DocuSign, Inc. (NASDAQ:DOCU) Q3 2023 Earnings Call Transcript December 8, 2022
DocuSign, Inc. beats earnings expectations. Reported EPS is $0.57, expectations were $0.42.
Operator: Good afternoon, ladies and gentlemen. Thank you for joining DocuSign’s Third Quarter Fiscal Year 2023 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 from the Investor Relations section of the website following the call. 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 the DocuSign Q3 2023 earnings call. I am Heather Harwood, DocuSign’s Head of Investor Relations. Joining me on the call today are DocuSign’s CEO, Allan Thygesen; and our CFO, Cynthia Gaylor. The press release announcing our third quarter 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?
Photo by DocuSign on Unsplash
Allan Thygesen: Thanks, Heather, and good afternoon, everyone. I’m happy to be here for my first earnings call as DocuSign’s CEO. I’d like to begin by thanking Maggie Wilderotter for leading the team as Interim CEO. Maggie set the stage for a smooth and seamless transition, and we’re grateful to her for her leadership and for her continued stewardship as our Board Chair. There are three main points I’d like you to take away from today’s call. First, we delivered solid third quarter results, exceeding the key operating metrics we laid out last quarter despite the continued macro headwinds. Our results are a reflection, I think, of the continued signs of stabilization across the business. I’d like to commend our team for their unwavering commitment despite the considerable distraction.
Second, as the global leader in the eSignature category, DocuSign is expanding across broader agreement related workflows. We have challenges to address, but we have an exceptionally strong foundation and meaningful competitive advantage, which leads me to my third point. I believe our future is bright. Along with the team, I’m personally energized by the opportunity and the work that lies ahead. I’m confident in our progress, and I believe we are unequivocally well-positioned for the long-term. Now before I move on to discuss the future of our business, I want to share what compelled me to join DocuSign. I followed the company for many years, and like our over 1 billion users, I find our value proposition distinctive and invaluable. We’ve built a powerful brand that’s recognized by decision-makers well before we even engage with them.
That combination of affinity that DocuSign has with customers and users, and our untapped market potential is very rare in the enterprise software space. DocuSign created and built the eSignature category, yet agreement process are still at the early stages of moving from pen to paper to more automated ways of working. In fact, I believe we’re just at the beginning of revolutionizing how businesses initiate, negotiate and manage agreements, and we will leave that as we did for e-Signature. We provide solutions for customers of all sizes, industries and functions. During my almost 12 years at Google, I first led the global SMB and mid-market business, and then the enterprise business in the Americas, including managing our relationships with our largest global partners.
I’ve experienced firsthand how exceptionally powerful a broad, diversified customer base can be, and I’m excited to bring that experience to DocuSign. For my first 60 days, I’ve focused on gaining a deeper understanding of our business, meeting with employees across the company as well as spending time with customers and partners. Through these conversations, I’ve started to identify some critical areas in which we can improve to strengthen our value proposition in addition to scaling the business by streamlining and creating efficiencies. I continue to see customers embrace and expand with our core eSignature offering. For example, this past quarter, one of the UK’s largest health care providers expanded their use of e-Signature. They began the journey as a customer during the pandemic, and they’ve now migrated their entire patient onboarding process and adopted our products across their HR, legal, joint ventures and other departments.
Key criteria in the recent competitive selection process, included privacy and security of their customer data, and the ability to utilize the advanced workflow features we offer. Notwithstanding our considerable strengths, I believe it’s important to acknowledge where we have not executed as well. It’s clear we did not pivot quickly enough and we were slow to make changes. As we experienced tremendous growth during the pandemic, we did not scale the team properly. We lost some innovation velocity. We didn’t fully address the changing market dynamics nor mature our operations and systems sufficiently. We understand those gaps, and we’re committed to moving forward with more transparency. I think the good news is that the future is in our own hands.
