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ChannelAdvisor Corporation (NYSE:ECOM)

Q2 2014 Results Earnings Conference Call

August 05, 2014 05:00 PM ET

Executives

John Baule - Chief Financial Officer

Scot Wingo - Chairman and CEO

David Spitz - President and COO

Analysts

Colin Sebastian - Robert Baird & Co.

Brad Reback - Stifel

Terry Tillman - Raymond James

Justin Furby - William Blair & Company

Jobin Mathew - Deutsche Bank

Shawn Milne - Janney Capital Markets

Michael Huang - Needham & Company

Greg Dunham - Goldman Sachs

Operator

Good day ladies and gentlemen, and welcome to the Q2 2014 ChannelAdvisor Earnings Conference Call. My name is Whitley, and I’ll be your operator for today. At this time, all participants will be in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).

I would now like to turn the conference over to your host for today, Mr. John Baule, Chief Financial Officer. Please proceed, sir.

John Baule

Thanks. Good afternoon and welcome to ChannelAdvisor's conference call for the second quarter of 2014. I am John Baule, Chief Financial Officer of ChannelAdvisor. And with me today on the call are Scot Wingo, CEO and Chairman; and David Spitz, President and COO.

After the market closed today, we issued a press release with details on our second quarter performance as well as our outlook for the third quarter and full year 2014. This press release can be accessed on the Investor Relations section of our website at ir.channeladvisor.com. In addition, this call is being recorded and a replay will be available following the conclusion of the call.

During today's call, we will make statements related to our business that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be considered representative of our views as of any subsequent date.

We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from expectations. These risks are summarized in the press release that we issued today.

For a further discussion of the material risks and other important factors that could affect our actual results, please refer to those contained in our most recent Form 10-K, as well as our other filings which are available on the SEC website at www.sec.gov.

During the course of today's call, we will refer to certain non-GAAP financial measures including core revenue, which excludes revenue from two small legacy acquisitions that are not a core focus of our business. A reconciliation of all non-GAAP measures to the most comparable GAAP measure is included in our press release.

Finally, at times in our prepared comments or responses to your questions, we may offer metrics that are incremental to our usual presentation to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that we may or may not continue to provide this additional detail in the future.

And with that, let me turn the call over to Scot for his prepared remarks.

Scot Wingo

Thanks John and welcome everyone to our second quarter 2014 conference call. Results from the second quarter exceeded our expectations. Core revenue came in at $20.5 million, a 32% year-over-year increase. With comScore and Forrester forecasting 15% growth in e-commerce for 2014, we're pleased to be growing more than twice that rate.

We added 108 core customers in the quarter, which brings our customer count up to 2,673, a 25% increase from the same period last year. In the second quarter, there was a substantial increase in activity in the e-commerce industry, and I wanted to share some of the highlights along with what they mean for ChannelAdvisor.

Starting with marketplaces, Amazon recently introduced the Fire Phone, the first smartphone with an e-commerce orientation. The Fire Phone features a new innovation Firefly that allows the consumer to scan barcodes, listen to songs, watch media, and use advanced image processing along with machine learning to identify any object.

From there, the consumer can purchase that product on the Amazon. Firefly is the ultimate showrooming tool. Also this quarter, we saw Amazon raised their bar on solid performance, which caused an unprecedented level of suspensions.

Next, as you probably saw, eBay had a challenging quarter facing the one-two punch of a Google SEO action and a data breach. This caused eBay's growth to slow to 7% to 8% for the quarter, half the rate of e-commerce. While our same-stores sales came in above that, it’s definitely a tough quarter for eBay, and we're watching carefully to see how they recover from both of these headwinds.

Also this quarter, as with Amazon we saw eBay significantly raise the bar on their sellers, which has resulted in more suspensions and limitations being imposed than we have seen historically. Finally, within marketplaces, last quarter I talked about our theory that we're going to see a dramatic increase in the number and variety of new marketplaces. In this vein, Facebook just introduced the ability to buy products on Facebook without leaving the popular social network. This is an experiment called, the Facebook buy button. With over 1 billion active users, if just a small fraction of those users engage in e-commerce, this could become a very large new marketplace. We believe this is just the beginning. The industry press recently discovered Twitter testing a similar feature. We see a wave of innovative new marketplaces coming to the U.S. social networks, mobile applications, mobile operating systems, and even existing digital marketing channels such as search engines.

ChannelAdvisor, our value proposition for marketplaces is twofold. First, we insulate our customers from changes on the large incumbent marketplaces like eBay and Amazon, and we also have features and functionality that gives them a competitive edge. Second, with 37 global marketplaces, we’ve built a large network giving retailers access to hundreds of millions of buyers and hundreds of millions of dollars in GMV or gross merchandise value. In keeping with our mission of connecting our customers to new sources of global demand, we expect to continue adding new marketplaces as they develop.

The next trend I wanted to update you on is cross-border trade or CBT. Over the last six months, we launched support for MercadoLibre in Brazil and Tmall Global in China. We continue to see strong interest in this trend from retailers of all sizes and in all geographies. Retailers view ChannelAdvisor’s network of channels as the best way to get their products in front of global buyers. We call this Agile Cross Border Trade. Instead of the traditional approach of frontend loading expense and backend loading revenue or sales, we leverage our network to reverse this process, in front-end the revenue piece.

