Workiva Inc Q2 FY2020 Earnings Call

Good afternoon, ladies and gentlemen. My name is Catherine, and I will be your host operator on this call. After the prepared comments, we will conduct a question-and-answer session. Instructions will be provided at the time. Please note that this call is being recorded on August 4, 2020, at 5:00 p.m. Eastern Time. I'd now like to turn the meeting over to your host for today's call, Adam Terese, Director of Investor Relations at Workiva. Please go ahead.

Good afternoon, and thank you for joining us for Workiva's second quarter 2020 conference call. Today's call has been prerecorded and will include comments from our Chief Executive Officer, Marty Vanderploeg; followed by our Chief Financial Officer, Stuart Miller. We will then open the call up for a live Q&A session. Jill Klindt, our Chief Accounting Officer will also be on the call. A replay of this webcast will be available until August 11. 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 the third quarter and full fiscal 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 press release. With that, we'll begin by turning the call over to our CEO, Marty Vanderploeg.

Thank you, Adam, and thank you to everyone for joining today's call. Despite challenges from the COVID-19 pandemic, we are pleased with our second quarter 2020 financial results, which exceeded guidance for revenue and operating results. Our results reflect our employees' resiliency and their dedication to our customers. Our sales and marketing teams have successfully transitioned to a virtual environment, and we now have greater visibility into the second half of the year. As a result, we are reinstating full year guidance, which is close to our pre-pandemic full year guidance for revenue. Stuart will provide further details about our financial results and outlook later in the call. In Q2, demand for our platform improved across all of our growth vectors, which include EMEA, Wdata, and our platform solutions for Integrated Risk, Global Statutory Reporting, and the U.S. Government. Our partnerships with technology companies and advisory firms remains an important catalyst for our long-term growth. We are proud that three of the four largest advisory firms in the world are now Workiva partners. Customers are embracing our new platform's capabilities as we further streamline their complex business and reporting processes by connecting teams, documents, and data from initial sources to final reports. Our new platform also increases our flexibility and speed when developing new solutions, enabling us to enter more markets faster than ever. For example, our FERC reporting and ESEF solutions were both launched on the new platform. After identifying the opportunity, we quickly moved from concept to launch within a few months. Developing and delivering new solutions on our platform will continue to be a key driver of our success. As we discussed last quarter, we switched to virtual marketing events in response to COVID-19. We have been pleased with the large attendance at our virtual events and the number of sales leads generated. Next month, we will host our Annual Amplify Global User Conference virtually. This year's timely theme is 'Building trust in business data and supporting business continuity in an age of transformation.' Over 4,500 people have already registered to attend. At Workiva, culture is a key driver of our success. Every day, whether we are in our offices or working remotely, our employees create an award-winning workplace that attracts and retains top talent. Recently, Computerworld named Workiva one of the 2020 Best Places to Work in IT. And Fortune named us a 2020 Best Workplace in New York. In closing, we are pleased with our second quarter results and our team's ability to effectively execute during this challenging time. We remain well positioned and confident in our ability to capitalize on the many opportunities that lie ahead of us. With that, I will turn it over to Stuart Miller.

