Upwork Inc. (UPWK) Earnings Call Transcript & Summary

Good afternoon, guys. Thank you for coming. My name is Kunal Madhukar. I'm the SMID Cap Tech analyst at UBS. It's a pleasure to host a fireside chat with Erica Gessert, CFO of Upwork. Erica, thank you so much for coming to the conference.

Thanks for having me. It's an honor to be here.

Absolutely. Great. So we -- this is a fireside chat, so I'll be asking some of the questions. You're free to raise your hand and ask your question. Or you can log the question into the online system. Either way, it works.

So Erica, let's start with diving into the drivers of demand, right. In 2019, GSV growth was mid-teens and deceling. There is a significant acceleration that we have seen since. How much of that was -- how much of the demand during the COVID period was more related to businesses going online versus a general secular trend that kind of helped support it?

It's hard to pull that apart, Kunal. What I would say is the pandemic years weren't -- for a business like ours, weren't like a pull forward in demand. There were really a wholesale change in how people thought about work, right? And so look at -- for all of us, right, we all changed. We were just talking about before we came on stage, we all changed the way we were working during the pandemic. And this was really an enabler for a business like ours. It created more freelancers. It created more demand on the business side. And so that was really a wholesale change. And any time that people are rethinking modernizing and changing the ways that they're working, Upwork stands to benefit from those changes. So we are really excited about the future. We've been able to -- during the more stable, I would say, current macroeconomic trends, time when -- the changes in an interest rate environment, other things are sort of working and they're causing a pullback on business demand, we've been able to untether our -- the rest of our financial results from kind of the macroeconomic environment and grow revenue and EBITDA really, really well during this period.

Great. So when you think about SMBs, over 80% of your revenue probably comes -- or GSV comes from SMBs.

Yes.

And SMBs have probably slowed, at least slowed, or maybe stopped hiring -- and even hiring on a freelancer basis. So as you think of like growth going forward, what is going to drive your growth faster than, say, GDP?

Right. Well, look, I mean, there are 33 million small businesses in the United States alone. lat quarter, we served about 836,000 clients or businesses, only a portion of which are small business. So -- and these businesses have myriads of use cases for our platform. They need to build websites. They need accounts. They need all kinds of services: design, logos, other things, right? And they need to start services from our platform to do it. So there's a tremendous demand of kind of a latent demand out there. Like I said, I think, in many ways, the sort of heightened interest rate environment is working, and businesses aren't spending as much, right? They're making money on the cash in the bank. And so it's more -- it's kind of sideways trend in terms of growth right now, but there's certainly latent demand out there. All these services need to get fulfilled. And so -- and there's a tremendous amount of just volume of businesses that need it. So I think, like I said, as businesses continue to modernize and continue to rethink and identify new ways of fulfilling this demand, our platform offers the fulfillment of business work faster, cheaper, better. And so that's where the growth will come from.

It's interesting that you talk about accounting and other things out there. So can you talk about the different services that SMBs take? And what kind of like length of project do they have? Is that like maybe a 1-day thing? Or is there an ongoing kind of federations like themselves?

I mean, our platform is incredibly diverse. So it's really hard to kind of pigeon-hole millions of SMB customers into -- SMB projects into a single use case. We tend to have larger, more complex projects on our platform in general. And so our average GSV per client is $5,000. And so this means that, in general, our customers, and as you say, 80% of our GSV is coming from small business, so this means that our customers are, in general, hiring freelancers for longer-term products. That said, there are certainly spot projects as well, and we have a good balance between long-term fixed-price contracts and hourly wage contracts as well.

Okay. And then one of the things that people talk, at least, on the Enterprise side is land and expand. So at least for the SMBs, it's slightly different. But the thing is, when you look at like repeat rates, how has that kind of trended in terms of SMBs coming back with like bigger jobs that they want to get done after the first experience was good, or maybe a slightly different thing? So they came in to build a website, and now they are coming back because they want to do accounting, they want to do maybe legal work or something else.

