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InnerWorkings, Inc. (NASDAQ:INWK)

Q2 2014 Earnings Conference Call

August 6, 2014, 05:30 PM ET

Executives

Brad Moore - Vice President, Corporate Development

Eric Belcher - Chief Executive Officer

Joe Busky - Chief Financial Officer

Analysts

Nate Brochmann - William Blair

Randy Hugen - Feltl & Company

George Sutton - Craig-Hallum

Matthew Kempler - Sidoti & Company

Kevin Steinke - Barrington Research

Operator

Good day, ladies and gentlemen, and welcome to the InnerWorkings Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Brad Moore. Please go ahead.

Brad Moore

Thanks, Patrick, and good afternoon, everyone, and thank you for joining our second quarter 2014 earnings call. This is Brad Moore, Vice President of Corporate Development. I'm joined by Chief Executive Officer, Eric Belcher; and Chief Financial Officer, Joe Busky.

Before we begin, I'd like to note that this call will include forward-looking statements relating 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.

This call will discuss, among other measures, non-GAAP adjusted EBITDA, non-GAAP adjusted SG&A, non-GAAP adjusted operating cash flow, and non-GAAP diluted earnings per share, which are all non-GAAP financial performance measures. Please refer to the company's earnings release issued earlier today for a reconciliation of these non-GAAP measures. 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.

After Eric provides some remarks, Joe will cover our financial results. And we'll then open the call to your questions. With that, I'll turn the call over to Eric?

Eric Belcher

Thanks, Brad, and welcome everyone. We continued to execute against our plan in the second quarter. Our revenues grew 23% with over half of the growth being generated organically from our core enterprise business. This organic growth was a blend, ramping up new clients that signed on with us earlier this year as well as meaningful growth coming from the expansion of our solution with many longstanding clients such as Unilever, InterContinental Hotels, MoneyGram, William Grant, to name just a few.

Over the past few years, we've put a lot of energy in developing related service offering, new product categories, while also expanding the new geographies in order to deliver even more value to our large multinational clients. And I'm pleased to see the results of these efforts come together. And we believe there's substantial opportunity for us to continue expanding within our large and loyal existing client base.

The balance of our second quarter organic growth came from some of our more recent client wins such as Callaway, Energizer, DEFENDER Direct and Pizza Hut, all of which are coming online nicely. In addition, we've been awarded a few very promising new contracts over the past several months with a diverse group of impressive companies including Sanofi, Newsday and Edrington. I'll briefly take you through what our initial scope of services are for each of these new clients.

But first, our new agreement with Sanofi, which is one of the world's largest pharmaceutical firms, has us managing the creation and production of their global promotional materials. After a successful six-month period of testing and development across 15 different countries throughout the Americas, Europe and Africa, we were chosen for our ability to bring innovation, to deliver savings, to drive corporate and social responsibility through a disciplined international supplier selection process and to enhance brand consistency across Sanofi's international platform. As the leading global provider, our niche, we were the clear logical partner to serve Sanofi's needs.

We also signed a long-term contract with Newsday, one of the largest newspapers in the US and a wholly-owned subsidiary of Cablevision. We've been hired to managed all of the marketing materials purchased by Newsday and their advertisers. This agreement builds on our growing roster of successful clients in the publishing vertical, which today include companies like Gannett, Houston Chronicle and Advance Publications.

And lastly, we've also signed a new enterprise agreement with Edrington, the owner of some of the leading scotch whiskey and rum brands in the world such as Macallan and Cutty Sark to name just a few. As part of this agreement, we'll manage their point-of-sale materials and their value-added packaging in the UK and Russia and in the United States. This new win deepens our expertise in the spirits vertical as Edrington joins a lineup that includes longstanding InnerWorkings' clients such as William Grant, Campari and Pernod Ricard.

Moving on from our new contracts, I'd like to give you a quick update on two of our new client implementations. First, as most of you know, we pivoted our inside sales efforts late last year into a partnership with a large national retail partner who serves small and mid-size businesses across the United States. This Fortune 500 company has over 1,800 retail locations with a strong local presence in the communities that they operate within. As of mid-July, our team has successfully completed a full rollout of our services across every one of their stores. Our partner is now using our real-time automated coding and ordering platform to develop incremental business from their foot traffic of small business owners. We continue to ramp up volumes and our results show a significant increase in same-store sales since our solution was introduced into their stores. We believe that this approach to growing our SMB business will be much more effective (technical difficulty) watching this partnership grow.