Thank you, Marty. Following the initial shock of COVID-19 in March, we began to see a more predictable cadence to closing deals particularly in June and into July suggesting that our customers and prospects are settling into a new normal. I want to highlight one market development related to COVID-19, the Financial Conduct Authority or FCA that the U.K. regulator has opened a consultation on whether it should delay the initial ESEF reporting deadline by a year. While the comment period lasts another month, we expect the FCA to approve the delay for U.K. companies. Of the 5,300 companies affected by the ESEF mandate, approximately 1,400 are headquartered in the U.K. Our expectation of a delay of the mandate for the U.K. market has had no material impact on our outlook for EMEA. Now turning 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 address our performance against Q2 guidance first. We beat Q2 2020 revenue guidance at the midpoint by $3.3 million. Higher subscription revenue accounted for most of the beat. We succeeded in collecting a high percentage of the receivables that we had held in reserves at the end of Q1. The pandemic had less of an impact on collections than we had anticipated in March. We beat guidance on Q2 operating income by more than $5 million. The revenue beat I just mentioned accounted for two-thirds of the swing. Lower employee travel and entertainment and medical care expenses accounted for the remaining one-third of the beat on operating income. Now turning to a comparison of Q2 2020 to Q2 last year. We generated total revenue in the second quarter of $83.9 million, an increase of 14.1% from Q2 2019. Breaking out revenue by reporting line item, subscription and support revenue was $70.7 million, up 16.9% from Q2 2019. New logos and new solutions helped drive strong revenue growth in Q2 2020. Fifty-three percent of the increase in S&S revenue in Q2 came from new customers added in the last 12 months. The balance of the increase came from companies who have been our customers for more than a year. Professional services revenue was $13.2 million in Q2 2020, an increase of 1.2% from the same quarter last year. Growth in revenue from setup and consulting overcame a small decrease in XBRL services relative to Q2 last year. Turning to our supplemental metrics, we finished Q2 with 3,512 customers, a net increase of 91 customers from Q2 2019 and a net increase of five customers from Q1 2020. The average annual contract value of the new logos signed in Q2 2020 was 34% higher than the same value for a churn account in Q2. Our revenue retention rates remained strong. Our subscription and support revenue retention rate was 94.5% for the second quarter of 2020 compared to 95.4% for the same period last year. Almost half the attrition in the quarter came from M&A, delistings, and bankruptcies. With add-ons, our subscription and support revenue retention rate was 107.9% for the second quarter of 2020 compared to 114.5% in Q2 2019. The decline reflects winding down conversion of customer contracts to solution-based licensing as well as pandemic-related impacts on both price increases and solution churn. We continue to increase our number of larger subscription contracts. In the second quarter of 2020, we had 716 contracts valued at over $100,000 per year, up 28% from Q2 of the prior year. The number of contracts valued at over $150,000 totaled 342 customers in the second quarter, up 44% from Q2 2019 results. Moving down the P&L, gross profit totaled $62.4 million in Q2, up 16.4% from the same quarter a year ago. Consolidated gross margin was 74.4% in the latest quarter versus 73% in Q2 2019, a net expansion of 140 basis points. Breaking out gross profit: subscription and support gross profit totaled $59 million, equating to a gross margin of 83.5% on S&S revenue, a contraction of 30 basis points compared to Q2 2019. Additional headcount to help upgrade customers to our new platform was the primary driver of the contraction. Professional services gross profit in the second quarter was $3.4 million, equating to a 25.7% gross margin compared to 22.8% in Q2 2019. Research and development expenses in Q2 totaled $21.5 million, up 7.6% from Q2 2019, primarily due to higher compensation costs. R&D expense as a percentage of revenue improved to 25.6% in Q2 2020 from 27.1% in Q2 2019. Sales and marketing expenses for the quarter increased 23.5% from Q2 2019 to $32.3 million, primarily reflecting our investment in sales talent to drive bookings growth. General and administrative expenses totaled $10.5 million in Q2, up $3.1 million compared to Q2 2019. G&A expenses as a percentage of revenue increased 240 basis points to 12.5% due to severance costs, additional headcount, and higher software expenses. We posted an operating loss of $1.9 million in Q2 2020 compared to an operating profit of $86,000 in Q2 2019. Workiva's operating margin in Q2 was better than our guidance as I discussed earlier. Turning to our balance sheet and cash flow statement, at June 30, 2020, cash, cash equivalents, and marketable securities totaled $509 million, an increase of $12.5 million compared to the balance at March 31, 2020. In Q2 2020, net cash provided from operating activities totaled $7.1 million, compared with cash provided of $18.8 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 and take the amounts out of both accounts receivable and deferred revenue until payment is collected, which is when we begin to recognize that revenue. At June 30, 2020, we classified $5.6 million of receivables to this reserve account, up from $3.2 million of receivables at June 30, 2019. This reserve account reduced deferred revenue by an equal amount and therefore reduced billings at the end of the quarter. Remaining performance obligations on subscription contracts continue to vary from deferred revenue as we implement multi-year contracts with annual billing terms for some customers. Turning to our guidance. As Marty indicated, we are reinstating guidance for full year 2020 based on improved visibility on new business, both pipeline and deals closing. Our new full year guidance is close to our pre-pandemic full year guidance on revenue and substantially improved on operating loss. We are factoring in the expected impact of COVID-19 on our business and results of operations based on information available to us today. For the third quarter of 2020, we expect total revenue to range from $84.3 to $84.8 million. We expect subscription revenue to grow at a faster rate than services revenue in Q3. We expect non-GAAP operating loss to range from $5.2 million to $5.7 million. For the full year 2020, we expect total revenue to range from $341.5 million to $342.5 million. We expect non-GAAP operating loss to range from $11.5 million to $10 million. We will now take your questions.

