AI Drives Growth for Tech Companies in Q3 2024 Earnings

FiscalNote (NOTE) Q3 2024 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the FiscalNote third quarter 2024 financial results conference call. All lines have been placed on mute to prevent any background noise, and after the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Thank you. I would now like to turn the conference over to the company. Please go ahead. Bob Burrows -- Investor Relations Good evening. My name is Bob Burrows, founder and principal of Western Avenue Advisers LLC, an investor relations consultancy. I am interim investor relations officer for FiscalNote, having been hired by the company back in April following the departure of the former IRO. Thank you for joining the call today as we discuss FiscalNote's third quarter 2024 financial results, as well as the additional news today regarding the announced leadership change for the company. With me on today's call with prepared comments are Tim Hwang, current chairman, CEO, and co-founder; Josh Resnik, current president and chief operating officer; and Jon Slabaugh, CFO and chief investment officer. Other members of the senior management team will be available as needed during the Q&A session that will follow these prepared comments. Please note copies of today's press release, the current report on Form 10-Q for the quarter, and the required current report on Form 8-K related to today's disclosures, as well as an updated version of the corporate overview presentation, are all available on the company website. In terms of important housekeeping, it is important to mention the following. During this call, we may make certain statements related to our business that are forward-looking statements under federal securities laws. These statements are not guarantees of future performance but rather are subject to a variety of risks and uncertainties. Our actual results could differ materially from expectations reflected in any forward-looking statements. For a discussion of the material risks and important factors that could affect our actual results, as well as the risks and other important factors discussed in today's earnings release, please refer to our SEC filings, which are available either on our company website or the Securities and Exchange Commission's EDGAR system. Additionally, non-GAAP financial measures will be discussed on this conference call. Please refer to the tables in our earnings release or the updated version of the corporate overview presentation, both of which are available on the Investor Relations portion of our website, for a reconciliation of these measures to their most directly comparable GAAP financial measure. Finally, we use key performance indicators or KPIs in evaluating the performance of our business. These include run rate revenue, annual recurring revenue or ARR, and net retention revenue or NRR. Again, please refer to the earnings release or the updated corporate deck for definitions of these important metrics. And with that, I'd like to turn the call over to FiscalNote's current chairman, CEO, and co-founder, Tim Hwang. Tim? Timothy Hwang -- Co-Founder, Chair, and Chief Executive Officer Thank you, Bob, for that introduction, and thank you all for joining us this evening. It's great to be with you today as we discuss a variety of items in the company, including our third quarter 2024 results, the state of our overall business, and of course, the leadership transition also announced this evening. Given that change, I'll share my thoughts on the company I co-founded before turning the call over to Josh, who will provide an update on the state of the business. First, let me address the rationale for taking a step now to transition the leadership of the company to Josh starting January 1, 2025. When we set out more than 10 years ago in founding FiscalNote, our guiding principle and mission was to help customers make sense of the complicated and constantly changing world we live in by delivering a proprietary AI-enabled platform that aggregates and organizes regulatory, political, and macroeconomic information and analyze the impact on their organizations overall. As of today and reflecting back over that time frame, that is exactly what we have done. Back then, applying machine learning and Big Data analytics to text and laws and regulations were just an inkling of an idea. Fast forward to today, we are now living in what I believe will be one of the largest technology transformations in my generation. Today, we are the market-leading AI platform for the regulatory legislative policy and geopolitical intelligence sectors. As you've heard from me many times, we are essentially the Bloomberg Terminal for regulatory, legislative, and strategic risk, drawing upon a deep reservoir of technical expertise, proprietary data, and analytical tools. I take tremendous pride in knowing that we have amassed a collection of proprietary high-quality and authoritative data on a range of aspects, including international, federal, state, and local legislation across 80,000 cities, all 50 states, and every major federal regulatory agency, as well as deep profiles and tens of thousands of policymakers, millions of legislative regulatory bodies, and purpose-built analytical tools, monitoring governments around the world and resulting in what we have established as of today: a market-leading position across thousands of customers. More than that, we have grown to become several hundred passionate individuals around the world, serving thousands of customers from the White House to the DOD to almost half the Fortune 100, empowering decision-makers around the world with the intelligence they need. This success as a company from the very beginning of three guys in a laptop with an idea happened because we focused on the customer, cared about our employees, and continued to push the envelope on innovation. From aggregating the world's legal data to putting predictive analytics on it, pushing the boundaries of cloud collaboration and now pushing the envelope on generative AI, FiscalNote has been at the forefront of innovation at every turn, all while staying true to customer needs and making it a great place to work. Looking ahead, the company, like any start-up, now requires new leadership and a fresh perspective on the strategies and approaches to realizing the next phase of growth for the business. After almost 12 years at the helm of operating FiscalNote every day and after deep considerable thought, I've decided to pass the baton and transition to the role of executive chair, allowing me to step into a new chapter, returning to my founder roots with renewed passion and focus as we continue to scale FiscalNote to even greater heights. Josh Resnik, FiscalNote's current president and COO, is the absolute right person for that task. I'll continue to work to reinforce my continued commitment to the company's vision and success in this new role, where I will continue to focus on strategic initiatives and the continuity of FiscalNote's mission as it enters the next phase of growth. I'm incredibly proud of what FiscalNote accomplished and excited to direct my passion, energy, and motivation in the role of executive chairman, working closely with fiscal leaders on culture, nurturing new innovative products, accelerating our generative AI growth, working on strategy, and being a continuous advocate for FiscalNote externally. And I'm, of course, happy to support Josh, who has been an effective and impactful No. 2 for the last four years. The future is bright for FiscalNote, and the company could not be better positioned for the future. We are now living in a world where our customers need our products more than ever to navigate a rapidly changing geopolitical environment. And while our level of invention and innovation continues to push the boundaries of our products at the intersection of law and AI, with this leadership transition, the future has become even more promising as we continue to pursue our multiyear journey to earning our place in the history books and becoming the dominant player in our industry. It has been both an honor and a privilege to have served as CEO of FiscalNote. Josh and I, over the course of the next month and a half, will work together with the rest of the senior team, ensuring a smooth transition so that come January 1, we enter the new year well-positioned to execute on the company's mission and vision and to ensuring we continue to impact the daily lives of our thousands of customers around the world. Thank you, and I'll now turn it over to Josh to update you on the current state of the company. Josh Resnik -- President and Chief Operating Officer Thank you, Tim, for those kind words and for your heartfelt views about the company. I want to thank everyone here for joining us this afternoon, and I look forward to discussing our third-quarter results as well as what you can expect to see from us in the future. But first, I want to take a moment to address the change in Tim's role. Like a number of FiscalNote team members, I joined FiscalNote because of Tim. In the early part of the start-up's lifespan, its success rests on the founders' shoulders. And from the moment I first met Tim and ongoing throughout my time working at FiscalNote with him, I've continued to be impressed by his unique qualities and skills, his vision, his creativity, his boldness, and his commitment and, in particular, his passion for FiscalNote, his understanding of our market, and his relentless drive to achieve a successful return for all our shareholders. And that's why I'm so glad Tim isn't leaving FiscalNote and that he'll continue to work with us actively on strategy and other drivers of this next phase in the FiscalNote story. As for me, I've succeeded at both ends of the spectrum, including in senior roles at some of the world's largest companies, as well as with hands-on experience with tech start-ups as an early hire, venture advisor, and leader and mentor to founders and teams. So, I bring a balanced perspective that supports growth and innovation at any scale. I'm looking forward to continuing to collaborate with Tim as each of us steps into our new role. With that, let me turn now to the state of the company with a focus on what we've done and what you can expect to see from FiscalNote going forward. Let me begin by first taking a broad view of the recent past. We've spent the last two years rightsizing our cost structure as well as going from consistently negative adjusted EBITDA to five quarters in a row of positive adjusted EBITDA, including this most recent quarter. Importantly, today, we are announcing an upward revision for the full year 2024 to approximately $9 million adjusted EBITDA. This is a tremendous accomplishment for all of our FiscalNote teams and a testament to their hard work, and it also should serve as a clear statement from the entire FiscalNote team as to the discipline with which we are operating the company. In 2023, we were laser-focused on achieving adjusted EBITDA profitability for the first time, and we did that one quarter sooner than planned. In 2024, we wanted to expand that profitability, and we've done that regardless of circumstance. We've been continuing to refine our product portfolio so that we can apply focus in the areas with the greatest foundation for future profitable growth. This includes the sales of Board.Org and more recently Aicel, as well as sunsetting of non-core underperforming products, all of which continues our ongoing initiative to divest non-core businesses, reduce business complexity, delever the balance sheet, and drive efficient and profitable growth. Excellence matters, and we simply cannot be excellent if our teams are spread too thin, trying to advance unproductive or unprofitable initiatives. As I'll discuss in a moment, we are actively evaluating other elements of our current product mix as we proactively reduce our organizational complexity and focus on the ways in which we best deliver value to our core customers. This has the additional benefit of positioning us to realize increasing margins and profitability. We have continued to optimize our commercial organization, giving us a solid foundation on which we can embark on a new phase of growth and sustain financial performance. We're driving alignment and replicating playbooks across our global teams to increase customer engagement and improve performance management and sales productivity. We have leveraged AI technologies as the centerpiece of new products such as our copilots for policy and global intelligence, and we have integrated these technologies into our core offerings as a means to surface critical information more quickly and to help our customers be more productive and drive better outcomes for their organizations. And we continue to see promise in our ability to leverage our unique mix of data sets, proprietary content, and both human and artificial intelligence to better serve our customers' needs. And now, we're increasing our focus on product under the leadership of our new chief product officer, Can Babaoglu, whose hiring we announced in the third quarter. Can pioneered the development of Casetext and helped drive its rapid expansion by creating engaging customer experiences and leveraging new technologies such as generative AI to become one of the top products in all of legal tech, leading to a successful $650 million all-cash sale to Thomson Reuters. Importantly, given FiscalNote's own roots and our desire for a product culture centered on rapid iteration and innovation, Can is a true entrepreneur, having founded companies on his own as well as helping build and grow Casetext. So, he knows what it means to protect and provide a return on investor capital. So, with that brief lookback, I'll turn to the future. First and foremost, building on what I just noted regarding our emphasis on product, we will focus on delivering best-in-class product experiences, leveraging our strengths in data collection, aggregation, normalization, synthesis and analysis in artificial intelligence, and in our proprietary content, the whole of which provides us with a competitive advantage that is difficult to replicate. As a core component of that, under our new chief product officer's leadership, we are consolidating and deprecating legacy platforms in parallel with our prioritization on creating new product experiences that address the core challenges our customers face. With the targeted use of generative AI where it puts customer value first, as well as by leveraging other cutting-edge technologies and our data science capabilities, we will deliver robust, intuitive solutions that empower and enable our customers to achieve outsized outcomes. The end result will be improved customer experiences that drive higher growth and retention, more product-led growth and product-led sales that will decrease our customer acquisition costs over time and streamline operations that enable us to continue to increase profitability. Second, we will be increasingly focused in areas and segments where we see the greatest growth and opportunities, including international, where we are experiencing demand for our global policy data as well as our EU policy analysis and global intelligence, and corporates, where there is continued room for expansion in our core markets and where we've seen traction and growing opportunity in key segments such as large enterprise and midmarket. Tied to this, we will continue to evaluate further portfolio rationalization and de-emphasis in areas that we see as non-core or suboptimal, including sunset of any non-core underperforming products. While this may include wholesale reduction or elimination of non-core initiatives, we also are digging into areas where we don't view the growth profile as a long-term fit. For example, we've implemented more margin discipline on one-time revenue from our advisory business, which has had a near-term impact on top-line growth but which will better enable our increased profitability and returns over time. Third, we will continue to take steps necessary to improve our capital structure. As you're aware and as I reiterated earlier, we've already begun this process with the sales of Board.Org and Aicel, and we will continue to take advantage of opportunities in the market where we feel we can realize value for shareholders, deleverage further, and refine our focus so that we can better drive growth. Jon and his team have done an excellent job in driving successes this year, and they will continue to do so as we look ahead. Overall, the changes we've made and are making to our organization and our portfolio are intended to position us to return to a trajectory of sustainable growth and increasing profitability. We have delivered on profitability. We continue to get more profitable, and that's just the start. We better positioned our organization for growth, and we are investing in the product improvements that will drive that growth. Jon and his team will continue to take steps to improve our capital structure while we maintain our commitment to driving growth in the core business and compete to retain our existing customers and win new business every day. Together, these initiatives are foundational to the next phase of long-term sustainable growth for the company. I'm both humbled and honored to step into the role of CEO at the outset of the New Year, but mostly, I'm excited about the large global opportunity that lies ahead, and I look forward to updating you on our progress across 2025 and beyond. With that, I'll now turn the call over to Jon to take us through the numbers. Jon? Jon A. Slabaugh -- Chief Financial Officer and Chief Investment Officer Thank you, Josh. My comments will be brief this afternoon, and given today's other news, I want to take a moment to congratulate Tim on his transition to executive chair. Tim's contribution as founder, CEO, and chairman cannot be understated. Tim, it has been a pleasure working with you these past five years, and I look forward to continuing to collaborate with you in your new capacity. And Josh, I'm equally thrilled to continue our work together as you step into the CEO role and continue driving the next phase of profitable growth for FiscalNote. With that, let me turn to the quarterly performance, starting with the income statement. Total revenue for Q3 2024 was $29.4 million, in line with our forecast and lower than the prior year due primarily to the divestiture of Board.Org. While down period to period, subscription revenue remains the cornerstone of our business, accounting for 93% of total revenue this quarter and in line with the company's historical trends. Looking at our key performance metrics. As of Q3 2024, run rate revenue was $119 million and annual recurring revenue is $109 million. On a pro forma basis, adjusting for the impact of the Board.Org divestiture, the current-year run rate revenue is $5 million lower than the prior year third quarter, and ARR was level with prior-year third quarter. And as of Q3 2024, net revenue retention was 99%, slightly lower than the prior year. Turning to expenses, principal operating expenses in Q3 2024 continued the trend of year-over-year decreases, reflecting the impact of cost-saving initiatives instituted last year, the Board.Org divestiture, and sunset products during the current year. Cost of revenues decreased by over $4 million or 40% due to certain technology-related amortization expenses in 2023 that did not recur in 2024. R&D decreased by $1.2 million or 28%. Sales and marketing decreased by just over $2 million or 19%, and G&A decreased by just under $4 million or 26%. In aggregate, total operating expenses in Q3 fell over $11 million versus the prior year or 24%. On a pro forma basis, excluding amortization expenses, stock-based compensation, and the impact of the sale of Board.Org, opex decreased approximately $4 million or 12%. Looking at profitability for the quarter, let's start above the line. Gross margins remained strong in the quarter with Q3 2024 coming in at 79% on a GAAP basis and 86% on an adjusted basis, both increases over prior-year period. These improvements primarily reflect our focus on consistent adjusted EBITDA growth and the impact of the sale of Board.Org, sunset products, and improved efficiencies. As I've stated at each of our earnings calls this year, we continue to pursue and find further incremental operating efficiencies. The GAAP net loss for Q3 2024 was approximately $14.9 million, slightly higher than the prior-year period. EBITDA for Q3 2024 was negative $5 million, slightly higher versus the prior-year period. And adjusted EBITDA was positive $3.4 million versus just under $1 million for the prior-year period. With a positive adjusted EBITDA for the quarter, that brings FiscalNote to five consecutive quarters of positive performance for this key profitability metric, a total of $9.4 million on a trailing four-quarter basis. At quarter-end, we had cash and cash equivalents, including short-term investments, of approximately $33.4 million, which continues to reflect the positive contribution from the sale of Board.Org in March. Period-end cash also reflects the ongoing initiatives to improve efficiencies across the company and our continuing attention to prudently allocate capital to investments in the business with the highest potential for growth and positive return. Additionally, at quarter-end and after giving effect to our sale of Aicel and the principal repayment, our total debt outstanding, including principal and accrued interest, stood at $168 million, sequentially lower than $172 million at the end of the second quarter. Turning to guidance. Today, taking into consideration the visibility we have on the remainder of the year, we revised our full year 2024 numbers slightly. Specifically, we raised our full-year profitability forecast for adjusted EBITDA to $9 million, up from approximately $8 million forecast in August. At the same time, we lowered our full-year revenue forecast for total revenue to $120 million, down from the previous $121 million forecast in August. This $1 million reduction reflects the divestiture of Aicel and also the impact of anticipated lower advisory revenue as we continue to evaluate the trajectory of that business going forward, offset by the realization of improved operating leverage resulting from further operational rightsizing initiatives. Of note, the forecast of $9 million in adjusted EBITDA marked the first full calendar year of adjusted EBITDA profitability for FiscalNote. The company expects to continue to drive deleveraging and, therefore, improvement of its capital structure, reduce complexity of its product portfolio, and strengthen customer experience and retention rates through the ongoing optimized product strategy and road map through the end of 2024 and continuing into 2025. We also, today, provided guidance for Q4 2024 total revenues of approximately $29 million and adjusted EBITDA of approximately $2.5 million, both reflecting divested and sunset products and the continued trends we've experienced throughout the year. Finally, I wanted to note that the board continues to review all strategic alternatives available to the company to maximize value for shareholders. As always, we do not intend to provide updates on the outcome of this review until further disclosure is appropriate or required. In summary, our business through the first nine months of 2024 remained stable and well-positioned to drive future impact and success. We continue to implement our product strategy while executing our operational efficiency initiatives as we further solidify our position as a critical partner to our diverse customer base. This concludes my prepared remarks. I'll turn it over to the operator to begin the question-and-answer session. Operator? Thank you. We will now begin the question-and-answer session. [Operator instructions] Your first question comes from the line of Jesse Sobelson with D. Boral Capital. Hi, everyone. Thanks for taking my question. Congrats on the shift in the C-suite. It's a big move, and I think investors are going to be, you know, excited to see some changes with the business. I am curious, looking forward here, what -- in terms of the target capital structure over the medium term, we've sold some assets. We've improved profitability quite dramatically quite recently. What is the goal for the capital structure maybe on a net debt-to-EBITDA basis, and how do we get there from here? What's the vision over the medium term? Jon A. Slabaugh -- Chief Financial Officer and Chief Investment Officer Thanks for the question, Jesse. It's Jon. And that's something that we spend a lot of time thinking about the right capital structure. As we said, we're still continuing to kind of evaluate that and other strategic moves we might make. The company has, you know, a senior credit facility and some subordinated debt as well. We're looking at ways to reduce our overall cost of capital and be able to service that with the cash flow that we plan to generate in the subsequent years. So, as we get into our budgeting and planning for the upcoming years, that will really be informative about kind of the right level of debt that the company can sustain long term. But I think we'll continue to try to find ways to deleverage and reduce the overall debt profile of the company, and that will be a driver of, again, the long-term equity value for the company. Jesse Sobelson -- Analyst OK. Yeah. Understood. I think just one quick follow-up for me. You know, there's a lot of talk on the bigger picture on the business here, just kind of drilling into specifics. You know, one thing that I think a lot of people are really excited to hear about was this copilot program with AI being utilized. I was wondering, you know, there were some pilots done earlier in the year. There's certainly been some progress there. Would you guys be able to elaborate on any customer reception with the new technologies that you guys are executing on, implementing with your product? And any developments there, please? Thank you. Josh Resnik -- President and Chief Operating Officer Sure, Jesse. This is Josh. I'll address that. So, we launched two copilots earlier this year. One is our copilot for policy. One is the copilot for global intelligence. With the copilot for global intelligence, that's essentially combined with the other aspects of our product experience. It gives our end users a new way to interact with our data and analysis and a way in which they can get to the heart of answers to their most pressing issues much more quickly. We've been really happy with the customer uptake that we've seen. We've seen a very, very broad uptake among our customer base. We're seeing a lot of good, healthy metrics in terms of things like return visits, repeated -- kind of repeat inquiries. And we like, actually, the nature of the questions that we're seeing being asked. And we've also seen promise in terms of the potential that that has to help drive upsell and cross-sell through product-led sales and product-led growth, which is important for us going forward as well. So, a lot of good successes there, and we feel really good about that product and what it will be able to do to help drive us to more growth going forward. For copilot for policy, that was a bit of a different nature of launch. So, that was taking an approach of essentially slicing off a single piece of functionality and making that available to users to interact with in a different way. So, taking just really a small subset of what our core product is able to do for users from a policy standpoint, giving them the chance to interact much more simply around just this simplified set of functionality. And what's been good about that is, again, we've had a lot of learnings from how users have interacted with it, different -- some different types of users than we have typically worked with in the past. And we've been able to leverage both that technology that we developed and the learnings from that to bring a lot of that functionality directly back into our new core product initiative as well, which is something I talked about in terms of how we're focused on driving these improved customer experiences across the core. So, again, a lot of good work from that and good learnings coming from that one. Jesse Sobelson -- Analyst Great. Thank you very much for taking the questions. Your next question comes from the line of Mike Latimore with Northland Capital Markets. Please go ahead. Michael Latimore -- Analyst All right. Great. Yeah. Thanks, and congrats, Tim and Josh, on your new roles. The gross margin was -- or overall profitability was great. The gross margin, you know, was up nicely. I guess is that -- it seems like that would be sustainable given the drivers here, but do you view gross margin levels as sustainable? Jon A. Slabaugh -- Chief Financial Officer and Chief Investment Officer Hi, Mike. It's Jon. So, we believe so. The gross margins increased by virtue of the Board.Org divestiture, which had a little bit of a different cost profile to it. And it's also improved as we've de-emphasized some of the advisory and service-oriented lines of business. They had a higher fulfillment cost as well. So, as we kind of double and triple down on our core policy and global insights business, those are subscription businesses with really great margin profiles. Michael Latimore -- Analyst OK. Good. And then in terms of thinking about a return to growth, it sounds like, you know, new products are key. Do you feel like the new products you just talked about are the -- are sufficient to get back to growth, or are there going to be others that you're launching here that are kind of critical? Josh Resnik -- President and Chief Operating Officer Hey, Mike, it's Josh. So, thanks for the question there. So, a good part of what's going to help us get back to the level of growth that we expect is what I talked about generally speaking regarding product and the focus that we have on product going forward. What's really key for us is creating the right customer experiences that can drive the right levels of engagement, that can help us drive better retention, as well as that cross-sell/upsell. As I mentioned before, those are where we've had the most significant challenges. And so, what we want to do is bring those new experiences to our core products and our core customers. That will give us a very strong basis for growth going forward and a basis of not just growth but long-term profitable growth. And that will give us the ability to continue to invest in new product development over time as well. Michael Latimore -- Analyst OK. Got it. And then just last -- actually, on the third quarter, I believe historically has been an important quarter for government bookings. I guess, how did the government perform in the quarter? Josh Resnik -- President and Chief Operating Officer So, yeah, Mike, this is Josh. So, we saw good government performance in Q3, and that continues to be a strong basis for us going forward as well. Michael Latimore -- Analyst OK. And just last one. You know, you talked a lot about looking at de-emphasizing or divesting non-core product areas. I guess, can you give us a sense of what percent of the revenue or ARR could be in that non-core category? Jon A. Slabaugh -- Chief Financial Officer and Chief Investment Officer I don't really want to give any kind of guidance on that right now. I think it's fair to say that, you know, a substantial portion of our revenue really is in businesses that we intend to be in for the long haul. But, you know, we're still going through that evaluation and need to kind of make decisions kind of one by one as we continue to focus on simplifying the business and kind of clearing the path to growth. Your next question comes from the line of Zach Cummings with B. Riley Securities. Please go ahead. Ethan Widell -- B. Riley Financial -- Analyst Hi. This is Ethan Widell calling in for Zach Cummings. Thanks for taking my questions. To start, Tim, congrats on the transition. Can you elaborate maybe on why now is the right time for the leadership transition? Timothy Hwang -- Co-Founder, Chair, and Chief Executive Officer Yeah. No, I appreciate the question. I mean, I think first of all, you know, it's been a great run here kind of running the company day to day and operating for the last 12 years. As I mentioned in my remarks, I literally started the company with three guys in a laptop in a Motel 6 room in Silicon Valley. I've been grinding 365 days a year ever since, and so I do think that the company is quite well-positioned here. We have launched a number of new products, have gotten to a place where we have several thousand customers. And as was mentioned today, you know, we've had, you know, effectively sort of record profitability on an adjusted EBITDA basis and now consecutive profitability five quarters in a row. And so, looking at 2025 and beyond, I think, you know, we're quite well-positioned to make the transition. As I mentioned, I'm still, you know, very involved in the business. I've got a strong interest in making sure that the company continues to be successful, leading the board in strategy and quite a number of different product and culture-based initiatives. And so, I think -- you know, I've been working with Josh for the last almost six years now, and it just seemed like the right time to make that transition here. Ethan Widell -- B. Riley Financial -- Analyst Got it. That's helpful. Thank you. And then looking toward fiscal '25, maybe what assumptions are underpinning your confidence in return to growth next year? Josh Resnik -- President and Chief Operating Officer Sure. This is Josh. I'll address that. We actually -- you know, we obviously look very deeply in the business to see where things are working and things that are not. And as I mentioned, a big part of what we're doing going forward is making sure that we're doing the right things to focus on the areas where we see that promise and the opportunity for growth. So, a couple of sectors and segments that I've mentioned. We're seeing a lot of promise in international. That includes areas of our global policy data sets, our EU policy analysis, and global intelligence, and we see that as a very strong foundation, as well as in corporates and especially in large enterprise and midmarket. So, we're seeing some good signs in the mix of what we review. And then, you know, as I said, in addition to just, generally speaking, bringing that focus in those areas that work is bringing that focus onto product as well and bringing the right product experiences in front of our customers to help drive that retention and that cross-sell/upsell that will be a foundation for growth as well. And we've been undertaking efforts in that regard. We have improvements underway for our core products, and the early signs there that we're seeing are very promising. So, we feel excited about the direction that we're going there as well. [Operator instructions] Your next question comes from the line of John Roy with Water Tower Research. Please go ahead. John Roy -- Analyst Thank you. Obviously, there's a lot of focus on growth on the top line and new products and possibly new geos, which would seemingly require new products. I was curious if you could give us any color on the competitive landscape. Are these seeming to you purely greenfield opportunities that no one is there? Are you -- do you see players that are already there? Just curious if you could give us some color on the competitive landscape. Josh Resnik -- President and Chief Operating Officer Sure. This is Josh, and maybe I can help clarify a bit in terms of what I'm talking about in terms of international. You know, what I'm talking about there in the areas that we see promise is really about the global data sets that we have in park and policy analysis that we have regarding markets outside the U.S. So, these are assets that we already have. We have customers already engaging with them. And we're seeing a lot of -- as I said, we're seeing metrics and indicators underneath that are giving us an indication of a lot of promise in terms of the demand for those existing data sets and content sets that we already have. And so, when I'm talking about the optimism that we have in terms of where we see that promise going forward, it is in regards to data we already have, content we already have, and focuses in on products we already have but the improvements to those products that we are making in order to drive better engagement with our existing customer sets. We do see promise in new logo as well, But in terms of key areas that we're focused on in terms of driving that continued improvement, a lot does focus on that retention, cross-sell, upsell, and that's where the improvements to our existing current core products come into play. Great. You got a lot already in hand to really get to these new areas. That sounds great. We have no further questions in our queue at this time. I will now turn the conference over to Bob Burrows for closing comments. Bob Burrows -- Investor Relations Great. Thanks, Krista. That concludes our call this evening. We appreciate everyone's participation on the call. With any additional questions, please contact any of us, and again, all materials related to the company's third quarter '24 financial results are available on the FiscalNote website. We look forward to speaking with all of you again in the future. Good night.

