our operation staff, which means a significant amount of our non-sales employees are now insight with our largest clients providing excellent customer service and driving customer loyalty on a daily basis.

Now, in terms of our two primary sales channels, enterprise sales represented 72% of total revenue and transactional sales represented 28% of total revenues we saw in the quarter. And although we do not target a specific mix of enterprise versus transactional revenue, we do believe this increase in the percentage of enterprise revenue bodes well for the company’s feature, as this revenue is both contractual and recurring in nature.

Reported gross profit for the quarter was $29 million and reported gross margin was 24.1% versus $24.7 million and 24.7% in quarter 2009. The year-over-year 60 basis point decline in gross margin reflects the mixed impact of greater enterprise sales in the second quarter, slightly offset by the impact of increased early pay discounts taken with our suppliers. We expect the gross margin percentage in the second half of this year to remain consistent with the gross margin we saw in the first half.

Now, SG&A as a percentage of revenue still continues to improve as it declined to 160-basis pull versus Q2 last year. Our SG&A was $22.2 million in the quarter, a $2.2 million increase versus Q2, 2009, due primarily to increased sales commissions and higher revenue and the cost of additional procurement staff to service new enterprise clients.

SG&A expense as a percentage of revenue decreased sequentially as well from Q1 this year by 120 basis points. Our diluted earnings per share for the quarter was $0.07 versus $0.05 from the second quarter of ‘09 and previous year quarter EPS figures include approximately one penny of gain from the sale of Echo Global Logistics stock and we intend to continue to sell over time. Adjusted EBITDA excluding stock-based compensation increased 35% from $5.7 million in Q2 last year to $7.7 million in Q2 of this year.

Adjusted EBITDA excluding stock-based compensation as a percentage of revenue also increased to 6.4% in Q2, as compared to 5.7% in Q2 of ’09, and it increased sequentially as well from Q1 this year by 150 basis points.

The year-to-date adjusted EBITDA is $13.2 million, an increase of $4.2 million or 46% versus the same period in ’09, and the year-to-date income from operations increased $4.1 million or 120% as compared to the same period in ‘09.

Now in terms of liquidity and balance sheet, although 5.3 million of our auction rate security investment is held by DDS, we’ll liquidate it as of June 30. The remainder was sold in early July and all of these auction rate securities were sold at full par value. We did experience a $4.3 million operating cash outflow in the quarter due to a reduction in accounts payable and days payable outstanding or DPO, as a result of using excess cash created from the sale of our auction rate security investments to pay our vendors faster.

This is done to take advantage of increased early pay discounts of our supplier base, which have a high return on investment. This outflow of cash is one time in nature and is poised to an incremental step down in our DPO. In fact, our DPO dropped 10 days in the second quarter versus Q1 of this year.

We ended the second quarter with $47.6 million of gross debt on our $75 million revolving credit facility, offset by $15.1 million of cash and short-term investments, which is comprised of $3.5 million of cash-on-hand and $11.6 million of investments, including approximately $6 million of Echo Global Logistics stock.

In early August we refinanced the company’s three-year $75 million credit agreement yet to expire in May of next year, with a new 40 year oversubscribed agreement for $100 million. We have no plans to increase our leverage ratio, but we are pleased to have the added security and flexibility to invest strategically in support of the company and it’s growth plan.

But before I turn the call over to Eric, I want to reiterate InnerWorkings’ commitment to managing our expenses prudently, and with our increased financial flexibility, InnerWorkings is favorably positioned to capitalize on opportunities that will allow us to better serve our customers, support our growth initiative and add value for our shareholders.

And now, I’ll turn the call over to Eric Belcher.

Eric Belcher

Thanks Joe and hello to everyone on the call. I’d like to begin my remarks by welcoming our six new long-term contractual customers that we signed on in the second quarter: Advanced Auto Parts, Payless Shoes, Faulkner Strategies, Crimson Hotels, Pentair and Rent-A-Center. These companies are embracing new and better methods of sourcing in key areas of their indirect supply chain, and our solution will enable them to increase service and quality levels, while eliminating unnecessary costs.

We look forward to working with each of these organizations in the months and the years ahead. You have heard the results of our strong quarter from Joe, I’m just going to spend the bulk of my time on InnerWorkings longer term outlook and the things that make us excited to get up and coming to work everyday.

