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Upland Software Inc (UPLD -8.33%)
Q3Â 2020 Earnings Call
Nov 6, 2020, 5:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Thank you for standing by, and welcome to the Upland Software Third Quarter 2020 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 third quarter 2020 earnings release, which was distributed today at 4:00 p.m. Eastern Time. If you have not 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 -- Chief Executive Officer and Chairman of our Board since
Thank you, and welcome to our Q3 2020 earnings call. I'm joined by Tim Mattox, our President and Chief Operating Officer; Rod Favaron, our President and Chief Commercial Officer; and Mike Hill, our CFO. I'll summarize our results and recent sales, product and operations highlights. Following that, Mike will provide some insights on the Q3 numbers and our guidance. Then we'll open the call up for Q&A. Before we get started, Mike will read the safe harbor statement. Mike?
Michael D. Hill -- Chief Financial Officer
Thank you, Jack, and good afternoon, everyone. During today's call, we will include statements that are considered forward-looking within the meanings of the securities laws. These statements are subject to risks, assumptions and uncertainties that could cause our actual results to differ materially. A detailed discussion of these risks and uncertainties are contained in our annual report on Form 10-K as periodically updated in our quarterly reports on Form 10-Q 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 third quarter 2020 results, which is available on the Investor Relations section of our website. Please note that we are 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 -- Chief Executive Officer and Chairman of our Board since
All right. Thanks, Mike. In the third quarter, we posted record organic growth and free cash flow. And based on strength we're seeing in the business, we also raised our revenue and raised our adjusted EBITDA guidance for Q4 and the full year. So let's go through the numbers. In Q3, we had 35% growth in total revenue. We had 21% adjusted EBITDA growth. Now our EBITDA growth was lower than our revenue growth due to our ongoing sales and marketing investments and also a temporary uptick in CXM messaging costs based on the high election year volumes.
Q3 cash flow was $18.5 million. We only had $3.6 million of acquisition expense in the quarter, and we had a little over $3 million of net positive working capital changes. And from this point forward, we're focused on generating material GAAP operating cash flow and free cash flow, even after acquisition expenses, even after we turn the acquisition program back on. We completed in the third quarter a transformational equity raise. And we are now capitalized well enough to be able to grow double digits through a combination of organic growth and acquisitions for a very long time and are no longer dependent on the equity capital markets due to our free cash flow generation.
Our Q3 organic growth in reported recurring revenues came in at 14%. Now this recent acceleration in organic growth is all being driven by that bump in election year CXM usage by political campaigns and other advocacy organizations. And that usage has, to date, more than offset any COVID-related bookings and churn impact. And we see continued strengths in organic growth as we move into Q4, but we don't view this as any kind of a new normal for organic growth. Some of this election year usage bump will continue in 2021 as political campaign spending shifts to issue advocacy spending. But we can't say exactly how much, so we're going to maintain a conservative organic growth outlook for 2021.
And in fact, our strong 2020 results and COVID impacts to net revenue retention are going to, combined, create an organic growth rate headwind in 2021 versus our normal kind of low- to single-digits organic revenue growth guidance. In addition, while we're continuing to invest in our sales and marketing initiatives, we're not expecting those investments to impact organic growth rates until late 2021 and beyond. And of course, there could be no guarantees around that impact. On the sales front in Q3, we expanded relationships with 247 existing customers, 37 of which were major expansions. And we also welcomed 108 new customers to Upland in the third quarter, including 34 new major customers. On the product side, we had six major releases and 15 feature packs across our product set.
A couple of examples: in the project and IT management area, we introduced a new resource request workflow to help users streamline resource allocation requests, resulting in greater utilization and profitability. And in our enterprise sales and marketing area, we added a new key Microsoft integration that enables users to access their request for proposal and proposal library directly from within Word and Excel. On the M&A front, due to the strength in our business, our acquisition program is now turned back on, and we are active in the market for acquisitions. And again, as I referenced a moment ago, we are now self-sustaining for our acquisition program with no need to tap the equity markets.
