Q3 2019 Earnings Call
Hello, and thank you for joining the call.
Earlier. This afternoon after market closed we released a stock holder lector as well as our quarterly press release and file our 10-Q for the third quarter, we the FCC offering a detailed look at our results.
We will open up the cold to Q any shortly but I first wanted to cover some brief highlights.
We're very pleased with our third quarter.
Revenue grew 23% year over year to 78.8 million marketplace revenue grew 25% year over year to 17.7 million core clients grew 19% year over year to approximately 120005 hundred.
Client spend retention was 104% with client spend retention from clients on the Upwork business and enterprise offerings above a 125%.
Gross margin expanded more than three points year over year to 71%.
We continue to see great opportunity and clear signs that our investments are paying off while our market opportunities very lounge. We are still in the early stages of a long term shift in how we're gets done and this is what is driving our decision to invest further across three initiatives, where we have experienced early success sales.
Marketing and product.
As such we announced our plan to further invest in our growth initiatives, including increasing sales head count and in Q3 with 65 quota carrying account executives with 90 planned by the end of Q4.
And with that I look forward to discussing our results further in Q any.
Operator, Brian and I are now ready to take your questions.
Thank you ladies and gentlemen.
Last question.
All right into one key touched on telephone.
Your question please.
Please.
Okay.
First question coming from the line.
From RBC your line is open.
Okay. Thanks, I'm, sorry, I'm going ask a couple of questions one.
Fiscal two the gross margin improvement year over year to what extent that was a mix shift or whether they were core factors driving that secondly in terms of the Q4 guidance. It looks like you beat your guidance for them.
The third quarter, but your new guidance is a little bit lower than what you. It implied before in your full year guidance just speak to that please and then third in terms of these investments in new areas you talked about increasing the sales head count from 65 to 90 can you talk about other changes or other new areas of investments in that marketing in a product side.
Thank you very much.
Sure. So the three different questions for me I'll make sure I get them you know there so gross margin.
He is a combination of mix shift and true operational leverage so the mix shift comes from.
Managed services growing slower than marketplace and managed services because of GAAP accounting rules, we recognize the gross so the GSV, we recognize as revenue and so when managed services is growing slower than the marketplace, which it has in the last few quarter than we expected to continue moving forward.
That means that take rates is going in one direction and gross margin is going in the other right and so that's the mix shift the true.
Operational leverage that we're getting is a combination of payment cost, which is the number one source of cost of revenue.
Where progressive you were shifting people to LCH and also we are continuing to improve the different initiatives some of which I described in the stockholder later the different initiatives to strengthen our payments platform as well as another big source of cost of revenues. They ws cost and we've been focused on me.
Ensure that dws cost was growing slower than DSV and slower than revenue and we've been successful in doing that for the last several quarters. So those are.
Really margin expansions. If you will you are looking purely at the marketplace side of the business. If you look at the ratio of gross profit for the market base of our revenue for the marketplace you find it to be pretty close to nine sorry to 80%, which is kind of what we've said in the long term model. We think we can get to a gross margin level of 80% to 85%.
And on the market rate side of this we already getting really close to that to answer your question about guidance I would say.
Some of the revenue that we expected to get very early in Q4 ended up happening really late in Q3, so there's a little bit of a shift from Q3 in Q4 that explain some of this I mean net net we are talking about a million dollars between the two quarter. So you know the back half the year, we're going to do about a 150 million dollar revenue so million between 150 million is still pretty accurate.
But I would say so there are some of that there's also justifying that from a lapping standpoint, Q4 is little bit more difficult than Q3 wise and so we do expect Q4 to be a little bit less strong than Q3 has been.
And then that the to your third question about sales and what else are we doing.
As you can imagine it's a massive efforts for the company to be dramatically increasing the size of the sales team and we're encouraged to do this because salespeople are hitting the numbers and when they hit their numbers. The ROI of that investment is very sound. We also thing that we have lots and lots of leads there as well over 10000 companies that are using.
Apart today.
On the basic our plus product that have not been touched by sales and who look like the types of customers that should be upgrading to a business. Our enterprise. So we think we have lots of leads we think the salespeople that we've had in place.
