Upland Software, Inc. (UPLD) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Upland Software First Quarter 2018 Earnings Call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] The conference call will be simultaneously webcast on Upland's Investor Relations website, which can be accessed at investor.uplandsoftware.com. As a reminder, this conference call is being recorded. Following the completion of the conference call, a webcast replay will be available for twelve months on Upland's Investor Relations website at investor.uplandsoftware.com. By now, everyone should have access to the first quarter 2018 earnings release, which was distributed today at approximately 3:00 p.m. Central Time, 4:00 p.m. Eastern Time. If you've not yet received the release, it's available on the Investor Relations tab of Upland's website at investor.uplandsoftware.com. I’d now like to turn the conference over to our host, Mr. Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.

All right, thank you, good afternoon everyone and welcome to our Q1 2018 earnings call. With me this afternoon are Tim Mattox, our President and COO; and Mike Hill, our CFO. On today’s call, I’ll summarize our results and some recent highlights. After that Mike will give a more detailed look at the numbers and talk about our guidance in more detail both for the second quarter and the full year 2018. And then Tim will cover sales and operations highlights from the first quarter. After that, we’ll open the call up for questions. But before we get started, Mike will read the Safe Harbor statement. Mike?

Thank you, Jack, and good afternoon, everyone. During today's call, we will 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 our discussion of 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 as periodically updated as needed and 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, May 9, 2018. 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 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 first quarter 2018 results, which is available on our Investor Relations section of our website at investor.uplandsoftware.com. To learn more about our outreach plans, please feel free to contact us at investor-relations@uplandsoftware.com. And with that, I'll turn the call back over to Jack.

All right, thanks, Mike. I would say eight major headlines today. We had a record Q1 with better than 50% growth in total revenue better than 50% growth in recurring revenue, so really stellar revenue growth in total in recurring revenues. It's worth noting that Q1 recurring revenues broke through $100 million on an annualized basis for the first time, so actually broke through $110 million and that number continues to grow. So a very – a strong percentage of our total revenues are comprised of contractual recurring revenues providing a great stability for the business. We had record adjusted EBITDA. And again if you look at the annualized run rate, it is now north of $40 million in Q1 and getting close to $50 million annualized adjusted EBITDA run rate in the second quarter based on the midpoint of our guidance. So we see cash flow growing rapidly. This was the 15th straight quarter of meeting or beating guidance and that’s every quarter since going public, so delivering results on a consistent and predictable basis. We had a host of new product innovations in the first quarter. Tim will cover some of those in more detail in a few minutes, but it shows that our model is not only generating best-in-class adjusted EBITDA margins, but it is enabling us to invest in our products to grow customer value, to grow customer satisfaction, to grow our position in the marketplace and long-term enterprise value. On the organic growth side, we had a very strong quarter with organic growth and recurring revenues at 6%, 6% growth – organic growth in recurring revenues. Now, we're very pleased by that, but we are not ready to declare that as sustainable. So we had a relatively easy compare to Q1 of last year and we had a number of customer go lives that increased revenue in the quarter. Tim will touch in a few minutes on a number of the investments we're making in products, in customer success and in sales to drive organic growth in the future for the long-term. And again very happy with that 6% organic growth number in the quarter, but not ready to declare that’s the new normal. We had a strategic and accretive acquisition of InterFAX in the first quarter. This was our first in Europe. It added $15 million in revenues immediately accretive on adjusted EBITDA basis. It added foundational capabilities to our workflow automation product family with HIPAA, PCI and ISO compliant cloud fax and secure document distribution capabilities. And of course, as I say, the first in Europe, so it provided a platform for additional growth in Europe and additional acquisitions there as well. And I would note that our M&A pipeline remains strong and that we have the operational and financial resources to execute. And finally, our guidance for Q2 strong guidance as I say annualized adjusted EBITDA run rate approaching $50 million in the second quarter and accelerating growth in recurring revenues. So, the Upland engine is firing on all cylinders and we are looking forward to a great 2018. So with that I'm going to turn the call over to Mike to give you a more detailed look at the numbers. Mike?

