Another look at ZUO

Hi all:

I wrote this for the TMF ZUO board. Thought I’d post it over here too, to add to the recent discussions on this board about ZUO.

ZUO Fools:

This is a deep dive into Zuora (ZUO). It will be lengthy, but the purpose is to document the first 3 quarters of Zuora’s existence as a public company. I am putting this on the board here, so that when they report the coming quarter (reportedly on March 7, 2019), those of us following the company will have some context into which we can view and understand their results. I am also hoping to spark discussion on this board about the merits (or not) of the company as an investment. I’ll start with some basic background on the company and then take a look at qualitative and financial results for the company’s 1st, 2nd and 3rd Quarters of its Fiscal Year 2019.

Zuora’s Beginnings (source: Wikipedia & ZUO Website):

K.V. Rao and Cheng Zou (who were previously engineers at WebEx) and Tien Tzuo (an early executive at Salesforce) founded Zuora in 2007. Reportedly, the name of the company derives from a combination of their three surnames.

On March 16, 2018, the company filed for an initial public offering. On April 12, 2018, Zuora listed in NYSE under the ticker symbol ZUO. The company raising a total of $162.2 million in net proceeds,and entered the market as a public company at a $1.4 billion valuation. The stock opened at $20 a share, above its initial pricing of $14 a share, and held those gains throughout the first day.

Zuora hosts a conference series called “Subscribed,” covering topics related to the subscription economy and taking place in various cities each year. You can view the highlights of their 2018 Subscribed Conference in San Francisco here:

The mission of Zuora is “to create cloud-based software on a subscription basis that enables any company in any industry to successfully launch, manage and transform into a subscription business.”

During the Q3FY19 Conference call (pg. 4), ZUO CFO Tyler Sloat stated: Zuora’s core strategy is to identify industries that are in the early stages of transitioning to a subscription business model, lock in that industry and as their subscription revenues grow we get to grow with them–and others in the industry that follow suit…this is in line with our intent of delivering consistent 25%-30% growth over a very long period of time."

You can learn more about the products and services provided by Zuora here:

Now lets look at some of the key financial metrics that ZUO reported in Q1, Q2 & Q3, their first three quarters as a public company (these are the metrics I will use in future reports as well):

Dollar Based Net Retention

Q1     Q2       Q3  
112%   112%     115%

Customers spending over $100K annual contract volume (ACV)

Q1      Q2      Q3
441     474     504

*If you are new to this metric, here is a good article to help you understand why this metric is key to understanding the financials of a SaaS company:…

Q1      Q2      Q3
36.1    41.47   44.5
*Professional Services*
Q1      Q2      Q3
15.6    16.28   17.15

**Total Revenue**
Q1      Q2      Q3
51.74   57.75   61.64

**Cost of Revenue**
Q1      Q2      Q3
9.86    10.42   10.99
*Professional Service*
Q1      Q2      Q3
16.15*  18.23*  19.19*

**Free Cash Flow**
Q1      Q2      Q3
(-9.6)  (-7.3)  (-10.3)

**Net Loss (GAAP)**
Q1      Q2      Q3
(-19.4) (-19.6) (-17.9)

**Cash & Equivalents**
Q1      Q2      Q3
207.7   185.5   181.4

**Customer Usage of ZUO Solutions (Billing Transaction Volume):**
Q1      Q2      Q3
7.2B    7.5B    8.6B

*Notes to consider:

–ZUO has negative gross margins on their Professional Services Revenue. In other words their cost of professional services revenue is higher that the revenue they generate from these services. As investors, we are are going to have to keep a close eye on this issue. We’ll want to see services revenue getting smaller as an overall percentage of total revenue, and the cost of service revenue at least in line with the revenue generated (i.e. neutral or positive gross margins). Some analysts and investors see this as a short term problem. As an example of this sentiment, here is what noted Tech Investor Bert Hochfeld ( says about this issue (according to this post:… ):

“Part of the reason for the negative gross margin on services has to do with the impact of the RevPro acquisition a year ago and the deferred revenue write down that is required. RevPro had lots of services revenue as proportion of the total and you are seeing that impact. That will normalize in fiscal year 2020-that is to say after one more quarter. The company will not run at a negative professional services Gross Margins.”

Others express concern that professional services represents too large of a percentage of total revenue. So even if it declines over time it skews valuation. The best recent case along these lines was made by poster PaulWBryant (here:…), he says:

"…you need to look closer. Yes, they say year-on-year comparisons also include the financial impact of a RevPro product which we began to offer following our acquisition of Leeyo on May 31st 2017. But look at the quarter before that (ended April 30 2017). Services already made up almost 20% of total revenue! (they had $6.3m services revenue and $32.3m total revenue)

And even if services does taper off, that will slow total revenue growth rate! This is a mess – simply too complicated. This is a business that’s really priced at 14x (subscription) sales, where total revenue growth rate is expected to slow to 25-30%, and profit is a long way away. No thanks. There’s going to be some confusion the next couple quarters, and frankly as I looked back at the conference calls, they haven’t been very clear about it. Hard pass."

