SharpSpring, Inc. (SHSP) CEO Richard Carlson on Q2 2018 Results - Earnings Call Transcript

SharpSpring, Inc. (NASDAQ:SHSP) Q2 2018 Earnings Conference Call August 2, 2018 4:30 PM ET

Executives

Richard Carlson - CEO, President, Secretary & Director

Edward Lawton - CFO

Analysts

Eric Martinuzzi - Lake Street Capital Markets

Eric Des Lauriers - Craig-Hallum Capital Group

Operator

Good afternoon. Welcome to SharpSpring's Second Quarter 2018 Earnings Conference Call. Joining us today for today's call are 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 will be recorded and made available for replay via link available in the Investor Relations section of the company's website at investors.sharpspring.com.

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

Richard Carlson

Welcome, everyone, and thanks for joining us on the call today. Before I get started, I want to let you know you may hear a little bit of background noise. We've got a bit of a construction zone going on outside of our building here, not much we can do to control that. So please bear with us if you hear some random sounds as we're discussing things today. After the market closed, we issued a press release announcing our results for the second quarter ending June 30, 2018. A copy of the press release is available in the Investor Relations section of our website.

The second quarter was yet another period of strong performance for SharpSpring. Not only did we post record revenues, we also added more than 300 new customers onto our platform, which is also a record. We were able to accomplish this performance with a consistent customer acquisition cost, continuing to prove that our sales and marketing engine can remain efficient as we scale up new programs to drive more leads and increase our sales.

With the acceleration we're seeing from these programs, we believe the numbers both reinforce and validate our decision last quarter to bolster our balance sheet for the purpose of further supporting long-term growth of our business. SharpSpring now has over 1,500 agency partners and over 7,000 businesses using its marketing automation platform. Moreover, we believe that this user base is just the beginning as we continue to make headway within what continues to be the largely untapped marketing automation industry.

We have a lot more to share with you regarding this quarter's positive developments, but before I further elaborate on our highlights and other operational updates, I'm going to turn the call over to our CFO, Ed Lawton, who'll walk you through the financial results for the quarter. Then I'll come back on to provide additional insights into our progress for the quarter as we look at the outlook for the rest of the year as well. Ed?

Edward Lawton

Thank you, Rick. Turning to our financial results for the second quarter ended June 30, 2018. Our total revenue in the second quarter increased 37% to $4.4 million from $3.2 million in Q2 of last year. Our flagship SharpSpring marketing automation solution grew by 40% to a record $4.3 million compared to $3.1 million last year. Our gross margin for the second quarter of 2018 increased to 66% from 60% last year. In dollar terms, gross profit increased 50% to $2.9 million from $2 million in Q2 of last year.

Over the past few years, we have invested significant resources in our hosting infrastructure and support organization to reinforce the current and future growth of our product. As we continue to layer more revenues onto the platform, we will create more and more operating leverage in our model as evidenced by our year-over-year improvement in gross margins. In the future, we expect to continue to see margin expansion as we move forward and generate more revenues for our platform. More specifically, as I mentioned in last call, we expect margins to gradually trend upward over the second half of 2018 to approximately 70% by the end of 2018.

Turning to our operating expenses. For the second quarter of 2018, our operating expenses increased 35% to $4.9 million from $3.6 million in Q2 of last year. The increase was due primarily to investments in sales and marketing initiatives to accelerate our future growth and to a lesser extent, additional investments in our R&D organization to accelerate road map items. Our GAAP net loss for the second quarter totaled $2.5 million or $0.29 per share compared to a GAAP net loss of $1.3 million or $0.15 per share in Q2 2017.

On the balance sheet, we had $12.5 million in cash at the end of the quarter compared to $12.3 million at the end of the prior quarter. The increase in our cash position was due to $2 million received for net tax refunds related to NOL carrybacks during the quarter, offset by our use of cash in operations as we invest in growth initiatives.

Looking at our non-GAAP measures, our adjusted EBITDA loss for the quarter, which we reconcile in our earnings release, totaled $1.5 million. This compares to an adjusted EBITDA loss of $1.3 million in the same year ago period. The higher adjusted EBITDA loss was the result of our continued investment in new sales and marketing programs designed to perpetuate growth as we -- as well as our continued investment in development team to launch new features on the platform.

We expect our adjusted EBITDA to remain relatively consistent during the remaining quarters of 2018 with increases to revenue being offset by investments in future growth initiatives.

Our core net loss, which is also reconciled in our earnings release, for the second quarter of 2018, totaled $1.7 million or $0.21 core net loss per share.

