SharpSpring, Inc.
Q3 2019 Earnings Call Transcript

Published: 10 Nov 2019

[Operator:]

Good afternoon. Welcome to SharpSpring's Third Quarter 2019 Earnings Conference Call. Joining us today are SharpSpring's CEO, Rick Carlson; and CFO, Brad Stanczak.Following their remarks, we will open up the call for your questions. Then, before we conclude, 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 a link available in the Investor Relations section of the company's website at investors.sharpspring.com.Now I'd 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 third quarter ended September 30, 2019. A copy of the press release is available in the Investor Relations section of our website.In Q3, we put together another record revenue performance and continued to make considerable progress on our product road map and our long-term customer success initiatives. More specifically, this quarter marked the 10th consecutive quarter of record revenues reaching $5.7 million.We finished the quarter with 1,933 agency customers and nearly 8,500 businesses on our SharpSpring Marketing Automation platform, which speaks to the steady new agency customer growth we've been able to generate for some period of time.At a high level, we're moving decisively forward with strong new customer growth and maximize lifetime values as our dual guiding lines of focus. We've also seen some of our efforts with account management and more broadly net revenue attrition begin to pay off in tangible ways that we believe are early signs of things to come.Turning to product. In Q3, we introduced a number of exciting new features that improve the experiences of our customers, and extends our positioning as the strongest solution for digital marketing agencies. We continue to have a robust pipeline of value-adding features that we'll be rolling out in the coming months, some of which I'll be sharing today.However before I go any further, I'm going to turn the call over to our CFO, Brad Stanczak, who will walk us through our financial results for the quarter. Brad?

[Brad Stanczak:]

