ChannelAdvisor Corporation
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to the ChannelAdvisor's Third Quarter 2015 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I'd now like to introduce your host for today's conference, Mr. Garo Toomajanian, Investor Relations. Sir, you may begin.

[Garo Toomajanian:]

Good afternoon and welcome to ChannelAdvisor's conference call for the third quarter of 2015. My name Garo Toomajanian and with me on the call today is David Spitz, ChannelAdvisor’s Chief Executive Officer; and Mark Cook, ChannelAdvisor's Chief Financial Officer. . After the market closed today, we issued a press release with details on our third quarter performance as well as our outlook for the fourth quarter and the full year 2015. 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 after 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 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 adjusted EBITDA, which excludes depreciation, amortization, income tax expense, interest and stock-based compensation expense. 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 my 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 information in the future. With that, let me turn the call over to David for his prepared remarks. David?

[David Spitz:]

Thanks, Garo. Welcome everyone and thank you for joining our call today. We reported quarterly revenue of $24.4 million in the third quarter, above high end of our expectations and an increase 16% from a year ago, or 19% on a constant currency basis. Our revenue over performance combined with improved operational efficiency to produce positive adjusted EBITDA of just over $700,000, our first quarterly adjusted EBITDA gain since becoming a public company and significantly exceeding the high end of adjusted EBITDA guidance for the quarter by over $2.2 million. Our strong expense discipline also yielded positive operating cash flow of $1.1 million in the quarter, reaching our medium term objective of achieving neutral cash flow much more rapidly than anticipated. Several factors contributed to this performance. We had our best booking quarter of the year and in particular our enterprise team set an all time bookings record exceeding its previous record by a wide margin. Additionally, churn was down compared to the year ago period not only a percentage of revenue basis but also on an absolute dollar basis despite significant revenue growth. I am excited and encouraged by these results. This rapid improvement and profitability and operating cash flow reflects our commitment to continue investing in top line growth while operating our business on a roughly neutral adjusted EBITDA basis. As I said on our last call, revenue growth remains our top priority but the focus remains on revenue growth that we believe can be profitable over time, with improving unit economics. We believe our third quarter results demonstrate our ability to successfully execute the strategy. To reach our objective we have been focused on improving pricing and prospect qualification in order to emphasize larger customers and brand which favor unit economics. In the third quarter, we achieved several sales and revenue related milestones I'd like to share. As I mentioned, one, we delivered our strongest bookings performance of the year and our enterprise sales team had its best ever quarter in company's history. Two, we signed 12 new customers that we expect will each generate in excess of $100,000 in annual revenue, up from three such customers a year ago, reflecting the performance of our enterprise sales team. Notably, 2 of these 12 were in China. Three, our average deal size for newly signed customers was nearly $32,000 well above recent quarters reflecting an improved focus our sales team in targeting larger customers including great names with marquee clients like Chicos, Electrolux, BrightStar, Fujitsu, Beyond the Rack, Shoe.com and Dell. Four, the proportion of the new business deal that exceeded $15,000 in annual contract value was by far highest proportion we've seen in any quarter approaching 90% compared to 70% to 75% in recent quarters again reflecting our focus on larger, more strategic customers, improvements in pricing and better prospect qualification. Five, we have 14 customers who each contributed more than $100,000 in revenues in the quarter, a 56% increase compared to nine such customers a year ago, reflecting our ability not only to sign larger customers but to grow them. And finally number six, our average revenue per customer increased to a record $32,748 on a trailing 12 