So with that, I'll turn the call over to Mike.
Michael D. Hill -- Chief Financial Officer
Thank you, Jack. I'll cover the financial highlights for the third quarter and our outlook for the fourth quarter and full year 2020. On the income statement, total revenue for the third quarter was $74.2 million, representing growth of 35%. Recurring revenue from subscription and support grew 39% year-over-year to $71 million. Professional services revenue was $2.8 million for the quarter, an 8% year-over-year decline, which was expected due to the COVID-19 travel impacts. Overall, gross margin was 66% during the third quarter, and our product gross margin remained strong at 67%, or actually 71% when adding back depreciation and amortization, which we refer to as cash gross margins.
Operating expenses, excluding acquisition-related expenses, depreciation, amortization and stock comp, were $28.3 million for the third quarter or 38% of total revenue, all generally as expected. Also, acquisition-related expenses were approximately $3.6 million in the third quarter. And as I mentioned on the last quarter's call, these costs will continue to dramatically decline without further acquisitions, and we anticipate Q4 to be around $1.5 million. Our third quarter 2020 adjusted EBITDA was $25 million or 34% of total revenue, up 21% compared to $20.7 million or 38% of revenue for the third quarter of 2019. Adjusted EBITDA margin was lower due to our continuing sales and marketing investments and a temporary increase in cost of revenue from CXM mobile messaging due to high election year volumes.
As we look out to 2021, the sales and marketing investment will continue. In a scenario where we do know additional acquisitions, that would result in adjusted EBITDA margins for the full year of 2021 in the low-30%. However, as Jack noted, we are turning acquisitions back on based on the strength of our business. With acquisitions, our target is to be back to the mid-30% adjusted EBITDA margin by Q4 of 2021.
For cash flow, for the third quarter of 2020, GAAP operating cash flow was $18.7 million, and free cash flow was $18.5 million. Free cash flow should be over $50 million on a forward 12 months basis before additional acquisitions. And even with additional acquisitions, should be over $30 million and possibly over $40 million, depending upon the size and timing of future acquisitions. On the balance sheet, this ongoing free cash flow generation is in addition to our existing liquidity of $293 million, comprised of approximately $233 million of cash on our balance sheet and $60 million of our undrawn revolver.
With regard to income taxes, I will note that Upland currently has approximately $351 million of total tax NOL carryforwards, and of these, approximately $211 million will be available for utilization prior to expiration. As of September 30, 2020, we had outstanding net debt of approximately $301.6 million after factoring in the $233 million of cash on our balance sheet. I will note that the principal payments on our term debt are 1% per year, or about $5.4 million per year, with the remaining balance maturing in August of 2026. The interest rate on our term debt is locked at 5.4%, making our annual cash interest payments approximately $30 million a year. Additionally, I will point out that our term debt has no financial covenants on current borrowings. And now on to guidance.
For the quarter ending December 31, 2020, Upland expects reported total revenue to be between $70 million and $74 million, including subscription and support revenue between $67 million and $70 million. For growth in recurring revenue it's 16% at the midpoint over the quarter ended December 31, 2019. Fourth quarter 2020 adjusted EBITDA is expected to be between $23.2 million and $25.2 million for an adjusted EBITDA margin of 34% at the midpoint, representing a reduction of 3% at the midpoint over the quarter ended December 31, 2019. Because as you may recall, we recognized a significantly outsized $3.5 million of perpetual license revenue in Q4 last year, which spiked adjusted EBITDA in that year ago quarter.
For the full year ending December 31, 2020, Upland expects reported total revenue to be between $283.5 million and $287.5 million, including subscription and support revenue between $269.6 million and $272.6 million for growth in recurring revenue of 33% at the midpoint over the year ended December 31, 2019. Full year 2020 adjusted EBITDA is expected to be between $96.5 million and $98.5 million, for an adjusted EBITDA margin of 34% at the midpoint, representing growth of 18% at the midpoint over the year ended December 31, 2019.
