Q4 2023 Upland Software Inc Earnings Call
Participants
John Mcdonald; Chairman of the Board, Chief Executive Officer; Upland Software Inc
Mike Hill; CFO; Upland Software Inc
Scott Berg; Senior Analyst; Needham & Company LLC
Presentation
Operator
Thank you for standing by and welcome to the Upland Software Fourth 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 fourth quarter 2023 earnings release, which was distributed today at 4 P.M. Eastern time. If you've not received received the release, it's available on Upland's website.
I'd now like to turn the call over to John McDonald, Chairman and CEO of Upland Software. Please go ahead, sir.
John Mcdonald
Thank you, and welcome to our Q4 2023 earnings call. I'm joined today by Mike Hill, our CFO, on today's call. I will start with a Q4 review and following that, Mike will provide some detail on the numbers and our guidance for 2024. After that, we will open the call up for Q&A. But before we get started. Mike, can you read the Safe Harbor statement?
Mike Hill
Yesterday, 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 the 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 in combination with GAAP results provide Upland management with additional analytical tools and to understand its operations, Upland has provided reconciliations of non-GAAP financial measures to the most comparable GAAP measures in our press release announcing our financial results, which is 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 Mcdonald
Thanks, Mike. The headlines we beat in Q4 our revenue and adjusted EBITDA guidance midpoint. We welcomed 154 new customers to Upland in Q4, making that a total of 678 new customers in 2023 in the fourth quarter, that new customer add included 15 new major customers on the product front, very busy in Q4.
And of course, we've got a number of initiatives underway on the AI front that are very exciting and of course, we saw some great recognition of our products in Q4 Upland was recognized for the 3rd year in a row as a gold medalist and leader in the 2023 enterprise content management data Quadrant report from software reviews that was for our document management and workflow automation product, which is called file bound.
The award is based on the combined knowledge of real users and placement is based on overall satisfaction with product features, better experience capabilities and emotional sentiment. In addition to that, Upland RO innovation has launched a new customer reference activity hub to help sales, marketing and customer success teams find and engage with their most influential customer references so they can route Boost brand awareness and generate more business in December, we hosted a webinar on content search intelligence featuring and covering how has your AI search went seamlessly integrated with BA insights, cutting edge technology that can revolutionize how organ organizations, access, manage and derive insights from there.
Again, just one of many exciting AI initiatives that we've got underway across half dozen or so products or more, and then also in the fourth quarter, we earned 44 badges in G2's winter 2020 for market reports, and that was across a variety of products. These included our knowledge management solutions often right answers and Upland pan Veeva, along with Upland CBD in our proposal management software and our digital marketing products, Upland Adeptra and Upland Second Street and rankings on those G2 reports, of course, are based on independent data provided by real software buyers. Overall, we continue to make progress on our go to market growth plan, and we remain focused on building great software and delivering value for our customers.
We feel encouraged by the progress the progress we've made to date on the growth plan. We are processing out the sunset assets as planned and clearing the way for core growth and our goal. Mike's going to cover 2024 guidance in a few minutes, but our goal is to exit 2024 at a core organic growth rate of around 3% and our guide will be more conservative than that, probably closer to 1% exit. But the goal is to get to a 3% exit. Again, we've spent a year building and investing, and we are encouraged by the progress we've seen to date and view this year as our year to turn the business back to positive core organic growth and exit with positive core organic growth. So more to come on that later.
And let me now turn the call over to Mike.
Mike Hill
Thank you, Jack. I'll cover the financial results for the fourth quarter of 2023. And as Jack said, our outlook for the first quarter and full year 2024. These results and our outlook for 2024 reflect another year of significant incremental sales, marketing and product investments, as well as the planned runoff of the sunset assets revenue.
Total revenue for the fourth quarter was $72.2 million, representing a decrease of 8% year over year. Recurring revenue from subscription support decreased 8% year over year to $68.2 million. Perpetual license revenue decreased to $1.8 million in the fourth quarter, down from -- actually increased up from $1.6 million in the fourth quarter of 2022.
Professional services revenue was $2.2 million for the quarter, a 26% year over year decline these revenue declines are consistent with the planned runoff of the sunset assets revenue. Overall gross margin was 67% during the fourth quarter, and our product gross margin was 68% or 72% 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 comp were $38.4 million for the quarter or 53% of total revenue, all generally as expected. Also, acquisition related expenses were approximately $0.5 million in the fourth quarter, which should represent the last of our restructuring costs from those acquisitions that we did last year, though the acquisitions in 2022 acquisitions related expenses should remain insignificant going forward until our acquisition activity picks back up in the future.
