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..

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..

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..

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..

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

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..

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..

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..

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?.

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..

Okay. Really helpful. Thanks everyone..

Thanks, Adam..

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

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?.

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..

I think [indiscernible] customers, they continue to spend with us. The numbers that we pulled out, I mean, that $250,000 plus cohort, that grew 17% year-on-year, $500,000 group, 24% year-on-year. So we continue to see that because it is mission-critical to what they do..

And that really just speaks to the general agility that we have and how we attack the marketplace..

Got it. That's helpful. And then 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 this fiscal year in your operating expenses? Thanks guys..

So, Josh, we're continuing to be super disciplined on everything that we're spending. One of the things that we said this year was we want to have the ability to either if the market makes sense to go ahead and invest in top line growth, feel good about where we are on top line, we're going to be where we said we'd be at the beginning of the year.

We've not seen a reacceleration in the market. So we're not adding additional capacity in -- so 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 and doing that another area where we're looking at. The same thing with G&A. So it's really across the board where you go.

Obviously, the first area that in our biggest area of spend is to go to market, and we are constantly working to get that more efficient. And then like I said, we'll continue to evaluate and as it makes sense, we'll continue to get leverage out.

But as we continue to grow and more and more of our bookings, as 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. And so as we continue to get larger, that will also give us more leverage in the operating model..

I mean, Josh, just to add one more thing, this is Tien, take this as an opportunity to show off some [indiscernible] stuff. Obviously, at the end of the day, it's about efficiencies, 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, we are using our own products to become more efficient. And we've taken a number of days on our side, down from 13 days to five days close and that's the type of thing that we think we can use our technology for that our customers really can have benefit as well..

Got it. Super helpful. Thanks guys..

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

Great. Thanks for taking my question. So just on kind of the progress you're making on the smaller and faster lands.

Just in terms of magnitude, is there any way to think about kind of where those -- if there's any historical data of 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?.

Chad, I think at a couple of ways. One is, if you take a look, we have landed a bit lower on the ASP over the last couple of quarters from the standpoint of having more deals and those deals are bringing more new logos on and bringing them a bit lower.

They're not like half the size of what we were doing before, but there's still 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 right around [100, 150] (ph). And those are now customers running over $5 million a year in ARR.

So we certainly have shown we picked 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 there are companies that we can grow with over the long term..

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? But if we can start smaller with them and have confidence that we can grow them up to that point, then given the macro situation, given the scrutiny on technology spend, why not get started with them now..

Okay. I appreciate the color. And then maybe just on the dollar-based net retention at 107%. I know you reiterated, I think, the 107% to 109% range. Just in terms of the level of confidence and visibility that 107% is kind of the trough here.

As you look at the pipeline, Tien or Robbie or Todd for that matter, just what gives you confidence that, that 107% holds to potentially improve over the next couple of quarters here, if you think that..

Sure, Chad. I'll maybe take that. So two things that impact the DBRR, the first is our retention rates, and I feel really good about the fact that three of the last five quarters, we've talked about another record from a standpoint of higher retention rates. We had the highest historical retention rates this quarter of all time.

So feel really good about our ability to pick the right customers and keeping them. And a lot of that has 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. And one of the things that we've talked about is there's a volume element of that for us.

And 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, keep in mind, Q2 was a really tough compare for us from last year.

So 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 most recently reduced -- or excuse me, released, I'm confident that the 107% is definitely the bottom end of it, and we'll be in that 107% to 109% range as we exit the year, as we said at the beginning of the year..

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

Thanks, Chad..

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

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. So Tien, you called out Pete Hirsch and the enthusiasm over is hire. I was wondering if you could just talk a little bit about what made him a good fit? And what are some of the priorities that you had or he has coming in to the role..

Yeah. So I think 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. But 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 capabilities is people are incredibly enthusiastic of -- and so we're not looking to make any short-term changes with Pete, brings in really is a deep understanding of financial systems.

He's obviously built a point of view of working with CFOs and Chief Accounting Officers in the past four years where he's been at and obviously one of the big areas that he's really excited about too is going to be not a surprise here, but AI and so there's a lot of conversations 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 using AI quite a bit. We use it in our payments and collection capability to get retry rates, right, payment completion rates from somewhere, call it, 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. But 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 subscriber experiences for our 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 is really driving right now internally..

