Q2 2023 Upland Software Inc Earnings Call
Participants
John T. McDonald; Founder, President, CEO & Chairman; Upland Software, Inc.
Michael D. Hill; CFO & Treasurer; Upland Software, Inc.
Jacob Zerbib; Research Analyst; William Blair & Company L.L.C., Research Division
Jeffrey Van Rhee; Partner of Institutional Research & Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Johnathan M. McCary; Research Associate; Raymond James & Associates, Inc., Research Division
Michael Ethan Rackers; Research Analyst; Needham & Company, LLC, Research Division
Presentation
Operator
Thank you for standing by, and welcome to the Upland Software Second Quarter 2023 Earnings Call. (Operator Instructions) The conference call will be recorded and simultaneously webcast at investor.uplandsoftware.com, and a replay will be available there for 12 months. By now, everyone should have access to the second quarter 2023 earnings release, which was distributed today at 4:00 p.m. Eastern Time. If you haven't received the release, it's available on Upland's website. I'd now like to turn the call over to Jack McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.
John T. McDonald
All right. Well, thank you, and welcome to our Q2 2023 earnings call. I'm joined today by Mike Hill, our CFO. On today's call, I will start with our Q2 review. And following that, Mike will provide some detail on the Q2 numbers and our guidance. After that, we'll open the call up for Q&A. But before we get started, Mike, can you read the safe harbor statement?
Michael D. Hill
Yes, sure. Thank you, Jack. During today's call, we will include statements that are considered forward-looking within the meanings of the securities laws. A detailed discussion of these risks and uncertainties associated with such statements is contained in our periodic reports filed with the SEC. The forward-looking statements made today are based on our views and assumptions and on information currently available to Upland management as of today. We do not intend or undertake any duty to release publicly any updates or revisions to any forward-looking statements.
On this call, Upland will refer to non-GAAP financial measures that, when used in combination with GAAP results, provide Upland management with additional analytical tools to understand its operations. Upland has provided reconciliations of non-GAAP measures to the most comparable GAAP measures in our press release announcing our second quarter results, which are available on the Investor Relations section of our website.
Please note that we're unable to reconcile any forward-looking non-GAAP financial measures to their directly comparable GAAP financial measures because the information which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. And with that, I'll turn the call back over to Jack.
John T. McDonald
All right. Thanks, Mike. So here are the headlines for Q2. We beat our Q2 revenue and EBITDA guidance midpoints. We, in the second quarter, expanded relationships with 313 existing customers, 32 of which were major expansions. We also welcomed 155 new customers to Upland in the second quarter, including 20 new major customers. New customer deals were distributed across our products and industry verticals. On the product front, in Q2, I'll note that this was a busy quarter for our sales enablement product, Altify, starting with a webinar that featured Forrester, which covered best practices for B2B enterprise sales. Following that, a launch of the new Altify book, not just another vendor, which is a collection of real experiences and best practices from outstanding sales leaders who have used account planning to multiply pipeline and grow revenue.
Two of Upland's products were listed among notable vendors in recent Forrester landscape reports. Upland Altify was included in The Account-Based Selling Technologies Landscape, that was the Q2 2023 report. And Upland Kapost was included in the content enablement solutions landscape again, the Q2 2023 report. Qvidian announced its latest release, which is focused on UI and UX improvements, really optimizing the user experience and also a revamped -- significantly revamped content library that aims to help customers increase productivity, shortened sales cycles and accelerate win rates on deals.
In June, Upland was awarded HP's Global Partner Excellence Award for our continued efforts in providing HP customers with flexible, dynamic product solutions that enable modern document life cycles for their businesses and that align with their unique requirements. It's still early in the process, but we are making solid progress on our new growth plan and remain focused on building shareholder value. Specifically, our goal is to achieve a mid-single-digit core organic growth rate next year. So targeting 5% core organic growth next year, plus or minus. It's not guidance. It's a goal and no guarantees, but our organization, our team is laser-focused on that achievement. So with that, I'm going to turn the call back over to Mike.
Michael D. Hill
Thank you, Jack. So I'll cover the financial results for the second quarter and our outlook for the third quarter and full year 2023. On the income statement, total revenue from the second quarter was $74.5 million, representing a decrease of 7% year-over-year. Recurring revenue from subscription and support decreased 6% year-over-year to $70.5 million.
