Zuora, Inc. (NYSE:ZUO) Q3 2024 Earnings Call Transcript
Zuora, Inc. (NYSE:ZUO) Q3 2024 Earnings Call Transcript November 29, 2023
Zuora, Inc. beats earnings expectations. Reported EPS is $0.09, expectations were $0.06.
Operator: Good afternoon. My name is Krista and I'll be your conference operator today. At this time, I would like to welcome everyone to the Zuora Fiscal Year '24 Third Quarter 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. I would now like to turn the conference over to Luana Wolk, Vice President of Investor Relations and ESG at Zuora. You may begin your conference.
Luana Wolk: Thank you. Good afternoon, and welcome to Zuora's third quarter fiscal 2024 earnings conference call. On the call we have Tien Tzuo, Zuora's Founder and Chief Executive Officer; and Todd McElhatton, Zuora's Chief Financial Officer. Robbie Traube, our President and Chief Revenue Officer will be joining us for the Q&A session. During today's call, we will make statements that represent our expectations and beliefs concerning future events that may be considered forward-looking under federal securities law. These statements reflect our views only as of today and should not be relied upon as representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook.
These statements are subject to several risks and uncertainties that could cause actual results to differ materially from expectations. For further discussion of the material risks and other important factors that could affect our financial results, please refer to our filings with the SEC. And finally, unless otherwise noted, all numbers except revenue mentioned today are non-GAAP. You can find a reconciliation from GAAP to non-GAAP results for both the current and a prior-year periods in today's press release. Our press release and a replay of today's call can be found on Zuora's Investor Relations website at investor.zuora.com. Now I'll turn the call over to you, Tien.
Tien Tzuo: Thank you, Luana. Congratulations again. It's so great to have you back. And thank you everyone for joining us today. Welcome to Zuora's third quarter fiscal 2024 earnings call. Q3 was another quarter where we exceeded guidance on subscription revenue, total revenue, and operating income. In Q3, subscription revenue rose to $98 million, up 14% in constant currency and 13% as reported. ARR grew by 13%. Non-GAAP operating income exceeded the high end of our guidance range by $5 million and we exceeded our full-year goal for adjusted free cash flow one quarter ahead of plan. I would say that the Q3 headline was our margin expansion. Our Q3 non-GAAP operating margin was 15%. This is a huge increase from nearly a breakeven position just one year ago.
And as Todd will show our outlook for FY'24 illustrates that we plan to deliver a $65 million positive swing in our adjusted free cash flow for the year. We've done this while building a durable business that delivers a double-digit growth even in this macro-environment where budgets are scrutinized and deal cycles are taking longer. I would say there are two things that have allowed us to accomplish this. Our enterprise customers and our mission-critical technology. As you know, we chose to focus on the world's largest and fastest-growing companies across industries and all around the world. This gives us a customer base that many would be envious of. And in Q3, many of these companies are recommitted to Zuora. We saw several expansions with multi-year commitments that drove a 20% year-over-year increase in our total RPO or Remaining Performance Obligations.
This also helped drive our dollar-based retention rate to 108% in Q3, up one point quarter-over-quarter. Let me give you some examples. In Q3, we expanded our work with Google, Google Fiber, Alphabet's high-speed broadband Internet service that spans 15 states and counting. Now Zuora will power GFiber's full order-to-revenue process as they continue to grow. Or, you all know we power 12 of the top 15 automobile companies around the world. Well, in Q3, one of them, which is also one of our top five customers, renewed their commitment to Zuora for another five years. Not only that, in one of the world's largest telecommunications and entertainment companies, we expanded to yet another business unit, signing a five-year, seven-digit deal, which also was a competitive replacement.
Of course, this isn't just about our install base. Because of our technology, our people and our vision, companies continue to choose Zuora to drive the growth of their recurring revenue businesses. For example, in Q3, FreshBooks, a high-growth leading invoicing and accounting software built for business owners and accountants came to Zuora after their previous legacy systems required complex manual intervention to meet their needs. Now, with Zuora, they plan to streamline and simplify how they manage recurring revenue, including consumption. As another example, a leading healthcare technology platform selected Zuora to power their care services. We will be working with them to make their pricing and packaging more flexible, along with driving operational efficiency.
And of course, we continued to have amazing companies go live on Zuora. In Q3, LinkedIn, the world's largest online professional network is now using Zuora for their LinkedIn subscription revenue stream. This is within their LinkedIn Talent Solutions. After an in-depth search for the right partner, LinkedIn selected Zuora to minimize the need for manual intervention in their revenue recognition processes and expedite their time to market. This is why in Q3, we saw an uptick in both the number of large deals and the number of customers with an average contract value at or above $250,000. We now have 453 of these customers, up by nine quarter-over-quarter. This quarter, we saw seven deals with an ACV at or above $500,000, compared to six deals in Q3 of last year.
