Workiva Inc

NYSE:WK

Earnings Call Transcript 2018-Q4

[Operator]

Good afternoon. My name is Christine and I will be your conference operator today. At this time, I would like to welcome everyone to the Workiva Quarter Four and Full Year 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Adam Rogers, Director of Investor Relations, you may begin your conference.

[Adam Rogers, Director, Investor Relations]

Thank you and good afternoon, everyone. Welcome to Workiva’s fourth quarter 2018 earnings conference call. This afternoon, we will begin with comments from our Chief Executive Officer, Marty Vanderploeg, followed by our Chief Financial Officer, Stuart Miller, and then we will turn the call over to questions. Also on the line today is Jill Klindt, Chief Accounting Officer.

A replay of this call will be available until February 27. Information to access the replay is listed in today’s press release, which is available on our website under the Investor Relations section. As a reminder, today’s conference call is also being broadcast live via webcast.

Before we begin, I would like to remind everyone that during today’s call we will be making forward-looking statements regarding future events and financial performance, including guidance for our first quarter and full fiscal year 2019. These forward-looking statements are subject to known and unknown risks and uncertainties. Workiva cautions that these statements are not guarantees of future performance. All forward-looking statements made today reflect our current expectations only and we undertake no obligation to update any statement to reflect the events that occur after this call. Please refer to the company’s annual report on Form 10-K for factors that could cause our actual results to differ materially from any forward-looking statements. Also during the course of today’s call, we will refer to certain non-GAAP financial measures. Reconciliations of non-GAAP to GAAP measures and certain additional information are also included in today’s earnings press release.

And with that, we will begin by turning the call over to our President and CEO, Marty Vanderploeg.

[Marty Vanderploeg, Chief Executive Officer]

Thank you, Adam and thanks to everyone for joining the Workiva fourth quarter and full year 2018 conference call. We are very pleased with our fourth quarter results, which exceeded guidance for revenue, operating loss and loss per share. Our operating margin improved significantly and we remain committed to achieving profitable growth over time. Stuart will review the numbers in detail and provide guidance later in the call.

I want to start by saying our customers are continuing to validate the broad-based value of our Wdesk reporting platform. As I have talked about before, organizations have made huge investments in ERP systems that provide transactional data, which is the source for numerous reports to executives, shareholders, regulators and tax authorities. Amazingly, these reports are still being created manually using e-mail, spreadsheets and word processors. The inefficiencies and risks associated with these manual processes are becoming widely recognized driving the need for financial transformation in organizations all over the world. Wdesk is the only cloud platform that provides data assurance and connected reporting throughout the entire reporting process from ERP data all the way to final reports.

As customers use Wdesk, the value of our connected platform becomes apparent and customers start to move more additional reports under the Wdesk platform, driving broad-based adoption across their organizations. As we watch our Wdesk deployments expand, we become even more excited about our platform’s potential and how we can capture the large underserved market of compliance and financial reporting. Our solution-based licensing model, which gives our customers unlimited seats per solution is showing good early success. This new pricing model is easier to scale, drives wider adoption and opens more markets for Wdesk. We are already seeing increased user accounts per solution as customers are recognizing the value of unlimited seats and predictable costs.

In the fourth quarter, we continued to improve our operating margin by streamlining our current go-to-market activities. These operating efficiencies have positioned us to increase our investments in 2019 in the areas where we see the most opportunities for growth and still show significant improvement in operating cash flow. We plan to continue to invest in integrated risk, which includes SOX, internal audit, enterprise risk management and policy and procedures. Since launching internal audit last year, we are encouraged by early demand. We are also expanding our presence in EMEA, where we are seeing strong demand for Wdesk for financial reporting and compliance. Currently, less than 5% of our revenue comes from EMEA. We expect to grow that business to produce between 25% and 30% of total revenue over time. We are also accelerating investments in global statutory reporting, which is complex financial reporting mandated for legal entities across all countries where they operate.