Generating a good ROI.
In order to ramp up we do.
I have to create a little bit of growing pain. So we've had to promote some of the top performers to sales management roles. We've promoted some of the sales development drops who were generating those leads in the first place to sales executive roles and Weve.
Change our marketing approach to do a lot more.
A lot more brand advertising relatively speaking less SCM than before so there's a lot of moving pieces of the same time, but it's a combination of product marketing and sales in a very integrated way and in a way that it's probably more line than it's ever been in the company and generally everybody is really focus on this idea of companies that have a 100 employees are more.
I will become the majority of the business in the future even though at this stage, it's only about 20% of the business.
Okay. Thank you Stephanie.
And our next question coming from the line.
Joe.
JMP Securities Your line is open.
Great. Thanks for taking the question and now that we got marks there those are very helpful questions remark, but maybe longer bigger picture Stefan you talked about the 10000 clients that are using Watson basic today, just talk about the penetration there last quarter you talked about the first half of the you're seeing I think around 60, or so new contracts. One so just talk about that.
Titration, how youre going up against that and how you're selling into those 10000 and then in the letter you talked about not yet reaching full potential for sales productivity. We're growing salesforce ratings do understood, but can you just talked to us how do you reached at full potential how far away are you from reaching natural potential. Thank you very much.
Sure.
So maybe maybe start with the second question around sales productivity.
It is good enough, meaning like the CAC to LTV is sound. It gives us a good ROI a strong payback period, you will see it in the numbers. However in the short term increases sales and marketing as a percentage of revenue and therefore puts downward pressure on EBITDA.
Unit economic being strong overtime this will more than pay for itself. It will also help us get to scale faster, which gives us more leverage on DNA and more leveraging R&D. So it's the right type of investment for the business that being said.
We do want to continue to improve sales rep productivity and that comes frankly from I would say three different angles, one which is.
Sales operations itself and partly to stabilize the sales team the issue of promoting not than other people is you're removing some of your best performers in a specific role and moving them to become you in a new role in that causes some amount of stress in the system.
Another angle is around marketing efficiency, we hired loss.
A few months ago, now who came from off from a traditional b to B enterprise sales and marketing background and.
He is.
Helping us shift from a very self service online only type of approach to doing marketing to something that is more of a partnership we sales where the role of marketing is too.
Do sales enablement to do field marketing to do.
Demand generation to drive marketing qualified leads.
Into their cell development team and then eventually into the account executive and account management team and lastly, I would say from a product standpoint, we focus a bigger part of our R&D efforts in.
Sales productivity and sales efficiency features like.
Single sign on that makes it easier for existing users to sign up more hiring manager for us.
Our internal tools that we can use to help the sales team get access to a consolidated view of the data across the different data sources that we have internally.
Number of deal Oh, sorry. Your other question was on the number of deals.
Yes, I mean, it's kind of a continuation of what we saw last quarter. The Upwork enterprise business consists continues to be one that is driven.
Quite a bit by the sales team itself and the sales cycle remains multiple months the upward business accounts tends to be a lot of upsells from the traditional marketplace.
While sales driven and where the sales cycle is more like a few weeks and then the other thing about up our business is not only is it high velocity, but you're starting with customers that are spending money already so what happens is as the upgrade we increased the take rates because it goes from the Upwork basic off work, let's take rate to the upward business take rates, which is significantly higher.
And they start spending more money almost instantly. So it's a faster cycle that also ramps up faster if you will but one of the numbers I wanted to call out that we wrote in the so called Liletta, because we got a lot of questions about that last quarter is this notion of client spend retention and people kept on asking me what is clients better retention better for the.
Our customers than it is for the smaller customers and while the overall client spend retention for the business is about 100 and focus on at this stage the clients by retention for the global clients that are signed up for airport business upward enterprise has been north of 125% for several quarters now.
Thanks, Stephanie.
Our next question coming from the line of brands still with Jefferies. Your line is open.
Hi, Thank you Mr., John Ghansham Glentel.
Well.
Yes.
On.
When he felt that if you talk about the trend for the first and second half.
