SharpSpring's (SHSP) CEO Rick Carlson on Q2 2016 Results - Earnings Call Transcript

| About: SharpSpring, Inc. (SHSP)

SharpSpring, Inc. (NASDAQ:SHSP)

Q2 2016 Earnings Conference Call

August 9, 2016 4:30 PM ET

Executives

Rick Carlson - Chief Executive Officer

Ed Lawton - Chief Financial Officer

Analysts

Louie Toma - Craig-Hallum Group

Eric Martinuzzi - Lake Street Capital Markets

Jason Revland - Blueprint Capital

Operator

Good afternoon. Welcome to SharpSpring’s Second Quarter 2016 Earnings Conference Call. Joining us for today’s call is SharpSpring’s CEO, Rick Carlson; and CFO, Ed Lawton.

Following their remarks, we will open up the call for your questions. Then before we conclude today’s call, I’ll provide the necessary cautions regarding the forward-looking statements made by management during this call. I would like to remind everyone that this call is being recorded and made available for replay via a link in the Investor Relations section of the company’s website at www.investors.sharpspring.com.

I would like to turn the call over to SharpSpring’s CEO, Rick Carlson. Sir, please proceed.

Rick Carlson

Welcome everyone and thank you for joining us today. After the market closed, we issued a press release announcing our results for the second quarter ending June 30, 2016, a copy of which is available in the investor relations section of our website.

As you can see from today's earnings release, Q2 proved to be another solid quarter for SharpSpring. The record 251 new customers we secured on our premium SharpSpring marketing automation platform during the quarter drove not only record revenue but also record gross profit.

In addition to being a record quarter on the financial front, Q2 was truly transformational from an operational perspective. This was highlighted by our successful migration of GraphicMail users on to our new SharpSpring Mail+ product and equally important, the divestiture of our SMTP relay business unit for $15 million in aggregate consideration. Both milestones streamlined our operations allowing us to more effectively leverage our price and product competitive advantages. They have also provided us with significantly more resources to accelerate our growth in the burgeoning marketing automation market. Simply put, where we were three companies, we are now one, well funded and focused operation.

But before I comment further on our operational progress during the quarter and provide outlook for the rest of the year, I would like to turn the call over to our CFO Ed Lawton who will walk us through the financials for the second quarter. Afterwards I'll return to provide more insight into our operational progress, key initiatives and outlook for the year. Ed?

Ed Lawton

Thank you, Rick. Turning to our financial results for the second quarter ended June 30, 2016. Our revenue increased 18% to over $4.2 million from $3.6 million in the same year ago period. The improvement was driven by the strong growth in our revenue from our flagship SharpSpring marketing automation platform which totaled a record $2.1 million or 50% of our total revenue. This was up 111% from about $1 million in Q2 of last year.

As expected, revenue from our SharpSpring Mail+ product was down year over year to $800,000 from $1.2 million in Q2 of last year. The decrease was primarily due to the increased attrition we experienced related to the migration of GraphicMail customers on to our SharpSpring platform. These revenues were also negatively impacted by exchange rates compared to last year causing a $48,000 decline.

A few quarters ago, we forecasted that we might lose about 40% of the customers through this migration process. While we did lose some white label relationships and intentionally jettison customers with some parts repetition [ph], we were able to migrate the majority of the good GraphicMail customers over to the SharpSpring Mail+ marketing automation platform. The revenue from some of these customers will take some time to ramp back up to pre-migration levels as customers get more familiar with the platform and spending levels increase over time. So this revenue may be flat or decline slightly in the third quarter as we shed some smaller customers and continue to see higher than normal churn. However we continue to believe our lighter marketing automation product SharpSpring Mail+ has the potential to be a growth driver in the future and could be a solid lead generation source for our premium offering.

And finally, revenue from our SMTP e-mail relay business which we divested at the end of the quarter on June 27 was $1.3 million. You will notice that our P&L presents the SMTP revenues and expenses separately as a discontinued operation. This presentation is required to be retroactively applied to prior periods and will be further described in our upcoming 10-Q filing. My comments throughout this presentation refer to the combined business, including SMTP email relay business unless noted otherwise.

Our gross profit increased 8% to $2.9 million or 68% of total revenue from $2.7 million or 74% of total revenue in the same year ago period. We realized higher infrastructure costs related to the GraphicMail migration because we ran both systems in parallel. Additionally, we continue to invest in our support and network operation teams to more rapidly grow our SharpSpring marketing automation platform.