Thanks, Rick. Good afternoon to everyone on the call today. Let's turn to our financial results for the third quarter ended September 30, 2019. As Rick just mentioned, our total revenue in the third quarter increased 17% to a record $5.7 million from $4.9 million in Q3 of last year. SharpSpring Marketing Automation revenue grew 18% to a record $5.7 million compared to $4.8 million last year.Our gross margin for the third quarter of 2019 decreased to 68% from 70% last year. In dollar terms, gross profit increased 14% to $3.9 million from $3.4 million in Q3 of last year. As we've mentioned on previous calls, over the past few years, we've invested significant resources in our hosting infrastructure, account management teams 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 greater operating leverage in our model as evidenced by our steady year-over-year improvement in gross margins. We've done a nice job scaling and leveraging our infrastructure, which has allowed us to maintain gross margins of approximately 70% year-to-date.That said, with our account management team now fully onboarded in Q3, as expected and as mentioned on the last call, we did realize a slight sequential gross margin rate decline in this quarter. As a reminder, these new account management hires are accounted for in our cost of sales line.Going forward, with the initial traction we're seeing related to the team's revenue retention efforts, we expect gross margin to be flat to slightly up in Q4 with a return to at least our recent historical levels which have been north of 70% in the near future.While I'm on the topic of gross margin, I think it's insightful to point out that year-to-date we've been able to capture 79% of our incremental revenue at gross margin. And we think this is an indication of long-term gross margins that could be in excess of 80% over time.Turning to our operating expenses. For the third quarter of 2019, our operating expenses increased 9% to $6.4 million from $5.9 million in Q3 of last year. The quarterly increase was due primarily to ongoing investments in sales and marketing initiatives to accelerate our future growth, additional investments in our R&D organization to accelerate road map items and increases to our G&A expenses, mainly due to additional personnel to support the future growth of our business and our new office space.Our GAAP net loss for the third quarter totaled $2.5 million or $0.23 per share compared to a GAAP net loss of $2.7 million or $0.32 per share in Q3 of 2018. On the balance sheet, we ended the quarter with $13.8 million of cash compared to $9.3 million at December 31, 2018 and with no debt.At this time, we feel that we are in a solid financial position with adequate cash reserves to fund our long-term growth initiatives and with a clean balance sheet that provides us maximum flexibility.Looking at our non-GAAP measures, our adjusted EBITDA loss for the quarter, which we reconcile in our earnings release, totaled $2 million compared to an adjusted EBITDA loss of $1.5 million in the same year ago period. Going forward, we expect our adjusted EBITDA to improve sequentially.Our core net loss for the third quarter, which is also reconciled in our earnings release, totaled $2.1 million or $0.20 core net loss per share, compared to a core net loss of $1.9 million or $0.22 core net loss per share in Q3 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 Q3, our cost to acquire a customer was approximately $10,800, which was impacted by lower sales activity during the current period and increased sales and marketing spend in the prior quarter.This customer acquisition cost is also a result of us landing higher quality customers with a higher mix of agency customers and with over 85% of new direct customers signing annual contracts, which we believe will lead to higher lifetime values for this quarter's cohort of new customers.That said we feel this level of customer acquisition cost is higher than we would like and we have already implemented changes to improve our efficiency in this area. As a reminder, we calculate customer acquisition cost as the sum of all-in sales and marketing costs from Q2 2019 divided by the new wins from Q3 2019.It's important to mention that this CAC calculation is imperfect, because it does not take into account that marketing spend in one quarter has a long tail and continue to drive deals that we win in future quarters. So, on a cohort basis, we see lower CAC than what the reported number reflects.So we do experience fluctuations in this metric quarter-to-quarter. We are confident that we can continue to consistently acquire customers at our 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 $40,000 to $50,000 to the business on average. This long-term value reflects the benefit of the company on a fully discounted basis after reducing for estimated gross margin costs to support the customers on the platform.Based on these figures, our expected lifetime value to customer acquisition cost ratio, continue to be compelling and we are working to make it even better.Turning to our financial outlook for the fiscal year ending December 31, 2019, we expect total revenue to range between $22.4 million and $22.5 million, which would represent an approximate increase of 20% to 21% respectively compared to the prior year. The company's guidance is based on recurring revenue from our current customer base and year-to-date performance continuing in Q4.Looking at next year, we expect our growth rate will reaccelerate and be significantly above 2019 and expect our cash burn to decrease meaningfully. Going forward, we will continue providing revenue guidance on an annual basis. At this time, we intend to release our preliminary 2020 financial outlook early in the coming fiscal year.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 Q3 as well as our outlook for the rest of 2019. Rick?

[Rick Carlson:]

