Workiva Inc Q1 FY2020 Earnings Call

Thank you for joining us for the Workiva Inc. First Quarter 2020 Earnings Conference Call. I would now like to introduce your speaker for today, Adam Terese.

Good afternoon and thank you for joining us for Workiva's First Quarter 2020 Earnings Conference Call. Today's conference call is prerecorded. This afternoon, we'll begin with comments from our Chief Executive Officer, Marty Vanderploeg, followed by our Chief Financial Officer, Stuart Miller. A replay of this call will be available until May 7. Information to access the replay is listed in today's press release, which is available on our website under the Investor Relations section. Before we begin, I would like to remind everyone that during today's call, we'll be making forward-looking statements regarding future events and financial performance, including guidance for our second quarter and commentary on our full year 2020. These forward-looking statements are subject to known and unknown risks and uncertainties. Workiva cautions that these statements are not guarantees of future performance. All forward-looking statements made today reflect our current expectations only, and we undertake no obligation to update any statement to reflect the events that occur after this call. Please refer to the company's annual report on Form 10-K and subsequent filings for factors that could cause our actual results to differ materially from any forward-looking statements. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. Reconciliations of non-GAAP to GAAP measures and certain additional information are also included in today's earnings press release. With that, we'll begin by turning the call over to our CEO, Marty Vanderploeg.

Thank you, Adam, and thanks to everyone for joining the Workiva first quarter 2020 conference call. Our hearts go out to the people directly affected by COVID-19, and we are grateful for the essential workers and community leaders around the world who are on the front lines. At Workiva, we are doing everything we can to protect our employees and their families during this difficult time. We are grateful that all of our employees are able to work from home and that we are able to fully compensate the small number of employees who do not have roles outside of our physical offices. To keep our team connected and focused, I host a weekly live stream Q&A to offer updates, insights, advice, and support to all employees. As a cloud-based technology company with a highly distributed workforce, the shift to work from home has been smooth for us. With cloud platforms and digital channels, it's been mostly business as usual. We continue to deliver the highest levels of performance, availability, and security. Our technology, global infrastructure, and operating model, along with our 24/7 customer support, enable our customers to work from home in a controlled, secure environment with their most sensitive data. This ability to work from anywhere is becoming the new baseline. We believe that Workiva will be a key player in this broad-based shift to remote work, which will drive increased demand for our reporting and compliance platform for years to come. Workiva entered this global crisis from a position of financial strength. We believe we are in a stronger, more flexible financial position now than ever before, including nearly $500 million in unrestricted cash and short-term investments. We are pleased with our first quarter 2020 financial results, which exceeded guidance for revenue and operating results. However, like many other companies, the month of March delivered some unprecedented challenges as we saw a number of customers and prospects delay software purchases. In March, we restricted nonessential business travel, and we transitioned to all virtual sales meetings, even though our traditional sales process has been disrupted. In many cases, we are finding it easier to access people, and we are having engaging conversations with customers and prospects. In fact, most of the companies that delayed first quarter purchases are back in our pipeline. Stuart Miller, our CFO, will provide more details about our financial results later in the call. In times of rapid change, our commitment to each other and our customers remains the same. Workiva is driven by our values, which sustain us in these uncertain times. We are a strong, resourceful company, and we are moving forward, staying focused on our goals and objectives. We continue to execute on our growth vectors, which include EMEA, Wdata, and our platform solutions for integrated risk, global statutory reporting, and the U.S. government. And we are continuing to hire people in the areas where we see the most potential for growth. Despite COVID-19, we remain confident that Europe will comprise 25% to 30% of our total revenue over time. We recently launched a new solution to help mid-sized companies comply with the European Single Electronic Format, commonly known as ESEF. Our new solution offers limited functionality, specifically for this market. Because this solution resides on the Workiva platform, customers are able to upgrade to our more comprehensive ESEF solution and leverage additional platform capabilities at any time. We also plan to continue extending the capabilities of our platform into additional industry verticals. Earlier this week, we announced that we will be working with utility, pipeline, and other energy companies, many of which are existing customers, automating data integration and streamlining reporting to the Federal Energy Regulatory Commission, known as FERC. Last June, FERC adopted XBRL as its reporting standard. With our connected reporting platform and our leadership in XBRL, Workiva is ideally positioned to capture this market. In response to COVID-19, we shifted all marketing activities to virtual channels. As a result, our annual Amplify User Conference will be hosted virtually later this year. In March, our 2-day virtual event, Amplify GO, was attended by nearly 2,400 customers, prospects, and partners and was our largest event to date. I want to thank our amazing employees for their ongoing dedication and commitment to delivering our platform and supporting our customers and partners around the world. With that, let me turn it over to Stuart Miller, our CFO.

