Zuora, Inc. (NYSE:ZUO) Q2 2024 Earnings Call Transcript

Zuora, Inc. (NYSE:ZUO) Q2 2024 Earnings Call Transcript August 23, 2023

Zuora, Inc. misses on earnings expectations. Reported EPS is $-0.16278 EPS, expectations were $0.03.

Operator: Good afternoon, and welcome to Zuora’s Second Quarter of Fiscal 2024 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] With that, I would like to turn the call over to Carolyn Bass, Investor Relations for introductory remarks. Please go ahead.

Carolyn Bass: Thank you. Good afternoon, and welcome to Zuora’s Second 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, who 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 laws. These statements reflect our views as of today only 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 the prior year’s 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, Carolyn. Thank you, everyone, for joining us today, and welcome. Welcome to Zuora’s second quarter fiscal 2024 earnings call. I’d like to start off by congratulating our Head of Investor Relations, Luana Wolk, on the birth of her second son. And thank you, Carolyn, for stepping in while Luana is out on parental leave, although I suspect that she might be listening in right now. Q2. Q2 was another solid quarter where we delivered on our guidance, progressing our top line and coming in ahead of our bottom line. In the second quarter, subscription revenue was $95.5 million, growing 16% in constant currency and 14% as reported. ARR grew 14% as reported and we came in at 9% non-GAAP operating margin for the quarter.

This is up from 6% last quarter and up 900 basis points from Q2 of last year. We are now halfway through our fiscal ’24, and it’s a good time to recap our larger mission and strategy and the progress we have made towards building a durable profitable business. The core thesis of the company is to be the leading beneficiary of a broad, long-term secular shift in business models. Our mission is to offer differentiated hard-to-replicate technology that helps companies thrive with these new business models. Our technology goes into the guts of a company’s operations. When we go in, we’re very sticky. And so our strategy is to sign up the biggest and best companies in the world, turn them into customers for life and tie our growth to the growth of their recurring revenue business in two ways.

First, with a consumption-based pricing model and second, through a consistent pace of organic and inorganic innovations that we can sell. When I look at Zuora, I see a durable business model that is riding a wave that will last decades, not years. So what do we see in Q2 along this journey? I’d say the key message for Q2 is steady as she goes. As we go through this period of higher scrutiny around technology spend, we are seeing that companies continue to embrace recurring revenue models. But the adjustments we made to focus on smaller, faster lands continues to pay dividends. We continue to demonstrate the durability of our enterprise segment. And finally, our innovation train continues to roll forward and take hold within a customer base that most companies would be envious of.

Let me go through each point with examples of what we saw in Q2. On our last earnings call, we said that buyer behavior has settled into a consistent pattern and this extended into Q2. There continues to be good demand for what we do. Why? Well, because modern businesses know that they must center their business around their customers and Zuora powers the business models that makes this possible. Let me give you some examples of new logos from the quarter. The DISH Wireless, a subsidiary of DISH Network and a 5G network provider that reaches more than 240 million Americans. They purchased Zuora Revenue in Q2. Zuora has the unparalleled functionality DISH needs to automate their revenue recognition as they grow their subscriber base. Another example, one of the top five largest companies in Japan [went live in] (ph) Zuora in Q2.

And we are now helping manage their media SaaS offerings. This company has hundreds of thousands of subscribers. We use this service every month to edit, archive and share their media files, and they selected Zuora Billing and Zuora Revenue because of our enterprise class capabilities. A third example The Atlantic, a great proof point of the success of our Zephr acquisition last year, which further strengthened our position in the media and publishing vertical. In previous quarters, we’ve talked about our work with the New York Times and Gannett. In Q2, we were proud to welcome The Atlantic, a leading magazine and multi-platform publisher with over 925,000 subscribers, which signed out with Zuora Billing and Zephr together to power their paywall and billing solutions.

Zuora will give them new flexibility to experiment and enhance the reader experience while freeing up engineering resources to innovate. Again, the technologies we offer continue to be relevant in this marketplace. On our last earnings call, we talked about how we displayed agility, by adjusting to the macro and we’re targeting smaller, faster lands with a single Zuora product versus starting customers with the full suite. And that strategy continued to pay-off this quarter as it did in Q1. This quarter, we closed over 35% more new logos compared to Q2 of last year, and our average sales cycles improved by over 30% year-over-year. Now, while we have the agility to land smaller, faster deals, it’s important to remember that we remain committed to the enterprise segment, the premium durable segment in this marketplace.