Our GAAP operating expenses for the second quarter of 2016 decreased 27% to $3.6 million from $5 million in Q2 of last year. The decrease was primarily due to a reduction in earn-out related charges. Excluding these charges, our operating expenses increased $201,000 or 6% compared to last year.

Our GAAP net income totaled $9.1 million or $1.19 per share compared to a net loss of $1.9 million, or $0.32 per share in the second quarter of 2015. Our net income for Q2 2016 was primarily attributable to the sale of our SMTP email relay business for $15 million in aggregate consideration on June 27, net of the related tax expenses associated with the gain on the sale.

Turning to our non-GAAP measures. Our adjusted EBITDA loss defined as earnings before interest, taxes, depreciation, amortization, non-cash stock based compensation, acquisition related charges and restructuring expenses for the second quarter of 2016 totaled $19,000. This compares to an adjusted EBITDA income of $36,000 in the same year ago period. Our actual adjusted EBITDA loss was better than the $200,000 to $400,000 we forecasted in May reflecting lower headcount related costs and partner reselling fees compared to our projections.

Turning to our other profitability metric, core net income or loss, which excludes amortization, acquisition related costs, stock compensation expenses, restructuring expenses while adjusting for taxes. Our core net income for the second quarter of 2016 totaled $79,000 or $0.01 core net income per share. This was a slight improvement from a core net loss of $20,000 in Q2 of last year.

Looking forward we continue to see strong long term demand for our premium offering. However the summer season has historically been a season of comparable slowness. Further our team’s focus during the past few months has been consumed by migration related items and SMTP divestiture related activities, which might increase the sale cycle past the typical two to three month timeline in the short term.

With that being said, we have over-achieved on our sales effort in the first half of 2016 and feel confident in our ability to grow the number of new customers choosing SharpSpring in Q4 2016 and into 2017.

In terms of future profitability, we are losing a strong contributor to our EBITDA in the SMTP business. We continue to plan to invest heavier in SharpSpring in order to accelerate growth and expand SharpSpring’s customer base. With these increased investments and the loss of the SMTP EBITDA, we current protect an adjusted EBITDA loss of around $1 million per quarter for the next two quarters. In 2017 we will take incremental steps towards profitability expecting to achieve breakeven adjusted EBITDA in Q4 2017. We expect our cash on hand to be more than adequate to fund our operations throughout this period. For more detail on our adjusted EBITDA and core net income metric, please see the reconciliation to GAAP terms included in the supplementary tables of our earnings release.

Turning to our balance sheet. We have $15.3 million in unrestricted cash at the end of the quarter, up from $3.2 million at the end of the previous quarter. This increase was due to the sale of our email relay business at the end of the quarter which generated $14 million of cash. An additional $1 million of cash was held back pursuant to the terms of the transaction to be paid at the one year anniversary.

We also completed the final share issuance related to the SharpSpring earn-out in May. This issuance completes all acquisition related earn-out payments and leaves us with approximately 8.3 million shares outstanding at the end of the quarter. This completes my financial summary. For more detailed analysis of our financial results, please reference our Form 10-Q which we plan to file by August 15.

I’d now like to turn the call back over to Rick for additional insights into our operational progress in Q2 and outlook for the rest of 2016. Rick?

Rick Carlson

Thanks, Ed. While I always look forward to providing these investor updates, I'm particularly excited about the progress I can report to you today. Over the last two years we've consistently delivered on our goals and have built SharpSpring into a leading marketing automation company. In this respect, the second quarter was no different. Q2 brought a record number of new clients to our SharpSpring marketing automation platform and we expect these new customer additions will generate a record $1.8 million of annualized recurring revenue.

But even more telling of our progress is that just in the first half of this year alone, we increased the number of businesses using our platform by more than a thousand to a record 4000 businesses. While part of this can be attributed to the rapid growth of the industry, it demonstrates how we continually are successful in capturing market share from our largest competitors in the industry, especially at the agency level. Our agency partners recognize the value of our solution in addressing their clients' digital marketing needs. In just over two and half years, these agencies have propelled SharpSpring to the number two position in the market surpassing such notable competition as Marketo, ActOn, Pardot and Eloqua all of whom have had a five to eight year head start.