Perpetual license revenue decreased to $1.3 million in the second quarter, down from $1.9 million in the second quarter of 2022. Professional services revenue was $2.8 million for the quarter, an 18% year-over-year decline. These revenue declines are generally as expected, pursuant to our strategic product realignments and future growth initiatives described on our previous calls.
Overall, gross margin was 68% during the second quarter, and our product gross margin remained strong at 69% or 74% when adding back depreciation and amortization, which we refer to as cash gross margin. Operating expenses, excluding acquisition-related expenses, depreciation, amortization and stock-based compensation were $37.7 million for the quarter or 51% of total revenue, all generally as expected.
Also, acquisition-related expenses were approximately $1.1 million in the second quarter, which represents the last of our restructuring costs from our acquisitions in Q1 of 2022. Acquisition-related expenses should remain insignificant going forward until our acquisition activity picks back up in the future. Our second quarter 2023 adjusted EBITDA was $16.6 million or 22% of total revenue, down from $24.5 million or 31% of total revenue for the second quarter of 2022.
This adjusted EBITDA decline is generally as expected, considering our growth investments described on previous calls. Cash flow for the second quarter of 2023, GAAP operating cash flow was $7 million and free cash flow was $6.7 million. We continue to anticipate $30 million to $40 million of free cash flow generation for the full year 2023.
Our ongoing free cash flow generation is in addition to our existing liquidity of approximately $323 million comprised of approximate $263 million of cash on our balance sheet as of June 30, 2023, plus our $60 million undrawn revolver. As of June 30, 2023, we had outstanding net debt of approximately $257 million after factoring in the cash on our balance sheet.
Now for guidance. We are lowering our full year 2023 revenue guidance by -- midpoint by $2 million due to accelerated win not if sunset asset churn and lower perpetual license and PSO revenue. We are revising down our 2023 adjusted EBITDA guidance by $2.8 million -- the midpoint by $2.8 million due to that lower revenue level as well as some incremental growth investment in our CLA product group.
With that, for the quarter ending September 30, 2023, Upland expects reported total revenue to be between $70.4 million and $76.4 million, including subscription and support revenue between $65.5 million and $70.5 million for a decline in total revenue of 8% at the midpoint over the quarter ended September 30, 2022.
The Third quarter 2023 adjusted EBITDA is expected to be between $14.5 million and $17.5 million for an adjusted EBITDA margin of 22% at the midpoint. This adjusted EBITDA guide at the midpoint is a decrease of 36% from the quarter ended September 30, 2022.
For the full year ending December 31, 2023, Upland expect reported total revenue to be between $292.1 million and $304.1 million, including subscription and support revenue between $274 million and $284 million for a decline in total revenue of 6% at the midpoint over the year ended December 31, 2022.
Full year 2023 adjusted EBITDA is expected to be between $63.2 million and $69.2 million for an adjusted EBITDA margin of 22% at the midpoint. This adjusted EBITDA guide at the midpoint is a decrease of 32% over the year ended December 31, 2022. And with that, I'll pass the call back to Jack.
John T. McDonald
All right. Thanks, Mike. We are now ready to open the call up for Q&A.
Question and Answer Session
Operator
Great. Thanks, Jack. (Operator Instructions) And it looks like our first call from Scott Berg with Needham.
Michael Ethan Rackers
This is Michael Rackers on for Scott today. Congrats on the quarter here. But how are you thinking about the leverage profile over time and then potentially refinancing debt as it comes due over the next few years?
Michael D. Hill
Yes. So Michael, this is Mike. First of all, our debt is due August of 2026, our term debt, and we've got the interest rate locked at 5.4% through the remainder of that term. We do -- so we've got plenty of time to deal with that. We think as hopefully, the interest rate environment, the rate curve comes down over time, our leverage right now at sort of depressed EBITDA levels is about 3.9x net debt leverage to annual EBITDA.
And so as our growth investments kick in and EBITDA levels improve, and we build cash every year with our $30 million to $40 million of free cash flow generation, thus reducing net debt over time, those lines should get a little bit easier for us from a refi standpoint, and we'll pull the trigger on a refi in the future.
Operator
And our next call comes from Jeffrey Van Rhee with Craig-Hallum.
Jeffrey Van Rhee
A couple for me. Just on sales, maybe, Jack, I know you're spending a lot of time and effort to drive that organic growth acceleration into next year. I know you've made a lot of changes. Can you just expand on what's going on? I know you said you're early innings, but have made good progress. Maybe a little more there. What have you changed? Where are you, reps, structure, whatever you're changing?
