Zuora - Q2 2024

Transcript

Operator (participant)

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 speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star one on your telephone keypad. If you would like to withdraw your question, again, press the star one. With that, I would like to turn the call over to Carolyn Bass, Investor Relations, for introductory remarks. Please go ahead.

Carolyn Bass (Investor Relations)

Thank you. Good afternoon, and welcome to Zuora's second quarter fiscal 2024 earnings conference call. On the call, we have Tien, 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 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. 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 (Founder and CEO)

Thank you, Carolyn. Thank you, everyone, for joining us today, 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. Thank you, Carolyn, for stepping in while Luana is out on parental leave. 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 this second quarter, subscription revenue was $95.5 million, growing 16% in constant currency and 14% as reported. ARR grew 14% as reported, 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 2024, 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. 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 them. When I look at Zuora, I see a durable business model that is riding a wave that will last decades, not years. 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, that the adjustments we made to focus on smaller, faster lands continues to pay dividends, that 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 in to a consistent pattern. 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 in 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 Zuora in Q2, and we are now helping manage their media SaaS offerings. This company has hundreds of thousands of subscribers who 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. The third example is 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 CNET. In Q2, we were proud to welcome The Atlantic, a leading magazine and multi-platform publisher with over 925,000 subscribers, which signed on 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 through targeting smaller, faster lands with a single Zuora product, versus starting customers with a full suite. 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 catalysts 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. 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 continued to make me proud.

I know many of you were able to join us at Subscribed 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 billing models that are all the rage in 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.

Finally, we announced Zephr for all Industries, allowing all companies in all industries to implement subscriber-led growth strategies with a demo that people are still talking about. 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 a billion-dollar global electronic marketplace operator. The Zuora Command Center has already rolled out to 20 early adopters who are universally saying this is already making them more productive, and they're eager to see it grow. Finally, we have been busy showing Zephr for all Industries, to SaaS companies, gaming companies, auto companies, and more. 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 bring 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, 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 ZEOs, who continue to execute and innovate, who continue to turn Zuora into a durable, profitable business, and who helped 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 (CFO)

Thank you, team, 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 2024, 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 two points from FX headwinds 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 multi-year 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%, 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 in 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. Let's dive into some of the key metrics. Dollar-based retention rate or DBRR ended at 107%, down one point sequentially and four-point 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 the 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 eight sequentially and 37 year-over-year. This cohort represents over 80% of our business. This quarter, we closed seven deals with an ACV of $500,000 or more, this includes one deal over $1 million, compared with none in Q2 of the prior year. Looking at ARR and free cash flow. At the end of Q2, ARR was $384.2 million 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 services 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-$97.5 million, professional services revenue of $11 million-$12 million, total revenue of $107.5 million-$109.5 million. We expect non-GAAP operating income of $10 million-$11 million, and non-GAAP net income per share of $0.05-$0.06, assuming a weighted shares outstanding of approximately 141.6 million.

For the full year 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-$384 million, professional services revenue of $48 million-$49 million, total revenue of $428 million-$433 million, non-GAAP operating income of $34 million-$36 million, and non-GAAP net income per share of $0.21-$0.23, assuming weighted average shares outstanding of approximately 140.3 million. For fiscal 2024, 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%-109%, and ARR growth of 12%-15%. We continue to expect annual share dilution for fiscal 2024 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 multi-product 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, team, Robbie and I will take your questions, and I'll turn it over to the operator.

Operator (participant)

Thank you. If you have a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, simply press star one again. One moment please, for your first question. Your first question comes from the line of Adam Hotchkiss. Your line is open.

Adam Hotchkiss (VP of Emerging Software Equity Research)

Great, thanks for taking my questions. I, I guess, Team, to start, would be great to get some more color on some of the comments you made around improving sales cycle and deal momentum. You know, 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 re-acceleration? Is this just purely macro, or do you think of some of it as driven by the announcements you made in June? Thanks.