months basis. This marks a 4.4% year-over-year growth rate, our largest increase in a year. All of these milestones showcase our fantastic success with larger retailer and brands this quarter. And I am really excited by the opportunities ahead to continue growing on the upper end of the market. We ended the third quarter with 2,910 customers, up 5% from a year ago. You may notice that consistent with our strategy to focus on larger and more profitable customers and to become more selective with respect to smaller customers, our total customer count did not show sequential increase. In fact, as we focused up market, we believe net ads and customer count alone is no longer an effective way to value at our performance. As they do not sufficiently reflect business activity given the vast differences in customer size we have in our business. To illustrate this point consider that the smallest thousand of our customers, more than a third of customer base by count accounted for only 7% of our revenue in the third quarter. These smaller customers because of their high prophecy to churn yield unfavorable and ultimately unprofitable unit economics. In contrast, our top 100 customers accounted for 26% of revenue in Q3. And we believe it will provide a higher level of profitability due to higher expected lifetime values and lower relative customer acquisition costs. For these reasons, we are focused on signing larger and high quality customers and did that very successfully in Q3. Because we are not as aggressively back filling smaller unprofitable customers, I'll reiterate a point I made in our last call. Revenue growth is likely to decelerate before reaccelerate. However, we believe this is the right approach to maintain and improve our long-term profitability and continue to scale the business in a sustainable manner. I also continue to believe the ChannelAdvisor has the potential to grow significantly faster than the rate of e-commerce growth as we complete this transition and work to continue to attract new customers and drive further growth among our existing customers. To attract new customers and to help our existing customers grow, we continue to make significant enhancement to our platform. During the third quarter, we launched our integration with gate.com, a new market place for the scale at a remarkable pace out of the gate and are already our fourth largest market place by GMV with over 500 active sellers from our platform. Given their recent strategy shift to offer free membership, we believe gate.com will continue to scale rapidly and it is possible that Jet will be our third largest market place after Amazon and eBay in 2016. We have been a strong partner for Jet and expect to continue to play significant role in their growth. During the quarter we also made an important step and expanding the array of market places available to our customers. With our launch of access channel advisor which was part of our autumn release, we opened our platform directly to third party market places so that they can integrate to our platform. Access channel advisor enables us to more easily integrate numerous niche market places in different parts of the world while giving our customers access to more channels and ultimately more consumer demand. As part of the launch access channel advisor we announced new integration with Wish, Bluefly, Choxie, Miracle and several other market places. Another major innovation in our autumn release was e-compass benchmarking, an industry first suite of seller specific analytics that leverages our billions of dollars in global transaction data to enable retailers and brands to benchmark their performance against thousands of users -- thousand of other users of our platform and uncover hidden insights to their performance. We believe all of these efforts and investments continue to strengthen the appeal of our platform to customers globally and to provide us with a significant competitive advantage. In summary, I am very pleased with the progress we've made during this transition year and especially in Q3, delivering strong top line growth while making rapid and significant improvements to the bottom line. We believe our strategy to focus on top line growth while maintaining a roughly neutral adjusted EBITDA profile will enable us to build scale and ultimately optimize our long-term profitability potential. And we expect to continue to make progress towards these goals in the fourth quarter and next year. Now let me turn the call over to our new CFO, Mark for details on our financial performance. Mark?

