Upland Software, Inc. (UPLD) Q1 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Sherilyn, and I will be your conference operator today. At this time, I would like to welcome everyone to the Upland Software First Quarter 2015 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.

Thank you, and good afternoon, everyone. Welcome to our Q1 earnings call. With me today, I've got Tim Mattox, our President and COO; and Mike Hill, our CFO. So in today's call, I'm going to summarize our Q1 results, talk briefly about the Q2 outlook and discuss some recent highlights. Following that, Mike will provide a more detailed look at the Q1 numbers and share our guidance for Q2 and reaffirm guidance for full year 2015. And then finally, Tim will cover sales and operating highlights from the first quarter. Following that, we'll open the call up for questions. So before we get started, I'm going to ask Mike to read the Safe Harbor statement and also cover some upcoming investor outreach.

Thank you, Jack, and good afternoon, everyone. The press release announcing our fourth quarter result -- our first quarter results and our business outlook as well as a reconciliation of management's use of non-GAAP financial measures as compared to the most comparable GAAP measures is available on the Investor Relations section of our website at investor.uplandsoftware.com. During today's call, we may include statements that are considered forward-looking within the meanings of the securities laws. In addition, we may make additional forward-looking statements in response to your questions. These statements are subject to certain risks, assumptions and uncertainties that could cause our actual results to differ materially. We caution you to consider risk factors and other uncertainties that could cause actual results to differ materially from those in the forward-looking statements contained in the press release and in this conference call. A detailed discussion of such risks and uncertainties are contained in our Annual Report on Form 10-K, which was filed on March 31, 2015. The forward-looking statements made today are based on our views and assumptions and on information currently available to Upland management as of today, May 14, 2015. We do not intend or undertake any duty to release publicly any updates or revisions to any forward-looking statements whether as a result of new information, future events or otherwise. On this call, Upland will refer to non-GAAP 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 to the most comparable GAAP measures in its press release announcing its first quarter results. Before I turn the call back over to Jack, I would like to announce that we will be at the William Blair & Company's 35th Annual Growth Stock Conference in Chicago on June 9 and the Canaccord Genuity 35th Annual Growth Conference in Boston on August 12 and 13. To learn more about our outreach plans or to schedule some time to meet with us at the conference, please feel free to contact us at investor-relations@uplandsoftware.com. With that, I'll turn the call back over to Jack.

Thanks, Mike. I would say 4 major headlines for the call. First, we achieved record Q1 revenues and beat versus consensus on both revenue and adjusted EBITDA, and Mike will have more details on that in a moment. Second, a good traction quarter on the sales side. We added over 100 new customers in the first quarter. Tim's going to speak more about that in a few minutes. Third, we are announcing strong inline guidance for Q2 and reaffirming our full year 2015 guidance. And then fourth, a piece of news, which is not in the earnings release, but will be disclosed momentarily here. There'll be an additional press release going out. We are pleased to announce that we've entered into a $60 million, $60 million credit facility with Wells Fargo Capital Finance, and this is going to provide capital for acquisitions for Upland. So really, a critical piece of our financing structure. The facility provides up to $60 million in borrowing capacity for acquisitions and to refinance existing debt. The facility also permits us to issue an additional $10 million in subordinated seller notes. And in addition to that, as subject to customary liquidity requirements, the facility permits stock buybacks, permits stock buybacks of up to $5 million. So really, as I say, a critical part of our financing structure, and I think answers definitively any question about whether Upland would have the capacity to execute against our M&A plan. If you look at it, combined with cash on hand, the seller note capacity and share currency, this gives us north of $90 million, close to $100 million of buying power. So given our planned pace of acquisitions, this is 2 to 3 years’ worth of firepower for acquisitions. So really, a critical piece of the puzzle, and we'll be talking more about that later in the call. So again, great quarter. Since our IPO late last year, we've now delivered 3 consecutive quarters of record revenues. So we're keeping our promises and remain excited about the year ahead. So with that, I'm going to turn the call over to Mike, who's going to give you a more detailed look at the Q1 numbers and share with you guidance. Mike?