Right. Well, so it's a very, very typical -- I mean, it's a trend on our platform. And this is something that you can generalize about new customers coming on to the platform tend to ramp over time. And so they'll come on the platform, they'll kind of put -- dip their feet in and then, over time, start to ramp up longer-term projects. So that we've seen very clearly. Now in the most current environment, we've actually seen, I guess, really in the past couple of quarters, we started to see newer clients coming on and not ramping as quickly as in previous years. And that's one of the things that we've seen as an impact from the external macro environment is that people just aren't spending as much as quickly. But in general, that ramp provision continues to grow. And underneath the covers on our platform, one of the dynamics that we've also seen that we think is macroeconomic kind of associated is, we've actually seen the hours per contract grow year-over-year. But typically, each year, we would also see some wage accretion each and every year. And this year, we did not. We saw wages be flat to even down a little bit on an hourly basis. So that tells us there's -- again, there's actually some good growth dynamic in terms of hours per contract, and we're seeing that grow. But we want to see some of the wage accretion come back, too.

And then on the Enterprise side, you did a change in the sales force earlier this year. And on the 3Q call, kind of reported Enterprise customers grew 43%.

Yes. That was on the expand side, yes.

Okay, okay, okay. Yet your Enterprise revenue was kind of flattish year-over-year. So what will make that grow?

Yes. So there's -- we certainly have talked about -- and in Q1 with -- when we made the decision because we saw a real tightening. Look, it's hard to remember 2 quarters, it feels so long ago. But back in Q1, it was when -- there were huge numbers of headcount reductions, FTE reductions and severe tightening of spend across all large, large -- many, many, many large corporations. So we certainly felt that the reduction in vendor spend and just overall cost reduction is sort of like slash cost first, ask questions later. And so we made the decision at that time to make reductions in our own Enterprise sales force, which we had ramped quite quickly to keep up with demand. That was really the right thing to do for us. And I've been super proud and impressed to see that, despite the reduction in our sales force, each and every quarter since Q1, we've actually increased the number of logos that we've added on the land side of the house. Last quarter, we improved our new logos by 21% quarter-over-quarter. So that's been really, really great. And we'll continue to work on the optimization of the sales force. We really think that we can continue to get more with less in that -- with our teams and improve the productivity there. I will say, to your point, we're not seeing growth in revenue on the Enterprise side, and that business is not where we want it to be. We want to see continued growth there. And quite frankly, we do not have any significant share of wallet on the Enterprise side. That means that there's a lot of growth opportunity on that side of the business. And so we're going to continue to invest in the product, continue to differentiate the product from our kind of core marketplace product and expect that there will be growth to come there.

Great. And so the 21% Q-on-Q increase in logos in the last quarter, were these logos already using freelancers? Or were they already using maybe traditional freelancing services? How do you get that?

Yes. I mean, our biggest competitor, we always say, is convincing people to stop doing things the old way and start modernizing. It's -- I come from large enterprise myself in my previous life. And so I really know how these organizations run their alternative workforce programs. And they're using a lot of the kind of old ways of working. And when we go in and we sell to these large enterprises, I think it's quite eye-opening the fact that they can quickly self-serve. They can identify cheaper, faster. They can onboard labor -- alternative workforce super, super quickly. And so all of these things are benefits. And by and large, when we go into these guys, this is sort of a new way of looking at alternative workforce for them.

So then effectively, your competition would be companies managing their own freelancing efforts? Or would that be...

No. I mean on the Enterprise side, it's sort of using some of the legacy suppliers' level, yes.

Okay, okay. And is there a way to kind of go in and target some of the enterprises that are already using legacy suppliers?

I mean, we are going in and talking to everybody. And we have both inbound and outbound on the land side and identifying the most qualified prospects like anyone else.

And can you talk about, like within your Enterprise customer base, how much of that is like tech versus maybe finance, maybe some other industry?

I don't think we've ever broken out the -- I mean, I don't think we've ever broken out the exact balance of industry on the Enterprise side. Traditionally, we have had a concentration in tech, for sure. And that makes sense, obviously, because of the nature of our platform. Most recently, if you look at the logos we've added in most recent quarters, it hasn't been heavily tech-focused. It's been very diverse. We've had like Las Vegas Sands, R.R. Donnelley, Mastercard. We've had a number of various different industries. So we're definitely seeing demand and interest across the board and across industries in Enterprise.