As many of you know, the market in which InnerWorkings operates is note of a $100 billion a year just in the US alone, a very small percentage of that total is currently running through an efficiency channel such as InnerWorkings.

The opportunity we face is a massive land grab; unlike with most companies will ever have a chance to experience. The company continues to execute against our growth strategy on a daily basis and the cornerstones of this strategy are progressing on schedule. Our enterprise business is strong and we’ve demonstrated it over the past two quarters, its generating 20% growth for the company, and our new transactional growth initiatives continue to progress as expected.

Our online printing site inkchaser.com is scaling up and is now fully integrated with our PPM4 procurement platform allowing for 100% automated transactions over the Internet. Our inside sales team already has several, regular, repeat customers utilizing InnerWorkings as their primary provider for their printing needs.

We continue to be active on the small broker recruiting front and we’re currently pursuing a number of new hires from this segment of the market, and we’re continuing to develop a high powered sales team to pursue BPO or Business Process Outsourcing opportunities with the largest end users of print in the country.

Let me talk a little bit about our BPO initiative. While our enterprise business has historically been comprised of companies spending up to $30 million a year on print, there are a significant number of corporations with print spends far greater than this. InnerWorkings is now in a strong position to compete for, to win and to service its clients of this magnitude and our BPO team is focused on its efforts exclusively in this arena.

The core of this team is in place and we expect to continue building out and developing the group throughout the rest of the year, but keep in mind, we are already generating organic growth of 20% apart from any of these new initiatives, which puts us in a great position to accelerate our growth going forward.

We’ve taken a patient approach to funding these new initiatives, first gauging the traction gained from each initiative before taking the next step forward. Each has shown substantial potential to make a meaningful contribution in InnerWorkings performance in 2011 and beyond.

We are investing in these growth initiatives appropriately in a manner that’s commensurate with the opportunity. At the same time, we will also strive to strike the appropriate balance between longer-term opportunities in our short-term performance targets.

Now on another note, there has been a number of interesting developments coming out of our technology group making this a good time to provide an update here. Recent enhancements to our system have both improved our client solutions and enabled us to take additional cost out of delivering those solutions.

One specific example from the second quarter is an e-store automation module that several members of our IT and developed deployed. This solution fully integrates the entire ordering and invoicing process between our e-stores, our suppliers and our management systems.

This development has also been implemented into Inkchaser and its just one small example of how we have reduced manual intervention into the ordering process resulting in savings for the company and for our clients, and providing our sales team with further value to offer to there prospects.

Our technology team is an unbelievably talented and dedicated group and they have burning the midnight oil lately to develop these and many other crucial enhancements. I would like to thank each and every one of them for their hard work. We believe our technology is a significant competitive advantage for the company and the continued efforts of this group will enable us to further differentiate ourselves from other providers in the market place.

In closing, the company is energized and we all see the incredible opportunity we have to grow this organization into a multi-billion dollar company. We know it’s simply a question of execution at this point, the massive market opportunities are undeniable and our strategies are in place with the full backing of the board and the management team.

Now regarding guidance, we are maintaining our full-year revenue and EPS guidance of $440 million to $470 million in revenue and $0.24 to $0.29 per share in earnings. Let me add a little more color on our outlook beginning with our revenue guidance.

I know we had a great first half and our internal projections indicate that we’ll end the year at the higher end of our revenue range. We are not however, in a position to raise our guidance at this time and in this economic environment.

Regarding earnings per share, our expectation is that we’ll finish the year at the lower end of our EPS guidance range. After assessing the progress of our growth initiatives throughout the first half of the year, we are even more convinced about their potential and therefore we plan to make additional modest investments in these initiatives of approximately $0.02 per share in the second half of 2010. More specifically, we are going to build out the BPO sales team and sales personnel to the inside sales group and ramp up marketing expenditures for inkchaser.com.

Obviously these investments are tied to specific revenue producing areas and we anticipate these initiatives will make a meaningful contribution in 2011. As a reminder, our EPS expectation includes gains from the sale of our investment in Echo Global Logistics stock. We expect the gains in the second half of 2010 to be consistent with those from the first half.

I would like to thank all of our employees for their continued daily efforts, as well as our shareholders for their sustained support and our clients, channel partners and suppliers for the opportunity to work together to deliver value in our marketplace.