ZoomInfo Technologies (ZI) Q3 2024 Earnings Call Transcript | The Motley Fool

Good day, and thank you for standing by. Welcome to the ZoomInfo third quarter 2024 financial results conference call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Jerry Sisitsky, vice president, investor relations. Please go ahead. Jerry Sisitsky -- Investor Relations Thanks, Victor. Welcome to ZoomInfo's financial results conference call for the third quarter of 2024. With me on the call today are Henry Schuck, founder and CEO of ZoomInfo; and Graham O'Brien, our interim CFO. During this call, any forward-looking statements are made pursuant to the safe harbor provisions of U.S. securities laws. Expressions of future goals, including business outlook, expectations for future financial performance, and similar items, including without limitation, expressions using the terminology may, will, expect, anticipate, and believe and expressions which reflect something other than historical facts are intended to identify forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including those discussed in the Risk Factors section of our SEC filings. Actual results may differ materially from any forward-looking statements. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events that may arise after this conference call, except as required by law. For more information, please refer to the forward-looking statements in the slides posted to our Investor Relations website at ir.zoominfo.com. All metrics on this call are non-GAAP unless otherwise noted. A reconciliation can be found in the financial results press release or in the slides posted to our IR website. Thank you, Jerry, and welcome, everyone. We continue to see stabilization and improvement in our net retention rates and believe that we're moving forward with a clean slate while delivering improved financial results. Q2 was about implementing new initiatives to position the company for long-term success, and Q3 was about executing on these initiatives and moving the business forward. In Q2, we successfully deployed a new business risk model, which has successfully reduced the volatility around future write-offs. In the third quarter, we applied this model more broadly and transacted more than 55% of our new business opportunities through upfront prepayments, up from 33% in Q2. In doing so, we also disqualified more risky small businesses than ever before. While this is absolutely the right thing to do for the long-term health and durability of our business, it will remain a headwind to the optics of our growth in the coming quarters. In the quarter, ZoomInfo Copilot performed better than expected. Our NRR stabilized at 85% for the third consecutive quarter, and we accelerated our shift upmarket by delivering strong enterprise growth and growing both our $100,000 and $1 million-plus customer cohorts sequentially. As a result, GAAP revenue for the third quarter was $304 million, and adjusted operating income was $112 million, a margin of 37%, both above the high end of our previously provided guidance. We remain committed to efficiency with a focus on growing levered free cash flow per share. To that end, unlevered free cash flow for the quarter was $111 million, up 17% year over year. In Q3, we also retired 24 million shares, approximately 7% of our total shares outstanding. Since March of last year, when we announced our first share repurchase authorization, we have retired 68 million shares, or approximately 17% of total shares outstanding. We believe in the long-term opportunity to drive shareholder value through compounding growth and levered free cash flow per share. When you combine our strong cash generation with the ongoing share count reduction, we expect the company will do at least $1 of levered free cash flow per share this year, and we plan to grow that number meaningfully in 2025 and expect to continue to grow it over the long term. In a seasonally slower quarter for our upmarket business, we were able to deliver another strong enterprise quarter. Our $100,000 customer cohort grew by 12, the second consecutive quarter of sequential growth, ending the quarter with 1,809, greater than $100,000 customers. Revenue from this cohort now makes up 44% of our ACV. We had one of our best year-over-year increases in million-dollar-plus customers and drove accelerating sequential ACV growth from that cohort. An enterprise ACV, which now represents approximately 41% of the business, grew 1% sequentially. More customers are turning to ZoomInfo because we're driving demonstrable results with strong ROI that helps customers increase their revenue and reduce their costs. During the quarter, we closed transactions with leading organizations of all sizes, such as Commerce Bank, Samsung, BambooHR, Sonesta Hotels, Bentley, Clari, and Premise Health. At Amplitude, we consolidated a number of existing data vendors, deployed ZoomInfo Copilot across 150 sales reps, added operations for their rev ops team, and continue to support their marketing and audience building and execution efforts with ZoomInfo marketing. Recently, The Economist entered our $100,000 customer cohort through an investment in Copilot licenses as part of a multiyear agreement designed to drive efficiency in their sales and marketing operations. Facing challenges with data accuracy, CRM decay, and Process Automation, they chose our AI-driven solutions to consolidate intelligence providers and streamline workflows. This strategic decision aims to double their sales opportunities, bolster ABM strategies, and gain efficient access to global business intelligence. And a Fortune 50 customer successfully replaced a legacy firmographic provider with our operations and Data as a Service products and grew into our $1 million customer cohort. They will leverage ZoomInfo to better understand and expand their total addressable market in their SMB and midmarket segments to identify high propensity to buy accounts and to build dynamic audiences for digital activation. They will also rely on ZoomInfo to help create a new, more efficient outbound sales motion. In Q3, ZoomInfo Copilot showed strong performance, delivering results that exceeded our expectations, especially in our midmarket and enterprise segments. The driving force behind Copilot's adoption is the measurable return on investment it offers. Our customers report 25% of their total pipeline directly attributed to opportunities identified by Copilot, a 58% increase in prospect engagement rates, a 62% improvement in email response rates, and productivity gains of eight hours per week, per user. The foundation for Copilot success is a combination of relevant customer context with best-in-class activation for go-to-market teams. Customer context comes from the strength of our data asset unified with the customer's business context from systems like CRM or data warehouses. We're known for our leading contact and company data, which provide actionable insights against hundreds of millions of contacts and companies. Now, our new sets of products expand into processing billions of data points daily to prioritize and personalize engagement at scale. During the quarter, our product innovation focused on increasing Copilot opportunities and strengthening product-market fit. First, we expanded our signal ecosystem to capture additional mission-critical go-to-market insights that neither exist nor are actionable in legacy CRM. We now process over 300 million daily signals to help every member of the go-to-market team win faster. For enterprise sellers, we added buying group and executive tracking signals, including hiring trends, expanded person moves, or updates to previously engaged contacts. For transactional and SMB sellers, we added SMB signals like business origination or lean data. For value selling, we added key unstructured data assets like earnings transcripts, financial filings, analyst research, or podcast transcripts that deliver relevant context, pain points, and growth expectations. And for competitive intelligence, we added competitive intent signals, social proof, and insight into customer satisfaction to increase retention, including integrations with competitive intelligence platform like G2, TrustRadius, and TechnologyAdvice. Copilot in the signal ecosystem can now be activated by a larger share of our customer base, thanks to new integrations with Microsoft Teams for enterprise, HubSpot for downmarket customers, and Outreach, SalesLoft, and Groove for technology companies, in addition to existing integrations with Salesforce, Gong, and Slack. Going forward, we will expand Copilot's use beyond prospecting to support key use cases for account executives and account management teams. Early results show Copilot is reactivating dormant seats and driving demand for expansion, particularly in the midmarket and enterprise segments. Examples include account executives using AI-powered account planning, customer success teams managing renewal risk through signal monitoring, and marketing teams driving sales execution through Copilot. This comes on the heels of recently being named a leader in this -- recently being named a leader this year in the 2024 Gartner Magic Quadrant for Account-Based Marketing Platforms. We believe this is a serious nod to the speed of innovation coming from our product and engineering teams and the market demand coming from the marketing departments of our customers. The demand for Copilot shows that successful automation and AI and go-to-market strategies require high-quality, reliable data. Our customers have realized that running large language models on their CRM data falls short. ZoomInfo Copilot goes beyond the CRM to create a complete picture of the addressable market, every account, every buyer, what they care about, and how to engage them most effectively. What sets ZoomInfo apart is our ability to unify contextual data across the entire customer journey with a multichannel activation layer across sales and marketing. This combination of context and activation drive successful AI and go-to-market, and we're best positioned to capitalize on this platform shift. Before turning it over to Graham, I want to acknowledge and thank the team. Across the organization, we are doing great things, from the work in finance and accounting to the innovation we're driving in product, to the sales team and beyond. We are focused, we are aligned, and we are operating with a sense of urgency. In Q2, we took the necessary steps to ensure that we were very well set up for the future, and I am pleased that our positive operating momentum translated into strong financial performance this quarter. We continue to focus on enterprise growth, driving customer outcomes with Copilot, and we're committed to driving long-term value creation through consistently growing levered free cash flow per share. While we are not guiding to 2025 today, I would call out that you should expect a very conservative approach to our guidance communications going forward in general, but particularly as we navigate this SMB transition. With that, I'll turn the call over to Graham. Graham O'Brien -- Vice President, Financial Planning and Analysis Thanks, Henry. In Q3, we delivered $304 million in revenue and adjusted operating income of $112 million, both better than the top end of the guidance we provided. When adjusting for the charge we took in Q2 and its impact on the second quarter as well as the additional day in Q3, sequential revenue growth for Q3 was negative 2%. As expected, write-offs continued at elevated levels in Q3, but showed signs of abating as we exited the quarter. The operational improvements we implemented are delivering results as our business risk model disqualified a record number of high-risk small business transactions in the quarter. As we exit Q3, that refined SMB sales motion is disqualifying more than $2 million of higher-risk new sales per month, which we anticipate will improve the quality of revenue and reduce write-offs over time, a near-term trade-off that benefits us over the long term. We believe the challenges that led to the accounting charge in Q2 are behind us, and we are seeing stabilization and early signs of growth in a number of different areas of the business. As Henry indicated, net revenue retention was stable at 85% for the third consecutive quarter. We are growing the enterprise business. We added to our $100,000 customer cohort. We added to our $1 million customer cohort. We drove an acceleration in ACV growth for $1 million-plus customers, and we are seeing strong early traction with Copilot. In short, we are controlling what we can control, and we are executing very well against our key priorities. Enterprise ACV, which now represents approximately 41% of the business, sequentially grew 1% in the quarter. With continued stabilization in midmarket and enterprise strength, approximately two-thirds of our business is on a path back to growing mid-single digits or better. As we grow in the enterprise, turnaround midmarket and more aggressively disqualify smaller and riskier businesses from the platform, we expect SMB to become a smaller and smaller percentage of our overall business. As that happens, we have a more favorable mix of revenue, and the business is set up for a more durable and higher levels of growth. Our operations business increased 22% year over year as we saw continued momentum, helping companies with their data foundation as they look to leverage AI. Taken together with our success driving Copilot, Advanced Functionality increased to 38% of the overall business in Q3, up from 35% in Q2. Copilot surpassed $60 million of ACV in the quarter, exceeding our expectations. In addition to the rapid innovation on the platform, we continue to successfully drive new-to-the-platform sales, off-cycle upsells, and Copilot migrations on renewal. We continue to see meaningful uplift on accounts as we transition them into a Copilot experience, with the majority of these migrations coming in midmarket and enterprise accounts. Utilization is up, and customer satisfaction is trending higher, which we believe is a leading indicator of improving renewal trends and higher net revenue retention. In Q3, we took advantage of the dislocation in share price and retired more than twice as many shares in the quarter than ever before, repurchasing 24 million shares of ZoomInfo stock for $242 million, in part through an accelerated share repurchase program. These repurchases reduced total shares outstanding by approximately 7%. As of the end of Q3, we had 343 million shares outstanding with $157 million in remaining repurchase authorizations. We will continue to be enthusiastic and opportunistic buyers of the stock, based on the wide gap we see between the intrinsic value of ZoomInfo and our current market value and because it is one of the best and highest returns on our capital. Operating cash flow was $18 million in Q3. And as we indicated on our last financial results conference call, we restructured our Waltham lease agreement early in Q3 and paid a $59 million termination fee as we continue to rightsize our real estate footprint. We estimate that this will save us more than $100 million going forward. Additionally, in Q3, we funded a $30 million settlement related to right of publicity lawsuits, providing avoidance of future litigation costs and liabilities. Unlevered free cash flow for the quarter was $111 million, a margin of 36%. And relative to levered free cash flow, we incurred cash interest of $19 million in the quarter. We ended the quarter with $148 million in cash and cash equivalents, and we carried $1.24 billion in gross debt. The $650 million in 3.875% senior notes have a maturity date of February 2029 and the remaining balance of $590 million in first lien term loans has a maturity date of February 2030. Our net leverage ratio is 2.3 times trailing 12 months adjusted EBITDA, and 2.2 times trailing 12 months cash EBITDA, which is defined as consolidated EBITDA in our credit agreements. With respect to liabilities