This was an increase from a core net loss of $1 million or $0.12 core net loss per share in Q2 of last year. For more details on our adjusted EBITDA and core net income metrics, please see the reconciliation to GAAP terms included in the supplementary tables of today's earnings release.

Moving to some of our other metrics. During Q2, our customer acquisition cost decreased from Q1 due primarily to timing differences between the sales and marketing dollars we -- between when sales and marketing dollars are spent and when the customers are acquired. As a reminder, we calculate customer acquisition cost as the sum of our all-in sales and marketing costs from Q1 2018 divided by the new wins from Q2 2018. This resulted in a customer acquisition cost of $7,800 for Q2.

Using the prior quarter costs provides a better estimate of our customer acquisition costs to account for the average sales and marketing cycle we experience. However, this measurement is still imperfect, because marketing spend in one quarter impacts the deals we win in many future quarters. While we do experience fluctuations in this metric quarter-to-quarter, we are confident that we can continue to consistently acquire customers that are historically attractive all-in rates that will deliver significant lifetime value for the business in the future.

Our lifetime value calculations, which are long term and include estimates for future performance, continue to indicate that agency customers could be worth approximately $50,000 to the business on average. This long-term value reflects the benefit of -- to the company on a discounted basis after reducing for estimated gross margin cost to support the customers on the platform.

Based on these figures, we -- our expected lifetime value to customer acquisition cost ratio continues to be compelling.

Finally, one housekeeping item before I turn the call back over to Rick. This quarter, we recognized a $452,000 noncash expense related to the revaluation of embedded derivatives on our convertible notes. As you can imagine, the accounting for these instruments can get pretty complex depending on the terms, and we had to revalue a few of these embedded derivatives this quarter for accounting reasons.

The economics of the notes do not change, and we have backed this noncash charge out of our core results.

This completes my financial summary. I'd now like to turn the call back over to Rick for additional insights into our operational progress in Q2 as well as our outlook for the rest of 2018. Rick?

Richard Carlson

Thanks, Ed. As I highlighted earlier, we had a strong second quarter. With record top line numbers as well as new customer wins, we're not only growing effectively but efficiently, which is reflected in our improving gross margins and lower customer acquisition costs. In many ways, this quarter represented more of the same, and for us, that's a really great thing because that means we're continuing to execute. But more of the same at SharpSpring also means constant change and improvement. We know that we need to continue to develop and grow in order to be competitive and continue winning business from our larger rivals. To that point, we are constantly finding ways to make our sales and marketing funnel more efficient overall. While our existing sales and marketing initiatives are obviously providing us really solid growth, we're constantly tinkering with our process to come up with new strategies to drive more leads to our business and convert as many of those leads as we can into new SharpSpring customers.

We look at a variety of different metrics to assess our performance in this area, but one of the most important ones is our cost per attended demo. This measures how much money has been spent in the process to generate a lead and progress that lead through our marketing funnel to the point where that lead attends a web-based demo of our product. This metric has decreased significantly over the past few quarters. While during the same period, the overall number of attended demos has increased significantly, positive feedback loops like this are telling us that we're headed in the right direction, and continuous evaluation allows us to be bold in our decision-making process, one that's supported by data like this.

One initiative in particular that we've begun working on as a result of our optimized performance is what we're calling the world's best agency list, which is comprised of digital agencies we've specifically identified as potential SharpSpring agency partners.

We've been working on this initiative for the better part of 2 quarters now. As of right now, the list represents tens of thousands of net new agencies that we've not yet been in contact with, and we expect it will grow as we refine our data. Having such a large database of potential customers is, no doubt, an asset we can utilize in a number of novel ways. Going forward, we plan to continue adding to this database and converting the list into key business development -- into a key business development asset.

Beyond further refinements to our strategy, another area where we're making constant improvement is in our product. During the quarter, we improved our smart e-mail capabilities. Sales people who sync their personal e-mail accounts now have the added benefit of sending Smart Mails through their individual SMTP accounts. This will -- allows ISPs like Google and Microsoft to recognize these e-mails as one-off messages for optimum delivery, which in turn, increases response for our customers and helps them capture more business. We also improved our e-mail syncing functionality. E-mail syncing is a powerful tool that allows you to connect your inbox to SharpSpring. Once enabled, any e-mail you send through that inbox will be recorded and will add to the lead record to enhance the data for that lead. In addition to these future enhancements, we also focused on GDPR compliance during the quarter, making sure that we manage our own compliance as a company and also assisted the thousands of businesses that use SharpSpring to manage their marketing leads to be GDPR compliant via a number of product enhancements. Thanks to the tireless efforts of our development team, we were prepared to handle these regulations by the May 15 -- excuse me, May 25, go-to-live date.