So with that operator, I’d like to now open up the call for questions please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from George Sutton from Craig-Hallum Capital.

George Sutton - Craig-Hallum Capital

Hi guys, nice numbers. So the first thing I wanted to address was related to the enterprise deals. In 2009 you talked a lot about how those deals you had signed in ‘09 were larger than the ones you had signed in 2008. Can you give us a sense of how that dynamic compares from 2010 to 2009 and I’m referring to kind of an average if you would?

Eric Belcher

Hi George. Yeah, the trend continues George and as we get larger and our aspirations grow and in our opinion, our ability to deliver value to increasingly larger companies grows, as you can imagine our average enterprise agreement is also growing. Of course we are half way through the year, we don’t have a projection in terms of what our contribution from our enterprise wins in 2010 will be in 2011, but we can say that we continue to see very strong performance in terms of that segment of our business.

George Sutton - Craig-Hallum Capital

Okay and it’s kind of the answer I expected. It sort of leads into a question about the BPO sales process, because you’ve really been moving more and more towards larger and larger companies. How does the process, the sales process differ in the “BPO side” relative to your normal sales process?

Eric Belcher

The work that we do upfront with our perspective clients is far more intensive. We gather quite a bit more information, we have more individuals within our company digging in and the upfront sales cycle as a result as you can imagine tends to be longer, there’s more data, there’s bigger dollars at stake, there are more stakeholders at our clients site to speak with and interact with. So I would say more than anything, there’s a more intensive opportunity assessment conducted upfront.

George Sutton – Craig-Hallum Capital

That’s really more in the upfront process. Okay, then with respect to the $0.02 number, and this is my last question, the $0.02 in new initiative cost, Joe has consistently said don’t expect anything from the transactional initiatives this year. With this spending, does that help accelerate our expectations to start to see some revenue contribution?

Joseph Busky

Yes. Hey George, this is Joe. We have as Eric said in the prepared remarks, we’ve seen really good progress in all three of these initiatives, that make us feel comfortable to put this investment in the second half, but we are still not going to have a significant contribution financially from any of these until 2011.

George Sutton – Craig-Hallum Capital

And I’m referring more in 2011, so this kind of increases that potential opportunity for 2011?

Joseph Busky

Correct.

George Sutton – Craig-Hallum Capital

Okay. Thanks guys.

Joseph Busky

Thanks George.

Operator

Our next question comes from Nate Brochmann with William Blair & Company.

Nate Brochmann – William Blair & Company, L.L.C

Hey gentlemen.

Eric Belcher

Hi Nate.

Nate Brochmann – William Blair & Company, L.L.C

Hey, I wanted to talk a little bit about just flushing out the investment. Just a little bit in terms of -- we obviously understand all the growth opportunities that you have ahead of you, and granted I haven’t been around in this time, but it sounds like some historical issues that plagued the company a couple of years ago and I do know that you have a new framework around how you invest.

But maybe if you could just give us a little bit of color in terms of what’s different today versus maybe two years ago regarding the investment strategy and how we can be confident that these will resolve in positive ROIC-type investments and generate higher returns in 2011?

Joseph Busky

Hi Nate, it’s Joe. I’ll start with this and maybe Eric can chime in too, but the investments that were made in 2008 were more related to the G&A side of the infrastructure, whereas the investments that we are talking about now for the second half of 2010, are entirely focused on the past of the SG&A line. So the selling aspect or selling structure, all of these costs will directly impact revenue in some way.

And then the second thing I would say, is that in 2008, the company just did not have the focus that we have now on ROIC. I said this on several calls, but literally every decision we make in this company in terms of investment runs to that ROIC runs, to make sure that we are going to get that return before we spent the money.

Eric Belcher

Yes, that’s right Joe, and Nate I’ll just add to that, that we are a growth strategy. We could if we chose, remove 10% to 20% of our workforce tomorrow and significantly increase our near-term earnings, but that’s not the investment thesis, that’s not the value maximizing share strategy we believe and so we are keeping our focus on ensuring that we capitalize on the market opportunity in front of us.

Nate Brochmann – William Blair & Company, L.L.C

That’s great and I think that makes a lot of sense. You know maybe Eric, just to elaborate on your point a little bit too, so the lens is definitely ROIC. This is helping the selling effort.