Thanks Brad. For the remainder of today's call, I'll focus my remarks as I have for the past few calls on our two broader initiatives that are going to collectively drive success for our customers and by connection in our business.The first is acquiring new customers. The second is improving our net revenue attrition through an increased focus on customer success. I'll spend a little bit of time upfront breaking down our new customer acquisition efforts before our more in-depth discussion relating to ongoing customer success initiatives.During the quarter, we brought on 264 new customers. Like last quarter, we continue to execute on our most important area which is our domestic agency customers as this group represents the highest potential lifetime values for us.In Q3, we brought on 191 new domestic agencies which was consistent with our results from Q2 and relatively in line with historical sales. Beyond agency wins, we continue to experience some friction in our direct customer transition to an annual contract model.However, we remain confident that this decision over time will result in a stickier higher quality customer for SharpSpring. This belief is informed by evidence that we've tracked directly. More clearly as customers get older, they generally become stickier. And by creating a force function within a group that has historically yielded higher attrition rates early on, we feel good about that long-term prospect once we get them in the door.Put simply, the direct customers that we landed during the quarter, while fewer in number than we've offered -- when we offered monthly terms, are of much higher quality and will yield higher lifetime value to the company.While increasing the lifetime value of our customers remains a top issue, we're also inverting our approach by continually looking at ways we can bring prospects into the fold in a more efficient manner. While our LTV-to-CAC ratio remains above best-in-class companies we believe that we can improve on our industry-leading metrics.Specifically, we think that we can reduce our customer acquisition cost by more efficiently acquiring and closing new prospects. One key area where we think we have significant room for growth is within our BDR team. This is the middle of the funnel team that creates demos for our sales team to close from leads that our marketing team brings into the top of the funnel.Speaking frankly, our business development representatives or our BDR team has not executed to the degree we would have liked over the course of this year. And that has led to fewer demos scheduled for our sales team and less efficiency than we like with regard to CAC.While this has been an area of disappointment for us, we believe the reasons can best be categorized as normal growing pains for a business that is evolving rapidly. What's important to note is that we are not seeing increased competition, we are not seeing any pressure on our TAM, and we are not seeking any -- seeing any lack of interest in marketing automation or our platform in particular.Quite to the contrary our product has never been stronger, our TAM continues to grow as more businesses turn to marketing agencies for their digital marketing needs, and the interest in both marketing automation and our brand specifically has increased. For these reasons, we believe that we are at the very beginning of the adoption of marketing automation and our success within that market.That said, the difficulties we've seen in our BDR team have been the result of a lack of sales leadership and DNA in this critical area. As a marketing automation company, we have been very good at marketing and generating leads at the top of the funnel.For the bottom of the funnel, once we get someone on a demo, the strength of our product and the obvious value built into our pricing allows us to close deals at very high rates. But as we've grown, we've had the most difficulty in the middle of the funnel and we have been working to find the best formula to convince the leads that we have created to give us the time to get on a demo with one of our sales reps.The good news is that we feel we've fixed these issues. Over the past two months we've added new managers, adjusted BDR compensation, and revisited the BDR team's processes by working to optimize their activities using our newly released Sales Optimizer tool that automatically schedules and enforces an optimized process designed to maximize BDR production and conversion.Frankly, while these results have been too late to impact the last quarter the results have been remarkable nonetheless. In October, based on these changes, we increased the number of monthly attended demos by nearly 40% over recent months. And we did this without any corresponding increase in marketing spend or new product prospect accounts at the top of the funnel.We simply executed 40% better in the middle of the funnel with the resources we already had. Moreover because these are structural changes in the way we approach the BDR process, we expect these changes to be essentially permanent.While we are as of yet uncertain whether this will increase -- this increase in demos will translate into an exact 1

[Operator:]

Thank you. [Operator Instructions] Now our first question will come from David Hynes of Canaccord. Please proceed.

[David Hynes:]

Hey, thanks guys. So you talked about some of the mid-funnel challenges and I appreciate the color there. But it's a couple of quarters now where I guess you -- I think you'd admit that you've kind of under-executed on the agency ads side. So I guess I'm just curious, what is it that you're seeing in the business today that gives you confidence to say that growth is going to accelerate next year?

[Rick Carlson:]

Yes. Well, first I want to maybe tweak what you said there a little bit. The difference in sales is almost exclusively from the end user side where we've moved to direct contracts or excuse me where we moved to annual contracts. In the press release we put out, we showed that there were some 40 I believe less.I'm not looking directly at it. And we moved from essentially nearly 100% monthly contracts to 85% 84% annual contracts. And so, if we're looking at the sales numbers, the shortfall is largely due to that. And those are higher quality clients. So I don't want that message to be lost.That said, we definitely feel as though -- I think I spent some time talking about it in the prepared statement that it really is 100% a function of execution within our BDR team and a lack of delivery of demos to our sales team. We've seen our conversion rates. We've seen our ability to generate leads that are high-quality leads remain the same. We've seen our conversion rates once somebody gets on a demo with us, where we've sort of had not perfect execution is on the -- is in that BDR group and we think that is not just fixable but already fixed.And so that's frankly what gives us confidence that we we're obviously not reporting on -- although we gave a data point on the number of demos we're not yet ready to talk about our sales this quarter but we're pretty confident that those -- the demo scheduling problem has been fixed and that we will accelerate our sales further.This last quarter was I believe the highest mix of agencies to direct that maybe the company has had. I'm not 100% sure on that but it was a very high mix of agencies to Direct. And again that's because the shortfall is mostly on the direct side. Sorry for the long-winded answer.