This message is really resonating with customers, and we are seeing a lot of demand for our cross-border trade capabilities in all regions. The last trend I wanted to update you on is what I call B2B is the new B2C. In the past calls, we have mentioned that we are seeing more consumer-oriented branded manufacturers that are currently not selling direct but have now made it a strategic priority to start selling direct to consumer. Today, we are able to offer our digital marketing in marketplace solutions to these branded manufacturers and seeing acceleration in demand from those types of prospects.

As we get to know this new type of customer, we have some ideas on how we can help them even more. In summary, in the second quarter, retailers saw acceleration on the pace of innovation, change in fragmentation, and it’s not even the third quarter where we usually see the largest increase in new features in preparation for the holiday selling season.

Complexity, fragmentation, and change in e-commerce creates more demand for our solutions and increases the value of the ChannelAdvisor platform. With that, I will turn it over to our President and COO, David Spitz, who will take you through some of the operational highlights for the quarter.

David Spitz

Thanks Scott. I was pleased with our Q2 performance, our fourth consecutive quarter where we delivered accelerating core revenue growth. In addition to our strong revenue performance in the quarter, I also realize your attention will be focused on our net customers adds ahead of 108 -- adds of 108. So, I would like to spend a few minutes walking through this particular metric.

As many of you know, we have a diverse customer base with a wide range of revenue per customer for less than $10,000 per year to over $1 million per year. In other words, we generate roughly 100 times more revenue from our largest customers compared to our smallest customers. It’s for this reason, we encourage investors to incorporate both our customer count metric as well as our average revenue per customer metric when evaluating the future trajectory of our business.

Simply put, with such a wide range of revenue per customer, any shift in the size of customers we add or lose or the extent to which the proportion of sales to existing customers increases relative to prior periods can have considerable effects on our net add number, which taking in isolation, is not necessarily indicative of our future growth. The importance of evaluating customer count in conjunction with average revenue per customer became more pronounced in the second quarter. Specifically, three factors contributed to our lower net add number compared to Q1.

First, we closed deals that were incrementally larger compared to prior quarters. For instance, we closed an Internet Retailer 500 top 10 retailer with expected first year revenue to us exceeding $350,000, a relationship whose revenue to us will be 30 to 35 times more than our lowest-tier customer, but still counts as a single net add. We now incidentally serve 31% of the top 500 U.S. Internet retailers, up from 27% a year ago.

Second, we closed incrementally more business with existing customers compared to prior quarters, in each case representing net new revenue for us that does not increase our customer count. This represents both customers who were growing with us on existing channels as well as customers who seek to expand the use of our platform to incorporate additional modules and new channels.

Our new digital marketing offering, announced in Q1, has been well received in the market and it's helping to drive incremental growth amongst existing customers seeking to consolidate management of feeds, Google product listing ads, and other digital marketing programs on our platform. Third, we also saw an increase in customer unit churn at the lowest end of our customer base, on average, smaller sellers paying us less than $15,000 per year. Although the resulting lost revenue, measured as a percentage of overall revenue, it was consistent with what we’ve seen over the last few years. More of it was concentrated in smaller customers, and thus had a larger than usual impact on our net customer unit growth.

As Scot mentioned, we are seeing an uptick in suspensions by eBay and Amazon of smaller sellers, and this affects the viability of some of these smaller customers. In fact, the largest single contributor to churn in this segment is sellers facing business continuity issues. So we’re not losing these customers to competitors, rather they’re generally just going out of business or at least leaving a channel. Additionally, this dynamic is unrelated to the length of our relationship with customers. We are seeing an uptick in trend at the low end of our customer base whether a customer has been with us for five years or five months, so we do not believe this indicates any change in deal quality.

Put simply, in Q2, we lost an increased number of smaller customers and replaced them with larger, and we believe more profitable customers slowing our net customer growth compared to recent quarters. But at the same time, we saw average revenue per customer growth increase year-over-year in Q2 when measured on a trailing 3-month basis, the first sequential increase in trailing 3- month average revenue per customer we’ve seen in a year. Thus, the slowdown in net adds relative to last quarter was offset by an acceleration in average revenue per customer.

Our sales team continued to deliver solid execution, increasing new business 18% sequentially compared to Q1, which was already our previous record. At the same time, our opportunity pipeline remained close to record levels despite this continued growth in new business, reflecting strong demand for our platform. Overall, this represents our continued, albeit gradual move upmarket to larger retailers and brands, and while we never like to lose any business, we are comfortable that we're placing losses at the low end of our customer base with larger customers is a healthy trend for our business.

We believe that over time, the low end of the market will continue to face fierce pressure among sellers as the competitive bar and e-commerce continues to rise that GMV will continue to migrate up the stack as the market evolves and as we execute on our path towards profitability over the next two to three years, something John will touch on momentarily, an increased focus-on and concentration of larger customers is likely to improve the leverage in our model and our overall prospects for profitability, even if from time to time this means we favor adding a smaller number of net larger customers in a period versus chasing a larger number of smaller, but ultimately less profitable customers.

In fact, effective July 1, we implemented a price increase in support of the strategy of continuing to gradually move upmarket and further reflecting our confidence in our competitive position. In conclusion, while our net customer growth was slower than recent quarters, this metric should be evaluated in conjunction with average revenue per customer, which accelerated for the first time in a year on a trailing three-month basis.