This means that we have runway to expand within our accounts. And it also means that we’re still seeing big deals as we do still see companies with the right catalyst to invest in large transformational projects. In fact, if you look at our Q2, we closed seven deals with an average contract value at or above $500,000, including one at above $1 million. These large deals helped us add eight customers sequentially in Q2 with an ACV at or above $250,000. And of course, our system integrator partners also remain important to our ecosystem. In fact, in Q2, partner sourced and partner influenced bookings both increased sequentially. Finally, in Q2, our innovation machine continue to make me proud. I know many of you were able to join us as described live in June, either live in New York, or virtually online, where we made four key product announcements.

First, we announced enhancements to our Zuora for consumption capabilities, the only solution that provides end-to-end billing and revenue recognition specifically designed for these new consumption building models that are all the rage and technology companies. Second, we announced the Zuora Command Center, which helps admins monitor critical activity, manage multiple environments and proactively troubleshoot issues with embedded AI. Third, our new Zuora warehouse with our BYOW or bring your own warehouse technology allow customers to power large volumes, high-speed data analysis directly in Zuora, using a natural language interface that again is powered by AI. And finally, we announced Zephr for all industries, allowing all companies in all industries to implement subscriber-led growth strategies with the demo that people are still talking about.

And we’ve already started seeing the impact of these innovations in Q2. For example, Zuora for consumption helped us close a high six-figure ACV deal with $1 billion global electronic marketplace operator. And Zuora Command Center has already rolled out to 20 early adopters who are universally seeing this is already making them more productive and they are eager to see it grow. And finally, we have been busy showing Zephr for all industries, to SaaS companies, gaming companies, auto companies and more and today, I am so excited to be able to say that we’ve already signed our first non-media customer for Zephr. In Q2, we expanded our relationship with 24 Hour Fitness, a major fitness center chain. They came to us to tailor their pricing and packaging across their close to 300 locations with Zephr’s new dynamic offers.

We’ll be helping 24 Hour Fitness bringing memberships and personal training products to market even faster, all while reducing dependency on their internal IT resources. The news doesn’t stop there. We are taking subscribed events global, and we will be making additional announcements at our upcoming October subscribed Connect event in London. All this incredible work is now being led by our new Chief Product and Technology Officer, Pete Hirsch, who joined us from BlackLine just last month. Pete has deep experience in technology, he understands financial systems and, in fact, was already knowledgeable about Zuora as one of our customers. I am confident that Pete is the right leader to lead this charge and to further accelerate our product innovation, and I am excited for what’s to come under Pete’s leadership.

In closing, I want to thank our CEOs, who continue to execute and innovate, who continue to turn Zuora into a durable profitable business, it will help Zuora in being named one of Fortune’s Best Workplaces in the Bay Area for a second year in a row. With that, I’ll turn the call over to Todd to review our financials.

Todd McElhatton: Thank you, Tien, and thanks to everyone for joining. In Q2, we once again executed on our plan of balancing growth and profitability. During the quarter, we observed the same buying behavior we saw in Q1. Our subscription revenue and total revenue were within our Q2 guidance with non-GAAP operating margin exceeding the high end of our range. For the full year fiscal ’24, we’re raising our non-GAAP operating margin and adjusted free cash flow outlook. In Q2, subscription revenue was $95.5 million, growing 16% year-over-year in constant currency and 14% as reported. Similar to last quarter, we continue to experience 2 points from FX headwind based on the strength of the US dollar. Professional services revenue was $12.6 million, a decrease of 16% year-over-year and represented 12% of total revenue.

The decline in PS revenue is a result of our SI partners taking more implementation business. Given the demand for multiyear digital transformation deals has declined in the current environment, partners have adjusted to take on a broader range of projects, including those we have typically done in-house. Total revenue was $108 million, up 11% in constant currency and 9% as reported year-over-year. As a reminder, over a third of our total revenue is international, which created FX headwinds of approximately $2 million this quarter. Non-GAAP subscription gross margin in Q2 was 81%, and an improvement of nearly 90 basis points year-over-year as we continue to see our investments in infrastructure pay off to expand our margin. Non-GAAP professional services gross margin was negative 5%, a reduction of nearly 190 basis points year-over-year.