Great. And as you look at these cohort of enterprises coming back to the land and expand, so how can -- is there a way in which you've been able to kind of measure how much share of total freelancing business you have and how that kind of matures over time?

I mean, like I said, our reality is that right now, we have a quite little share of wallet. I mean if you just look at our total Enterprise business, it's about 20% of our revenue. You can infer -- some of you can infer the GSV, although we don't break it out. There -- we have Enterprise clients on our platform whose total spend in alternative workforce space is equal to our total GSV. We've got some of these huge tech partners and other things like that. So there's a tremendous amount of more growth to come and opportunity for us as we continue to kind of grow up with these businesses.

One of the things that becomes a gating factor with enterprises is a lot of times, it so happens that the accounting guys might be using freelancers, but the finance guys may not or somebody else in the organization may not. Is there a way to kind of propagate it across enterprises so that you can get that expand part of the business?

Yes. It's very, very true that, quite frequently, within large enterprise, different departments do not talk to each other. And we offer -- and especially with the use of alternative workforce, part of that is because of, again, the way old ways of working traditional specialization in these areas, whereas we can offer a very diverse set of alternative workforce opportunity and usage. So there are ways that we are exploring and some kind of product investments that we're making, more to come in that space, that will help enable sort of cross-pollination there.

Got it. And then we are in a cycle where there has been a lot of uncertainty. There has been a lot of slowdown, a lot of risks across the board. So as you think of -- at some point in time, macro and confidence will increase in the economy. But it might take some time. There will be a period when things may be still mixed. And maybe enterprises may not want to go and invest in a full-time employee but look at freelancers.

I could not agree more, Kunal. I say this all the time, which is -- and having observed again, coming from a large enterprise myself and observed the pendulum swings in hiring over the years for many, many years. The reality is that when companies pull back dramatically on kind of their workforce in a very, very rushed fashion, there's still a tremendous amount of work to get done. That is now latent work in the system and waiting for workers to produce it. And you're right, as the pendulum swings back, companies should be looking much more to alternative workforce. One, just to bring people on the platform faster, right, because it takes the hiring time to get it at -- an FTE into someone's company is much, much longer than alternative workforce. So it's both speed to hire as well as lower risk in terms of getting the work done that is waiting there to get done.

Got it. And then from a freelancer perspective, your take rate is 10%. And then, of course, there is value-added services, advertising, whatever else that you can kind of put on top of that. So in the traditional freelancer space, how much are they paying to traditional freelancing companies?

So how much do our...

So if I'm a freelance and I'm looking at different alternatives, why would I come to Upwork versus go to one of the traditional freelancing companies?

Well, I mean, there are many, many reasons that freelancers want to come to Upwork, the diversity of project, diversity of clients. One of the things that we -- talking to some of our most valuable freelancers on the platform, which we do very frequently, that we hear from them is, one of the things they like about working on Upwork is they have a diversity of jobs that they're fulfilling or have a diversity -- they have a suite of clients. Whereas like in a traditional services firm, they're essentially working for the firm, right? And then they're outsourced to a company. The diversity that we provide means that they can't get fired, right? They may have 3 or 4 jobs going at once. And so if one ends, they can start another one. And so it's actually, in many ways, in an uncertain kind of job market, the way that we're kind of all working through right now, it actually provides a little bit more stability for some of these guys.

Interesting. One of the things that you mentioned earlier was you've noticed that the dollar per hour has been declining?

Just -- I mean what we really saw was a lack of growth on the wage -- on hourly wages or a little -- ever so slight declines. And so it's really, I would say, more flat than anything else.

And then the other thing that has happened is you've reduced your take rate from 20% to 10% for a number of your freelancers. So it is possible that maybe instead of charging $105, now they can do with $100, simply because they're paying you 10% now. So how much of that wage decline or wage flattening is because of a take rate decline?

So this is -- I was referring to just hourly wages, and we also have fixed price contracts. So it's a very diverse network that we are running. But yes, so in May, we had -- we formerly had a tiered pricing structure, for those who aren't aware, where we -- projects that were priced for $500 or less were at 20% and then 10% for kind of $501 to $10,000 and then 5% below that. We've now evened it out. We have a flat fee pricing structure. It's much, much simpler for our freelancers and for our clients in terms of how they can bid and price on projects. That said, to your point, when we announced the change in May, there was an immediate price down of those 20% projects down to 10%. And so there would be some impact to GSV on limited impact to GSV. It wouldn't be a huge.