and future performance obligations, unearned revenue at the end of Q3 was $419 million, and remaining performance obligations, or RPO, were $1.05 billion, of which $780 million are expected to be delivered in the next 12 months. While sequential growth remains the best metric to evaluate the business, we know some of you look to other metrics. For those looking at billings, the mix of our balance sheet reserves and the changes in practices that we made relative to higher-risk businesses requiring prepayment in advance, drove higher than normalized growth in billings this quarter, and I would caution you from extrapolating too much from the billings growth trajectory. With that, let me turn to guidance for Q4. We expect GAAP revenue in the range of $296 million to $299 million, adjusted operating income in the range of $103 million to $105 million, and non-GAAP net income in the range of $0.22 to $0.23 per share. As a result, we expect for the full year 2024, GAAP revenue in the range of $1.201 billion to $1.204 billion and adjusted operating income in the range of $416 million to $418 million. We expect non-GAAP net income in the range of $0.92 to $0.93 per share based on 378 million weighted average diluted shares outstanding. We expect unlevered free cash flow in the range of $420 million to $430 million, which consistent with historical reporting, excludes the impact of the restructuring and settlement payments in the quarter. Our full-year guidance implies negative 3% revenue growth and a 35% adjusted operating margin at the midpoint of our guidance range. Now, I will turn it over to the operator to open the call for questions. Operator Thank you. [Operator instructions] Please limit yourself to one question. Please stand by as we compile the Q&A roster. One moment for our first question. Our first question will come from the line of Alex Zukin from Wolfe Research. Your line is open. Alex Zukin -- Analyst Hey, guys, thanks for taking the time. I apologize for the background noise. Maybe just the first one. Henry, can you comment on just the demand environment, what you're seeing kind of exiting the quarter into Q4, how it's changed? I noticed a couple of new customers were kind of in, I would say, sectors very adjacent to your core, so that was kind of interesting. And then maybe as a follow-up on retention, you talked about gross retention getting better. Is that gross? Is that expansion? Is it both? And kind of how you see those trending over the course of the next three quarters. Henry Schuck -- Founder and Chief Executive Officer Yeah. Thanks, Alex. I think on demand environment, it's relatively unchanged from Q2. We're seeing really strong demand in the upmarket, particularly in the midmarket and the enterprise segment. In midmarket, we're seeing strong demand for Copilot. in our enterprise and strategic segments. We're seeing Copilot in the enterprise and a lot of DaaS and OperationsOS in the strategic segment of our business. The SMB segment, particularly the lowest end of the SMB continues to be challenged, particularly from a net retention perspective. Yeah. And I'll just add on top of that. Net revenue retention was 85% for the third quarter in a row, so reflecting stabilization there. We are seeing less down-sell pressure, specifically in midmarket, where we experienced a lot of that over the past two years. But we're also -- we have much more expansion and upsell opportunity from Copilot and then operations up in the enterprise. Operator Thank you. One moment for our next question. And our next question comes from the line of DJ Hynes from Canaccord Genuity. Your line is open. DJ Hynes -- Analyst Hey, thanks. So, Henry, you have this $1 per share in levered free cash flow target out there for '24. You also said that you expect to meaningfully grow that in '25. How much of that free cash flow per share growth in '25 is predicated on a recovery in revenue growth? I mean, can you get there without a bounce-back in the top line? Graham O'Brien -- Vice President, Financial Planning and Analysis Yeah. This is Graham. The way I think about this is there's a few levers to drive that meaningful growth in levered free cash flow per share. And the lever that we're going to prioritize is growing the top line. We're resourced for that. If we aren't achieving that, then it becomes a margin expansion lever and then continuing to retire shares, which we'll continue to consider. DJ Hynes -- Analyst OK. And then, Graham, while I have you, so sequential growth normalized is minus 2% in Q3. You're guiding to minus 2% in Q4. Is that a good way to think about the early part of next year given the new conservative guidance posture? And do you expect to return to positive sequential growth at any point next year? Graham O'Brien -- Vice President, Financial Planning and Analysis Yeah. We're going to be very conservative when we -- in our guidance period. And we again had positive momentum exiting the quarter in Q3 from an operational perspective, but we're going to be really conservative about the in-period assumptions in Q4. That's our largest expiring quarter. And with that level of activity, we're going to continue to be conservative from a guidance approach. One moment for our next question. Our next question will come from the line of Brad Zelnick from Deutsche Bank. Your line is open. Brad Zelnick -- Analyst Great. Thank you so much, and thanks for all the disclosure, but I'm hoping, guys, you can just help clarify the SMB dynamics. Because Graham, you say that the SMB changes are largely behind you. But Henry, you're also talking about a more conservative approach into your guidance methodology in next year. So, I guess two questions. I had thought in Q2, you cleared the deck, so to speak, as it related to charge-offs for your smallest customer segment. And that hit revenue in Q3, and it was a bit of a cleanup. Are we still seeing perhaps upon renewal customers that are in that segment that are not paying as expected? And are there additional charge-offs that are hitting Q3 and expected forward? And then related to that, as we think about the impact of the stricter credit that you're applying and credit practices in that segment, is that having a more pronounced effect than you would have thought when you came out of Q2? Or is what you thought consistent as you saw it perform in Q3? Thank you. Graham O'Brien -- Vice President, Financial Planning and Analysis Yeah. Thanks. I'll start. The charge in Q2 did clear the deck there, like that is not something that persisted in Q3. There's no real P&L volatility or continued impact from the change in estimate in Q2. What is happening is as we do disqualify high-risk SMB new sales transactions at a higher rate, it does create a growth headwind until we lap that in Q2 of next year. So, the way that we're thinking about this is that disqualification was up to $2 million plus per month in Q3, up from $1 million per month in Q2. And as we think about SMB, we expect SMB to decrease as a percentage of the business and actually potentially decline in ACV for a period of time until we lap the introduction of that new business risk model from last year. So, our focus is on prescriptively and efficiently capturing SMB business, and continue to believe that there's a high level of quality demand in the segment that we can grow with. And then the write-offs, again, we reserved against the P&L impact. We still have an elevated level of processing write-offs in Q3, but we saw that level abate as we exited Q3. And as we get further away from Q2 when we implemented the new business risk model, call it, six months, maybe nine months down the road, that's where we'd expect to start to see that benefit from higher quality SMB new sales and lower write-offs. Thank you. One moment for our next question. Our next question comes from the line of Elizabeth Porter from Morgan Stanley. Your line is open. Elizabeth Porter -- Analyst Great. Thank you so much for the question. I wanted to first in on some of the cost reductions that you guys have talked about, including some of the real estate changes that you've made. Any way we should think about some of the early guide rails on operational margin improvements as we look into 2025? Graham O'Brien -- Vice President, Financial Planning and Analysis I know we were at 37% in Q3, the guide for Q4 is 35%. There is some just timing between those two quarters rather than trajectory. But we think about this in the framework of levered free cash flow per share. And growing that next year and one of the ways to grow that, if not the way to grow that is to expand margin. Elizabeth Porter -- Analyst Got it. And then just as a follow-up, on the Copilot side, so it's good to see that adoption there. I just want to understand just given some of the headwinds that kind of we're seeing still across the macro, is Copilot adoption driving up average deal sizes across most of those customers that are taking it? Or is it viewed right now as an opportunity to keep renewals flat despite some of just the broader headwinds? Henry Schuck -- Founder and Chief Executive Officer Well, today, we are seeing double-digit growth on migration to Copilot. When we're migrating our customers, we are seeing that grow ASP when we do those migrations. Thank you. Our next question comes from the line of Raimo Lenschow from Barclays. Your line is open. Unknown speaker -- -- Analyst Hey, thanks for taking the question. This is Frank on for Raimo. Following up on that last one with another quarter in the market for Copilot, what's been the incremental feedback from customers around that? And what's the best way to think about that contributing to net retention in Q3? Graham O'Brien -- Vice President, Financial Planning and Analysis We've seen really positive sentiment from our customers on Copilot. Our customers are telling us that 25% of their pipeline is attributed to opportunities that were flagged to them through Copilot. 58% more meetings, more engagement from the emails that are being generated through our AI emailer. And so -- and we're seeing higher engagement in the utilization rates of customers on Copilot versus our legacy solution. And so, we feel really good about the product that we're building. We continue to add a tremendous amount of functionality to the product as well. And so, additional integrations, additional signals that will all drive additional engagement by our customers and take away go-to-market friction upfront. And so, we continue through Q4 to see really good momentum from Copilot. Operator Thank you. One moment for our next question. Our next question will come from the line of Parker Lane from Stifel. Your line is open. Parker Lane -- Stifel Financial Corp. -- Analyst Hey, guys, thanks for taking the question this afternoon. Henry, you look at the NRR stabilization, you see growth in the enterprise segment, maybe less of an emphasis on SMB long term. Wondering if you could talk about any further sales changes or just the absolute number of sales resources you have as you approach year-end and start thinking about how 2025 can be best set up for the business. Henry Schuck -- Founder and Chief Executive Officer Yeah. I think we've been on a phased journey to continue to move resources up market into our midmarket and enterprise segments. We think we have a continued opportunity in Q4 and then into 2025 to move resources from the lowest SMB segments up into our midmarket and enterprise segments and then drive a digital -- more digital self-serve in the lowest segments of our SMB business and manage that business much more efficiently with our PLG motion and free up resources to go into our upmarket segments where we're seeing meaningful growth and success and we want to capitalize on. Thank you. One moment for our next question. Our next question will come from the line of Brent Bracelin from Piper Sandler. Your line is open. Hannah Rudoff -- Piper Sandler -- Analyst Yes. This is Hannah Rudoff on for Brent today. Thanks for taking my question. Just one for me. I want to ask about the Data as a Service business. It sounds like you're seeing really solid momentum with your Copilot product. Just wondering if you're seeing equally strong momentum with the Data as a Service product. Graham O'Brien -- Vice President, Financial Planning and Analysis Yeah. We continue to see really strong momentum in our Data as a Service business and that business is growing 22% year over year. We feel really good about that. The adoption is really strong in our enterprise and strategic segments where they're leveraging that asset to build AI solutions to cleanse data in their CRMs and their data warehouses and their marketing automation systems. And we think that that's a business that will continue its momentum going into 2025. Operator Thank you. One moment for our next question. Our next question comes from line of Koji Ikeda from Bank of America. Your line is open. Koji Ikeda -- Analyst Yeah. Thanks, guys, for taking my question. I wanted to follow up on a previous question about the exit growth rate for 4Q and thinking about 2025. And so, when we do look at the exit growth rate in 4Q, it's a little bit lower than it was during the prior guide. And I get the really conservative part of that. But maybe help us understand a little bit more what we could underwrite in the business momentum, maybe one, two, or three positive drivers here that's giving us -- that could give us confidence that 2025 revenue growth would not be flat to even negative next year. Thank you. Henry Schuck -- Founder and Chief Executive Officer Yeah. The positive drivers that we're really focused on are upmarket right now. So, we're growing the enterprise business. And we continue to have an opportunity to reaccelerate that further in midmarket, specifically in our software vertical. We saw retention improve sequentially for the second quarter in a row after multiple quarters of decline. That's really where we had the most down-sell pressure over the last two-plus years. So, we're really just balancing that with being selective in the SMB and finding the right growth balance between the three segments. Graham O'Brien -- Vice President, Financial Planning and Analysis And while we're seeing good momentum continue in October and into November, we're going to continue to be conservative with our guidance. Thank you. One moment for our next question. Our next question will come from the line of Taylor McGinnis from UBS. Your line is open. Taylor McGinnis -- Analyst Yeah. Hi. Thanks so much for taking my question. Maybe on the SMB side. So, I know you mentioned disqualifying more than $2 million of higher-risk new sales per month versus $1 million prior. But to clarify, is that on existing customer renewals? Or is that new logos? Because I'm just curious how we should think about the growth algorithm, I guess, in the near term being maybe more weighted toward existing expansions versus new logo sales? And then just quickly as a follow-up, in terms of the guide, was there any changes that were embedded in the 4Q guide in terms of how you're thinking about the headwind from SMB and what that might have been? Thanks. Graham O'Brien -- Vice President, Financial Planning and Analysis Yeah. Thanks for the question. That disqualification numbers, those are new business, new logo driven. So, $1 million in Q2 per month of new business ACV that we're disqualifying, and then that number has increased to $2 million with our updated model in Q3. And then on the guide, yes, that disqualification is a near-term headwind to new sales ACV but, at the same time, either high-risk customers that were very unlikely to pay, and that will quickly turn into a midterm tailwinds as we have a higher quality of revenue in 2025. One moment for our next question. Our next question will come from the line of Arti Vula from JPMorgan. Your line is open. Arti Vula -- JPMorgan Chase and Company -- Analyst Hey, thanks for taking the question. This is Arti on for Mark Murphy. My question was, I know there's kind of a lot of