While our strategy of moving upmarket may, from time to time, cause net customer growth to slow from one period to the next, it does not necessarily represent a negative trend in the business and certainly did not in the second quarter as is evident in our strong revenue performance. As John will detail, we are also increasing our full year revenue guidance for 2014, a further sign of our confidence in the business and our strategy.

Now, I would like to turn the call over to John for details on our financial performance for the quarter and our outlook for Q3 and the remainder of 2014. John?

John Baule

Thank you David. Let me start by making a few points about our performance this quarter with a particular focus on providing context around our revenue growth. Then, I will make a few comments regarding our increased guidance for 2014, our third quarter outlook, and our long-term profitability outlook.

I would like to start by drilling down a little further on our strong 32% core revenue growth in the quarter. As we noted on our last call, results for the second quarter of 2013 included non-recurring revenue of $300,000 for implementation services for some of our channel partners. Excluding this amount, our core revenue base for the prior year will be $15.2 million. There were also items approximating $400,000 in the second quarter of 2014 that are non-recurring in nature.

The largest of these items related to an international business development arrangement designed to encourage cross-border trade by enabling our customers to access new marketplaces. This item was the primary reason for the increase in international revenue to 24% from 21% of total revenue. Excluding the non-recurring revenue from both periods, the real growth rate for core revenue in the second quarter was approximately 32%, $20.1 million compared to $15.2 million.

Applying these same adjustments, the total revenue leads to an adjusted growth rate of 30%. We believe that our strong revenue growth is indicative of ChannelAdvisor's unique positioning as we continue to penetrate a large and growing target market. In terms of the composition of our new business in the second quarter. As David pointed out, we saw a mix shift to an increasing number of larger deals, which led to an increase in our average deal size. We also saw continued expansion with our existing customers as they committed to higher monthly GMV levels.

The fact that customers are buying up to higher tiers of service is reflected in the continued upward progression of our fixed revenue, which climbed to 76% of total revenue compared with 68% in the same quarter last year.

Turning to expenses, gross margins declined in this quarter as a result of a one-time investment in translation services provided to some of our customers to help them expand their market reach. We believe that this investment will enable our customers to increase their GMV in the future. Adjusting for this item, which increased cost of sales by approximately $600,000, gross margins would have been in excess of 71% and closer to last year’s levels.

We continue with our strategy of investing in sales and marketing. On a non-GAAP basis, this expense line increased 50% compared with the same quarter last year. However, as I noted during the last call, sequential and year-over-year growth in sales and marketing expense was impacted by the timing of our annual U.S. Catalyst Conference, which we held in the first quarter of 2014, but in Q2 in 2013. The cost of Catalyst in 2014 was approximately $1.5 million. Adjusting for the impact of Catalyst timing by adding 1.5 million to the Q2 2014 expense and subtracting it from Q1 2014, sales and marketing expense on a non-GAAP basis increased 66% from a year ago and 13% sequentially from the first quarter of 2014 consistent with our planned investment approach. And our adjusted EBITDA loss of $6.1 million was within the guidance range we provided last quarter.

Now, I would like to provide some comments regarding our guidance starting with the full year 2014. We are raising our revenue guidance to a range of $86 million to $86.7 million for 2014, an increase of over $800,000 at the mid-point and representing growth of 26% to 27% for the full year. Our increased revenue guidance is based on our over performance in the second quarter and our continued positive view on the demand environment for the remainder of the year.

From a profitability perspective, we noted on last quarter’s call that we were likely going to be at the higher end of our loss guidance for the year. Nothing has changed in that regard. And as such, we are narrowing our expected EBITDA loss range for the full year to $17.5 million to $19 million.

Turning to the third quarter. Our guidance for the third quarter is $20.5 million to $20.9 million, which represents total revenue growth of approximately 25% at the mid-point and 26% at the high end of the guidance.

We anticipate adjusted EBITDA in the third quarter to be a loss of between $5 million and $5.6 million. While we are currently investing for growth, both domestically and internationally, we are managing the triggers of investment carefully with a close eye on our long-term profitability targets.

From a longer-term perspective, we continue to be optimistic about the scalability of our operating model and see significant potential to leverage on each line of our P&L. We will maintain a balanced focus between the investment opportunity presented by our large and untapped target market and our ultimate goal of profitable, sustainable growth.

And finally, while we have not provided guidance beyond 2014 yet, we can share that we expect to get the positive cash flow without requiring any additional capital beyond our current balance sheet, and that includes the ability to maintain a healthy cash balance to adequately fund our day to day operations.

And with that, I’ll turn it back over to Scot for closing remarks.

Scot Wingo

Thanks David and John. Before we turn it over to Q&A, I wanted to thank the ChannelAdvisor team for all their hard work. In the Research Triangle Park, North Carolina area, there’s a publication, the Triangle Business Journal that surveys local companies’ employees to determine their workplace satisfaction. We’ve recently notified that the ChannelAdvisor team voted ChannelAdvisor a Triangle Business Journal best place to work for the fourth consecutive year in a row. As with any software company, we’re only as good as our people. We’re really proud about this recognition, especially given the period of substantial growth we’ve recently gone through.

With that, operator can we turn it over to Q&A please?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Colin Sebastian with Robert Baird & Co. Please proceed.

Colin Sebastian - Robert Baird & Co.