Being a little bit low and high everything is that really mainly due to congestion or are there other fundamental thank you Sir.
And then in terms of the guidance and the new revenue standards with that means that in my attention to be more backend loaded into second half.
Thank you.
Yes.
Yes, I tried to answer the question in two pieces, one it's kind of the overall trends in the business and then the second one is how does it look from a quarter standpoint, as if you look at the overall trend in the business. We've been acquiring about 5000 core clients every quarter more or less for the last several quarters and we think that trend is going to continue.
For the foreseeable future obviously the base keeps on getting bigger right. So if it's a constant number of core client adds then as a percentage it goes down slightly over time.
The second thing that we think is going to happen is client spend retention has peaked at 108% a couple of quarters ago. It's back to 104, right now and we see a trend where it's probably going to two soft land you know slowly back into their historical average over 100 around 100% and we can talk in more detail that.
So why that is.
Within the marketplace take rates, which is higher than it's been in several quarters is now stabilizing more or less at the new rates and again, we can go into the details of why that is but the changes we've made to pricing and monetization in the last few quarters.
Mixed shift between business enterprise and.
The basic product all of these things drive a more or less concerned market based take rate moving forward and then managed services has been growing slower than the marketplace for several quarters in a row and we expected to continue that way right. So all of these things together I mean that you know when people are modeling the future of the business that's those out some.
The key inputs into figuring out what the model looks like now in terms of what that looks like from a quarter standpoint.
Realize that this quarter. This year, we had relatively weaker Q1 in Q2 and relatively stronger Q3 in Q4, and so from a lapping standpoint that makes.
Q1 in Q2 next year easier in Q3 in Q4 next year, a little bit how there and so if you think about market based revenue as a key component of the overall business relatively speaking market based revenue is going to be stronger in Q1 and weak during Q3 in Q4 add to that the fact that there's a number of mandates that is also somewhat different between next Dan.
This year. The next year is a leap year, which is one more day.
And so if you're looking at it Q1 is going to be relatively stronger from that standpoint, whereas Q3, Q4 are going to be a little bit more challenging now of course, that's more than 12 months from now so hopefully we can do all sorts of other things to try to get above and beyond those numbers, but thats. What we have line of sight for at this stage and under all these numbers obviously in or so.
So five so we are working with our auditors are the new six of six standards. So we would as of January Onest of 2019 have an adjustment to our balance sheet retained earnings and deferred revenue and that will bleed over time.
We're still determining the impact what we do not believe is going to immaterial to our consolidated income statement going forward, but when we do give our Q4 call at that point, we'll do everything or six so six which interest rate is not material.
Thank you.
Our next question coming from the line.
With Citi. Your line is open.
Thank you asked two questions here. So first the states, California recently passed the execution of assembly below five which requires the reclassification as independent contractors to full time employees interest rate and sex and if you.
Can you just gets about INTECH of expectation our business and how would you assess the changing opportunity in volume and Genthree last economy at home.
Second I guess can you also share some of the latest thoughts around M&A strategist, how would you define it sort of organic target and then in terms of complementary business.
Dancing or market positions, what you're focused on vertical integration or whether geographic expansion.
Great question. Thank you. So let me start really they be five so.
Maybe five is gratifying into law what was the call just his decision from a cocktail dynamics, which is going back and my memory.
Escapes me, a little bit, but somewhere between 12 and 18 months ago. So I think most companies, who think about worker classification and where we are definitely there has been operating under the assumption of maybe five for quite a few kratos already.
There's a few things through it so first of all some of the work that's being down through platforms like up work is actually excluded from maybe five and if you look at the tax of the law. There is various mentions of that around professional services being excluded so thats one component of it a second component of it is the fact that we actually offer pay rowing services. So we.
We would we go in freelancing, but some of the work on up work is underwritten 89. Some of the work on up work is onto a W. Two through a product offering we have called up our payroll, it's actually a profitable product. So we actually somewhat selfishly make more money on W. Two engagements than we make on the 99 engagements. So its may potentially a concern for other friends.
They're not very happy to be forced to become W. Two.