Tien Tzuo (Founder and CEO)

Yeah. I've also got Robbie here. This is Tien on, on... I'll let him jump in. I, I would say, we talked last quarter really about, you know, people have this impression that because we sell an ERP-like system, that we can only do you know, large deals with large implementations. What we wanted to highlight was, in actuality, our architecture allows us to go in with one product, not the entire suite. We adjusted at the start of the year to say, "Look, given everything we were seeing in, in, in last year, in Q3 and Q4, let's start to, to direct our, our sellers to take down smaller, faster deals." We wanted to say, look, we still have a balance.

We still see companies that come in and say, "Look, we have a, a catalyst in our company that requires us to put a large transformation project in place." We highlighted some of the larger deals that we did. At the same time, you know, 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. Our ability to tackle the market in this agile way does allow us to do smaller, faster deals, and we're seeing the positive impact of that.

Robbie Traube (President and CRO)

Yeah. I would agree with Tien. I mean, what we have is the opportunity. 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. We have a choice, right? We have multi-products in what we do. We can land in multiple different ways, and then we can once landed, then we can expand. That's just been working well for us.

Tien Tzuo (Founder and CEO)

Our goal is to continue to sign up these companies. 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, they're customers for life. If we can land them with smaller deals and continue to execute our expansion strategy, that's going to be all goodness, whether you know, the macro is slower or if it's back up to a faster speed.

Adam Hotchkiss (VP of Emerging Software Equity Research)

Got it. That, that's really helpful. Thanks. Then, you know, when we think about the product launches from Subscribed Live, you know, there's, there's a lot there, right? With Zephr, Data Warehouse, Consumption Billing. You know, I recognize some of this will take some time to play out as you push these product improvements into the marketplace. How should we, as analysts, be thinking about, when we might see the financial catalyst from these things? I know you mentioned-

The one customer from Zephr that joined outside of the media space. You know, how are we thinking about that from a financial impact perspective?

Todd McElhatton (CFO)

Hey, Adam, it's Todd. Obviously, as we release products, we have an expectation that they grow over time. As these products are just going GA this quarter or in the last quarter, we'll see that pick up over time. Look, feel really good about what happened with Zephr and 24 Hour Fitness. There's a good pipeline of other opportunities there. We saw, like, consumption billing through one of our, you know, high six-figure deals this last quarter, so feel very good about the prospects there. Overall, you know, 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 (VP of Emerging Software Equity Research)

Okay, really helpful. Thanks, everyone.

Todd McElhatton (CFO)

Thanks, Adam.

Operator (participant)

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

Joshua Reilly (Senior Analyst)

Yeah, thanks for taking my questions, and nice job here on the quarter, guys. Maybe just one on the macro. You know, 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's kind of waiting to see where demand bottoms out? Then what do you think ultimately we should be watching for as the catalyst to see a demand recovery? You know, what, what, what is there in the market that could change the current dynamic?

Tien Tzuo (Founder and CEO)

Yeah, I would say, you know, what we're experiencing is, is on the one hand, is not anything different. There's more scrutiny on spend certainly out there. You know, it depends on industries, right? You're seeing the media industry continue to invest in, in, in subscriptions because they know that that's where their, their revenue growth is coming from. Look, overall, at a, at a macro, generalized level, there's, there's scrutiny on spend. When you look at our specific space, companies are still saying, "Look, the future is gonna be recurring revenue. The future is gonna be monetizing these new digital services. This is something that we simply have to do," right?

You know, the projects that are, 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. With other companies, we can say, "Look, you know, 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 then you can continue to grow with us over time?

Robbie Traube (President and CRO)

I think, just so I can see. The customers, they continue to expand with us. You know, the numbers that we called out, I mean, that $250,000+ cohort, that grew 17% year-over-year, $500,000+ grew 24% year-over-year. We continue to see that because it is mission critical to what they do.

Todd McElhatton (CFO)

That really just speaks to, you know, the general agility that we have and how we, how we attack the marketplace.

