Upland Software, Inc. (NASDAQ:UPLD) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Jack McDonald – Chairman and Chief Executive Officer
Mike Hill – Chief Financial Officer
Conference Call Participants
Jeff Van Rhee – Craig-Hallum
Jake Roberge – William Blair
John Messina – Raymond James
Operator
Thank you for standing by, and welcome to the Upland Software Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions 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 third quarter 2022 earnings release, which was distributed today at 4:00 p.m. Eastern Time. If you have not received the release, it’s available on Upland’s website.
I now would like to turn the call over to Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.
Jack McDonald
Thank you. Welcome to our Q3 2022 earnings call. I’m joined today by Mike Hill, our CFO. I’ll start with our Q3 results and provide some color around go-to-market and around product development. Following that, Mike will provide some insights on the Q3 numbers and on our guidance. After that, we will open the call up for Q&A.
But before we get started, Mike, could you please read the Safe Harbor statement?
Mike Hill
Certainly, Jack. During today’s call, we will include statements that are considered forward-looking within the meanings of the 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 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. 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 third quarter and year-to-date results, which are available on our Investor Relations section of our website.
Please note that we’re 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.
With that, I’ll turn the call back over to Jack.
Jack McDonald
All right. Thanks, Mike. So the headlines on Q3, we beat our guidance mid-points on both revenue and adjusted EBITDA, so beat the mid-points on both. And we outperformed on both even with an FX headwind in the quarter. We made a number of product announcements during the quarter, which I’ll talk more about in a moment. We continued during the quarter, our integration of two acquisitions that we made in Q1, Objectif Lune and BA Insight, and all of that is proceeding as planned.
We closed in the quarter a strategic equity investment from HGGC, and more on that in a moment. Cash on hand as of the end of the quarter, as of September 30, was just over $240 million, so a strong cash position. Our Q4 guidance, as Mike will talk about in a moment, remains unchanged in constant currency. We should see strong free cash flow generation in Q4, keeping us on pace for the $30 million to $40 million of free cash flow generation for 2022 that we have expected. And of course, that $30 million to $40 million of free cash flow is after absorbing acquisition-related expenses. And of course, we remain active in the market for additional acquisitions.
On the go-to-market side, in the third quarter, we expanded relationships with 305 existing customers, 28 of which were major expansions. We also welcomed 171 new customers to Upland in the third quarter, including 17 new major customers. The new customer deals were distributed across our products and industry verticals. In terms of the demand environment, we did see some lengthening of sales cycles in Q3. It remains to be seen whether this was a one-off.
In terms of products, a few announcements that I would highlight here. Our text messaging platform, Waterfall, announced that it expanded its SMS marketing footprint into the United Kingdom. Powering millions of text messages weekly, Waterfall enables brands to automate and schedule two-way SMS conversations and to use SMS as an effective channel for timely notifications and promotions.
In addition, BA Insight was recognized in KMWorld’s Trend-Setting Products of 2022 list, which features tried-and-true products that help enterprises address the challenges of modern knowledge management.
I want to offer a couple of thoughts on the HGGC equity investment and the value creation plan that we’ve been working on. On August 23, we closed a $115 million pipe investment from HGGC, which is a leading private equity firm.
They’ve got a proven track record of partnering with management teams to build shareholder value and a great track record in the software business and to drive growth. It was an attractive growth pipe priced at $17.50 per share on a convert, with a clean structure and a cash or pick dividend at our option.
We’ve been doing significant focused work internally and together with HGGC on a value creation plan. The key components of that plan include bringing more focus to our go-to-market product bundles and also putting more energy behind those products with higher growth potential.
This plan also includes continued investment in product, and we’ll be doing a lot of that through our India-based center of excellence that we’ve talked about previously, as well as some focused work on strengthening our marketing and demand generation. More to come on this as we go. Our team is excited and focused and energized. Personally, I’m a believer, and I personally bought, during the third quarter, roughly $1 million worth of Upland stock on the open market.
So with that, I’m now going to turn the call over to Mike.
Mike Hill
All right. Thank you, Jack. I’ll cover the financial highlights for the third quarter and our outlook for the fourth quarter and full year 2022. For the income statement, total revenue for the third quarter was $79.5 million, representing an increase of 5% year-over-year. Without the FX impact, growth would have been 7%. Recurring revenue from subscription and support increased 4% year-over-year to $75.1 million and without the FX impact, recurring revenue growth would have been 6%.