So let me turn to our focus going forward. We are committed to broadening the category. That starts with a more clearly defined product road map that leverages our core eSignature strength and our ambition of delivering easier, smarter, trusted agreements. We see opportunities beyond the replacement of paper signatures to deliver innovative new experiences and integrate more deeply with partner applications. If you think about it, many use cases don’t require editing or completion of the static, unstructured, highly formatted traditional agreement. Instead, I think data capture for agreements should happen through digital forms on the web or in an app. The agreements themselves should be dynamically generated, and the metadata should be automatically captured to enable personalization for future interactions.
With our new web forms offering, which is currently in early beta, we’re enabling our customers to transition from a PDF-centric experience to guided web-native experiences. We’re also continuing to innovate on the CLM front, further solidifying our vision, customer validation and execution within the CLM space. Most recently, DocuSign was named the leader in the Gartner 2022 Magic Quadrant for CLM for the third consecutive year. We play the highest of all vendors on the ability to execute access and second highest on the completeness of vision access. These products directly support each other. We’re encouraged by how existing eSignature customers continue to embrace our CLM capabilities to enhance and speed their workflows. For example, this past quarter, we expanded our relationship with one of the largest ride-sharing organizations.
Our team identified key areas of expansion using our Signature and CLM product to support their evolving business needs. They expanded their eSignature footprint and are now more streamlined in their internal processes, thanks to our CLM offering. Over the next few quarters, we’ll expand our work here and augment the road map to broaden the power of managing workflows throughout the agreement life cycle. While we’re not seeing dramatic shifts recently in the competitive landscape, it is important to recognize that today’s market is more competitive, particularly for the basic sign use cases, which further highlights the importance of an innovative and differentiated product portfolio like DocuSign’s. I want to touch on our plans to improve operations and sales productivity.
While we are continuing to lead with innovation, we are staying hyper-focused on making the customer experience more seamless and integrated, particularly with our go-to-market motion. I think that starts with bolstering our self-service mill initiatives. I was deeply involved in enabling self-serving for every stage of the order cycle for customers at — of all sizes at Google, and I know the power of a frictionless experience. I’m confident we can achieve both improved customer experiences and greater go-to-market efficiency as we move in this direction. We already have over 1 million customers who self-serve. The inbound traffic to our website continues to grow, and we have a highly recognized and trusted brand. So we have a lot to work with.
We also want to create stronger efficiencies in our direct sales and field efforts and strengthen our partner ecosystem. So I’m pleased that sales attrition is continuing to moderate, and we’re seeing stabilization in the field. Moving forward, we’re focused on improving funnel conversion, consolidating and streamlining our teams, strengthening our focus on customer success and retention and implementing new incentive structures, all with the goal of driving efficiency and accountability. We’re also leaning in on simplifying our pricing and packaging strategy, recently began rolling out new product bundles to enable customers to more easily access useful and differentiated productivity features, which in turn further the customer ROI and improve retention and being the customer a richer experience.
We know that customers who use more than three features are more likely to expand their footprint with us, and that will be critical for more profitable growth at scale. We already have an industry-leading partner ecosystem. This represents a significant opportunity to expand customer value and distribution reach through our network of ISVs, resellers, system integrators and developers. By reimagining how we engage that ecosystem, we expect to create a platform that will see stronger revenue contribution from our partners and help unlock and fuel international expansion opportunities in particular. I personally visited customers and teams in four of our key European markets last week, which reaffirmed that one of our most significant growth opportunities, will come from international markets.
During the trip, I had the pleasure to meet with one of the world’s leading communications carriers. They’ve been a customer for seven years now. Our account team identified key areas to drive growth with expanded use cases, which accelerated adoption, which in turn led to an early renewal expansion. So we’re excited to grow our footprint in their ecosystem as they continue to leverage our products to digitize their customer experience and reduce operating expenses while helping to create a more sustainable future. Lastly, internally, our operational focus has been on streamlining our processes, upgrading our internal systems and modernizing more of our own workflows to improve efficiency and scalability. As an example, we just closed our first quarter on our new ERP system, which has been a key dependency for automating more of our operations.