Great, thanks, congrats on the quarter. First off David, thanks for the details on the net adds. I guess if you could talk about your level of satisfaction with salesforce productivity, whether we should see an uptick in productivity in the back half of the year? And related to that, if the uptick in sales and marketing spend is still a positive signal regarding the traction you’re seeing in markets such as China and Brazil?

David Spitz

Hey Colin. Yes. Look, I was very satisfied with our sales team performance and their productivity. As I mentioned, we set a record last quarter and exceeded that by double digits this quarter, so the team continues to perform. And as the sales reps that are part of that team continue to matriculate and gain tenure, yes, I do expect that we’ll continue to see productivity gains from that team. We’ve also been making investments in inside sales, which is our lead qualification team. We found that folks who get promoted from inside sales hit the ground faster and are able to get to quota faster, and so that's another area that we've been investing in that we should start to be able to harvest over the next quarter or two.

So, I feel very comfortable with our sales team and continue to invest in that. Yes.

Colin Sebastian - Robert Baird & Co.

Okay. Thanks. And then secondly, Scott, you mentioned the eBay issues in the quarter, if perhaps you could quantify any impact from those in your business. And you also recently mentioned a survey of your client base that showed Amazon actually being the most popular marketplace ahead of eBay. I wonder if those lines have crossed yet in terms of transaction volume as well, at least on the ChannelAdvisor platform? Thanks.

Scot Wingo

Yes. Hey Colin. We don’t separate out any specific channel, so I can't really comment on that. What I will say is, we were -- our same-store sales were about the eBay data points that were out there; for the quarter, they did 8% and they kind of said June was 7%. We haven’t put out our June numbers yet.

So, we feel like our software is giving our customers a bit of an edge even during those headwinds. The area where we did see some impact, and Dave mentioned this on the net adds, is we did see both from eBay and Amazon some increase in terminations or suspensions and limitations.

So, the marketplaces all have different kind of effective actions they can take on sellers for different things. We’ve seen them just really dramatically ratchet those up here in the last 90 days or in the second quarter.

So that’s probably something that is a little unusual, little bit of a perfect storm. We had some press out there, specifically around prescription drugs and counterfeit items that I think have caused both eBay and Amazon to sway that pendulum really hard over to one side. So, we’ll have to kind of wait and see how long that lasts. It ended up being good for the long run. So, I think that's what we've seen. Another one that is kind of an unknown is, as you know eBay has this new thing called the defect rate, and we're really not going to see the impact of that until we get to August. So, we are kind of watching that closely and hopefully our customers are advantaged as we go into that period because we've given them tools and data that give them a bit of an edge, but I do think that's going to be another kind of dislocation in the market as sellers figure that up.

Colin Sebastian - Robert Baird & Co.

Okay. Thanks very much.

Operator

Your next question comes from the line of Brad Reback with Stifel. Please proceed.

Brad Reback - Stifel

Hi guys. How are you?

Scot Wingo

Hi Brad.

John Baule

Hi Brad.

Brad Reback - Stifel

On the customer add side, can you tell us what it would have been if churn hadn’t increased at the bottom end of the market?

David Spitz

Hi Brad, this is Dave. So, as you know, we don't breakout gross adds and net adds, but consistent with the performance that I indicated about our sales team, we really manage to new dollars of revenues as opposed to units, right. So, if we wanted to focus on units, we could chase a number of small deals or drop prices and go after smaller customers, but we don't do that. So, I'm very pleased with the dollar amount of new business that our sales team generated, and what I would say is that it was obviously incrementally higher, significantly higher than what we saw in Q1, and from a unit basis, I would say it was consistent with what we saw in Q1 as well and a continued uptick from what we have seen in prior quarters. So, I think from a unit dynamic or a customer count dynamic, this is not a question about sales or sales productivity or sales generation. This is really just around some churn at the lower end of the customer base.

Scot Wingo

One metric is we did add 16 larger retailers from the IR 500 list that was good set of new customers to put on this quarter.

Brad Reback - Stifel

Can you then give us a sense of how much bigger bookings were this quarter versus last year?

Scot Wingo

So I don’t have that handy in front of me Brad. We did increase it 18% sequentially, which I mentioned in my script, and Q1 was a record as well.

Brad Reback - Stifel

Okay. And then maybe a little more detail on the price increase you instituted on July 1, is that just for new customers, is that on renewals? Any detail would be great, maybe the magnitude.

Scot Wingo

Yes, I would characterize it as an incremental price increase on new customers. So, this does not affect -- we don’t grandfather or rather I should say we do grandfather existing customers into their existing pricing schemes, this was for new customers. And we continue to analyze the profitability and cost characteristics of various customers, and as I mentioned in my prepared remarks Brad, we continue to believe that GMV will continue to migrate upmarket. The bar of e-commerce continues to get raised, and it makes it harder for smaller sellers to maintain their competitiveness.

And so as we look at the cost of customer acquisition, the cost of launching and supporting customers, we want to make sure that we are sending an economic signal to the market about what is the threshold at which it makes sense for a seller to consider ChannelAdvisor as a platform, and when might be – when are they potentially too small for us. So I would consider there is an incremental pricing change consistent with what we have done in the past, and again applied to new customers.

Brad Reback - Stifel

Thanks a lot guys.

Scot Wingo

Thanks Brad.

David Spitz

Thanks Brad.

Operator

Your next question comes from the line of Terry Tillman with Raymond James. Please proceed.

