Upwork Inc. (UPWK) Earnings Call Transcript & Summary

Hi, everyone. I'm Nat Schindler, Internet analyst here, obviously, and I've got Hayden and Erica from Upwork. Love to -- these are pretty short, 30 minutes, so we're going to go pretty quick. If you don't know what Upwork does, read a 10-K before you come in here.

Okay. So let's just jump right into it. So the overarching topic that is affecting everybody in my space right now and clearly has been affecting you and don't blame me for our specialty sales list of disrupted companies, AI. Let's talk about this a little bit. I think the bear case is pretty simple, that people believe that AI will replace some of the work that freelancers do on your platform. And so there would be less need for freelancers in general. How do you respond to that?

Yes. Let's start with that. I saw an ad recently that said, AI won't take your job but someone doing -- working with AI will. And I think that sums up our view of the opportunity for Upwork. Freelancers are already using AI in every single category we serve. It's making them better, faster, cheaper at what they do. And we know from the laws of supply and demand that people buy more, not less of what is better, faster, cheaper for them. So our view is that this is a huge opportunity, both in terms of creating net new jobs. We see this already last -- in the last 3 months, we saw a 1,000% increase in jobs in AI-related categories on our site. We also saw a 1,300% increase in searches for AI-related work on our site. So we're seeing an explosive demand for people with the skills to serve this burgeoning ecosystem of work. And we're also seeing that workers are adopting these tools to make their own work product better and more competitive in the ecosystem. So I think there's a huge tailwind for workers who -- we already know that freelancers are the fastest to upskill, reskill and adopt the best tools in their space. They do this a lot faster than captive in-house employees because they have to. It's what puts food on their table. So this is going to make them even more competitive relative to staffing firms, relative to in-house workers, the fact that freelancers are and will continue to be the best at doing the types of work they do and the most competitive in the ecosystem, I think it's going to give them an even further advantage relative to alternatives in the spaces that they serve. So this is a huge, I think, opportunity for freelancers in general and freelancers on our platform, in particular, that we're really looking to fuel.

Okay. That makes a lot of sense. And I've always had a comment that freelancers are the most adaptive people in the economy. They are the fastest to do anything new. So if they've been replaced with AI, do you really think any of you have a job still? Sorry.

Totally. I mean -- and to that point, I mean, we were talking to some talent even just in the last 2 weeks, and seeing them, how quickly they are adapting this into all of the categories on our platform, starting with Jackie, who is doing consulting services, helping businesses figure out how to use AI across the work that they do in their businesses and then she's actually turning around and helping them adopt the technologies. We talked to this guy, Marcus, who does content development. He's using ChatGPT to do rebranding work for talent, for his clients, and then he's actually turning around and helping them figure out what prompts they can be using to do that work themselves. So again, we're seeing this in every category. The talent is so sharp in terms of figuring out how to apply this to their work and turn that into new business opportunities.

Let's just go a little deeper on that. When you talked about the 1,000% increase in AI-related searches, what are the -- can you talk more about the types of work that these people are doing that are AI that -- first, that the businesses are searching for people to help them with AI, what do they want? And then talk about how the freelancers, as you just mentioned, there are some examples of how the freelancers are actually using AI.

Sure. I mean the work itself is everything from data engineering, data labeling, machine learning. There's a lot of different categories of work that actually is required to deliver the models that we're all seeing and using and playing with every day to the market. These models actually don't build themselves, so there's a lot of that work that's happening. Then there's the fact that people are using these products and getting results that they actually need to be checked by humans or tuned by humans. And so there's that category as well. And then there's the fact that a lot of companies are trying to figure out how do we integrate these models, these large language models, these chat models into our own products and solutions for our customers and how do we find that talent that can actually go in and do that integration work themselves. So those are just some examples of where talent is needed to apply the technology, to build the technology, to integrate the technology into the products and services that a lot of us are either using already or will be using soon. And so that's where I think a lot of clients are coming to Upwork to look for the talent across all of those workflows.