[Mark Cook:]

Thank you, David. It is pleasure to have joined the ChannelAdvisor team. I will provide additional color on our third quarter financials and our guidance for the fourth quarter and full year. Revenue in the third quarter was $24.4 million, an increase of 16% over 2014 and above the high end of our guidance range. On a constant currency basis, our year-over-year revenue grew by approximately 19%. Revenue from outside of the United States was 24% of our revenue in the third quarter, an increase of 23% of revenue a year ago despite a generally stronger dollar. Our proportion of fixed revenues continued to grow and represent 80% of revenue in the third quarter, that's up one percentage points from a year ago. Fixed subscription revenue increased 20% from Q3 of last year and 3% from the second quarter. Variable revenue of $5 million increased $500,000 or 11% from a year ago. This is significant since you may recall our variable revenue actually declined about 1% between Q3, 2013 and Q3, 2014. We believe our year-over-year variable revenue increase reflects a continuation of our improvements from the second quarter. As more rigorous pricing practices in particular those restricting mid contract negotiations continue to have the desired effect. Now moving to the expense side of the P&L, my comments regarding expenses will all be on a non-GAAP basis and all comparisons will be on a year-to-year basis unless otherwise specified. Our press release includes a GAAP to non-GAAP reconciliation. Gross margin in the third quarter expanded 300 basis points to over 75%, this is in line with our longer term target model. We plan to continue to make additional investments to support the scaling of our business at this level. Operating expenses were down 7% from a year ago as the third quarter received the full benefit of our strategic realignment from earlier this year. The combination of revenue upside, healthy gross margins and lower operating expenses resulted in adjusted EBITDA of a positive $700,000 well ahead of our guidance and a meaningful increase from an adjusted EBITDA loss of $4.7 million a year ago. The same factors driving our strong adjusted EBITDA performance also produced a better than expected non-GAAP net loss of $1.7 million, or $0.07 per basic and diluted share. This represents an improvement of $4.7 million from our non-GAAP net loss of $6.5 million, or $0.26 per share a year ago. Now turning to our balance sheet. Our cash position remain strong with $59 million in cash and cash equivalents at the end of the quarter, an increase of $1.3 million from the end of the second quarter and this was due primarily to positive operating cash flow of $1.1 million in the third quarter. Now turning to guidance. For the fourth quarter, we are anticipating revenue of $26.2 million to $26.6 million, an increase of our implied guidance provided last quarter as we see continued momentum from other some larger, more profitable retailers and brands as we no longer work to replace smaller customers. Keep in mind however that in the fourth quarter we typically see a seasonal shift in revenue mix to more variable revenue. And we expect this fourth quarter to reflect that trend. From expense perspective, we expect to continue to strategically invest in the business primarily from the area that could support our long-term growth including key enterprise sales and account managers. However, given our expectations for seasonally strong revenue which we anticipate will grow faster than expenses on a sequential basis, in the fourth quarter we expect positive adjusted EBITDA of between $600,000 and $1 million. It is important to point out that while we were adjusted EBITDA positive in Q3 and expect to be positive in Q4 as well. Our target for breakeven adjusted EBITDA will be measured of our trailing 12 months basis. We expect to experience seasonal fluctuations that may produce results that are below or above breakeven on a quarterly basis while we focus on top line growth. The first quarter for example tends to be our weakest revenue quarter seasonally and that might well result in adjusted EBITDA returning to negative for that period .However, we believe our performance in Q3 highlights the leverage inherent in our model which we can take advantage of in order to prudently invest in the business and grow to top line and achieve higher levels of scale. For the full year of 2015, we now expect revenue to be in the range of $97.4 million to $97.8 million. From a profitability perspective we anticipate an adjusted EBITDA loss of between $3.3 million and $3.4 million for the full fiscal year. This would represent a year-on-year margin improvement almost 2,000 basis points after midpoint of our original guidance on February. In summary, with majority of this transition year now behind us, we believe we are now on more solid footing. Our emphasis is to shift at larger retailers and brands that we believe will better position us to achieve our target model goal over time. Meanwhile we continue to focus on driving revenue growth and we are working to enhance our leadership position in the market are remaining roughly neutral from an operating cash or adjusted EBITDA perspective. Over the longer term, we believe this approach will enable us to scale for ultimate goal of creating a larger, highly profitable company. With that operator, we would now like to open the call to questions. Thank you.

[Operator:]

[Operator Instructions] And our first question comes from Justin Furby from William Blair. Your line is now open.

[Justin Furby:]

Great, thanks guys. And congrats and Mark welcome. I wanted to ask on the -- first on the churn. David, you talked about the year-over-year improvement which I think you said even on a dollar basis was down. Did I hear that right? And can you get any more specific? Are we in sort of now the 10% or below 10% gross churn? And are we at a point or a close to a point where you think on net basis meaning when you consider growth in your basic churn is zero or even negative and then I have a got a couple of follow ups. Thanks .