Of those seven deals, two were over $1 million. And our relationship with our system integration partners continues to be incredibly important to help us move these large companies to Zuora. In Q3, we continue to see solid growth for partner sourced pipeline. The second thing that enables us to continue to deliver strong results is, of course, our differentiated technology and our constant pace of innovation. And I'm so excited that this technology is more important than ever. Why? Because we believe we are entering a new phase of the subscription economy. Let me explain. The past 15 years have been a great period of growth for subscription businesses. But today you have all heard of the phrase subscription fatigue, the idea that we all have too many streaming services subscriptions or our companies have too many SaaS applications.
So does that mean the subscription era is over? Well, of course not. What it means, however, is that a shakeout is now happening. And what we are seeing is the winners of the shakeout are using our technology to deliver not just recurring relationships or recurring revenue. They are using our technology to create recurring growth. In fact, if you came to any one of our subscribed international events, for example, in New York, London, Paris, Munich, Stockholm or Tokyo, we showed that two dominant strategies are emerging for how to create recurring growth. The first is around consumption. In fact, our new research with BCG found an almost 3x increase in adoption of hybrid consumption models over the last three years. And so in Q3, we expanded Zuora for Consumption to help companies take their unpredictable raw usage data, better understand exactly how their customers use their offerings and translate that to the right pricing model.
Companies like AVEVA, a global leader in industrial software in Europe, are adding Zuora for Consumption to give their customers visibility into consumption habits and with that new transparency, deliver new value to customers. We're also seeing greater recognition of our product portfolio by third-party research firms. IDC Research, for example, has stated that Zuora is providing the revenue platform of tomorrow, especially with these new consumption-based capabilities. The second dominant strategy we're seeing emerge is what I'll call strategic bundling and unbundling. In this digital era, companies like New York Times, as an example, they no longer ask you to buy their entire newspaper. Instead, they have unbundled their offerings, allowing people to subscribe to just games or news or sports or cooking and more.
And this is how they have grown to now more than 10 million subscribers. And so, in Q3, we announced new capabilities for Zephr that enabled our customers to gain a deeper understanding of their subscribers through their own data combined with industry benchmarks across the entire Zuora customer user base, helping them drive conversion and retention through personalized offers. All of this builds on our family of market-leading products, Zuora Billing, Zuora Revenue, Zuora Payments, Zephr, and Zuora Platform, including Zuora Warehouse with BYOW Technology, Zuora Extension Studio and Zuora Command Center with the new integration hub. In closing, for Q3, I would like to thank every ZEO for their work, not just in the quarter, but for the entire year.
We have built a fantastic customer base with the biggest and best brands. We have the right technology suite which we are constantly innovating, and we have a passionate team of ZEOs in place to help us take the momentum that we have seen through Q3 into Q4 and into the New Year. Now I'll turn over the call to Todd to review our financials. Todd?
Todd McElhatton: Thank you, Tien, and thanks to all for joining our call. In Q3, we once again did what we said we would do. Consistent with what we have seen over the past few quarters, we continue to see extended sales cycles in Q3. Regardless of the backdrop, we are committed to building a long-term, durable business that can post double-digit growth while delivering double-digit operating leverage and generating healthy cash flow. In fact, we exceeded our full-year goal for adjusted free cash flow one quarter ahead of plan. Our subscription revenue, total revenue, and non-GAAP operating income all exceeded the high end of our guidance range. Let's start with our Q3 performance. Subscription revenue was $98 million, growing 14% year-over-year in constant currency and 13% as reported.
Professional services revenue was $11.8 million, a decrease of 19% year-over-year and represented 11% of total revenue. System integrators remain an important piece of our strategy, and similar to prior quarters, we leveraged our SI partners for implementation of our solutions. Total revenue was $109.8 million, up 9% year-over-year. Non-GAAP subscription gross margin in Q3 was 83%, an improvement of over 400 basis points year-over-year. This increase was driven by optimization of our cloud hosting and a one-time vendor credit. In the near term, we expect our subscription gross margins to be between 81% and 82%. Non-GAAP professional services gross margin was negative 1%, an improvement of over 30 basis points year-over-year. Our long-term plan is to run professional services at or near breakeven.
Professional services margin may fluctuate based upon investments we make in customer support for near-term subscription revenue growth. Our non-GAAP blended gross margin was 74%, an increase of over 650 basis points year-over-year. We are very pleased to share that our non-GAAP operating income in Q3 was $16 million compared to $0.6 million in the prior year, and exceeded the high end of our outlook by $5 million. This resulted in a Q3 non-GAAP operating margin of 15%, a significant improvement of nearly 1,400 basis points over last year. This was driven by top line growth and our continued commitment to disciplined investment. Our fully diluted share count as of the end of the quarter was approximately 178.3 million shares, using both the treasury stock and if converted methods.