As we stated previously, our PS margin may fluctuate based on investments we make and customers to support near-term subscription growth. Our non-GAAP blended gross margin was 71%, an increase of nearly 350 basis points year-over-year. The improvement was driven by increased subscription margin and a higher mix of subscription revenue. Non-GAAP operating income in Q2 was $9.6 million compared to a non-GAAP operating loss of $0.2 million in the prior year. This resulted in Q2 non-GAAP operating margin of 9%, a significant improvement of 900 basis points over last year. This was driven by top line growth and disciplined investments in the business. We will continue to generate non-GAAP operating income on a quarterly basis going forward. Our fully diluted share count at the end of the quarter was approximately 171.6 million shares using both the treasury stock and if converted methods.

Now let’s dive into some of the key metrics. Dollar-based retention rate or DBRR, ended at 107%, down 1 point sequentially and 4 points reduction year-over-year. Not surprisingly, customer demand for volume has been impacted due to the macro backdrop. We continue to have very strong retention rates. We’re seeing our customers staying and growing with us, given how mission-critical our solutions are. In fact, Q2 was a third quarter in the past five quarters where we’ve seen record high retention rates as a percentage of entering ARR. At the end of Q2, we had 444 customers that spend at or above $250,000 in average contract value, which was up 8% sequentially and 37% year-over-year, as cohort represents over 80% of our business. This quarter, we closed seven deals with an ACV of $500,000 or more, and this includes one deal over $1 million compared with none in Q2 of the prior year.

Now looking at ARR and free cash flow. At the end of Q2, ARR was $384.2 million and grew 14% as reported. Adjusted free cash flow was positive $4 million in the quarter, a meaningful improvement of $11.5 million over Q2 of last year. Adjusted free cash flow is operating cash flow adjusting for capital expenditures, acquisition-related costs and non-ordinary course litigation costs. As a reminder, adjusted free cash flow fluctuates on a quarterly basis due to the timing of cash collections, vendor payments and seasonality. We believe it’s best to assess our cash flow performance on an annual basis. Total CapEx for the quarter was $2.2 million. Turning to the balance sheet. We ended the quarter with $406.2 million in cash and cash equivalents, a sequential increase of $9.4 million.

Turning to our financial outlook. As Tien noted, we’re seeing similar buying patterns relative to last quarter, and our outlook assumes these trends will continue for the remainder of the year. We’re also assuming that the trends in our professional service business will continue and we’re standing by our partner first strategy to enable our SI partners to take on more of the implementation work. This will impact our PS revenue in the second half. Starting with our guidance for Q3. We currently expect subscription revenue of $96.5 million to $97.5 million, professional services revenue of $11 million to $12 million, total revenue of $107.5 million to $109.5 million. We expect non-GAAP operating income of $10 million to $11 million and non-GAAP net income per share of $0.05 to $0.06 assuming weighted shares outstanding of approximately $141.6 million.

For the full year of fiscal 2024, we’re raising the low end of our subscription revenue and raising our guidance for both non-GAAP operating income and adjusted free cash flow. We now expect subscription revenue of $380 million to $384 million, professional services revenue of $48 million to $49 million, total revenue of $428 million to $433 million, non-GAAP operating income of $34 million to $36 million and non-GAAP net income per share of $0.21 to $0.23, assuming weighted average shares outstanding of approximately 140.3 million. For fiscal ’24, based on our strong cash flow generation in the first half of the year, we are raising our adjusted free cash flow from $24 million to at least $28 million, a dramatic improvement from fiscal 2023.

We are also increasing our operating profit objective for the second quarter in a row. We are now committed to delivering a minimum of 8% non-GAAP operating margin for the year, up 200 basis points from the initial guide of fiscal 2024. Turning to DBRR and ARR growth. For the fiscal year, we continue to expect DBRR of 107% to 109% and ARR growth of 12% to 15%. We continue to expect annual share dilution for fiscal ’24 to be under 5% with a 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 total shares outstanding at the end of the year. We see demand from the long-term secular trends of companies finding new business models to monetize.

Looking ahead, we remain focused on balancing growth and profitability. Based on the current environment, we believe it’s prudent to put dollars to the bottom line. We have the sales capacity to deliver on our outlook for the second half of the year, and we have the ability to ramp up as needed. Our solutions are critical for our customers to run their business. Our multiproduct portfolio offers customers the necessary agility to monetize and expand their offerings. We look forward to continuing to innovate and create more opportunities for our customers to grow with us. With that, Tien, Robbie and I will take your questions, and I’ll turn it over to the operator.

See also 15 Highest Paying Countries for Engineers and Billionaire Ken Fisher and Corporate Insiders Are Betting On These Stocks.

Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Adam Hotchkiss. Your line is open.