John T. McDonald
Sure. So a couple of things. One, if you look at where we've built our growth plan, it's really around 3 efficient motions, 2 of which are go-to-market. The first is inside sales. So complementing our field sales motion with an inside sales capacity and a full complement of sales development reps or SDRs.
In addition to that, it's really been about adding a modern digital marketing capability to provide for a much more efficient pipeline generation. We have, at this point, fully filled out our SDR roster and are just a few heads short on these roster, which is bringing these classes on according to schedule. The change in the organization's culture has been significant. There's been a ton of work going on in the -- on the product marketing side in terms of positioning our products in the right place in the market with the right pricing.
And Jeff, as you know, as a part of this new go-to-market plan, we're really focused in on a group of roughly 15 growth products that combine -- comprised, I should say, roughly 75% of our revenue and where we think we can really drive some outsized growth. We brought in a couple of quarters ago, a new sales leader who came out of Infor, a new marketing leader who came out of TIBCO. So those folks are fully in.
They've built out their teams, and we are starting to see some early green shoots, particularly around pipeline generation, which is where you would expect to see signs of progress first. If you look at pipe generation sequentially and year-over-year, if you look at the second quarter, it's a pretty healthy uptick from what we were seeing -- healthy uptick sequentially from Q1, healthy uptick, year-over-year.
So really across the board in terms of marketing, demand gen in terms of product marketing and sales enablement in terms of adding a new inside sales capacity, in terms of radically expanding our SDR capacity. And in terms of providing our field sales force with a full complement of tools and training and collateral that they need to successfully execute. It's really a completely different organization.
Now in addition to that, the third leg of our growth plan is really centered around our Indian COE, Center of Excellence for development. And while we will continue to have some portion of our product development onshore, we are expanding aggressively the size of our India COE. And this enables us to not only, we believe, expand margins through time, but also increase our product investment. So you'll see the pace of our product, investment and product innovation in those -- particularly in those growth products increase here as we move through the end of this year and into next year.
So let me stop there as a kind of summary overview, and I'd be happy to take any other questions from me on that topic.
Jeffrey Van Rhee
Yes. No, that's great. And then one other, obviously, with roughly the 15 core growth products, about 3/4 of revenue and then the other products that make up the 25% altogether kind of the go-forward suite, excluding the sunset products. In terms of the retention on those products, obviously, there's the growth factor but also the retention vector. How is retention trending? And have there been any changes in terms of how you're approaching or attacking the retention issue?
John T. McDonald
So retention has been tracking in accordance with plan. So the target remains what it was, which is, we focus on an NDRR KPI that we report publicly on an annual basis. And so the target is to get to 95% or better for this year, as reported as of December 31. And so I would say at this point, Jeff, no significant changes. Now in terms of the groundwork that we are laying in to improve retention rates through time, there are a number of significant initiatives underway.
One of them, of course, is on the development side and on the product management side. And so part of the process of better positioning our products to compete in the market to drive more organic growth. And by the way, I would say to you that what's been heartening as we've gone through this is the strength of a number of our products.
And really, we just need to do a better job of putting them in the marketplace and positioning them appropriately. But part of the visibility that we have as a result of that process on competitive intelligence, I think, is leading to some targeted investments in product innovation that we think are going to drive higher retention through time.
Secondly, on the customer success side, we have promoted a new customer success leader. We have built out a centralized customer success, shared service organization that we did not have previously. We have adopted a new approach to the customer success function and will be adopting in the second half of the year a new customer success software platform.
Again, with the goal to get our exceptional CSMs, we have really a great team of CSMs, but to enable them to add to their great customer care responsibilities, a more strategic mindset on both monitoring customer health and also being able to engage with a longer-term view on increasing retention rates.
And we've also spent a good deal of time on the cross-functional cooperation that's necessary to ensure better customer health and better retention rates and specifically making sure that our sales organization, that our professional services organization and that our customer support organization are working hand-in-hand, right, and doing the right kind of handoffs and kickoffs for moving from that sales process and that solutions consultant, creating an initial customer success plan to building more packaged implementation services from our PSO group to ensure more robust product adoption and ultimately, better customer health because it's going to drive better business returns and ROI for customers.
