Zuora, Inc.
Q3 2021 Earnings Call Transcript

Published: 3 Dec 2020

[Operator:]

Good afternoon. And welcome to Zuora's Third Quarter Fiscal 2021 Earnings Conference Call. Joining us today for today's call are Zuora's Founder and CEO, Tien Tzuo, and CFO, Todd McElhatton. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. . 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 third quarter fiscal 2021 earnings conference call. Joining me today are Tien Tzuo, Zuora's Founder and Chief Executive Officer, and Todd McElhatton, Zuora's Chief Financial Officer. The purpose of today's call is to review our third quarter results, as well as provide our financial outlook for the upcoming quarter.

[Tien Tzuo:]

Thanks, Carolyn. And thank you everyone for joining us today on Zuora's third quarter earnings call for fiscal 2021. I'm very pleased with our third quarter results. Let's walk through a few key highlights from the quarter. We exceeded expectations across our key financial metrics, including total revenue, subscription revenue, gross margin, operating income and free cash flow. And this is even after backing out the impact of a one-time benefit that Todd will discuss later. In fact, we reached a milestone of free cash flow breakeven one quarter ahead of plan. We added 25 new customers in Q3, including the largest deal in the company's history. We closed six deals with over $500,000 in annual contract value. We had over 100 upsells, showing a strong continued potential of our land and expand go-to-market motion. We got 41 customers to go live. Over one-third of the go-lives involved a systems integration partner, showing strong progress in our alliances strategy. Finally, we had strong adoption of our most recent products. More than two-thirds of our customers are already using our platform capabilities like workflow, custom objects and increased agility, and over a quarter of our customers are now using our analytics tool, which we just launched last quarter. These results show that we are making good progress of the things that we outlined in previous quarters. First, in previous quarters, we've talked about how we believe that our market opportunity resonates with bigger companies as changing customer preferences force big brands to rethink how they innovate and turn their customers into subscribers.

[Todd McElhatton:]

Thanks, Tien. And thanks everyone for joining the call today. Our third quarter performance exceeded expectations across our key financial metrics. I'm particularly pleased with our ability to show additional leverage in our operating model. We posted breakeven free cash flow one quarter ahead of plan. As we look ahead, we plan to drive additional margin improvements and build a more efficient company. Let me review our operating margins. Q3 was highlighted by good traction in the larger enterprise segment as Tien noted earlier. Looking at customers over $100,000 and higher in ACV, we ended with 653 customers, reflecting an 11% year-over-year growth. This customer group continues to represent 90% of our business.

[Operator:]

. And your first question comes from the line of Chris Merwin from Goldman Sachs.

[Christopher Merwin:]

I wanted to ask about the large deal in the quarter. I think you mentioned it was the largest you ever signed. Could you share a bit more about maybe what industry the customer was in, what was included in that deal? Was it just the core billing product or was there platform in there as well, maybe other things? I'd love just to hear a bit more about that deal. Thanks.

[Tien Tzuo:]

It was one of the top three electronic retailers. And it's a big, big strategic bet. Obviously, with what's going on in the retail industry, certainly, we see the shift from retail stores to e-commerce going on right now. But I think the story is much more deeper than that. The retailers are realizing that waiting for the customers to purchase something or to come to the website or to go to the store is not sufficient. They've got to deepen their relationships. They're going to have a lot more constant interactions with their customers. They've got these fantastic brands. But how do they translate those brands into a deep customer relationship? In other words, turn the customers into subscribers. The deal was for the billing product, but think of it as a broader subscription management system. And it was for the platform. As we get into the implementation, as we continue to create customer success, we will have other opportunities to upsell the customers as well.

[Christopher Merwin:]

Maybe just a follow-up. I think you also mentioned in the prepared remarks that two-thirds of your customers are using platform and I think a quarter of customers are using analytics. Obviously, very strong attach rates for both of those products. Can you talk a bit more about how you're charging for both of those and how we should think about improving attach of platform and analytics, benefiting net retention going forward?

[Tien Tzuo:]

You can see the key part of our strategy and our ability to drive net dollar retention up over time is we have a very sticky product. We've got a great customer base. You've seen us skew towards larger companies that are going to have longevity. And so, the ability for us to go back and sell a broader suite of products after the initial sales is really important. So, the adoption of what we have, we're feeling really, really good about. The products are priced in different ways. It really depends, but they're primarily based on the functionality of the system. And we're not at this point yet where we're ready to sort of break out our revenue by these different product lines. I think I'd like to see everything be a little bit more mature before we do that. But it's very promising that we're able to bring these new products to market as well.

[Todd McElhatton:]

This is Todd. Maybe a little bit more color too. As customers are utilizing the platform, we'll have the ability to upgrade. And as you're aware, we've got three different editions in the platform. We have Growth, we have Enterprise, we have Nine. And so, this will certainly give customers a reason to upgrade as they have more use of the platform and get more use out of the functionality.