[David Hynes:]

No, no that makes sense. I mean it sounds like renewed activity kind of since the close of the quarter following some of the changes you made kind of gives you confidence. The demos that you did get in the quarter, any change in conversion rates, conversion yield there?

[Rick Carlson:]

Yes. No is the answer. So we paid very close attention to that right? We could easily fool ourselves. But no the demo quality has been maintained. It's just the -- an increase in volume a substantial increase in volume there.

[David Hynes:]

Yes. Very good. And then maybe one last one if I can for Brad. And this is a kind of a bigger picture maybe harder to answer. But at what revenue run rate, do you think it's reasonable that we should expect to see the firms start to generate cash flow profits? I mean is it $35 million? Is it $50 million? Is it higher? Just how are you thinking about this?

[Brad Stanczak:]

I'd be hesitant to give you a specific dollar amount because we really let our metrics guide whether or not we would want to drive ourselves to profitability too early. So insomuch that we could continue to get new customers at the right economics we would want to do that. That said, we have always felt that we were setting up for a strong 2020. And I think you will see significant improvement towards that goal next year.

[David Hynes:]

Okay. I’ll give you a task. Thanks guys.

[Rick Carlson:]

Yes. Good enough.

[Brad Stanczak:]

I think that's the right way to think about it.

[Rick Carlson:]

That's right.

[Operator:]

Our next question will come from Eric Martinuzzi with Lake Street Capital. Please proceed.

[Eric Martinuzzi:]

The decline in the new customers I'm trying to I don't know normalize or had you been on top of the BDR process earlier. In other words, I guess that the new customer adds is going to decline because of your new policy regarding direct sales. But in Q2 the new customers declined I think 4% and then in Q3 new customer decline year-on-year was 24%.I get it's going to go down but what is sort of a normalized -- and I understand 2020 will come up on easier comps here. But could you help me get my head around what's normalized we should expect?

[Rick Carlson:]

Yes. We are -- I think we alluded in our last call that this quarter would sort of be more of the same. We were affecting -- we were affected -- our sales were affected by two major factors. The move to an annual contract affecting directs and then some numbers coming from Brazil in particular, where there's been pressure on the currency and also some political situations I believe as well.But I think at this point we're at the bottom of that and we should see sales accelerate from here. So I would without giving a specific number say that we're going to have a stronger Q4.

[Eric Martinuzzi:]

When you say sales accelerate from here are you talking about new customer -- that simple blend instrument new customer metric year-on-year?

[Rick Carlson:]

No. Well and quarter-on-quarter like we're going to have a better quarter next -- this quarter.

[Eric Martinuzzi:]

Got you okay. Thanks. And then I'm not sure have you reported this reduce this average monthly net revenue attrition. That 1.2% for comparable cohorts have you reported that number before? Am I seeing that for the first time? Because I have to admit I don't understand it.

[Rick Carlson:]

We've mentioned that number before, I think -- in previous calls, we've talked about net revenue attrition and the inverse retention in previous calls as well. And we spent some time in the last earnings call, really trying to say that this is the way to look at our business. Our logo attrition is one thing and that is because we bring on very small agencies, some of which are unstable themselves. But we see that are -- and as long as we don't put up large barriers like an annual contract for example, we would expect to continue to get small agencies that join us, some of which turn into great agencies that expand with us.Because of that we've seen our net revenue attrition continue to improve over time because the larger agencies stick with us. And so, we've seen that number over the years go from nearly 3%, down to 1.8%, 1.5% and this -- and at times, when we do a price increase, it will jump to positive. But as a general trend, we've seen it improve over time, approaching 0%. And this last quarter, it was at 1.2% on a monthly net revenue attrition number.

[Brad Stanczak:]

On average for Q3.