Joshua Reilly (Senior Analyst)

Got it. That's helpful. If you look at the change in the operating income guidance, you guys seem to continue to find areas of savings there. What would you say is the biggest piece of savings maybe versus your initial plan for the year, and where do you continue to see a source of operating leverage, maybe for the rest of the this fiscal year in your, in your operating expenses? Thanks, guys.

Todd McElhatton (CFO)

Josh, we're continuing to be super disciplined on everything that we're spending. One of the things that we said this year was, you know, we wanna have the ability to, you know, either if the market makes sense, to go ahead and invest in, you know, top-line growth, feel good about where we are on top line. We're gonna be where we said we'd be at the beginning of the year. We've not seen a re-acceleration in the market, so we're not adding additional capacity in. That's certainly an area that's helping us. We've spent a lot of time in the go-to-market areas on how do we get more efficient there. That will continue to drive efficiencies. You saw the COGS, especially on the subscription side, jumped up to 81%, so I feel very good about what's happening there.

Taking a look at how we put engineering resources in and doing that, another area where we're looking at, the same thing with G&A. It's really across the board where you go. Obviously, you know, the first area that and our biggest area of spend is to go to market, and we're constantly working to get that more efficient. Then, you know, like I said, we'll continue to evaluate, and as it makes sense, we'll continue to get leverage out. As we continue to grow and more and more of our bookings, as you know, we become a larger company, those dollars, a lot of them go to the upsell bookings. Just the CAC on that is a lot better than when we're investing in new logos.

As we continue to get larger, that will also give us more leverage in the operating model.

Tien Tzuo (Founder and CEO)

I mean, Josh.

Joshua Reilly (Senior Analyst)

Got it.

Tien Tzuo (Founder and CEO)

Add one more thing. Take this as a team, take this as an opportunity to show off some internal stuff. Obviously, at the end of the day, it's, it's about efficiencies, it's about... It's productivity, it's about being able to do more with the same number of resources. If you look at Todd's organization, partnering with the IT organization under Daisy, you know, we, we are using our own products to become more efficient, and we've taken the number of days on our side down from, you know, 13 days to five days flows. That's the type of thing that we think we can use our technology for, that our customers certainly can have benefit as well.

Joshua Reilly (Senior Analyst)

Got it. Super helpful. Thanks, guys.

Operator (participant)

Your next question comes from the line of Chad Bennett of Craig-Hallum. Your line is open.

Chad Bennett (SVP and Research Analyst of Software)

Great, thanks for taking my question. Just on, on kind of the progress you're making on, on the smaller and, and faster, lands, just in, in terms of magnitude, is there any way to think about kind of where those You know, if there's any historical data of, of, you know, kind of where a land would be today relative to what you've seen in the past and just kind of the magnitude of the ACV difference there?

Todd McElhatton (CFO)

You know, Chad, I, I think at it a couple of ways. One is, if you take a look, you know, we have landed a bit lower on the ASP, over the last couple of quarters from a standpoint of having more deals, and those deals are bringing more new logos on and bringing them a bit lower. You know, they're not like half the size of what we were doing before, but they're still, you know, nice six-figure deals. The other thing that I would say about when we're looking at those, if I look at our top five customers, I want to say four of those five started off, you know, right around $100-$150, and now those are now customers running over $5 million a year in ARR.

We certainly have shown we pick the best and the fastest-growing companies, and I say the fastest-growing, that may mean they're subscription businesses. We have a huge opportunity to expand, and so that's kind of the filter that we're putting on when we're going after smaller lands, is again, making sure they're companies that we can grow with over the long term.

Tien Tzuo (Founder and CEO)

That's right. I mean, each of these companies we're signing on, we still believe that the lifetime value of that customer, that we're pursuing has not changed, right? If we can start smaller with them and have confidence that we can grow them up to that point, then, then given, you know, the macro situation, given the scrutiny on technology spend, why not get started with them now?