Thanks, Jack. I'll cover the financial results for the first quarter and our outlook for the second quarter and full year 2015. Total revenue for the first quarter was $17.5 million, an increase of 12% from a year ago, and $18.1 million or 16% growth on a constant currency basis. Recurring revenue from subscriptions support grew 22% year-over-year to $14.3 million or 26% growth on a constant currency basis. Professional services revenue was $2.4 million for the quarter, down 30% year-over-year. Perpetual license revenue grew 84% year-over-year to $811,000. Moving down the P&L to gross margin. Overall gross margin was 62% compared -- or during the first quarter, and product gross margin remained strong at 69%. Professional services gross margin was 20% during the first quarter, and we expect these margins to improve during the year back up to the traditional levels above 30%. Turning to our operating expenses. Research and development expense was $3.8 million for the quarter representing 21% of total revenue. We have and expect to continue to invest in product development to strengthen our software applications and maintain product quality. Sales and marketing expense was $3.5 million representing 20% of total revenue for the first quarter. General and administrative expenses were $5.1 million in the first quarter representing 29% of total revenue. Excluding noncash stock compensation, G&A expense was $4.6 million in the first quarter representing 26% of total revenue. This reflects certain investments that we have made in personnel, internal enterprise systems and internal processes for operating as a public company. Operating loss was $3.1 million in the first quarter of 2015 compared to a loss of $11.9 million in the same period of 2014. GAAP net loss was $3.7 million compared to a loss of $12.6 million in the year ago period. Our first quarter 2015 adjusted EBITDA was $344,000, down 78% compared to $1.6 million for the same period last year. Now onto our balance sheet and statement of cash flows. We ended the first quarter 2015 with $26.6 million in cash compared to $31 million at the end of the fourth quarter of 2014. Cash flows from operating activities were a negative $3.4 million for the trailing 12 months ended March 31, 2015 compared to a positive $3.6 million for the trailing 12 months for the period ended March 31, 2014. Now I want to cover Q2 and full year 2015 guidance. For the quarter ended June 30, 2015, we expect our constant currency total revenue to be in the range of $17.9 million to $18.7 million or growth of 13% at the midpoint over the quarter ended June 30, 2014, and reported total revenue to be in the range of $17.2 million to $18 million or growth of 9% at the midpoint over the quarter ended June 30, '14 based on a current foreign currency exchange rates. For the quarter ended June 30, 2015, adjusted EBITDA is expected be in the range of between breakeven and $600,000 or adjusted EBITDA margin of 2% of total revenue at the midpoint for the quarter. For the full year ending December 31, 2015, Upland expects its constant currency total revenue to be in the range of $70.7 million to $74.7 million or growth of 13% at the midpoint over the full year of 2014, and reported total revenue to be in the range of $68.1 million to $72.1 million or growth of 9% at the midpoint over the full year 2014. Adjusted EBITDA is expected to be in the range of $2.3 million to $4.3 million or adjusted EBITDA margin of 5% of total revenue at the midpoint for the year, and we expect to achieve an 8% to 12% adjusted EBITDA margin by the fourth quarter of 2015 or 10% at the midpoint. With that, I'll turn the call back over to -- or over to Tim Mattox, our President and COO.