[Eric Martinuzzi:]

Got you. Okay. And then, I want to come at the breakeven question from a little bit different angle. Just I know, it was asked by the previous caller. But the cash usage in the quarter, I'm just looking at the cash balance between Q2 and Q3. It looks like we declined a little bit over $2 million. Just curious for -- should we think about a similar decline in the fourth quarter or are there puts and takes, where it won't be -- where won't be substantial?

[Brad Stanczak:]

As I've suggested, EBITDA will sequentially get better, but I would expect a similar cash burn in Q4. And then, as I made in the prepared comments, it will be meaningfully lower burn in 2020.

[Eric Martinuzzi:]

Okay. Okay. Thanks for taking my questions.

[Brad Stanczak:]

You’re welcome. Thanks.

[Rick Carlson:]

Thanks, Eric.

[Operator:]

[Operator Instructions] Our next question will come from Mike Malouf of Craig-Hallum. Please proceed.

[Mike Malouf:]

Great. Thanks for taking my questions.

[Rick Carlson:]

Hey Mike.

[Mike Malouf:]

I'm wondering as -- you've done a lot of enhancements to the product this year and some of them are -- that you are charging extra for instance as you said the Sales Dialer and I think the Sales Optimizer. Are you getting specifically on the Optimizer? Are you getting any traction with regards to that product?

[Rick Carlson:]

We are. Yes. We've had a number of customers. We don't report the number, but we've had a bunch of customers adopt that. And I think that along with incremental gains in other products that we charge for and overages and things have helped us to get pretty -- quarter-over-quarter, a pretty solid improvement in our net revenue retention. So, those are some of the things that are helping with that.

[Mike Malouf:]

And where are you with regards to the enhancements? It sounds like, obviously, this year was a big year for that. You've got most of them or maybe all of them out. Do we expect another bunch coming up in the next six months? Or are we sort of past that now?

[Rick Carlson:]

No, we definitely see -- so Sales Dialer, a product we've been talking about is in beta. We are very, very close. And as maybe if not this month and early next month for launching, something we call custom reports with cloud dash-boarding and that's going to be really neat. Our customers are going to like it. We've done -- we've got a bunch of things coming out. We are working very hard on a chatbot that will be coming out at the very beginning of next year.And that chatbot integrates with our customers' websites and takes advantage of our rules engine in a way that a disconnected or third-party chatbot just can't accomplish. And so, we continue to innovate and have really neat new features that customers are adopting. We mentioned on our call, I believe this Meetings feature that we launched, I believe the number is 1,600 individual users and more than 1,000 companies adopted that Meetings feature with at least one user. And that's the fastest adoption we've ever had for a feature. And so, we are definitely enhancing or improving the value of the platform, which is already pretty fantastic in terms of value.

[Mike Malouf:]

Great. And then as you did all these enhancements, I think, you did not take a price increase this year. And I'm just kind of wondering how you're thinking about the following year 2020?

[Rick Carlson:]

We think, we're going to have a really nice -- look, I think we've talked all year long about 2020. We don't really talk about price increases on earnings calls, but we're excited about what we're going to do in 2020 in both an acceleration of sales. We certainly have the pricing power in front of us, should we choose to use it. And these are the kinds of things that drop to the bottom line and help us with EBITDA as well.And so, I think all of that remains the same. We think we'll -- we think we'll do well next year. Not to be KG on that answer, but I think we view price increases as just a possibility for us and we look at it in the mix with some of these other things, expansion revenue that our agency -- that our account managers have been able to improve and produce. That's been happening and adoption of these products and so forth.

[Mike Malouf:]

Okay. Great. Thanks for the help.

[Rick Carlson:]

Thanks Mike. Appreciate it.

[Operator:]

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.

[Rick Carlson:]

I just want to thank everybody, our analysts, our investors, our employees and other supporters. And I appreciate your time and we'll see you on the next one.

[Operator:]

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 take any responsibility to review 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 financial 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 available for replay via link available in the Investors section of the company's website. Thank you for joining us today for SharpSpring's Third Quarter 2019 Earnings Conference Call. You may now disconnect.