Good day, ladies and gentlemen, and welcome to the Upwork Q2 2019 Earnings Question and Answer Conference Call. At this time, all participants are in a listen only mode. Shortly, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Marilyn Kurlok, Director of Investor Relations.
You may begin.
Good afternoon, and welcome to Upwork's discussion of its Q2 2019 financial results. Leading the discussion today are Stephane Kasriel, Upwork's President and Chief Executive Officer and Brian Kinion, Upwork's Chief Financial Officer. Following Stephane's introductory remarks, we will be happy to take your questions. But first, let me review the Safe Harbor statement. During this call, we may make statements related to our business that are forward looking statements under the federal securities laws.
These statements are not guarantees of future performance, but rather are subject to a variety of risks, uncertainties and assumptions. Our actual results could differ materially from expectations reflected in any forward looking statements. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings available on the SEC's website and on our Investor Relations website as well as the risks and other important factors discussed in today's press release. In addition, reference will be made to non GAAP financial measures. Information regarding reconciliation of non GAAP to GAAP measures can be found in the press release and stockholder letter that we issued this afternoon on our Investor Relations website.
Please note that the stockholder letter is currently available on our Investor Relations website at investors. Upwork.com. Now I'll turn the call over to Stephane.
Hello, and thank you for joining the call. Earlier this afternoon, after the market closed, we released a stockholder letter as well as our quarterly press release offering a detailed look at our results. We will get into Q and A shortly, but I wanted to cover some brief highlights first. We had a solid second quarter. Total revenue increased by 18% year over year to $74,300,000 in the Q2 of 2019, which was approximately $800,000 above the top end of our guidance range, and we had an increase in our gross margins.
We have a large market opportunity deriving primarily from 3 categories of project work: agency engagements, which is any spend with an agency larger engagements, which is any spend with an individual freelancer over $1,000 and not performed by an agency and gig work, which is project spend under $1,000 The vast majority of our gross services volume or GSV comes from the first two categories, generally associated with larger, more enduring projects. This quarter, we added products and features with the goal of enhancing our marketplace with the highest quality talent to help larger companies solve their skills gap and meet their business needs. In the first half of twenty nineteen, our sales team exceeded its overall new business goals, closing a record number of business and enterprise deals. We will continue to invest in creating a vibrant and healthy marketplace for the long term. And with that in mind, I look forward to discussing our results further in Q and A.
Operator, Brian and I are now ready to take questions.
Our first question coming from the line of Ron Josey with JPM Securities. Your line is open.
Great. Thanks for taking the question. I just wanted to go through 2 questions. The first one, I wanted to ask about the sales force. And Stephane, you talked about how I think you've closed 4x of deals in 1H 'nineteen versus 'eighteen.
So can you just talk about the tenure of the sales force, how that's grown and really how a more experienced sales force is helping to close that? And then I'd also like to talk just questions about the take rate. I think you gave some good color in the shareholder letter in terms of the components of take rate. But just talk about maybe the benefits from Upwork Plus and business in that take rate. Thank you.
Sure. Great questions. Thank you. So the ForEx, if you look at H1 of 2019 over H1 of 2018, we closed 4x more deals. And I would combine this into maybe 3 buckets.
1 is we increased the size of the sales team, right? So we've hired a lot of people over the last 12 months. And along with that, what you were hinting at, some of the people we hired in 2018 were still ramping up in the beginning of the year and they are now fully ramped, right? So the pure number of salespeople has increased. Multiply that by the productivity of the sales reps is increasing due to specialization, due to scale, due to maturing of the team.
So that's part of it. And then the second part of it was the launch of Upwork Business. And this was something that we had known for a while, and I mentioned this on the last call. Upwork Enterprise was too complex for the mid market clients. And what used to be called Upwork Standard, which we are now sunsetting, was on the opposite scale, too simple, meaning it wasn't meeting all the needs of these mid market clients.
