DocuSign, Inc. (NASDAQ:DOCU) Q3 2024 Earnings Call Transcript

DocuSign, Inc. (NASDAQ:DOCU) Q3 2024 Earnings Call Transcript December 7, 2023

DocuSign, Inc. misses on earnings expectations. Reported EPS is $0.1865 EPS, expectations were $0.61.

Operator: Good afternoon, ladies and gentlemen. Thank you for joining DocuSign’s Third Quarter Fiscal Year ’24 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. As a reminder, this call is being recorded and will be available for replay on the Investor Relations section of the website following the call. [Operator Instructions] I will now pass the call over to Heather Harwood, Head of Investor Relations. Please go ahead.

Heather Harwood: Thank you, operator. Good afternoon and welcome to DocuSign’s Q3 Fiscal Year 2024 Earnings Call. I’m Heather Harwood, DocuSign’s Head of Investor Relations. Joining me on today’s call are DocuSign’s CEO, Allan Thygesen and our CFO, Blake Grayson. The press release announcing our third quarter fiscal year 2024 results was issued earlier today and is posted on our Investor Relations website. Now let me remind everyone that some of our statements on today’s call are forward-looking. We believe our assumptions and expectations related to these forward-looking statements are reasonable, but they are subject to known and unknown risks and uncertainties that may cause our actual results or performance to be materially different.

In particular, our expectations regarding the pace of digital transformation and factors affecting customer demand are based on our best estimates at this time and are therefore subject to change. Please read and consider the risk factors in our filings with the SEC, together with the content of this call. Any forward-looking statements are based on our assumptions and expectations to date, and except as required by law, we assume no obligation to update these statements in light of future events or new information. During this call, we will present GAAP and non-GAAP financial measures. In addition, we provide non-GAAP weighted average share count and information regarding free cash flows and billings. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results.

We encourage you to consider all measures when analyzing our performance. For information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today’s earnings press release which can be found on our website at investor.docusign.com. I’d now like to turn the call over to Allan. Allan?

Allan Thygesen: Thanks, Heather, and good afternoon, everyone. DocuSign’s third quarter operating results reflect progress on our initiatives to expand beyond e-signature into agreement management. And our financial performance underscores our ongoing focus on driving profitability and sustaining healthy free cash flow. As I reflect on our journey over the last 12 months, the three key pillars of our strategic vision remain the same. First, to accelerate innovation towards agreement management, which we believe will further expand market opportunity; second, improving the reach and efficiency of our omnichannel go-to-market efforts; and third, strengthening our financial and operational efficiency. Now before we discuss each pillar in detail, let me first highlight this quarter’s financial results.

Total Q3 revenue came in at $700 million, up 9% versus prior year. We’re particularly pleased with the improvement in our overall profitability this quarter against persistent macro headwinds and delayed at customer caution. Specifically, our Q3 non-GAAP operating margin came in at 27%, a 400 basis point increase versus prior year and non-GAAP operating income grew 27% year-over-year to $187 million. We also generated record free cash flow in Q3 coming in at $240 million, up significantly versus the prior year. We’re focused on strengthening our profitability while making balanced investments in areas with strong long-term growth opportunities. We’re also seeing encouraging signs of business stabilization. With improvement in some metrics, notably customers with annualized contract value greater than $300,000.

Blake will expand on the metrics further in his remarks. With respect to our first pillar, accelerating product innovation. Our focus is twofold. First, we continue to improve our core e-signature product capability. In Q3, DocuSign became the exclusive e-signature provider for Microsoft’s Power Page Integration, making it easy for website makers to incorporate signatures and forms without code, improving the client signing experience and opening the door to building pre and post signature workflows. In November, we also launched a WhatsApp integration for e-signature. In an internal comparative study, we found that agreements delivered via WhatsApp are signed nearly seven times faster than those sent via e-mail. Given the ubiquity of WhatsApp globally, it’s an important update to bring e-signature to markets outside the US.

