Earnings Call Transcript - UPLD Q2 2022

Operator, Operator

Thank you for standing by, and welcome to the Upland Software Second Quarter 2022 Earnings Call. At this time, all participants are in listen-only mode. Later, we will conduct a Q&A 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 second quarter 2022 earnings release, which was distributed today at 4 PM Eastern Time. If you've not received the release, it's available on Upland’s website. I'd now like to turn the call over to Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.

Jack McDonald, Chairman and CEO

All right. Thank you. And welcome to our Q2 2022 earnings call. I’m joined today by Mike Hill, Upland’s CFO. On today's call, I will start with our Q2 results, and then provide some color around go-to-markets and product developments. Following that, Mike will provide some insights on the Q2 numbers and our guidance. We'll then open the call up for Q&A. But before we get started, Mike, will you read the Safe Harbor statements?

Mike Hill, CFO

Yes. Thank you, 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 is contained in our annual report on Form 10-K as periodically updated in our quarterly reports on Form 10-Q filed with the SEC. The forward-looking statements made today are based on our views and assumptions and on information currently available to Upland management as of today. We do not intend to 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 second quarter 2022 results, which is available on the Investor Relations section of our website. Please note that we are unable to reconcile any forward-looking non-GAAP financial measures to their directly comparable GAAP financial measures because the information necessary to complete a reconciliation is unavailable at this time without unreasonable effort. And with that, I'll turn the call back over to Jack.

Jack McDonald, Chairman and CEO

All right. Thanks, Mike. Q2 was a strong quarter and here are the headlines. We beat our midpoints on revenue and adjusted EBITDA and we outperformed our plan on operating and free cash flow. I would note that we outperformed on both even with an FX headwind in the quarter. We generated in the quarter $13.9 million in free cash flow. We also had a good bookings quarter and I'll cover that in a little bit more detail in a moment. We announced in the quarter a host of product improvements including new releases for Altify and Objectif Lune, which are reflective of our increased commitment to innovation. We continued the integration of our two acquisitions from the first quarter, Objectif Lune and BA Insight, and all is proceeding as planned. We remain active in the market for additional acquisitions. After the quarter closed, we announced a strategic equity investment from HGGC. So let me dig in on those headlines as we go here. Around go-to-market, again, as I mentioned, Q2 was a good bookings quarter. In the quarter, we expanded relationships with 403 existing customers, and 53 of those were major expansions. We also welcomed 123 new customers to Upland in the second quarter, including 27 new major customers. New customer deals were well distributed across our products and industry verticals. We had a particularly strong expansion quarter across our products in Q2: Kapost, our content operation software platform; InGenius, our CRM phone integration product; Objectif Lune, our document composition and business communication automation product; and BA Insight, our AI-driven enterprise search product all had strong expansion quarters. Q2 was also a strong quarter for selling Premier Success Plans, which are subscription services packages that give our customers high fidelity support to help them be more successful. On the product side, we had a busy Q2 for product enhancements. Altify’s spring 2022 release introduced Altify Account Plan, which was a long-awaited capability that's been included for all account manager customers, enabling users to start working on assigned accounts directly from within account records inside Salesforce. Objectif Lune announced a series of customer-driven innovations and enhancements aimed at supporting complex business communications and digital transformation efficiency in their first major release post-acquisition. InGenius announced that its CRM telephony integration is now available as a premium application on the Genesys AppFoundry, which is the industry's largest dedicated marketplace focused on customer experience solutions. Additionally, on July 14, after the close of the quarter, we announced a $115 million PIPE private equity investment from HGGC, a leading $6.8 billion private equity firm. HGGC has a proven track record of partnering with management teams to build shareholder value and drive growth. This new HGGC partnership will help us strengthen our business and fully capitalize on the once-in-a-decade acquisition opportunity we see emerging as the recent turmoil in financial markets fundamentally reshapes funding and valuations for venture-backed cloud software companies. We announced on July 14 that Rod Favaron will be stepping down as President, effective August 31st. Rod made his decision for personal reasons, and I want to thank Rod for his service and wish him the very best. A few additional points on the HGGC announcement: this is an attractive growth PIPE priced at $17.50 per share with a clean structure and cash or pick dividends at the company's option. This investment validates the Upland business model and our platform, coming as it did from a smart software investor following rigorous strategic, operational, and financial diligence. This is a partnership with a major private equity firm that will help us build long-term value, with support for strengthening our go-to-market efforts. We believe HGGC is the right partner; we've known them for multiple years and they've had great success in supporting software companies, particularly M&A-driven platforms like IDERA and Health Systems, which have similar models to Upland. More about our value creation plan with HGGC will be shared later in the year. Lastly, I want to note that pro forma for the HGGC investment, our cash on hand will be $248.3 million, together with our nearly $100 million in annual adjusted EBITDA, and our attractive long-term credit facility form a robust foundation for growth. With that, I'm going to turn the call over to Mike.