Okay. If we can just put the AI to bed then, and let's move on, always talking about it. This -- last quarter, you definitely saw an -- for your guidance for the year, you've seen some further macro weakness, and it's kind of changed your strategy of this. Can you go a little more detail into what the macro weakness you saw here and how it contrasted from what people were seeing and what you were seeing over the last year and how you see this playing out for the rest of the year?

Sure. The macro weakness we saw showed up a little bit differently in the 2 parts of the business that we serve. So we have our enterprise business and we have the SMB business that largely is kind of using our self-service marketplace product. The slowdown we saw was most noticeable in the enterprise business. This is -- was more than 50% responsible for the takedown in our guidance. So this was disproportionately impactful for our outlook for the rest of the year. And that was really because we saw larger enterprises that we serve both in our existing portfolio and those that we would be bringing in from a new -- net new deal standpoint, both slowing down their deal flow with us just because they themselves were saying, look, we don't even have the decision authority to sign new deals or our budget caps have come down in this environment, we're on pause in terms of what we can do because we are experiencing layoffs, budget freezes, things like that in their own decision-making processes. And we saw a number of our customers who themselves were doing those types of -- were experiencing the economic headwinds, were doing layoffs, were doing budget management across their entire business, not just related to Upwork saying we thought we would be stepping up our spend this year, in fact, we're going to be holding it steady or even decreasing it because we're taking these cost management initiatives across the business. So in the enterprise space, we saw a pretty severe change in Q1 versus what we would have normally seen if the macro environment isn't what it is and what we would normally see in a year that wasn't impacted in that way. In the SMB side of the business, we've actually seen a lot of resiliency despite the macro. The number of clients continues to grow in that space, the hours per contract continues to grow in that space. But we have seen a little bit of softness in terms of what would ordinarily be the rate increases in terms of the hourly wages growing year-over-year with the talent. That has been somewhat headwinded in this environment where wage growth has been slower on our platform than it ordinarily is because of both customers saying, you know what, we're constraining our budgets more. So we're not increasing the amount that we're spending on a per-hour basis with talent the way we normally do. And I think generally, we've also seen so much influx of talent on our platform, prices are very competitive. And so that's a good thing for clients. We're getting a good deal, but that means that the annual increase in per-hour rates that we normally see on the platform has been slower this year than what we've seen in the past.

And the SMBs reacted earlier, you saw that last year. How have they -- how have you seen that play out historically? And also, can you just remind everybody the percentage of your business roughly that's SMB versus enterprise?

Yes, it's more than 80-20, about. So yes, SMB is the vast majority of the business, enterprise is the minority of the business.

And so 50% -- more than 50% coming from that 20 is a big hit...

It's a big hit, that's right. Our expectations for that side of the business is for significant growth this year. It is still going to be a growing part of the business, but a lot less than what we had previously expected because of these impacts on the macro side.

Okay. And I think we didn't go over the -- going over the SMBs and how they responded last year and how they have kind of adjusted to the slow walk to recession.

Yes. And so we did see some of the macro headwinds in the SMB side of the business with just some slow growth starting in the back half of last year and continuing through this year. I wouldn't say those patterns changed noticeably, but what we did see in terms of a little bit more softness in Q1 that we had baked into the forecast was more around that hours per contract growth, which slowed down relative to our expertise of what we would see in a non-macro impacted year. And that was probably the biggest delta there. We also saw more of a lower spend on the SMB side, actually in our larger SMB customers, which is consistent with the idea that it's the larger customers who are doing more of the budget management right now as the smaller customers are continuing more the way they used to, but our larger SMB customers are the ones that are being a little bit more cautious in this environment.

Okay. That's interesting. And now as you go towards the enterprise guys that are really -- been the change in your business, has there been a change in your ability to land? Or is it just an ability for these businesses to kind of increase spend or begin new kind of changes that are happening...

We saw -- we've seen the impact on both sides that led to one of our major decisions, which was to reduce the size of our enterprise sales team this year to rightsize that team with what we're seeing in terms of the activity metrics on both land and expand. So we did see impacts on both. Given the way our model works and how in-year revenue is mostly driven by existing customers continuing to spend or expanding their spend with us, I would say the -- a change in outlook in terms of our expectations of our existing customers, expanding their spend the way we would expect in the non-macro impact of the year is probably what impacted us more in terms of the guidance number that we reduced for this year. Did you want to touch on that?