And so we built Upwork Business precisely to be able to be a simpler sale, higher velocity, shorter sales cycle and more adapted, better priced for those mid market type of customers. So I would say the acceleration, the 4x in a year is the combination of those three things: more salespeople, more productive and a better product market fit, thanks to the launch of our Port for Business. The second question on take rate. So if you look at take rate, it's now been like the overall total take rate for the business, which is about 14.3%, has now been stable for the last 4 quarters in a row, right? So if you take Q3 'eighteen, Q4 'eighteen, Q1 'nineteen and Q2 'nineteen, it's been hovering between 14.3 and 14.2, 4 quarters in a row now.
What's underlying this is multiple different components. On one side, the managed services part of our business, which by definition has 100% take rate due to how GAAP accounting rules work, is growing slower than the marketplace part of that business. So that has a tendency to push downward the take rate for the business. And that's why we also talk about marketplace take rate separately. The second component that tends to want to go down, which is the fact that as our retention rates continue to be above 100%, engagements between a client and a freelancer on the Upwork Basic or Upwork Plus plan progressively graduate from 20% to 10% to 5%, and that obviously has an impact on take rate.
And then the 3rd piece of this is we are continuing to push bigger companies to pay us by ACH. That's partly why we launched the Upwork Plus plan to have an easy way of telling slightly bigger companies that if they're going to be spending tens of 1,000 of dollars a month on the site, we would prefer that they use ACH rather than credit cards. We waive the client payment fee when people are on the plus plan and they use ACH. And as a result, that improves gross margin but deteriorates take rate. So those are the things that makes take rate want to go down.
The reason why it's been stable for the last 4 months sorry, 4 quarters despite of that is because of all the other things we're doing in the business. So when we increase the adoption of Plus, which comes with a subscription fee, we increase the adoption of Upwork for Business or Upwork Enterprise, which not only have a subscription fee but also have a higher take rate that drives take rate up as well as the launch of Connect. So if you remember last time on the call, we said that we are revamping how freelancers pay in order to bid for jobs on the platform. Historically, we had this virtual currency system called Connect, which were really expensive. We used to charge $1 per Connect.
But because they were really expensive, we were giving a lot of them away for free. And the net net of it was the vast majority of the connects that were being used by freelancers in order to obtain jobs on the platform were free connects. And therefore, the mechanism was not doing what we were needing for it to do. So when we relaunched Connex over the last few months and it's still rolling out today, the idea was to make Connex less expensive but give a lot fewer of them for free. And so net net, you're starting to see this in the numbers that more and more of the bids that are happening on Upwork are coming from bid connects and those go into the freelancer part of the take rate, if you will.
Very helpful. Thank you very much.
And our next question coming from the line of Brent Thill with Jefferies. Your line is open.
Hi, this is John Guyan for Brent Thill. Actually, I wanted to go back to the previous question as well. Is there any more color, let's say, between Upwork Business and Enterprise since the launch of business? I mean, is that hitting kind of an unmet demand? Or is it fairly similar traction with both of those?
There are different dynamics. I would say the length of the sales cycle for our product business is much shorter than it is for our product enterprise. And the type of clients as a result is also also fairly different. We do see some very large companies adopting Upwork Business because they're buying at the team level, and that's a shorter path for them rather than go through the whole process of legal and procurement and things that typically take 6 months or more. But generally, we've tried to mostly target the mid market clients for our port business, so typically companies that have between 100 and 1,000 employees more or less.
And a big chunk of those is coming from customers who have been using the Upwork Standard product historically. So we have a if you look at the bucket of companies that are in that mid market range that have used Upwork in the last 12 months, typically using Standard. We're talking about tens of thousands of customers. And a handful of them are converting to Upwork Business every month now. So we're still just scratching the surface.
The good news about this is not only we're seeing the adoption level that we wanted, meaning the sales cycle is roughly what we wanted it to be and the sales reps are hitting their quota. But on top of that, what we are seeing is that existing Upwork Standard customers, when they upgrade to Upwork Business, end up spending 25% more after the upgrade compared to what they did before. Now mind you, this is early days, right? I mean, it's relatively small number of months and relatively small number of clients, But it's very encouraging to see that not only are they paying us more, right? The take rate for Upwork Business, as a reminder, is 10% on the client side, 10% on the freelancer side as opposed to plus where it's 0% by if they pay by ACH or 3% if they pay by credit card and then the sliding rate on the freelancer side of 20,105.