And then as I say, giving the customer success teams, the tools and methodology they need to better execute strategically and measure and manage and improve customer health and retention. So that's the main focus there. Again, happy to take any other questions on that.
Operator
And our next question comes from Jake Roberge with William Blair.
Jacob Zerbib
Congrats on the quarter. This is Jacob Zerbib on for Jake Roberge. Just wanted to ask on the reduced full year guide. What do you attribute it more to the general macro impacts? Or are there any execution issues we should be aware of? Is there, I guess, an accelerated sunsetting of your legacy products? And just to follow up on that, given the macro, are you still active on the M&A front with the valuations these days?
John T. McDonald
Yes. So on the first question, this is Jack. Really, the primary driver of that is accelerated sunset asset churn, which, frankly, is it's better for us to burn that off sooner as opposed to later, because those are noncore assets. And so that was the primary driver of that. Now of course, with that, you're going to have -- and with the sunsetting of assets, you're going to have a little bit less PSO, right, because that is driven by new logo activity, new implementations.
And in terms of the perp revenue, it's really mostly about timing of some of our OEM relationships, and so we expect that to be temporary. So not related to execution and at this point, not related to the macro environment, really related more to those kind of idiosyncratic factors that I just outlined. In terms of -- I'm sorry, if you have a follow-up on that, happy to take it or I can go to the M&A question.
Jacob Zerbib
No, yes, you can go to the M&A question. Thank you, sorry about that.
John T. McDonald
On M&A, we are actively in the market. We are looking at a number of acquisition opportunities. As we build out our go-to-market capabilities, of course, it starts to make some of these acquisitions more attractive because we are positioning ourselves, we believe, to not only drive the cost synergies that we have historically, but to better drive revenue synergies.
And I see it in some of the recent acquisitions that we did like BAI, Insight, BAI, which is an enterprise search tool where really, we drove the integration of that product with more of the new Upland mindset around go-to-market. And we're seeing growth rates on that product that are really strong. And so we're going to keep building out this capability so that we can go and do additional acquisitions and again, not only drive margins but continue to drive revenue growth.
Now we're well positioned. We've got plenty of capital. We're known in the market. We've got a pipeline of deals, but we control timing on it. So we're going to execute at the right time. We are being purposeful and thoughtful about it. Don't feel rushed to have to get something done this quarter. But we anticipate getting back in the business of closing deals by -- within the next few quarters and feel like we're well positioned for that.
Operator
Yes. Our final question will come from Alex Sklar with Raymond James.
Johnathan M. McCary
This is Johnathan McCary on for Alex. Just one from us. So I know you kind of touched on the innovation engine already, but you've had the R&D center up and running for a little over a year now. You've had a nice cadence of new products and functionality announcements. So what can you tell us about how we should think about how product velocity should trend over the next year? And how should we think about monetization of those investments?
John T. McDonald
Yes, I think the first and most significant way in which we'll monetize those investments is taking this business from a minus 1%, minus 2% organic growth rate in 2023 to a positive mid-single digits organic growth rate next year. Now again, that's a goal. It's not guidance and there are no guarantees. But this organization is laser-focused on the levers that can drive that growth.
I think that is a game changer for this business. And we're not saying that's a ceiling. We're saying that is a target for next year, long term. Our goal there is 5% to 10% organic and 30% to 35% EBITDA margins. I think that's just an absolute game changer for how the company will be viewed and valued on an ongoing basis.
And then, of course, turning back on the M&A engine and doing it in the context of a business that has a working go-to-market motion and levers to pull around the Indian COE on the product side and the ability to generate pipeline and the ability to not only support any acquired field sales personnel, but also to add an inside selling capacity to the products that we acquire a scaled inside selling capacity where we can now plug in inside sales pods on a pretty systematic basis.
So look, I'm not saying that everything is humming right now because we are in the process of laying this all in, but then we are seeing real and solid progress operationally on creating this capability that we believe is going to drive that growth and that return on investment. And as I mentioned, there are some early green shoots, particularly around pipeline generation that I think give us increased optimism for the future.
All right. So that's our final question. So let me just thank everyone for joining the call, and we will see you after the next quarter. So we'll see you on the Q3 call. Thank you very much.
Operator
Thank you, Jack. And ladies and gentlemen, that does conclude today's call. Thank you all for joining, and you may now disconnect. Have a great day, everyone.