Great. That's really helpful. Appreciate that. And then, Todd, one for you. With 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? And given that these large professional service partners know your complete portfolio, what does this potentially do in terms of pipeline creation on the back end for you guys with the smaller lands? Thanks..

Hey. Thanks a lot, Rob. So we're absolutely focused on the subscription revenue side of the business. That grew 16% in constant currency this last quarter. You saw the gross margin increased to 81%, and that's where we make our money. And the services at the ancillary business to us, you know that we run that at a breakeven to a slight loss.

And so the design of -- or by design, we said we continue to want to bring down the services mix in our business. And so it 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.

So from my perspective, we're kind of at the range where I think will remain over the next time over the next several quarters and we feel good about that because subscription is being very healthy, provides us a great margin, and that's where we'll get focused on..

And so I mean, if I can as well, again, we want to win the best companies in the world. Right? It's about growing subscription business for that long term.

We are partner first, and that is our strategy, right? So 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.

And I was, 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. So absolutely, we will continue that relationship and that strategy in a partner-first strategy..

Thank you..

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

Thanks for taking my question. Well, I guess, first, congrats, Luana. But second, I just wanted to touch on the releases you made in June. The assumption billing in particular.

I was wondering in terms of the reception you got from customers, have you seen a ramp up of kind of activity there, maybe not necessarily deals to call out, but have you seen kind of incremental interest since that event?.

Absolutely. Look, I mean, you could tell them I was excited about the capabilities when we launched in June. It was something that 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, and these ideas are really incubated out of that.

And on the call, I tried to highlight some of the successes -- and so the consumption billing capabilities already drove -- the deal with probably just shy of seven digits, I think we call it a high six-digit deal and that deal wouldn't have happened without this Zuora consumption capabilities.

I highlighted Zephr right? It's -- when we did the acquisition, obviously, you can see it has a big impact already in our media space with The Atlantic.

But the big, big bet was, can we take it outside of media into all the other industries that we have -- and so announcing a 24-hour fitness and existing customers are saying, look, we like that Zephr Vision.

We want the Zephr vision, we need Zephr vision, and they became the first nonmedia customer of Zephr and that was really, really exciting as well. And again, we're sitting here in August and the subscribed live was in June. And so you're seeing that the impact of these innovations are happening fairly quickly..

Thanks for that. And then, Todd, I had what sort of a two-part question. First, on the -- I know you don't normally call this out, but the billings growth was really strong in Q2. I'm just wondering if there's anything there.

And 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 would see that flattening out if the macro improves? Or if there's some kind of other element that we're not aware of?.

Okay. So -- on the calculated subscription billing, we continue to kind of 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 for quite some time, there's a lot of movement in the calculated billings.

We've got a little bit of FX this quarter that's in it, but renewals -- timely renewals, 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. So really, the ARR is the way to look at it.

And again, if you look at the subscription -- package subscription billing over a longer period of time, what you see is that pretty much tracks where the ARR growth is up 14% this year. So I don't think there's anything that -- to see in that, just it’s ebbs and flows, and that's why we guide to the ARR.

From a standpoint of where we are on the services revenue, I'd go back to what I said is, I think we're around 12%. We'll probably -- we might be a point or two from a mix perspective that might change over the next couple of quarters. It's always going to be an ancillary business. But look, you're always going to have services as part of our revenue.

Our services team have tremendous amount of expertise and knowledge of our customers.

When there is the hardest problem to solve that’s the team that's going to solve it, those are the teams that help train our partners, and there's always customers that are going to look for certain deals to be implemented by Zuora, just that's how some companies want to roll.

Outside of that, though, we're happy, it's our preference to go partner first. And 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 on. I really look at the services.

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

Great. Thanks..

Thanks, Andrew..

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

I'll just add my congrats here on the quarter and congrats to Luana as well. Just two quick ones for me here. Tien, 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?.

Robbie, do you want to answer?.

Yeah. I think in terms of the -- looking at the pipeline, very specifically with our SI partners. And that has continued -- momentum there has just continued.

And 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 package pieces that we go to market together with one of the actual great opportunities that we closed in our Q2 was actually through this with a partner.

So that continues and that pipeline continues..

The other thing I would just add to that, Jacob, is if I take a look at nice sequential growth and what the partner pipeline is looking like, and in fact, this was the highest quarter that of generating pipeline, I think, in four or five quarters for that part.

So we're really happy about how that's progressing with some of the changes that we made at the beginning of the year..

