Good day, ladies and gentlemen, and welcome to the Upwork Q3 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today’s conference, Palmira Gerlach, Director of Investor Relations. You may begin.

Hello and welcome to Upwork’s discussion of its third-quarter 2018 financial results. Leading the discussion today are Stephane Kasriel, Upwork’s Chief Executive Officer, and Brian Kinion, Upwork’s Chief Financial Officer. Following management’s prepared remarks, we will be happy to take your questions. But first, let me review the Safe Harbor statement. During this call, we may make statements related to our business that are forward-looking statements under the federal securities laws. These statements are not guarantees of future performance, but rather are subject to a variety of risks, uncertainty, and assumptions. Our actual results could differ materially from expectations reflected in any forward-looking statement. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings available on the SEC’s website and on our website as well as the risks and other important factors discussed on today’s earnings release. In addition, reference will be made to non-GAAP financial measures. Information regarding reconciliation of non-GAAP to GAAP measures can be found on the press release that will be issued this afternoon on our investor relations website. Please note that the prepared remarks corresponding to the information reviewed on today’s conference call will also be available on our investor relations website at investors.upwork.com once the call has concluded. With that, I will turn the call over Stephane.

Good afternoon and thank you, everyone, for joining us for our first quarterly earnings call as a public company. We are excited to share our progress with you and to provide details on our financial performance. But before I do, I would like to take a moment to express my gratitude to our investors, our clients, the freelancers on our platform, the freelancers who provide services to us, and our employees. Each of you has put your passion and trust in us over the years and I greatly appreciate it. We were pleased with our IPO process and investors’ reception to our offering. We are excited to share today that we exceeded our own expectations for the third quarter of 2018. While our IPO was a major milestone for Upwork, it was just another step in the evolution of the Company. We are addressing a large and expanding market opportunity, of which we believe we have merely scratched the surface. Since many of you are new to the Upwork story, I wanted to provide a brief review of our business and our opportunity before we look more closely at the progress we made in the third quarter. Upwork’s mission is to create economic opportunities so people have better lives. The world is in the midst of a transformation in how we work. Technology is enabling people to work how, where, when, and with whom they please. Upwork is at the forefront of addressing this opportunity as our platform removes the constraint of location, making hiring faster and more efficient. We operate the largest online marketplace for highly skilled freelance talent, as measured by gross services volume, or GSV. As a reminder, GSV is the total amount of business transacted through our platform. As we last disclosed, over 475,000 clients hired…

Thank you, Stephane. Good afternoon, everyone. My remarks today will start with a brief update on our key operating metrics for the third quarter, then turn to the financial results and our guidance for the fourth quarter that we provided in our earnings release filed today. Numbers are rounded for the sake of convenience, and I will make comparisons on a year-over-year basis unless otherwise noted. I’ll be referring to GAAP measures unless explicitly cited as a non-GAAP measure. We monitor and measure our business performance using certain key operating metrics, which include GSV, core clients, and client spend retention. We believe these metrics are key indicators of our growth and the overall health of our business. GSV, which includes both client spend and additional fees that we charge for other value-added services, increased by 27% in Q3 to $449 million. The growth in GSV was driven by an increase in core clients and an increase in our client spend retention. Growth in core clients is an important metric for two reasons. Core clients have been historically more likely to continue using our platform; and two, they represent approximately 80% of our GSV. We define a core client as a client that has spent in aggregate at least $5,000 in their lifetime on our platform and have spent in the last 12 months. As of September 30, 2018, we had approximately 101,000 core clients, representing a 22% increase. Client spend retention was 108% on a trailing 12-month basis at September 30, 2018, compared to 95% at September 30, 2017. Client spend retention is derived by dividing recurring client spend by our base client spend from the same clients over the four quarters ended one year from the date of measurement. We are pleased that client spend retention has continued to…

Thank you, Brian. I am very excited about the trends we are seeing in online remote work. The world is now in the Fourth Industrial Revolution. This revolution is a chance to make a more positive future of work with more economic opportunity a reality. Upwork is a leading force in this positive future of work. Our innovations bridge the skills gap to reduce friction in the labor market. At Upwork, we ourselves practice a work-without-limits model that includes a distributed team of on-site and remote employees. And we also engage with over 1,000 freelancers all over the world for our own specialized projects. It is amazing to have access to this highly skilled global workforce, which we believe to be a key component of our business success. Again, thank you to our employees, the freelancers who provide services to us, the freelancers and clients who use our platform, our partners, and our investors. I believe Upwork can provide economic opportunities for millions of people. We are excited about the opportunities in front of us and we look forward to sharing this journey with you. And with that, we are now happy to take your questions.