And then when you look at the other side, so when you did the rate changes earlier this year, you deferred some of the rate changes, especially for the people at 5% levels going to 10% to maybe next year or whenever the project ended.

That's right.

So when that starts happening, when those people go to the 10% level, at that time, do you think they will increase their pricing, and so that could potentially affect demand?

So we've -- it's a marketplace, right? And so the supply and demand dynamics and pricing dynamics should even out, and it should be self-correcting in many ways. But these things do have effect. And the reality is, the price increase from 5% to 10% on the freelancer side that's happening, these are for -- these are very high-earning freelancers. They are in many ways that most attractive freelancers on the platform, they're experienced, they have long-term contracts, $10,000 and more. And so there should be some room there for them to kind of price in that 5% in order to take home the same amount. And so we're working with them. And as -- I'll tell you that as the 5% price change has started -- or the 10% -- 5% to 10% price changes started to come through, which it has, as contracts expire, we've seen very, very good performance on the platform and in fact, probably a little bit less turn than what we had modeled coming into it.

Great. And so your take rate is mid-teens.

Yes, 17%.

17%. So between the 10% and the 17% is a bunch of advertising, and there would be other elements of the take rate.

So we have client side fees. Yes.

Client side fees, totally. So when you think of like the 5% going to 10%, and you think of potential advertising opportunities kind of improving take rates, how do you think about take rates in, say, '24 and '25?

So we haven't guided on take rates, but I'll give you a few thoughts. We do -- as we articulated, we do have more take rate accretion to come from the pricing change that we've just made. And so at the end of this year, all 5% contracts that haven't already shifted to 10% will move up to 10%. We have also seen very, very strong good growth in some of our ads and monetization projects -- products. Ads products like boosted proposals, which means that freelancers can boost their proposal up for better visibility by clients, and also subscription products, value-added services for freelancers, we've seen some good growth this year. So actually, these ads and monetization products are one of our fastest -- it's really our fastest-growing revenue stream, and we expect to continue to see that into 2024, for sure.

Great. Coming to margins. So you have a long-term target of 30%, 35% EBITDA margins. You've delivered a significant beat in 3Q, but that was on the basis of lower sales and marketing spend. So as we think of the future and, at some point in time, the macro will improve, and you would probably want to spend more on sales and marketing. So how should we think of EBITDA evolution and how you're thinking of balancing growth and profitability?

Yes. Thank you for asking this question. I love this question. We are very focused on both EBITDA margin accretion and top line growth, and we intend to produce both. The previous -- we published this kind of long-term margin target of 30% to 35% back in 2021. We are due for a refresh on that, which we would expect to provide next year. And we are really thinking about the management of this business more on the Rule of 40 basis and really making sure that, like I say, we produce both top and bottom line growth. I will say, you said that we produced an 18% EBITDA margin just based on sales and marketing reductions, that's not totally accurate. We also did reduce G&A as well. We've also, under the covers, it's hard -- you can't see it in the published numbers, but this is a -- as I came into the business 7 months ago, this is really a wholesale look at how -- at our investment portfolio. And even underneath R&D, we have been looking at our portfolio of projects, reducing spend, cutting projects that we think are nonproducing or nonproducing over -- or will be productive but a longer-term time horizon, and reinvesting in kind of near-term time horizon projects. So there's a lot going on underneath the covers. I think that there's more we can do on the cost optimization side to enable both top and bottom line growth. Last thing I'll say on this topic, of course, I can go on forever, but like I said, on the sales side, I think we have pretty strong conviction that we can now -- we focus on efficiency first. We can now focus more on productivity of the sales force, and we can kind of produce more with less. On the Marketing side, I do think as -- we have nice, strong, healthy gross margins in this business, 75%. And so I do think, going forward, that there will be a time and place, as things come back, where we want a little bit more share of voice out there. But we'll always balance, making sure that we're growing EBITDA margin with investments like that.

Interesting. You talked about efficiency and then you talked about productivity. How should we think of your focus on Enterprise versus SMBs and how you're guiding your sales force to kind of target both sets of opportunities?