So the Upwork for business take rate is, although the magnitude, almost twice what it is for the plus or standard rate. But in addition to that, they're increasing their GSV spend by 25%. So what we're seeing is a lot of upsell opportunities from existing customers and there's a lot more that are still in the marketplace that are still using the traditional Upwork, the old standard and now basic and plus. So we think there's many, many more quarters of this type of upgrades before we need to go full blown in outbound sales. I would say in addition to that, we do get inbound inquiries as well.
So if you went to our website, you would see there's a section on the website where you can essentially create a lead, right? You can say, I'm interested in your solution. Please have somebody contact me. And that goes into sales force, and we have a sales development team that's in charge of qualifying those leads and then sending them to the sales reps. So it's both a combination of upsell of the existing marketplace customers as well as net new clients that we're signing through inbound marketing as well.
That's very helpful color. Just one more question on some of the metrics. So the client spend retention rate of 1.0 and 5 is a little bit lower, I guess, than in the past. Was there anything to read in there as to why they might be? I know you've been outperforming on that, but just curious.
Thank you, and that's it.
Sure. I mean, it's a combination. I mean, it is a little bit lower than it was last quarter. I think we've always said it's going to be fluctuating from period to period. I would say there's 2 things going on here, and I would say it's early days to unpack what the real trend is.
But one is the domestic marketplace continues to grow nicely. It's growing at about 35% right now. And the dynamics of the domestic marketplace are different from the dynamics of the cross border global marketplace, if you will. So that can have an impact on the client spend retention positively or negatively. The second thing is we've made a lot of changes here, right?
We've changed the pricing for connects, and we've changed the pricing for the vast majority of our clients that used to use Upwork Standard and that is no longer an option for them. And if you go online and you see what people are saying about this, people don't like change. I mean, the happy people tend to be very quiet, so you don't hear a lot about them. But the unhappy people are very vocal about it. And we've seen this the last time we did a pricing change as well.
In late 2016, quite often we see a short term dip because people overreact and they think that they don't need us anymore and they're going to go somewhere else. And then a few months later, people become rational. They realize that it's still a very good deal for them to do business with us on both sides and the numbers get better as a result. I would say that there's a little bit of a trade off between GSV and take rates, right? Part of the reason why the take rate has stabilized despite the underlying trends that I mentioned earlier is because we've increased pricing for some of those solutions, and there is some level of price elasticity in what we do.
So when we increase pricing, it does have some impact on retention. Again, the main goal of all of these things was to increase quality, right? The goal for the company focusing really on long term trends is to say we don't believe that gig work is the future of this business, which is why we showed this pie chart on the stockholder letter where we show gig work even though it's how a lot of people still think about us is a very small portion of our overall GSV. We think that the future of this business is not about getting projects $1,000 at a time. It's going to be about bigger companies that have bigger projects that are more complex, more likely to be done through staffing and other types of agencies, I mean, as an example.
And so all of these changes are really designed to make these more professional freelancers more successful and make the bigger companies more successful on Upwork, which may have, as a result, the impact that we are seeing a little bit more churn in the slightly less professional, less reliable freelancers as well as some of the smaller companies that struggle to justify the cost.
Thanks very much.
Our next question coming from the line of Marvin Fong with BTIG. Your line is now open.
Great. Thank you guys for taking my question. Just a follow-up, just like you're saying on how some clients are going to be unhappy whenever there's a change in pricing. Could you just help us understand if you're seeing more churn than you might have been expecting based on your plans or compared to the last time in history? Just help us think about client churn.
Yes. So usually we talk about client spend retention, which is a GSV dollar number as opposed to logo retention. And if you remember, back in the S-one that we published now a while ago, we did disclose the total logo churn because we wanted people to know what the number looks like. But in practice, it doesn't really mean much in terms of GSV. And the reason is we have close to half of the sign ups on Upwork.
Every day, there's about 2,500 sign ups on the buyer side. Close to half of them are people that sign up with a personal e mail address like a Yahoo! Or Gmail address. And as you can expect, those are not likely to spend a lot of money. They're not likely to retain for a long time.