Before we open our call to your questions, I'd like to take a minute to step back and remind you of our core strategy. We talk about this a lot, but with the results we've been consistently generating for some time now, I think it's important to revisit the value propositions SharpSpring provides to our customers so that I can better explain why our sales and marketing engine has been so effective.

As we've said in the past, while the marketing automation industry is an industry with an untapped multibillion dollar opportunity, it is also one with extremely large barriers to entry. At this point, any business that wishes to enter or compete in the marketing automation market would have to cover an incredibly broad set of features, including but not limited to, e-mail marketing, social media management, CRM functionality, analytics, web visitor tracking and anonymous visitor identification, web forms and landing pages and shopping cart features to name just a few.

They'd have to build an advance rules engine and begin to inform it with artificial intelligence. Finally, they'd have to integrate with hundreds of other ancillary software platforms and provide all of that functionality reliably and at scale. For the incumbent players in this space, HubSpot, Marketo, Act-0n and Pardot, providing a comprehensive solution has historically translated to higher cost being passed on to the customer. The resulting problem is that in order for an agency or SMB to get access to marketing automation solution they want, they'd either have to spend astronomically more than is reasonably for their budget or sacrifice important functionality and feature set for a more affordable price. Neither really works out in the long run. SharpSpring alone is uniquely positioned to address this need. For the last 6 years, we've built the platform from the ground up to be both incredibly powerful and yet very affordable for both our agency partners and the SMBs that they serve. This is not just something that -- this is not -- this is just not something that HubSpot or any other competitor can say with a straight face. At this point, we just blow these guys out of the water when it comes to value and frankly, they know it. But this in mind, it shouldn't surprise you that we feel we have a tremendous opportunity in front of us. We feel our performance this year is only the start of a very long road of strong results that we'll see in the future.

We're in a solid cash position and have done the necessary things to put our company in a position and go out and execute against our long-term plan. In the near term, we're now firmly into the second half of the year and in a great position to finish 2018 strong.

Our pipeline remains at record levels thanks in part to our sales and marketing investments but also due to the sustainable competitive advantage we enjoy over the incumbent competitors. We plan to work diligently to convert this pipeline and the new sales in the coming months ahead.

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

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Eric Martinuzzi with Lake Street Capital Markets.

Eric Martinuzzi

It's great to see that -- see those 301 new SharpSpring customers as well as the $2.1 million of incremental ARR. That's good business. I do have a question though. Obviously, you're signing up a lot of new customers. At the other side of the business though, we have to be focused and make sure that the retention of your existing installed base is hanging in there. You have put through a price increase at the beginning of the year, and I think at the time you expected that to have some negative impact. How was the retention in the second quarter?

Richard Carlson

Oh, sure. Well, we did not see any noticeable increase in attrition and logo attrition due -- well, we didn't see any noticeable increase in attrition overall and certainly, not anything to do with the price increase. And in fact, the price increase -- because there was no noticeable logo attrition and because it involved essentially expanding revenues, we saw net revenue attrition creep in. I believe we said last quarter something about 1% or actually last quarter, it was positive, which is to say we suffered no monetary attrition as well. So yes, that has not been an issue for us to date, and we don't believe it will be. We're just -- we're at a price point that is just markedly different than everybody else in the space. And so while there is 1% increase, it resulted in not a huge impact for our agency partners.

Eric Martinuzzi

Okay. And then looking at the adjusted EBITDA, you talked -- I think it was in Ed's remarks. You talked about the adjusted EBITDA that minus $1.5 million that you had in Q2, you're not expecting that to change much in Q3 and Q4. Obviously, you've got a growing business. Is it safe to assume that the incremental growth in your revenue then will be offset by an equivalent amount in your sales and marketing spend? Or is there spend going to other places?

Edward Lawton

It's predominantly sales and marketing. I mean, we've been kind of constantly and consistently adding to our R&D team as well. And so as we grow as a business, we'll try to add to that group over time. But I think in the near term, as we look out over the next few quarters, most of that expense growth would be to sales and marketing.

Eric Martinuzzi

Okay. And then last question for me. You talked about kind of filling the channel with leads. What are you doing to increase your lead flow? Obviously, you guys make an engine for other people that does exactly that, but are you doing anything different now that you're getting to new levels of scale in the business, Rick?

Richard Carlson

Well, no. Our tactics are -- as we alluded to, we're always trying new things and measuring those -- measuring the performance of every channel. So I would say, our channels are largely the same. Tactically, there's new tactics going on in each of those channels or new, what I would call, subchannels or outlets that're -- that we're kind of constantly trying out. But there's no -- it really is kind of a more of the same kind of thing but being able to spend more in the channels we know. And we think we can continue to do that. So we're not -- we're certainly not shifting gears and opening up whole new untested grounds as much as we are looking at reliable channels and just expanding our spend in each of those.