I mean, is some of your initial success in the BPO space helping generate the confidence here or is this kind of just such a brand-new initiative, and I guess what I am trying to get at is, like was there enough testing of this to have the confidence in your ROIC metrics to invest more heavily or is it just more about the forecast. So just kind of where we are in the BPO process?

Eric Belcher

So Nate, are you asking specifically about the investment behind the BPO initiative now?

Nate Brochmann – William Blair & Company, L.L.C

Yes.

Eric Belcher

We are upping our investing in building out that team based on the experiences we’ve had over the last six months.

Nate Brochmann – William Blair & Company, L.L.C

Great, yes, that’s what I like to hear. And then just the second, I asked this question before, but just want to talk about, obviously you are seeing a lot of strength in your top line, and I think that’s very encouraging, both about the work that you are doing, as well as the economy, but I was wondering if you could give us a little bit of update on the pipeline there and also how you feel that those kind of same customer trends are continuing in terms of the second half?

Eric Belcher

Okay, on the enterprise pipeline, it’s strong. I would just repeat what I said earlier with George in terms of the confidence we have and our ability now to deliver meaningful new clients that ramp according to our expectations.

On the questioning Nate about same customer spend, of course now we’ve got two quarters in a row at 2% growth, much better than the negative 25% we experienced in 2009. Looking forward we don’t have any reason to believe that the number will be meaningfully different up or down from the 2%. So our expectation right now is somewhere between flat same customers sales, up to positive 5%.

Nate Brochmann – William Blair & Company, L.L.C

Great, thank you very much, I appreciate it.

Eric Belcher

Alright. Thanks Nate.

Operator

Our next question comes from Vance Edelson with Morgan Stanley.

Vance Edelson - Morgan Stanley

Hi, and thanks for taking the questions. Could you just comment on trends throughout the quarter and maybe into July if you can? What are you seeing on the frontline? Has the selling process been getting any easier? Did it improve during the quarter would you say?

Eric Belcher

No Vance, I wouldn’t say that there any real meaningful trends happening here week-to-week, month-to-month. I’d say it’s been a great and very receptive market, the inner workings of late, and you can see that in our numbers, but beyond that Joe I don’t know if you got something to add.

Joseph Busky

I would just say Vance, the sales cycles for these enterprise deals is still the same. We haven’t seen any changes up or down in the sales cycle and the sales cycles from the BPO deals as we talked about it is much longer, but there has been no change there.

Vance Edelson - Morgan Stanley

So, do you feel like the economic cycle is not improving much or is it just that your business is not adapting that. It’s sensitive to the economy right now. It seems to be strong regardless of what’s going on economically, is it more along those lines?

Eric Belcher

It’s more along those lines. I mean 90% of the growth we experienced came from us gaining market share, a very minor risk from improving marketing spends and print spends within that. So I would say we are seeing very steady, albeit very small improvements in market conditions based on print spends, and we are seeing very large gains in market share based on the effectiveness of our sales team and our reputation in the marketplace now.

Vance Edelson - Morgan Stanley

Okay, that’s helpful. And could you help us think about guidance as it relates to new enterprise, customer wins. My understanding is that throughout the year new wins can be incremental to the guidance, does that remain the way we should think about it, just that as you add new customers going forward guidance could potentially go up?

Eric Belcher

Yes, that’s fair. As we have 2010 enterprise adds ramping in this year, it’s going to be significant to this year, we would add that to the guidance.

Vance Edelson - Morgan Stanley

Great. And lastly, you spoke about the long-term outlook. Could you remind us where we stand in terms of geographic expansion plans, either into major or new markets or perhaps secondary markets around your primary ones, is that another potential growth driver for InnerWorkings?

Eric Belcher

It is. There are some major geographies of United States we currently don’t have an office presence or a meaningful selling platform. Colorado, Arizona, Pacific Northwest, New England, those would be the most obvious, Florida, and so they are all opportunities for us, they are all M&A opportunities that exist for us that we are evaluating all the time.

We know the market now extremely well and we do believe that you should expect us to penetrate these geographies in the future, and in the longer-term future there are international opportunities that are increasingly becoming apparent to us. We are going to focus our effort on ensuring that we capture our fair share of the US marketplace and not get distracted by running around the globe. That said, there are international opportunities that we evaluate as they arise and we do intend over time to be a global company.