Thank you, Marty. I'll comment on our financial position, review our business model, and then explain at a high level why we beat our Q1 guidance. Next, I'll discuss Q1 2020 results versus Q1 last year and finish with forward guidance. We believe Workiva is well positioned financially to weather the storm from COVID-19. Indeed, we believe Workiva has never had a stronger or more flexible financial position than we do now. At March 31, Workiva had $496 million of unrestricted cash and short-term investments. The first maturity on our funded debt occurs in more than 6 years. Our debt obligations have no restrictive financial covenants. We believe our business model mitigates many of the challenges posed by COVID-19 for 6 reasons: first, demand for our solutions is relatively insulated from the business cycle. Software to assist larger enterprises with regulatory compliance and performance management is needed in both good times and bad. Second, our cloud-based platform is designed for team members to collaborate remotely, including those who work from home. On-premise systems cannot compete as well in this environment. Third, we enjoy high revenue retention rates because our customers love the design and functionality of our software and the high quality of our customer service. Our platform saves time, reduces risk, and eliminates many of the tedious aspects of financial and managerial reporting. We think our value proposition is compelling relative to alternatives and the markets we serve. Fourth, most of our customers pay us annually in advance for a subscription to our software platform. These contracts renew fairly evenly among the 4 quarters of the year. As a result, around 90% of the subscription revenue we recognize every quarter comes from deferred revenue. Fifth, no customer accounts for more than 1% of our revenue. Our 10 largest customers account for less than 5% of our revenue in the aggregate. Sixth, the sources of our revenue are diverse. But Note 8 to the financials in our 10-Q breaks out revenue contribution by industry of our customers. Shifting now to our financials. As always, I will talk about our results and guidance on a non-GAAP basis. Refer to our press release for a reconciliation of our non-GAAP and GAAP results and guidance. I'll talk about how well we did against guidance first. We beat Q1 2020 revenue guidance at the midpoint by $2.75 million. Higher subscription revenue accounted for about 1/3 of the beat, while higher services revenue contributed the balance. We beat guidance on Q1 operating income by a relatively wide margin. I'd like to explain the $8 million positive operating income swing at a high level. The revenue beat I just mentioned accounted for 1/3 of the swing. Expenses accounted for the remaining 2/3 of the beat, as follows: travel and entertainment expenses were just over $1 million better than forecast due to COVID-19 travel restrictions; medical care expenses were almost $1 million better than forecast due to postponement of discretionary medical visits from COVID-19 restrictions and a higher percentage of our employees electing the high deductible medical insurance plan; sales commission expense was about $0.5 million better than forecast due primarily to a change in our sales commission structure; fees paid to recruiters, consultants, and legal advisers were $0.5 million better than forecast. The remainder of the beat on Q1 operating income, just above $2 million, came from hiring at a slower pace than forecast, some of which was related to COVID-19. Now turning to a comparison of Q1 2020 to Q1 last year. We generated total revenue in the first quarter of $85.8 million, an increase of 22.6% from Q1 2019. Breaking out revenue by reporting line item, subscription and support revenue was $68.4 million, up 21.8% from Q1 2019. New solutions, new logos, and conversions to solution-based licensing help drive strong revenue growth in Q1 2020. 56% of the increase in S&S revenue in Q1 came from existing customers. The balance of the increase came from new customers added in the last 12 months. Professional services revenue was $17.4 million in Q1 2020, an increase of 26% from the same quarter last year. Growth was driven by helping customers migrate to inline XBRL, additional revenue and setup in consulting, and organic XBRL growth. As a reminder, the first quarter is seasonally the high point for our revenue from XBRL tagging since most of our publicly traded customers prepare their 10-Ks in the first quarter. Turning to our supplemental metrics. We finished Q1 with 3,507 customers, a net increase of 141 customers from Q1 2019 and a net decrease of 3 customers from Q4 2019. On a gross basis, 73 customers churned in Q1, which is a normal level of churn for us, and we added 70 new logos in Q1, which is below normal for us and was due to the impact of COVID-19. In early March, 50 new deals in our pipeline carried our highest rating for a probability to close by month end. Of