Upland Software, Inc.
Q4 2022 Earnings Call Transcript

Published: 23 Feb 2023

[Operator:]

Thank you for standing by and welcome to the Upland Software Fourth Quarter 2022 Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. Instruction will be given at that time. The conference call will be recorded and simultaneously webcast at investor.uplandsoftware.com, and a replay will be available there for 12 months. By now, everyone should have access to the fourth quarter 2022 earnings release, which was distributed today at 4 p.m. Eastern Time. If you've not received the release, it's available on Upland's website. I'd now like to turn the call over to Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.

[Jack McDonald:]

All right. Thank you and welcome to our Q4 2022 earnings call. I'm joined today by Mike Hill, our CFO. On today's call, I will start with our Q4 review, and then we will be discussing our new comprehensive growth plan. Following that, Mike will provide some insights on the Q4 numbers and our guidance, and then we'll open it up for questions. But before we get started, Mike, could you read the safe harbor statement.

[Mike Hill:]

Yes. Thank you, Jack. So during today's call, we will include statements that are considered forward-looking within the meanings of securities laws. These statements are subject to risks, assumptions and uncertainties that could cause our actual results to differ materially. A detailed discussion of these risks and uncertainties are contained in our annual report on Form 10-K as periodically updated in our quarterly reports on Form 10-Q filed with the SEC. The forward-looking statements made today are based on our views and assumptions and on information currently available to Upland management as of today. We do not intend or undertake any duty to release publicly any updates or revisions to any forward-looking statements. On this call, Upland will refer to non-GAAP financial measures that when used in combination with GAAP results provide Upland management with additional analytical tools to understand its operations. Upland has provided reconciliations of non-GAAP measures to the most comparable GAAP measures in our press release announcing our fourth quarter and year-to-date results, which are available on the Investor Relations section of our website. Please note that we are unable to reconcile any forward-looking non-GAAP financial measures to their directly comparable GAAP financial measures because the information which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. And with that, I'll turn the call back over to Jack.

[Jack McDonald:]

All right. Thanks, Mike. So here are the headlines

[Mike Hill:]