And with that, I'll pass the call back over to Jack.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Thanks, Mike. And now we're ready to open the call up for Q&A, and please feel free to direct questions to Mike, Tim, Rod or me.
Questions and Answers:
Operator
We will now begin the question-and -answer session. [Operator Instructions] Our first question today comes from Brad Zelnick with Credit Suisse.
Brad Zelnick -- Credit Suisse -- Analyst
Great. Thanks so much. Congratulations, guys, on a great Q3. Jack, in your prepared remarks, you mentioned the company is no longer dependent on the equity markets for M&A just given your free cash flow generation. And it's great to see the flywheel of the model working nicely with the added benefit of strong organic growth. But I guess my question is, what would you have to see to deviate from your framework to perhaps look at bigger deals or acquire with more frequency that might bring you back to raise more equity? And maybe for Mike, how should we think about the upper bounds of net leverage at this point?
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
So thanks for the questions, Brad. We feel that we are targeted on the right segment of the market for acquisitions. Those are companies out of venture portfolios in the $5 million to $25 million revenue range that have strong products and great blue chip customers, but they on their own, can't achieve escape velocity. And we've done over 25 acquisitions in that category, and I really think the opportunity we've got is to be the de facto consolidator of that category of companies. And it's a beautiful segment to be in because most of the private equity firms aren't interested in targets that small. And we're buying up to 20% organic growth company, so sort of below $25 million of revenue, below 20% organic growth, there's not really a PE bid or a growth equity bid.
So we think we can be the de facto consolidator, and there is a massive flow of these companies maturing out of VC portfolios every year, and that quantity of attractive targets is going to grow significantly over the next five to 10 years, right, because it is trailing the VC investment that went in six, seven, eight years ago as those funds started then begin to age out. And of course, we know those numbers of investment dollars moved up rapidly over the past eight years, and so you're going to see that corresponding supply of companies there. So we're going to stick to our knitting on the size of companies we acquire.
In terms of the quantity of deals, we are quite comfortable in the $50 million a year, plus or minus category, and that's roughly four deals a year. Maybe in some years, it will be three; in some years, it will be five. But we're comfortable with that pace here. So I don't really see any shiny objects out there that are going to distract us from that course. In terms of leverage multiples, let me let Mike answer that part of your question.
Michael D. Hill -- Chief Financial Officer
Yes, Brad, thanks for the question. So net debt leverage, upper boundary. We see now around 4.0 times leverage as that sort of upper bound. Our term loan B credit facility is geared around 4.0 times leverage. So that makes sense. So right around that area. Of course, over time, as we continue to grow and scale and generate more and more free cash flow, we will expect that net debt leverage to come on down below four, down to 3.5, and ultimately lower than that, toward three.
Brad Zelnick -- Credit Suisse -- Analyst
Thanks, Mike. And Jack, if I could just follow-up on what you've said. As we think about the M&A landscape out there, it makes perfect sense that there's a lot of companies that are actionable that meet your criteria. But just on valuations right now and competition for deals, especially when we look at public market multiples that are, in some cases, very rich relative to recent history, is it fair to say that what you're seeing in the public -- in the private side as well is tracking similarly? Or is there perhaps a disconnect?
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
So yes, that's a great question, and there is a disconnect. But before I get into the meat of that answer, let me just say one thing. Mike, you spoke a moment ago about four times as the upper bound of our leverage range. But I just wanted to make clear that current leverage is significantly below that. And so where are we today, Mike, on the net debt leverage?
Michael D. Hill -- Chief Financial Officer
Yes, Jack, we're about 3.1 times today.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Right. So again, 3.1 today and managing it up to 4, and hopefully, keeping it below that. In terms of valuation, yes, I mean, there is, obviously, in the public market, a set of companies that enjoy a public market trading multiple. It's a different environment with respect to these $5 million to $25 million businesses, particularly the ones that are growing less than 20%. And so historically, if you look across our 25-plus acquisitions, we've paid roughly 6 times to 7 times the pro forma EBITDA. That's the EBITDA that we're able to enjoy from the business once it's been put on to the Upland platform, which is a process that happens within the first quarter or two post acquisition. And I don't see anything changing that in the current environment.