Thanks, Mike, and good afternoon, everyone. I'm going to cover our sales and operating areas. On the sales front, as Jack mentioned, we acquired 102 new customers, of which 13 were major accounts. We saw a particular strength in our Professional Services Automation and advanced workflow areas. In addition, our 2 latest acquisitions, Mobile Commons and Eclipse, performed nicely. In the Professional Services Automation area, we're seeing software vendors with medium to large service organizations utilize our solution to drive new levels of efficiency and effectiveness. Internal IT organizations are also using this solution in a similar way to deliver better levels of service and accountability to their internal customers. For our portfolio and program management area, we're seeing particular strength in the Lean Six Sigma area, driven by reporting, dashboard, financial controls and the customization capabilities inherent with our offering. We also continue to see strengths in the healthcare and education verticals with our project and portfolio management space as well as with our Mobile Commons digital engagement platform. In our Web Content Management area, we're using established relationships to drive new business. The strong loyalty of this offering means that when a sponsor joins another company, they typically introduce the Upland offering very early in their tenure, and we saw that this past quarter. On the cross-sell front, a key initiative for us, we continue to make progress. We increased the pipeline of cross-sell deals quite a bit in Q1 with additional momentum from a recently completed Upland Impact User Conference in Orlando, Florida. We had over 300 partners and customers in attendance. Was happy to see some of the analysts on this call there as well. And the energy was high, and the enthusiasm for Upland offerings was very strong there. In addition, our first quarter renewal and expansion efforts came in on target. Some of the major renewal and expansion examples for the first quarter were a large media company signed a multiyear agreement for both our Web Content Management application and our portfolio and project management offering with a total value of 150k per year; a health care IT solutions and services company signed a 240k renewal for our project and resource management tool; a large legal administration services company signed 150k multiyear renewal for our Professional Services Automation offering, and finally; a large Canadian electric utility signed a 5-year deal at 220k per year for our project and time tracking tool, and an additional 80k in services this year. On the product front, we continue to focus on customer-driven innovations and delivering consistent reliable service through a strong technical foundation. In Q1, we achieved Upland-wide uptime of 99.99%, building on continued investments in our data centers, networking and application reliability and performance. In addition to product releases improving our technical foundations, Q1 included a few major releases. We completed an integration of our FileBound advanced workflow product into our portfolio and project management offering called PowerSteering. This enhancement is called the Upland Workflow Manager. Initially, customers are using this capability to manage capital expenditures that are associated with projects being managed by PowerSteering, but it can also be used to handle other advanced workflow requirements. We also enhanced our PowerSteering product with additional features and usability improvements as part of our winter release. And finally, we launched an integration between Tenrox, our Professional Services Automation tool, and Concur. Tenrox can now be found at Concur's app center. We continue to enhance our customer success and service team capabilities to further drive customer loyalty. We'll continue to invest in these areas and the product areas I mentioned to provide an exceptional customer experience. In summary, we've got a lot of high impact initiatives underway that, over time, we believe will enable us to scale the business effectively. With that, I'll turn the call back over to Jack.

Thanks, Tim. So again, off to a strong start to the year. Record quarter on revenues, maintaining strong guidance for 2015 and expanded EBITDA margins, and of course, the exciting news on that $60 million credit facility for acquisitions. So at this time, let's go ahead and open the call up for Q&A. So I'd ask the operator to please go ahead and do so.

[Operator Instructions] Your first question comes from Bhavan Suri of William Blair.

Just to talk about the line of credit quickly before I jump into the business. When you look at it, and you specifically said it gives you 2 to 3 years’ worth of firepower for acquisitions, just sort of, Jack, maybe just remind us in terms of the size of the acquisitions you'll typically make, what that means in incremental revenue potential over that 2- to 3-year period.

Sure. So we're looking at acquiring $20 million a year of revenue run rate, and that will be 2 to 3 acquisitions per year. So let's say average size of around $7 million or $8 million. And if you look at it, the 8 acquisitions we've made to date, we've paid an average of 1.3x total revenue. So if you took -- and we'll only do acquisitions if they're EBITDA-accretive within the first year, post-acquisition. So if you look at $60 million of acquired revenue over that 3-year period at those kind of historic multiples or even something a little higher than that, it requires consideration of about $90 million or $100 million. And this facility, which will refi our existing indebtedness, our $20 million Comerica facility, is to provide $40 million of dry powder, gives us a $10 million seller paper basket, and of course, it's in addition to our $25 million of cash on hand. And of course, over that 3-year period, we'll use some share currency as well for probably about 1/3 of total purchase price, less so now in all likelihood given where the stock price is, but more so once the market value begins to reflect the intrinsic value of the business. So -- sorry?