the 50 deals, 10 did close in March, and 32 returned to the pipeline, of which 30 would have been new logos. Normally, a very high percentage of these types of deals would have closed by month end. Our revenue retention rates remained strong. Our subscription and support revenue retention rate was 94.5% for the first quarter of 2020 compared to 95.7% for the same period last year. Almost half of the attrition in the quarter came from M&A, delistings, and bankruptcies. Looking ahead, we expect a higher incidence of bankruptcies and delistings. On the positive side, we expect less pressure from M&A in the near term. With add-ons, our subscription and support revenue retention rate improved to 110.9% for the first quarter of 2020 compared to 110.7% in Q1 2019. Our progress with larger subscription contracts continues to be promising. The number of contracts valued at over $100,000 per year totaled 670 in the first quarter of 2020, up 36% from Q1 of the prior year. The number of contracts valued at over $150,000 totaled 308 customers in the first quarter, up 49% from Q1 2019 results. Moving down to P&L. Gross profit totaled $64.3 million in Q1, up 25.5% from the same quarter a year ago. Consolidated gross margin was 74.9% in the latest quarter versus 73.2% in Q1 2019, a net expansion of 170 basis points. Breaking out gross profit. Subscription and support gross profit totaled $56.6 million, equating to a gross margin of 82.9% on S&S revenue, a contraction of 30 basis points compared to Q1 2019. Additional headcount to help upgrade customers to our next-generation platform was the primary driver of the contraction. Professional services gross profit in the first quarter was $7.6 million, equating to a 43.7% gross margin compared to 32.7% in Q1 2019 due to improved utilization. Research and development expense in Q1 totaled $21.4 million, up 6.5% from Q1 2019, primarily due to higher compensation costs. R&D expense as a percentage of revenue improved to 25% in Q1 2020 from 28.7% in Q1 2019. Sales and marketing expense for the quarter increased 42.6% from Q1 2019 to $33.4 million, reflecting our investment in sales talent primarily to drive bookings in EMEA, integrated risk, global statutory reporting, and U.S. government. General and administrative expenses totaled $8.7 million in Q1, up $1.9 million compared to Q1 2019. G&A expenses as a percentage of revenue increased 40 basis points to 10.1% due to additional headcount, higher software expenses, and increased rent expense. We posted an operating profit of $800,000 in Q1 2020 compared to an operating profit of $900,000 in Q1 last year. Workiva's operating margin in Q1 was substantially better than our guidance, as I discussed earlier. Turning to our balance sheet and cash flow statement. At March 31, 2020, cash, cash equivalents, and marketable securities totaled $496 million, an increase of $8.1 million compared to the balance at December 31, 2019. In Q1 2020, net cash provided from operating activities totaled $4.7 million compared with cash provided of $5.1 million in the same quarter a year ago. At the end of each quarter, we review outstanding invoices to determine which ones present a collection risk due to a variety of factors, including credit risk, consistent with ASC 606. We remove the invoices at risk, taking the amounts out of both accounts receivable and deferred revenue until payment is collected, which is when we begin to recognize revenue. At March 31, 2020, we classified $6 million of receivables to this reserve account, up $1.7 million from the reserve at year-end in anticipation of the impact of COVID-19. The increase in this reserve account reduced deferred revenue by an equal amount, and therefore, it reduced billings at the end of the quarter. Remaining performance obligations on subscription contracts continue to vary from deferred revenue as we implement multiyear contracts with annual billing terms for some customers. Turning to our guidance. For the second quarter of 2020, we expect total revenue to range from $80.3 million to $80.8 million. We expect subscription revenue to grow at a rate in the low teens compared to Q2 last year. We expect services revenue to show the normal seasonal decline from Q1. And in addition, we expect to post Q2 services revenue below last year's Q2 results. You may recall, we had a one-time contribution to services revenue from a regulatory change in Q2 last year. We expect non-GAAP operating loss to range from $6.8 million to $7.3 million in Q2 2020. The depth and duration of the economic disruption from COVID-19 is unknown. While we have a large pipeline of new deals, we have limited visibility on when the deals will close. So we are suspending specific guidance for full year 2020. However, we are providing some directional guidance for the rest of the year. Relative to the guidance that we gave in February, we now expect full year 2020 revenue to grow at a slower pace and operating margin to improve.