We've made great progress with Pizza Hut since the contract was finalized in May. We've managed five large point-of-sale campaigns to date, which contain complex multiple versioning requirements and were distributed across their 6,300 US-based locations. And we've already branched beyond the initial scope of the agreement, which centered around Pizza Hut's corporate marketing spend by beginning to support several of their large franchisee groups with their branded merchandize needs. And plus, we just launched an automated online e-commerce ordering system for franchisees to purchase customized marketing materials to support their local initiatives. We see numerous additional areas for growth with this [countdown in road] including possibility of supporting their international operations, which represent an additional 5,000 locations.

As we look ahead, our company is in a great position to increase our share of a large underpenetrated market. In a few short years, we've evolved from a regional provider of commercial printing services to a global firm executing across a broad range of marketing categories, which now include point-of-sale displays, promotional merchandize, direct marketing, creative services, branded retail fixtures, events and promotion and the packaging market. This diversification of our services along with our growing technology advantage and truly global footprint gives us platform to continue adding new large clients to our roster, while also expanding the scope of our services with our longstanding existing clients. And with these capabilities and the foundation for sustained organic revenue growth in place, the operational leverage of our business will continue to accelerate.

With that, I'll turn the call over to Joe now to provide more detail on our financial results. Joe?

Joe Busky

Thanks, Eric. We generated the highest quarterly revenue in the company's history at $260.3 million in the second quarter of 2014, an increase of 23% compared with the second quarter of 2013. And as Eric said, organic enterprise growth accounted for $27 million or growth of 13%. Growth from acquisitions made in 2013 represented $22 million or 10% growth.

The organic enterprise growth includes new account enterprise wins as well as incremental spend with existing customers in new categories and new geographies, plus a 1% increase in the same customer same contract spend. Existing customer new geography growth represents approximately 35% of the total organic growth, highlighting our ability to expand internationally within our existing customer base.

For the six-month period ended June 30, our revenue was up $86 million or 21% versus prior-year period. This growth was primarily driven by $51 million or organic enterprise growth, plus $44 million of 2013 inquisitive growth.

In Q2, we continued to see significant revenue growth across our geographic segments. Our EMEA region grew organically by 41% and our Latin American region grew organically by 27%. For the quarter, international revenues made up 30% of our total revenues compared to 23% in the prior-year period. And margins of our international business are improving.

Now looking at the sales channel mix of the quarter, our enterprise channel accounted for 78% of revenue and middle market accounted for 22%, which compares to a 76%, 24% mix in the second quarter of 2013. We also generated record gross profit for the quarter of $58.9 million, an increase $11 million over the prior-year period. Our gross margin for the quarter was 22.6%, down 20 basis points from 22.8% in the prior-year period. Year-to-date gross profit percentage for the six-month period ended June 30 is 22.6% versus 22.8%. We expect the gross profit percentage to remain in the same 22.5% to 23% range for the second half of 2014.

Now turning to expenses, SG&A expense excluding both the current and the prior-year contingent liability impact and the restatement activity from the prior year was $50.6 million or 19.4% of revenue for Q2 of this year versus $43.9 million or 20.8% of revenue in the year earlier period. The increase in SG&A dollars is due to $5.3 million from acquisitions completed last year with the remaining $1.5 million due to incremental headcount to support $27 million or organic enterprise growth in the quarter. The 140 basis point decrease in SG&A as a percentage of revenue versus the prior-year quarter is driven primarily by the leverage created from our topline growth and the organizational changes that we made when shifting the sales strategy of our SMB business.

For the six-month period ended June 30, SG&A excluding again contingent liability impacts in both periods and the restatement related activity from both periods was $98.1 million or 19.6% of revenue, which is up $34 million, down 80 basis points as a percentage of revenue from the prior-year period. About $11 million of this increase is from 2013 acquisitions and the remaining $2.7 million is due to incremental headcount to support $51 million of year-to-date organic revenue growth.