And just I was saying you'll be generating cash also by year-end, and so that should be helpful, too.

That's right. That's -- in addition to being currently adjusted EBITDA positive, we go free cash flow positive in the second half of the year. So that will help as well. So we feel very good about it. It really gives us control over our own destiny in terms of executing against the growth opportunity that we've always seen for the business.

Great, great. And then just turning to the business. Subscription overall growth rate was nice. Can you give us any color on the organic growth rate in the subscriptions business?

Yes. So Bhavan, this is Mike. So organic growth for the recurring revenue is 5% again this quarter. So again, that's consistent with what we've messaged and what we've been expecting.

Okay. And then one quick one for Tim, maybe. Tim, it's great to hear about the cross-sell pipeline growing, and you sort of said the pipeline increased quite a bit. Any color on sort of quite a bit? And then as you look at the products, what's driving the cross-sells? Is it ComSci? Is it Mobile Commons? Is it Tenrox? Which part of the business are you seeing greater cross-selling synergy with?

Sure. As you know, Bhavan, we're early days in the effort but have a lot of focus on, so you'd expect a big increase off of the base. But the pipeline is shaping up nicely. It's definitely a focus of our efforts. We're honing the messaging and targeting. And as you alluded to, there are some products that have at least initially more natural appeal than others. We actually took the User Conference as an opportunity to introduce the products en masse to the -- to that customer base and saw a number of opportunities come from that User Conference. Certainly, Mobile Commons, with its sort of ability to grasp quite easily with how the offering can drive value, was one that had a lot of initial interest. But I'll say that we had it pretty much across the board. So really dependent on the decision-maker, and my interaction with who I was talking with in terms of what product resonated. So as an example, if I had someone who is running IT, and they were wrestling with some of their budget justification with their CFO, ComSci was a natural one to introduce there with great interest. So what I found encouraging was introducing the basic messaging and value propositions of the different products, to our base, resonated quite well. We just need to find the effective vehicles beyond the User Conference to do that most efficiently.

Your next question comes from Terry Tillman of Raymond James.

I guess, my first question just, Mike, as it relates to the gross margins for both the subscription business and pro-services, our numbers or our assumptions were off. I guess, was there anything in the first quarter that was maybe acquisition-related or onetime in nature? I think you did say, though, by the end of the year you see progression and improvement in gross margin. But I was just wondering if there was anything that was onetime in nature in the first quarter and how we should see that progression. Should it be a steady increase throughout the year? Or should it start stepping up right away in 2Q?

Yes. So Terry, the -- really, the onetime, I guess, note for Q1 is that we had a little bit of professional services revenue that was tied to some milestones that didn't quite get completed in Q1, and so that revenue has pushed to Q2. And so therefore, we didn't have as much professional services revenue in Q1, which brought the professional services margins down a bit to that 20% level as opposed to the close to 30% or better that we normally run at. So really, that's I think the onetime thing in Q1 that should correct itself in Q2. Other than that, as far as the trend goes and on the product side, I think it's just more of a steady progression through the balance of the year kind of quarterly. So no big herky jerks, but improving steadily.

Okay. And I was yearning to ask that organic question but Bhavan beat me to the punch on that. But maybe I can keep on that theme, though. As it relates to the rest of the year, should there be a notable delta between the recurring revenues growth organically or the subscription revenue growth organically and then total revenue growth? So I guess, said another way, pro-services, will it be a headwind for your organic total revenue growth for the rest of the year? Or will it be a headwind but to a lesser extent as the year progresses?