Over 50 customers are already using Wdesk to create statutory reports. This is yet another large and underserved market for Wdesk that we will aggressively pursue. We see increasing demand for Wdesk from the government agencies. Our authorization to operate under the FedRAMP program makes it easier for federal agencies to choose Wdesk. We also continue to win awards. Just last week, Fortune Magazine named Workiva one of the 100 Best Companies to Work For across all industries. This year, we are the youngest company to make that list. And in January, Fortune named Workiva one of the Best Workplaces for Technology. We are proud to be joining many of our customers on these prestigious lists. In summary, we are very pleased with our many accomplishments in 2018 and we are excited about capitalizing on our growth opportunities going forward.

With that, let me turn it over to Stuart Miller, our CFO.

[Stuart Miller, Chief Financial Officer]

Thank you, Marty. I will highlight a few significant items and then get into some details and finish with guidance. So first, our operating margin improved 1,500 basis points in Q4 compared to the same quarter last year and we are obviously pleased with that outcome, growing our top line 18% while maintaining tight controls on hiring accounted for 860 basis points of the improvement in our operating margin. The balance of the improvement, 640 basis points, came from deferring sales commissions consistent with ASC 606. Second, we are raising our guidance for 2019 revenue due mainly to improved bookings growth in Q4 2018.

In fact, Workiva generated the highest quarterly bookings for subscription and support in the history of the company in Q4 2018. Beginning to implement solution-based licensing definitely helped our bookings, but we would have recorded record Q4 subscription bookings even if solution-based licensing were excluded from the calculation. The breadth of improvement in bookings across multiple use cases was impressive. Our teams selling SEC reporting integrated risk, managerial reporting and capital markets, all made strong contributions reflecting our recent investments in product, messaging and sales training. While we have not commented on bookings in the past and we don’t intend to do so, on a regular basis, we thought it was important to do so today to provide context for our guidance. A substantial part of the improvement in bookings was generated late in Q4 boosting accounts receivable at year end. We caught up with collections in Q1 and accounts receivable are back down now to normal levels of DSOs.

On a related note, I want to highlight change in billings. As we approach the end of our program to convert our customer contracts from quarterly to annual payment, the average age of our contract terms has stabilized at around 1 year, making change in billings a more comparable metric than it used to be at Workiva. Billings defined as the sum of quarterly revenue and change in both deferred revenue and customer deposits rose 28% sequentially in Q4 from Q3. One reminder on accounting, as discussed last year at length, we adopted ASC 606, the revenue recognition standard, using the modified retrospective method. Our Form 10-K provides a reconciliation of the impact of the adoption of ASC 606 on our full year 2018 financial results.

Now, to some details on the quarter, we outperformed our revenue guidance for the quarter. We generated total revenue in the fourth quarter of $64.4 million, an increase of 18.2% from Q4 2017. Breaking out revenue by reporting line item: subscription and support revenue was $53.8 million, up 18.1% from Q4 2017; 51% of S&S revenue increase in Q4 came from new customers added in the last 12 months; professional services revenue was $10.7 million in Q4 2018, an increase of 19% from the same quarter last year. Growth of services revenue is largely a function of the growth in subscription revenue.

Turning to our supplemental metrics, we finished Q4 with 3,340 customers, a net increase of 277 customers from Q4 last year and a net increase of 51 customers from Q3 2018. Our retention rates continued to be strong. Our subscription and support revenue retention rate was 96.1% for the month of December 2018. With add-ons, our subscription and support revenue retention rate was 107.1% for the month of December 2018.

So, one comment on calculating revenue retention rates, through December 2018, we calculated revenue retention rates using monthly ASC 605 revenue. We will start reporting revenue retention rates using quarterly ASC 606 revenue when we have comparable data in Q1 2019. We expect the new quarterly measurement to reduce the variability of this metric that to-date we have been calculating monthly. Our progress with larger contracts is encouraging for annual contract value of $100,000 plus, we had 443 customers in the fourth quarter, up 37% from Q4 last year. For ACVs of $150,000 plus, we had 190 customers in the fourth quarter, up 30% from Q4 2017.