[David Spitz:]

Sure. So great question, Justin. So we are not disclosing specific percentage at this point. You did hear correctly that I said churn was down not only on a percentage revenue basis but also on an absolute dollar basis. We did have last Q3 a relatively heavy churn quarter as you may recall and so probably the comp was a little bit easier but I would say still that I was quite pleased with the results. We did implement a customer success team revised our approach to that earlier in the year as you may recall and I believe that's beginning to have some positive effects. And I also think that over time as we are more selective in terms of the customers that we sign and backfill with smaller customers the churn off, my hope and my expectation is that, that will gradually reflect itself in longer those customers and consequently churn rates that are lower than what we saw in the last prior year.

[Justin Furby:]

And do you think David that at some point you hit a point if you are not there already where the growth with your base more than offset any incremental or any churn?

[David Spitz:]

I am not sure I understand your question, Justin. You mean about unit calendar

[Justin Furby:]

No. Just meaning as your customer grows they of course pay incremental dollars to you. So do you feel like when you consider that, do you think that will more than trump the churn at some point?

[David Spitz:]

Well, our subscription dollar retention rate as published remains above a 100% and so at least by that metric and that calculation I would say it does. I am not sure that answer your question fully but I think when I would say qualitatively again the strength that we had on larger customers that we expect will be longer lived and obviously higher margin customers for us I think eventually will be reflected in sustainable improved churn rates.

[Justin Furby:]

Got it, thanks. And then on the enterprise activity in the quarter from a booking standpoint. Just curious if you think about what drives that. Is it more just focus and execution on your end? Is some of that do you think a reflection of the market and more of these bigger enterprises saying, hey, we need to be on Amazon, we need to be on marketplaces, how would you sort of bifurcate between those two dynamics? Thanks.

[David Spitz:]

Well, the good news is its several factors that I think it is broad based. One we have been investing in our enterprise team and that's an area of continued investment for us. So even that we restructured our sales team earlier this year as you may recall that was focused really at sort of the customer acquisition of smaller customer. So enterprise team remains intact following that. And we have been investing in that. Also our mid market team has also been focused on larger customers with better deal qualification in the process. I think the pipeline remains strong for enterprise. IO 500, IO 1000 types of customers, brands, we are starting to see and have seen over the last few quarters' strong interest from brand. I was yesterday at dinner last night in New York with probably 65 or 70 prospect and customers including brands and there is lot going on in the industry. You got the long term Jet, you got Amazon continue to take share, you got the rise of mobile, you got things like purchase on Google going on and most of the people in our universe realize that they need ways to manage that. So enterprise pipeline I would say remains pretty strong.

[Operator:]

And our next question comes from Brendan Barnicle from Pacific Crest Securities. Your line is now open.

[Brendan Barnicle:]

Thanks so much guys. Just kind of follow on a little bit on Justin's question around bookings. David, you listed a bunch of factors that attributed to the booking strength. You talked about the signing up larger customers, increase in ASP, you had 90% folks with over 15k, what do you think is your stack ranked those were the biggest factors that are attributing to that bookings acceleration?

[David Spitz:]

Well, I think probably the strength of our enterprise pipeline more than anything. And modestly increased capacity on the sales team. This is a team where we do expect to invest and expand especially as we continue to turn our attention to the opportunity in brand space. You remember that we acquired Where to Buy company last November and we've seen good success with that. And I'd like to see more of our sales reps really focused and dedicated on that product line. So I would say more than anything it is probably for me strength of the pipeline which I think is a pretty good indication of customer demand. We've also had -- I was just going to say we've also had some competitors get taken out in the market and frankly when that happens that usually tends to benefit us. We have one competitor that was acquired and acquired had significantly raised prices on their customer base which benefited us.

[Brendan Barnicle:]

And then following up on your commentary on enterprise sales expansion. How does hiring go for sales in the quarter? Are you going to meet the goals that you had? How does it look for the remainder of the year and can you give us any commentary about what you might think about for next year?

[David Spitz:]

Yes. So we did our restructuring in Q2 as you know and I would say we were relatively steady state over the course of, as it relates to hiring over the course of Q3. And I think given some of the strength that we saw rep productivity was higher than it has been since 2012. So it also strengthened our sales capacity and our pipeline. So that give us incremental confidence to not only decide to increase more especially on the enterprise side but actually to focus on pulling in some of that investments that we were actually planning for 2016 into Q4 as much as possible so that we can get the ground running in 2016. So I would say over the course of the quarter got incrementally more bullish on the performance of that team and our ability to increase capacity.