Yes, Terry, so the -- as we've talked about last quarter, professional services revenue is really sort of defocused for us here for 2015, and we focused on product revenues. So we did -- in Q1 of 2014 and Q2 of 2014, we had a little bit of outsized professional services revenue. So as we compared to those year ago periods, it is a headwind. So I would say that we will have that headwind on through sort of Q2 here. And then we'll sort of be adjusting to it. But as you know, professional services revenue is a little bit less of a focus this year for us.

Okay. And just my last question relates -- and Tim, you were talking about the -- there is a bit of a coming-out party at the User Conference really unveiling a lot of products -- unleashing them, I should say, on the customers in attendance and partners. Is there anything to think -- is there anything to hear or to think about in terms of maybe some low-hanging fruit bookings activity or some abnormal or nonseasonal activities that could occur in 2Q and 3Q because of that conference and the timing of that conference in terms of just some low-hanging fruit new sales? Or should we think that maybe the business will be more kind of back-end loaded more in the fourth quarter around end of the year budget-plus-type activity?

Yes. It's a good question, Terry. Some of our products can close on shorter sales cycles, but most of them tend to have longer multiple quarter sales cycles or multiple month sales cycles. So our FileBound business and the discussions we had with the reseller network that sells those clearly sort of reenergized at the conference, so that could be something that helps us in the current quarter. But the opportunities around, say, our Professional Services Automation or portfolio and project management, they tend to be longer term. So no real near-term impact on that, but more towards the back end of the year.

Your next question comes from Richard Davis of Canaccord Genuity.

Speaking of the credit facility, could you talk about how you see your kind of inbound M&A pipeline evolving over the next year or 2 in terms of focus? Has it changed at all? And then I guess, the second question is, has the relevant target list, aspirationally, or what have you, narrowed at all now that apparently every private company on the planet thinks they are worth $1 billion...as you probably have run into from time to time?

Well, first of all, thanks, Richard. The inbound activity continues to be strong, and we see probably 5 new inbound opportunities a week. So it's really a question of weeding through those and looking at potential product adds that create value for our product family and also create value for our customers that we think can ultimately drive expansion sales into our base and also cross sell. And we feel good about it. I wanted to get that Wells facility in place as sort of the predicate for getting more aggressive on acquisitions this year. So I feel very good about having that in place and look forward to executing against getting some deals done here in 2015. In terms of valuations, our positioning has always been as the dirty end of the field guys, right? We're buying those $5 million, $10 million, $15 million businesses that have blue chip customer bases and good products, good management teams, but just can't achieve escape velocity on their own and no longer makes sense inside the BC portfolios where they're held. And we represent a good home for those customers and responsible adults on the playground in terms of managing those businesses, a good home for the entrepreneurs that have built them, and really, in a sense trade certainty and speed for a more attractive purchase price and stay below the radar screens of the bigger strategic buyers or private equity firms. So when you look at the market the way we do, you really are filtering out those outlier, $1 billion private market valuations. If it's in the hype and glory phase, it's not a target for us. But I got to tell you, there are thousands of great cloud businesses out there that are not in that hype and glory phase, but that have excellent products that can add a ton of value and we see a good supply of them going forward, so we feel good about the potential.

Your final question comes from Michael Huang of Needham.

Just a couple questions for you. I'm not sure that you have kind of all the specific details on hand around this, but as you look at the cross-section of your customers added in the quarter and maybe just focusing on the major one, how are they spread across the product areas? And I guess, how does that compare to what you've seen in impact areas? I guess, what I'm trying to get at is, are you seeing any products stand out with respect to helping you land some of these big customer accounts?

I think one thing that we've seen, and it really gets to the power of cloud, is the ability with multiple products in the family to create that beachhead and then expand. So we've seen that with our Tenrox Professional Services Automation application where you go into a major account at a $25,000 or $50,000 a year ARR departmental implementation, and we've had them where they grow to $250,000, $500,000 north of $1 million. Similar situation with PowerSteering, with our program and portfolio management product, where we've seen that kind of progression. And it really is -- again, it speaks to the power of cloud. We are selling the same product to a larger SMB customer than we're selling to a Fortune 2000. And those expansion sales, which make up more than half of our total bookings, are the most cost-effective new sales that we can generate. So that is a core focus for us in addition to what Tim alluded to earlier in the call in terms of quality and uptime and reliability and performance driving higher Net Promoter Scores and higher net dollar renewal rates. It's -- you can really be creating a significant, we think, organic growth machine before the sales guys even report to work. And that's our goal for where we want to get the business.