And then do you see...

I was just going to add a couple of things. The revenue impact was coming from sort of the expand piece of it and the fact that just like -- I myself came from a large enterprise company before coming to Upwork. All company budgets are kind of being curtailed right now. People are firing, not hiring, right? They're -- the first thing that goes when people -- when enterprises cut their budgets is vendor spend and then FTEs. And so there's this swing right now that's kind of going back. And so that actually hits both the land and the expand on the enterprise side, right, because these budgets are either getting cut or they're getting -- like curtailed a bit. So that's what we saw. I think that the decision to reduce the sales team by Upwork was really an observation of some of these trends that I think was actually very prudent.

And on the enterprise side, do you have any industry concentrations that are seen -- for example, being around here, technology-oriented, where you're seeing more layoffs while the overall economy has actually seen a completely robust hiring?

Yes, we did see more impact from our tech companies, that's true. I mean we do -- we're not overly indexed just on that one sector, but that is an area where we do have a lot of our corporate customers and they were more impacted right now. And so that definitely did flow through to some of our economics.

Yes. But I think on the enterprise side, it's sort of across the board.

It is.

Yes. I mean there sort CPG, other industries where we're seeing kind of budgets getting just cut or just more caution, right, with money being more expensive and the companies focusing on profitability in general.

So do you think these are customers that are just delaying projects? Are they just going to say, I'm not going to do this new build-out of a new piece -- internal piece of software that we need to use for something, so I don't need to hire that contract developer? Or is it just there -- won't do to start anything?

No. I mean -- Hayden also has a lot of conversations with customers, but I mean the reality is, right, when companies are in this kind of pendulum swing that they're in right now, what they're doing is they're pausing work, right? The work -- the demand of per work is not going away. Companies are just reducing their FTEs, they're reducing their vendor spend and they're pausing the work that they want to get done later. So when the pendulum starts to swing back, actually, it's a very, very good time for a company like Upwork, companies don't have FTEs in house. They may not want to hire them again, right, right away, but they have work to do that they want to get done, and that's a great time for us to come in.

Yes. And I think related to that, we did talk last quarter about -- in our like previous quarter about these different phases of decision-making that we see clients going through. We definitely are talking to a lot of customers who have been flashing budgets first and asking questions later about how they actually meet the demand of the organization around getting the work done. So it's -- they're being -- they're under intense pressure to meet certain numbers, to just put things on pause and then scrambling on the other side to be like, okay, I hit my budget goal, but now what? I have to do 100 things with 60% of the budget, let me figure out which things are actually going to get done and get cut. So it's been -- I think what we're seeing in the environment is it's a lot of like cut first, ask questions later and figure out how to meet the ends there. And then they're coming back to figure out, okay, like I was talking to a customer in New York last week, they know their existing model does not work to deliver the amount of things they have to do. They cannot do it through their traditional in-house employee team. They have to use Upwork to get a lot of that work done. So now they've addressed their budget need, they're figuring out, okay, how do I retool? What do I do next? How do I do this? But it's like a multi-phased process where companies are just kind of like going through the pain of that and coming through and out the other side to figure out answers next. It's not -- they're not done yet, they're kind of figuring out -- we did the budget thing, now we've got to retool to the work, and they'll be coming back to us to figure out how to do that in the future.

Okay. That makes sense. And then of these new -- with newer cohorts, are you seeing any change? Are they completely on the enterprise side, where you have contracted relationships? Are they truly churning out and just saying, no, we're not working with you for now? Or are they just dialing back?