But from our standpoint, we've essentially make more money from it and then the last point I would say is California presenters at this stage, our low single digit percentage of the overall GSV in revenue for the business and so at this stage, it's not a meaningful part of the business, but again when the work needs to get that state as W. Two we offer other peer rolling offering.
When the client is a.
And Upwork enterprise clients on the subscribed to our compliance offering we actually make the decision for them and we indemnify them. If we got it wrong and then the last thing I would say is there's a pretty significant substitution effect, which is something that we sell regulators all the time, if youre, making it how they're for free answers in California to be competitive plants will hire for answers in Colorado.
Our artisanal frankly outside of the U.S. and so not necessarily in the best interest of local freelancers to be impacted by those types of regulations.
And then your question about M&A.
We we hired amended evensen as our new as VP of corporate strategy incorporate developments a few weeks ago and one of the things. She is working on is building a.
Street, no well defined strategy around M&A that allows us to be more proactive and more disciplined in how we look at opportunities, but I would say.
Big buckets for us would be either.
Properties that offer additional capabilities that we don't have internally our companies that bring the types of clients on the types of talents that we want to get into the business. The latter might look companies like us that might be other take marketplaces for friends work all there might be very traditionally run professional staffing firms and then.
Everything in between there are plenty of companies out there that are semi take enabled but mostly services companies and we'd be looking at them in the former we'd be looking at capabilities that we can sell three there are the clients all the free answers on Upwork and this would include things that.
I've mentioned, when we were doing IPO, but we're very interested in topics around financial services for Financers. We're interested in benefits for free answers were interested in collaboration tools.
Education training and certification those types of things, but I would say at this stage. It's very open we're just getting our.
Now.
Jim started to look at some of these opportunities.
Thank you very much Stefan its very helpful.
Thank you.
Our next question coming from.
Your line is open.
Great. Good evening, Thank you for taking my questions.
No.
I want to drill down actually on the take rate stabilization since you did mention that you.
Well, we could go deeper into that and I certainly would like to just just curious some of the the tailwind.
Okay.
Sort of suggesting that take rate will stabilize from here on out with source is just that the some of those tailwinds may have played out already.
You could just kind of go further into your thought process behind behind that that'd be great. Thank you.
Sure. So maybe I can start with the headwinds to explain what where we've been right. So there has been squeeze things that we're driving take rate down one is managed services growing slower than the marketplace, which is by design, we sell back the market base operating Marlin reseller managed services offering.
But because our revenue recognition policy.
Services is recognized as a 100% take rate, whereas the rest of our business is recognized as the net.
Revenue being the take rate and so when managed services are growing slower slower than marketplace. It puts downward pressure on take rate that was one headwind second one was we were actively pushing clients to pay us based CH instead of paying us by Grey card you know as I mentioned earlier on the call. Our number one source of cost of revenue is great account fees when we can.
Get clients appears base usage, we lower the cost of revenue in order to convince them to do it we give them a discount for doing it and that puts downward pressure on take rate and then there's something was Lee.
On the Upwork Clos and up work basic the freelancers pay us a tiered service, which goes down overtime as they earn more money from a given clients right and it's based on lifetime earnings of a specific relationship between a specific client on a specific freed answer but at the beginning of a relationship the freedom.
Just passed 20 percents and then goes down to 10, and then it goes down to five and overtime as client spend retention has been north of 100%, but that means is a lot of these relationships graduate from the 20% to the 10% to the 5%. So the effective freelancer tiered service fee has progressively continued to come down and if you look at the.
Graphics that we pushed in.
In the stockholder letter you see how the take rate coming from the free to answer side on the judge service fee keeps on going down I. So those are the headwinds and they would have continued to happen. If it were installed the changes that we've made recently and so the changes. We've made recently one was it just a onetime bump increase to the clients payment processing fee. So.
When clients Theres like great job on upward basic up our class until a few months ago, we would charge them an extra two points over 5% now that rate went from 2.75% to 3% tried so that the onetime increase to the price.
Second thing we've done was launching a new version of the virtual currency that is.
That we called connects that the freelancers use in order to be done on jobs and we've reduced the number of reconnects, but we've also reduced the cost of connects and the goal was to both improve quality, so, forcing people to think a little bit more about whether they were truly interested and available and qualified for a job before blind to it but.