Mike Hill, CFO

Thank you, Jack. I'll cover the financial highlights for the second quarter and our outlook for the third quarter and full year 2022. Total revenue for the second quarter was $80.2 million, representing a 5% year-over-year increase. Without the FX impact on Q2 growth would have been 8%. Recurring revenue from subscription and support increased 4% year-over-year to $75 million; without the FX impact, recurring revenue growth would have been 6%. Perpetual license revenue was $1.9 million in the second quarter, up from $0.4 million in the second quarter of 2021. Professional services revenue was $3.4 million for the quarter, a 3% year-over-year decline. Overall gross margin was 67% during the second quarter, and our product gross margin remained strong at 69%, or 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 compensation were $34.5 million for the second quarter, or 43% of total revenue, generally as expected. Acquisition-related expenses were approximately $4.9 million in the second quarter, in line with the plan. Our second quarter 2022 adjusted EBITDA was $24.5 million, or 31% of total revenue, up from $23.7 million, or 31% of total revenue for the second quarter of 2021. For second quarter 2022, GAAP operating cash flow was $14 million, and free cash flow was $13.9 million. We are successfully generating substantial GAAP operating cash flow and free cash flow even after acquisition-related expenses. We're targeting $30 million to $40 million of free cash flow for the full year 2022. This ongoing free cash flow generation, in addition to our existing liquidity of approximately $198 million, which consists of approximately $138 million of cash on our balance sheet as of June 30, 2022, plus our $60 million undrawn revolver, is healthy. Additionally, as Jack noted, we expect to close on a new $115 million PIPE transaction in the coming weeks, which will increase our liquidity further to around $308 million. As of June 30, 2022, we had outstanding net debt of approximately $387 million, after factoring in the cash on our balance sheet. After our new $115 million PIPE closes in the coming weeks, our net debt should drop to around $277 million, and our net leverage should decrease to around 2.8 times based on the midpoint of our 2022 adjusted EBITDA guidance. The principal payments on our term debt are approximately 1% per year, 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%, which makes our annual cash interest payments approximately $30 million at our current debt level. Additionally, 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 carry forwards, of which we estimate approximately $211 million will be available for utilization prior to expiration. We still expect around $5 million of cash taxes per year. Now for guidance. Upland's forward guidance remains unchanged in constant currency. Since May 4, 2022, the U.S. dollar has strengthened, resulting in a larger FX headwind in both Q3 2022 and full year 2022. The total impact is estimated to be approximately 1.5 percentage points of currency headwind for 2022 revenue growth and a $1.5 million currency headwind for 2022 adjusted EBITDA. The following adjusted guidance includes the estimated FX headwinds in the period. For the quarter ending September 30, 2022, Upland expects reported total revenue to be between $75.7 million and $81.7 million, including subscription and support revenue between $70.8 million and $76.2 million, translating to a growth in total revenue of 3% at the midpoint over the quarter ended September 30, 2021. Third quarter 2022 adjusted EBITDA is expected to be between $23.2 million and $26.2 million for an adjusted EBITDA margin of 31% at the midpoint. This adjusted EBITDA guidance at the midpoint marks an increase of 1% from the quarter ended September 30, 2021. For the full year ending December 31, 2022, Upland expects reported total revenue to be between $310.5 million and $322.5 million, including subscription and support revenue between $290.4 million and $301.2 million, marking a growth in total revenue of 5% at the midpoint over the year ended December 31, 2021. Full year 2022 adjusted EBITDA is expected to be between $94.5 million and $100.5 million for an adjusted EBITDA margin of 30% at the midpoint. This adjusted EBITDA guidance at the midpoint is an increase of 1% over the year ended December 31, 2021. With that, I'll turn the call back over to Jack.

Jack McDonald, Chairman and CEO

All right. Thanks, Mike. Let's open the call up for questions.

Operator, Operator

Thank you. Our first question today comes from Scott Berg from Needham. Your line is open. Please go ahead.