Another highlight of the quarter was the successful commencement of a strategic partnership with WSI, a digital marketing company that boasts the largest network of digital marketing consultants around the world. WSI will be promoting SharpSpring to their vast network of digital marketing experts and will be launching other co-marketing efforts with SharpSpring. They have also adopted the SharpSpring marketing automation platform for their own corporate use. This is an interesting case study because HubSpot who we consider to be our primary competitor was unsuccessful in building a strong presence within the WSI network, we think due to their higher price point and product complexity. While HubSpot failed to generate traction we feel optimistic that our price point and product functionality will propel this partnership to success. We are happy to announce that although the relationship is still young, we've already begun to see new customers from these efforts and look forward to growing this partnership in the future.

We were also able to make some advancements to the SharpSpring product. Recently we announced the addition of a dynamic landing page builder and blog builder to our platform. These new tools represent a next generation marriage of traditional CMS and next-generation marketing automation, reading web pages that automatically adapt to the individual visitor in ways that a simple CMS like Wordpress and Drupal simply can't. This matters to marketers because these adaptive web pages improve lead conversions and drag revenue for their clients. We’ve worked hard to make these powerful features easy to use designing them with intuitive WYSIWYG interfaces but make it simple for marketers to build adaptive landing pages and blogs without the need for a developer. Until this point the lack of a landing page builder and blogging tool in the SharpSpring platform was a deficit that our sales team had to overcome.

With the addition of these highly advanced components to the platform, we've not only included all of the major product features customers expect to see in a marketing automation tool set, but moved beyond the number of competitors’ functionality in the process. Clearly it’s been a great quarter and we have some real momentum behind us as we move forward.

I want to take a moment to point out that we were able to accomplish these goals in the face of significant distractions over the past two years. In late 2014 SharpSpring was acquired and found itself one-third of a relatively complex international company. Necessarily the three-way merger diverted focus and attention away from the business operations and growth of the company. In 2015 we began the integration of the three businesses, including backend e-mail sending platforms and customer support operations. During the middle of 2015, we made major scalability enhancements to the marketing automation platform and the adoption of the platform far exceeded even our most hopeful estimates. And late last year we began a code-base consolidation project and the subsequent migration of 12,000 GraphicMail customers onto the SharpSpring platform, representing a concerted nine month effort by our team that ran through the first half of this year.

Most recently, we completed the sale of the SMTP relay product, again creating a near term distraction from our primary objective of growing SharpSpring market and automation. All of these initiatives made sense, consolidating to a single code base and platform while giving GraphicMail customers a highly competitive marketing automation tool with more advanced features was the right thing to do. Integrating our organizations and aligning our efforts around the SharpSpring marketing automation platform was the right – was the correct decision. And strengthening our balance sheet by selling off a non-core business was the right thing to do. Through all these challenges we continued to produce record quarters and accelerate sales. As you can imagine, though, for a small team working through all of these issues was certainly a challenge.

While some clean up remains over the next quarter, I'm pleased to say that as we sit today, all of these distractions are essentially behind us. We are one company supporting one marketing automation technology platform. That platform from a practical perspective is nearly infinitely scalable. We have a rock solid balance sheet and capital to grow the business until we get to cash flow breakeven and we have nearly 1000 digital marketing agencies, the thought leaders in our space in our corner and spreading the word about a value proposition. We launched key new features that address common objections during our sales process and we have a team of developers that can now focus on creating new features and functionality to allow us to win new customers moving forward. Today for the first time since we were acquired in 2014, we are a 100% focused on the SharpSpring marketing automation platform.

In summary, Q2 marked another record quarter for SharpSpring. In addition to generating strong revenue and adding a significant number of new customers to our expanding base, we made tremendous progress on our plan to elevate our company's position and market share in a rapidly growing and largely untapped marketing automation space. With a host of significant distractions behind us, we're confident we will be able to leverage our bolstered balance sheet, agency-oriented business model and industry leading platform to achieve our financial goals for this year, which include doubling our SharpSpring revenue and more than tripling the number of businesses using our platform.

And with that, we're ready to open the call for questions. Operator, please provide the appropriate instructions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Louie Toma from Craig-Hallum.

Louie Toma

Hi guys. Thanks for taking my question. Just a couple of quick questions. First of all, can you give us a little bit of color on what you're seeing in growth from the U.S. versus international side of your businesses?