Operator

[Operator Instructions]. Our next question comes from Eric Des Lauriers with Craig-Hallum Capital Group.

Eric Des Lauriers

This is Eric on for Mike Malouf. So thinking of recent addition of Social to your product. And as overall marketing automation matures, I was wondering if there's anything that you feel SharpSpring needs to add to their offering to remain competitive.

Richard Carlson

Well, so in one sense, I would say the answer to that question is always yes. The industry is evolving. There's new features and functionality being added across all of these platforms. It's the kind of project that will continue to evolve for many, many years to come. Having acknowledged that fact, I would say that SharpSpring has never been in a more competitive place, never had a more complete platform, and I would say that the differences between our platform and what I'll call the incumbent players, the ones that started many years before us, is now relegated to fairly inconsequential subfeatures of features. And so we've got all of the major parts of a marketing automation platform. In the coming years, we'll all be looking at adding more AI-powered tools to the set, but we've never been more competitive than we are today and -- which is to say, we've -- we don't have any holes in our platform that are hindering sales at this point. So really feeling good about where we are.

Eric Des Lauriers

All right. That's great to hear. And then kind of piggy backing off that and touching on some of the comments you made in your prepared remarks. I was wondering if you could kind of give us an outlook on the competitive landscape over the next couple of years. Obviously, you guys are in kind of a unique position in that small and medium businesses and obviously, the very low price point. So I'm just wondering how you see the competitive landscape changing, given your pretty envious position in the industry right now.

Richard Carlson

Yes. Well, I tell you, I don't want to -- certainly, don't want to make the mistake of being overly confident. And we're -- we have a nice healthy dose of paranoia built into the company where we're all working hard every single day to -- looking behind us at potential new entrants, looking at our competitors and seeing what they're doing, but the -- so please understand that. Having said that, we really do -- the comments I made about how high the barriers to entry are. We're competing with the same people that we're on my competitive analysis before I started SharpSpring. It's the same folks.

And in fact, when we bump up with those folks in a competitive environment, we generally don't lose. I mean on occasion, we'll lose a deal to a competitor because they've got a larger brand name or what have you, but that really isn't the problem. We've actually identified that when we lose deals, it's more because of, what we call internally is complacence, which is to say that the business continues to piecemeal together a bunch of despair technologies and try to -- into a complicated technology stack. We've actually done some work on the sales side to address that particular objection in a more comprehensive way. And we think that just the general trend, things like GDPR and the world just getting more complicated make that a harder and harder option for these businesses to pursue and pick.

And so competitive-wise, we just aren't seeing heavy competition from the -- or competition that we're not able to deal with is probably a better way to say that from the competitors that are out there. And we really view our #1 challenge of getting people familiar with the value proposition of integrated marketing automation platform like SharpSpring. So we don't see that changing over the next couple of years. We don't see a lot of incumbents come -- excuse me, a lot of new entrants because of the laundry list of things they'd have to do. Now that our -- and that list is only getting longer, and we don't see the competitors able to come down and compete with us at our price point.

Eric Des Lauriers

Okay. That makes sense.

Richard Carlson

All that said, we're going be paranoid that both of these two things are happening, and so we'll keep our edge.

Eric Des Lauriers

That's good to hear. Last for me. I just have a housekeeping question for Ed. I was wondering if you could give us the direct customer number at the end of the quarter.

Edward Lawton

Yes, it was right around 400 direct customers.

Operator

[Operator Instructions]. Ladies and gentleman, at this time, this concludes our question-and-answer session. I'd now like to turn the call back over to Mr. Carlson for his closing remarks. Thank you.

Richard Carlson

Thanks everyone for joining the call today. Very much appreciated. As always, I want to thank our employees, our partners, our investors and the analyst community. Thank you so much. Appreciated. We'll see you in another 90 days or so. Take care. Operator?

Operator

Thank you, sir. Before we conclude today's call, I would 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 were 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 heading Risk Factors and elsewhere in the company's latest annual report on Form 10-K and quarterly reports on Form 10-Q, that may cause actual results, performance or achievements to be 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 this 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 net income or loss to non-GAAP measures is included for your reference in the Financials section of the earnings press release and made available on the company's website. Finally, I would like to remind everyone that a recording of today's call will be made available for replay via link available in the Investors section of the company's website.

Thank you for joining us today for SharpSpring's Second Quarter 2018 Earnings Conference Call. You may now disconnect.