Moving down the income statement, I will talk about our results and guidance before stock-based compensation or on a non-GAAP basis. Please refer to our press release for a reconciliation of our non-GAAP and GAAP results and guidance. Gross profit was $47.4 million in Q4, up 22.1% for the same quarter a year ago. Gross margin was 73.5% in the latest quarter compared to a gross margin of 71.1% in Q4 2017. Breaking out gross profit, subscription and support gross profit was $45.3 million, equating to a gross margin of 84.2% on S&S revenue, an improvement of 300 basis points from Q4 2017 due to a higher utilization rate and better pricing. Professional services gross profit in the fourth quarter was $2.1 million equating to a 19.4% gross margin, down 50 basis points from the same period last year due to investments in additional talent to enhance services and address new markets.

Moving down to P&L, research and development expense in Q4 was $19.1 million, an increase of 4.7% from Q4 last year due to higher compensation. R&D expense as a percentage of revenue improved this quarter to 29.6% compared to 33.4% in Q4 last year. Sales and marketing expense for the quarter increased 2.1% from Q4 last year to $21.5 million. Sales and marketing expense as a percentage of revenue this quarter improved due to the capitalization of sales commissions as required under ASC 606. General and administrative expenses totaled $7 million in Q4, down $844,000 compared to Q4 2017. Operating loss was $268,000 in Q4 2018 compared to an operating loss of $8.4 million in Q4 2017.

Turning to our balance sheet and cash flow statement, at December 31, 2018, cash, cash equivalents and marketable securities totaled $98.3 million, an increase of $1.4 million compared with the balance at September 30, 2018. In Q4 of 2018, net cash used in operating activities totaled $419,000 compared with cash used of $6.2 million in the same quarter a year ago. Full year 2018 cash from operations was a positive $6.4 million, the second consecutive year that Workiva has posted positive operating cash flow.

Turning to our guidance. In the first quarter of 2019, we expect total revenue to range from $68.8 million to $69.3 million. Non-GAAP operating loss is expected to be in the range of $1.5 million to $2 million. For full year 2019, we’re raising guidance for total revenue to range of $282.5 million to $284.5 million. We expect the growth rate of subscription revenue to outpace the growth rate of services revenue in 2019. We expect non-GAAP operating loss to range from $15 million to $17 million. Investing in new talent is necessary to pursue the attractive growth opportunities that Marty discussed. However, we intend to continue to manage headcount growth carefully. We expect cash flow from operations to be positive in 2019 for the third consecutive year. In addition, we expect cash flow from operations will improve significantly in 2019.

So, we are now ready to take your questions. Operator, please begin the Q&A session.

[Operator]

Thank you. [Operator Instructions] Your first question comes from the line of Terry Tillman from SunTrust Robinson. Your line is open.

[Terry Tillman, SunTrust Robinson]

Hi, gentlemen. Can you hear me okay?

[Stuart Miller, Chief Financial Officer]

Yes.

[Terry Tillman, SunTrust Robinson]

Hi. Great job on the bookings, so it’s great to hear that. Hi, Marty, Stuart and Adam. Maybe my first question, Marty for you, in terms of what’s Stuart’s commentary was about the bookings strength and it sounded like peeling back the onion, it wasn’t just the re-platforming, but also other factors. What I’m curious about is if you guys are to continue this bookings momentum into 2019, could you maybe stock rank what do you think the drivers of that would be, the expanded product or use cases, execution and/or just re-platforming benefits? Maybe just trying to understand how each of these could affect the bookings and the relative importance?

[Marty Vanderploeg, Chief Executive Officer]

Well, we don’t comment on bookings per se. And so, I will say this, as Stuart indicated, we saw good growth across all of our business lines and feel positive and good about all the existing business lines. And then the second thing is execution. We’re just much more focused now as I’ve always talked about, and we’re looking for growth opportunities where we have some experience before we invest heavily. The three I mentioned, all of those we’ve seen enough success to know that there is, real growth opportunities if we invest. So those are really it’s across the board and those are the main drivers.

[Terry Tillman, SunTrust Robinson]

Okay. And my follow-up question, Stuart. As it relates to the re-platforming, how do we think about though as we move out over the next couple of years, existing customers and how they might move to this new solution-based pricing model and how that would reflect in billings? Just trying to understand, is this a long-dated kind of process or is this going to be more compressed in terms of time frame and how we see that in the model? Thank you.

[Stuart Miller, Chief Financial Officer]

Sure. Thanks, Terry. So, and you know, we comment on this in the 10-K too, but we expect to be completed with the move to solution-based licensing sort of by mid-2020 or so, and it’s a longer-term conversion process. There is uplift when we convert, and we are providing quite a bit of incremental value to our customers, which Marty touched on, but we haven’t we’re not breaking out the difference that contribution, particularly.

[Terry Tillman, SunTrust Robinson]

That’s it from me. Thanks.

[Operator]

Your next question comes from the line of Tom Roderick from Stifel. Your line is open.

[Tom Roderick, Stifel]

Hi, gentlemen. Good afternoon and thanks for taking my questions. So, Marty, I couldn’t help but notice one of the growth drivers you addressed in your comments was Europe. EMEA representing less than 5% of revenues today, the thought that you can get that to 25%, 30% over time is obviously pretty appealing. Talk a little bit about what the drivers and catalysts are in that market? And in particular, I think you’ve noted before sort of ESMA announcing a mandate for a variety of public companies moving to Inline XBRL tagging. So, I don’t know if there’s a parallel to drawn from the U.S., but would love to hear about that as a catalyst. And then and with the catalyst like that and other demand out there, how fast do you want to move new bodies and new sales heads into Europe and what kind of investments does that sort of look like? Thanks.

[Marty Vanderploeg, Chief Executive Officer]

Well, that was a long question. I’ll see what I can do here. First off, I want to say that we Europe is more heavily regulated than North America is, and they have a lot of different types of financial reporting and compliance requirements. And there’s just a whole host of those I could list. ESMA is only one of those. And so, I would say that we see broad-based demand for the SOX. It’s very similar to the things we do in the U.S. they have control different control requirements, not just like SOX, but still they have different types of things that they mandate, they manage controls on. And the financial reporting needs there not just in ESMA, but in other areas are just as prevalent or even more than in the US. So, we view a broad-based demand there, very much like we see in the U.S. now or in North America. So, we know ESMA is going to help us, that’s still a couple years away. But the increase in success we’ve had there recently has been because of our leadership change there and more of a focus there. So, it’s really across the wide number of use cases.

[Tom Roderick, Stifel]

Excellent. Okay. Good.

[Marty Vanderploeg, Chief Executive Officer]

And then, the second part of the question, I forgot.

[Tom Roderick, Stifel]

Well, in the second part is just simply how fast you want to ramp resources into that market, particularly on sales heads?

[Marty Vanderploeg, Chief Executive Officer]

We really don’t talk much about the sales head. I think Stuart referenced that or maybe he didn’t. Most of the investment that we’re making in terms of the guidance is in sales and marketing, and it will be both in Europe and then also going after the statutory reporting I referenced.

[Tom Roderick, Stifel]

Perfect. Stuart, I’ll make my second question shorter for you here. Looking at the guide for Q1 and then sort of looking at the full year, it certainly implies a pretty aggressive ramp in operating expenses. I would assume that’s where they’re coming from. So, is this just a ramp that’s informed by the record bookings and the traction in the marketplace and you simply need more sales and marketing coverage or is there other things we should be thinking about here?

[Stuart Miller, Chief Financial Officer]

So, a couple things there. I think that we absorbed a lot of the capacity that we had in sales last year, and so we did feel that we needed to add incrementally to sales and marketing. That’s number 1. Number 2 is, Europe is obviously different geography. And so, we have got to add there and we’re going to add in, as Marty indicated, in statutory reporting and go after that incrementally. But we did we have sort of reached that point where we needed to make incremental investments in sales and marketing and the ramp, you’re right, reflects these additional hiring that we’re going to be doing throughout the year.

[Tom Roderick, Stifel]

Perfect. I’ll jump back in queue. Thank you, guys. Nice job.

[Operator]

Your next question comes from the line of Brian Peterson from Raymond James. Your line is open.

[Brian Peterson, Raymond James]

Thanks, guys, and congrats on the quarter. Just one question from me, but it will be in 50 parts, but no, seriously, just on the solution-based pricing. I wanted to get a sense for customers that have moved over to the new model. Is there anything that you can share beyond just use cases, anything related to usage of the platform or activity? I’m just curious how those customers have actually used the platform since they switched over?

[Marty Vanderploeg, Chief Executive Officer]

Sure. I’ll take that. We have seen a market increase in the number of users in each solution, which is, if you recall, some of the previous conference calls. Our goal is to get more exposure in these organizations and to reduce the friction to get seats out and when you charge an additional dollar for each seat, there’s just a lot of organizational friction from back office functions, procurement, things like that. So, this frictionless way is allowing us to have many more users, more eyes on it, more people looking at it over someone’s shoulder and just getting more exposure and also providing a much higher value for the customer. When they have everybody that’s in the process using it, it’s a higher value for the customer. So, we’re seeing the number of users go up quite significantly and we’re very pleased about that.

[Stuart Miller, Chief Financial Officer]

I think the other aspect of it, Brian, is that, it does simplify the sales process on incremental solution sales because it reduces the number of variables that are being discussed.

[Brian Peterson, Raymond James]

Got it. Thanks, guys.

[Operator]

Your next question comes from the line of Rob Oliver from Baird. Your line is open.

[Matt Lemenager, Baird]

Good afternoon. Thank you. It’s Matt Lemenager on for Rob. Stuart or Marty either one I suppose, the 4Q bookings number is quite strong across the board. Was curious if there was any business that was pulled forward or maybe came and renewed early that you were expecting to perhaps renew in the first quarter and ended up contributing to that fourth quarter bookings number?

[Stuart Miller, Chief Financial Officer]

Well, I’d say that some of the solution-based licensing, there was quite a lot of enthusiasm I think, for that. So, there was a little bit of pull-forward there, but not a great amount. But I think it was more about the sort of better execution and the investments that we’ve been making in sales and marketing and the product coming to roost.

[Matt Lemenager, Baird]

Got it.

[Marty Vanderploeg, Chief Executive Officer]

As I said, it’s been broad-based improvement in terms of execution and efficiency on generating bookings.

[Matt Lemenager, Baird]

Okay. Got it. Yes. That’s helpful. It seems like the execution has really picked up, build. Second question I had was on the next-generation enterprise platform. I think we talked at the Analyst Day that it was about 30 customers who had been filing with that first quarter and then it was 60 in the second quarter. Is there any update on the uptick of that next-generation platform and the number of people filing? Just generally, is it perhaps over 100 or is there any estimate you can give us?

[Marty Vanderploeg, Chief Executive Officer]

I can give you. We’ve had over – well over 100 customers in the app, I think it’s over 150 in the new platform. And the way you want to roll the software out when you have a very happy customer base who are used to a very high-functioning piece of software is to roll it out slowly. When the time comes that we’re comfortable, we’ll migrate the rest of the customer base fairly quickly. We just intend to slowly raise it each quarter and as I mentioned, we’re way north of 100 now.

[Stuart Miller, Chief Financial Officer]

That’s 150 filing.

[Marty Vanderploeg, Chief Executive Officer]

150 customers filing, yes.

[Stuart Miller, Chief Financial Officer]

Yes, they are actually –

[Matt Lemenager, Baird]

Got it. Thanks, guys.

[Stuart Miller, Chief Financial Officer]

Thank you.

[Operator]

Your next question comes from the line of Mike Grondahl from Northland Securities. Your line is open.

[Mike Grondahl, Northland Securities]

Hey, thanks, guys. Any update on Wdata kind of progress there and kind of client engagement?

[Marty Vanderploeg, Chief Executive Officer]

Sure. I mean, we’re – Wdata is part of our platform and it has had several effects. Number 1 is, it’s increased – where it’s been included in these deals, it’s increased deal size quite a bit. And secondly, it enables a lot more customers that are anxious to integrate directly and bring in large amounts of data. So, we’re very pleased with the success we’ve had there, but it is part of the platform. It isn’t a standalone solution as we’ve alluded to before, but it has done a lot of good things for us in terms of increasing deal size and enabling us to bring in much, much larger data sets into Wdesk.

[Mike Grondahl, Northland Securities]

Got it. And then SAP or NetSuite, any update there on how that progress is going?

[Marty Vanderploeg, Chief Executive Officer]

Sure. With the SAP integration, we’ve – that partnership, as we talked about enabled us to build an integration into SAP that is sanctioned by us and SAP. And it’s a very – it allows us to get in these accounts and have the credibility knowing that we’re going to be able to get SAP’s data into our platform. So, from that point of view, it’s been a success for us.

[Mike Grondahl, Northland Securities]

Got it. Hey, thanks a lot, guys, and congratulations.

[Operator]

Your next question comes from the line of Stan Zlotsky from Morgan Stanley. Your line is open.

[Stan Zlotsky, Morgan Stanley]

Hey, guys. Stan Zlotsky on for Stan Zlotsky. A quick question, maybe just wanted to follow up on a few questions from Terry and Tom. Just on the limited seats, as we continue to see more of unlimited seats in solution-based pricing, what is the impact to net revenue retention rates as we move forward?

[Stuart Miller, Chief Financial Officer]

So, the specific impact of SBL on revenue retention rates should be – it should help retention rates because it will make – as we – as Marty mentioned, we’ve seen a pretty big uptick in the number of users per account. And historically, when we’re seeing a lot of engagement with the customer, it tends to make the application stickier.

[Marty Vanderploeg, Chief Executive Officer]

Yes, that’s exactly right. The more people in the app, the more the process is sort of woven throughout the organization and it just makes it a lot stickier.

[Stan Zlotsky, Morgan Stanley]

Well, I was more referring to like the net revenue retention rate, the 105 ballpark percentage net revenue retention rate. As we move forward with contracts getting bigger, would you expect net revenue retention rate to increase as well as more users come onto the platform?

[Stuart Miller, Chief Financial Officer]

Certainly, it’s our hope if that’s the case. I mean, one way to look at it, Stan, was relative to what it displaced, which was seat add-ons and the breakeven relative – seat add-ons are no longer relevant, right, with this model. And the breakeven relative to what we were earning from seat add-ons is a no-brainer. And so you take that into account and you take into account the broader use of the platform, the broader exposure within the companies – within these companies, we think it’ll accelerate the adoption of additional solutions.

[Stan Zlotsky, Morgan Stanley]

Got it. Perfect. And then just a clarification on the EMEA opportunity. It certainly sounds very interesting to be able to take it from 5% now to 20% to 25% over time. How do you guys come up with 20% to 25% estimates? Where do you see – what are the milestones that you’re looking at to try to get there? And well, I’ll stop there. Thank you.

[Stuart Miller, Chief Financial Officer]

Yes, so a couple of things. Certainly, we’re looking at the current pipeline for the applications that we have, which are around CASS, C-A-S-S, for banks and asset management firms and around ICAAP and ILAAP and resolution plans and stress testing for banks and then global staff reporting. And then longer term, the ESEF mandate affecting 5,000 companies, that we only have as Marty said a very relatively small number of customers there. So, it’s certainly our goal to increase it 25% to 30%. We’ve certainly seen a lot of other B2B SaaS companies with that sort of contribution, and it’s heartening to see from a ground-up basis that these use cases supports that analysis.

[Marty Vanderploeg, Chief Executive Officer]

And then we’ve actually looked at – we’ve actually drawn up all the target list and see what regulatory requirements they have and it’s potentially a larger market than the U.S. in terms of number of companies and all the different regulations and requirements they have for reporting. So, we’ve done that very thoughtfully.

[Stan Zlotsky, Morgan Stanley]

Got it. And then maybe just a quick follow-up. I know you mentioned that you plan to get there – to the 20% to 25% over time. But maybe just narrow that down, is it over the next 5 years to 10 years or is that the timeframe we should be thinking about?

[Stuart Miller, Chief Financial Officer]

Well, I mean, I think the answer is we don’t forecast it that far out, but we are comfortable for instance that this – again, the progress that we’ve got – existing progress we’ve got and then the visibility we have on these use cases and with the regulatory mandate getting ESEF, it’ll really affect us in 2020 and 2021 give us some confidence in that viewpoint.

[Stan Zlotsky, Morgan Stanley]

Got it. Perfect. Thank you.

[Operator]

And there are no further questions at this time. This concludes today’s conference call. You may now disconnect.