Rick Carlson

Sure. We're seeing growth in Europe. Interestingly we have, as economic situations somewhat become more problematic, we're a cost effective solution. So in a lot of ways we seem a little bit insulated and perhaps even better positioned than other more expensive companies in terms of offering a solution in Europe. So we've seen a healthy growth in Europe. We remain, though, very very focused, the market in the U.S. and the North America in general is just so large that we're really -- this is where we feel like we want to spend the majority of our time in terms of customer acquisition. That said we continue to feel strong about the UK and our traction there. We probably have more than a hundred partners as a guest, just I don't have that number off the top of my head but we probably have one hundred partners in the UK. So we have significant traction in the UK. We also have, due to our GraphicMail business significant partners in South Africa and then of course in other European countries as well. I would say, though, that moving forward our real focus in terms of driving new business is going to be in the UK, or excuse me in the U.S. and North America as well.

Louie Toma

And can you just give us the number of agency customers you have and the number of total customers?

Rick Carlson

I don't -- I don't know, Ed, if you have the exact number as of the end of Q2 but I'm going to say we're right around 900 agencies at the end of Q2, maybe just shy of that number and roughly 1150 total customers including end customers that work directly with SharpSpring. Because this can be a little bit confusing for some folks, I want to make sure that I separate those two numbers from the total number of companies which is also an extremely important number for us. We have more than 4000 customers -- different companies using the platform. And so the difference between those numbers and the 4000 is the agency customers. In other words, the companies that are using the platform through the agencies. So we've reached roughly 4000 total companies with about 900 agencies, hope that makes sense.

Operator

And our next question comes from Eric Martinuzzi from Lake Street Capital Markets.

Eric Martinuzzi

Congratulations on the quarter as well as the sale of the SMTP relay business. I wanted to talk about how the business model has changed here now that we’re no longer -- going to be having either the revenue or the profit from that – the relay business. You talked about the – GraphicMail, no, it’s not the GraphicMail anymore, I want to say SharpSpring Mail+, that’s flat to down here in Q3. I assume we’re going to be slightly up on the marketing automation side. But given that we just finished the Q2 in which the pro forma revenue was about $2.9 million. Is the revenue for Q3 expected to be sequentially up?

Ed Lawton

Yes, we would project an increase there, Eric, related to the marketing automation revenues that are coming in the door. Once we gain new customers, they do contribute to revenue pretty quickly. So we would expect to be up $300,000 or so related to the automation side and then like I said before flat or possibly sequentially down a little bit on the Mail+ side as we see a little bit more churn there.

Eric Martinuzzi

And then as far as, any early read – you made this transition happened, I think the bulk of it in April. Early read on the cross-sell, you talked about kind of a little bit but the install base -- SharpSpring Mail+ installed base -- but turning on the marketing automation module, anything to comment on there.

Rick Carlson

Yes, I think the short answer to that question is no. Right now we finished up the migration. There's a lot of customers that we feel like are really interesting prospects in terms of upgrading to full marketing automation. But with the sale of SMTP and just really trying to work very hard to get the migration right, I don't want to bore everybody on this call but I will say that was a complex process. You can imagine moving over billing systems and lists and email, and all kinds of stuff from one platform to another for 14,000 roughly customers, it was pretty complex. So we're actually looking forward and delving into that over the next couple of quarters. We still remain excited about the upsell possibilities that the customers, that are currently on SharpSpring Mail+ plus present to us in terms of upgrading to a full marketing automation suite. But we're just not -- we're not there yet. And frankly we view that as just one other potential lead source. What we’re really excited about is bringing on brand new customers to the platform as you can imagine as well. So we’re identifying those customers the right one, so that's a process in and of itself but we feel like there's a couple thousand customers in that base of customers that could potentially be interested in marketing automation, if not immediately, than over the next couple of years as the market becomes even more aware of the power of marketing automation. So that's kind of where we stand with that upsell tactic as we move forward.

Eric Martinuzzi

Okay, let’s talk about the gross margins. You’ve talked about 68% in Q2 but you no longer have the relay business. How do gross margins change in Q3 and then if you could talk about your expectations about whether or not your former asset will continue to be your relay provider?

Ed Lawton

I will take the gross margin one. We're projecting between 64% and 65% gross margins for the next couple of quarters. And that does relate to the fact that SMTP was very profitable operation with a little bit higher gross margins than the rest of the business.

Rick Carlson

In terms of the second question and whether SMTP will remain our email provider of record, the short answer to that is yes but I will let you know that we've got some real opportunities here as a company not being tied directly to SMTP like we were in the past. And so you can imagine a scenario where we could offer multiple vendors to one of our customers and allow them to pick the vendor of choice and we think that that might be an interesting product feature within the SharpSpring platform that, if you're a customer and you want to send through SMTP we can let you do that. If you want to send through another provider, we could let you do that as well, maybe choose between two or three providers. So this is something that we're actively exploring and looking at but the relationship with SMTP is excellent and as you might imagine we know those guys extremely well and it was a successful acquisition. So we are – or divestiture from our side and so we'll continue to work with SMTP moving forward as well.