[Operator:]

Next question comes from the line of Stan Zlotsky from Morgan Stanley.

[Calvin Chu:]

Hi, everyone. This is Calvin Chu on for Stan. I just have two questions for you guys. The first one is, what are you seeing out of the partner ecosystem? I know you mentioned it. And it sounds great. And I just wanted to know, in terms of both as a go-to-market motion and how partners are continuing to build out practices around you, could you comment a little bit more on where you see that going and trending over the next few quarters?

[Tien Tzuo:]

We feel really good. If you look at the statistics, we've mentioned one-third of our customers that went live this past quarter, there was an SI involved in that implementation. I think that's the reality that we're going to, right? I know you phrased it as these SIs are building practices around Zuora. What these Sis are really doing is they're building practices around digital transformation. And they're realizing that this next phase of digital transformation is not just playing around with digital technologies, but actually turning them into revenue, right? Turning to real revenue. And by and large, these tend to be subscription based or recurring revenues. They are customer-centric revenues. And when you look at what's happening with the physical product space, manufacturing, they're all launching products, they are connected to the Internet. And these companies are excited about the vast new revenue streams that are available to them. And so, the Sis are really a big, big part of that. And so, what we're seeing is, as they're trying to build out their digital transformation or grow their digital transformation practices, we are a key part of that because it's all about monetizing your customer relationship, monetizing your digital initiatives. Our platform is really the best platform to do so. It's the only platform that gives you the insights, the agility, the automation of subscription economy.

[Calvin Chu:]

On to my second question. Could you comment a bit on sales productivity within the quarter? I know you mentioned that churn has returned to normal levels. And where do you see that going over the next few quarters, especially with COVID and with the overall macro environment?

[Todd McElhatton:]

Calvin, we would look to stay at the historical levels that we've had. So, we feel like we'll be in the same range where we've been prior. The other thing that I guess I would say is, from a sales productivity, we continue to see improvements in the productivity that we've seen from the sales force. And we're really pleased with changes that have happened there and where we expect it to be.

[Operator:]

And your next question comes from the line of Brent Thill from Jefferies.

[Luv Sodha:]

This is Luv Sodha on for Brent Thill. Congrats on a nice quarter. It's good to see some improvement. I wanted to ask a question on the go-to-market motion and the pipelines, if you will. It sounds like you guys are having increased enterprise traction. And one of the themes that we've seen in our partner checks is that the front office was sort of the focus in 2020. But in 2021, the focus is going to be back offices digital transformation. And so, maybe as you look to the next year, what are you seeing up there in the pipelines? Is there sort of like a pent-up demand that we could see come back next year?

[Tien Tzuo:]

Yeah. I would say, the definition of the words, front office and back office, that might be a little bit dated, right? And that division made a lot of sense when you were shipping product. The front office sold the product, the back office fulfilled, it accounted for it, collected for it. And it's a very product centric view of the world. And if you look at the companies that are subscription businesses, they've always been subscription businesses. For example, the telecom companies. They don't look at it like that. They start with the customer and they build great subscriber experiences for those customers. And those subscribers’ experiences have to span the front office and they have to span the back office, right, whether it's calling the call center or changing your credit card on your billing account or spinning up some more service on a Sunday night without having to talk to a salesperson, those are the things that are the most important. And what companies are realizing is, if they're going to win in the future – just think about your own life right now, sitting at home, picking up your phone, and then food shows up. You get work done. Entertainment shows up. Those are the subscription experiences you will demand going forward. Companies realize that and they realize that that, in order to do so, they have to put in a customer-centric subscription management platform. And so, what we're seeing on a broader sense is the COVID shelter in place situation, it’s only accelerating companies' efforts to say we have to go build customer-centric subscription business model. That's really the business model of the future.

[Luv Sodha:]

And maybe one additional one on the go-to-market changes. It sounds like you're having some traction with that. I guess, in terms of the competitors, you're seeing as we go more up market, are you mainly replacing Excel systems or is it more legacy competitors who weren't meeting the needs? Thank you.

[Tien Tzuo:]

We replaced homegrown billing systems, we replaced Excel spreadsheets. A lot of times we're doing launches where it's a greenfield opportunity. It's the first time they're actually launching a subscription business. So, it's a brand new application. In those situations, we have to get customers up and running in 90 days or less. And I would say, though, that as we go up market, as subscriptions are becoming more mainstream, one of the things that you're going to see us focus more on – this is where the platform is really, really important is, how do I integrate this thing within my existing enterprise application backbone, right? It's okay to launch something on the side, but when the subscription starts becoming 5%, 10%, 20%, 30% of my revenues, then integrating into my existing enterprise software backbone is really, really important. And we're doing a lot of those types of work with the big companies.

[Operator:]

And your next question comes from the line of Joseph Vafi from Canaccord.