Due to adjusted EBITDA with $9.5 million for the second quarter, up 62% from the $5.9 million in the year-earlier period, year-to-date adjusted EBITDA is $18 million versus $12.7 million in the prior-earlier period, an increase of 43%. EBITDA margin trends are improving and we expect to see continued improvement going forward.

Our non-GAAP diluted earnings per share for the quarter were $0.04, a doubling as compared to $0.02 in the year-earlier period. The $0.01 difference between non-GAAP and the GAAP $0.03 per share is attributable to $600,000 of contingent liability expense net of tax as we increased our earn-out expectations based on the aggregate performance of acquired companies still in their earn-out period.

As far as guidance, we're reaffirming our 2014 revenue and non-GAAP diluted earnings per share guidance. And we are quite pleased with the performance of the business in the first half of this year.

With that, I'm going to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Nate Brochmann from William Blair.

Nate Brochmann - William Blair

You really have seen this international expansion, and I know that was part of the game plan, particularly going in this year, Eric. Could you talk about the main drivers of that, whether that's been additional sales efforts or whether that's just been like that you've done such a great work with getting a chunk of their account and they're just asking you to kind of come to different regions in terms of how that sales process has been working for you?

Eric Belcher

It's more of the latter. Our customers appreciated what we were doing for them in the United States. And they're global and they wanted a solution globally. And so we developed it. Of course, many corporations would prefer to go second or third versus first. So there is the slower adoption of our services in newer markets. But once established and a referenceable track record has been built, which it has now in basically every major economy in the world for the InnerWorkings platform, well then it's natural that we would have our clients talking to us about supporting them in these new markets.

So I would say that the reason for this growth and this acceleration of the growth, which is happening, as Joe mentioned, in large part because of existing clients adopting our services in new markets. It's due to the fact that the original decision to develop this platform was based on a market need.

Nate Brochmann - William Blair

Okay. And then I assumed that a lot of your current customer base obviously are pretty big customers and have global opportunities. Do you have a rough percentage that you might be able to share, what percentage of your companies that you could continue to expand with in different geographies and just to give us a sense of the opportunity there in terms of your existing base?

Eric Belcher

There is so much opportunity within our existing base not only in expanding internationally, I mean our business could be a multiple of ourselves many times over by expanding geographically within our existing client base, but also offering new solutions in areas like packaging and retail environments and creative services. And so there really is a substantial opportunity within the Fortune 500 global conglomerates that we have been serving in the United States originally for quite some time. And it's really nice to see here in 2014 that that expansion within the existing client base, which you've been a part of these calls now for many years and we've talked about and been more theoretical historical, and now it's actually appearing in our business in a fairly major way. And we expect that to continue for the foreseeable future.

Nate Brochmann - William Blair

Yeah. I think that's great that you guys had that vision for that and it seems like it's finally starting to pay off here a little bit for you. Just with some of those other services that you talked about in terms of some of that creative or packaging, does that have a different margin profile to it that we should think about at all in terms of as you get deeper on some of those services?

Eric Belcher

The answer is yes, there are slightly different margin profiles for the various services and the way in which we invoice and how that plays out in gross versus net and these types of things. In the macro, you actually see in our blended margins today and I don't expect anything changing in a meaningful way going forward as these services get adopted around the world.

Operator

Our next question comes from Randy Hugen with Feltl & Company.

Randy Hugen - Feltl & Company

It was nice to see the uptick in new enterprise growth sequentially. I think you previously said that you were hopeful that you would get $100 million in new enterprise account growth for the year. Are you still feeling good about that? Are you cautiously optimistic that you might be able to do better?

Joe Busky

Randy, we've had a really good first half, good start to the year. We feel pretty confident that that form is going to continue in the second half of the year.

Randy Hugen - Feltl & Company

And then growth from acquisitions, have we seen most of that for the year or will there continue to be some acquisitive growth that shows up in the back half?

Joe Busky

All of the acquisitions that we completed in 2013 were done prior to 30th. So at this point, absent any new acquisitions we potentially would do in the second half of the year, there'll be no acquisitive growth in the balance of 2014.