moving pieces in terms of hiring in the installed base. But for some of these companies that are really investing in kind of agentic solutions and hiring behind that, are you seeing any of that benefit across your installed base, maybe across the larger customers? Thanks. Henry Schuck -- Founder and Chief Executive Officer Sorry, I just want to make sure I understand the question. Is this companies that are building agentic solutions for the broader market or who are building it for their own use cases? Arti Vula -- JPMorgan Chase and Company -- Analyst Yeah, that's correct. Building it for the broader market and kind of hiring sales reps to go out there and sell that. Henry Schuck -- Founder and Chief Executive Officer Got it. For the broader market, we're not seeing those types of customers come in. I think where we are seeing that benefit is where internal large customers are building their own AI solutions for internal usage for their own sellers to use where they're leveraging our DaaS solutions to be the foundational data component to those solutions. One moment for our next question. Our next question will come from the line of Jackson Ader from KeyBanc Capital Markets. Your line is open. Jackson Ader -- Analyst Great. Thanks for taking our questions, guys. I just had a question about the kind of the difference between SMBs and the midmarket. So, I'm just curious like what is it that SMBs are -- why aren't the SMBs seeing the value that a midmarket customer would that's kind of keeping them from staying on the platform and expanding with ZoomInfo at the moment? Graham O'Brien -- Vice President, Financial Planning and Analysis I think a big portion of our SMB base is seeing the value and we can grow with those customers. This is really a lower end of SMB cash question where we want to make sure that we are not extending credit to high-risk customers. So, there's a broad swath of SMB, where we want to go and sell to those customers and grow with those customers. Jackson Ader -- Analyst OK. And then I guess for a quick follow-up, I mean, if we think about -- take all the noise from the last few years, right, the pandemic noise kind of out of our -- if we think to a pre-pandemic life versus today, how should we be thinking about your -- the data moat, right, today relative to your competition? Is it wider? Is it narrow? Or is it about the same? Henry Schuck -- Founder and Chief Executive Officer We feel really good about our data moat. We continue to grow our contributory network. We continue to grow our community network. We're now expanding that data moat with a variety of new signals that we're ingesting and integrating into our platform. And so, from a data perspective, they're more contributors, they're more community members, there's more signal data that we're licensing and integrating into our Copilot product. And so, that ecosystem is getting larger. And so, I feel really good about the data moat continuing to expand. One moment for the next question. Our next question comes from the line of Michael Turrin from Wells Fargo. Your line is open. Michael Berg -- Analyst Hi. You got Michael Berg on for Michael Turrin here. Thanks for the question, and congrats on the quarter. I wanted to get a better sense of maybe a better characterization of what the incremental conservatism is including here. You talked a lot about the write-downs and the ongoing macro, but maybe some incremental color there. And then I got a quick follow-up. Graham O'Brien -- Vice President, Financial Planning and Analysis Sure. We value consistency with the guide, and we're going to craft guidance with an expectation that we can meet or exceed the ranges provided. As Henry indicated, we intend to take a conservative approach to our guidance communications going forward. And part of that is discounting positive operating momentum from recent quarters. The general philosophy is that we model and consider a wide range of outcomes based on all the information we have at hand at the time. Michael Berg -- Analyst Got it. Helpful. And then in terms of the Copilot, you mentioned $60 million in ACV. Is that incremental to the $18 million in Q2 you saw? Or is it $60 million total since launch? Graham O'Brien -- Vice President, Financial Planning and Analysis That's an exiting total, so that includes the $18 million. One moment for our next question. Our next question will come from the line of Brian Peterson from Raymond James. Your line is open. Johnathan McCary -- Raymond James -- Analyst Hey. Thank you. This is Johnathan McCary on for Brian. Just one from us here. Is there any update you can share on the call about ARR split by vertical and how that's performing? Graham, you answered this in part in the software ARR stabilizing or -- software NRR stabilizing. But curious to hear about how the traction is building outside of the software and tech exposure more broadly, if you can give anything there. Thanks. Graham O'Brien -- Vice President, Financial Planning and Analysis Sure. Yeah. We had software retention improved sequentially for the second quarter in a row after declining back through, I think, the end of 2021. The other verticals, at least we're continuing to see across some of them double-digit growth, if not high single-digit growth. One, a couple of them that we wanted to highlight were manufacturing had strong growth in Q3 as did finance, transportation, and logistics. One moment for our next question. Our next question will come from the line of Tyler Radke from Citi. Your line is open. Tyler Radke -- Citi -- Analyst Yeah. Thanks for taking the question. As you look out at NRR, can you just walk us through the puts and takes there? It sounds like you are seeing some positive momentum on the enterprise business and presumably the focus on higher-quality customers should provide a benefit to that. So, when do you think that starts to improve? And then secondly, as you think about the initiative to reduce the lower quality customers, I believe you talked about kind of extending the restrictions for prepayment to 55% of the customer base. Is that kind of as high as you think you'll go? Or do you think that there's further enforcements and room to take that higher? Thank you. Graham O'Brien -- Vice President, Financial Planning and Analysis Sure. On the puts and takes into retention, enterprise certainly getting that -- maintaining and getting that above 100% and then getting midmarket back closer to 100%, like those are the big drivers of improving retention over time. One of the things we want to call out in retention is that this is a trailing 12-month or year-over-year view. So, the in-period activity effectively takes a little bit longer to show up in that year-over-year view, and we're optimistic about the trajectory there. And then on the disqualification, I guess, that's the clip that we have right now coming out of Q3. I would characterize it as this is the level -- that $2 million plus we would expect to continue at a minimum at that level moving forward and continuing to run the greater portion of our new sales pipeline through this new business risk model. I think just -- if I just add it on there, I think if you're thinking about where -- if I'm thinking about where I see the opportunity from an NRR perspective, I think, first, in the midmarket and enterprise segments of our business, we have this real opportunity with Copilot, where we're gaining momentum in our ability to take that to the customer base. It helps us when we attach from an upsell perspective or on a renewal perspective. There are also places where it's helping us mitigate down-sell. And I think we're seeing that with the improvement in midmarket, particularly in the software sector, where we're able to leverage Copilot to get that segment back to growth. And then in our way upmarket segment, our strategic segment, I think what we're seeing there is much more interest in our DaaS solutions as they continue to build AI internally and they need cleansed and accurate and complete data assets to be able to do that. And so, we're pushing on Copilot in midmarket and enterprise. We continue to see great growth from a DaaS and operations perspective in the strategic segment. And then in the SMB segment, we're bringing on much healthier customers today who are paying us upfront. And so, we get a dual benefit of that once we lap that at the moment in time where we started doing that in Q2 of this year. We'll see that in Q2 of next year where we have this healthier customer base who paid us upfront and so we won't have the headwind of write-offs. And then we have a -- and we've disqualified the riskiest, highest churn customers out of that cohort anyways. And so, we end up with a healthier group of customers. And in new business, we're selling more midmarket and enterprise customers upfront. And so, the installed base is much healthier when you lap Q2 of next year. Operator Thank you. And our next question will come from the line of Rishi Jaluria from RBC Capital Markets. Your line is open. Rishi Jaluria -- Analyst Wonderful. Thanks so much for taking my questions and apologies for any background noise. Just really quickly, I want to hit again on Copilot. Maybe help us understand how do you feel about your right to win in Copilot, especially versus maybe more neutral platforms that can integrate their data? And if you think about maybe the whole kind of argument of Copilot versus agentic AI, can you talk about some of the potential agentic capabilities that you are or intend to build out some of that? Thank you so much. Henry Schuck -- Founder and Chief Executive Officer Yeah. Look, I think a couple of things. First of all, we really believe that if you're trying to build any go-to-market AI on top of just your internal data or potentially data that lives in your CRM or your data warehouse, if you're trying to build go-to-market AI on top of those data assets, and we're hearing this from our customers, they just can't build solid AI solutions with that data. Not only do you need data that's cleansed and accurate, but the information that lives inside of your systems of record, they don't give you a complete picture of the market in front of you. It's not your total addressable market. It's not dynamic data that's constantly changing with news releases and job postings and earnings calls and interviews, and expert calls. All of that information is constantly changing, and that's not appearing in a dynamic way inside of your CRM or your data warehouse. And so, when you go try to build go-to-market AI on top of static scale and almost always outdated data, you're going to get a pretty bad AI solution on the other side of it. And so, we have a lot of confidence that the foundation that we start with are the best B2B data asset in the world is the foundation that you need in order to build AI for go-to-market. And then anybody else who starts with a foundation that's any different than that just ends up at roadblock after roadblock after roadblock. And so, we absolutely believe that the B2B data asset that we've put together over the last 20 years, in addition to all of the new signals that we're adding on top of that data asset, gives us the right to win or go-to-market AI and to be the go-to-market AI platform of the future. When we think about agentic additions to the platform, the way we think about it is, first, you have this data foundation that gives you a full view of any company's total addressable market, including the companies, the people at those companies, the signals that they're demonstrating that would tell you whether they're in market or not. And then we use that foundation to start building out the different tasks that an account executive, an account manager, an SDR is doing every day. We start with prospect research, we move to account planning, we move from there to flagging risk in the customer base to building the communications to reach out to customers, to building the follow-ups to reach out to customers. And so, we're taking every slice of what an account executive, an account manager, an SDR, a rev ops, and a sales op professional does, and we're using the AI capabilities to automate those tasks out of their day-to-day, and we're building that on the only data foundation you can actually build go-to-market AI on top of. Thank you. One moment for our next question. Our next question will come from the line of Patrick Walravens from Citizens JMP. Your line is open. Patrick Walravens -- Analyst Great. Thank you. Henry, how do you see the space consolidating over the next few years? If I step back and look at it, I feel like there's five segments. There's data, there's revenue enablement like Seismic, there's engagement like SalesLoft and Outreach, there's conversational intelligence like Gong, there's revenue forecasting like Clari. You guys have a lot of -- a little bit of these categories already. Where does this all go? Henry Schuck -- Founder and Chief Executive Officer Listen, I'm of the fundamental belief that when generative AI came to the market, a gun went off to a new race. And a lot of competitors or people in the space laid back and said, "Oh, we're going to see how this plays out." And we leaned in, and we put a bunch of investments between product and engineering and our teams behind Copilot. We enabled our go-to-market teams. We rearchitected our platform to be AI first, and we leaned into this opportunity. And so, I think like all of the segments that you see today will be fundamentally changed over the next two to three years. But the constant, the constant in all of that is that every one of those solutions is going to need the highest quality data as its foundation to build AI for the future. And so, I think we're fundamentally benefited from the fact that in this space with a lot of different players doing a lot of different things, we start with the foundational asset that you need to build AI. We have the scale in this space, we leaned in at the right time, and we're going to continue to build AI around the only data foundation you can build go-to-market AI around. Patrick Walravens -- Analyst Awesome. And if I could ask a follow-up. You made an interesting comment in your remarks about reactivating dormant seats with Copilot. Can you explain that a little more? Henry Schuck -- Founder and Chief Executive Officer Sure. I think they are -- like across any user base, there are users who are leveraging the platform in a day-to-day or week-to-week motion, and then there are users who are not. And what Copilot has done for us is it's reactivated a number of seats that were historically being unused as frequently as we would like to have seen them use. And we're doing that because now, day to day, we are sending -- or every day, we are sending our users and our customers key signals on their target accounts. And so we're able to understand who their target accounts are. We're able through our AI to understand what would be happening within those target accounts that they would care about. And so -- and then we're using all of that data, that intent data, those earnings call transcripts, podcast interviews, job posting to identify key moments at those target accounts and then deliver that to our customers through email, through Slack and Teams messages, through notifications on mobile. And so, we're putting the key moments happening at their customers right in front of them and then giving them one click to engage with the right buyers at those companies. Thank you. Now, I'll turn it back over to Henry for any closing remarks. Henry Schuck -- Founder and Chief Executive Officer Great. Thank you, everyone, for joining us tonight. We realize that one or two quarters do not make a trend line, but we are excited about the operating momentum in the business and the number of green shoots we are seeing. We continue to believe that the best path for long-term shareholder value creation is to delight our customers, and by doing so, grow levered free cash flow per share, and we continue to expect to do that.