Michael Rackers, Analyst

Hi, everyone. This is Michael Rackers, and I'm on for Scott Berg. Thanks for taking my question today. Could you just go a bit deeper on the cross-selling and expansion success within existing customers? Considering the strong quarter for customer expansions, maybe just a bit more on which modules are seeing strength and where?

Jack McDonald, Chairman and CEO

Yes. The investments we've made in go-to-market over the past couple of years, particularly focusing our global account managers on our Diamond accounts, our top 175 accounts with an eye toward driving more cross-sell, have created some good momentum there. As I look at the quarter, I'd call out the strong expansion activity as really the area where we saw the best traction. In my opening remarks, we saw some great expansion traction in Kapost, in InGenius, in Objectif Lune, and in BA Insight. So that's where we saw the best motion in the quarter.

Michael Rackers, Analyst

Great. Thank you. And then just one more. Are there any specific products or regions where you're seeing a bigger macro impact or any additional headwinds just with the macro environment we're facing today?

Jack McDonald, Chairman and CEO

No.

Michael Rackers, Analyst

Great. Thank you.

Operator, Operator

Our next question comes from Terry Tillman from Truist Securities. Your line is open.

Unidentified Participant, Analyst

Great. Thanks for taking the question. This is Robert on for Terry. I was hoping to delve deeper into the HGGC partnership. What kinds of benefits do you see accruing on the go-to-market side specifically with their expertise, and when can we start to see some of that benefit accrue? Thanks.

Jack McDonald, Chairman and CEO

Yeah. We think that HGGC is a very strong partner for us. We love the terms of the PIPE that we put together at a substantial premium to the market. I think it's a real validation of our business and our operating model coming after rigorous diligence. When you look at their track record, HGGC has a long history of investing successfully in software companies, bringing deep expertise, experience, and resources in both M&A driven value creation as well as driving go-to-market improvements. They've executed 20 software platform transactions with 65 add-on investments totaling around $15 billion. These businesses range from high organic growth companies to M&A platforms. We are engaged in building a value creation plan with HGGC and will be talking more about that later in the year. Additionally, pro forma for that investment, we will have roughly $250 million in cash.

Unidentified Participant, Analyst

That's great. Thanks again.

Operator, Operator

Our next question comes from Jeff Van Rhee with Craig-Hallum Capital Group. Your line is open. Please go ahead.

Aaron Spychalla, Analyst

Hey, guys. This is Aaron on for Jeff. I appreciate you taking the question. First one, maybe for Mike, should look at the guidance. If you take the midpoint of Q3 and then back in the midpoint of Q4, it's essentially flat sequentially from Q3 to Q4. So just talk to me a little bit about the puts and takes of what went into that and kind of confidence around growing sequentially through the back half of the year?

Jack McDonald, Chairman and CEO

Yeah, Aaron. Thanks for the question. We're always conservative on guidance, so I think most of that is just being conservative on the out quarter in terms of sequential flatness. The guidance has only been changed for FX impacts. So that's really the essence of the situation.

Aaron Spychalla, Analyst

Got you. That's helpful. Can you share if there have been any changes in your investment strategy? There's been significant focus on R&D and product development recently, so please discuss how you plan to balance product development with sales in your go-to-market strategy moving forward.

Jack McDonald, Chairman and CEO

I'd say no major changes there just yet. We have increased our commitment to innovation. We've made additional investments in go-to-market. We're looking at several items with HGGC right now, and I will have more to say about our value creation plan later in the year.

Aaron Spychalla, Analyst

Perfect. That's helpful. And then last one if I can sneak one more in. Just curious if anything has changed in the pipeline, any color you can give as far as new versus expansion going forward, the size of customers, anything like that?

Jack McDonald, Chairman and CEO

I think if you look at the results in Q2, it was a kind of current course and speed quarter, good bookings, no major deviations from what we've been delivering. The team is excited and executing in Q3, so I would say nothing to highlight beyond the continuation of what we've been doing.

Aaron Spychalla, Analyst

Awesome. That's it for me. Appreciate it, guys.

Operator, Operator

We now turn to Jake Roberge from William Blair. Your line is open. Please go ahead.

Jake Roberge, Analyst

Thank you for answering my questions. Could you elaborate on your observations regarding the macro environment, specifically in relation to customer buying patterns? Have you noticed any deals being delayed due to macro factors, or has it largely been business as usual? The fact that there have been over 400 expansions is unprecedented, which is fantastic. I would appreciate more insights on what you're experiencing in the macro landscape.