Randy Hugen - Feltl & Company

And then thinking about same customer spend, I think it was down slightly in the first quarter. It was, I believe, up slightly this quarter. Is that kind of your expectations for the rest of the year?

Joe Busky

Yeah, we were at 1% same customer same contract spend globally. And I would expect for the second half would be somewhere in that same range between flat to up slightly. That's a fair assumption.

Randy Hugen - Feltl & Company

And then could we also get an update on the progress of developing the procurement technology?

Eric Belcher

The headline is that our technology platform as we're rolling it out as we speak around the world is really progressing well. I mean it's just a fantastic platform. Nate had asked a question earlier about global clients looking for solutions that are global. I mean to have for this platform (technical difficulty) across five continents under the thousands of discrete job specifications that VALO is capable of collecting in a user-friendly way and then having the archivable and searchable across product categories and geographies, running orders, piggybacking orders within the company and baselining an automated real-time manner to report savings on a job-by-job basis, I mean I could go on. It's really a fantastic tool. And we couldn't be more proud of it.

As we said before, my guess is we'll find scenarios where the equipped internal client procurement teams with this tool, with the licensing of our software-as-a-service solution, down the road we've already started that with Novartis. And there's no doubt it, as a tool and the data that it has underneath it are a huge source of competitive advantage for us. And it's just getting better as the development continues and new ideas are born and adoption grows around the world. So VALO is a fantastic tool and we're really pleased with where we are with that program right now.

Operator

Our next question comes from George Sutton with Craig-Hallum.

George Sutton - Craig-Hallum

Joe, I'll ask the question, I think, most people on the call are wondering, it would look like you would have had room to raise the range for the year. And can you just give us some thoughts around that?

Joe Busky

We had a great first half versus the second quarter. Both were great in our view. We did think about the guidance and where it should be. And based on the performance in the first half and the way our new clients are ramping right now, (technical difficulty) second half of the year. And we'll get back on the call three months from now and we'll have (technical difficulty) revisit it after the third quarter call.

George Sutton - Craig-Hallum

Eric, in your prepared comments, you talked about a large underpenetrated market and obviously we're very close to this having covered it for several years. So it doesn't necessarily feel underpenetrated to us. And I wondered if you have any statistics. If you look at our Fortune 1000 or global 1000, how many companies actually deploy your kind of solutions today?

Eric Belcher

When looking at the penetration, we have to ask the question you just asked that how many companies, but to what extent do they do it across their company. I mean it's an extremely small number. The vast majority of materials currently being managed in the marketing supply chain are being managed by internal procurement departments or advertising agencies. And our offering is still innovative and novel and we find ourselves explaining what it is and who we do it for and what the results are, the vast majority of the time, to corporations.

The adoption has been steady. It's obviously brought us to a meaningful global business today in a short period of time. And the market opportunity is far larger than where we and anybody that offers a similar solution around the world add up to. So the penetration question, I mean the market opportunity in front of us is almost as large as it was five years, 10 years ago.

George Sutton - Craig-Hallum

Joe, you gave some great numbers and details. I got a little confused when you started to break down the organic growth relative to enterprise, an increased spend versus new category and new geos. Could you just explain that a little bit?

Joe Busky

George, are you referring to the SG&A detail that I gave in the prepared remarks?

George Sutton - Craig-Hallum

No, I think you were giving a breakdown of organic growth and 35% of the organic growth was new category, new geo. And I missed some of the other pieces.

Joe Busky

The total growth in the quarter was 23%. The organic enterprise growth was $27 million or a growth of 13% versus prior year. And then the growth from acquisitions is $22 million or 10% growth. And then within the organic growth, there was a 1% increase in same customer same contract spend. And within that organic enterprise growth, about 35% related to existing customer, but new geography growth. That's a subset of that total $27 million in organic growth.

Operator

Our next question comes from Matthew Kempler with Sidoti & Company.

Matthew Kempler - Sidoti & Company

I just wanted to follow up on the revenue guidance question. Does the fact that we're getting an update to revenue guidance range reflect (inaudible) question or others and moving parts that we should be aware of in the second half?