PubMatic (PUBM) Q3 2024 Earnings Call Transcript | The Motley Fool

Hello, everyone, and welcome to PubMatic's third quarter 2024 earnings call. My name is Kelsey, and I will be your Zoom operator today. We thank you all for your attendance today. And as a reminder, this webinar is being recorded. And now, I would like to turn the call over to Stacie Clements with The Blueshirt Group. Stacie, over to you. Stacie Clements -- Investor Relations Good afternoon, everyone, and welcome to PubMatic's earnings call for the third quarter ended September 30th, 2024. This is Stacie Clements with The Blueshirt Group, and I'll be your operator today. Joining me on the call are Rajeev Goel, co-founder and CEO; and Steve Pantelick, CFO. Before we get started, I have a few housekeeping items. Today's prepared remarks have been recorded, after which Rajeev and Steve will host live Q&A. If you plan to ask a question, please ensure that you've set your Zoom name to display your full name and firm. If you would like to ask a question, please use the raise hand function located at the bottom of your screen. A copy of our press release can be found on the website at investors.PubMatic.com. I would like to remind participants that during this call, management will make forward-looking statements, including without limitation, statements regarding our future performance, market opportunity, growth strategy, and financial outlook. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy, and future conditions. These forward-looking statements are subject to inherent risks, uncertainties, and changes in circumstances that are difficult to predict. You can find more information about these risks, uncertainties, and other factors in our reports filed from time to time with the Securities and Exchange Commission and are available at investors.PubMatic.com, including our most recent Form 10-K and any subsequent filings on Forms 10-Q or 8-K. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution you, therefore, against relying on any of these forward-looking statements. All information discussed is as of November 12th, 2024, and we do not intend and undertake no obligation to update any forward-looking statement, whether as a result of new information, future developments, or otherwise, except as may be required by law. In addition, today's discussion will include references to certain non-GAP financial measures, including adjusted EBITDA, non-GAAP net income, and free cash flow. These non-GAAP measures are presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance with GAAP. A reconciliation of these measures that are the most directly comparable GAAP measures is available in our press release. And now, I will turn the call over to Rajeev. Rajeev Goel -- Co-Founder and Chief Executive Officer Thanks, Stacie, and welcome, everyone. Our third quarter results exceeded expectations on both the top and bottom line. Revenue in the quarter grew 13% year over year. Clients continue to build their advertising businesses on our platform, and we are becoming more embedded into clients' tech stacks and more integrated across the ecosystem. Over the last few months, driven by the strength and scale of our CTV solutions, as well as the depth of our expertise, we capitalized on the surge of political advertising demand. In just a few short years, we have organically scaled our CTV business, and we now work with 70% of the top 30 streaming publishers. Even as we further penetrate the head of this market, where the bulk of consumers are spending their time, we also have tremendous opportunity to expand our existing streamer relationships. On average, CTV monetized impression volume was up over 100% year over year for the third straight quarter as we have reached a critical mass of streaming inventory to meet the surge in ad demand on our platform. Included in this surge was greater-than-expected activity from political advertising, which was heavily focused on CTV. Certainly, the increase in streaming inventory on our platform drove growth in this category, but more impactful is our ability to quickly build new products that drive incremental growth. In Q3, we launched new tools to help unlock streaming inventory in order to better capitalize on political ad budgets. For context, many publishers typically block political ads altogether as a way to protect the user experience from unwanted political issues or candidates. But this is a blunt strategy and leaves money on the table. We developed a better approach for streamers utilizing generative AI technology. Our solution classifies each ad on granular criteria, such as political party, federal, state or local candidate, or issue, sentiment, and more. As a result, more than 250 incremental publishers and streamers that have historically blocked political ads chose to open their inventory to PubMatic for political campaigns that meet their user experience criteria. This enabled us to scale political spend on our platform much faster than we expected as buyers were able to reach the audiences they were targeting, while content creators maintained control over their inventory. Further, political buyers were able to leverage Connect to curate rich political data sets on PubMatic inventory for targeted higher ROI advertising. This underlying gen AI technology will have ongoing applications as we leverage it in other ad sensitive categories or markets such as language and sentiment detection. Looking forward, we'll continue to build solutions that unlock inventory and increase monetization. This includes our recently launched CTV Marketplace, which offers real-time inventory curation along numerous dimensions built on sell-side technology. With the simple opt-in, streamers can unlock more value from their inventory while making it easier for buyers to access premium content and targeted audiences. For example, ad buyers specifically looking to reach sports fans can leverage our off-the-shelf and easy to buy live sports inventory. DirectTV Advertising and Roku are already leveraging PubMatic's CTV Marketplace with positive feedback from both publishers and buyers. As the CTV Marketplace grows, we believe it will create stickiness for our CTV business. We continue to onboard new streamers, growing our streaming customer count by 13% year over year to over 280. For example, we recently signed Xumo, a joint venture between Comcast and Charter that offers streaming devices and services to tens of millions of customers per month. Through this partnership, PubMatic will bring demand from our SPO relationships across their content portfolio, including Xumo Stream Box, Xumo TV, and its FAST app, Xumo Play. Also aiding our growth are agencies and advertisers that increasingly consolidate buying on PubMatic. Half of our activity is from SPO as buyers move more ad spend to our platform due to our growing technology, workflow, and data capabilities. Major agency holding companies have moved and are in the process of moving direct buys on behalf of their clients to our platform to capitalize on their supply path optimization relationships with us, including through Activate. Earlier this year, dentsu launched Merkury for Media, which is a centralized data, media activation, and creative execution platform that is being rolled out across its agencies. We are thrilled to partner with dentsu on this transformative initiative as PubMatic technology is being integrated at the center of Merkury for Media. PubMatic's Connect will increase audience reach and cost efficiency, particularly within CTV and streaming. Activate will provide end-to-end cookie-less digital media activation and measurement at scale. Our platform sits at the intersection of data, commerce media, SPO, omnichannel inventory, and global scale. Our innovative technology and differentiated approach are what enable us to scale with our clients and partners as they build integrated digital ad businesses. It's also why clients and partners choose PubMatic. PubMatic's SSP is one of the only omnichannel platforms with a scaled SDK footprint which seamlessly integrates directly into publishers' apps. This key differentiator was just one of the reasons that one of the largest global mobile mediation platforms expanded their partnership with us. We are now a certified bidder and exchange partner, making it easier for app developers to integrate our solution with the click of a button, streamlining access to PubMatic's valuable advertising demand that app publishers have historically struggled to access at scale. The partnership expansion brings more than 80,000 global app developers into our sales funnel, creating a significant growth opportunity for us. Our mobile app business grew over 20% year over year for the fourth consecutive quarter. Our strong foothold in this market positions us well for continued growth. Per MAGNA's forecasts, 58 billion in mobile app ad spend is expected to flow through the Open Internet this year. The value of our comprehensive, integrated platform offers multiple new revenue streams and TAM expansion opportunities, like commerce media. As retailers and transactional commerce companies lean into advertising as a major revenue and profit driver, they are realizing their need for SSP technology. For example, PubMatic's integrated platform allows Western Union to scale its advertising initiatives more effectively. Originally integrated to support onsite monetization, we have recently expanded our partnership as they launched their Western Union Media Network earlier this year. Using Convert, Western Union will leverage our offsite media solutions, applying insights from their 115 million annual consumer money transfer transactions in the U.S. across PubMatic's premium inventory. This gives them the power to manage their monetization strategy via a single, unified tech stack, streamline operations, and enhance efficiency. At the same time, the publishers integrated into our SSP benefit from unique ad budgets only available on the PubMatic platform when Western Union data is applied. The added value customers receive through solutions like Convert also creates incremental revenue opportunities, such as data and SSP fees, for PubMatic. Another vector for our long-term growth includes social media companies entering the open internet arena, as they expand their ad businesses outside of their own walled gardens. To do this, they need solutions to help them monetize their audiences, curate their inventory, and access open internet ad budgets. Signaling a strategic focus, many of these companies have hired programmatic leaders with industry expertise and are partnering with PubMatic to help them build and scale. We are particularly excited to launch advertising with X, formerly known as Twitter, which serves more than 335 million users. Historically, X had only accessed social media ad budgets. They selected PubMatic as an SSP partner, opening up their traditionally closed ecosystem to tap into the 26 billion in open internet native display and video ad spend. PubMatic is able to build differentiated solutions across these customer segments because of the strength of our integrated platform and our consistent track record of organic innovation. Over the last two years, we've been successfully adopting generative AI technology across our software development, testing, and release process. We estimate a 10% to 15% increase in engineering productivity so far this year with more gains to come. What's even more exciting is that we are also leveraging new AI capabilities in customer-facing solutions to drive higher revenue. In Q3, we hosted our first AI-focused hackathon, where internal teams take two days to ideate and innovate around the clock. An annual tradition since 2014, this was our largest hackathon to date. More than a third of our global employee base participated across 90 teams. One-third of the submissions incorporated AI and machine learning. The idea creation and collaboration were inspiring, highlighting PubMatic's deep commitment to innovation and technology. The AI-based creative classification tool that helped publishers monetize political ad budgets across our CTV inventory came from our hackathon. I'm particularly pleased with how quickly we were able to launch it in our live environment in time for this year's election cycle. Looking ahead, we have a number of additional customer-facing applications on the horizon related to reporting, private marketplace deals, and workflow. I recently spent time at Advertising Week in New York, where conversations were centered around the need for end-to-end supply chain control, transparency, efficiency, effectiveness, and privacy. We'll continue to innovate and invest in key growth areas to drive greater value across the ecosystem. As publishers, buyers and data partners build and scale their ad businesses, they must address the complex needs of the evolving ecosystem, with sell-side technology becoming a critical component. The growing importance of sell-side technology has led Forrester to address the SSP category for the first time in more than a decade. I couldn't be more proud of our team's vision and their accomplishments. PubMatic was recognized as an SSP leader in The Forrester Wave, achieving the highest possible scores in the criteria of programmatic auctions, publisher protections, commerce media, and innovation. Our platform provides a foundation for innovation and expansion for many of our clients across the ecosystem, including publishers, app developers, agencies, and commerce media platforms. Plus, the strength of our leading SSP is driving new entrants to the open internet sector to select PubMatic as their tech partner. These trends have resulted in significant growth in key secular areas of the business, and I'm excited by the large opportunity in front of us as content creators and buyers alike choose PubMatic to scale their ad businesses. I'll now turn the call over to Steve for the financials. Steve Pantelick -- Chief Financial Officer Thank you, Rajeev, and welcome, everyone. Revenue grew 13% over Q3 last year, above expectations, driven by strong growth in CTV. In addition, we successfully monetized more inventory against a strong political ad buying cycle. Even more exciting, our business grew 17% year over year, excluding political advertising and the large DSP buyer that I called out earlier this year. Highlighting our differentiated infrastructure approach, gross profit increased at an even faster pace. Due to the combination of cost management, productivity improvements, and an increasing proportion of high value impressions like CTV, gross profit was up 23% year over year. Other important call outs in the quarter. We increased monetized impressions across all formats and channels with the fastest growth coming from omnichannel video impressions at nearly 50% growth year over year. With the growing mix of video, our overall platform CPM also increased. In addition, our emerging revenue streams more than doubled year over year and contributed an incremental 3 percentage points of year over year growth. Our Q3 performance underscores the value of our diverse omnichannel platform and the significant impact of our strategic multi-year investments in key secular growth areas. It also demonstrates the strength of our durable model and our ability to deliver profitable growth. We delivered adjusted EBITDA of 18.5 million, or 26% margin, ahead of expectations. Breaking down Q3 by format and channel. We saw continued secular growth above market rates for omnichannel video revenue, which grew 25% over Q3 last year, an acceleration from last quarter's 19% growth. The share of omnichannel video revenue to total revenue hit an all-time high of 36% in the quarter. Notably, CTV monetized impressions more than doubled over last year. Our mobile app business continued to perform strongly and grew over 20% year over year for the fourth quarter in a row. Our display revenues across both mobile and desktop channels grew 9% year over year. We saw strong organic growth as our existing publisher revenues on a trailing 12-month basis continued to grow with net dollar-based retention at 112%. SPO represented approximately 50% of total activity on our platform. Underscoring the long-term strategic value and stickiness of these relationships, the trailing 12-month net spend retention rate from SPO partners with at least three years of spending on our platform was 113%. Across the globe, all regions grew in the third quarter. Looking at growth in ad spend, the top ten ad verticals inclusive of political increased by 20% year over year. Among the four verticals that I commented on last quarter, we saw some recovery in travel and arts and entertainment, while technology and automotive remained soft. Shifting to our operating priorities, we continue to make significant progress. As a reminder, our priorities are focused on delivering multi-year revenue growth and incremental margin expansion. First, we continue to invest in areas where we see the highest revenue growth opportunities. We have added over 100 team members in sales and technology since Q3 of last year. As a result of our innovation and focused sales efforts, we have reached critical mass in our CTV business and are seeing strong CTV growth as buyers and publishers are making us a preferred partner. We are also investing in supply path optimization to address the large greenfield opportunities from independent agencies and direct brands. We have filled the majority of the buyer focused sales positions we had planned to hire this year. As these team members ramp, we expect increased productivity that will position us well for continued growth in 2025. And our investment in people and technology to drive emerging revenues is paying off. As I mentioned, emerging revenue streams contributed 3 percentage points of growth in Q3 and is on track to be 4% to 5% of total revenue in Q4. We are at the early stages in the adoption cycle of these products. And looking ahead, we anticipate that these innovative solutions will continue adding meaningful incremental revenue and profitable growth in 2025 and beyond. Second, we continue to prioritize efficiency and operational excellence by optimizing