Adam Hotchkiss: Great. Thanks for taking my questions. I guess, Tien, to start, it would be great to get some more color on some of the comments you made around improving sales cycle and deal momentum. What is it that you think is driving some of these improvements? And how do you think about when some of that might start to flow through in the form of revenue reacceleration? Is this just purely macro? Or do you think of some of it is driven by the announcements you made in June? Thanks.

Tien Tzuo: Yeah. I’ve also got Robbie here. This is Tien and I’ll jump in. But I would say we talked last quarter really about people have this impression that because we sell an ERP-like system that we can only do large deals and large implementations. And what we wanted to highlight was — and actually, our architecture allows us to go in with one product, not the entire suite. And so we adjusted at the start of the year to say, look, given everything we were seeing in last year in Q3 and Q4, let’s start to direct our sellers to take down smaller, faster deals. And so we wanted to say, look, we still have a balance. We still see companies that come in and say, look, we have a catalyst in our company that requires us to put a large transformation project in place.

And so we highlighted some of the large deals that we did. But at the same time, when we go in, we don’t have to do that. We can just land with billing, we could just land with revenue. We could just land with Zephr in our ability to tackle the market in this agile way, it does allow us to do smaller, faster deals, and we’re seeing the positive impact of that.

Robbie Traube: Yeah. I don’t know it’s great. I’d say — what we have is the opportunity at the market for us, we are a mission-critical solution. But at the same time, we can land smaller in the deals and the customers that we wish to — the enterprise customers. And we have a choice, right? We have multi-products and what we do. So we can land in multiple different ways, and then we can once land it, then we can expand. And that has been working well for us. And so our goal is to continue to sign up these companies, and we’re not adjusting the companies we’re targeting. We’re still targeting what we see as the best and biggest companies in the world. We do believe these are fantastic customers or customers for life, and so if we can land with smaller deals and continue to execute our expansion strategy. That’s going to be all goodness whether the macro is slower or if it’s back up to a faster speed.

Adam Hotchkiss: Got it. That’s really helpful. Thanks. And then when we think about the product launches from subscribe live, there’s a lot there, right, with Zephr warehouse consumption billing. I recognize some of this will take some time to play out as you push these product improvements into the marketplace. But how should we, as analysts, be thinking about when we might see the financial catalysts from these things? I know you mentioned one customer from Zephyr that joined outside of the media space, but how are we thinking about that from a financial impact perspective?

Todd McElhatton: Hey, Adam, it’s Todd. So obviously, as we release products, we have an expectation that they grow over time. So as these products are just going GA this quarter or in the last quarter, we’ll see that pick up over time. So look, feel really good about what happened with Zephr 24 Hour Fitness. There’s a good pipeline of other opportunities there. We saw like consumption billing drew one of our high six-figure deals as last quarter. So we feel very good about the prospects there. But overall, I don’t expect it to change outside of our guidance. I think this will build and this will certainly lead into next year and provide us the pipeline to continue to grow as we move forward.

Adam Hotchkiss: Okay. Really helpful. Thanks everyone.

Todd McElhatton: Thanks, Adam.

Operator: Your next question comes from the line of Joshua Reilly of Needham. Your line is open.

Joshua Reilly: Yeah. Thanks for taking my questions and nice Job here on the quarter, guys. Maybe just one on the macro. I guess maybe some more color here would be helpful. What are you hearing from customers on why they’re delaying some of these digital transformation projects? Do you think it’s uncertainty around interest rates and where they peak, or just general weakness in the tech economy and their end markets and everybody is kind of waiting to see where demand bottoms out? And then what do you think ultimately we should be watching for as the catalyst to see a demand recovery? Or what is there in the market that could change the current dynamic?

Tien Tzuo: Yeah. I would say what we’re experiencing is, on the one hand, I think different, there’s more scrutiny on spend currently out there. It depends on industries, right? So you’ve seen the media industry continue to invest in subscriptions because they know that, that’s where their revenue growth is coming from. But look, overall, at a macro generalized level, there’s scrutiny on spend. But when you look at our specific space, companies are still saying, look, the future is going to be recurring revenue. The future is going to be monetizing these new digital services. So this is something that we simply have to do. right? And so the projects that are in companies that saying, look, regardless of what’s going on in the macro, we have to invest in this space now.

Those are the bigger deals that we’re seeing. And with other companies, we can say, look, you know you want to get started, you know it’s important to you. If you have downward pressure on spend right now, why don’t we get started in this part of the portfolio and you can continue to grow with us over time.