Perpetual license revenue increased to $1.7 million in the third quarter, up from $0.7 million in the third quarter of 2021. And professional services revenue was $2.8 million for the quarter, an 11% year-over-year decline. Overall gross margin was 68% during the third quarter. And our product gross margin remained strong at 69%, which is 73% when adding back depreciation and amortization, which we refer to as cash gross margin.
Operating expenses, excluding acquisition-related expenses, depreciation, amortization and stock-based comp were $33.7 million for the quarter, or 42% of total revenue, all generally as expected.
Now as we move into 2023, we expect our cost structure to increase by 2% to 3% of total revenue due to wage inflation. Also, acquisition-related expenses were approximately $3.6 million in the third quarter, which were in line with plan. Our third quarter 2022 adjusted EBITDA was $24.9 million, or 31% of total revenue, compared to $25 million or 33% of total revenue for the third quarter of 2021.
For cash flow, for the third quarter of 2022, GAAP operating cash flow was $1.9 million and free cash flow was $1.5 million, bringing year-to-date free cash flow to $23.4 million. As expected, we did have temporary timing differences in the working capital accounts, which temporarily lowered our free cash flow generation in Q3.
We should see strong free cash flow generation in Q4, still keeping us on pace for the $30 million to $40 million of free cash flow generation for full year 2022, even after absorbing acquisition-related expenses. This ongoing free cash flow generation is in addition to our existing liquidity of approximately $302 million, comprised of the $242 million of cash in our balance sheet as of September 30 plus our $60 million undrawn revolver.
As of September 30, 2022, we had outstanding net debt of approximately $282 million after factoring in the cash on our balance sheet. Our net debt leverage dropped to around 2.9 times based on the mid-point of our 2022 adjusted EBITDA guide.
I will note that the principal payments on our term debt are 1% per year or about $5.4 million per year, 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 levels.
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 $366 million of total tax NOL carryforwards. And of these, we estimate that approximately $211 million will be available for utilization prior to expiration. I will note that we still expect around $5 million of cash taxes per year.
Now for guidance. Let me start by saying that Upland’s forward guidance remains unchanged in constant currency. Since our last guidance was issued on August 3 of 2022, the U.S. dollar has strengthened, resulting in a larger FX headwind in the fourth quarter. The additional FX impact is estimated to be a 2.2% currency headwind on fourth quarter revenue growth and $0.5 million currency headwind on fourth quarter adjusted EBITDA.
The following adjusted guidance includes the impact of those FX headwinds in the fourth quarter. For the fourth quarter ending December 31, 2022, Upland expects reported total revenue to be between $74.1 million and $80.1 million, including subscription and support revenue between $69.2 million and $74.6 million, for growth in total revenue of 2% at the mid-point over the quarter ended December 31, 2021.
Fourth quarter 2022 adjusted EBITDA is expected to be between $22.9 million and $25.9 million, for an adjusted EBITDA margin of 32% at the mid-point. This adjusted EBITDA guide at the mid-point is a decrease of 3% for the quarter – from the quarter ended December 31, 2021. For the full year ending December 31, 2022, Upland expects reported total revenue to be between $312.6 million and $318.6 million, including subscription and support revenue between $292.9 million and $298.3 million, for growth in total revenue of 4% at the mid-point over the year ended December 31, 2021.
Full year 2022 adjusted EBITDA is expected to be between $95.7 million and $98.7 million, for an adjusted EBITDA margin of 31% at the mid-point. This adjusted EBITDA guide at the mid-point is an increase of 1% over the year ended December 31, 2021.
And with that, I’ll pass the call back to Jack.
Jack McDonald
All right. Thanks, Mike. Let’s open the call up for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question today comes from the line of Jeff Van Rhee with Craig-Hallum. Your line is now open.
Jeff Van Rhee
Great. Thanks for taking my questions. Just a couple. Jack, maybe just to circle back on the macro situation. Actually, most of comp called out sort of rapid pace of change during the quarter. Just circle back to that, any behavioral changes that were notable? It sounded like you were saying nothing definitive. I just wanted to circle back to that, if anything else jumped out at you.
Jack McDonald
Yes. Thanks. As I mentioned, in terms of the general environment, we did see some lengthening of sales cycles in the quarter. But at this point, really, it’s too early to say whether it was a one-off or not.
Jeff Van Rhee
Okay. Mike, I think you commented, I just want to make sure I heard it correctly. You talked about wage pressures, and I think you mentioned 300 basis points of pressure in 2023. Can you just hit that again? What were you saying there?
Mike Hill
Yes. You bet, Jeff. So we do expect structural cost increases due to wage inflation in 2023 to the tune of 2% to 3% of the total revenue.