Chad Bennett (SVP and Research Analyst of Software)

Okay, I appreciate the color. Then maybe just on, on the dollar-based net retention, at, at 107. I, I know you reiterated, I think, the 107-109 range. Just in terms of, of the level of confidence and visibility that, you know, 107 is, is kind of the trough here. As, as you look at the pipeline, Tien or Robbie or, or Todd, for that matter, just what, what gives you confidence, confidence that, that 107 holds to, to potentially improves over the next couple of quarters here, if you think that?

Todd McElhatton (CFO)

Sure, Chad, I'll maybe take that. Two things that impact the DBRR. The first is our retention rates, and I feel really good about the fact that, you know, three of the last five quarters, we've talked about another record from a standpoint of higher rate retention rates. We had the highest historical retention rates this quarter of all time. I feel really good about our ability to pick the right customers and keeping them. A lot of that's been a strategy that we embarked upon three years ago and going after the enterprise. The second thing that drives that is certainly the expand base. One of the things that we've talked about is there's a volume element of that for us.

We have certainly seen that as our customers aren't growing as fast, that what we've seen is there's been a bit of a slowdown from what they're purchasing on us in additional volume. One interesting thing to note, this is the first time, I think, in four or five quarters, that we actually saw a sequential uptick on the volume. The other thing I would say is, you know, keep in mind, Q2, that was a really tough compare for us from last year.

As I take a look at what the pipeline looks like and what we can see with our customer base and what their needs are for growth and the different products that we've, you know, most recently reduced, or excuse me, released, I'm confident that, you know, the 107 is definitely the bottom end of it, and, you know, we'll be in that 107-109 range as we exit the year, as we said at the beginning of the year.

Chad Bennett (SVP and Research Analyst of Software)

Great. Thanks for the color. Great job on the quarter, guys.

Tien Tzuo (Founder and CEO)

Thanks, Chad.

Todd McElhatton (CFO)

Thanks.

Operator (participant)

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

Rob Oliver (Senior Research Analyst)

Great. Thanks, guys. Good afternoon. Good to be on the call. Tien, I had one for you, and then Todd, a follow-up for you. Tien, you called out, you know, Pete Hirsch, and the enthusiasm over his hire. I was wondering if you could just talk a little bit about what, you know, what made him a good fit and what are some of the, you know, priorities that you had or he has coming in to the role?

Tien Tzuo (Founder and CEO)

You know, I, I think, he's, he's been in the job for, I think, six to eight weeks right now, so I want to give him a little bit of time. The first thing I would say is, we don't have any major changes, right, that we were looking for Pete to come in and do. Things were going well, the innovation machine was going well. The adoption of our, our capabilities is people are incredibly enthusiastic of. We're not looking to make any short-term changes. What Pete, you know, brings in really is a deep understanding of financial systems. He's obviously built a point of view of working with, you know, CFOs and Chief Accounting Officers in the past four years where he's been at.

Obviously, one of the big areas that, that he's really excited about, too, is gonna be, you know, not a surprise here, but, but AI. So, you know, there's a lot of conversation that he's really starting to drive about what is our future around AI. There's a lot of good ideas that we have. We've obviously been, you know, using AI quite a bit. We use it in our payments and collection capability to get retry rates, right, payment completion rates from, you know, some would call it, you know, high 80s to 99% or better. We announced a lot of AI capabilities with the four product announcements that we had just a month ago around Zuora Warehouse, around Zuora Command Center.

If you look sort of step back and say: Does AI have a big, big opportunity to really transform financial systems and allow our products to be much, much more valuable? Absolutely. It's in the area of insights, it's the area of being able to improve, you know, subscriber experiences for our customers' customers, and obviously, to be much, much more efficient in their financial operations. We think AI can have a big capability in all three areas, and it's something that, that Pete's really driving right now internally.

Rob Oliver (Senior Research Analyst)

Great. That's really helpful. Appreciate that. Then, Todd, one for you. With, you know, the partners, taking on some of the smaller deals and the impact on the PS revenue, makes sense. It strikes me as a bit of an encouraging sign, too. I'd be curious to hear your take. Is this something you expect to kind of revert back? I know you said it's, you expect it to continue as long as there's pressure on large digital transformation deals, but is it something you expect to revert back when those do return? You know, given that these large professional service partners know your complete portfolio, you know, what does this potentially do in terms of pipeline creation on the back end for you guys of these smaller lands? Thanks.