Terry Tillman - Raymond James

Hey, good afternoon guys. Hopefully you can hear me okay.

Scot Wingo

Yes.

Terry Tillman - Raymond James

I guess, as it relates to lower end of the market, which is still part of your core business. Given what we're seeing with suspensions and just the dynamics there, has it actually propelled you all to reallocate some of your go-to-market and your sales resources more towards mid-market or mid-size deals or larger deals?

And then, I'd like to then follow up with another question on that front.

David Spitz

Yes. Hey, this is David. I think the answer is, we're not specifically reallocating sales reps in that regard. We already reject a lot of deals that come to our pipeline that aren’t large enough, but we're constantly tweaking that and our pricing change is an example of that.

So, it's more than anything kind of how we market ourselves, how we go-to-market from a messaging standpoint. What leads our inside sales teams will qualify, and attempt to send over to the sales team, et cetera, and then of course pricing that ends up being applicable to a customer. John?

John Baule

Hey Terry, this is John. We've always said that we don't incent our sales people on number of customers. We incent them based on dollar bookings. So they are obviously incented to get the biggest and best deals they can.

Terry Tillman - Raymond James

Got it. And I know Brad had asked about bookings. I don't know where you are in terms of the maturity of being able to sell larger deals, larger retailers, or etailers, but maybe you could talk about the quality of the pipeline for larger deals and should we assume that maybe actually on a quarterly basis, even if we don't get the number that, because you're on the hook for bigger deals, there could be much more volatility quarter in, quarter out from a booking standpoint?

David Spitz

Well, hey Terry, this is Dave. If I understand your question correctly, even on the enterprise side of the equation, our deals, our sales cycle is not particularly long I mean we’re typically looking at 60 to 80 days maybe 75 days on an average for an enterprise deal, obviously some are longer and some are shorter. So, but these are not typically nine month or 12 month types of deal. So I don’t think we -- I would not expect increased volatility on the dollar volume of bookings that we’ll generate. I think my message is I wouldn’t necessarily focus exclusively on net ads because the net ad number could go up and down from one period to the next for reasons I’ve said, right. We’ve always advocated from pre-IPO to today that it’s not a metric that should be evaluated on isolation as I mentioned in my call. So, as I mentioned we signed a top 10 retailers that whose revenue to us is 30 to 35 times revenue of our smallest type of customer. So, those types of dynamics will happen in the business and you may see some volatility in that number. But I do not expect to see significant swings in our dollar volume of bookings from one quarter to the next because our sales cycles are still relatively short even for enterprise.

Terry Tillman - Raymond James

Okay, okay. And John maybe just a quick question I was really pleased to hear you talk about the cash flow dynamics and about how the model’s self-funded or will be self-funded. Could you give us any more details though either on what’s the sustainable sustained growth rate that allows this to happen for any kind of duration or just anything else you could add to the cash flow comment? Thanks for taking my questions.

John Baule

No problem, Terry. Well, I mean I think what we said is one I don’t want to quantify at this point exactly how much we think we get to before we turn to cash flow positive. But I will say I think I know us we’ve got a conservative management team. We like to sleep peacefully at night so we want to know that we have adequate cash reserve for contingencies in the bank. And so that's probably the most important thing. Does that answer your question Terry? Yes, sir.

Operator

Your next question comes from the line of Justin Furby with William Blair & Company. Please proceed.

Justin Furby - William Blair & Company

Hey guys thanks for taking my questions. I guess I want to focus on the guidance for the second half of the year, it seems to suggest a fairly big de-sale in Q3 and Q4 versus what you did in the first half. And I am just trying to contrast that with strong bookings in Q1, strong bookings in Q2 and retention that seems to be on a dollar basis pretty consistent with what you've seen historically.

So what are -- what would it take for you to see that kind of a deceleration in Q3 and Q4. And is there any reason why you couldn't continue to grow mid 30 type core revenue growth in the back half of the year?

John Baule

Hey Justin good question. I think that the first thing is we look at a lot of variables when we try to put together guidance in revenue. We look at the different phasing of deals and when they can end, we look at the mix of customers, we look at numerous variables.

And I know it seems like a big deal when you look at a point of growth, but I'll just remind you a point of growth rate for us is about $160,000 and that equates to roughly $10 million in GMV. So when you are talking about big marketplace like an eBay or Amazon $10 million in that world is a blip.

So we just take, we try to take a realistic and careful approach to looking at all those metrics when we look forward. And that's we've been able to provide you with I think good guidance so far in revenue by taking a careful prudent approach.

Justin Furby - William Blair & Company

Okay. And if you guys print exactly as you guide for the second half of the year internally how are you viewing that outcome?

John Baule

I think, we applied ourselves on being the management team that does what it says it’s going to do and that's what we said we're going to do. So I think, we obviously love to do better, but we're very happy with the performance we've got it to or we would be very happy with the performance we guided to if it were to materialize.

Justin Furby - William Blair & Company

Okay. And then on the 18%, I wanted to clarify that. So that's a sequential growth in total committed bookings, so that would be new customers time contract, average contract dollars plus any up-sale of that that 18% growth that you're referring to?

Scot Wingo

Yes. So we look at people define bookings differently all over the industry, we look at bookings as a measure of annual contract value, the vast majority of which is committed revenue, there is obviously in some cases, some estimate of variable revenue if there is a known stream there. But yes, we're looking at the dollar value of annual contract value to us.