The share count increased primarily through the issuance of our second tranche of convertible debt with Silver Lake. Now let's dive in some other key metrics. Dollar based retention rate or DBRR ended at 108%, up one point sequentially and a one point reduction year-over-year. As Tien noted, we saw contract expansions, many of which were long-term commitments, driving our total RPO to a 20% year-over-year growth and a non-current RPO grew 28% year-over-year. In addition, we continue to see very strong customer retention rates. As we deliver more innovative solutions and value, we're giving our customers more reasons to stay and grow with us driving continued improvements in retention as a percentage of ARR. At the end of Q3, we had 453 customers that spend at or above $250,000 in average contract value, which is up nine sequentially and 33 year-over-year.
This cohort represents 83% of our business. This quarter, we closed seven deals with ACV of $500,000 or more, up from six in Q3 of last year. This includes two deals over $1 million, consistent with two in Q3 of the prior year. Now, looking at ARR and free cash flow. At the end of Q3, ARR was $396 million and grew 13%. Adjusted free cash flow was positive $12.7 million in the quarter, a meaningful improvement of nearly $20 million over Q3 of last year. Adjusted free cash flow is operating cash flow, adjusting for capital expenditures, acquisition-related costs, and non-ordinary course litigation costs. We believe cash flow is best assessed on an annual basis as adjusted free cash flow fluctuates on a quarterly basis due to the timing of cash collections, vendor payments, and seasonality.
As I noted earlier, three quarters into the year we have already exceeded our annual target, which demonstrates the health and durability of our business. Total CapEx for the quarter was $3.1 million. Turning to the balance sheet, we ended the quarter with $493.7 million in cash and cash equivalents, a sequential increase of $87.5 million. In Q3, we had two notable events that affected our cash balance. We received a second and final tranche of our funding from Silver Lake Partners. Additionally, we dispersed payment associated with the completion of a litigation settlement. In Q3, the macro environment remained challenging, and we anticipate this to continue through the near term. As we discussed last quarter, our professional services business is now a smaller portion of our revenue mix as we support our partners in leading customer implementations.
Starting with our Q4 guidance, we currently expect subscription revenue of $99.3 million to $100.3 million. Professional services revenue of $10.5 million to $11.5 million. Total revenue of $109.8 million to $111.8 million. We expect non-GAAP operating income of $12 million to $13 million and non-GAAP net income per share of $0.04 to $0.05, assuming a weighted average shares outstanding approximately 144.2 million. For the full fiscal year, we're tightening the range for revenue and based on the outperformance in Q3, we're raising our guidance for non-GAAP operating income and adjusted free cash flow. We now expect full year subscription revenue of $382.5 million to $383.5 million, professional services revenue of $48.3 million to $49.3 million.
Total revenue of $430.8 million to $432.8 million. Non-GAAP operating income of $43.6 million to $44.6 million and non-GAAP net income per share of $0.25 to $0.26, assuming a weighted shares outstanding of approximately 140.1 million. We continue to make headway on our goal of balancing growth with profitability. For full-year fiscal '24, we are raising our adjusted free cash flow guidance from $28 million to $37 million or more. This outlook is a nearly $65 million improvement and adjusted free cash flow over fiscal '23. Similarly, we are increasing our outlook for non-GAAP operating margin, which we are raising from 8% to a minimum of 10% for the full fiscal year. Recall, at the beginning of the year, we expected to be at an annual share dilution for fiscal '24 at under 5% with a midterm target of 4%.
We now expect fiscal '24 to be closer to our midterm target of 4%. For this purpose, dilution is calculated as the number of equity awards granted net of forfeitures during the fiscal year divided by the total shares outstanding at the end of the fiscal year. Turning to DBRR and ARR growth. For the fiscal year, we now expect DBRR of 107% to 108% and ARR growth of approximately 12%. Since Q4 is our largest booking quarter, we believe it is best to wait one more quarter to provide you with full guidance for fiscal year 2025. Having said that, we do want to share some color on the year ahead. As I noted, we expect to end fiscal '24 at approximately 12% ARR growth. We believe this could be the leveling point of our ARR growth in the near term based upon the current environment.
We have the product and sales capacity to accelerate top line growth when the macro environment changes, but we believe it is wise to be prudent at this point. I would also remind you that subscription revenue growth trails ARR growth by a couple of quarters. Given the recent trends in our professional services business, we expect our SI partners to continue to take on more of the implementation work. As such, we expect our PS revenue mix to be approximately 10% of our total revenue. Lastly, we are committed to driving incremental operating margin improvement regardless of the economic backdrop. As you've seen this year, we have been quite aggressive in accelerating non-GAAP operating margin as the year progressed, and we plan to continue this trend next year.
Our objective is to exit fiscal 2025 at a rule of 30 run rate as defined as the sum of the year-over-year subscription revenue growth plus non-GAAP operating margin. In closing, we delivered on our strategy and did what we said we would do. Q3 has further illustrated that Zuora is a durable double-digit margin and growth business. We continue to expand our enterprise customer base, keeping our retention rate strong while expanding profit margins and increasing free cash flow. With that Tien, Robbie and I will take your questions and I'll turn it over to the operator.
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