Todd McElhatton (CFO)

Hey, thanks a lot, Rob. We're absolutely focused on the subscription revenue side of the business. You know, that grew 16% in constant currency this last quarter. We saw the gross margin increase to 81%, and that's where we make our money. The services, that's ancillary business to us, you know that we run that at a break even to a slight loss. The design of or, you know, by design, we said we've continued to want to bring down the services mix in our business. Might be happening a little bit faster now. That's been something we've been talking about now for quite some time. It's something that we're very comfortable with, and we're happy to have our partners take that over and work that. We work well with them. It also helps drive additional pipe for us over time.

From my perspective, you know, we're kind of at the range where I think we'll remain over, over the next time, over the next several quarters, and we feel good about that because subscriptions being very healthy provides us a great margin, and that's where we'll be focused on.

Robbie Traube (President and CRO)

I mean, if I can as well. Again, we want to win the best companies in the world, right? It's about growing the subscription business for that long term. We are partner first, and that is our strategy, right? As we are, they are adjusting to the current macro, and so we're going to continue our commitments to them, and they're doing the same with us. You know, you know, for example, in two of our top global SIs, two of the people who've been there sponsoring and their commitment, they've become partners because of the work that they've done with Zuora. Absolutely, we will continue that relationship and that strategy and a partner-first strategy.

Rob Oliver (Senior Research Analyst)

Thank you.

Operator (participant)

Your next question comes from the line of Andrew DeGasperi of Berenberg. Your line is open.

Andrew DeGasperi (Senior Analyst)

Thanks for taking my question. Well, I guess first, congrats, Zuora. Second, I just wanted to touch on the, the releases you made in June, consumption billing in particular. I was wondering, in terms of the reception you got from customers, have you seen a ramped up of, of kind of activity there? Maybe not necessarily deals, to call out, but, have you seen kind of incremental interest since that event?

Tien Tzuo (Founder and CEO)

Oh, absolutely. Look, I mean, you could tell I was excited about the capabilities when we launched in June. It was something that, you know, we have worked closely with our customers. We have this thing called the Zuora Advisory Group, the ZAG, that our key customers are involved with, these ideas are really incubated out of that. On the call, I try to highlight some of the successes. The consumption billing capabilities already drove, you know, the deal was probably just, just shy of seven digits. I think we call it a high six-digit deal, that deal wouldn't have happened without the Zuora for Consumption capabilities. I highlighted Zephr, right? When we did the acquisition, obviously, you can see it has a big impact already in our media space with The Atlantic.

The big, big bet was, can we take it outside of media into all the other industries that we have? And so, you know, announcing a 24 Hour Fitness, the existing customers are saying, "Look, we like that Zephr vision. We want the Zephr vision. We need the Zephr vision." And they became the first non-media customer on, of, of Zephr. That was really, really exciting as well. And again, you know, we're sitting here in August, and, and, and the Subscribed Live was in June. So you're seeing that the impact of these innovations are happening fairly quickly.

Andrew DeGasperi (Senior Analyst)

Thanks for that. Then, Todd Elhatt, what sort of a two-part question? First, I know you don't normally call this out, but the billings growth was really strong in Q2, and just wondering if there's anything there? Then secondly, just as a follow-up to Rob's question earlier on the services, I mean, clearly the numbers are coming off a bit faster than we've modeled. Just wondering, in terms of the steady state level that you foresee beyond maybe even this year, do we continue to see that number coming down slightly, maybe not at this sort of range, but at a lower level? Would you see that at some point, we see, we would see that flattening out, you know, if the macro improves or if there's some kind of other element that we're not aware of?