Our fourth quarter 2023, adjusted EBITDA was $14.1 million or 19% of total revenue, down from $24.3 million or 31% of total revenue for the fourth quarter of 2022. This adjusted EBITDA decline is generally as expected, considering our growth investments in our decision regarding the sunset assets, as described earlier.
For cash flow for the fourth quarter of 2023, GAAP operating cash flow was $8.8 million and free cash flow was $8.6 million, bringing our full year 2023 free cash flow to $48.7 million which was in line with our expectations. As a reminder, our full year 2023 free cash flow was benefited by the liquidation of half of our interest rate swaps in Q3 adding $20.5 million of additional free cash flow in 2023, this a one-time event, or is it just a one-time event unless we decide to liquidate more swaps in the future.
Our ongoing free cash flow generation is in addition to our existing liquidity of approximately $297 million, comprised of the approximate $237 million of cash on our balance sheet as of December 31, 2023, plus our $60 million undrawn revolver. As of December 31, 2023, we had outstanding net debt of approximately $245 million after factoring in the cash on our balance sheet. As of December 31, 2023. Our gross debt was approximately $482 million, of which approximately $259 million is still fully hedged, effectively locking our interest rate at 5.4% on that portion of our debt through the full maturity of our term debt, which is August of 2026.
The remaining approximately $224 million of term debt now floats at an interest rate of sulphur plus 385 basis points, which was about 9.2% at December 31 2023. I will also note that we used $10.8 million of cash to buy back stock, approximately [2.5 million] shares of common stock during the quarter ended December 31, 2023, under our limited stock repurchase program that began in early September of 2023. This brings the cumulative total of our stock buybacks through December 31st of 2023 to $14.2 million. And as a reminder, our stock buyback plan is for a potential total of $25 million should it fully execute for guidance?
The following guidance reflects another year of some significant incremental sales, marketing and product investments that we are making as part of our comprehensive growth plan as well as the effects of decreasing revenue and expenses related to the sunset assets. I will note that as usual, our forward guidance assumes no M&A activity. So our forward guidance will, of course, be adjusted upon future acquisitions.
For the fourth quarter ending March 31, 2024, Upland expects reported total revenue to be between $65 million and $71 million, including subscription and support revenue between $62.5 million and $67.5 million for a decline in total revenue of 12% at the midpoint from the quarter ended March 31st, 2023.
For the first quarter 2024 adjusted EBITDA is expected to be between $11.3 million and $14.3 million for an adjusted EBITDA margin of 19% at the midpoint. This adjusted EBITDA guidance at the midpoint is a decrease of 27% from the quarter ended March 31, 2023. For the full year ending December 31, 2024, Upland expects reported total revenue to be between $259 million and $283 million, including subscription and support revenue between $247 million and $267 million for a decline in total revenue of 9% at the midpoint from the year ended December 31, 2023.
Full year 2024 adjusted EBITDA is expected to be between $49 million and $61 million for an adjusted EBITDA margin of 20% at the midpoint. This adjusted EBITDA guide at the midpoint is a decrease of 15% from the year ended December 31, 2023.
So with that, I'll pass the call back over to Jack.
John Mcdonald
All right. Thanks, Mike. We are now ready to open the call up for Q&A.
Question and Answer Session
Operator
(Operator Instructions) Scott Berg, Needham & Co.
Scott Berg
Jack and Mike, thanks for taking my questions here today. So I got a couple of them, Jack, I guess in your kind of new go-to-market strategy, what you guys more kind of start rollout, what do you think you are on the process for that because you feel pretty confident about exiting this year with core revenue growth. I believe you said target at 3%, but trying to understand where you are in that process and your visibility to drive growth or segment as you get through the year?
John Mcdonald
So yes, so we're starting we've been at it now a little over a year. We've made significant improvements on the product development and innovation side, and we're starting to see those pay off course, the build-out of our center of excellence in India over 130 people there now and growing. And it is enabling us within our cost envelope to innovate across our product portfolio. And again, I think we're starting to see some green shoots from that.
The 44 winner badges from G2 and some of the other analysts and awards that we've received, I think, are indications that that is beginning to bear fruit. I look at where we are in terms of our investments to build broader digital marketing capability. Again, we've made real progress there. I can look at a number of KPI.'s internally around organic search around pipeline build, where we are really starting to see and significant improvements in performance.
On the sales side, more generally, we've built out the sales team, sales process sales tool sales hygiene. It's a different organization culturally today than it was a year ago in terms of really building a true sale, our culture and most recently, we hired a new Chief Revenue Officer, Matt Breslin, who was the executive at Infor, where he ran a $700 million business actually was a colleague at Infor with Oliver gates, who's our Head of Sales. So bringing some of that team back together.