Eric Belcher

We decided to leave it as it is. We're happy with the first half of the year and we like where we're headed.

Matthew Kempler - Sidoti & Company

I was wondering if you could expand a little bit on the pipeline. In the beginning of this year, the company freed up their enterprise sales team to get more focused on enterprise sales cycles. And I'm wondering to what degree that's impact the pipeline at this point in sales cycle activity?

Eric Belcher

It's having a positive impact. We are deeply involved in a number of major pursuits all around the world right now. And so the pipeline is strong and the organic growth coming from our enterprise solution whether that be with an existing client we're working with and have an established track record with or introducing our concept to new clients, the pipeline is extremely strong right now.

Matthew Kempler - Sidoti & Company

It was good to see the renewed EPS growth and your guess is right in target with expectations. But I'm just curious, because last quarter we had a little bit of a victory where the revenue upside closed to the bottomline, was there anything in particular that's avented seeing some incremental earnings coming out of the revenue upside this quarter?

Eric Belcher

The quarter's bottomline margins were right where we expected them to be.

Matthew Kempler - Sidoti & Company

Then maybe we can just talk to the second half of the year. We're looking for second half earnings of $0.17 to $0.21 versus $0.06 in the first half based on the guidance. Could you just walk through the biggest components of what'll drive that incremental earnings power in the second half of the year?

Joe Busky

It's two main things, Matt. It's the improved profitability in the European region, in particular with the former product graphics business unit where there was a loss last year. And we will get that business back to close to breakeven by year-end. And then the second impacting item is the ramping of the channel partner in the SMB space, which we'll turn more profitable in the second half as that account continues to ramp up from a revenue perspective.

Operator

Our last question comes from Kevin Steinke with Barrington Research.

Kevin Steinke - Barrington Research

You highlighted the portion of enterprise growth coming from expanding existing relationships. And I guess is it fair to assume that most of that growth came internationally?

Eric Belcher

Yes, I think that's a fair assumption, though I would add that whether international or domestic, the additional solutions that we're now offering contributed as well. But a lot of the growth within our existing client base came from expanding into new geography.

Kevin Steinke - Barrington Research

I guess how heavily weighted was that expansion to Europe? And just getting at your expectation of improved profitability in Europe in the second half, so just trying to get a sense of how much of that is coming from ramping existing clients versus perhaps signing new clients or clients that have already been signed in the first half?

Eric Belcher

The growth is fairly well mixed around the world whether it be Asia or Latin America or Europe or Canada, Mexico. I would say that the growth has been fairly evenly distributed much in the same manner percentage as you might imagine a client's existing business to break down in percentage terms. And so Europe is obviously a meaningful chunk of the growth, particularly with Unilever and some other longstanding clients. But really it's been around the world.

Kevin Steinke - Barrington Research

Fair to say that obviously Europe is having good organic growth and the outlook remains good for the rest of the year on the revenue front?

Eric Belcher

Absolutely, yeah. And Kevin, that's a big part of the bottomline margin improvement to it, the cost containment as well as revenue growth within that region. And we're seeing it being both sides of that.

Kevin Steinke - Barrington Research

On the acquired growth in the first half of the year, I believe the original expectation was $20 million to $30 million from prior-year acquisitions and you actually exceeded that nicely. So I guess I suppose, first of all, it's an indication that the acquired companies are doing well. And just refresh my memory, I believe much of that acquired growth was in Europe. Is that correct?

Eric Belcher

Yeah. Kevin, most of the 2013 acquisitions we did were centered in the EMEA region, so yeah.

Kevin Steinke - Barrington Research

Okay. And they're obviously doing well?

Eric Belcher

Yeah, they are exceeding the high end of that range that we gave out.

Kevin Steinke - Barrington Research

Just in terms of the second half really with gross margin remaining relatively constant, we should see SG&A expense leverage flowing through in the second half. Is that where you see the profitability bump coming from?

Eric Belcher

That's right, yes.

Operator

This ends Q&A and the call for today. Thanks for participating in today's program. You may all disconnect.

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Source: InnerWorkings' (INWK) CEO Eric Belcher on Q2 2014 Results - Earnings Call Transcript

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