Thank you, Jack. Today, I'll cover the financial results for the first quarter and our outlook for the second quarter and full year 2018. Total revenue for the first quarter was $31.6 million representing growth of 52%. Recurring revenues from subscription and support grew 53% year-over-year to $27.7 million. Professional services revenue was $2.3 million for the quarter, 18% year-over-year increase and perpetual license revenue was $1.6 million for the first quarter for an increase of 134% year-over-year. Moving down to P&L to gross margins, overall gross margin was 66% during the first quarter and our product gross margins remained strong at 68% or 75% when you add back depreciation of equipment and amortization of acquired intangible assets, 75% cash gross margins as we call them. Professional services gross margins were 38% during the quarter, which is slightly below our target of 40% as a result of newly acquired businesses entering the mix and we continue to bring those newly acquired PSO teams into model over the coming quarters. Turning to our operating expenses, research and development expense net of refundable Canadian tax credits was $4.8 million for the quarter, representing 15% of total revenue for the first quarter. Sales and marketing expense was $4.4 million, representing 14% of total revenue for the first quarter. As a result of our adoption of the new accounting regulation ASC 606, we now defer the recognition of sales commission expense over the expected customer relationship life. The net effect of this adoption is a reduction of sales commission expense by a couple $100,000 per quarter, which has been mostly offset by the incremental investments in the sales personnel from our more recent acquisitions like Qvidian and further offset by our continued investments in infrastructure systems and preparation for our future growth. General and administrative expense was $7 million in the first quarter representing 22% of revenue, but excluding non-cash stock compensation for the first quarter of G&A expense was $4.7 million or 15% of total revenue. Acquisition related expenses were $3.1 million in the first quarter representing – resulting from the recent acquisition activity. These expenses are expected to taper off over the next few quarters unless or until we have additional acquisitions. Operating loss was $0.5 million in the first quarter compared to a loss of $3.6 million for the same period in 2017. GAAP net loss was $3.2 million or a loss of $0.16 per share compared to GAAP net loss of $5.6 million or a loss of $0.33 per share in the first quarter of 2017. Non-GAAP net income was $7.7 million or non-GAAP net income of $0.37 per share in the first quarter of 2018 compared to non-GAAP net income of $2.9 million, or non-GAAP net income of $0.16 per share in the first quarter of 2017. Our first quarter 2018 adjusted EBITDA was $10.8 million or 34% of total revenue, up 98% compared to the $5.5 million, or 26% of revenue for the same period of last year. Now on to our balance sheet statement of cash flows. We ended the first quarter with $32.5 million in cash. Cash flows used in our operating activities were $0.5 million for the quarter and removing the cash portion of one-time acquisition transaction restructuring cost from our operating cash outflows adjusted operating cash flows would have been positive $4.2 million for the quarter. During Q1 2018 here, we acquired InterFAX for which we spent $34.2 million net of the cash acquired and we expect to pay another $1.1 million in Q2 to settle the purchase price obligation. We also expect to pay $5 million of cash holdbacks, which are payable over the 18 month of holdback period, which is subject to reduction for indemnification claims and this excludes any future earn out payments tied to performance based goals. In order to fund, this acquisition during Q1 of 2018 here, we expanded our credit facility from $200 million to $258.7 million represent – specifically $50 million of new term debt was drawn down, taking Upland’s gross debt outstanding from $113.7 million, up to $163 million with debt – net of cash on hand now to approximately $130 million as of March 31, 2018. Now, I’ll cover the second quarter 2018 guidance. For the quarter ended June 30, 2018, Upland expects reported total revenue to be in the range of $33.5 million to $34.5 million including subscription and support revenue in the range of $30.5 million to $31.5 million, for growth in recurring revenue of 60% at the midpoint over the quarter ended June 30, 2017. Adjusted EBITDA is expected to be in the range of $11.7 million to $12.3 million for an adjusted EBITDA margin of 35% to midpoint, representing growth of 76% at the midpoint over the quarter ended June 30, 2017. For the full year ended December 31, 2018, we expect reported total revenue to be in the range of $133.2 million to $136.2 million including subscription and support revenue in the range of $119.9 million to $122.9 million, for growth in recurring revenue of 42% at the midpoint over the last year end. Adjusted EBITDA is expected to be in the range of $46.8 million to $48.8 million for an adjusted EBITDA margin of 35% at the midpoint, representing growth of 58% at the midpoint over last year. And with that I'll turn the call over to Tim Mattox, our President and COO.