In addition, IDC recognized DocuSign as a leader in its 2023 e-signature assessment. DocuSign continues to hold the leadership position of IDC for e-signature based on having a complete portfolio of solutions for customers. And we’re seeing existing customers grow and expand their use cases. Hantz Group, which is a Michigan-based wealth management firm is using e-signature to deliver a fully digital experience for its clients through a proprietary mobile app and is expanding their use of DocuSign products with notary, SMS, identity verification and monitoring. Our APIs and strength and compliance made DocuSign the best choice for Hantz and they’ve made DocuSign the standard across their entire organization, which will approximately double their use of our products.

Second, we’re also investing towards broadening our value proposition beyond e-signature and into agreement management. In Q3, we shipped embedded agreements that deliver a seamless signing experience directly on our customers’ websites and applications. In addition, we launched Microsoft Power Automate for the generation of personalized professional-looking documents for signing directly from Microsoft Power Automate flows. We also launched foundational features and functionality that help us expand beyond e-signature into wide-scale agreement management. These features deliver customer delight and remove friction from all aspects of the agreement process. We see the success of CLM as a proof point that there are broader agreement management use cases to address the customers of all sizes.

CLM continues to grow well, particularly with North American enterprise customers. And for the fourth year in a row, our CLM solution was recognized as a leader by Gartner in contract life cycle management. Noting our strong market understanding, product strategy and road map vision, including upcoming Generative AI enhancements. This quarter, we expanded a relationship that began more than five years ago with Veeco USA, who’s the leader in workplace innovation. Veeco began using DocuSign e-signature and has added CLM as part of this transformation into a digital services company. Our AI solution will help Veeco streamline and enhance search and review of executed customer contracts with actionable insights to better serve its customers. Thank you to our partners at Spaulding Ridge, who are helping to strengthen our commitment and partnership with Veeco.

As we look ahead, we envision serving similar customer needs not addressed by CLM via a broader agreement management platform designed for all of our customers in all segments. We are previewing with slide customer now and will have much more to share on our product road map and strategic vision at our Momentum User Conference in April 2024. Across both our e-signature core and future agreement management products, we believe our investment will lead to even further differentiation in a competitive market. We’re encouraged by steady win rates and excited for the impact we can create for customers. This past quarter also demonstrated execution against our second pillar, improved omnichannel go-to-market where we gained traction across our direct sales, digital and partner engagement.

Our international business spans all channels as an important part of our addressable market. It’s really an untapped opportunity for DocuSign expansion. In Q3, our international revenue grew approximately three times faster than our North American business. We also saw traction in the adoption of our Identity education solutions, which meet stringent regulatory standards in the EU and elsewhere. And in Q3, we launched a Japanese localized version of our CLM product. The recently launched WhatsApp integration also highlights our international ambitions. Our digital channel once again grew at a faster rate than our direct business during the quarter, a strong sign that our product-led growth initiative continues to drive new customer acquisition and top of funnel activity.

We continue to optimize our site and remove friction from the try-and-buy journey while creating a more personalized experience with improved localization. We’re seeing particular strength in new customer acquisition in our international markets as well as improved conversion rates in the trial to pay license purchase conversion rates. Our trusted brand and product strength continue to be assets for our direct sales team. Mountain America Credit Union, one of the biggest credit unions in the US has reduced the time it takes to close a credit card application by 30% by integrating DocuSign with its proprietary loan origination system. Mountain America switched to DocuSign from a different electronic signature provider in part because our strong brand reputation inspires confidence from its members, but also because our rich catalog of best-in-class APIs give its developers the flexibility to create solutions that are customized to its exact needs.