All right. Thank you, Jack. So I'll cover the financial highlights of the fourth quarter and our outlook for the first quarter and full year 2023. Total revenue for the fourth quarter was $78.8 million, representing an increase of 4% year-over-year. And without the FX impact, growth would have been 7%. Recurring revenue from subscription and support increased 3% year-over-year to $74.1 million. And without the FX impact, subscription and support revenue would have -- growth would have been 5%. Perpetual license revenue increased to $1.6 million in the fourth quarter, up from $0.7 million in the fourth quarter of 2021. Professional services revenue was $3 million for the quarter, an 11% year-over-year increase. Overall gross margin was 66% during the fourth quarter. And our product gross margin remained strong at 68% or 72% when adding back depreciation and amortization, which we refer to as cash gross margin. Operating expenses, excluding acquisition-related expenses, depreciation, amortization, stock compensation and impairment of goodwill, were $32.2 million for the quarter or 41% of total revenue, all generally as expected. But I should note that we did incur a $12.5 million noncash goodwill impairment charge triggered by the dip in our stock price at the end of the quarter. Had our stock price not dipped, we would not have had an impairment. Also, acquisition-related expenses were approximately $2.6 million in the fourth quarter, which were in line with plan. We expect acquisition-related expenses to further decline here in Q1 and should be insignificant after Q1 until our acquisition activity picks back up in the future. Our fourth quarter 2022 adjusted EBITDA was $24.3 million or 31% of total revenue, down from $25.1 million or 33% of total revenue for the fourth quarter of 2021. For the fourth quarter of 2022, GAAP operating cash flow was $5.8 million and free cash flow was $5.7 million, bringing our year-to-date free cash flow to $29.1 million. We did have temporary timing differences in working capital accounts of approximately $6.3 million, including several million dollars of negative FX impact, which temporarily lowered our free cash flow generation in Q4. But we do not expect these negative temporary timing differences or an FX impact to repeat in Q1, and therefore, we should see strong free cash flow generation in Q1. As Jack mentioned, we anticipate $30 million to $40 million of free cash flow generation for the full year 2023 after absorbing the remaining tail of acquisition-related expenses in Q1. Our ongoing free cash flow generation is in addition to our existing liquidity of approximately $309 million comprised of the approximate $249 million of cash on our balance sheet as of December 31, 2022, plus our $60 million undrawn revolver. As of December 31, 2022, we had outstanding net debt of approximately $274 million after factoring in the cash on our balance sheet. I will note that the principal payments on our term debt are 1% per year or about $5.4 million with the remaining balance maturing in August of 2026. The interest rate on our outstanding term debt is locked at 5.4%, making our annual cash interest payments approximately $30 million at our current debt level. Additionally, I will point out that our term debt has no financial covenants on current borrowings. With regard to income taxes, Upland currently has approximately $358 million of total tax NOL carryforwards and of these, we estimate that approximately $203 million will be available for utilization prior to exploration. I will note that we still expect around $5 million of cash taxes per year. Now for guidance and for Q1 and full year 2023. This guidance reflects the significant incremental sales, marketing and product investments that we are making as part of our new growth plan totaling $15-plus million per year. Okay. So for the fourth quarter -- for the first quarter ending March 31, 2023, we expect reported total revenue to be between $72 million and $78 million, including subscription and support revenue between $67.5 million and $72.5 million or a decline in total revenue of 5% at the midpoint over the quarter ended March 31, 2022. First quarter 2023 adjusted EBITDA is expected to be between $15.5 million and $18.5 million for an adjusted EBITDA margin of 23% at the midpoint. This adjusted EBITDA guide at the midpoint is a decrease of 27% from the quarter ended March 31, 2022. For the full year ended December 31, 2023, we expect reported total revenue to be between $288 million and $312 million, including subscription and support revenue between $269 million and $289 million or a decline in total revenue of 5% at the midpoint over the year ended December 31, 2022. Full year 2023 adjusted EBITDA is expected to be between $63 million and $75 million for an adjusted EBITDA margin of 23% at the midpoint. This adjusted EBITDA guide at the midpoint is a decrease of 29% over the year ended December 31, 2022. And with that, I'll pass the call back to Jack.

[Jack McDonald:]

All right. Thanks, Mike. We are ready to open the call up for questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Scott Berg from Needham. Your line is open.

[Michael Rackers:]

This is Michael Rackers on for Scott. Appreciate all the color on the new growth plan. Kind of digging in on the new growth plan that you outlined, I guess, what's the number one thing that gives you the confidence that the elevated level of spend will drive growth acceleration? And then why do you feel the timing is right?

[Jack McDonald:]

Yes. We're building the growth plan around 3 efficient motions

[Michael Rackers:]

And then net dollar retention has trended nicely up year-over-year. Is there anything specific you can point to driving this improvement? And then is it more weighted towards stronger expansion or just general reduced churn?

[Mike Hill:]

Well, Michael, so I would say that yes, in the last 2 years, prior 2 years, the end of 2020 and the end of 2021, we were at 94% net dollar retention rate. And this 95% here at the end of '22 does illustrate an improvement. Now keep in mind, this excludes the sunset assets. But yes, in terms of bookings, we have continued to see decent expansion from our customers. The churn is still there. Of course, we think we can do a lot better. Our goal on net dollar retention is to get to 100% target goal ultimately, and that has been our goal for -- since we've had the metric. And so yes, it's a mix of both expansion and churn. But it's again, one of those things that's moved a little bit in our direction. But we've got a long way to go, and we think we can improve it significantly from here.

[Operator:]

Your next question comes from the line of Terry Tillman from Truist.

[Robert Dee:]

It's actually Bobby Dee on for Terry. I'm curious, given the focus on digital and digitally enabled go-to-market with the new plan, I'm wondering if that reflects any major change in sales head count? And separately, how should we think about a rough time line of bridging the gap from a 20% EBITDA margin up to that 30% to 35% target?

[Jack McDonald:]

Yes. So as a part of this investment, we are going to be adding significant head count both in marketing and demand generation and in sales. The sales head count that we're adding will be inside sales head count. There'll also be additional outbound SCRs. And again, our existing field sales force continues to play an important role, and it's going to be directed at larger opportunities in the market. So that's the picture, and you can obviously get an idea of the scale of this from the fact that we'll be investing roughly $15 million a year in growth.