Justin Furby - William Blair & Company

Okay. And is there any way to, I mean the average revenue per customer is helpful but again it's just blended, because you have everybody in the base. So is there any way to give any sort of sense for kind of average selling prices and what they look like year-on-year or even sequentially that might, I think that would help investors better get a sense for the types of customers you signed in Q2 versus other quarters?

David Spitz

Yes. Justin that's a fair question. I don't think we would breakout today average deal size. Obviously we believe we have favorable dynamics as customers age overtime and if you look at average revenue per customer overtime we believe that you see some favorable dynamics there. So I don't think it would be unreasonable to assume that average deal size is typically less as I've said in previous calls and average revenue per customers. But as customers grow with us, we obviously benefit from that as well.

Justin Furby - William Blair & Company

Okay. Any update on, I guess on hiring plans in the back half of the year for you guys; has that changed at all? And I guess if you are looking at that normalized sales and marketing expense, I think you said it grew something like 60% when you adjust for the changes in your catalyst conference. So, I guess what I am trying to get is the bookings number, the bookings growth year-on-year, is it something closer to that or is it something closer to the revenue growth that you guys put up in Q2?

David Spitz

I think Justin, I mean we are not going to -- I don’t think we can guide to bookings right now. We obviously hope to continue to increase bookings at an increasing rate. And sales and marketing I understand over the next two quarters is reflected in the 17.5 million to 19 million EBITDA loss -- adjusted EBITDA loss.

Justin Furby - William Blair & Company

Okay. And then one quick one on China, we get a lot of questions on it and just I know David you were out there recently, I would love just sort of an update on kind of how big of an opportunity you are seeing that? If there was any early data points on the import side of the equation, so the Tmall business and whether what that could mean even to 2015, 2016 numbers?

David Spitz

Yes, so just to remind everybody on the call, so, we really kind of divide China into three discrete concepts. One is the export side of the business which is Chinese manufacturers using our platform to sell into western countries, typically eBay or Amazon; the second is the import business which is helping western retailers or western brands selling into China through Tmall Global and other channels; and then the final bucket if you will is the domestic market of China. So helping Chinese sellers sell into China. And that’s roughly the sequence to think about ChannelAdvisor.

So, we have had for a good couple of years now in existing export business and we believe that’s a substantial market opportunity for us. Up until late last year, we did not have a China presence, yet that business was essentially flourishing, almost on its own. So, we’ve built up a -- we hired a Managing Director and spent the first half of this year, building up a team in China to really build that export business. And I think there is a lot of room to run there. And I think for the, at least the immediate future that will continue to be the dominant theme for us as it relates to China.

The import side of the business relates to our Tmall Global relationship. I think I have been pretty consistent in saying that this will take time to build. It's got some complexities associated with it. There is a lot of things that brands need to do to be successful there and ChannelAdvisor is one component of that equation, but not the only one. So, I think that will -- that has a lot of opportunity for us, but I think it will continue to take some time to build up.

And then I think the domestic market, we do have a number of prospects asking us about domestic opportunities there as we’ve built up our China team, a lot of our customers now are saying, hey you guys are really good helping us on the export side, can you help us on the domestic market. It's something we're evaluating, but it's not something we've launched or announced yet at this time. But all-in-all, I would say, based on my multiple visits and time spent with our team in China and customers and prospects in China, I think it's a rather remarkable opportunity on a global basis. And it's something we're really pleased to be part of.

Justin Furby - William Blair & Company

Okay, great. Thanks guys. I appreciate it.

Operator

Your next question comes from the line of Karl Keirstead with Deutsche Bank. Please proceed.

Jobin Mathew - Deutsche Bank

Hey guys, this is Jobin Mathew sitting in for Karl. Thanks for taking my question.

Scot Wingo

Hey, Jobin.

Jobin Mathew - Deutsche Bank

Hi. So, the first quarter is as you guys -- so you guys have been investing in the international markets for a few quarters now. As you build up these investments, are you concerned at all that the pricing here might be dilutive with the co-pricing that you have?

David Spitz

Hey Jobin, this is Dave. I don't believe that to be the case in any of our markets today, and we operate as you know in North America, Europe, South America, Brazil specifically and Australia as well as China. I don’t believe that to be the case in any of the markets we operate in with the possible exception of China where we -- there is a different market dynamic in China. Our competitor in China more often than not -- is not another software platform, it’s actually human labor. And there is at least the historical tendency in China to just hire potentially dozens of people to do the work that software might otherwise do, so just because of the cost of human capital or human labor over there. So, that’s one area where we do have a different pricing scheme to make sure that we’re addressing the right segments of the market there. It’s not necessarily large enough but at this stage of the game that I think it’s meaningfully dilutive to our overall average revenue per customer or anything like that. But we do recognize the fact that different markets may have different characteristics and different dynamics. And as a result, we listen -- part of the reason I went over to China, was to spend a lot of time with my team over there and make sure that I had a good understanding of the market dynamics and so on.

So, I don’t think it’s something that we are concerned about it, it’s not something I am worried about at this time, and like I said it’s our pricing scheme is consistent from one geography to the next with the exception of China where the structure is the same but we are willing to price lower in certain circumstances.