Jeff Van Rhee
Got it. Okay. And then talk a bit about HGGC. Obviously, balance sheet’s in great shape. You talked about – the focus there going to be on a couple of things, sales execution or go-to-market and some products. And in particular, understanding it’s early, but I think you referenced sort of go-to-market bundles. Just talk about the early thinking on what might be changing there with respect to go-to-market.
Jack McDonald
Yes. I think I would summarize it as follows. We’ve been doing a lot of work together with HGGC and their operating advisors. They’ve been a really great team of folks to work with. And our management team here at Upland is super energized and excited. We are focusing on a number of different elements. One is bringing more focus to our go-to-market product bundles and really identifying those products that have a higher growth potential and putting more energy behind those.
And that will take a couple of forms, both in terms of more focused marketing and demand gen efforts and of course, the continuation of what we’ve been doing on the product side with investment in those products and doing a lot of that, as I mentioned, through our Indian Center of Excellence, although that’s obviously just one piece of our global staffing strategy where product is concerned. So it is early in the process, and there will be more to be said on this in subsequent quarters, but we’re very pleased with the partnership and the work thus far.
Jeff Van Rhee
Got it. Good [indiscernible] quarter. Thanks for taking the questions.
Operator
Your next question comes from the line of Jake Roberge with William Blair. Your line is now open.
Jake Roberge
Hey guys, congrats on the great results. So really strong quarter on the new customer front, adding 171 new logos to the platform. Was that driven by any specific product suite? Or is it more a result of your recent sales investments? Would love to get some more color on what’s driving that acceleration in new logos given, I think, the highest quarter in the last year or so was actually in the 130 range. So pretty big acceleration there.
Jack McDonald
Yes. I would say, as I mentioned, that our – the bookings were well distributed across products and across verticals. So I wouldn’t call out any specific area. We’re continuing to work on, as I say, sharpening our focus around higher-growth products and on driving additional – both expansion and new bookings of major customers, and so that work continues.
Jake Roberge
Great. Thanks. And then it sounds like there’s been a slowdown in sales cycles, but would love to hear how the pipeline has been tracking over the past few months. Are deals still entering the top of the funnel at a similar pace and cadence as before, but just taking longer to close now in this uncertain macro? I’d love to hear kind of what you’ve been seeing over the past few months.
Jack McDonald
Yes. I think without putting too fine a point on it, we saw a little bit of lengthening of sales cycles in the third quarter. And it’s really too early to tell whether that’s a one-off or not. But we’ll have more to say on it as we get into Q4. I mean we’re – the sales team is energized and working a number of opportunities. So we could see – so we’ll see whether the lengthening of sales cycles that we saw in Q3 is a one-off or not as we move further through the quarter.
Jake Roberge
Great. Thanks for taking my questions.
Operator
[Operator Instructions] Your next question today comes from the line of Alex Sklar with Raymond James. Your line is now open.
John Messina
Hi, thanks for taking the question. This is John on for Alex. Can you talk about how you’re thinking about the opportunity for your long tail of customers outside of your top 200 or so global accounts? I know they’re a much smaller contributor today, but I’m curious if you see any opportunity to retarget some of those customers moving forward. And then I have a quick follow-up.
Jack McDonald
Well, there have been a number of initiatives that we’ve rolled out in the past year. One that I would highlight with respect to smaller customers is introducing more self-service e-commerce capabilities for those accounts in order for those customers to both transact and the self-service. So yes, we’re trying to leverage technology to serve those customers in the most efficient way we can.
John Messina
Okay. Perfect. That’s helpful color there. And then just as a quick follow-up here, for Mike or for Jack. How are you thinking about pricing as a growth lever in the coming years? So obviously, you’re seeing the inflation, pressure on headcount expense, but any opportunity for some maybe outsized pricing increases on renewals moving forward?
Mike Hill
Well, yes. So John, we are – we have started rolling out price increases. Of course, it’s going to take a while. We’ve got an average 1.5 years customer contract term. So it takes a while to get to the renewal dates and have that – those price increases take hold. They’re not outsized, they’re sort of normal in the context of the macro environment that we see broadly with inflation. So anyway, it’s going to take a while to realize those, but nothing outsized.
John Messina
Okay. Thank you very much.
Operator
That was our last question for today. Back to you, Jack.
Jack McDonald
Great. Well, thank you, all, and we will see you on the next earnings call. Good afternoon.
Operator
This concludes today’s conference call. Thank you for attending. You may now disconnect.
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