Eric Martinuzzi

And then driving into the operating expenses, here the last page of the press release, you talk about the continuing ops versus discontinued ops. Obviously sales and marketing you’ve said you're going to be investing a little bit more there. So I am anticipating that would increase but are there major puts and takes here elsewhere across the OpEx compared to the dollars that I'm looking at in the breakout between continuing and discontinued?

Ed Lawton

Eric, I think one of the things to remember here is that the discontinued operations column which represents the SMTP email relay business does have some allocations included in it for partially allocated resources. So we had some people in the marketing group and the sales group and the R&D group that were partially allocated to the SMTP business but in the end are staying with SharpSpring. So they are going to continue with our business. So what you will see is that some of those costs, actually a lot of those costs in that discontinued operations column will actually shift back over to the continuing ops column going forward, because of those allocations that were applied prior to the acquisition. So we do expect the sales and marketing costs to go up in future quarters partially because of that shift in allocations now going away from the SMTP business and continuing on with our SharpSpring business.

Eric Martinuzzi

Well, maybe I should start with a consolidated column and just say all right, if I ignore the change in the earn-out liability and the intangible asset amortization, you have $3.2 million of operating expenses in Q2. Just with that as a starting point, is that a safe assumption in Q3?

Ed Lawton

Yes, that will be pretty close. I think with the gross margin that we talked about being 64%, 65% and our targeted EBITDA which is about a $1 million loss for the next couple of quarters, you can back into the OpEx from that as well. But yes, this shouldn't be too far off, if you really just look at the consolidated OpEx excluding those acquisition related charges.

Eric Martinuzzi

Certainly terrific new customer adds here in Q2, so it's good to see that, they are a number on the rise. So congrats on the quarter and good luck for the rest of the year.

Operator

And our last question comes from Jason Revland from Blueprint Capital.

Jason Revland

Actually, Rick and Ed, thanks for taking my call. Nice job so far this year. And just a quick question on the Marketo acquisition. Just would like to get your general perspective on the competitive impact do you think that might have on your business, whether there will be opportunities you'll see any positioning or pricing changes or just how the company might be affected as that acquisition gets digested?

Rick Carlson

I think it certainly remains to be seen. I will say that we bumped into Marketo and we win against Marketo today and we do so fairly regularly but they are -- they do tend to play -- but especially in recent years they've tried to move upstream. And so we've bumped into them kind of less and less as time goes on. And so while we still consider them a competitor, we don't bump into them too much. So I'm not sure that that we're foretasting any real change from – as a result of the acquisition announcement. I think that's really the short answer on that. We typically bump into the HubSpots of the world and ActOn and Pardot as probably a third player there and we kind of see more of the same.

End of Q&A

Operator

Thank you. I’d now like to turn the floor back over to Mr. Carlson for any closing comments.

Rick Carlson

Thank you all for joining us on the call today. It’s been a pretty great quarter the across the board and so we're excited to have this one behind us and looking towards the future. I especially want to thank all of our employees, our partners and investors for the continued support and we look forward to updating you on our next call. Operator?

Operator

Before we conclude today's call, I’d like to provide SharpSpring’s Safe Harbor statement that includes important cautions regarding forward looking statements made during this call. During today's call, there are forward looking statements made regarding future events including SharpSpring’s future financial performance. These statements reflect the company's current views with respect to future events. These forward looking statements involve known and unknown risks, uncertainties and other factors including those discussed under the risk -- under the heading Risk Factors and elsewhere in the company's latest annual report on Form 10-K that may cause actual results, performance or achievements to materially different from any future results, performances or achievements anticipated or implied by these forward looking statements. The company does not undertake any responsibility to revise any forward looking statements to reflect future events or circumstances.

Also note that during today's conference call, we may make reference to adjusted EBITDA, core net income or loss and core net income or loss per share which are non-GAAP financial measures presented as supplemental measures of the company's performance. A reconciliation of the net income or loss of non-GAAP measures is included for your reference in the financial section of the earnings press release and made available on the company's website.

Finally, I’d like to remind everyone that a recording of today’s will be available for replay via a link available in the investors section of the company's website. And with that, thank you for joining us today. You may now disconnect.

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