In summary, I believe we’re acting with urgency to recalibrate the business and leverage our strong foundation to adapt to the evolving business landscape and the changing and challenging macro environment. These efforts will take time, and they represent a continued evolution for DocuSign. However, I am fully confident that the opportunity is here for DocuSign and is within our reach with a clear strategy, focus and execution. Thank you for your time today. I’m thrilled to be leading DocuSign, and I’m committed to being transparent with all of you about our progress as we move forward. Now, I’ll hand it over to Cynthia, who will take you through our Q3 financial results and outlook. Cynthia?
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Cynthia Gaylor: Excellent. Thanks, Allan, and good afternoon, everyone. We delivered solid Q3 results, delivering on the top and bottom line. We continue to expand our customer base and remain focused on progress against our key priorities as we execute against our long-term strategy. As the macro becomes more challenging, we are seeing softening demand trends materialize, including smaller deal sizes and expansion, with increased customer scrutiny on priorities and budgets in some cases. On the other hand, we are still seeing healthy results as customers recognize DocuSign offers high-ROI applications that are easy to use, efficient and cost-effective. Let me now review our Q3 results. Total revenue increased 18% year-over-year to $645 million, and subscription revenue grew 18% year-over-year to $624 million.
The continued strengthening of the US dollar resulted in a couple-point headwind to total revenue growth in the quarter, in line with our previous expectations. The impact was not material to our results. Our international revenue grew 23% year-over-year to reach $157 million in the third quarter, representing 24% of our total revenue. Third quarter billings grew 17% year-over-year to $659 million as our installed base continued to expand. The strength in billings growth was partially driven by early renewals, particularly renewals from Q4. As a reminder, quarter-to-quarter billings can fluctuate due to the timing and completion of deals, including timing of renewals and expansions. Customer growth remained strong as we added approximately 42,000 new customers during the quarter, bringing our total installed base to 1.32 million customers worldwide at the end of Q3, a 19% increase compared to a year ago.
This includes the addition of approximately 10,000 direct customers to reach a total direct customer base of $202,000, a 26% increase over last year. We also saw a 34% year-over-year increase in customers with an annualized contract value greater than $300,000, reaching a total of 1,052 customers. These results demonstrate progress against our key initiatives. However, we continue to see the effects of a more challenging macro environment. Real estate and financial service verticals continue to see headwind. So even within these sectors, we see pockets of expansion with customers for specific use cases. Expansion use cases underscore our product differentiation and value for our customers as we continue to invest in innovation around broader agreement workflows.
As it relates to verticals, we are also encouraged by relative strength in our manufacturing, retail, business services and technology sectors, highlighting the important benefit of our diversified customer base. And while the global slowdown presented challenges more generally, we saw varying degrees of strength and weakness across all regions and segments. Dollar net retention was 108% for the quarter. We continue to see more muted buying patterns and slower expansion rates from customers in the current climate. We expect buying patterns to remain cautious in the near-term, resulting in dollar net retention continuing to trend downward for the remainder of the year. Total non-GAAP gross margin for the quarter was 83% compared to 82% last year.
Q3 non-GAAP operating profit reached $147 million compared with $122 million last year. Non-GAAP operating margin was 23% from 22% last year. Non-GAAP net income for Q3 was $118 million compared with $121 million in the third quarter of last year. As noted on our Q1 call this year, we introduced a non-GAAP tax rate within our non-GAAP net income calculation as we reached consistent non-GAAP profits for the prior three years. We’re using a non-GAAP tax rate of 20% for fiscal 2023. Q3 non-GAAP EPS was $0.57. In September, we announced a restructuring plan, which included a workforce reduction in response to the changing environment. This was not an easy decision, but was an important step for the health of the business. Our GAAP results include $28 million in Q3 restructuring-related expenses as we take a long-term view of the opportunity ahead, we will evaluate the best ways to reinvest capital into areas that accelerate initiatives and present the strongest return.