Thanks, Mike, and good afternoon everyone. I'm going to cover our Q1 results across sales, product and operating areas. Our Q1 results continue to show the power of Upland’s model. Combining our commitment to 100% customer success with ongoing investments in the Upland One operating platform to enable our enterprise customers to achieve greater success and improved outcomes for their businesses. With respect to sales, we expanded relationships with 193 existing customers in Q1 including 22 major expansions over $25,000 in annual recurring revenue. In addition, 55 of our expanding customers increase their annual recurring revenue by 25% or more. Some examples of major renewals and expansions include the social services administration of a major city, so expanded its commitment to our mobile messaging platform by more than $230,000 per year, a major financial institution, who expanded its commitment to our secure document capture product for more than $165,000 per year, an IT services provider, who expanded its commitment to our professional services automation solution by just shy of $120,000 per year and a global agricultural firm who expanded its commitment to our project and portfolio management solution by more than $95,000 per year. In aggregate, 189 other customers expanded commitments by more than $1.7 million per year. We also welcome 91 new customers to the Upland family, 19 of which were major accounts with at least 25,000 in annual recurring revenue, notably a department of the federal government committed to our knowledge management platform for more than $340,000 per year, a major financial institution and top public accounting firm and a telecommunications equipment provider each committed our RFP and sales proposal automation platform for more than $120,00 per year, $85,000 per year and $60,000 per year respectively, and an industrial service provider committed to our project and portfolio management solution for more than $90,000 per year. In aggregate, 86 other new customers made commitments of more than $1.1 million per year. Stepping back, as Jack mentioned, we grew our recurring revenue 6% organically in Q1. Some of the investment areas that could help support similar organic growth in recurring revenue going forward are the marketing of our Premier Success Plans, our cross-sell promotions, the launch of Upland Analytics, our Upland Mobile Messaging usage initiatives and sales capacity additions. Again, it's a bit early to gauge the payoff of these investments and our guidance doesn't contemplate any improvement over the historical baseline from these incremental investments, but we're monitoring them closely and are optimistic. On the product front, we enhanced our workflow automation product family by acquiring InterFAX as Mike and Jack mentioned, the leading provider of secure and cloud-based messaging solutions including enterprise cloud fax and secure document distribution. With the addition of InterFAX, Upland now offers comprehensive document management and workflow automation solutions and capabilities that include document capture, data extraction, data loss detection, secure storage, intelligent routing and approval and secure document distribution through cloud fax, mobile messaging and email. We also invested in customer driven product innovation including the release of Upland’s knowledge-enabled professional services automation solution, which integrates our Tenrox PSA with RightAnswers Enterprise Knowledge Management for a much more powerful solution. Enhancements to the Project & IT Management product family included improvements to resource and project management in our Tenrox PSA solution, as well as significant improvements in dashboards and reporting of our ITFM solution, ComSci, to support our Upland Analytics initiative. Improvements in the Workflow and Automation product family by enhancing performance and user experience to streamline the RFP approval process for Qvidian, our automated bids and proposals offering; and improved FileBound interconnectivity with other applications, FileBound or Workflow Automation solution. We also delivered significant performance upgrades to Upland Mobile Messaging. Turning to operations, we continue to invest in Upland One, our unified operating platform. Progress in Q1 included completing the full integration of RightAnswers and Qvidian into Upland support model and reducing cost per ticket while keeping customer satisfaction at very high levels augmenting our Upland Integration playbook to incorporate acquisitions outside the United States as a next milestone in our integration approach. For example, our integration process for InterFAX covers teams in Ireland and Israel. We also extended our formal executive outreach program to include partners of our recently acquired InterFAX business. And as Mike mentioned, we continue to transition from our company managed data centers to Amazon Web Services creating a much more scalable, secure, and cost-efficient cloud environment to support our ongoing customer growth. We have migrated two additional products in Q1 and expect to fully migrate all existing products in 2018. In summary, we're pleased with Q1 strong results across each of our sales, product and operations areas and anticipate sustained positive momentum going forward. With that I'll hand the call back to Jack.

All right, thank you, Tim. So at this point we're ready to open the call up for questions. So, operator, if you could please go ahead and do that.

[Operator Instructions] Your first question comes from the line of Bhavanmit Suri from William Blair. Go ahead please. Your line is open.

Thank you. Hey, guys. Can you hear me okay?

Yes.