[Mike Hill:]

And then, yes, the second part of the question was the adjusted EBITDA guide that we just put out is a 23% margin. And we talked about our long-term goal at scale at 30% to 35% margin and how long that's going to take. Of course, it's going to take a while for these growth investments to take effect. So we'll be waiting on that as well as when we mention at scale, that's going to require some further inorganic growth, some acquisitive growth as well. So this is a multiyear plan, as Jack described, and it's going to take us a while to get to those goals. I would say probably scale ultimately is going to be sort of double the size of the company now, call it, $500 million to $600 million of revenue. But again, we're focused on increasing margins, focused on the organic growth piece first and then adding additive inorganic growth on top of that.

[Jack McDonald:]

Yes. I think that's a great way to put it, Mike. Because as we drive organic growth, that marginal dollar of revenue is going to be disproportionately more profitable than the dollar before it. And again, a key part of this growth plan is obviously that core organic growth, but this is also about enabling us to capture revenue synergies from acquisitions. And so we've got that engine as well. And those 2 things together driving a substantial growth rate, profitable growth, that will increase margins through time.

[Operator:]

Your next question comes from the line of Jeff Van Rhee from Craig-Hallum. Your line is open.

[Jeff Van Rhee:]

I got several. So maybe just quickly on the $15 million, can you break that down by the OpEx lines? Just give me a better sense of how that $15 million is going to be spent. And then on the sunset of the 10% of revenues, how quickly does that come out?

[Jack McDonald:]

So on the $15 million, it is a mix between digital marketing and inside sales and additional investment in development. I'd say the go-to-market piece of it is roughly two-thirds and the product piece is roughly one-third. In terms of the sunset assets, I think a good working assumption is roughly 24 to 36 months.

[Jeff Van Rhee:]

And then I guess, as you look back sort of stepping back to very high level and kind of reflect on the progression of the company like I think you started the call doing that, in 2018, you had $150 million of revenues, 35% EBITDA margins. And you're resetting here to get to similar margins but at like $500 million, $550 million in revenues. And at that time, you were growing, growing modestly targeting low single digits. And you -- obviously, you're targeting a bit higher growth. But nonetheless, you were showing some growth -- modest growth and really good margins. When you reflect back, what's changed since then to make it that much more difficult to get the growth and get the margin?

[Jack McDonald:]

I think the business, as you rightly point out, has gone through phases. I think when we look at the business in balance, we've built a strong portfolio of products. We've got a cohort of those products that we think have great growth potential. We've got a great customer base. And we need to do a better job on the go-to-market piece of it. We probably ran margins a touch too high. And we're going to make a bigger investment right now in growth. Again, we're going to take those margins down to the mid-20s. But our goal at scale is to bring them back up into that 30% to 35% range. Again, the core goal here is to get that organic growth -- that core organic growth up to 5% to 10%. And again, we think it's scale that supports 30% to 35% EBITDA.

[Jeff Van Rhee:]

If I could sneak one last in. I know you don't want to get into product-by-product analysis. But if you look at the portfolio of products and you look at those that are showing the most churn/the least growth, is there any commonality to that group, namely in target markets, verticals, geographies, age of the acquisition, other characteristics?

[Jack McDonald:]

Yes. So we did a pretty thorough review of the portfolio as we were putting this plan together and really looked at common points of leverage amongst the products, everything from customer support leverage to tech stack leverage, to go-to-market leverage, to competitive characteristics in the marketplace, to the growth of those markets that those products are serving. And based on that analysis, we really liked what we saw for 90% of the portfolio. We need to do a more effective job of bringing those products to market and getting attached for our sales team. We did identify some areas where we could make some targeted product investments to be more competitive. And as I say, roughly one-third of this comprehensive growth plan is directed toward that. But what we really saw is the need to focus our product groupings, and again, to invest in a more modern digital marketing capability and that inside sales capability. And those are all efficient motions that will enable growth with expanding margins. It was really just that one piece of the business, the sunset assets, that did not fit our business strategy going forward, as I say, roughly 10% of the revenue. And that's the part that we are taking off the field.