Jobin Mathew - Deutsche Bank

Got it. And on the net ads for this quarter, I mean if I look at it, it’s a little bit of decline from what we’ve been seeing the last couple of quarters. So the question is, over the last one year when you guys have accelerated the pace of customer ads, do you feel like that broadened maybe customers at the lower end who would not stay sustainably on the ChannelAdvisor platform? And are these the customers that are falling off or is it something -- or are these customers -- have they been with ChannelAdvisor for more than a year? And it seems like they just haven't grown their business and that’s the reason why they're falling off.

Scot Wingo

Yes, hey Jobin. So I touched on this during my prepared remarks. We really don't see -- if you look at it, like on a cohort basis, you really don’t see any dynamic that would indicate that this is something that's afflicting recently added customers. If you look at the average life span of these customers that have churned off, it's actually incrementally up from historical levels. So, they're actually lasting longer.

I think what you are seeing here is increased competition at the lower end of the market. Scot touched on some of the increasingly difficult dynamics and hurdles that sellers have to meet when selling on marketplaces like eBay and Amazon. And that's really just impacting smaller folks generally. It's got -- as far as our data shows, it’s nothing to do with customers added in the half year or two years or anything like that. It's consistent; the real indicator is just somebody at the very low end of the market who may not have the operational wherewithal to keep up with some of those requirements relating to fast shipping et cetera, et cetera.

Jobin Mathew - Deutsche Bank

Got it. And when you say that bookings was up 18% sequentially, is there a way you can break that up between what the portion between new bookings was and what the upsell portion of that was?

David Spitz

No. So Jobin, we don't publish that. What I think I would continue to say is consistent with previous quarters, we did have, as I mentioned in my prepared remarks, an uptick in sales through existing customers. Frankly I would characterize that more as a result of our offering, our digital marketing platform in Q1 which has, as I said, been well received in the market and caused more interest across our existing customers to adopt it, which will be characterized as sales to existing customers. But I'd say aside from that consistent with the past few quarters the sales reps that we've been adding to our team almost by definition tend to be focused on net new prospects in the pipeline. And so I would say qualitatively excluding the benefit from digital marketing, there hasn't really been a meaningful uptick in sales to existing customers versus new customers.

Jobin Mathew - Deutsche Bank

Got it. Thanks.

Scot Wingo

Thank you.

Operator

Your next question comes from the line of Shawn Milne with Janney Capital Markets. Please proceed.

Shawn Milne - Janney Capital Markets

I just a couple of quick questions. One John could you just give a little more color on the gross margin issue in the quarter and we had some of the launch costs in the first quarter so maybe this is something you clearly didn't expect in Q2 and do you think we'll get a cleaner gross margin number in Q3? And then also John for you just can you be a little more specific where on the cash flow comment. What were you saying about '15, what you're saying you expect to be free cash flow positive or operating cash flow positive? Can you just clarify on that? Thanks.

John Baule

Sure. Starting with the gross margin question. So you're right, last quarter we had - which we talked about which was more of a phasing shift in the hiring of launch personnel to handle a lot of the new customers we had brought in over recent quarters. And that had a timing adjustment in Q1. The item and that largely worked itself out, so if nothing else had changed the margins would have returned to the levels consistent with last year. The event this particular time was a very specific decision to invest that we made during the quarter to invest in some services basically to help some of our international customers reach different marketplaces, we translated - we helped with some translation cost that enabled them to sell across borders. So that is a very specific investment and very separate from the one that we talked about in Q1. So if we don’t have anything like that in subsequent quarters I would expect that gross margins will return to levels similar to what we saw in the prior year. I mean we may make different decisions during the quarter, but we haven’t at this point, so that would be where we were.

As far as the second question I never said and I want to be really clear on this, I never said that we would be cash flow positive in 2015. What I said was and I get this question from investors a lot, do you foresee the company ever needing to go back to raise additional capital to fund sales and marketing investment. And I think what we are saying is that we think we will reach cash flow profitability before we need additional cash on the outside. And I also said that I think we would want to have a reasonable safety margin in how far we will go before we start to be cash flow positive.

One of the nice things about this business and we’ve said this all along is that our investment in sales and marketing is very much an incremental decision. We can turn that down at any point in time when we don’t think we are getting a return and go to cash flow positive and let me just kind of remind you that if you back historically we’ve been cash flow positive for most of the history of the company. But I am not saying that that’s happening in 2015 and no way am I making that commitment at this point.

Shawn Milne - Janney Capital Markets

Okay, thanks for the clarification.

Operator

Your next question comes from the line of Michael Huang with Needham & Company. Please proceed.

Michael Huang - Needham & Company

Yes Thanks very much. Obviously impressive with the larger retailer activity that you saw in the quarter. I was wondering -- could you generalize what it is these large retailers are buying from you guys and what you are displacing? And just in terms of kind of the success that you are seeing in that segment I mean is it just a natural evolution focus here or is there some other driver that's helping you win some of these larger retailers?

David Spitz

Hey Mike, this is Dave. I think our digital marketing platform has proven to kind of hit a - strike a chord with some larger retailers. As you look across some of the largest brands, the largest retailers this is a segment where you are more likely to see institutional resistance for example the selling on eBay or to selling on Amazon right. They may have competitive concerns about Amazon or they may have brand concerns around eBay, although I think eBay has done a good job to improve that perception over time.