[Operator:]

Our next question comes from Colin Sebastian from Robert W Baird. Your line is now open.

[Colin Sebastian:]

Great, thanks. And congrats on the quarter. Hopefully you can here me. I am overseas. David, first off, could you or Mark could you remind us what -- that your operating expense variable as we look forward to accelerating growth next year? And then secondly with eBay showing some weakness in September from Scott's data I wonder how much of an impact that might have had on the quarter or whether you are still seeing that headwind thus far in Q4?

[David Spitz:]

Yes, so Colin you broke a little up on that first part. I think you asking the proportion of fixed and variable and Mark I think we are right around 80% fixed 79.5% of the range.

[Mark Cook:]

That's correct in terms of revenue. But will you asking Colin about our expenses that were variable as we invest or was it about the revenue?

[Colin Sebastian:]

Yes, the operating expenses.

[Mark Cook:]

Well, I mean obviously a large portion of our expenses is people it's headcount. So that's the variable portion as we invest that expense would go up with, as David mentioned earlier obviously we are hoping that was rapidly as our revenue and so we had to gain some leverage in that respect.

[David Spitz:]

Yes. And then it relates Colin to eBay, I think our expectation is that eBay at least in the near term continues to grow in the kind of low to mid single digits. As you may recall in Q2 eBay was surpassed by Amazon for us in terms of total GMV being driven through our platform on a trailing 12 basis. So I do think it represents probably a bit of continued headwinds and maybe we were starting to annualize that headwind but it is a diminishing headwind as the proportion of our business that is depended on eBay's performance gradually become smaller. Is that answer your question?

[Colin Sebastian:]

Yes, that helps. And maybe as a follow up to the enterprise commentary, enterprise bookings, sounds like the sales cycle for this group is shorter than you anticipated. And I wondered how much of that is related to the fact that manufactures are now really willing to sell directly to consumers, to market places versus managing carefully their retail constituents, if you could comment on that. Thanks guys.

[David Spitz:]

Yes, good question. Sales cycle for us in enterprise has historically not been that long. I think we've typically circle in 60% to 75% day type of cycles, obviously there are some longer and some of them are shorter. It is quite a mix sometimes brands are ready to dip their toe into market places, there is definitely I would say meaningful uptick in conversations about brands who traditionally haven't gone direct to consumer, who are either going direct to consumer or contemplating it. That was a big topic last night at the dinner that I mentioned with a number of brands. The Where to Buy capability that we acquired last year has also been something that's been strong in terms of pipeline growth and I would expect that to be source of strength for us. There is a lot more to do on the brands platform beyond Where to Buy and we are excited about the potential for that. But generally speaking I would say sales cycle for enterprise customers are not especially long in our business and at least thus far.

[Operator:]

And our next question comes from Brad Reback from Stifel. Your line is now open.

[Brad Reback:]

Hi, David. Quick question to your comment before about the potential for revenue growth to decelerate as this lower third this 1,000 customers churns off. Are there any big quarters upcoming where there is a larger than expected or larger than normal renewal period for those where they might chunk out in a certain quarter?

[David Spitz:]

Hi, Brad, good question. No, there isn't. I might have expected this past Q3 to be one of those. We had a very strong bookings quarter last Q3 but also relatively heavy churn and I might have expected some of those bookings on a lower end to fallen out in this past quarter. But as I mentioned in the call, churn performance actually went down on a dollar basis. So, no, I don't see any kind of lumpiness or non-linearity as it relates to upcoming churn. I think my comment is more generally around. We did our restructuring in Q2; we had to essentially get the team kind of spun back up around the existing pipeline. And my expectations are that there is still work to be done to work through this transition and as a result I think we are more likely to deceleration before we see acceleration. But I feel quite good with the results of this quarter and what it means for at least next few quarters for us.