[Operator:]

Your next question comes from the line of Jake Roberge from William Blair. Your line is open.

[Jake Roberge:]

Appreciate all the color on this new growth plan. But just focusing more on the quarter and guide, so really strong quarterly results with even better growth on a constant currency basis. But then the guide is obviously calling for a decline in total revenue. Could you kind of parse out how much of that decel is related to the macro versus the sunsetting of these product suites that you'll be sunsetting in 2023 and 2024?

[Mike Hill:]

Yes. Jake, it's Mike. It's really -- you can really attribute it to the sunset, as Jack just described, sort of defocus on that 10% of our '23 revenue group and just kind of the refocus where we have the leverage point. So I would attribute it to that.

[Jake Roberge:]

And then I understand the margin scale and how $500 million or $600 million revenue, that's when we start to get to that long-term target margins. But could you put any more time lines or milestones around those targets you laid out in terms of how many years we should expect the incremental $15 million of expenses? And how long until we could expect that core organic growth rate?

[Jack McDonald:]

Well, look, we think this is a multiyear plan. It's a comprehensive plan. But look, we're getting at it right now in terms of adding outbound SDR capacity, in terms of adding additional marketing program costs, additional demand generation head count, additional inside sellers and better equipping our field sellers. So we are at it today, hammer and tong here to get this business growing faster. Obviously, there's going to be a little bit of lag time. But it's quarter-by-quarter, and we're taking a long-term view on value creation. I love the team we've got in place right now. This is a growth plan that makes sense for this business and is well thought through, and we're just going to go execute against it.

[Operator:]

And our last question for today comes from the line of Alex Sklar from Raymond James. Your line is open.

[Alex Sklar:]

Jack or Mike, just following up on the growth outlook. It does -- it sounds like most of it is tied to the sunset assets. The new motion seem to be much more additive than disruptive. So besides the sunsetting now, is there any other changes occurring to the prior direct team or to your customer support motions?

[Jack McDonald:]

No. I mean we talked about our new Head of Sales, our new Head of Demand Gen, the promotion of Karen Cummings into the EVP and CGM role, where she's got operating responsibility for the various product groups. I love the team that we have in place here. I love the new adds to the team. And of course, they're -- we're investing and we're growing. And I think, look, if the economy slows down a bit, we're already seeing a different tenor to the labor market today than we saw, frankly, even 60 days ago. So it's just going to make that hiring process, that investment process that we want to do that much easier. So we feel good about it. We feel good about the team. As you say, I think this is additive. And we're adding on top of everything else a little bit more of a sales culture and go-to-market culture of the business. So we're excited and appreciate the questions.

[Alex Sklar:]

And just a quick follow-up on that. So we're more than halfway through the quarter. How fast are you all thinking you can deploy that $15 million of increased investments? Has that started in earnest already? I know the leadership hires are in place, but when do you think you'll be fully staffed from a hiring perspective?

[Jack McDonald:]

Yes. So it has started already. And our goal is to be fully staffed over the course of the next 3 quarters or so. Obviously, with an index action here, particularly around the demand gen and inside sales team. So I mean I would hope to have those folks in place even sooner than that. But we're on it aggressively as we speak.

[Alex Sklar:]

And maybe I'd just sneak one more in for Mike. Just given you've identified the products already, is there any opportunity to move some of the sunset products to like a discontinued operations as far as kind of showing the core -- the rest of the core business results?

[Mike Hill:]

Yes. There's a lot of accounting rules around that classification. And frankly, the sunset assets that we have don't amount to a big-enough materiality to be able to do that based on the reg so as -- based on what I understand.

[Jack McDonald:]

But in that core organic growth number that we're citing, that excludes the sunset assets.

[Operator:]

And I will now turn the call back over to you, Jack, for some final closing remarks.

[Jack McDonald:]

Okay. Great. Well, thank you, everyone, for joining today, and we will see you on our next earnings call.

[Operator:]

This concludes today's conference call. Thank you for your participation. You may now disconnect