That is enabling Mountain America to deliver a seamless, minimal click experience that aligns with the standards as members expect in their financial institutions. An important pillar of our go-to-market plan is strengthening our partner ecosystem. In October, we hosted our first ever partner day. It was fantastic to meet with our system integrators, resellers and software vendors from around the world, sharing our commitment to growing our business together. As an example, the ISV Embed pay-as-you-go initiative we announced in Q2 is accelerating and driving new customer wins. Before I pass it to Blake, I want to address some progress on our third strategic pillar. Our company’s focus on financial and operational efficiency. In the quarter, we delivered record operating margin and free cash flow.

While we continue to invest for long-term growth, we will also continue to be strong financial stewards of the business. We still have a lot of work to do, but I am pleased with our progress over the past 12 months. I am more confident than ever in the value we can create for our customers in our business and the scale and strength of our customer base. We’re in the early stages of our journey to expand beyond e-signature into agreement management. But there is very concrete customer validation of the market opportunity and meaningful progress towards our goals. Thank you to the DocuSign team who’s inspired me with their commitment to this transformation. With that, let me turn it over to Blake.

Blake Grayson: Thanks, Allan, and good afternoon, everyone. As I approach my six-month anniversary at DocuSign, I remain excited about the long-term opportunity and our team’s execution against the three key pillars we’ve outlined previously. Accelerating product innovation, enhancing our omnichannel go-to-market strategy and strengthening our financial and operational efficiency. We delivered solid results in Q3, demonstrating the stability of our business model. In the third quarter, total revenue increased 9% year-over-year to $700 million, and subscription revenue grew 9% year-over-year to $682 million. We continue to drive solid new customer growth during the quarter, despite the challenging macro and software buying environment, which is evidence of DocuSign’s durable value proposition.

In addition, I’m proud of our operational execution highlighted by strong profitability and free cash flow generation. While we have much work still to do, we are making progress. Third quarter billings rose 5% year-over-year to $692 million. As expected, expansion headwinds continued to impact year-over-year billings growth. These dynamics are also visible in our dollar net retention, which was 100% in Q3. Expansion rates continue to be tempered by spending optimization and IT budget scrutiny. We expect dollar net retention to trend downward in Q4. That said, we are encouraged by a few early data points evident in our results this quarter. First, we saw year-over-year consumption stabilization or improvement in a number of verticals, including business services, technology and insurance.

Financial services by contrast, continue to be more impacted. Although real estate also continued to be pressured by the interest rate environment, it improved on a year-over-year basis for the third quarter in a row with significant opportunity for further improvement. We’re increasingly operating in a post-COVID environment and I’m pleased that our weighted average contract duration continues to remain consistent at 18 months. Also, by the end of this fiscal year, we expect only around 10% of our book of business to be from contracts signed during calendar years 2020 and 2021. DocuSign’s value proposition is broad-based, and we benefit long-term by doing business with customers across a diverse set of sectors and segments. Second, we are pleased with the early progress we are seeing from our investments in the omnichannel go-to-market efforts.

Driven by our direct sales efforts, the enterprise segment showed some early potential relative to performance in previous quarters. The number of customers with annualized contract values greater than $300,000 rose slightly to 1,051 from 1,047 in the prior quarter and was approximately flat year-over-year. This increase is an improvement after two quarters of sequential declines. Also, our CLM business grew double digits year-over-year. As enterprise customers continue to optimize their e-signature spend, we are seeing some customers taking advantage of our CLM product. Enterprise customer adoption is encouraging because CLM is the early proving ground for investment in a broader agreement management use case for our entire customer base. In addition, within our omnichannel pillar, international revenue grew 18% year-over-year, reaching 185 million in the third quarter, representing 26% of our total revenue.

This was a slight acceleration in year-over-year growth from the previous quarter. Most international markets remain at an early adoption stage due to regulatory history and cultural habits. At the same time, however, international represents the largest portion of our TAM, and I’m pleased to see continued success of our hybrid go-to-market strategy. Related to the investments we’re making in our PLG and self-serve motions, digital revenue growth outperformed direct. Digital remains the primary source for new customer acquisition, and we added approximately 36,000 new customers in Q3 and bringing the total customer base to 1.47 million, up 11% year-over-year. This includes the addition of approximately 7,000 direct customers bringing the total number of direct customers to 233,000, a 15% year-over-year increase.