Thank you. [Operator Instructions] Our first question comes from Mark May from Citi. Your line is now open.

Thank you for taking my question and congratulations on your IPO milestone. I had a couple of questions. One on revenue retention. Thanks for some of the color around how you are thinking about the outlook there in aggregate. But just wondering if there are any interesting differences in revenue retention growth rates by different types of clients, if it’s employers with fewer than 100 employees or greater than 100 employees. Or any other ways that maybe you slice and dice the numbers, if you see any sort of interesting differences and different types of client types. And then you’ve got a number of areas of investment and growth opportunity; enterprise comes to mind, brand, marketing comes to mind. How are you thinking about weighing investing in these growth opportunities versus trying to manage kind of near-term profitability improvements? Thanks.

Sure, great question. Thank you. So I would say the answer to the first question, if I had to like say it in one line: the bigger the client is, the more they retain. So the way we look at it is we have four segments of customers. We currently segment clients based on number of employees. So we have what we call very small businesses, or VSBs, which are companies with less than 10 employees. Then what we call small business, which are companies between 10 and 100; in-market, between 100 and 1,000 employees; and large businesses above 1,000. And for each segment, the retention rate goes up. One of the things we talked about in the S-1 was how we look at core clients versus noncore clients and the difference between logo retention or actual retention of individual clients versus dollar attention. And if you remember what we said back then, essentially the overall logo retention – and this is 2017 data, but the overall logo retention for the Company was 58%. The logo retention for core clients was 83%. The dollar attention overall, and it’s not very different for core clients versus noncore clients, but the dollar attention overall is 106%. So what happens is 80%, roughly 80% of our business is with these core clients who tend to be bigger companies. To give you an example, when you sign up with a gmail.com email address, if you don’t have enough money to buy a custom domain name, you probably won’t have a ton of money to spend on Upwork. So those tend to be one-and-done; they don’t tend to spend a lot of money. The ones that end up spending $5,000 and above, which are the ones that we call core clients, they still churn because…

Perfect.

Great question.

Thanks a lot.

Thank you. Our next question is from Mark Mahaney from RBC Capital Markets. Your line is now open.

Thanks. I wanted to ask about the domestic-to-domestic or the domestic marketplace and how that has rolled out for you in the U.S. I think you are also rolling that out in the UK. Just talk about the materiality of that, learnings you’ve had from that, and your optimism in terms of being able to roll that out to multiple international markets. Thank you.

Sure. So there’s kind of four things we have been doing and are continuing to do in our domestic initiative. So the first one, which we launched last year, was the U.S. domestic website itself. And as a reminder to explain what it means is when you sign up on Upwork today, either as a client or as a freelancer, if you state that you are based in the U.S., we give you a choice between participating in the overall global upwork.com marketplace or participating in the U.S.-only marketplace. And what that means is as a U.S.-based freelancer, if you choose the U.S.-based marketplace, you will only see the subset of jobs where everybody else who is bidding on the work is based in the U.S. And as a result, you are not competing against people overseas, people who potentially have a lower cost of living and therefore might be bidding at rates that are lower than something that you are comfortable with. On the client side, what it means is when you choose the U.S. marketplace, you will only see the subset of freelancers who are based in the U.S. Now, as you can imagine, U.S.-based freelancers love the feature. The idea that you – if you are based in San Francisco, you are competing against people in New York and Chicago, but you are no longer competing against people in Greece or Chile or Russia makes a ton of sense for you. So we have seen tremendous amounts of adoption from the freelancers because they are bidding against other freelancers in the U.S. They have been able to increase their rates substantially. So we are seeing the hourly rates on the U.S. marketplace be substantially higher than the global marketplace. And they have gone up over time as…

Okay. Thank you very much, Stephane.

Thank you. Our next question is from Brent Thill from Jefferies. Your line is now open.

Good afternoon. Stephane, just on the enterprise business, I was just curious if you could give us some more mile markers of where you are at, kind of how you see that business unveiling and rolling out over the next year. You mentioned you don’t have enough salespeople. Are you going to step on the gas there in terms of hires here going forward? And then I had a quick question for Brian as a follow-up.