Our pipeline is strong. And as I say, there are some bigger secular trends as these VC companies come out of portfolios that grew larger over the past 10 years. In addition to that, I would note kind of on a more specific basis right now, you've got a bunch of people bunched up at the exits who wanted to transact this year, but weren't able to because of the impact of COVID. So both in a sort of short-term and in the longer term we think those supply demand characteristics are going to keep prices reasonable. And again, for us, you look at an EBITDA multiple arbitrage which is very attractive relative to the pro forma EBITDA multiples we're paying, and if you look at the IRRs that we're getting on these deals, very substantial. So we like where we're positioned.
Brad Zelnick -- Credit Suisse -- Analyst
Excellent, thanks so much for the thorough explanations and keep up the good work, guys. Thank you.
Operator
Our next question comes from Bhavan Suri with William Blair. Hey everyone. Congrats on the quarter. This is actually Jake on for Bhavan. But I'd love to dig more into the sales restructuring that you guys are doing. So how have these initial cross-selling efforts impacted ACV? I know that you guys are saying end of2021, but just trying to understand where you see the low-hanging fruit and just kind of what's been happening already?
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Yes. So thanks for the question, Jake. It is early to be kind of pointing to specific impacts, but there's a lot of exciting initiatives that are under way. They're being led by Rob Favaron, our President and Chief Commercial Officer. So let me ask Rod to give you a broader picture of what we're doing here.
Rodney C. Favaron -- President & Chief Commercial Officer
Thanks, Jack, and thanks for the question. So Q3 progress, actually, it was a good quarter for progress, and this mission, as Jack put it, we're early in, really five to seven quarter journey from here, frankly. But we are deep in this evolution. So some highlights. The cross-sell pipeline is growing quite nicely. The -- we're sort of reshaping our marketing motion a bit. So we've centralized our lead gen machine just to get more efficient. We've also -- we're well into sort of an updated digital presence. As you know, the buyer's journey is pretty digital, and with COVID, it's now more digital. So under the offices of selling remotely for a long time, we spend a lot of time sort of reengineering kind of the buyer's journey with us digitally.
You'll see a lot more of that publicly from us as we get into 2020, but a lot of progress there. We also added a new leader for our sales development team. So this is the team that catches the lead flow and qualifies it. So we've centralized that team, hired a new leader and updated that motion. So we have a lot more visibility top funnel -- top of funnel. And then we talked about the global accounts initiative. That team is mostly hired, and we've added a leader. And they will manage our top 150 to 200 accounts globally. And so they're generally on the ground now and ramping and coming up to speed on all of our products and their accounts.
And so as we get into early 2021, we expect to see sort of an impact from that team on our cross-sell pipeline. But we're already seeing anecdotal impact of just finding opportunities within our biggest customers. So honestly, we -- the building is going great. I'm excited about sort of how the progress we're making on the ground operationally and structurally with the teams, talent, people and the processes. And so we're sort of encouraged as we exit the year and move into 2021.
Jake -- William Blair -- Analyst
That's great. Thanks for the color. Congrats again on the great quarter.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Thank you.
Operator
Our next question will come from Brent Thill with Jefferies.
Brent Thill -- Jefferies -- Analyst
Thank you. Jack, I'm curious if you could just talk about some of the higher level drivers and how the customer behavior is changing. It feels like things are starting to open up and feel a little better. Kind of maybe just give us a little more specific. And I guess, for Rod, on the sales build-out, I'm curious if you can give us a sense of the capacity you're adding in '20 over last year, and how do you expect that to roll into '21.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Sure. So thank you for the question. When we went into the slowdown that was precipitated by the response to COVID, we made some assumptions around impact to bookings and churn. And at the time, our belief was that we're going to see the most impact in the second quarter and the third would be better and the fourth would be better than that, and you would move back to a more normal situation by Q1. And we have seen that progressive improvement as we moved quarter-to-quarter.