But nonetheless in Internet Retailer 500 or the Europe 300 whatever you still see some of those kind of concern. So and these are retailers and brands who invested in many cases tens of millions of dollars in their website and they want to make sure they are driving traffic to that website. And they really want to make sure they are consolidating the management of the traffic on to one platform.

So, I would say on a larger end of the customer scale you are seeing that's really kind of the tip of the arrow for ChannelAdvisor.

And in terms of what we are displacing it's potentially a couple of different things. It's often an agency that somebody is working with that maybe the legacy of working on a 100 brand terms on Google was sufficient, but now with Google kind of raising the bar and doing things like product listing ads retailers can't - just advertising like a 100 brands terms doesn't cut it anymore. You really got to have a data feed you’ve got to have clean data, you’ve got to make sure your pricing is accurate and you need software to do that and a lot of agencies don’t necessarily have that capability. So we see people moving from agencies to be more attractive to a more sophisticated software platform like what we offer or sometimes you will see them using a multitude of vendors to do different things so maybe they’ve got an SEM platform that they’re doing bidding on but that SEM platform doesn’t do feeds very well or they’ve been working with a feed provider who doesn’t do bidding. So those are the kinds of things that when if you’re going to remain competitive you’ve got to combine those capabilities on to one platform and we’ve been well positioned to offer something attractive to that market that I think is fairly unique. It also includes capabilities around social media and other things. So again as the world becomes more complicated for some of these larger retailers the need to manage it in one place becomes even more important and that’s really what’s been appealing at that end of the market.

Michael Huang - Needham & Company

Great, okay. And then just my last question is, I know you had mentioned a couple of times that existing customer - that the [inaudible] existing customer knew it was biased a little bit towards existing customers for apps because of the digital marketing release. Was there anything -- should we be seeing that revert back to kind of the bias towards new as we get into Q3 and into 2015?

Scot Wingo

Yes, Mike it’s a little speculative. I mean we only announced digital marketing in March so towards the end of Q1 so it’s relatively new in terms of being out in the market for us. As you know we don’t guide to existing versus new, we don’t compensate sales reps differently whether a $1 booking is to an existing customer to a new customer and so I wouldn’t necessarily hazard a guess as to what that dynamic will look like. We’re still - I guess what I would say is it’s still heavily weighted towards new -- net new business to us. And so to the extent that a relatively small proportion fluctuates up or down to existing, I don't think it's a bad thing or good thing. I don't worry frankly that much about it. I like the fact that more and more of our customers are adding capabilities for us. I think that speaks to the long-term stickiness of the platform for our customers.

Michael Huang - Needham & Company

Great, thanks so much.

Operator

Your final question comes from the line of Greg Dunham with Goldman Sachs. Please proceed.

Greg Dunham - Goldman Sachs

Hi, yes. Thanks for taking my question. Most of them have been asked and answered; one question for you when you look at the pipeline and the mix in the pipeline between larger deals and just volume of deals, has the composition changed entering 3Q versus where it was entering this year and where it was entering a year ago?

David Spitz

Hey Greg, this is Dave. I would say incrementally up a little bit in terms of up market. We've -- for example, we've got enterprise events coming up here in Q3 that are going to be very well attended I believe just based on what I've seen. So I am fairly bullish on our opportunities at the upper end of the market and again the digital marketing stuff does help. So, I would say this is a qualitative statement; I don't have the quantitative info in front of me. But I would say that my sense is that yes, there has been an uptick in terms of the size of the typical deals we see in the pipeline whether that flushes out in Q3 and Q4 sales activity will remain to be seem.

Scot Wingo

We're seeing a secular increase in complexity. So we’ve talked some about - Google had Adwords and that was relatively easy and you could have an internal team. And then with the PLA, now they’re going to introduce a whole new thing called Google Shopping Campaigns. You take that and that's a layer of complexity - one other big thing that we're seeing in our industry is mobile. So, when we look at China for example mobile usage specifically smartphone is about 75%; US we’re at about 40%, 60% desktop. So that something all the retailers we talked to are really getting their heads around. And what we're seeing is that's carrying down some of these theological boundaries that used to exist. So folks would say I'll never partner – I’ll never sell on eBay or Amazon, but when they're start to see the mobile momentum those two companies have that's helping break down some of those barriers.

And then a third area is cross-broader trade. So a lot of these folks especially if there is brick and mortar component there is you can’t read a headline without store closures, pressure at malls, mall [inaudible] not going to malls. What's happening is the online side of that business is being tasked with supporting a lot of the growth - it's having to grow disproportionally due to the brick and mortar side losing share. So we have a VP of e-commerce that have been tasked with 60%, 70%, 80% growth. So that's pushing them into new regions and new areas faster than they have looked at as recently as a year ago.

So a lot of that is benefiting us and really helping us on the higher end of the market where we've always been there talking to these guys, but they have been kind of happy with this status quo and I think that pressure is pushing them our way.

Greg Dunham - Goldman Sachs

Okay. Thanks guys.

Scot Wingo

Thanks Greg.

Operator

There are no further questions in queue. I'll now turn the call back over to Mr. Scot Wingo for closing remarks. Please proceed.

Scot Wingo

We’d would like to thank everyone for joining us today. And we will talk to you in 90 days.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: ChannelAdvisor's (ECOM) CEO Scot Wingo on Q2 2014 Results - Earnings Call Transcript
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