We are committed to making progress in a sustainable way towards our long-term target margin. We ended Q3 with 7,522 employees compared to 7,056 last year. The restructuring process is well underway, and we expect to be substantially completed by the end of the fiscal year. The workforce reductions, coupled with more disciplined spending and cost containment throughout the company, drove strong Q3 non-GAAP operating margin. While we are pleased with the Q3 margin, we delayed some spend in the quarter, and we’ll continue to evaluate the most critical areas for investment. Operating cash flow in the third quarter was $53 million, representing an 8% margin. Free cash flow was $36 million or a 6% margin. As we mentioned on our Q2 earnings call, during the third quarter, we implemented a new ERP, a foundational system for our company.
The go-live was successful, with smooth implementation and no material disruptions to our core processes. As noted on our last call, the timing of cash collections and payments were impacted by the ERP transition as we anticipated, and some were pushed from Q3 to Q4. We also incurred one-time cash expenses in Q3 related to the restructuring. On a more normalized basis, excluding the impact from the restructuring and our ERP implementation, our operating cash flow margin would have been approximately 14%, and our free cash flow margin would have been approximately 12%. This compares with operating cash flow of $105 million or a 19% margin and free cash flow of $90 million or 17% margin for the same period last year. We expect lower restructuring cash payments to benefit fourth quarter cash flows relative to Q3.
We exited Q3 with more than $1.1 billion in cash, cash equivalents, restricted cash and investments. Turning to our share repurchase program, we repurchased approximately 740,000 shares during the quarter for approximately $38 million, which demonstrates our confidence in the durability of our business and in the opportunities ahead. As of the end of Q3, we had approximately $137 million in remaining buyback capacity. We remain committed to opportunistically return capital to our shareholders. With that, let me turn to our Q4 and fiscal ’23 guidance. For the fourth quarter and fiscal year ’23, we anticipate total revenue of $637 million to $641 million in Q4 or a growth of 10% year-over-year and $2.493 billion to $2.497 billion for fiscal ’23 or growth of 18% to 19% year-over-year.
Of this, we expect subscription revenue of $624 million to $628 million in Q4 or growth of 11% year-over-year and $2.423 billion to $2.427 billion for fiscal ’23 or growth of 19% year-over-year. For billings, we expect $705 million to $715 million in Q4 or growth of 5% to 7% year-over-year and $2.626 billion to $2.636 billion for fiscal ’23 or growth of 11% to 12% year-over-year. We expect non-GAAP gross margin to be 82% to 83% for Q4 and 81% to 82% for fiscal ’23. We expect non-GAAP operating margin to reach 20% to 22% for Q4 and 18% to 20% for fiscal ’23. We expect to see a de minimis amount of interest and other income. We expect non-GAAP fully diluted weighted average shares outstanding of 205 million to 210 million for both Q4 and fiscal ’23.
Looking ahead, we are in the early stages of planning for next year and focused on executing across our critical priorities to finish the year strong. While we will not be formally providing guidance for next year, we would like to share a preliminary outlook for fiscal ’24 informed by what we are seeing across the business and in the broader macro environment. We currently expect a slower start to the fiscal year. For total revenue, we would expect high single-digit growth during fiscal ’24. For billings, we would expect low single-digit growth for next year. We’re committed to maintaining our disciplined approach to expenses, carefully addressing and prioritizing strategic investments that will drive our sustainable growth at scale. As a result, we expect to operate at the lower end of our long-term target operating margin range of 20% to 25% in fiscal ’24.
In closing, we delivered a solid Q3 despite a challenging operating environment. To drive growth, we’ll continue to invest thoughtfully and closely monitor the returns on our investments, pivot as needed and evaluate opportunities to drive growth, efficiency and profitability at scale. Our Q3 results are a meaningful indicator of the strength of our business and the customer value proposition we deliver, that allows us to delight our customers in a meaningful way. We are thrilled to welcome Allan to DocuSign and want to take a moment to also thank our team for their exceptional work and focus during this time of transition. While we know it will take time for our progress to be fully reflected in our financial results, we are committed to advancing the business and executing against our long-term strategy, while delivering sustainable growth at scale.
We look forward to updating you on our progress. Thank you again for joining us. And with that, operator, let’s please now open up the call for questions.
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