Todd McElhatton (CFO)

Okay. on a calculated subscription, subscription billing, we continue to kinda go back to focus people. Let's take a look at what is the ARR. That's what we have in the bank. That's exactly how we model our business and run it. We've talked about, you know, for quite some time, there's a lot of movement in the, in the calculated billings. We've got a little bit of FX this quarter that's in it, but renewals, time to renewals, you know, companies bringing things in, that certainly has an impact. We've had a couple of situations where we've had some different billing terms, and that certainly provides some movement in it back and forth. Really, the ARR is, is the way to look at it.

Again, if you look at the subscription, calculated subscription billing over a longer period of time, what you see is that pretty much tracks where the ARR growth is of 14% this year. I don't think there's anything that, you know, to see in that. Just it ebbs and flows, and that's why we guide to the ARR. From a standpoint of where we are on the services revenue, I go back to what I said is, I think we're around 12%. We'll probably, you know, we might be a point or two from a mix perspective, that might change over the next couple of quarters. Always going to be an ancillary business, look, you're always gonna have services as part of our revenue. Our services team have tremendous amount of expertise and knowledge of our customers.

When there's the hardest problems to solve, that's the team that's gonna solve it. Those are the teams that help train our partners, and there's always customers that are gonna look for certain deals to be implemented by Zuora. That's just, that's how some companies want to roll. Outside of that, though, we're happy, and, you know, it's our preference to go partner first. As I said to Rob earlier, we make our margin on the subscription revenue side, and that's where I want to be focused. That's where we're doing really well on the margins, and we'll continue to focus that. I really look at the services.

I think when I talk to almost all of our investors, I think most people look at the, hey, you know, that's just part of doing business, but it's really not the fundamental recurring part of our business, which is subscription revenue.

Andrew DeGasperi (Senior Analyst)

Great. Thanks, Todd and team.

Todd McElhatton (CFO)

Thanks, Andrew.

Tien Tzuo (Founder and CEO)

Thanks.

Operator (participant)

Your next question comes from the line of Jacob Stephan of Lake Street Capital Markets. Your line is open.

Jacob Stephan (Senior Research Analyst)

Hey, guys, I'll just add my congrats here on the quarter, and congrats to Luana as well. Just two quick ones for me here. Team, you noted that SI partners, bookings grew sequentially, from Q1 to Q2. I'm just wondering if you could kind of provide some commentary on what we're seeing kind of as we go into Q3 here.

Todd McElhatton (CFO)

Yeah, Rob, Robbie, you want to answer it?

Robbie Traube (President and CRO)

Yeah. I think in terms of the looking at the pipeline, very specifically with our SI partners, that has continued, the momentum there has just continued. You know, even to the extent of, as we look at the mix or changing in terms of lands, we're actually creating solutions with them, and actually creating very direct sort of package pieces that we go to market together. One of the actual great opportunities that we closed in our Q2 was actually through this with a partner. That continues, and that pipeline continues.

Todd McElhatton (CFO)

Hey, the other thing I would just add to that, Jacob, is, if I take a look at, you know, nice sequential growth and what the partner pipeline is looking like, and in fact, you know, this was the highest quarter of generating pipeline, I think, in four or five quarters for that part. We're really happy about how that's progressing with some of the changes that we made at the beginning of the year.

Jacob Stephan (Senior Research Analyst)

Okay, great. Then just last one here. I know you broke out kind of, you know, ACV cohort has, you know, grown in both the 250 and over 500, but I'm just wondering about maybe the by year, so 2021 and 2022 cohorts, if maybe you could kind of give us some color on, you know, how they've grown over the last, year or two here.

Todd McElhatton (CFO)

That's not something that we got right in front of us now. It might be something that we can look at and talk about that in a future call, so I'll, I'll keep that in mind, Jacob.

Jacob Stephan (Senior Research Analyst)

Okay, understood. Best of luck going forward here, guys.

Todd McElhatton (CFO)

All right. Thanks, Jacob.

Robbie Traube (President and CRO)

Thank you.

Operator (participant)

Your next question comes from the line of Brent Thill of Jefferies. Your line is open.