And overall, they don't contribute to a meaningful part of the GSV. So they represent a lot of the sign ups for a very small part of the business. Conversely, they are, as we mentioned in the stockholder letter, there's now over 50 companies that spend more than $1,000,000 a year on the platform. And even though 50x1000000 does not end up being a huge part of the $2,000,000,000 GSV, there's no concentration. But nonetheless, $1,000,000 client is much more valuable to us than somebody that signs up with a Yahoo e mail address.
So we've always had very high logo churn, if you will. That's why we introduced this notion of core clients, who are the clients who have spent more than $5,000 in their lifetime since they have signed up and are still active today. And that's a number that we are disclosing every quarter, and you've seen it grow again by about 5,000 this quarter compared to last quarter, so growing about 21% year on year. So it's really the combination of those two numbers, the number of core clients and the client spend retention that together are how we look at the business internally and our best attempt at providing data that helps people understand what the future of the business looks like.
Okay, great. Thank you for answering that one. Just a follow-up, if I may. Just on gross margin, it was very strong performance and I read the comments in the letter. I was just hoping you could help give us some sense of what was driving that more.
Was it the ACH adoption? Kind of give us a sense of the magnitude of what drove that perhaps compared to the hosting leverage on hosting costs. And second part of the question is just do you think it can kind of hold or build on top of this 71% margin? I know you guys are taking up, for instance, the payment processing fee on basic to the 3%. Can we expect gross margin to continue to expand from here?
Yes. So on the roadshow, if you remember, we talked about gross margin in the 80% to 85% range on the long term target model. So it's progressing towards that and that is obviously the impact of the managed services business versus the marketplace business, where the managed services obviously has a different gross margin, but the more marketplace we have, the more it will grow. So that's one element of it. The biggest piece of that component of COGS is the payment costs, right?
And so more people adopt ACH, that helps with the leverage. And obviously with a 3% tier now, we get a little bit more lift on that from a gross margin perspective. The other piece which we've been really focusing on is on the hosting costs with regard to Amazon Web Services, and that has been growing slower than revenue for several quarters now. We feel like we've gotten that managed now. I think it's sort of stable from here for the rest of the year because we've got some work that we're doing on moving to another location in Oregon, which will again cause us to have some savings in the future, but in the interim, may have some double cost, but we will continue to focus on.
So I think in the short term, what you'll see is sort of that gross margin in that range, And then we'll be focusing on growing that gross margin over time towards that long term Tallrigger model.
Okay, great. Thanks, Stefanski. Thanks, Brian. Appreciate it. Yes.
Our next question coming from the line of Drew Kootman with Cantor Fitzgerald. Your line is open.
Hi, good afternoon. I wanted to touch on the enterprises this year. Any kind of feedback that you're getting from those larger enterprises? And I know it's early, but how has the retention been of those companies?
Yes. So the client spend retention for enterprise is much higher than it is for the marketplace. I would say in general, the bigger the company, the more they end up spending on the platform. And the more they spend on the platform, the more value they get from it. So it's always been much higher, and it continues to do well.
I would say in terms of feedback, to answer your question, we just did our annual executive summit with our top clients. So we do a lot of small events throughout the year. But once a year, we host this event that we call Work Without Limits or WWL. This one was in Chicago. It was about 100 different attendees represented mostly from Fortune 1,000 type of companies.
And frankly, the best part of it was not the speakers that we had or the announcements that we made. It was just our customers talking to each other and sharing their best practices. And it's always surprising, I think, to them, maybe less so to us, how differently different companies are using us. And so in a way, it's the best cross selling opportunity in the world. You've got companies, some of which are direct competitors, which is also interesting, companies that would say, well, here's how we use Upwork and the other company taking notes and hopefully experimenting with different categories, different ways of engaging with the freelancers on the platform.
And we've seen that to be extremely effective in the past. And I think this year was another addition where it seemed like the best sales pitch ever was just to put our customers on a panel and have them talk about their experience.
Got it. And then just a quick question on the how the domestic marketplaces are going and any updates on when those will start impacting revenue?