And your first question comes from the line of Tom Roderick with Stifel.

Gentlemen, thank you for taking my questions. Congratulations on a great finish to what was starting out to be a tough quarter. So well done on that. I guess, I want to go back to 90 days ago and you – Marty you had talked about a number of deals I think at the time there were some 50 deals that had kind of slipped out of closures and into the next quarter, 40 of them were kind of put back in the pipeline maybe 32 were put back in the pipe. But regardless, it was a pretty big number. Would love to just hear about what you did with the sales team? Any strategic changes? Any splits you put in place? What did you do in terms of getting the sales team to help close those deals? And then as you look at the pipeline, I'd love to hear a little bit more about what you're doing also to replenish the pipeline. Since it sounds like a lot of those deals did in fact close this quarter close rates are up. But talk a little bit about more of the pipeline replenishment as well. Thanks.

Well, good question. The first comment I would say is that, of those deals that slipped first quarter, we had a pretty typical distribution. A number of those closed, a number of those are still in the pipe for this quarter and potentially next quarter. And some went away. I mean, the examples, the really – the industries that are still suffering from COVID-19, hospitality, airlines, things like that. Those deals are not going to come back anytime soon. So, we saw – we didn't – one category didn't sort of outpace the rest, but we closed some, some slipped, and some are on long-term hold for sure. In terms of our sales team pivoting to virtual selling, we've really been pleased with that not only in closing deals but building pipe. And when you take into consideration a certain percentage of the economy is damaged and you really can't sell those industries. I mentioned previously, the rest of the economy is really, as Stuart said, come back to a new normal, and we're seeing pipe building very similar to we did in the past. And the closure rate is also coming back to sort of the normals before COVID. So, with the exception of those damaged industries or I should say stressed industries for the time being, we're seeing things sort of normalize and come back to normal. So things look pretty good from three months ago. The shock definitely affected everybody. And – but now after some time has settled in, we're just seeing normalcy sort of returning.

Yes. That's great to hear Marty. Thanks for that. Stuart you mentioned, Europe just a little bit – in your comments you referenced, the FDA evaluating a one-year delay. I guess, what I'd love to hear is how are your customers and potential customers over in Europe thinking about this ESEF mandate? I know that it was meant to be sort of a multiphase implementation anyway. So, it wasn't like a Y2K event where you either did it by January 15 or you didn't. Do you think that this FCA evaluation slows down the pipeline in the U.K., or is it sort of irrelevant where customers are thinking about digital transformation anyway and you're still ramping your own build over there in terms of sales headcount and marketing spend to improve awareness?

Yes, that's a great question. As we've mentioned before, we are using the ESEF mandate not to promote a specific solution, but to engage with the right people upfront to sell the platform. We are experiencing significant success in this approach. Therefore, we do not believe that any potential delay from the FCA regarding ESEF will hinder our progress. In fact, we have already gained substantial traction in those accounts and expanded the discussions beyond ESEF. As I noted earlier, this situation has not impacted our forecasts and has not affected our staffing levels.

Outstanding. I’ll jump back in the queue, but thank you guys. Nice job.

Thanks, Tom.

Thanks.

Your next question comes from the line of Alex Sklar with Raymond James.

Thanks. Stuart, just a question retention held really strong in Q2, but I was wondering if you could characterize the step down in the add-on revenue. How much of that is just math around the lapping of SBL?

Yes. Certainly, it was a combination of SBL and not taking price increases particularly for companies that were renewing and industries affected by COVID. And then a bit of solution churn, particularly from companies that were affected by COVID. Specifically, it's hard to isolate SBL. But as we've said in the past, it accounted for probably a couple of hundred basis points of the move.

Okay. Great. Thanks. And then Marty you mentioned in the prepared remarks, the partner channel you highlighted three of the top four global consulting partners. I'm just curious if you see any changes in terms of partner involvement in deals or partner resources being devoted to Workiva versus prior quarters?

Yes. We're really happy with our partner activity right now. Our partners are starting to recognize that not only can they make money deploying our solution and advising customers on how to use it, they can also build a real practice around it. And so, we're seeing a lot of our partners, not just the big ones taking us very seriously and engaging with their clients. So that's been a really positive thing for us. And like we've said all along, it takes a while to build that momentum, but we're really seeing it pay off now.

All right. Great. Thank you.