Okay. Great. And then just last one here. I know you broke out kind of ACV cohort has grown in both the 250 and over 500.

But I'm just wondering about maybe by year, so 2021 and 2022 cohort, maybe you could kind of give us some color on how they've grown over the last year or two here?.

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

Okay. Understood. Best of luck going forward..

All right. Thanks, Jacob..

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

Hi, Tien. 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. It looked like that was around $10 million, maybe down 9% year-over-year.

Was that in line with your internal plans? Or how did that compare to your internal plans?.

Hey, Luv. So thanks a lot for the question. At the end of last quarter, we talked about it. I think we added about $8 million, $9 million, worth I said I thought it'd be flat. We actually accelerated some. So I was very pleased that we did have that acceleration. And again, 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 what do we have weighted in the second half. And as you know, not only Zuora, but most SaaS companies have much higher weighting in the second half.

And when I take a look at the guidance and what we've done historically, what we got in that guide is less than what we've done historically weighted on the back end.

So again, 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 we'll see that acceleration continue into the second half..

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

Is that fair?.

That is correct. And like I said, a couple of 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.

But again, just 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 third quarter or the third and fourth quarters.

And obviously, the fourth quarter is always our largest quarter as a company, not atypical from any other SaaS company..

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

Luv, this is Tien here. I mean that's a great question. And so the question is, look, if you're doing smaller lands, what are the implications of that? It's one, the reasons we highlighted, we're still signing up the same target customer where we believe the customer lifetime value is the same.

And so when we are doing a smaller, faster land, our goal is ultimately once we get them live and that we can continue to grow with them. And so that is the mindset that I would have you approach how we're thinking about the business..

Yeah. 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. And I strongly feel it's a great, great approach for us, and we're seeing those results from that..

Got it. Appreciate it..

One last -- and again, well, I think the one thing that 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. And that's what we're being super disciplined about is picking those right customers that have the opportunity to build.

So 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 someone in the media business that's moving from an advertising to a subscriber model.

And those all provide us huge opportunities, not only through the billing and the additional products we can add there. We're putting the full suite of products on. And the other thing that's been a really good help on us, too, is Zephr. And the lands of Zephr tend to be a little bit lighter.

But one of the things that you saw this quarter was, two of the biggest deals that we had, including one of the deals over $1 million was Zephr plus Zuora, and The Atlantic was another very nice media deal for us that we highlighted. And again, that was Zephr plus Zuora.

So we've got a lot of opportunities as we can land 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..

Got it. Super helpful. Thanks, Todd..

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

Hey guys. Good afternoon. And Luana, if you're listening in, congratulations on your second son..

She is listening. I am getting text already..

A lot of questions have been answered and asked already. But maybe just I know you don't break out Zephr all that much in kind of terms of its profitability profile and maybe some of the other metrics. But -- it does seem like the business is doing well, moving outside of the media vertical.

And so if there's any color at least qualitatively, you can add on kind of its profile versus perhaps some of the core Zephr products and how we should think about it relative to any mix contribution it might provide over time..

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

The other thing I guess I would note, Joe, too, is one of the things we're seeing Zuora plus Zephr is an accelerator for us, especially in that media vertical. And 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. So again, we feel really good about that. But Zephr now is fully integrated into Zuora. And so we don't necessarily track the financials of the business. But as you know, we were very disciplined when we put that in.

We made room in our investment portfolio wasn't incremental. And last year, as we took on that investment, we saw that profit continue to improve..

Sure. I mean it does seem like a few quarters later, a year later, it was a thoughtful add, so congrats on that. So -- maybe secondly, I know you were kind of proactive with the cost structure here as the macro was slowing down. And obviously, we're seeing some of the benefits there with some really solid profitability and free cash flow.

Just in case we get into like the situation of a high-class problem and the macro gets better, just kind of wondering how you may tweak your go-to-market from here versus what might be a stronger macro and what we might expect -- would we expect -- I know you're not providing guidance, but would we expect to see like a flattening margin profile for a while or something like that or -- just some thoughts on your strategy around go-to-market if and when we get to a better macro.

Thanks..

So I guess I'll answer that in two ways, Joe. I think the first thing is we are absolutely committed, regardless of what the macro looks like to expanding our margins. Now if you 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. So what you might see is the margins aren't growing as fast, but they're going to continue to grow..

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

Thanks, Joe..

Thanks, Joe..

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

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 talking to you on these calls and outside in the rest half of the year. Thanks a lot..

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