No. actually, a lot of them are not churning out at all, some of them are just downgrading to our marketplace plan, which is less expensive. So that is one path for many customers. Some of them are just putting things on pause and saying, look, let's come back in a month or quarter, when we have better visibility into our budget than when we've worked through some of these cost containment measures. So there's definitely a variety of paths. We are hearing loud and clear from so many customers that even if they have to put things on hold now, they know the strategic value and they will be coming back through one of these avenues in the future. So a lot of the time -- one thing Erica and I have talked about is when we talk about churn, it's often just churn in dollars, not actually customer churn that we see. So we see people bringing down their spend, but it's not that they're leaving the platform all together, it's just that they're reducing that activity.

It's just the average contract size coming down rather than we're actually churning out.

So they're not going back to manpower, they're just using -- okay, that makes perfect sense. Contrary to this or some -- contradictory to this macro impact on investment, you also raised prices or at least simplified prices that in a way that's higher. Isn't that contradictory? And how are customers reacting to that change in price?

Well, we lower prices -- we actually lower prices. Our headline fee for talent went from 20% to 10%, which is a big deal. That's a 50% reduction in fees for talent. And that's a big deal because previously, talent were seeing a 20-10-5 fee structure and that 20% that we previously charged on the first $500 of a new relationship meant that talent we're pricing in that 20% for the full duration of our relationship. And that's a big deal. So if a talent was expecting to pay that 20% forever, that was baked into their fee and that was potentially dampening client demand because they were seeing that full 20% price in there. We reduced that headline fee to 10% flat for the lifetime of the relationship, meaning that now talent can price in not an expectation of 20%, but of 10%. That brings down overall pricing on the platform completely, and that has the opportunity to unlock demand in terms of clients posting more projects because Upwork just got a better deal for them and hiring more because they'll see more of that better value from Upwork talent and bringing more work as a result. So that is really one of the key things about the better pricing structure that we just aligned to. And on the back end, we do monetize more for longer-term relationships because that 5% fee we used to have for 10,000 and above relationships now went up to 10%. So we've really just restructured the pricing to give talent a better deal at the front, clients more opportunity to experience value from Upwork talent and from the platform, and then we capture more value at the back end in a different way than at the front end.

But overall, across the normal practice of your business unless everybody changes how they use talent, your average take rate goes up over time?

Our take rate does go up because our platform does deliver long-term high-value relationships for clients and talent. That is part of what we do.

Right. And regardless of how the talent priced at 20%, we only took 20% on the first $500, right? So...

Yes.

So we do think this is, in the interest of the platform long term, in terms of stimulating more of those long-term relationships actually starting and maturing rather than people being deterred from doing that because they felt like it was a higher, more expensive product at the outset.

And -- well, but the reason you have the low price on the long-term project was eventually, they'd become very used to working with that person, their -- the value -- they've already found the person through you, and now they theoretically could gray market you, could go around you at some way if they're talking about months-long projects. Does that change anything in going from 5% to 10% on the long term?

No, it turns out we add a lot of value through the entire relationship. And they don't need to leave us. So we have a lot of good data on this from when we had a flat fee structure pre 2016. We feel really confident with how we add value through the entire duration of the relationship. And this is really a win for both talents, clients and Upwork.

Okay. So then turning it over to somewhat related to what you said about pricing, how the talent prices on your platform. How have inflationary pressures as well as macro pressure, so less demand for long-term work from some of your clients, but at the same time, inflationary pressures, how has that affected how talent is pricing on the platform?

As we mentioned earlier, we actually have not seen -- so normally, what we see is every year, talent prices increase by kind of a steady amount on the platform in aggregate. And you can imagine that's driven by a bunch of things. We have over 110 categories of work on the platform. We have geographical dispersion across 180 countries. So there's a lot of factors that go into what the kind of average hourly rate across the entire platform is. But generally, we do see a step up every year. We haven't seen that same step up this year at the same rate that we have seen in previous years. Our belief is that's because of two things. One is the macro environment is putting more pressure on pricing from a client kind of what they're willing to spend out of pocket. As we mentioned earlier, we are seeing clients still actually spend more in terms of number of hours per project. So they're increasing the amount of work getting done, but they're putting more pressure on hourly rates. And then we've also seen, since COVID, an explosive amount of talent on the platform, both new people coming in and signing up and our existing talent, reengaging and wanting to do more work on our platform. That's creating a lot of competition for work. That also is probably headwinding rates, again, in certain places, not across the board. You can imagine there's pockets of places where hourly rates are going up, other places where they're more stable. But in aggregate, that's -- that's where we're not seeing that step up right now. And I think it's less about inflation, it's more about those dynamics specifically that are driving what's going on with the platform.

