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Zuora's (NYSE:ZUO) Posts Q3 Sales In Line With Estimates But Quarterly Guidance Underwhelms


Full Report / December 06, 2022
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Subscription management platform Zuora (NYSE:ZUO) reported results in line with analyst expectations in Q3 FY2023 quarter, with revenue up 13.2% year on year to $101 million. However, guidance for the next quarter was less impressive, coming in at $100.5 million at the midpoint, being 2.54% below analyst estimates. Zuora made a GAAP loss of $37 million, down on its loss of $22.8 million, in the same quarter last year.

Zuora (ZUO) Q3 FY2023 Highlights:

  • Revenue: $101 million vs analyst estimates of $100.2 million (0.85% beat)
  • EPS (non-GAAP): -$0.02 vs analyst estimates of -$0.06
  • Revenue guidance for Q4 2023 is $100.5 million at the midpoint, below analyst estimates of $103.1 million
  • Free cash flow was negative $7.24 million, compared to negative free cash flow of $7.62 million in previous quarter
  • Net Revenue Retention Rate: 109%, in line with previous quarter
  • Customers: 770 customers paying more than $100,000 annually
  • Gross Margin (GAAP): 60.1%, in line with same quarter last year

Founded in 2007, Zuora (NYSE:ZUO) offers software as a service platform that allows companies to bill and accept payments for recurring subscription products.

For a traditional product-based business, billing is simple, a product is sold and a customer is billed. However, for an enterprise subscription product, it is a lot more complex, as the price is constantly changing in real-time based on the number of seats, features and other factors. Managing that for hundreds of customers can mean a large administrative overhead.

Zuora’s software platform automatically handles all the pricing adjustments in real-time, plugs into the customer’s accounting software and provides them with analytics. The company is focused on serving the enterprise market, offering a complex product that takes a significant amount of time to implement, but once adopted, is difficult to leave.

Consumers want the ability to make payments whenever and wherever they prefer – and to do so without having to worry about fraud or other security threats. However, building payments infrastructure from scratch is extremely resource-intensive for engineering teams. That drives demand for payments platforms that are easy to integrate into consumer applications and websites.

Zuora is competing in this space with products like Stripe or Salesforce Billing (NYSE:CRM).

Sales Growth

As you can see below, Zuora's revenue growth has been mediocre over the last two years, growing from quarterly revenue of $77.2 million in Q3 FY2021, to $101 million.

Zuora Total Revenue

This quarter, Zuora's quarterly revenue was once again up 13.2% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $2.29 million in Q3, compared to $5.57 million in Q2 2023. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Guidance for the next quarter indicates Zuora is expecting revenue to grow 10.8% year on year to $100.5 million, slowing down from the 14.3% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 13.1% over the next twelve months.

Large Customers Growth

You can see below that at the end of the quarter Zuora reported 770 enterprise customers paying more than $100,000 annually, an increase of 25 on last quarter. That is a bit more contract wins than last quarter and quite a bit above what we have typically seen lately, demonstrating that the business itself has good sales momentum. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is working very well.

Zuora customers paying more than $100,000 annually

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

Zuora Net Revenue Retention Rate

Zuora's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 109% in Q3. That means even if they didn't win any new customers, Zuora would have grown its revenue 9% year on year. Despite the recent drop this is still a decent retention rate and it shows us that Zuora's customers stick around and at least some of them get increasing value from its software over time.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Zuora's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 60.1% in Q3.

Zuora Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.60 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has dropped significantly from the previous quarter, which is probably the opposite of what shareholders would like it to do.

Cash Is King

If you have followed StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Zuora burned through $7.24 million in Q3, increasing the cash burn by 337% year on year.

Zuora Free Cash Flow

Zuora has burned through $3.51 million in cash over the last twelve months, resulting in a negative 0.91% free cash flow margin. This below average FCF margin is a result of Zuora's need to invest in the business to continue penetrating its market.

Key Takeaways from Zuora's Q3 Results

With a market capitalization of $953.5 million Zuora is among smaller companies, but its more than $182.2 million in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.

We were very impressed how strongly Zuora accelerated the rate of new contract wins this quarter. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations and revenue growth is slower these days. Overall, this quarter's results were not the best we've seen from Zuora. The company is up 1.11% on the results and currently trades at $7.27 per share.

Is Now The Time?

Zuora may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We cheer for everyone who is making the lives of others easier through technology, but in case of Zuora we will be cheering from the sidelines. Its revenue growth has been weak, but at least that growth rate is expected to increase in the short term. And while its customers spend noticeably more each year, which is great to see, unfortunately gross margins show its business model is much less lucrative than the best software businesses.

Zuora's price to sales ratio based on the next twelve months is 2.9x, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.

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