Congrats, nice job there and thanks for taking my question. I guess I just want to touch on something that that really stuck out obviously just solid results all around, but your net expansions above 25% on the ARR side, I mean the 55 number I think you quoted was really, really high, especially compared to 102 expansions for the whole year of that size for last year. And so I guess I'm just trying to figure out what you guys are doing or what you've done to sort of drive this sort of really enhanced expansion within customers?

I would say that it's really part of the entire Upland One model, where we are focused on customer success. We've got a regular and intensive communications cadence. We've got product roadmaps that are aligned to customer needs. We've got a Net Promoter Score kind of virtuous loop, where we're taking that feedback and putting it back into what we're doing around product, what we're doing around service, what we're doing around support and on support we continue to invest there and provide and we could see it in the customer sat numbers and the NPS scores, higher level of customer satisfaction. And we're doing that at the same time that we're increasing margin. So it's really in all of the above kind of an answer Bhavanmit.

Sorry, thanks Jack. And then, I think that was Jack. But…

Why [Indiscernible]

His voice is getting [indiscernible] coming down with something. But I wanted to talk – we’ve talked about cross-sell and you guys touched a little bit on sort of not – sort of sticking or not sustaining the organic growth enough, so it's not a trend line yet. But as you think about the cross-sell initiatives, which you’ve now been going on for a few quarters and obviously driving some of the expansions you have just discussed. Help us to understand a little bit about how to think about the go-to market with the cross-sell and sort of structure of that sales force and the layering for each one of the stovepipe sets of applications you have you know the workflow automation, the marketing automation et cetera, just help to understand sort of how that’s going and if there’s some sort of predictability what we’re going to see there.

Yeah, I'll take that, Bhavanmit. It’s Tim here. Good question. So yeah in terms of the cross-sell initiative, we do have a focused effort that we've kicked off targeting some of our largest customers and tailoring the cross-sell efforts to those. As you probably noted as we have expanded our product portfolio with some very relevant products, like in the knowledge management area and the business proposals area, we’re finding relevance in more and more customers and in some cases we're linking or integrating those products more directly. So we announced knowledge management enabled professional services automation solution that actually got significant interest. So we have some pipeline going on from that. And so the more relevant to the existing decision maker or to the current installed products, the easier it is to do the cross-sell. Short of that it becomes a warm lead and we rely on the customer loyalty and high NPS that we’ve generated within the customer to basically get a warm interaction and begin the selling process that way. But I'll tell you knowledge management is a very hot area and we have a strong offering there, so lots of interest on that, the automated bids and proposals also very relevant from a cross-sell perspective, so we're seeing good initiative on that as well.

That's really helpful guys. Nice job, congrats and thanks for taking my questions.

[Operator Instructions] Your next question comes from the line of Scott Berg from Needham. Go ahead please. Your line is open.

Hi, Jack, Mike and Tim. Congrats on a good quarter. I have two quick ones, I guess. I don't know if Jack or Tim wants to take this, but the 6% organic growth number in the quarter – not putting the cart before the horse, obviously, but wanted to see if you had any maybe examples or any thoughts as to what was different in the quarter to drive some of those sales and not certainly thinking it's consistent yet, but is any of that then repeatable?

Yeah, so, I would say that obviously we're very pleased with the 6%, but we had relatively easy compare to the first quarter of last year. We had a number of customer go lives, which also increased revenue in the first quarter. So I would not call it a sustainable or the new normal at this point. Now, we are at the 6% rate. We’ve always talked about it sort of flat to 5% organic growth range for the business and we talked about the fact that there are a number of investments we're making in product, in customer success, in sales, in lead generation, in clustering products together, in bundling products, in cross-sell, in platinum support and in uniform price increases that we think are going to help us to achieve long-term organic growth at the upper end of that range. So we continue to execute. This first quarter was a bit of an outlier on the upside, which was nice to see, but we were laying in all of the things we need to be to drive organic growth.

Great. And then a follow-up question for Mike. Your gross margins continue to obviously trend up here over time and we’re better than we’re modeling in Q1 here. With the migration of the last applications [indiscernible] data centers to Amazon this fall, how should we think about gross margins maybe over the short and medium term? Not sure what type of upside there is from this kind of low 70s level?