Yes. I would just add that some of the products with larger inherent deal size whether it's PowerSteering, as Jack alluded to, or ComSci, our IT Financial Management tool, those are the ones that can generate the very large commitments -- as well as Tenrox. So those products have our focus in terms of building the pipeline and delivery on those. But I will tell you that the inside selling effort is very efficient for the low dollar value sales that might occur with our project management tools. Certainly, that can yield good profitability for us and have a very good momentum associated with them.

Now in terms of the kind of a customer kind of -- I see like a nice customer ask quarter from you guys, up quarter-on-quarter, which I guess, would -- I would assume kind of defies typical seasonality. Anything to help -- kind of any color kind of around what you're seeing there on the customer ask front, I mean, sales productivity or whatever else might be helping to drive that?

Yes. As we talked about in the last earnings call, we did align our outside selling resources with the general managers of the business. And that really did add some efficiency both in terms of getting closer to the product and the general managers closer to the customers, although they typically were involved in the larger customer deals anyway. So we saw a greater efficiency, a better attainment of the routes relative to their quota related to that. So that was very positive. As I mentioned, FileBound, our advanced workflow product, it really gets embedded in other products. That's sold through a partner network, and we saw a good productivity there. And our partner managers who manage those resellers did very well. We have an inside selling capability, as I alluded to. We invested in that. It's centralized. Associated with that is an outbound lead gen as well as inbound lead qualification, so those processes are now standardized across the products. And our focus is mainly on the low to midrange project management area in terms of how we fulfill as well as the lower end Professional Services Automation deals that might be just focused on basic time and expense management. So yes, the sales efficiency, we were pleased with, and I think that we've got the right selling model in place for this stage of the company.

Right. And I guess, final question, just kind of on product sales. Like to see that you've been busy from -- on the products front thus far this year. I guess, as you kind of step back, what are the highest priority product goals for the year? And is there any kind of product area that's getting the disproportionate amount of attention this year?

Yes. Our priorities are basically to address and deliver on the product foundations first, so you don't get the pass Go until you do that. Once we have those levels of quality reliability, performance, security at the right threshold levels and expectations of our enterprise-class customers, then we move on to doing customer-driven innovation. And that can take the form of leveraging some technology in the portfolio, like with our Upland Workflow Manager, or incremental organic development effort along the lines of input we've received from the customers. So a lot of effort on the product foundation and good yield from that. As Jack alluded to, selling more to our existing customers or renewing at a incrementally better rate is our most profitable business. So as we deliver more and more on those product foundations, we're seeing good responsiveness from our existing customers. So those are the focus areas today, not just from a development perspective, but also from an infrastructure perspective. As we bring in these smaller companies, they typically have not been able to enjoy the kind of scale agreements that we have on data center, hardware, connections to the Internet, those types of things, certainly security audits and the like. So we get those things in place and typically, the end user of the existing customer sees an immediate benefit in terms of performance and application reliability.

All right, Mike. Well, thank you and appreciate that question. At this point, we're going to conclude the call. If we didn't get your question, please feel free to contact us at investor-relations@uplandsoftware.com. On behalf of Mike and Tim, thank you, all, for joining us today. And have a great evening, and we will see you next quarter. Thanks so much.

Ladies and gentlemen, this concludes Upland Software's First Quarter 2015 Financial Results Conference Call. You may access an audio replay and the webcast replay on the Upland Software Investor Relations website as of 8:30 p.m. Eastern Time today. Thank you for your participation. You may now disconnect.