Also the same time improving.
The integration.
That's everything we've done was to introduce upper class and upward business upward plus has a $50 per month subscription fee.
It is more or less the same product that used to be called up our extended which did not have a subscription fee and so there's.
$50 per month of additional revenue coming from the claims that choose plus instead of downgrading two basic.
And then upward business, we've talked about in the past.
Big chunk of up our business is upgrading clients from basic of loss to business and business has a $500 per month subscription fee and the take rates does not have a sliding scale like like it has for basic and plus and so it's 10% on the buyer side, 10% on the free answer side, and then last but not least theres a lot of payment related we.
But pretty deep payments and fintech platform embedded inside of Upwork and there's all sorts of lever of both on the buyer side the payment side of the platform and on the three answer side. The disbursements side of the platform, where we constantly innovating really or reduce the cost increase the revenue that comes from it in some cases, it's things that we control on our.
And in other cases, it seems that we renegotiate with a provider that we felt that way.
Okay, great. Thank you for that and if I could a few follow it so.
None of were.
Now I guess over a quarter into into the new membership plans.
Could you update us on what you're seeing in terms of the adoption of upward plus versus versus basic and then the other question is just in the shareholder letter you referenced on client spend retention trending back to 100%.
It seems like you called out the you with us.
Marketplace.
The retention rate not being as good you have any any thoughts on what why that particular channel is the retention. The wallet retention is not if not as strong as it started out.
Thank you.
Sure Yes.
So let me start where the second one so.
You asked to us domestic clients, so clients, who only use us to hire us based screen answers.
Tend to spend more early in their lifecycle.
They tend to post higher value jobs hire people at a much higher rates and the early jobs tend to be longer.
However, they tend to return retain less which is new information frankly to all of us because we're just starting to see the early cohorts from last year and Conversely, what we find is that clients who starts with the us domestic marketplace and then graduates to hiring people outside of the U.S. and up spending significantly more than clients, who stay within the U.S. market.
And so.
One initiative, we've started to work on is that graduation, Pat how do we get clients essentially getting the training wheels off if you will people are more comfortable hiring in the U.S., but we find that they end up spending more and retaining more if they also higher free answers outside of the U.S. and so we're progressive Lee.
Building a graduation bass, if you will wear wireless once we feel like youre comfortable enough. We are using the platform. We introduce you to non U.S based screen answers now to answer your question why why do clients in the U.S. retain less when they only hire us based screen answers.
We don't know for sure but that is one very clear explanation for this which we hear constantly it's what the industry goals conversion attempt to higher contract to higher right, which is if you find a great screen on therapies base, especially if they're facing the same states that youll base and you decide that you want to work with them full time at that point you just make them your full time.
Employee and you take them off of the platform and its something that historically weve discourage people to do we consider the to be a fine essentially like will will find new and we'll say that your misbehaving for doing it I think you'll see us over the next few quarters building that capability to the product and saying look.
If you want to convert this person to full time employee that's actually completely fine with us, but you have to pay our say conversion features like you would fall in traditional professional services from if you will.
To your question about adoption the the way the system is designed everybody who.
You know every company that we believed to have more than 10 employees starts with the trial period on plus so we're not getting people to start on basic and upgrade them to plus we are studying all of these bigger companies on plus they get somewhere between one and two months for free.
And after that they can choose to either say or opt out and go to the basic plan and at this stage. What we found is that that approach works better and that the opt out rates is better than what we expected it to do and so at this stage. The breast revenue is completely incremental to business that we would have had before and the journey.
Eight of the downgrade rate from plus two basic is lower than we expected it to be.
Terrific. Thanks.
Very much thanks, Brian .
Our next question coming from your line.
Ken Joe Your line is open.
Hi, Thanks for taking my question I wanted to go back to sales hiring real quick once you get through this big push of hiring over the next couple of quarters and year, just curious how you see that.
Team evolving over time in terms of size and then second question just any changes to the longer term margin expectations and more importantly, what kind of timeframe are you looking at now that 2020 might be impacted a little.