Luv Sodha (SVP)

Hi, team. Hi, Todd. Hi, Robbie. This is Luv Sodha on for Brent Thill. Thank you for taking my questions. Todd, maybe one for you to start out with. Just wanted to ask about the net new ARR, looked like that was around $10 million, maybe down 9% year-over-year. Was, you know, was that in line with your internal plans, or how did that compare to your internal plans?

Todd McElhatton (CFO)

Hey, Luv. Thanks a lot for the question. You know, at the end of last quarter, we talked about it. I think we added about $8, $8, $8, $9 million worth. You know, I said I thought it'd be flat. We actually accelerated some, so I was very pleased that we did have that acceleration. Again, you know, we would expect that to accelerate in the second half of the year. The other thing is when I provide the guidance for the full year, take a look at, you know, what do we have weighted in the, in the second half. As you know, you know, not only Zuora, but most SaaS companies have much higher weighting in the second half.

When I take a look at the guidance and what we've done historically, what we've got in that guide is less than what we've done historically, weighted on the back end. Again, you know, if I take a look at what we're seeing in the pipeline, what we're seeing in close rates, what we've done historically, we feel comfortable that, you know, we'll see that acceleration continue into the second half.

Luv Sodha (SVP)

Got it. I guess just reconciling that with the comment around you factoring in similar buying patterns into the back half guide, are you, you know, expecting some acceleration in net new ARR in the back half? Is that fair?

Todd McElhatton (CFO)

That is correct. Like I said, a couple things to keep in mind. One is you certainly had a tough compare in Q2 of last year, so the second half of the year will be a much easier compare for us. Again, just as the, as the cadence of our business works, you certainly expect to see an acceleration in the second half. As we start the year off, kick off new territories, people build their pipeline, develop that, you start seeing that close in the second and the third quarter, or the third and fourth quarters. Obviously, the fourth quarter is always our largest quarter as a company, not atypical from any other SaaS company.

Luv Sodha (SVP)

Got it. One quick follow-up on the, you know, obviously, I appreciate the commentary around landing smaller and faster. I guess, how, how does that impact the upsell opportunity, you know, over the longer term and, you know, maybe over the near term, how, how do you offset the smaller lands against the NRR headwinds that you were seeing? Thank you.

Tien Tzuo (Founder and CEO)

Okay, Luv, this is Tien here. I mean, that's a great question. The question is, look, if you're doing smaller lands, what are the implications of that? It's one of the reasons we highlighted. Look, we're still signing up the same target customer, where we believe the customer lifetime value is the same. When we are doing a smaller, faster land, our goal is ultimately, once we get them live, in that we can continue to grow with them. That is the mindset I would have you approach, how we're thinking about the business.

Robbie Traube (President and CRO)

Yeah. Luv, just to reiterate that, it's an opportunity for us to then expand, and that's the relationship we have with our customers and the ability for us to do that and grow that as we go forward. I strongly feel it's a great, great approach for us, and we're seeing those results from that.

Luv Sodha (SVP)

Got it. Appreciate it.

Todd McElhatton (CFO)

You know, one last. Again, well, I think the one thing that, you know, we've seen is it's not the size of the initial land, it's who have you targeted, and what is the opportunity within their, in their business? That's what we're being super disciplined about, is picking those right customers that have the opportunity to build. Maybe that's the automobile manufacturer that is at the very beginning of their journey, starting to monetize these new services. Maybe that's a new company in the tech field that's growing, or maybe that's someone in the media business that's moving from an advertising to a subscriber model. Those all provide us huge opportunities, not only through the billing and the additional products we can add there, but putting the full suite of products on.

The other thing that's been a, a really good help on us, too, is Zephr. The lands at Zephr tend to be a little bit lighter. One of the things that you saw this quarter was, you know, two of the biggest deals that we had, including one of the deals over $1 million, was the Zephr plus Zuora. The Atlantic was another, you know, very nice, meaty deal for us that we highlighted, and again, that was Zephr plus Zuora. We've got a lot of opportunities as we can land, you know, at a size, maybe not as large as some of the things we've done in the past, but those have nice growth opportunities in front of them.