[Brad Reback:]

Great. And just one quick follow up. Obviously earlier this week demand were talked about some issues within a subset and their customer base is related to overages, obviously your overages was up, but are you seeing any trends out in market place that relates to customers unwillingness to pay overages or looking to fix higher percentages of their contract.

[David Spitz:]

No. I mean I would say we've always got some level of conversations going on with some subset of customers who may be on a renewal cycle and whose performance is different than what they expected and maybe they want to renegotiate to a higher tier or maybe lower takeaway so there is an ongoing kind of dialogue, I think we've always had with customers in that regard but I would say, no, no meaningful change qualitatively or even quantitatively in what we've seen there. In fact, I think one of the reason we are seeing some of the positive results we are seeing is that we have tightened up as you know some of the mid contract renegotiations and changes that we had last year and I think that starting to showing a rebound and variable revenue which has been pretty strong and pretty rapid this year. So it is not a phenomenon but I witnessed in our customer base.

[Operator:]

And our next question comes from Spencer Bogart from Needham & Company. Your line is now open.

[Spencer Bogart:]

Hey, guys. Thanks for taking my question and congratulation for the quarter. So when we think about again all these niche market and access channel advisor, what might this contribute to GMV over time?

[David Spitz:]

Hey, Spencer. Great question. It is hard to say, I think that the reality is there going to be a variety of outcome for the various market places that connect to us. We talked a bit over the last few weeks about Jet as an example where that's become quite significant relative to how early they are. And could be a meaningful driver for us next year. And we have had some long standing relationships that are not necessarily huge but they maybe important and meaningful to segments of our customer base. So segments that are -- for example in automotive or home and garden or different categories like that or maybe geographic focus as well. You got someone like Glendon in Germany or other types of similar market places. So measured on an individual GMV contribution basis, some will be meaningful, some will not be entirely meaningful but collectively they do actually represent a meaningful amount of GMV and attraction point for the sets of customers that otherwise we not have been able to close.

[Spencer Bogart:]

Got you. And just wondering if you can give us a little bit more color around sales productivity? Maybe how you are assessing that? Maybe what are you thinking about ramping as you pull in some of the hiring from 2016 into the fourth quarter?

[David Spitz:]

Yes. So when I measure sales productivity it is really bookings per rep and I think the way we are looking at bookings this year is more conservative than what we looked at last year in terms of some of these price change amendments that we talked about that on prior call, so when I look at rep productivity it is -- for the quarter it was higher than any quarter we had since sometime in 2012. I don't remember specific quarter in 2012 but we definitely saw nice a bump in rep productivity in terms of ACV generation.

[Operator:]

And our last question comes from Craig Nankervis from First Analysis. Your line is now open.

[Craig Nankervis:]

Thanks, good afternoon, nice quarter. Is it possible David -- is it possible to talk about the degree of net influence Jet had for you? Whether it is cannibalizing other marketplaces or how it might add to this dynamic?

[David Spitz:]

Yes, Craig, good question. I think it is probably a little bit early. We did do a blog post a few weeks ago, I don't remember the exact date but it is on our website where we talked about repeat buyer rate and this was I think three or four weeks after they launched. So I don't know how meaningful the data were at that particular point. But we did not necessarily see as far as we could tell strong evidence of cannibalization at least from the consumers that we could see across eBay, Amazon and Jet. So at the far end I am getting is very preliminary look like -- it look like a degree of incremental demand that they were driving. I haven't updated that data, I would expect as we get into holidays it will be something that we will keep an eye on and if there is something interesting to report we will report it. But I would say that we had very strong success and a lot of interest from customers who want to sell and this ranges from smaller sellers to larger retailers and brands. And just very rapid wise in sales from the rest of the customer selling on Jet. So it has been a really good success story for our product customers and I am sure for Jet as well.

[Operator:]

I am showing no further questions at this time. I will now like to turn the call back to David Spitz for any further remarks.

[David Spitz:]

Thank you, everyone. We are very pleased with the quarter and look forward to speaking with you in the near future. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.