Sure. I mean, I think the big long-term picture here is if you think about the underlying theme and the types of, I would say, incumbent providers that this Company is disrupting, they tend to do most of their business with large companies. So we have started, I would say, in classic disruptor playbook. You start with the small companies that nobody else is able to serve and then progressively you go after where a big chunk of the money is and you go after the bigger companies. So in the very long term, if you look several years out, the majority of this business will be in the enterprise space. But it’s starting from a small base. Less than 20% of our business is done with companies with more than 100 employees. So even though it is growing faster than the overall business, it’s going to be several years before it becomes 50%-plus of the business. What’s happening today is we have a relatively small sales team and people are hitting their numbers. We are happy with the productivity levels, even though we will continue to put pressure on people and increase quotas and make people even more productive over time. But generally, it is working. The payback periods and the ROI is good and so we are continuing to invest. To give you an example of this, we just signed a lease in Chicago for an office that can contain up to 500 people. Today we have about 100 people in Chicago, so we are definitely planning to expand quite a bit. At the same time, just to make sure I set proper expectations here, you don’t just double a sales team overnight. This is truly – you need to build the management bench strengths, you need to manage the processes to be able to do this at scale. So we will continue to hire as fast as we think we can hire. I don’t think at this stage that we are limited by the number of leads. We are limited by the ability to hire great talents and onboard them and allow them to be successful, including having all of the facilities or, if you will, the different stakeholders that help a salesperson be successful at Upwork.

Great, thank you for that. And Brian, I just wanted to clarify. In the first half of the year, you had high-20% growth. You dipped into the lower 20%s and you are guiding now back into 25% growth I think at the midpoint for Q3. So I am just curious. Was there any seasonality or anything unusual in Q3 that brought the growth down? Or are we just trying to parse the numbers too much and the overall trajectory looks pretty healthy from your perspective?

Yes. Stephane mentioned about the U.S. domestic-domestic site that was launched in Q2 of last year and it’s mostly lapping related to that. So we always try to give some color on that from that perspective. And as we have talked in the past, like, Q2 to Q3 are usually about similar in that there is seasonality in those business and you tend to see a little bit of acceleration in the fourth quarter over Q3. But you have that seasonal sort of billing that we’ve talked about in the past.

Okay. And nothing in terms of unusual on the take rate? I know it dipped down to one of the lower levels you’ve seen. Do you expect a stabilization around the low 14%s? Is that a reasonable level to think about in the models going forward?

It moves around a lot and that is why we have tried to model – provide guidance on the revenue number and not on GSV and take rate. The mix of business will move around, as we indicated; like, the managed services business probably will grow slower than the marketplace. We are seeing more and more in the 5% tier, which we see actually as a positive, as well as more and more ACH adoption. Both of those are actually benefiting us from the perspective that we are seeing less circumvention than we saw before the pricing change. But those three elements will move around a little bit and so there will be a little bit of downward pressure.

The thing I would add to this is we ourselves measure ourselves mostly on revenue, to be honest. The thing that I think matters a lot, like, if I were looking at this as an investor in the business, what I would worry about more is if take rates start to go up tremendously. This would be a case where you are saying, hey, this company is struggling to create a lot of value for its users and it’s overmonetizing as a way to compensate for it to try to jackup revenue numbers. We are in the reverse situation right now, where we are letting, on purpose, take rates decline. We are not planning to make major changes to the pricing because we think that the incremental GSV that we get at, even at a lower take rate, still generates more revenue, generates a lot of satisfaction from the customers. And that is what is driving this spend retention rate going up, the number of core clients going up. Generally, this is a very healthy business where people are spending more and more, they are retaining more, they are referring more people to us. And we are pretty happy with the evolution of revenue versus take rate right now.

Great. Thank you.

Thank you. Our question is from Ron Josey from JMP Securities. Your line is now open.

Great, thanks for taking the question. So two really quickly and the first one is just on escrow. And Brian, I know you talked about that earlier. But specifically, I wanted to ask about the competitive advantage that you believe you have on escrow. Only because in talking to a bunch of freelancers, everyone sort of highlighted the benefits of the escrow process that Upwork has. And so can you just help remind us why – how difficult it might be to replicate your escrow process, particularly as you process payments across so many countries? So that is one. And then the second question is just on advertising. And if you could talk about brand awareness, the success in your ad campaign thus far, and maybe how that ties to the adoption in the domestic marketplace. Thank you.

Sure. So I would say escrow, first of all, is really hard to do, and secondly, it is a huge competitive advantage. So I would say competitive advantage compared to what? So first of all, compared to traditional freelancing. So most freelancers at this stage do not work through an online platform like Upwork. We estimate in this study that I mentioned, Freelancing in America, we estimate that freelancers in the U.S. earned about $1.5 trillion last year. So obviously, online freelancing through Upwork and other platforms is only a small percentage of total earnings. If you ask traditional freelancers like what is their number one top-of-mind like problem, they would say getting paid. The number of freelancers who don’t get paid, get paid less than they expected, get paid late is huge. If you think about companies, companies treat freelancers like they treat their other vendors. The game of trying to push working capital off as far away in the future as possible, paying your freelancers like vendors, not like employees, is a huge issue. So compared to traditional off-line freelancing, this ability to know that you always get paid on time and you will always get paid the right amount is a huge part of the value prop. There is a separate question there, which is competitive advantage compared to other companies that might do what we do. And I would say the fact that we voluntarily decided to get regulated by the Department of Business Oversight, it’s a huge hurdle, it’s painful, it’s not easy to deal with having two sets of books and two annual audits and all of that stuff. It requires a level of precision in your numbers that is down to the penny, which, when you do $1.5 billion per year, is actually…

Great. Thank you.