Turning to our third strategic pillar. We delivered strong margin expansion and healthy cash flow during Q3, highlighting our focus on operating and financial efficiency. Non-GAAP gross margin for the third quarter was 83% in line with the prior year. Third quarter non-GAAP subscription gross margin was 86% also in line with the prior year. Q3 non-GAAP operating income reached a record $187 million, representing a 27% margin, up nearly 400 basis points from 23% and $147 million in the prior year. During the quarter, we increased focus on investment prioritization, hiring plans and operating expenses. There will be continuing opportunities for greater efficiency even as we invest to drive long-term growth. Q3 non-GAAP EPS was $0.79, a $0.22 per share improvement from $0.57 last year.

We ended Q3 with 6,945 employees compared to 7,522 the year prior and up from 6,748 in Q2. We will remain disciplined with our head count investment. Hiring will continue to focus on opportunities to drive sustainable long-term growth like those in R&D. Operating cash flow for the quarter was $264 million compared with $53 million in the same quarter last year. While an ERP transition impacted last year’s cash flow results, I’m proud of the significant free cash flow we generated this quarter. Third quarter free cash flow was a record $240 million representing a 34% margin compared with $36 million or 6% a year ago. Over the last 12 months, we’ve generated over $750 million in free cash flow, underscoring the strong fundamentals of this business.

With regards to the balance sheet, we exited Q3 with $1.7 billion in cash, cash equivalents and investments. This includes the repayment of $37 million of convertible debt that matured during the quarter. Our balance sheet remains strong, and we have ample liquidity to address the remaining convertible debt of $690 million that matures next month. Turning to our share repurchase program. We redeployed excess capital during the quarter and repurchased 1.8 million shares for approximately $75 million. In addition to our share repurchase program, during the quarter, we used $36 million to pay taxes due on RSU settlements, reducing the diluted impact of our equity programs. We remain committed to opportunistically returning capital to our shareholders.

With that, let me turn to guidance. For the fourth quarter and fiscal year ’24, we expect total revenue of $696 million to $700 million in Q4 or a 6% year-over-year increase at the midpoint and $2.746 billion to $2.750 billion for fiscal ’24 or a 9% year-over-year increase. Of this, we expect subscription revenue of $679 million to $683 million in Q4 or a 6% year-over-year increase at the midpoint and $2.670 billion to $2.674 billion for fiscal ’24 or a 9% year-over-year increase. For billings, we expect $758 million to $768 million in Q4 or a 3% growth rate year-over-year at the midpoint and $2.835 billion to $2.845 billion for fiscal ’24 or growth of 7% year-over-year. We expect non-GAAP gross margin to be 81% to 82% for Q4 and 81.5% to 82.5% for fiscal ’24.

We expect non-GAAP operating margin to reach 22.5% to 23.5% for Q4 and 24% to 25% for fiscal ’24. We expect non-GAAP fully diluted weighted average shares outstanding of $207 million to $212 million for both Q4 and fiscal ’24. In closing, we’re pleased to report a quarter of consistent execution against our three strategic pillars accelerating product innovation, enhancing our omnichannel go-to-market strategy and strengthening our financial and operational efficiency. We have a strong foundation with well over 1 million customer relationships and improving product momentum. We remain focused on creating shareholder value by investing in durable long-term growth, delivering on our profitability goals and generating sustainable free cash flow.

We look forward to keeping you updated on our progress as we focus on helping our customers accelerate their business growth, mitigate risk and enable customer experiences that are easier and more delightful. That concludes our prepared remarks. With that, operator, let’s open up the call for questions.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Jake Roberge with William Blair. Please proceed with your question.