The increase of supply in the platform, you saw it with COVID, obviously, more people at home. As businesses have pushed work from -- the return to office, has that increased -- has that pushed some people into freelance work and into your platform? Or people not wanting -- wanting to remain permanently virtual?

I think there's a massive secular trend here that is really not impacted by the return-to-office policies. I mean we saw people going towards this way before COVID, we've seen it explode with COVID as people gone back into the office. We have tons of clients who are in office still engaging with remote teams of freelancers and it doesn't really matter. So I think certainly, everyone discovered during the pandemic that they loved flexibility, freedom, not commuting, all those things, and that made online freelancing even more attractive. So on the margin, for sure, I think more people are thinking about working this way. We've got close to 6 million Americans working as freelancers already. But I think these work policies, they don't really impact whether people are working -- willing to work with freelancers or working on a platform. There's just like such a massive trend here that's just -- that's happening that we're riding.

Makes sense. Speaking of riding that massive trend, previously, you were pushing as we came out of COVID, the -- you pushed a big brand awareness campaign. Because the idea was, look, the world has learned that you can work remotely, so why won't we push -- lean into this and advertise and show people that we can help them have remote talent at a better price. Recently, you pulled on that brand campaign. So walk us through the decision. And what are going to be the impacts?

Yes. So the genesis of the brand campaign was the insight that awareness is one of the biggest things -- the biggest gaps that we need to close in the market. We have an amazing offering. It's better, faster and cheaper than any traditional alternative for hiring, getting work done. It's hugely transformative for the businesses we serve and yet most of the clients that we should be working with don't even know this category exists, don't even know that Upwork exists. So the insight was, if we can move from our single-digit awareness that we have had to double digit, that could be explosive growth for the business. What we're seeing in this environment is our confidence in our ability to translate a brand awareness investment into clients spending money on our platform in a meaningful time frame that we feel really good about with that investment is just lower. We've talked about what enterprise customers are doing. Erica talked about they're curtailing spend, they're just thinking about the bottom line right now and driving efficacy in the short term. So us investing in awareness right now in this moment feels less productive and less justifiable then in a different type of a macro environment. So we still believe in the awareness goal. We think that's a big one for Upwork, and we are pursuing that through some other channels. We will probably revisit this question of brand in the future and TBD, what we decide to do there. But at this moment, in this environment, it doesn't feel that we can have that line of sight to the ROI on that investment, the way we would want you to be comfortable continuing to invest at the level we were investing previously.

Yes. And the awareness investment was effective, it was very effective, actually. Energy awareness grew 40% with the brand investment. It's just that the confidence that it would convert to revenue just wasn't high enough. So it's something that -- I actually think we mean -- the awareness issue for Upwork continues to be one, it's something that we can continue to invest in, in the future when the time is right.

And obviously, the other side of this, kind of pulling back on that and going for profitability in -- right now, your margins are going to go up pretty dramatically. Assume we have this recession in the back half because everybody keeps saying we will and 2024, we go back to a more normal environment. Do you lean in again and go back to -- have margins go backwards again? Or is the new level of margins going to be kind of a baseline?

I think -- yes, I'll talk to it. Look, we're very focused on profitable growth. I think that's going to be an ongoing theme for us. It's not going to end in 2023. I think this -- that said, look, I mean, first and foremost, we are cutting back on brand spend where we've reduced the ranks of our enterprise sales force right now to get to the most productive. That said, we're still investing very handily in R&D and other areas of the business and able to produce profitable growth. So we're investing in growth. We're going to continue to grow. And as we enter 2024 and beyond, we're going to absolutely revisit brand spend. But I don't think we're going to walk away from profitability.

We walk back profitability? Or does it...