–ZUO is cash flow negative, not profitable. This is not unusual for SaaS companies at this point in their development.

–ZUO has significant cash on its balance sheet.

–Customers with ACV equal to or greater than $100,000 was 504, a net increase of 30 customers, representing 30% year-over-year growth and 6% quarter-over-quarter growth.

–Dollar-based retention rate increased to 115%.

–Customer usage of Zuora solutions grew, with $8.6 billion in transaction volume through Zuora’s billing platform during Q3, an increase of 37% year-over-year.

Zuora’s Competitive Advantage:

Zuora has first mover advantage and is the top dog in this space, creating and providing solutions that address the secular trend towards a subscription-based economy. They were out front of the trend that has seen many new service based companies emerge and other older businesses and industry beginning to transition from product sales to selling subscription services. Scroll through this list of Zuora Customers to see the impressive partnerships they have formed:

Zuora’s solutions are sticky. The transition from legacy accounting systems to ZUO software is complex. Once a company has put the time and cost into making this transition, they are unlikely to switch to another system for many years to come. This is part of the reason why the company’s professional services revenue is currently a big part of total revenue. ZUO is in the mode of helping companies transition to a much more efficient and effective way to manage their subscription business models. Here’s Tien again from the Q3 conference call discussing this issue in greater detail:

Now, most people know that our billing product is widely recognized as the best in market, but let’s talk about RevPro. It’s also recognized as the best product in the market. So for example, according to MGI Research, RevPro is the top ranked solution for revenue recognition software. For the last 90 days, we’ve heard a number of you ask for an update on the market demand for RevPro, especially now that many companies seem to be passed this ASC 606 deadline. So what we’re finding is that many public companies rush to get compliance, but a lot of them just manually with Spreadsheets, and they found this to be a short-term band-aid solution. These companies are realizing that the real problem was never ASC 606, the bigger more systemic trend is that these companies were struggling to scale their revenue operations because of all these new flexible consumption recurring models that their companies were launching, and they couldn’t do it with a manual Excel-based approach. ASC 606 is the thing that only highlighted the problem.

Let’s give an example, a great example from this past quarter was Viva; most of you know Viva, they’re a leader in the life sciences space, fantastic SaaS success story, and I suspect it’s in many of your portfolios. Now Viva it’s been public for a while, they’re now talking about hitting the $1 billion of revenue next year, and what ASC 606 really put a spotlight on was how complicated revenue recognition has become for them. They spent a lot of effort to become ASC 606 compliant last year, but using manual operations, and then this year they came back to putting in an automation solution, and they selected RevPro this quarter to help them to efficiently scale this part of the business.

So you can see that the underlying demand hasn’t gone away, but our value proposition is now more centered around automation and efficiencies, versus simply compliance. Not to see this quarter we also signed on other public companies like Carbonite and Pivotal, who both chose RevPro all because we’ve got the best revenue automation platform on the market, and there’s a big, big difference between being compliant and being competitive. And that was the reason to bring on the RevPro product in the first place. The need for revenue automation is not just driven by ASC 606 compliant. It’s a larger issue with many of these companies as the complexity of revenue recognition limits their ability to efficiently scale and meet their business goals. That’s why we continue to see good demand for our RevPro product.

Another important part of ZUO business plan is to work with system integrators, like Deloite Digital. Tien addressed this approach on the Q3 Conference Call. Here is what he said:

One last thing to cover about what we saw in the business in Q3 and that’s with our system integrators. I mentioned on the last call how Deloitte Digital helped bring us a significant enterprise deal with Clarivate, which is a spinout of Thomson Reuters. You may have seen this announcement earlier but Deloitte Tohmatsu Consulting in Japan recently announced a collaboration with Zuora to help companies in Japan shift to a subscription based business. This announcement is a great next step in our growing partnership with the Global Deloitte network. Second, we’re building stronger ties with audit firms of strategic partners for our RevPro solutions. Since the close of the Leeyo acquisition, actually about a quarter of our new RevPro customers have actually come through these partner channels. For example, PWC and Zuora have a joint business relationship focused on addressing the growing demand for revenue automation software. In fact, PWC has established a Center of Excellence to help customers succeed in using RevPro.

Now, I want to say we’re still in the early innings of building and leveraging these relationships, but we’ve got some great, great partnerships with system integrators around the world, and we really believe that over time this can turn into a healthy channel for our business. So, in summary, what we’re seeing this quarter is good momentum in the market, continued expansion of
the subscription economy across industries which leads to an expansion of our TAM, continued traction for our solutions and a growing ecosystem."

I hope this is helpful. Please share your thoughts.

Best, Swift…
Long ZUO
ZUO Ticker Guide


P.S. in the Tien quoate above “Viva” should read as “Veeva”. The conference call transcript misspelled the company name…