Thanks, Alex.

Your next question comes from the line of…

Hello, everyone. This is Nick filling in for Terry. I appreciate the opportunity to ask a few questions. My first question is about the ESEF mandate opportunity. Could you provide an update on how discussions are going with both larger organizations and smaller market segments regarding the W for ESEF solution? Additionally, are you noticing any changes in the competitive landscape in EMEA?

Let me start just by saying that, echoing what Stuart said, the ESEF is sort of one of the mechanisms we used to get to customers and to talk to them. We've had a lot of engagement over ESEF. We are starting to close deals on the bottom two-thirds of the market. And on the high end of the market, the top one-third where we sell platform sales, not our scaled-down product, we haven't seen any effect there. Those are large companies. They're making platform-type investments to satisfy more than just ESEF. They may be doing SEC in there. They may be doing all sorts of different types of compliance and internal reporting things. And so it's been a nice entry into those big companies, and I haven't seen any change I don't expect any, but it's going very well. On the bottom two-thirds of the market, we're getting really good engagement. And, like I said, we're starting to close some business. And again, there's a certain percentage of those companies that are going to carry on no matter what. They want to get it handled. They want to comply and be good citizens. So we've had good luck engaging, and we don't see this delay in the U.K. really affecting our advancement in the market.

Got it. Okay. That's helpful. And then, I guess, just kind of pivoting more towards go-to-market. With the hire of Julie is earlier this year, I was wondering if you guys could potentially touch on some of the operational enhancements she's put in place? And if these enhancements are leading to increased efficiencies in certain areas of the organization? Thanks.

Sure, I'm happy to respond to that. Julie has been an excellent addition to our company, bringing significant operational discipline. As I mentioned in the last call, I was attempting to manage two roles, but it wasn't as effective as it could have been. With her operational discipline and a stronger focus on metric-driven decision-making, we've concentrated on shaping our go-to-market strategy, particularly in how we communicate our value. We've invested considerable time in this area, and Julie has excelled at it. We believe her contributions will definitely enhance both sales and go-to-market efficiency. I would have more insights to share if it weren't for the impact of COVID. However, from what I've observed within the company, things are progressing very well.

Got it. Okay. Thanks, guys.

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

Perfect. Thank you so much, guys and hopefully everybody is doing well in the current environment. A couple of questions from me, on the ESEF mandate. As much as the U.K. is considering potentially delaying, have you heard any kind of rumblings about the rest of EMEA potentially also putting that discussion on the table?

I have not heard anything official about the situation. I believe it’s being discussed, but I doubt the European Union will be overly concerned about moving forward at this time. They seem to be managing COVID better than we are. Even if there is a delay, as Stuart has mentioned frequently, we haven’t factored that significantly into our forecasts. Regardless, a delay could still provide us opportunities to engage with new prospects and existing customers. Even before the pandemic, we considered the possibility of a delay, which seems typical for these regulatory matters. We had already built a model that accounts for such scenarios.

Okay. Perfect. Guys, that makes…

But then, to your question, we really haven't seen it happen in Europe. But if it does, it's not something I'm very concerned about. It's still going to happen and the conversations are still taking place.

Can you help us understand the $5.6 million allowance for receivables that you currently have? How did this impact billings for the quarter, particularly with the 2% year-on-year decline? I want to ensure we have all the details correct.

Absolutely. To compare it to June 30, 2019, the reserve last year was $3.2 million and now it's $5.6 million. If you adjust both numbers for that, the pro forma change in short-term billings would have been up 6.6%.

But that change that's a year-on-year change, or is that sequential change?

Yes, that's the year-on-year change. The sequential one would have been, I think that's the right way to look at it because our business is seasonal, particularly regarding billings. The $6 million figure was at the end of March this year, and if you consider it as a percentage of the combined number, which includes receivables plus the add-back, the total was $6 million, making it about 11.6% of the total at March 31, or around 11.9% at June 30.

Got it. Maybe we can follow-up one-on-one. Thank you so much. Appreciate it.

You bet. Thank you.

Your next question comes from the line of Mike Grondahl with Northland.

Yes. This is Michael on for Mike. Thanks for taking my question. Maybe first off just on the 10-Q on the segments it seems like it's pretty broad-based across the different silos even a couple of points and growth in energy year-over-year. Anything to call out there as far as surprises in the quarter more strengthening in certain industries?