Jack McDonald, Chairman and CEO

Nothing to call out right now. We're obviously monitoring that in this kind of environment, but I wouldn't highlight anything specific.

Jake Roberge, Analyst

Okay. Great. And then could you talk a little bit more about your M&A pipeline? There's been a lot of turbulence in the public markets and valuations coming down. Are you seeing more businesses enter the top of the funnel, or do you think we're still a few quarters before companies really start to explore that acquisition path and before VC funding drives more of that? Upland can capitalize on that macro volatility.

Jack McDonald, Chairman and CEO

You make a great point; what's gone on in the public markets will seep into the funding environment and valuation environment for VC-backed cloud software companies. We've all seen the headlines around that. I've lived through this cycle before, and there's always some delay in terms of the public market's sound echoing into the private market. However, we think there will be a once-in-a-decade opportunity here, and we are well-capitalized to pursue it. The pipeline looks good, but we will be patient and control the timing to execute when and where it makes sense.

Jake Roberge, Analyst

Sounds great. Thanks for taking my questions, and congrats on the great quarter.

Operator, Operator

We now turn to Alex Sklar from Raymond James. Your line is open. Please go ahead.

Alex Sklar, Analyst

Thanks, Mike. Really strong cash generation again this quarter. As far as the guidance goes, $30 million to $40 million. Does that contemplate additional M&A, or should we think about that being a floor, and it could be higher absent any additional deals?

Mike Hill, CFO

Yeah, Alex. So last year, we generated a little over $40 million of free cash flow. This year, we're expecting the same. We did $8 million in Q1, and $14 million in Q2, for a total of $22 million year-to-date. So targeting $30 million to $40 million seems appropriate. We're aiming for the upper end of that range, and it is possible we could exceed it. It’s too early to tell, considering timing differences and working capital accounts. The guidance does not assume future acquisitions, as we wouldn't know the timing or size of those.

Alex Sklar, Analyst

Okay. Thank you. Very helpful. And then Jack, following up on some go-to-market questions, have there been any changes in the sales organization following Rod’s departure? What should we expect going forward in terms of the overall structure of that team?

Jack McDonald, Chairman and CEO

Yeah. We've got a team in place that is energetic. I was on a bookings call with our team this morning, and the leadership there remains very strong. The team is excited and pursuing the opportunities ahead. We see an opportunity with HGGC to leverage their support and insights to enhance our go-to-market efforts, making our existing team even more successful. We'll provide more updates later in the year.

Operator, Operator

Our final question comes from Brent Thill from Jefferies. Your line is open. Please go ahead.

Luv Sodha, Analyst

Thank you for taking my questions. This is Luv Sodha on for Brent Thill. Following up on the go-to-market question, is the cross-sell motion still a top priority? Could you discuss the GAMs and the productivity and investment there?

Jack McDonald, Chairman and CEO

If you look at Upland's sales motion, expansion is crucial through our customer success organization and through our product Account Executives (AEs), and our Global Account Managers (GAMs). There are no significant changes; we are executing our current plan.

Luv Sodha, Analyst

Got it. One quick one for Mike. A lot of the companies we cover are embedding more conservatism given the macroeconomic environment. Are you embedding additional conservatism into your guidance?

Mike Hill, CFO

Yeah, Luv. Of course, we've always tried to be conservative with our guides, and we remain so. So there is a typical amount of Upland conservatism in our guidance.

Luv Sodha, Analyst

Got it. And one last question on the HGGC investment. Given the healthy cash position and the free cash flow generation, could you talk through the rationale of doing the raise at these levels?

Jack McDonald, Chairman and CEO

We're incredibly excited to have HGGC take a significant stake in Upland. This is an attractive growth PIPE, priced at $17.50 per share, which is at a significant premium to our current price. It has a clean structure with cash or pick dividends at our option. It validates our business model and establishes a partnership with a firm capable of helping us build long-term value with a strong track record in supporting software investments. We believe we have the right partner to support our growth and enhance our go-to-market strategy. The investment will provide us with $250 million of cash, reduce our leverage to 2.8 times, and coupled with our cash flow and attractive credit facility, give us a strong financial foundation for executing our anticipated M&A opportunities over the next couple of years.

Luv Sodha, Analyst

Got it. Thank you.

Operator, Operator

This concludes our Q&A. I'll now hand back to Jack McDonald, Chairman and CEO for final remarks.

Jack McDonald, Chairman and CEO

Okay. Well, thank you very much, and we will see you on the next earnings call.

Operator, Operator

Today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines.