Upwork, Inc. — Q3 2018 Form 10-Q
Business and period: Upwork operates an online marketplace connecting businesses with independent professionals, alongside managed services. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the same 2017 periods.
Key financial and operating metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $64.1 million (+23%) | $52.3 million | $186.0 million (+26%) | $147.8 million |
| Gross profit / margin | $43.6 million / 68% | $35.4 million / 68% | $125.4 million / 67% | $99.9 million / 68% |
| Operating income (loss) | $(3.3) million | $0.2 million | $(9.0) million | $1.8 million |
| Net income (loss) | $(7.3) million | $(0.3) million | $(14.5) million | $1.1 million |
| Adjusted EBITDA | $(0.1) million | $2.8 million | $0.2 million | $9.8 million |
| Gross services volume (GSV) | $449.5 million (+27%) | $353.5 million | $1,284.0 million (+29%) | $996.7 million |
Marketplace revenue was $56.8 million in Q3, up 23%, and represented 89% of revenue. Managed services revenue was $7.3 million, up 21%. Upwork reported 101,000 core clients, up 22% year over year, and client spend retention of 108%, versus 95% a year earlier.
Cash flow and liquidity: For the nine months, operating cash flow was $(8.2) million, investing cash flow $(4.4) million and financing cash flow $18.0 million; cash increased $5.5 million to $27.1 million. The operating cash outflow included a $15.1 million increase in trade and client receivables, partly reflecting quarter-end hourly billings and escrow timing. At September 30, funds held in escrow of $107.5 million were matched by escrow funds payable of $107.5 million.
At September 30, total debt was $49.0 million ($29.6 million current and $19.3 million noncurrent, net of discount); the weighted-average interest rate was 6.08%. The company reported compliance with debt covenants. Cash and debt figures at September 30 do not reflect subsequent IPO proceeds or repayments.
Changes versus prior comparable periods
- Revenue and GSV expanded, supported by more core clients and improved client spend retention. GSV grew faster than marketplace revenue partly because more freelancer-client relationships reached the lower 5% service-fee tier and clients increasingly used ACH, which carries no per-transaction processing fee.
- Despite revenue growth, profitability weakened: Q3 shifted from small operating income to an operating loss, and the nine-month period shifted from net income to a net loss. Sales and marketing rose 39% in Q3 and 47% year to date; research and development and general and administrative costs also increased.
- Other expense included a $3.6 million increase in the fair value of preferred-stock warrant liability for the nine months, primarily reflecting the approaching IPO and its offering price. Interest expense also increased with higher borrowings.
- Gross margin was unchanged at 68% in Q3 and decreased one percentage point to 67% year to date.
Outlook, unusual items and risks
- IPO after quarter-end: In October 2018, Upwork completed its IPO at $15 per share and received $109.4 million in net proceeds. The company used $10.0 million of proceeds to repay debt; it also repaid the separate $15.0 million escrow-related revolver draw on October 1. The filing’s pro forma September 30 presentation shows cash of $126.4 million and preferred stock converted into common stock; actual September 30 statements exclude these transactions.
- Management said cash, operating cash flow and borrowing availability were expected to cover working-capital needs for at least 12 months. It expected cost of revenue, research and development, sales and marketing, and general and administrative expenses to rise in absolute dollars; public-company transition costs were also expected. The filing provides no specific revenue or earnings guidance.
- Management attributed planned investment to platform development, marketing and brand awareness, and expansion of enterprise sales. It cautioned that results may fluctuate and that historical growth is not a reliable indicator of future performance.
- Control weakness: Disclosure controls were assessed as ineffective at September 30 because of a previously identified material weakness in financial-reporting controls. Remediation, including additional accounting staff and reporting controls, was ongoing and not yet validated as effective.
- Key disclosed risks include competition and user retention, contractor classification and related indemnities, payment fraud and transaction losses, escrow and money-transmission regulation, privacy and cybersecurity, international compliance, and the ability to attain profitability. No material pending legal proceedings were reported.
Investor verification priorities
- Track whether GSV and client retention continue to translate into marketplace revenue, particularly given tiered freelancer fees and growing ACH adoption.
- Assess expense growth, cash generation and progress toward profitability; compare GAAP results with adjusted EBITDA, which excludes recurring stock-based compensation and other costs.
- Confirm post-IPO cash and debt balances, including the timing and effect of both October debt repayments and ongoing escrow funding needs.
- Monitor remediation and independent validation of the material weakness in internal controls and disclosure controls.
- Review exposure to client receivable losses, worker-classification claims, payment and escrow regulation, and the substantial share dilution and resale overhang from equity awards and IPO-related lock-up expirations.