Yes so.
You know there's two ways you can accelerate the sales driven revenue one is more salespeople and the second one is better sales productivity all right and so what I mentioned I think in the stockholder lets areas.
This year about 20% of incremental revenue comes from sales, which means 80% of our incremental revenue does not right and so at this stage sales continues to present, a pretty small percentage of the overall business and a relatively small percentage of the incremental business.
That is not what the timing of Sag that is not what our ambition looks like so we need sales to grow significantly faster than the business in order for it to contribute a more meaningful part of the overall business and then even more meaningful part of the incremental business. So then you'll find us to continue.
As long as the engine continues to run well, you'll see us continue to higher salespeople at a pretty.
Significant rate and given the certain level of productivity sales head count is going to be growing more or less in line with revenue that is driven by sales that being said, obviously, we do want to invest in sales productivity improvements and that includes marketing. It includes.
Product et cetera et cetera.
The impact it has on on the model itself.
You can imagine what it means is sales and marketing as a percentage of revenue will grow up slightly it's not going to be overnight and it's not going to be massive but youre going to see a few percentage points over time.
Conversely, because it allows us to get to scale faster, you'll see us get leverage in DNA and in R&D faster than we would have had before so essentially the goal is to try to get to that.
Equilibrium faster than we would otherwise by accelerating some of the sales hiring and as we noted in the stock on the lower was wells in the marketplace is pretty profitable arc generating cash as well as a managed versus which allows to invest in the enterprise investment.
Thank you.
Our next question coming from the line of Logan Ben.
Your line is open.
Hey, guys. Thank you for taking my questions just a couple as far as usage patterns as you've seen in the market. Just just from macroeconomic perspective have you seen any kind of cautious behavior or anything that would that would indicate maybe as a slowdown in spending environment from the corporate side going forward and then.
Maybe just talk about the business versus enterprise opportunity in fires like your sales team focus our unique that better opportunity that maybe more profitable as the business or the large fortune 500, there are employees thousand more or where is your where you kind of fine tuning your sales focus going forward with new sales reps. Thanks.
Sure.
So there were not seeing any impacts of the economy, one of our economy's looked at.
How is the UK business doing compared to the the risk of Brexit and general fear that small businesses have in the UK and it doesn't seem like a merchant going on so we seem to be fairly resilient too.
Exchange rates to.
Economic cycle than all of that.
To answer your question about mid market versus the larger companies. We most of the hiring we're doing right now is in the mid market in fact, a lot of the hiring we're doing right now is.
Clearly junior sales development drops because the existing sales development drops who've been with us for some of them for a couple of you have now getting promoted too.
Account executives. So we are building this pipeline of relatively entry level junior ourselves the luverne trap suit.
Eventually graduate to become sales executives on the Midmarket team and from there potentially become sales executive on the large accounts and strategic team.
So badly its effect the sales cycle, it's easier to find lots and lots of of.
Resources to be able to serve that market et cetera, et cetera, partly it's also timeframe issue.
We're very proud of their relationship we have with Microsoft and some of the other fortune 500 companies in the wealth and I do think that if you look Daniels out these will be major major clients and a significant part of our revenue, but if you look at it today. The mid market is going to be probably a much bigger opportunity over the next two to three.
Yes than the very large companies and so as a result will continue to hire some amount of sales reps in the large accounts and strategic team, but we'll be doing a lot more hiring in the mean marketing and.
Good question by products, Therefore, our board business should be growing faster than up like enterprise.
Okay, Great and then one may one last one legacy again of the other 10000 leads that you mentioned, how should we think about the split between us and abroad opportunity in that if you can give some more dimension that.
Yeah right now we're looking for our sales team is based in the U.S., we don't have a ton of foreign language capabilities and so at this stage, we're really looking at U.S. and Canadian companies on me.
And in some cases were looking at the U.S. subsidiary of in International Company. When we have a U.S. company that also operates abroad, we'll be happy to serve them abroad as well, but for the most popular really targeting USA and Canada based companies on me.
Thank you guys.
Ladies and gentlemen. This concludes today's conference call. Thank you for participating you may all disconnect have a great.