We will now take your questions. Operator, we're ready to begin the Q&A session. And your first question will come from Brian Peterson with Raymond James.

This is Alex Sklar on for Brian. Marty, first one for you. This is in your prepared remarks, but can you just talk more about the resiliency of Workiva's platform in a work-from-anywhere environment? And with that, I think you talked about demand potentially picking up. Are you already seeing that in the current environment, catalyzing a greater number of conversations or leads? And then I had a follow-up for Stuart.

Adam, are you still online?

Your phone is muted, Marty.

Maybe I'll pass one for Stuart here while...

Yes, sorry, Marty's phone was muted.

Yes, okay.

Go ahead.

All right. Well, I guess, just talk about the visibility on the backlog. The RPO growth this quarter, especially in light of the commentary you gave on the March late-stage pipeline. Is there any reason from a Workiva standpoint that you wouldn't be able to implement or go live on any portion of that next 12-month balance? Understanding customers may ultimately push timing, but just curious on your own ability to meet all that backlog.

No, I don't think there's any restriction from our perspective on that. Most of the onboarding we do, or virtually all the onboarding we do, is remote anyway. Did you hear me, sorry?

Yes, yes. And then did we lose Marty on the first question?

Yes. I think he's trying to dial back in.

Okay. Well, maybe another one for you then, Stuart. On the backlog growth, it accelerated some even with the...

I'm sorry. Say that again?

The backlog growth has indeed accelerated for the full remaining performance obligations, not just for the next 12 months, which is impressive considering the comparison to last year's results. I'm interested to know if you could highlight any of your 4 to 5 growth opportunities as having made a significant impact.

Yes. To remind you about the RPO growth, part of it is due to our signing three-year deals with one year to pay, which is boosting the RPO. Additionally, we did experience significant deal size growth in Q1.

Next question is from the line of Rob Oliver with Baird.

It's Matt Lemenager filling in for Rob. The question pertains to the 32 deals that were either delayed or returned to the pipeline. Was there any common theme or message among them? I understand the impact of COVID, but was it primarily that spending in areas like the CFO suite or accounting suite was deprioritized as other IT trends took precedence? I'm curious if there were any consistent themes observed in those 32 deals that were pushed.

Let me check if Marty is still on, so I guess I'll place...

Can you guys hear me now?

Yes, we can now, Marty. You want to take that one?

Yes, it was correct. I wasn't connected, and I apologize for that because I could hear everything, including the same number of inquiries. Returning to the question about resiliency, when we launched the company in 2008, we were focused on cloud technology from the start, committing to a 100% web and cloud-based tool. Our customers have shared many positive experiences with this, especially as they adapt to working from home. While some were already engaged in remote work, everyone successfully met their needs using our product. Regarding leads, it's still too early to say definitively. However, we've noticed an increase in inquiries, especially since many of our competitors offer on-premise software. Though it's too soon to tell, I'm confident this will benefit us in the long run.

Marty, could you address Matt's question about the 32 logo deals that returned to the pipeline? Did you notice any patterns regarding why they were postponed?