Jake Roberge: Hey, thanks for taking the questions. I understand NRR is a trailing metric and I appreciate the color that Q4 will see another decline. But are we starting to get visibility in the trough for that metric now that you’re putting those headwinds from the multiyear COVID contract behind you and maybe the new product investments start layering in more meaningfully next year?

Blake Grayson: Sure. I’ll take a stab at this and Allan, if you want to jump in, feel free. So just a quick reminder, dollar net retention or DNR is our direct business only in greater than one year. Like you said, the trend downwards in line with our previous communications. And as covered in our prepared remarks, for me, we have — we expect to see continued pressure in Q4. It’s a tough macro environment still where companies continue to scrutinize investments and leading to smaller expansion opportunities for us. It’s a bit of a lagging indicator. So the thing that I’m focused on mostly and the company is focused on is what are the efforts we’re making to stabilize and improve it over the longer term. And so — like you said, things like the intelligent agreement management and the new product innovation, including CLM and pricing and packaging enhancements and stronger PLG motions that we’re working on in self-serve, which can help us improve those win or renewal weights, if you will, over time is what we’re focused on.

And as you heard in the prepared remarks, we are seeing some very early signs of potential, I would call it, cost of optimism, right? Like consumption up across a number of verticals. We saw sticky future adoption improve from last quarter on a year-over-year basis. And that’s the percentage of our direct customers using five or more kind of incremental features that was at 58% in Q3, up from Q2, and it was up about 12 points year-over-year. So they’re just — the early signs of potential optimism, but I think it’s too early for us to put any type of a target or a specific time line out there. But focusing on those product management efforts and those go-to-market efforts, I think, is how we get excited about the future.

Jake Roberge: Okay. Helpful. And then just a follow-up on those products you were talking about. When do you think CLM becomes a more meaningful part of the business where it actually starts impacting expansion rates instead of NRR just being really driven by e-signature consumption. It seems like you’ve been talking about the potential for that product suite for a few years. But what do you need to do to get that product the more main stage with customers?

Allan Thygesen: Yes, I’ll take a crack at that. So first, I’d say that if you look — if you think about our broader vision, CLM is really a leading indicator or early instantiation of our broader vision for intelligent agreement management. It is very heavily focused on the enterprise. And I think we and everyone else providing CLM solutions have been held back by the required significant services and customization investment that the current generation of CLM products mandate. And so our opportunity is to make that significantly more lightweight and delightful, lowering the bar for companies of all sizes really to take advantage of that platform. That is a huge part of our focus right now. We’re in early access on some important pieces of that.

And so over the next few quarters, you will see that going to roll out to a much broader set of customers than CLM and DocuSign or any other vendor can address today. And we think that unlocks opportunity, as I said, everywhere.

Jake Roberge: Helpful. Thanks for taking the questions and well done on the nice execution.

Allan Thygesen: Thank you.

Operator: Thank you. Our next question is from Josh Baer with Morgan Stanley. Please proceed with your question.

Josh Baer: Great. Thanks for the question. Wanted to dig in on margins and the margin outperformance. I was hoping you could provide a little bit more context on the source of upside in the quarter? And then how to think about the trajectory of investments going forward? Like the full year guide was raised. Just wondering if there’s been sort of any changes in the investment philosophy pulling back in any areas or just letting more of the upside flow through to the bottom line? Thanks.

Blake Grayson: Sure. I appreciate the question. So with regards to the outperformance on the operating margin, we made a concerted effort, I would say, starting kind of like late September to inspect and rationalize investments across the business. It’s really just about increasing focus on, what I would call, disciplined spending while we continue to invest in the areas that where we have longer-term growth aspirations. During Q3, we prioritize investments. And so that includes the rate of hiring, the value opportunities for organizational efficiency, but then also overall operating expenses with focus on leveraging existing resources where possible, but still being able to invest for longer-term growth. With regard to your question on the trajectory and the investment philosophy, we’re all big believers here in a balanced outlook, which is we need to be able to invest to get the long-term growth and achieve those aspirations that we have.