[Joseph Vafi:]

Nice to see the good results here. Tien, it seems like we heard a lot more about platform this quarter than the last couple. I'm just kind of wondering, number one, if you kind of see this quarter as a little bit of a breakout on that product? And then secondly, it'd be interesting to get a little bit of a metric on where platform was last quarter in terms of customer usage? And then maybe a follow-up after that.

[Tien Tzuo:]

I think about the platform all the time. And a gradual evolution of the software companies, especially something we do which is a mission critical system, the platform strategies become really important. These large companies, this last mile customization, a lot of times, that's where their secret sauce lies. And so, the ability for them to customize the system to meet their exact needs is really, really important. And our platform continues to advance. And every quarter, there's new capabilities, right? Most recently, we talked about launching custom objects, custom query capability. We've got other things that are – we're cooking in the labs, if you will. And those tools continue to evolve to help companies do some pretty amazing things. And so, I'm trying to remember what we said last quarter in terms of adoption, but it was it was south of the 230 number we said today. And so, our expectation really is that every one of our companies will ultimately use the platform because they all have specific needs that they want to do that the platform really enables.

[Joseph Vafi:]

And then, Todd, maybe on net retention, I know it's a trailing 12-month metric. But I think in Tien's prepared remarks, said you had 100 upsells in the quarter. And is there any way to look at net dollar retention or kind of a view of it or an opinion on it kind of on a run rate basis or kind of excluding a little bit of the kind of one-timers in Q2 just to kind of get a feel for the cadence of the business on that metric at least right now?

[Todd McElhatton:]

I think I would look at net retention, as you said, trailing metric, we feel really good about the upsells we had. But I think more importantly, if you look at the actual dollar turn, that decreased 55% from Q2. We said we thought Q2 would be our toughest. And that definitely turned out to be the case. But more importantly, when we look at the retention, we actually improved year-over-year. So, from my perspective, I think that gives the color that we're on the right track with retention. And we'll aim not only to keep the churn down, but continue to move forward on the upsells.

[Joseph Vafi:]

And then just maybe – I'll just sneak one more in. Is it fair to say that with some of these – you're signing bigger and bigger enterprises, is it fair to say that most of them are coming online initially at that kind of $500,000 ACV metric that you call out for the larger deals? Or do they actually start sometimes smaller? Thanks a lot.

[Tien Tzuo:]

It is a range. And it's a little bit part of what we do. We can do anything from a small launch. And so, there's a company that says, I want to get into subscriptions and not really sure how. Look, let's put an idea together, let's launch something. Typically, you find that that you've got pent-up demand in your customer base because of the power of your brand, the power of your customers. And you'd be pleasantly surprised by the success of the launch. All the way to, look, I've already got the subscription business, right, and I've got a $1 billion that I need to move on to your platform. That's going to be the foundation for my growth going forward. And so, you're going to see deal sizes really range quite a bit as a result. And I think that's the power of the pricing capability. And quite frankly, that's the power of subscription businesses, cloud businesses in general, right? The ability to size the usage and the size the consumption to the company wants to start with, but have a path to grow with them over time to be worth seven digits or more.

[Operator:]

It looks like we have time for one more question. And that will be from Scott Berg from Needham.

[Scott Berg:]

Congrats on a good quarter. First of all, Tien, you talked about kind of the recovery of the business. I guess just more zooming out a little bit, if you look at the deals that you signed recently and that are maybe in pipeline over the next couple quarters, is the composition of those deals or those transactions any different than maybe how customers would buy the Zuora Central Platform pre-pandemic?

[Todd McElhatton:]

Scott, as you know, we have been seeing that if we add a little bit more flexibility from a standpoint of being able to start, as Tien said earlier, start with a small launch or do something larger, and I think this quarter, we saw that we certainly had a nice traction with some deals starting larger.

[Scott Berg:]

As a quick follow-up, Todd, you'd mentioned your subscription revenues were 80% of the overall revenue mix for the quarter. 80/20 certainly is a good level and healthier than what we've seen historically out of the company. But with the push to partners, what should that mix be going forward? Is 80/20 kind of the plateau level here? Or do you actually see that mix progressing further?

[Todd McElhatton:]

I don't know that we've given specific guidance on where we see that, but I can certainly see it going lower. I think it's certainly really important for us to have a healthy SI community. As they build practices, we're happy for them to take the SI work on. And also, it gives us an opportunity to continue to build to build the pipeline, which we saw really good traction from this quarter. So, from my perspective, I can certainly see it going longer term below the 20% services.

[Operator:]

So, now, I will turn the call back over to management for any final remarks.

[Tien Tzuo:]

I want to thank everybody for joining us in the Q3 earnings call. And with that, I will close the session. Thank you very much.

[Operator:]

Thank you for joining today's conference call. You may now disconnect your lines.