Well, our sales force is really focused on the Enterprise side. So the Marketplace, we really focus more performance marketing on the Marketplace side, which we've actually seen some very good productivity in Q3 on the performance marketing side, which has been encouraging and produced some good client growth in Q3. And so starting to see some bright spots there. In terms of the focus of the balance of GSV, I suppose, growth between Enterprise and Marketplace, we're focused on both, to be honest. I mean, Enterprise is a smaller base and so -- and it has a very, like as we've already talked about, kind of a large share of wallet available to us. And so we'll see, but we're focused on both.

We'd be remiss to not about -- talk about TAM. And one of the numbers that you've kind of talked about in the past is $1 trillion. Can you help us understand how you got to the $1 trillion? What does this TAM kind of represent?

Well, the TAM represents really the kind of number of freelancers kind of in the U.S. and globally, kind of multiplied by the average wage per year, right? And so it's sort of -- it's a quite simple TAM number that was produced previously. But actually, I was just reading some of the new data that has been published on this topic, and I mean, I actually -- the publisher of the $1 trillion number is kind of before my time. But one of the latest numbers that's come out of total, what they're calling gig economy work, is around $4 trillion, right? But I think what the accessible TAM to a business like ours is actually, as I was looking at it, these are independent contractors that have no employees, that global market is $1.9 trillion, just that. And so I think this continues to be a TAM and addressable market that is growing and growing. And like I said, the pandemic, what it did was it produced more freelancers. It produced more businesses that we're thinking about how to get business done remotely, and that's certainly a good thing for us.

Totally. Some of those freelancers that already have been doing freelancing, some of them have been doing it because they don't come to a marketplace. They are basically just doing it based on their network and what have you and existing relationships. So what gets them into a marketplace?

Yes. I mean this is one of the things that we're really investing in right now as a business, which is producing tools, other talent enablement things on the platform, certification, education, other things like that, accessibility to AI tools that can enable them to do their work better, faster. We're really building out this true partnership ecosystem on our platform, both to enable talent and clients. And so more and more to come here, but we want to be the destination for AI-empowered talent in the world. And with all the partnerships [ data ] system we're building out, we think we will be. The other thing is I think that as we continue to build this ecosystem out, the value that we're going to be delivering to our freelancers and to our clients is going to be tremendous. And as I said, we've got kind of these very nascent subscription products right now, and we'll continue to think about how we balance kind of the free versus freemium versus premium for some of the things that we're delivering.

Great. I know we can continue with those questions for a long time. In the interest of time, one question that has been -- we've been getting from investors is about free cash flow, and you are now free cash flow positive.

We're not just free cash flow positive, we're also GAAP EPS positive.

Okay, great.

We forget it sometimes, [ truthfully ].

So when you become free cash flow positive, the question that people start asking is, okay, so what are you going to do with the cash? So can you talk about capital allocation, M&A, share buybacks, reinvestment maybe?

Yes, absolutely. We're super excited about the -- all of the profitability and cash that we're producing as a business, an inherently profitable business. And so -- and we expect to see very strong growth next year in free cash flow. So yes, so what are we going to do with it? I was really excited in Q3 to get the company's first share buyback authorization approved by our Board. And so we certainly intend to now start to utilize that going forward. So we haven't released exactly kind of a defined capital allocation strategy, but we do intend to use a portion of our free cash flow going forward to buy back stocks. Obviously, right now, we're going to be thinking of it more on an opportunistic basis. And going forward, we'll be thinking about that. We do think that there are inorganic growth opportunities for this business as well. And so that is another place that we're going to be looking at and thinking about, particularly as, hopefully, evaluations and some of these areas continue to come down.

And so when you think of M&A, what would be -- what would you be looking for? Would you be looking for like smaller marketplaces under the same space or maybe expanding services? Or how would you be kind of looking at that?

I mean, it's tough to get too specific there. We sit at a crossroads between so many different areas. And with a large TAM opportunity like our business has, there are just a tremendous number of vectors and places that we can go. So this is probably all I can touch on there.

Great. Hey, we are out of time. Thank you so much, Erica. This has been very helpful.

Thank you, Kunal.

Thank you for coming to our conference.

Yes, it's great.

Thank you.