our infrastructure and making prudent investments in capex. As a result, we have increased capacity on our platform, while improving margins and unlocking dollars to fund new products. We added 20% incremental gross impression capacity on our platform year-over-year. At the same time, software optimization initiatives led to lower unit costs. The cost of revenue per million impressions was down 18% on a trailing 12-month basis. This productivity contributed to the 23% gross profit increase year over year, which was an acceleration over Q2's growth of 10%. Overall, the progress we have made against our operating priorities has allowed us to return value to shareholders through our expanded share repurchase program. For example, we increased the pace of repurchases in Q3 to 29 million and bought back 1.8 million shares or 3.3% of fully diluted shares outstanding. Moving down the P&L. Q3 GAAP operating expenses were 47.6 million or 3% sequential increase from Q2 as we made targeted investments in technology and sales team members. Q3 GAAP net loss was 0.9 million, or loss of $0.02 per diluted share. Adjusted EBITDA was 18.5 million, or 26% margin. Moving to cash and our capital allocation. We have a healthy balance sheet and generated positive cash flow which supports our long-term capital allocation strategy. We believe a strong capital structure and effective capital allocation plan will help us deliver long-term shareholder value. We ended the quarter with 140.4 million in cash and marketable securities and zero debt. Since the inception of our repurchase program in February 2023 through the end of Q3, we have bought back 7.6 million class A common shares for 124.1 million. As of the end of the third quarter, we had 50.9 million remaining in our repurchase program authorized through December 31, 2025. In Q3, we generated 19.1 million in net cash provided by operating activities. Free cash flow in the quarter was 2.9 million and was impacted by the two items I called out last quarter: one, the timing of our capex investments which peaked in Q3; and two, the increase in DSOs resulting from a change in our receivables mix associated with the auction changes made by one of our large DSPs. We view this DSO change as a short-term phenomenon that will work its way through our working capital by mid next year. Now turning to our outlook. We are pleased with the growth we're seeing, particularly from secular growth drivers, and we remain cautiously optimistic as we head into the peak holiday season. In October, omnichannel video revenues grew in the double-digit percentages and political advertising continued its strong momentum. As we had expected, spending from the large DSP we called out earlier this year was steady, though as a reminder, at a reduced level year over year. In terms of Q4 holiday spending, trends were muted leading up to the election. Taking all of these factors into account, we expect revenue in the fourth quarter to be in the range of 86 million to 90 million. On an apples for apples basis, excluding political advertising and the DSP buyer, the implied year-over-year revenue growth in the fourth quarter is over 15%. As a reminder, we will lap the DSP impact at midyear 2025. For the full year, we have raised our revenue guidance to be between 292 million and 296 million, or 10% year-over-year growth at the midpoint, including the negative impact from the DSP buyer. In terms of costs, we expect Q4 GAAP costs to increase sequentially in the low single-digit percentages. With our revenue guidance and targeted investments associated with our operating plan we expect Q4 adjusted EBITDA to be between 34 million and 37 million, or approximately 40% margin at the midpoint. For the full year, we expect adjusted EBITDA to be between 89 million and 92 million, or approximately 31% margin at the midpoint. In summary, we are pleased with our Q3 results and the growth we're seeing across the business especially in CTV. Our investments in the secular growth areas of video and mobile are showing excellent results and we are building the pipeline for further incremental growth in the future with our emerging revenue products. Heading into 2025, the combination of our strong financial health, momentum in the fastest growing areas of programmatic advertising. And our differentiated, scaled technology platform gives me confidence that we are well-positioned to deliver significant value to our customers and shareholders. With that, I will turn the call over to Stacie for questions. Stacie Clements -- Investor Relations Thank you, Steve. As a reminder, you can ask a question by raising your hand located on the dashboard. If you're on your phone, please press star nine. In the interest of time, we ask that you please limit your question to one and one follow-up. Our first question today comes from Shweta Khajuria at Wolfe. Well, please go ahead, Shweta. Shweta Khajuria -- Analyst Thanks, Stacie. Let me try two, please. One is on what you've seen in terms of demand trends quarter to date from advertisers, as well as just consumer spend. If you have that visibility, that would be great, but specifically advertiser spend. And then, the second one is next year. So, Steve, as you think about next year with headcount opex, how are you positioning the company in terms of your goals for next year especially in light of maybe there was some change around 1% of headcount fairly recently. Thanks a lot. Steve Pantelick -- Chief Financial Officer Sure, nice to reconnect, Shweta. So, first, with respect to recent trends, you know, as I shared in the prepared comments, we started off the quarter very well. Omnichannel video continued its double-digit growth as it has all year long. And we saw, you know, continued very strong political. And as others have commented on, the political spending has been significant across the ecosystem, and that did seem to mute holiday spending. But as a reminder, we are going into the peak holiday spending, you know, mid-November onwards. So, from our perspective, you know, all the fundamentals are very positive. I shared the statistic that if you just look at the business that excludes the DSP change, excludes political, compared to last year, in the third quarter, that grew 17%. And the implied guidance that I shared is over 15%. So, our core business is very healthy. We're cautiously optimistic about the fourth quarter. But big picture, you know, we're doing all the right things in terms of investing in the right areas behind all the long-term secular growth drivers. Now, with respect to 2025, I'd say from our long-term perspective, we've always focused on efficiency and productivity. And that's not going to be any different going into 2025. And one of the things that we're going to do is to look for opportunities around efficiency. Rajeev shared some of the points around AI. But it's also going to be around productivity. So, I would say that we're probably not going to add as many people in the team as we did this year or prior years and really get more leverage. And primarily it's because we did a lot of really targeted hiring for the roles that we need, and they're in place. And so, we're feeling really good about the level of resources in the market right now. Our next question comes from Matt Swanson at RBC. Please go ahead, Matt. Matt Swanson -- Analyst Yeah, thank you so much for taking my question. Maybe building off Shweta's question, and you mentioned the hundred team members in sales and technology, could you expand a little bit about kind of the go-to-market motion with these new products and the emerging revenue stream and kind of how you're able to let people know the value proposition for them? Rajeev Goel -- Co-Founder and Chief Executive Officer Sure. Yeah, why don't I take that one? Hey, Matt, how are you? So, I think a big part of what we've been doing over the last couple of years and is continuing is to get deeper and closer on the buy side of the ecosystem, such with agencies and advertisers, primarily given our SPO value proposition. We mentioned earlier in the call that we're now 70% penetrated into, for instance, the top 30 streamers. You know, we're growing the commerce media business. We announced Activate partnership and Connect with dentsu. So, we really think that it's important that we engage with a growing sector of the -- of the buyer ecosystem. And while a couple of years ago we started with the agency holdcos, there's no shortage of large advertisers that also want to engage in supply path optimization, along with independent agencies. So, the go-to-market is really a combination of two things. One is we have relationship focused people on the buy side. So, they're covering the big buyers. And then, more recently, we moved to -- or in the process of moving to a specialist sales structure where we will have product specialists that are going in, you know, with those relationship folks in order to expand those relationships. So, we think that's a critical part of the opportunity. Again, the dentsu example is a good one, where we've been working with them with SPO for quite some time, and now expanding that into Connect and into Activate. You know, GroupM is another good example where we've been powering the premium marketplace for a number of years, and we've had a steady geographic expansion. We started in Europe, then into the U.S., and now, most recently, into Latin America. Matt Swanson -- Analyst That's super helpful. And maybe just a question on the DSP change. We talked a bit last quarter about the need to do some algorithm optimization post the change and about that taking some time. Could you just kind of give us an update? I know it's still early on, just what you're seeing from your reaction to the reaction, I guess. Yeah, happy to. So, one of the things that I commented, as Rajeev as well, that, you know, it was a process that we're going to work through and we had confidence that we're going to be able to do that. And the good news is that the spend from this buyer has stabilized. And so there was an adjustment at midyear. And, you know, since then, it's been steady going. So, I'd say that as we call that, it's a change in the level of spend but not the change in terms, you know, of how we're operating with that DSP. And we feel very enthusiastic about the ability to grow that over time. But we are going through an adjustment period as noted, you know, last quarter and this quarter and we will for the first half of '25. But the key point to note is the rest of the business, which is, you know, the majority of the business, over two-thirds, is growing significantly, you know, in the third quarter, 17% slated to grow, 15% in the fourth quarter. So, the fundamentals of our business are very robust. We see the DSP change as -- in the rear view mirror, and we're just working through it now. Rajeev Goel -- Co-Founder and Chief Executive Officer Yeah, maybe I can just add a quick comment on that. So, it's true, of course, Matt, that we're going to have a bit of a headwind with that DSP until middle of next year. But to Steve's point, you know, we're getting much more deeply embedded into advertising-driven businesses. You know, the X announcement, the supply path optimization with dentsu with Connect and Activate, you know, Western Union in commerce. We've expanded the Roku relationship into CTV marketplaces. So, these are all, I think, good examples of how we're getting more and more embedded into really large players in the advertising ecosystem. What I'm really excited about is how the pieces are very much overlapping and reinforcing. So, when we engage in supply path optimization, that brings more streamers and publishers and commerce media customers to our platform because they want access to those dollars. Commerce media partners, they bring more streamers to us because we can overlay the commerce data onto the streaming inventory. And then, commerce and Connect participants, they create more bids for our publishers, which generates more revenue for them. So, I think we're getting into a really interesting point here where all of these pieces are coming together and reinforcing each other. Our next question comes from James Heaney at Jefferies. Please go ahead, James. James Heaney -- Analyst Great. Thank you for taking the question. Rajeev, what do you think is helping you get to critical mass in CTV? Is that due to the increased focus on your buy-side solutions? Or do you feel like the big difference is the amount of CTV supply growth that you're seeing? Rajeev Goel -- Co-Founder and Chief Executive Officer Yeah, I think it's a combination of a couple of things. One is technology innovation. And then, the second is our SPO buyer relationships. And then, the third is what I was just referencing. But, you know, all of the pieces coming together like Connect for curation and data, as well as commerce media and Activate. So, just to kind of unpack that a little bit, we built I think a very significant now CTV business organically, right, over the last couple of years. So, we're excited to be at 70% of the top 30, and that creates a level of critical mass. But it's really coming through organic innovation, building all of those product capabilities. The gen AI example that we cited earlier is a great example of how we were able to unlock really a significant volume of political ad spend, you know, through innovation. Second, of course, is supply path optimization, right? So, because of the relationships that we have with buyers, then that brings streamers to our platform. This dentsu announcement is a great example, where, as that gets going, you know, there will be dollars flowing through Activate on our platform. And so, then streamers know that, "Hey, in order to access those budgets, we need to be working with PubMatic." And as we mentioned earlier, you know, those agencies are also moving their direct buys. So, that's a single buyer, single advertiser to a single publisher's inventory. They're moving those buys to our platform as well. And then lastly, as we, you know, scale up our Connect platform for curation and data partners and we scale up commerce media, that just brings more and more incremental demand to our publishers. And that is, you know, not necessarily demand that they'd be able to get elsewhere. And so, I think that combination of innovation and SPO and then the other demand drivers is really what's driving streamers to lean into working with us. James Heaney -- Analyst OK. And then, maybe just to follow up for Steve. Can you talk about the capacity needs for the business for the rest of '24 and '25? Do you expect you'll need to invest incrementally in infrastructure in the near to medium term to support the next leg of growth? Steve Pantelick -- Chief Financial Officer Sure. You know, we're already locked and loaded for '24. And so, that's done, and that's reflective of the capex that I referenced in the prepared comments. And as we look to '25, you know, our expectations are going to be continuing what we've seen has worked very effectively. You know, first, we look for opportunities to optimize our existing infrastructure, so no net new capex. And then, when we see sort of the runway for that opportunity, then we determine, you know, the incremental opportunity. And the great news is that we are really driving our CTV impressions, our omnichannel video impressions. And, you know, those carry with it a lot higher value CPMs. So, our expectation over time is that we won't need to invest at the same level as we have historically. And there's a variety of reasons why we feel very good about, you know, the gross margin profile, but not the least of which is, you know, long-term focus on efficiency and then managing our capex, and then always looking for optimizations. And we think those opportunities are going to just continue to be in front of us. But I do not expect sort of a major uptick in capex in '25 beyond, sort of, you know, the similar levels of the last year or so. Our next question comes from Ian Peterson, Evercore. Please go ahead, Ian. Ian Peterson -- Analyst Thank you for taking my questions. Two, if I may. First question, there's a pretty significant acceleration U.S. revenue in Q3. Can you just help us unpack that a little bit further? How much of that was just a function of political contribution, easier comps, or other factors such as emerging products contribution? And if emerging products contribution, can you just tell or give us some hints on which products are driving that? And secondly, related to the $7 million headwind you called out on the last earnings call related to DSP and macro environment, can you just remind us how much of that played out in Q3 and how to think about that headwind that's implied in the Q4 guide? Thanks. Steve Pantelick -- Chief Financial Officer Sure. So, with respect to the first question, just unpacking our performance, you know, the real driver has been CTV. Very strong growth, and it's all volume-driven, you know, impressions that we sold. And so, that was the lion's share of our performance. Now, as Rajeev also commented on, because we have such a significant scale and the innovation that we brought to bear in terms of the AI tool, most of the political advertising that we generated was via CTV. So, in that respect, they're both related. But number one, CTV was the key driver about performance. Number two, we continue to see great progress with mobile app. And as you know, we recently launched a partnership with a very large mobile app company. And that gives us access to over 80,000 mobile app publishers around the world. And so, we saw a strong growth out of mobile app, over 20% growth. It was a fourth quarter in a row delivering that kind of growth. And then, we also saw, you know, some solid display results. So, across the board, we feel like all the levers were in place. And, you know, the areas that we've been investing in are really showing dividends as I just outlined. Now, in terms of just thinking through the outlook that I gave, I mean, the most important point is that that situation has stabilized. And now, we're just growing through that as evidenced by the commentary that I shared on the fourth quarter. You know, overall, you