I would say that the one that's really showing a lot of promise is global statutory reporting. We're seeing very good-sized deals. And the competition there is much different. So it's an older technology competition. So that's all of the growth vectors showed very good progress through the first half of the year, but global statutory reporting really stood out.

Got it. And maybe just comments on changes in the last couple of quarters in the potential M&A market pipeline there?

I'll let Stuart comment on that. Go ahead, Stuart.

Yes. I mean we continue to look at opportunities brought to us and initiate conversations ourselves. I think it's fair to say that the pandemic has caused most of the companies that might be interested in selling to slow down on the M&A front. So I would say it's been relatively quiet.

Okay. And you do have a follow-up question from the line of Tom Roderick with Stifel.

Hi, everyone. I appreciate the opportunity for a follow-up. Marty, could you provide more details about the next-generation platform? We've received positive feedback from customers who have seen it in action and some are already using it. It seems to be a significant advancement in how remote employees can interact with one another; they can work on the same document simultaneously, for instance. My questions are: first, are you seeing greater acceptance of this product as more employees work remotely? Secondly, what is the potential for additional revenue as you roll out this product? Does it integrate well with add-on features like Wdata or global statutory and other products? I’d love to hear more about your monetization strategy since it appears to enhance functionality significantly.

Well, I would say first off that our rolling out of next-gen has been a very, very pleasant surprise. It's been very stable and has really performed well. When you rebuild a platform the size of ours that's a big undertaking. And we've been extremely pleased with how that's turned out. In terms of the leverage, we're going to get from that platform. Remember, we've gone to a truly modern microservices architecture. And for instance, FERC and W for ESEF those two solutions, I mentioned in the prepared remarks at the beginning, we created specific solutions for those in just a couple of months and packaged them and are selling them already and generating bookings. So, we aren't going to see direct new revenues from switching customers from classic to next-gen. But what we see in 2021, the leverage we're going to get there is, we're going to be able to package more and more specific solutions for sellers to put in their bag. And so that's really where we get the leverage.

Yeah. And then, just perhaps one quick follow-on on that. Wdata, would love to just hear a little bit more about that? Customers that are adopting it, what is that doing to the deal prices, and who are you looking at or who are they looking at as potential alternatives for Wdata? Is this more of a data prep tool-type of solution like an Alteryx, or is it pretty much something historically they've just done manually?

It's a simplified version of what Alteryx offers, designed specifically for our product and our customers. It functions as a data preparation tool, but the key aspect for us is its connectivity. Users can import their data to prepare it for our solutions and use cases, which customers appreciate. Importantly, we can connect to a wide range of source systems, including not only ERP systems but also CRM tools and platforms like Concur and various sales tools. This allows users to access both back office and front office data, and we are observing increasing usage of the platform for these purposes. Wdata was the missing component in our platform, and its inclusion has led to significantly higher average deal sizes. In terms of our product offering, it has completed our platform, and that's the best way to understand its value.

That’s great. That’s it for me. Thank you, guys. Appreciate it.

Thanks, Tom.

Thanks, Tom.

And your last question comes from the line of Rob Oliver with Baird.

Thanks, guys. It's Matt Lemenager on for Rob. I have one on the growth in customers greater than $150,000, which has held fairly steady. And I guess just comparing that with the growth in customers greater than $100,000 has kind of decelerated a little bit. Is there anything to unpack there? I mean it seems like maybe it's more a platform sale and the traction, but just kind of seeing that growth in $100,000 have come down a bit at least compared to two or three quarters ago while the growth in $150,000 is holding strong. So, anything to think about there?

Hey, Matt, it's Stuart. So, a, we're really happy to be growing them both at those kinds of levels during the time of COVID. I do think that the growth of the over $150,000 does reflect strength on selling the platform. But the 28% is down a little bit, and I do think that that's reflective of the impact of COVID more than anything else.

Okay. Okay, got it. Yeah. And Stuart, I was just going to ask on cash flow. Sometimes, you've provided additional color on the calls around operating cash flow or how to think about that? I mean, been operating cash positive, and it sounds like collections were strong in the first half. Is there anything you want to point people to looking at the second half of the year, anything around cash flow?

Yeah. Not specifically around the second half of the year. I mean we're pleased to be nicely cash flow positive on the first half of the year. So, I'll leave it at that.

Okay, sounds good. Thanks guys.

Thank you, Matt.

Ladies and gentlemen, this concludes today's conference call. We thank you for your participation. You may now disconnect.