So it's not to say our business has been immune, if you will, from the impact of the lockdowns. But it's been incredibly resilient. And of course, we've had some areas that have done spectacularly well and driven this above trend organic growth. So that's a little bit of a stage setting to, I think, some more specific insights that Rod can give you around what we're seeing from customers.
Rodney C. Favaron -- President & Chief Commercial Officer
Yes. Brent, to your capacity question, we're more taking current capacity and evolving it, retooling it and sort of changing out some players to the right type of players and then adding the global account team. That isn't completely incremental but -- because we've sort of swapped it out for some other AEs. So I would just say it's sort of a modest, slight increase in capacity. Nothing dramatic. Really, we want to make sure the model is humming. And so until we get to that point, I would call it a modest increase, but really a kind of retooling.
So do we have the right players? Do we have the right players in the right place in the field? Do we have the right skill sets? So we've upgraded a number of folks, and we've done a lot more training this year to get people more capable. And then we've added the global account heads, but they weren't -- even those weren't completely incremental. So I think that it's a -- modest is the word I would use, from an increased capacity as we head into '21.
Brent Thill -- Jefferies -- Analyst
And just a follow-up, Jack, on the above trend. Where are you seeing the biggest surprise on the upside?
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
So in terms of growth of the business, CXM usage in this quarter came in very strong, really driven by election year political campaign and issue advocacy usage. It wasn't necessarily unexpected, and that we knew we would have this kind of a bump given that we're on a 4-year cycle right now. But that's where I would say we've seen the biggest kind of above trend growth opportunity in Q3. And again, we see that strength continuing into Q4.
Brent Thill -- Jefferies -- Analyst
Thank you.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Thank you.
Operator
Our next question comes from Scott Berg with Needham & Co.
Alex -- Needham & Co -- Analyst
This is Alex on for Scott. Congratulations on the quarter. And I was wondering if you could give us a little bit of color on -- as we've been seeing in the news that some of the European countries have been experiencing some more shutdowns recently, what would be the impact to the business if more restrictions were put on domestically?
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
So Alex, thanks for the question. As you know, we do -- a part of our revenue's in Europe, but we didn't really see any differential in results there. In fact, the business has been good. So I'm not anticipating any broad changes from that. We've seen our ability as a business to be resilient through the lockdowns here in the U.S. and sort of Phase one of those in Europe.
So I think we're well positioned in terms of how we're going to market. And in terms of the set of products we've got and the use cases around those products to really help our customers operate their businesses remotely, whether that's customer journey and advocacy, or whether it's running back-office or professional services. So I think we're well positioned to be resilient through that.
Alex -- Needham & Co -- Analyst
Great, thank you.
Operator
[Operator Instructions] Our next question comes from Jeff Van Rhee with Craig-Hallum.
Jeff Van Rhee -- Craig-Hallum -- Analyst
Great. Thank you for taking my questions. I'll add my congratulations. Several questions for me. Jack, to the high level, great organic, 14%, I mean, blow out numbers there. Can you dial it in a little closer, what it would have been without the election year upside. That would be question one. And then two, you're moving fairly quick, but I just want to make sure I heard the '21 commentary on growth clearly as well. I think you referenced the low- to mid-single-digit guide may not be valid. But just maybe put a little finer print on both of those.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Sure. So this outsized performance was all driven by that bump in CXM usage for coming out of election year political campaigns. And so absent that usage, we would not have had this above trend result. We'd be back in our normal kind of outlook of low to mid-single digits, right? So just standard Upland range of performance. Now as I said, we're seeing this strength continuing into the fourth quarter. And in addition to that, we're going to be conservative about the outlook for '21 and assume that very little of that repeats.