Hey, Scott, yeah, it’s Mike. So, the AWS migration, we've got those slated to be completed here at the end of the year, so Q4 timeframe, which is what we’ve talked about before, so no change in that. We expect hopefully a 50 basis point maybe even a little bit more improvement in margins once we get through that sort of lift and shift, double bubble costs of making those migrations. In the meantime here, we do still expect to see margins improving just a little bit. Here we've got the InterFAX acquisition that’s going to come into play here in Q2 since we acquired them at the end of Q1, so that should be a little bit more improvement in margins. We're not really quantifying that from a guidance standpoint, but it's one of those things where we should see some incremental improvement and then hopefully some year end improvement as well.

Okay, great. That’s all I have. Thank you taking my questions.

Your next question comes from the line of Richard Davis from Canaccord Genuity. Go ahead please. Your line is open.

Thanks. So I was thinking when you go on to AWS, we've seen this with other companies. Is there a benefit in addition – obviously gross margins are always cool, but doesn't it save you on CapEx as well and would it not be logical and if so kind of could you put a circle around how much that would be? And then the second question I have is – and you kind of touched on this a bit in the prepared remarks, but if you found – is there a best go-to market strategy, i.e., inside sales light touch kind of developer laid out – because you have a bunch of different products, so I'm just trying to kind of think is there some way that you're seeing success in one particular methodology? Thanks.

Hey, Richard. It's Mike. I'll take that first one on the CapEx. And yeah, you're exactly right. What we've done, you can actually see, go back to our historical CapEx spending and really see that when we started the AWS migration at the beginning of last year for our products, we really quit spending much on CapEx at that point and knowing that we were in the process of migrating and we did not want to continue to buy equipment hardware for that purpose. So from a quantification standpoint if you go back to before we started the AWS migration, when everything was in the server forms, we were spending a couple of million dollars in CapEx per year, probably understanding. But as we leaned ourselves off, you've seen the CapEx drop down to $1 million or so last year and it should continue to fall, probably $0.5 million a year as what will end up with in CapEx. Going forward, we did have an extra CapEx spend here in Q1, but that was a one-time thing that we don't expect to repeat. So anyway yes lots of improvements and benefits from AWS.

Hey, Richard, it’s Tim here. In terms of the go-to market strategy, it really does vary a bit by product for us. Clearly, a lower ARR type of offering and inside model is most effective in that context. For the complex sales, field sales still is a component for us. So that I will say that with webinars, self-discovery by customers themselves, them talking within their own networks of folks, us using ROI examples and building case studies on that and doing – being able to do demos remotely. The need to visit a customer frequently and sometimes maybe only the critical point in the selling process is all you need for that. That said we do see a payoff in that area and we have added some additional capacity as part of our investment strategy in that area.

Got it. That's helpful. Thank you.

Your next question comes from the line of Brian Peterson from Raymond James. Go ahead please. Your line is open.

Thanks. This is Vince Celentano on for Brian. Can you talk about or how you’re seeing the pace of synergies with these larger deals compared to the one you've done historically? And then have you seen any differences with some of these larger companies that offer any additional complexity to completing them?

So, thanks for the question. This is Jack. We have a developed model called Upland One and in every acquisition we do gets ported on to the Upland One operating platform. So it's a consistent way to do everything from quote to cash to account management to customer support to product management to development to the entire back office. So whether it's a $4 million or $5 million revenue acquisition or $15 million to $20 million revenue acquisition that process and those synergies are the same. In terms of M&A generally, we like the pipeline we've got, right now. Mike mentioned the increase in the size of our credit facility. So we've got plenty of capacity to go after new deals. We've got a healthy pipeline and we feel very good about the prospects for additional M&A this year and keeping our growth rate going here.

Got it, thanks. And as you do look towards more M&As, is there any particular product group that you think best suited for near-term acquisitions?

If we look at it, I'd say it's pretty even across the three product families today and we've talked about the fact that we think those three products families can take us through to $250 million in revenue as a business. And so, we will continue to look at all three. The pipeline today is pretty evenly divided among those three product families and we've got growth targets within each of them. So I continue to think it's – they’re relatively evenly weighted from an M&A standpoint.

Great, thank you very much.

There are no further telephone questions at this time. I will turn the call back over to the presenters.

Okay, great well thank you so much for your time today and we look forward to getting back together with you on the Q2 call, later this year. So thank you and good afternoon.

This concludes today's conference call. You may now disconnect.