And I feel very good about where we are as we move into 2024 here. And as I say, view this is the year when we make the turn to positive core organic growth with that target of exiting the year at 3%. Again, we're going to guide more conservatively than that, but I feel good about the progress and encouraged by the progress we've made to date.
Scott Berg
Thank you, Jack. Mike, as I look at the guidance here for the year product revenue looks like it's going to be down a few million dollars quarter over quarter from Q4 into Q1. And your guidance suggests that your product revenue is probably flattish at that level for the rest of the year, maybe flat to modestly down from there.
I guess when we think of that non-core versus the core revenues, I assume some of the items that you're sunsetting, what's impacting the Q1 number to be lower than Q4, but how do we think of I don't know the curve of the non-current versus or non-core versus the core going through the end of this year. When was that noncore revenues be out of the model? And then when will we get to see truly what the actual revenues are good?
Mike Hill
So the fact by Jack just described, we're turning from a core standpoint, we're turning from a little negative 1% core organic growth rate in Q4 to positive here in 2024, at least by the exit, hopefully, you know, 3% target core growth by the exit. So a core is sort of making the trough turn there, if you will, on the Sunset assets, there's probably going to be a little less than $30 million of revenue here in 2024 related to the sunset assets that are going to continue to sort of runoff, if you will, over the next couple, three years. So again, those will be a bit of a drag. But the main point here is that the core should be it's turning up here this year.
Operator
Tj Hyed, Canaccord.
Hey, guys, this is Ryan on for TJ. Mike, this one's probably for you is related to Scott's question I was just kind of hoping you could maybe bridge me through your revenue guide for the full year coming up? I guess we're kind of like $27 million decline at the midpoint, what are your assumptions on things like natural churn, new bookings as well as you kind of alluded to those sunset assets, but any color there would be really helpful.
Mike Hill
Yeah, no problem. So most of that decline is going to be the sunset assets, recurring revenue. We do have a little bit lower perpetual license revenue and PSO revenue on that sort of adding to that. And of course, like we said, our guide, we think our guide is a little bit conservative there. So that really sort of adds up to that $27 million on walk. So headline is the sunset asset decline burning off.
Operator
Jeff with Credit Karma. Jeff, the floor is yours.
So it took a couple guys. Maybe Mike with you first on the sales approach, can you just spend a minute as I'm thinking through how what the sales approach is here. I know there have been periods where cross-sell was a vision and there was opportunities potentially to cross-sell from various products. Is this now purely a stand-alone, we're targeting each individual product and if so, are all reps selling all products some maybe a refresher on the sales approach right now?
John Mcdonald
Yes. So this is Jack and on the sales approach at the motion is principally product based. We've got a field sales force and we've also got an inside our sales capability that we stood up it last year. And again, starting to see from that inside sales force, some good early successes in terms of getting had some nice sized mid-market deals done. And now we still have a few it global account executives who will go after larger cross-sell opportunities. And of course, we've seen some of those, including certain one know million-dollar-plus deals in Q4, frankly, that were brought home by those global account executives. And so that will continue to be a part of the model. So again, it's inside an field with a limited number of global account executives.
And then finally, in terms of mix, this is a business that should run at roughly 50-50 expansion in new. It's been running higher expansion and a lower new. And so we want to bring that and expect through the course of this year to bring that back into kind of historical balance on a 50% expansion, 50% new mix.
I appreciate it. And I'm and then, Mike, the in terms of '24, what does that what's the expectation around what kind of free cash flow that EBITDA yield?
Mike Hill
Yeah, Jeff, we're targeting $20 million to $25 million of free cash flow this year or 2024.
And then just one last for me. The as we're looking at the organic and nonorganic, I think you answered the early question, like most of the decline is, I guess the sunset assets coming out, I think you said $30 million that has to work off of over several years. Just refresh me on the sunsetted. Is that the basket of products that is in this sunsetted basket, was that a one and done, you kind of picked a handful of products that for whatever reason needed to be sunsetted and then it hasn't and isn't expected to change? Or is it is there any variability to what's in there? Just refresh me on how that works.
John Mcdonald
So when we took the investment from HTGC., we did a strategic review of our product portfolio that we examine. What were those products that we really wanted to put some wood behind the arrow on in terms of driving growth. And at that point and as a part of that process, we identified the sunset assets. We made a revision to that about a year after where there were a couple of assets, frankly that we realized had some growth potential and there were others that we thought were better off being sunset. So we it was a it was a one-time. And then with the revision to it, it is not our plan to revisit that. We view that as a process that we've completed now, it's possible that it could come up again, but I don't anticipate anything near that kind of scale happening again.