I don't know yet, Nat. We'll see.

She just got here. She just got here a few weeks ago. Give Erica a minute.

Hold the line.

We've always known this business can be very profitable and a high-risk business. And that's -- our eyes are on that price. We want -- we know this business can do both. And so we're going to be focused on delivering that...

I mean the TAM for this business is too big to only focus on margin -- on bottom line margin growth. We think we can do both, I'm certainly confident we can. There's certainly ongoing leverage we can gain in the business, and we can take some of that and reinvest in the areas for growth.

Okay. These presentations are quick. We're 3 minutes left. So I really want to go to anyone in the audience. If you guys want to jump in here with any questions. Okay. So this was -- no one wants to jump in?

We answered all of them.

Sorry, we were trying to go quick. Okay. So going back to the margin question. Realistically, you had reasonably high margins earlier, you went to a more aggressive growth stance. Where do you think you can be -- where do you think this business -- and you talked about the TAM for this business, this is large and you can take more and more share in this, so it's a question of growth to margin. Where is kind of your Rule of 40, if you want to call it that? Where do you see that settling in a normal economy?

I think the Rule-of-40 rule, if you will, is probably sort of a good target for us. And I'm not going to make a call right now on which year we're going to hit it. But I think it's a very sensible target for a business like this one. Yes, and I'm still working on our long-term plan. I'm going to give it a couple of months.

Yes. I mean we have incredible assets given our market position. As a leader in our space, customer base that we have, the data asset that we have, which by the way, we didn't talk about the opportunities that we ourselves are leveraging from a gen AI perspective, like in our product, in our go-to-market, et cetera. But there's just a lot we're going to be unleashing here that I think is really exciting as we keep leading our market position forward here. So I think with all of that, this has been a tough economy. And to your point, if BofA and others are saying there's going to be a recession in the back half of the year, we'll see where that takes us. But we are really playing offense going into the next couple of quarters, position the business so that even as enterprise customers and others are ready to spend again, we'll be ready to partner with them to do that on Upwork.

So internal gen AI? You're going to -- no giant spending on NVIDIA chips? Sorry.

We've got a great platform of talent that we can actually use to develop any AI tools that we...

Yes, but please use others tools. You don't need to make your own large language model. Sorry. Okay. Well, anyone can jump -- I mean, one minute. Anyone? Come on. Okay, Stuart.

So in that sector, it is so [ privated ], right? And there's many private companies, a lot of funding in the last couple of years probably because you've been so successful, right? You're the leader in the space. How do you think about strategic growth over the next couple of years kind of given your leadership and scale versus a lot of fragmentation in point solutions?

I mean I think we have a huge advantage in terms of our ability to execute on the work marketplace strategy that we've been building because we aren't just a point solution for one type of freelance work. We recently launched our full-time offering, which lets people graduate freelance relationships into full-time offerings. We have the enterprise suite, so people can grow either from small businesses to large or start a small service and then move into more programmatic work. We really have this full suite of offerings, which enables us to box out competitors who are either just offering point solutions or single-category solutions versus us as a horizontal providers, that lets us do a lot of things with our marketing and the share-of-wallet growth strategies, that's really a virtuous flywheel for us. So I think all of that has been already a huge advantage that we'll continue to leverage. And in a world of gen AI, the data asset we have is tremendous, the talent scale asset we have is tremendous as we talked about at the top of the meeting. So there's, I think, a lot more that we will be putting to work to really continue to push forward ahead of others in the space, which is very exciting.

I think he wants to know if you want to buy any of these small guys?

Partner out...

But -- yes. I mean yes, I don't think -- the good news is I don't think we need to do any acquisitions to execute on our strategy. I think we always opportunistically look at what's going on in the market, but I don't think it's critical...

I would say we get a lot of outreach. At this point, we also have a lot of partnership opportunities. And so I think we're going to -- we'll certainly consider stuff. But for some of these very, very small kind of low growth point solutions, it just may not be the right thing for us.

Great. Well, we are past time. Gosh, it's quick...

Thanks, Nat.

Thanks.