Well, I mean, I would say they're impacting revenue today, right? So the biggest one right now is the domestic the U. S. Domestic marketplace, and that's now over 20% of the business and it's growing at about 35% year on year. At some point, it's going to start slowing down, right, because ultimately, we don't want it to be cannibalizing the international marketplace either.
But right now, it's still growing significantly faster than the rest of the business. So it's going to continue to gain share. I would say the next ones after that, the U. K. Experiment that we have, the Chicago, New York and San Francisco, I would say the main thing that's happened over the last couple of quarters is we've really ramped up the amount of brand marketing that we Probably the biggest empty white space for us at this stage is the fact that we still have extremely low awareness within the traditional buyers of staffing services.
The traditional staffing firms don't have very high Net Promoter Score. A lot of their buyers are not very happy, but they don't consider us as an alternative to it. So you may have seen some of our local radio and TV advertising in the last few quarters. And if you look at them, really what we are trying to say is instead of talking about how we are the future of work and we are platform and we are disruptive and all of the stuff that we think is cool, but frankly buyers don't care about. Instead, we really are trying to talk about use cases.
So and so went on parental leave and during that time you're really struggling to figure out how to get the project done rather than go next door and talk to your staffing firm, which is going to take months to fill the rack with somebody who is not very qualified, go online and find great talent within a couple of days. And you'll see more of us trying to explain to companies that otherwise would be using a very traditional service how and why they should be using Upwork instead.
Perfect. Thank
you. Our next question coming from the line of Nandan Amladi with Guggenheim Partners. Your line is open.
Thank you for taking my question. So, on the branding front, I know you touched on radio and so on, but how about online advertising? And as you approach enterprise customers, do you have to move to a different approach to marketing, use different channels?
Sure. Yes, that's I mean, that's a great question. So we I would say at this stage, we use every channel that we are aware of. Maybe one of the biggest changes to your to answer your question directly is we've just hired and I think I mentioned this on the last call, Lars, who is our SVP of Marketing, who previously had been at Robert Half for the last 17 years, in particular leading the digital marketing efforts. So we're trying to from a DNA standpoint, we're trying to have in the company people that come from the tech industry and really know how to innovate and move fast and disrupt things, but also people that come from the traditional world that we're disrupting, the agency consulting and staffing world, and LAZ is a perfect example of that.
So around LAZ, we're building marketing programs that are cross functional that include marketing itself, operations, sales and product, and trying to have a very end to end view on the different types of buyers that we are targeting. As you know, this platform is mostly demand constrained. Like for the most part, we are not trying to get more freelancers to sign up. We're really trying to get more companies to sign up. And there are very different types of companies signing up on Upwork today.
So the channel to acquire people with a very small business Ideally, it's a free channel. So it's a lot of search engine optimization. It's a lot of earned content like PR and other things. If you look in the SMB segment, you really want to have a go to market strategy that is as self-service as possible because you don't want to have a expensive sales team touching every single deal. So we've always had this self-service approach where you can enter your credit card.
And the new development here is when you sign up, you now have a choice between Upwork Basic or Upwork Plus to try to have a subscription part of the business as well as experience that is more adapted to the type of company that you are. But then from a go to market standpoint, we now have Upwork Business and Upwork Enterprise, which are not self-service solutions. You do need to talk to the sales team. There is a contract negotiation involved. And from a marketing standpoint, what that means is we've started to build a more B2B demand gen type of approach to this, which is less about SEO SEM, direct to a landing page, click to sign up, enter your credit card and you're done, and much more what you would see from other B2B and enterprise companies around nurturing the leads and understanding who the buyers and who the users are and making sure that the lead is of sufficient quality before handing it off to a sales development team who then qualifies the lead further and makes it what we call an SQL, a sales qualified lead, which then gets transitioned to a sales rep who is in charge of hunting, so closing the deal, getting the account started on Upwork and then transition further to an account management team who is in charge of growing the account and essentially owns the account from there on and is in charge of growing it forever.
Thank you. Very helpful.
And I'm not showing any further questions at this time. Ladies and gentlemen, thank you for your participation in today's conference call. This concludes today's program. You may all disconnect. Everyone have a great day.