Vance Edelson – Morgan Stanley

Okay, that makes sense. A good job on the quarter. Thanks guy.

Eric Belcher

Alright, thanks Vance.

Operator

Our next question comes from Youssef Squali with Jefferies & Company.

Naved Khan – Jefferies & Company

Yes, thanks. This is actually Naved Khan for Youssef. Just a few questions, just to clarify the guidance, I think you guys said in answer to the last question was, you said that you are not baking in any contribution from the near terms, you might do it in the second half. Is there a way to understand it?

Eric Belcher

If it becomes a significant portion Naved, it would change the guidance, correct.

Naved Khan – Jefferies & Company

I see. And if I look at the transactional revenues, year-on-year these were down. Any particular reason why you’re seeing softness in these?

Eric Belcher

The vast majority of our effort over the past couple of years has been in our enterprise segment. As we’ve said before, with respect to transactional business, it’s our new initiatives, specifically selling print online, selling print over the phone, something that we’ve never done before in our industry and we are certain it’s going to work, and then also recruitment of individual sole proprietor business brokers, print brokers, that we are targeting.

Those are the initiatives that are going to re-energize the transactional side of our business, but those initiatives have not meaningfully kicked in as of yet, which is why you’ve seen a dip in our growth and transactional business, which just highlights I think, how rapid the enterprise business has really grown of late. And by the way, we don’t necessarily prefer one customer over another, but we will say long-term contractual relationships with major corporations, we believe will drive substantial shareholder value in the future.

Naved Khan – Jefferies & Company

Okay and then now that you have some more flexibility in the balance sheet and you have expanded the size of the revolver, do you expect to be more active on the M&A front?

Eric Belcher

No, no more active than we’ve been recently. We’ve got the small independent broker initiative that’s ongoing. As deals come up on the traditional M&A front, if the deal make sense, it’s got the right return, we’ll do it, but at this point I wouldn’t expect us to be any more active just because the credit agreements been extended and increased to $100 million.

Naved Khan – Jefferies & Company

Okay, any chance you might consider actually buying back the stock?

Eric Belcher

No plans at this time.

Naved Khan – Jefferies & Company

Okay and then last question from me. Can you just update us on the announced deal for the remainder on this year and next year?

Eric Belcher

Sure. So the first half earn-out payments were just over $4 million and the second half of 2010 earn-out payments will be in the $6 million to $8 million range, and then 2011 will be in that same ballpark of roughly $10 million to $12 million of full-year earn outs.

Naved Khan – Jefferies & Company

Great. Thanks.

Eric Belcher

Okay, thank you.

Operator

Our next question comes from Jeff Blaeser with Morgan Joseph.

Jeff Blaeser - Morgan Joseph

Good evening. Thanks for taking my question.

Eric Belcher

Welcome Jeff.

Jeff Blaeser - Morgan Joseph

Could you give us some flavor from your existing customers and their sentiment? The consumer projection seems to change monthly. Are they more confident, less confident? Does variance change in terms of what they expect going forward and their expectations?

Eric Belcher

Jeff, we wish we would be of some help with questions like that, but the one thing that I can say is that, out of the 2% same customer growth that we have experienced now, two quarters in a row, we have broken that down across our customer base and there isn’t a tremendous amount of variance and there isn’t one or two clients driving up or down that number. So our general feeling is that trend is going to continue going forward.

Jeff Blaeser - Morgan Joseph

Okay, and now I am going to take a step back. I believe you mentioned long-term top-line growth expectations of 15% I think over a three-year period, correct me if I’m wrong. What type of mix are you assuming within that and the [Inaudible] 2011, but is that enterprise a transactional BPO, is there any guidance you can give us there?

Eric Belcher

Yes Jeff. The 15% organic growth it is just from the enterprise segment of our business. So there would be zero growth assumed for transactional or BPO in that or eminent.

Jeff Blaeser - Morgan Joseph

Okay, great. Thank you very much.

Eric Belcher

Thank you.

Operator

And that’s all the time we have allotted for questions today. I would like to turn the call over to our speakers.

Eric Belcher

Great. Well, thank you everybody for joining us, and we look forward to speaking to you again in three months at our third quarter call.

Operator

Ladies and gentleman, thank you for your participation in today’s conference. This concludes the program. You may all disconnect. Everyone has a great day.

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