Luv Sodha (SVP)

Got it. Super helpful. Thanks, Todd.

Operator (participant)

Your next question comes from the line of Joseph Vafi of Canaccord Genuity. Your line is open.

Joseph Vafi (Managing Director and Equity Research)

Hey, gang- hey, guys, good afternoon, and Luana, if you're listening in, congratulations on your second son.

Tien Tzuo (Founder and CEO)

Oh, she's listening. I'm getting texts already.

Joseph Vafi (Managing Director and Equity Research)

A lot of questions have been answered and asked already, but maybe we just... I know you don't break out Zephr all that much, you know, in kind of terms of its profitability profile and maybe some of the other metrics, but it does seem like business is doing well, you know, moving outside of the media vertical. You know, if there's any color, at least qualitatively, you can add on kind of its profile versus perhaps some of, you know, the core Zephr products, and how we should think about it, you know, relative to, you know, any mixed contribution it might provide over time.

Tien Tzuo (Founder and CEO)

Yeah, we don't really break it out. I would tell you that, you know, the Zephr team is only halfway through the year, right? They're above their plan for so far year to date. There's nothing special about them that would change their gross margin profile.

Todd McElhatton (CFO)

The other thing I guess I would note, Joe, too, is one of the things, you know, we're seeing Zuora plus Zephr is an accelerator for us, especially in that media vertical. Then the second point of that would be is that technology is now extensible elsewhere in the Zuora portfolio. You saw that within the upsell of 24 Hour Fitness. We've got other companies that we're talking with that are outside of the media vertical. Again, we feel really good about that, but Zephr now is fully integrated into Zuora, so, you know, we don't necessarily track the financials of business. As you know, we were very disciplined when we put that in. We made room in our investment portfolio. It wasn't incremental. You know, last year, as we took on that investment, we saw that profit continued to improve.

Joseph Vafi (Managing Director and Equity Research)

Sure. I mean, it does seem like, you know, a few quarters later, a year later, it was a thoughtful ad, so congrats on that. Maybe secondly, I know, you know, you were kind of proactive with the cost structure here as the macro was slowing down, and, you know, obviously, we're seeing some of the benefits there with, you know, some really solid profitability and free cash flow. Just, you know, in case we get into, like, this situation of a high-class problem and, you know, the macro gets better, just kind of wondering how, you know, you may tweak your go-to market from here versus, you know, what, you know, what might be a stronger macro and what, you know, we might expect, you know...

Would we expect, I know you're not providing guidance, but would we expect to see like a, you know, a flattening margin profile for a while or, you know, something like that? Or just some thoughts on your strategy around go-to market if, you know, if and when we get to a better macro. Thanks.

Todd McElhatton (CFO)

I guess I'll answer that in, in two ways, Joe. I think the first thing is, we are absolutely committed, you know, regardless of what the macro looks like, to expanding our margins. Now, if we started to see there was an opportunity to make investments and accelerate that, we would certainly be able to do that. The way Robbie's got the team structured, we have the leverage to be able to add additional selling resources on and get good leverage from that. You know, what you might see is the margins aren't growing as fast, but they're gonna continue to grow.

Joseph Vafi (Managing Director and Equity Research)

Got it. Thanks very much, guys. Nice to see the great results.

Todd McElhatton (CFO)

Thanks, Joe.

Tien Tzuo (Founder and CEO)

Thanks, Joe.

Operator (participant)

There are no further questions at this time. I will now turn the call back to Tien for any closing remarks.

Tien Tzuo (Founder and CEO)

Thanks, everyone, for joining us today. Congratulations to the entire organization for another solid quarter. We obviously remain committed to our strategy, and most importantly, we are looking forward to sharing additional product innovations with you all and, and, and talking to you on these calls in outside in, in the rest half of the year. Thanks a lot.

Operator (participant)

This concludes today's conference call. You may now disconnect.