Well, I would say this. The end of March, everybody was in a state of shock, and everyone was trying to understand how it was going to affect their cash flow. There were two categories to those from my perspective. One was industries that saw an immediate drop in cash flow like airlines or even credit card companies, things like that, obviously, hospitality, those were put on hold indefinitely, and we have several of those occur. The second category was, very prudent, CFOs saying, "Hey, let's just put the brakes on new deals, anything we're spending that's new for the next 2 or 3 months to see how this all shakes out." And most of the stuff that we saw slip was in that category where they're just being prudent in saying, "Let's see what's going to happen. Obviously, none of us have ever seen anything like this and how it affects the economy." That shock is sort of settling out now, and we're starting to see a lot of activity. So we're optimistic that things are going to slowly come back to normal in terms of our sales process.

That's helpful, Marty. My other question is regarding your sales quota-carrying team. Are you planning to make any adjustments, such as increasing the quotas they need to meet, considering that some of the close rates might not be as high? Essentially, to align with the numbers we initially anticipated, will there be any changes to the sales go-to-market strategy?

No, not yet. This is two months old, and we're now two months into this. We're not going to make any impulsive decisions. We're monitoring the situation closely. We're satisfied with our pipeline at this moment. However, since no one has experienced anything like this before, we can't predict how it will unfold. We do not plan on implementing any significant changes to our sales team, the size of their territories, or their quotas.

Your next question is from the line of Terry Tillman with SunTrust Robinson.

I appreciate the additional context you provided this quarter regarding sales activity and the pipeline. That was helpful. My first question pertains to the recent announcement about the change in sales leadership with Scott Ryan's resignation. It appears that Julie is assuming more responsibilities. I would like to understand more about the decision-making process behind this change and what prompted it. The press release mentioned broader sales leadership changes and an emphasis on sales efficiency, so I would appreciate any further details on what occurred and what drove this decision.

If you remember, when I became CEO just over a year and a half ago, I was also the acting Chief Operating Officer at that time. This change happened suddenly, and we knew we eventually wanted to appoint a new COO, which was our goal. This aligns with our desire to return to a traditional structure with a COO instead of a Chief Revenue Officer, as a company of our size clearly doesn't require both roles. We brought Scott on board to elevate our company from a transactional approach with smaller deal sizes. His role was to help us scale up in terms of talent, sales processes, and the skills of our sales team, and he succeeded in making significant improvements in that area. He also recruited additional managers and helped develop our existing managers while bringing in a leader for services during his time as CRO. Once Julie joined and found her footing, we recognized that we had an unnecessary extra layer and that we didn’t need both positions. Additionally, Scott expressed that he had been in sales leadership for quite some time and was looking for a short break, possibly to seek a new opportunity where he could replicate his successes with us. Thus, we mutually agreed on his departure and reached a joint agreement. We won’t be replacing him, as previously mentioned. A few other sales leaders have also left the company, and we believe we now have a very streamlined and effective sales management team. The excess layers were not necessary. Scott significantly advanced our positioning, and this was an opportune moment for organizational efficiency at the top.

Okay. Stuart, I have a follow-up question regarding the 111% revenue retention for the quarter. Can you provide some insight on what to expect for Q2? Additionally, although I understand you're not offering full-year guidance, what would you consider a reasonable estimate for revenue retention?

We do not provide guidance on that number. It reflects a buildup from add-on solutions and price increases, net of solution churn. We were satisfied with the number reported in Q1 and are optimistic about the pipeline of new deals, including both new logos and add-on sales. However, we do not have visibility on when these deals will close. In my previous remarks, I noted that we have strong visibility on revenue for Q2 due to our business model, which is why we felt comfortable providing guidance for that quarter. Until we have more clarity on the duration and impact of COVID, we won't have visibility on the closure of new deals at the end of Q2 or Q3.

Your next question comes from the line of Stan Zlotsky with Morgan Stanley.

This is Sarah on for Stan. Kind of following up on your prior comments. In the past, you viewed growth as being balanced between new logos and add-on sales. And I was wondering to what extent is this still kind of your growth equation? Or in reaction to COVID, are you seeing it leaning towards one or the other?