Thank you. Our next question is from Scott Devitt from Stifel. Your line is now open.

Hi. Thanks for taking my question. Was just wondering with the state of the U.S. job market approaching full employment and more jobs being available than workers to fill them, how that may play into the corporate adoption curve for your services? Or just more generally how it may impact the business. Thanks.

Sure. I think our business – there’s two parts of our value prop that we will emphasize differently depending on where we are in the economic cycle. So in today’s economy, even though we provide cost savings compared to traditional ways of doing work, that is not the number one reason why most companies use us. People use us for access to talent. They use us for the ability to hire people much faster. A typical job in the U.S. right now stays open for 30 days. The median time to fill a job on Upwork today is less than a day. So there is that part of the value proposition is really important. I would say one thing that people tend to underestimate is there are a lot of people that are college educated, highly skilled, and whose skills and time is underutilized right now. And to give you just one data point: in that survey we just completed, Freelancing in America, one of the questions we have been asking in that survey every year is how much money would a traditional employer have to pay you in order to take a full-time job. And literally every year, the answer is 50% of people say no amount of money would get them to take a full-time job. These are people that are not accessible to you as an employer if you are just looking for full-time employees. This year, we went a little bit further and we were trying to understand like – this sounds crazy, right? How could 50% of survey respondents say that no amount of money could convince them to take a full-time job? And that just seems to defy common intuition here. So we asked additional questions to try to understand, like, what is driving this. Why would somebody really not consider a full-time job? And what we heard back is about 42% of respondents are saying they have things in their personal lives that prevent them from taking a full-time job. And typically, this was around physical and mental health. It was around care, either young children or elderly parents or a sick spouse, and geography. People live in a place in the country where there are no good economic opportunities and for one reason or another, they are unwilling or unable to move. And so that’s actually 42% of the freelance population that is saying, look, I am not available for a full-time job, but I am fully available for freelance job. So part of the answer to this full occupation economy and local skills gap is you need to open up new channels. You as an employer need to look at different ways of hiring people. And I think we can be a very powerful way of expanding the size of the labor force in an economy like this, where there are fewer traditional jobseekers than there are open full-time positions.

Thank you.

Thank you. Our next question is from Nandan Amladi from Guggenheim Partners. Your line is now open.

Hi. Good afternoon. Thanks for taking my question. So as you approach building out your network with the different types of skills that you have in the system, how do you decide whether to go broad in terms of expanding the types of skills versus deep, where you have like levels of expertise? And how do you decide what skills to add?

Sure. So maybe to start with your second question, I mean, we don’t really decide. In a way, it is our customers that decide for us. So ultimately there is some engineering work to enable new skills and new categories, but typically either people explicitly tell us, like, I have this skill and I think you should be adding it to the platform. Or I am looking for this skill and you should add it to the platform. Or the machine learning algorithms will pick it up themselves. Like literally, we will see keywords that seem to be skills that we don’t know about. And that gets brought up to a category manager within our Company who looks up at what is going on. And if that seems to be a meaningful trend and something that we think we should be supporting in the Company, then we add it to the product and make it available to the entire customer base. Now to answer the first part of your question, historically, we haven’t gone very deep. Historically, a skill on Upwork or a category on Upwork, if you will, is a label. So when you post a job, you can say this is a web development job and I require PHP as a programming language and I require MySQL as the database. And the machine did not particularly understand what MySQL meant or what PHP meant. Our categories initiative, which is a big multi-quarter product development for us, is around deepening and verticalizing the platform. I mean, fundamentally, the way you hire designers or the way designers promote themselves is radically different from the way you hire a strategic consultant or the way a strategic consultant markets themselves. So you are going to see us progressively have taxonomies that are truly structured where we really understand what these things mean. And from a user experience standpoint, you will see the experience for hiring for different types of roles be different as we verticalize parts of the site. Now, we can’t do this overnight across 70 categories and 5,000 skills. So you will see us do it in places where we think it is going to have the most impact, both because of the size of the category as it is today and the increase in value proposition that we think verticalization would bring.

Thank you.

Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.