But as I mentioned in the opening remarks, in most cases, what we've seen in the past is that a portion of that spend moves over into issue advocacy and that you do get an echo of that in the year following. So that's our take on what the potential impact is. Now you've got that strong performance in '20. And as well as any COVID impacts around bookings and churn, particularly earlier in the year, that are going to impact and create a headwind for our organic growth rate in '21. So we just want to sort of be conservative in terms of our -- as we move into next year, recognizing the fact that these double-digit organic growth quarters are going to create a headwind for us in '21.
Jeff Van Rhee -- Craig-Hallum -- Analyst
That's helpful. And then maybe just, I guess, two for Rod. The global account team size, where are you -- where's -- kind of what's the near-term goal there? You said you're pretty close. And then from a product road map standpoint, I don't know if this is Tim or what -- who's best to answer that, but is there anything from the product road map as you're kind of getting into this new selling motion, you're really focused on cross-selling and maximizing those opportunities. Is that affecting the product road map at all with respect to integrations or other things that need to be done that might not have needed to be done prior to this push?
Rodney C. Favaron -- President & Chief Commercial Officer
So this is Rod. I'll start, and then pass it over to Tim. So from a global account perspective, we have, I'll call it Phase one of this theme for this year, for the late 2020 group. We have a leader plus 10 global account guys. We're almost completely on the ground now. We're at a leader plus eight or so. So -- and they will be -- or already are organized by industry. So we've got them with sort of our top accounts by industry so they can get some industry leverage.
Many of these hires came out of the industries that, or had been calling on these industries. So we brought in a lot of vertical expertise. And we're tuning our messaging for those industries for our top accounts. So as I said, we're still ramping these folks, and we don't have all their final territories funded. It will be in that top 150 to 200 customer number, which is a reasonable amount of IRR that they'll be paying attention to and then growing. I hope that helps.
Jeff Van Rhee -- Craig-Hallum -- Analyst
It does. And then the product question?
Timothy W. Mattox -- President & Chief Operating Officer
Sure, Jeff. I'll handle that. It's Tim here. So a few things. One is, first and foremost, our product road maps are heavily customer-informed. So by that, I mean, the feedback from our existing customers, what our support teams are telling us, what our customer advisory boards, our customer success teams. So Rod and I are working hand in glove to ensure that our road maps support high levels of customer retention. So that's vertical. And then on the cross-sell point, certainly, purposeful integrations, intra Upland integrations, if you will, are important where they add direct value.
So we'll be looking to continue to do those as well as integrate the third-party systems of record. You'd find that, that's another key way for us to add value to customers. We have a relationship with Dell Boomi to accomplish that. We also integrate into Salesforce, sometimes directly, sometimes into their environment. That's helpful as well. So those are the things that we're looking to do in addition to really the customer-informed incremental innovation. Now where we see a gap, either adjacent or with a particular product, we also have the M&A arrow in our quiver that we've used more strategically in the past few years. So we look to fill in the road map that way as well.
Jeff Van Rhee -- Craig-Hallum -- Analyst
Sounds good. That's helpful, thank you.
Operator
This concludes our question-and-answer session. I would like to turn the call back over to Jack McDonald for any closing remarks.
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Great. Okay. Well, thank you all very much for your time this afternoon, and we look forward to seeing you on our next earnings call. Thank you.
Operator
[Operator Closing Remarks]
Duration: 37 minutes
Call participants:
John T. McDonald -- Chief Executive Officer and Chairman of our Board since
Michael D. Hill -- Chief Financial Officer
Rodney C. Favaron -- President & Chief Commercial Officer
Timothy W. Mattox -- President & Chief Operating Officer
Brad Zelnick -- Credit Suisse -- Analyst
Jake -- William Blair -- Analyst
Brent Thill -- Jefferies -- Analyst
Alex -- Needham & Co -- Analyst
Jeff Van Rhee -- Craig-Hallum -- Analyst