I really don't see a change there. I think we're still going to see about 50-50 of add-on sales and new logos. And I think that a lot of the new logo activity or more of it will be in Europe, but I still see a lot of new logo activity in North America as well. So we really think it's going to remain about a 50-50 clip.

Got it. And then a quick follow-up. Are you seeing any customers asking to come back and essentially downsize their contracts or adjust payment terms in reaction to your business reacting to COVID?

Yes, we haven't seen much of that, honestly. We are monitoring our renewal activity and keeping track of which industries might be affected. However, it hasn't been a significant issue so far.

Our next question is from the line of Tom Roderick with Stifel.

It's great to hear that everyone is doing well and the team is in good health. We have a solid starting point right now. I'd like to discuss the European expansion plans further. I apologize for the delay in joining the call, so I'm not sure if this was covered earlier, Marty. The opportunity in Europe still exists. I assume that your hiring efforts and consideration of potential M&A targets have likely been delayed a bit given your strong balance sheet. Could you provide more details on how you plan to move forward in a region where you may not have as much presence as desired? How will this impact your timeline, and what is the urgency from customers in that region to advance their digital transformations in light of the January 15, 2021 mandate?

Several aspects are at play here. First, the M&A activity has definitely slowed down. As I've mentioned before, we are being very cautious with acquisitions to ensure we secure opportunities that align with our priorities, but this process has indeed slowed. Our ability to recruit in EMEA remains relatively stable; we continue to successfully hire salespeople and delivery personnel. Although we are slightly behind, this is not due to COVID. Our EMEA team takes a thorough approach to hiring and has a proven track record of attracting high-quality talent with minimal attrition. This cautiousness is about ensuring we have the best people on board. Regarding our growth strategy in EMEA, we are moving forward without slowing down, and customer reception has been encouraging. Our pipeline is growing at the rate we expected, and we are satisfied with our progress in EMEA, viewing it as a significant opportunity for expansion since we entered the region later than others.

Yes, perfect. Got it. Now that you have fully accounted for the SBL impact in the model, and more importantly, your customers are now on this all-you-can-eat plan, how does this affect your thoughts on churn? With customers on this all-you-can-eat model, it seems that even if they have fewer employees, the number of seats they utilize might not decrease. So, I assume that churn would still be influenced by typical factors like bankruptcies and M&A, among other things Stuart mentioned. Can you discuss churn as a concept moving forward and how it might differ from the past now that all your customers are on SBL?

I don't believe SBL has a significant impact on churn. What we've observed is that customers, previously limited by the number of seats, have made more careful decisions regarding expansion. Recently, many customers have increased their seat count, leading to a noticeable rise in the number of users since the introduction of SBL. This makes our offering more attractive. I haven't detected a decline in end users, though that may occur as COVID progresses. It's important to note that our services are often regulatory in nature and essential for compliance. Our churn rate is something we're very proud of, as it contributes to remarkable stability in our financial model. Therefore, I'm not particularly worried about churn from the perspective of SBL, and I don't anticipate that companies intending to stay operational will view us differently post-COVID.

You have a question from the line of Mike Grondahl with Northland Capital.

This is Michael on for Mike. Maybe just one quick one on the FERC announcement yesterday. Can you give us a rough idea of just the number of logos in that space?

It's about 600, isn't it, Marty?

Yes. I think it's around 660, mostly involving larger companies. As we mentioned in the press release, many of these are existing customers who have been inquiring about this. We're noticing that customers are increasingly encountering XBRL globally for regulatory compliance. They want a unified platform to manage all their XBRLs. Many of our SEC customers have been persistently asking us about this, but we were hesitant to commit until FERC released their taxonomy a couple of months ago. After that, we conducted thorough due diligence to assess its impact on our products and market strategy. We are well positioned, as noted in the press release, to capture a significant share of that market.

And there are no other questions at this time.

Great. Well, thank you, everybody. We appreciate it.

Yes, I think we're done, Adam. Thank you.

Thank you again for joining today's conference call. You may now disconnect.