Operator
Jake, William Blair.
Hey, thanks for taking the questions. And good to hear the 3% organic growth expectation exiting this year, just curious how much of that growth is related to political messaging business, just given it's an election year?
And then, Jack, if you take a step back, how should we be thinking about this business when you come out of this transition? And is there a certain kind of growth and margin profile that you're aspiring to? And then I have one follow-up to that.
John Mcdonald
So but I would not expect that the target core organic growth rate does not count any election year above. So there's none of that in there in terms of what our longer term target is for the business. It's for mid-single digits core organic growth. And we know that once we get through 2024 and get the core organic growth motions working that we will turn our sights to some significant margin expansion beginning in 2025.
Well, we'll have IT side at that point of which go to market investments and motions are yielding the highest return. So we'll be able to continue those and adjust spending on less efficient go-to-market motions. We've also put in place as a part of this growth plan, a couple of levers that we think will help us drive growth through time while reducing costs.
So one of those, for example, is the digital marketing capability and the ability to use organic search to drive pipelining, right? That involves some investment upfront, but then you create a flywheel that enables you to generate assets for the sales team through time and with increasing cost efficiency. And of course, in addition to that, on the innovation side, the center of excellence in India and our other offshore initiatives give us the ability to really have the right, hybrid mix and development capability that can deliver innovation and growth within a cost envelope that fits margin expansion.
So where we can get a headcount arbitrage and manage our costs effectively and drive margin through time. So again, coming out of this as we move into 2025 and beyond, targeting mid-single digits, core organic growth and then targeting through time adjusted EBITDA margins between 30% and 35%, driven by again, those efficient motions and the growth model also using AI to manage costs in various parts of our business and then finally, we're going to look this year to turn acquisitions back on something we didn't do last year as we were focused on our internal go-to-market plans.
And as we do that we'll get some operating leverage, which will drive margin expansion. And again, we're talking about one, maybe two deals for this year. We'd like to get done. But then again, through time, we would see that ramping up, and that will also also help to drive and margin expansion.
Very helpful. And then you kind of preempted the next question there in terms of just how you're thinking about capital allocation, sounds like you're turning back on the acquisition motion and looking for a couple of acquisitions this year. But how are you thinking about the balance between M&A, potential potential share buybacks? And then just the potential for debt paydown. Just curious how you're thinking about the capital allocation between those three buckets.
John Mcdonald
So as Mike mentioned, the $25 million buyback is underway, and we are a good part of the way more than half of the way through that. So we anticipate that continuing and filling the full buyback allocation of $25 million. So that I think is sort of step one on the acquisition side. Again, I think we're looking at one maybe two but know kind of internal plan is around one. But if the right opportunities present themselves, maybe that becomes two deals about this year.
And we've been in the market and actively looking at deals of all year round. And of course, we've got the capital we need as we go after those deals that we control the timing, but we are remaining patient for the right assets that are strategic and are available at the right price.
And again, I also wanted to really spend the time with the team focused on making the investments I described earlier and getting this business ready for core organic growth, number of sites feathering in and acquisitions on top of that, thanks for taking the questions.
Operator
Alex, Raymond James.
Alex, the floor is yours, particularly my question. This is John on for Alex. Jack, I think in the past, you've mentioned bundling solutions and focusing on groups and bundles of solutions. So can you give us an update on what successes you've seen there so far? And if there's any learnings that you have so far as you put more muscle behind the go-to-market motion to 2024? And then I have a quick follow-up.
John Mcdonald
Yes, the learnings there are that the most effective motion for us is going to be product centric. And it is, of course, further penetration of the existing customer base up, frankly, through straightforward expansion and then a new logo motion that is driven 80% by a point product sale. It may be 20% by cross-sell, and that is consistent with what I was speaking about earlier in response to Jeff's question regarding the composition of the sales force.
So we anticipate continuing to have a limited number of global account executives that are driving more of that cross-sell motion. But in general, and for the vast majority of it, 80%, you're going to be looking at a product point sales.
That's helpful. And then, Mike, how do you think its free cash flow contribution from the sunset assets here over the next two years. I appreciate you give us color for this year, but how do you think about that over the next two years?
Mike Hill
Yes, Will. By definition, the sunset assets are low margin, low free cash flow contributing and so sort of not quite neutral, but pretty close. So just not much impact on the know on the on the free cash flow there for those.
Operator
I would now like to turn the call over to Jack McDonald, Chairman and Chief Executive Officer.
John Mcdonald
Okay. Well, thank you for joining today, and we will see everyone on the next earnings call.
Operator
Ladies and gentlemen, that concludes today's call. You may now disconnect.