know, when you adjust for apples for apples, you know, the expectation is that, you know, the applied growth is over 15%. So, I'd say put the DSP change, you know, in a box. And we're going to grow through that in Q1 and Q2. But, you know, on an apples-to-apples basis, we'll be comparable Q3 onwards. And the most important factor is over two-thirds of our business is growing in the midteens, and that's helping us, you know, manage through this change that occurred midyear. Stacie Clements -- Investor Relations Thank you, Steve. Our next question comes from Tim Nollen in Macquarie. Please go ahead, Tim. Tim Nollen -- Analyst Thanks for taking the question. Rajeev, I wonder if you could elaborate a bit more on this, your work you're doing in curation, particularly in CTV. It's not exactly a new concept, but maybe sort of newish. And you referenced it as maybe a component to your success in CTV recently. Could you give us maybe some examples, or a bit more color around what you're doing with curation, and how you're doing it differently from others? Thanks. Steve Pantelick -- Chief Financial Officer Sure. We've been talking for several years now about cell site targeting. And as, you know, our Connect platform is roughly 5-years-old now. And just a little bit of context, right, as third-party cookies decrease in scale and privacy regulation ramps up, first-party publisher data or first-party data in general is becoming increasingly important. And that means targeting, and curation will move to the sell side. And we believe that we have a leading platform in the industry for that. And just to kind of level set on the definition. We view curation as inventory packaging and selection. So, it's often aggregating the right inventory together based on a buyer's custom needs, packaging that up, and then making it very easy to buy that inventory. And of, course, historically, that's been done on the demand side. But now, because of the reasons I mentioned, it's moving more and more to the sell side. And the reason I think we are doing so well is we have a pretty rich set of features, although there's always more to innovate and to build. We have very significant omni-channel inventory scale behind it, global as well. And so, we see that it's a significant contributor to our emerging revenue streams. And so, one of the, Tim, the way that it works is, you know, we might add political inventory -- sorry, political data through our Connect platform onto our inventory. So, this is a pretty common practice in Q3 and in October in our business. So, we would add political data. And then we would package up inventory across verticals and geos. So, a particular buyer might want, you know, Pennsylvania residents in certain zip codes that meet a certain audience profile, and they're looking for CTV inventory or they're looking for online video with a 80% viewable completion rate. And so, we can package that inventory up and make that available for a buyer to buy. And so, that's a very, I think, sticky opportunity. Another similar one is using commerce media data sets. So, we've talked previously about Instacart for instance, you know, layering Instacart data onto our platform and then packaging that up. And I think that's a really nice match with CTV. Because often in CTV and in commerce media, we have a logged in user. And so we're able to match that user. And so that's, I think, a really great opportunity because it brings unique ad spend to our platform and really highlights the strength of the PubMatic platform, and that brings more streamers into our portfolio. It also brings more buyers, and it brings more commerce and other data participants. Great. Thanks for the explanation there. Can I just tag on one more related -- Do you think the really big rise in inventory of CTV ads over the last year or two contributes to more demand for curation services? Steve Pantelick -- Chief Financial Officer Yeah, I think it does. I mean, I think if we think about the growth in CTV inventory, what it's causing is sellers to evolve their playbook in terms of how they sell that inventory. So, whereas let's say a couple of years ago, where maybe there was a lot less supply and there was a more demand focused in the market, so there's an imbalance, more demand than supply. And sellers could choose to say, "OK, hey, I'm going to just sell on a one-to-one basis, right? So, my salesforce is going to go out, and they're going to sell the value proposition of, you know, whatever the streamer's brand is. As you get to more and more supply, and you have obviously the entrance, you know, of purely digital players with no legacy businesses, you know, thinking of folks here like Amazon and Netflix, then that causes, I think, the typical seller to have to rethink their playbook, right? So, they might get the most premium CPM through that one-to-one deal where they're selling on the strength of their brand or the show. But then they need to fill the rest of their inventory. And so they're going to look to sell using curation. They're going to look to sell via our CTV marketplace. They're going to build that full book of demand at different price points. And we think we have a significant role to play in doing that, given the scale of the inventory on our platform from streamers. Our Connect, you know, capabilities are commerce and convert capabilities and then supply path optimization. Our next question comes from Brianna Diaz at JMP. Please go ahead, Brianna. Brianna Diaz -- JMP Securities -- Analyst Hi. Thank you so much for taking my question. Just one for me, with budgets increasingly moving into video, can you talk through the impacts of monetization and take rates for 2025 and longer term? Thanks so much. Steve Pantelick -- Chief Financial Officer Sure, I'll take the first pass. You know, from our perspective, the trends in omnichannel video, CTV plus online video are a very robust scenario. We've been investing in for a number of years. And so, at the beginning of this year, I'd said that my expectations for omnichannel video was for it to grow in the double digits. And that's exactly what we're on track to do. And I do expect that to continue in '25 and beyond. And it's because it provides, you know, what advertisers want, you know, the right context, the right content, the right targeting. And so, there's always going to be dynamics that shift in terms of supply and demand. And we are in a very advantaged position because we focus on the cost side, driving the unit costs down very, very much. And then, we're able to, as we invest and grow our business into video, get that marginal profitability because basically the cost to process a video impression and a display impression is roughly the same. And so, from our perspective, you know, wherever the pricing might go with video, we're going to be well advantaged because of the marginal profitability that delivers. And so, you know, as we look into the future, we fully expect our mix to grow in video. We hit an all-time high this past quarter at 36%. And as I had commented, that drove, you know, our gross profit, improved our average CPM. So, there's a lot of things that are going positively for video, which will be the case you know, for the foreseeable future. Thanks, Steve. At this time, I'm going to turn the call back over to Rajeev for closing remarks. Rajeev Goel -- Co-Founder and Chief Executive Officer Thank you, Stacie, and thank you all for joining us today. Our strong results in the quarter highlight our progress in the secular growth areas of our business: omnichannel video, CTV, mobile app, SPO, and our emerging revenue streams, all contributing to an accelerated year-over-year growth rate of 17% when excluding political and the one DSP buyer. We're launching new products and serving the critical mass of publishers and streamers while unlocking incremental value for our customers and us. We are partnering with some of the largest companies on the internet as they choose to build their advertising businesses on PubMatic. We have an exciting opportunity in front of us. We look forward to seeing many of you at upcoming conferences. Thanks, everyone, for joining us today, and have a great afternoon.

Monday.com (MNDY) Q3 2024 Earnings Call Transcript

Good day. My name is Desiree, and I'll be your conference operator today. At this time, I would like to welcome everyone to monday.com's third quarter fiscal year 2024 earnings conference call. I would like to turn the call over to monday.com's vice president of investor relations, Mr. Hello, everyone, and thank you for joining us on today's conference call to discuss the financial results for monday.com's third quarter fiscal year 2024. Joining me today are Roy Mann and Eran Zinman, co-CEOs of monday.com; and Eliran Glazer, monday.com's CFO. We released our results for the third quarter of fiscal 2024 earlier today. You can find our quarterly shareholder letter, along with our investor presentation and a replay of today's webcast, under the News & Events section of our IR website at ir.monday.com. Certain statements made on the call today will be forward-looking statements, which reflect management's best judgment based on currently available information. These statements involve risks and uncertainties that may cause actual results to differ from our expectations. Please refer to our earnings release for more information on the specific factors that could cause actual results to differ materially from our forward-looking statements. Additionally, non-GAAP financial measures will be discussed on the call. Reconciliations to the most directly comparable GAAP financial measures are available in the earnings release and the earnings presentation for today's call, which are posted on our investor relations website. Now, let me turn the call over to Roy. Roy Mann -- Co-Chief Executive Officer Thank you, Byron, and thank you, everyone, for joining us today. We're fresh off another strong quarter in Q3, highlighted by improving retention trends, strong financial performance, and robust product development. This quarter also marked a significant milestone for monday.com as we surpassed $1 billion in annual recurring revenue. Reaching the $1 billion ARR milestone is not just a number, it's a pivotal moment in our company's journey, and we are ready to build on that momentum. With the total addressable market of over 100 billion, growing 14% annually across four markets, work management, CRM, service management and software development, there is a substantial opportunity ahead. To drive our next stage growth, we remain committed to deepening and expanding our product offering and increasing our global presence. As the landscape of work evolves, we are determined to stay ahead of the curve by continuously investing in technology, exploring new markets, and fostering a culture of agility. monday.com is not just keeping pace with the industry. We are shaping its future. Before I turn it over to Eran, I'd like to cover a few changes in our management team. First, we are pleased to announce the appointment of Adi Dar as chief operating officer. With over 20 years of experience driving sustainable growth in global tech companies, Adi brings significant expertise to our executive team and has already made a strong impact since joining us a few months ago. On a different note, we would like to share that our chief revenue officer, Yoni Osherov, has informed us that he will depart the CRO role at the end of December. Since joining in 2017 as VP global sales and marketing and becoming the CRO in 2022, Yoni has been instrumental in developing our sales and partner channels. During Yoni's tenure, we have seen remarkable growth, with ARR increasing from $10 million to over $1 billion. We are deeply grateful for his contribution and wish him all the best in his future endeavors. We are conducting a global search for Yoni's successor, and he will continue to serve as an advisor until the CRO is appointed. Let me now turn it over to Eran to walk you through some of our product highlights for the quarter. Eran Zinman -- Co-Chief Executive Officer Thank you, Roy. I am pleased to share highlights from our recent flagship user conference, Elevate, which took place in London, New York City, and Sydney. This year's event was our largest ever, with attendance doubling compared to last year. Thank you to all who joined us. For those who could not attend in person, we invite you to participate in Elevate Online on December 4th. Our Elevate conference provided us with a platform to showcase our latest product innovations. This year, we featured monday AI, which include no-code AI building blocks that customers can tailor to their specific business needs. We're excited to report initial strong adoption, with a remarkable 150% increase in the use of AI blocks since Q2. Looking ahead, monday AI will be integrated throughout our entire product suite, enhancing functionality across the platform. We also highlighted our second-largest product, monday CRM, and our vision to expand its capabilities beyond sales, fostering collaboration across various revenue teams. Upcoming features will include email marketing functionality, enabling teams to manage their campaigns directly within monday CRM. Additionally, we are excited to demo our latest product, monday service, at Elevate. Although still in beta, monday service have shown promise in cross-sell potential, and it's on track for release by the end of 2024. As we expand our product offerings and support our customers' growth, we are committed to building a robust platform for scalable work. At Elevate, we announced the next iteration of mondayDB is now live. mondayDB 2.0 is all about scale and allows boards with up to 100,000 items and linked items and dashboard with half a million items. Lastly, we are pleased to report that monday work management continues to gain significant traction with enterprise customers. In Q3, our second-largest customer increased their seat count from 25,000 to 60,000 as part of their initiative to simplify and consolidate their technology stack. This represents a remarkable 24-fold increase in their seat count since 2022. With that, I'll now turn it over to Eliran to cover our financial and guidance. Eliran Glazer -- Chief Financial Officer Thank you, Eran, and thank you to everyone for joining our call. Q3 was another strong quarter for monday.com, with solid revenue growth and profitability and improving retention. We are pleased that fiscal year '24 is on target to be above our base case guidance outlined at our December Investor Day. Having surpassed $1 billion in ARR, we are now focused on leveraging our momentum to advance into the next stage of growth for the company. Total revenue in Q3 '24 came in at 251 million, up 33% from the year-ago quarter. Overall NDR increased to 111% in Q3 '24. We expect NDR to be stable through the end of the year. As a reminder, our NDR is trailing four-quarter weighted average calculation. For the remainder of the financial metrics disclosed, unless otherwise noted, I will be referencing a non-GAAP financial measures. We have provided a reconciliation of GAAP to non-GAAP financials in our earnings release. Third quarter gross margin was 90%. In the medium to long term, we continue to expect gross margin to remain in the high 80s range. Research and development expense was 43 million in Q3 '24, or 17% of revenue, compared to 15% in Q3 '23. Sales and marketing expense was 130.3 million in Q3 '24, or 52% of revenue, compared to 54% in Q3 '23. General and administrative expense was 21.4 million in Q3 '24, or 9% of revenue, compared to 8% in Q3 '23. Net income was 45 million in Q3 '24, up from 33 million in Q3 '23. Diluted net income per share was $0.85 in Q3 '24 based on 52.6 million fully diluted shares outstanding. Total employee headcount was 2,305, an increase of 195 employees since Q2 '24. We expect to increase headcount by mid-30% in fiscal year '24, with continued focus on our R&D, product, and sales teams as we build out our platform and product suite. Moving on to the balance sheet and cash flow. We ended the quarter with 1.34 billion in cash and cash equivalents, up from 1.29 billion at the end of Q2 '24. Free cash flow for Q3 '24 was 82.4 million, and free cash flow margin, as defined as free cash flow as a percentage of revenue, was 33%. It should be noted that free cash flow for the quarter was impacted by a one-time net cash incentive of approximately 11 million for our new London office rental agreement. Free cash flow is defined as net cash from operating activities less cash used for property and equipment and capitalized software costs. Now, let's turn to our updated outlook for fiscal year 2024. For the fourth quarter of fiscal year 2024, we expect our revenue to be in the range of 260 million to 262 million, representing growth of 28% to 29% year over year. We expect a non-GAAP operating income of 29 million to 31 million and an operating margin of 11% to 12%. We expect free cash flow of 63 million to 66 million and free cash flow margin of 24% to 25%. For the full year 2024, we expect revenue to be in the range of $964 million to $966 million, representing growth of approximately 32% year over year. We expect full year non-GAAP operating income of $121 million to $123 million and an operating margin of 12% to 13%. We expect full year free cash flow of $286 million to $289 million and free cash flow margin of approximately 30%. Let me now turn it over to the operator for your questions. Thank you. We will now begin the question-and-answer session. [Operator instructions] Our first question comes from the line of Gili Naftalovich with Goldman Sachs. Your line is open. Gili Naftalovich -- Analyst Hey, team. It's Gili on for Kash. Thanks for taking the question and congrats on reaching the 1 billion run rate mark. Two questions if I may. As we see your larger cohort supporting an inflection in NRR, but we see a softening of your net new customer adds, can you share how monday's engagement with customers is evolving and whether you are seeing any changes in the broader demand or competitive environment? Eran Zinman -- Co-Chief Executive Officer Yeah. Hi, Gili. It's Eran. So, first of all, as you mentioned, we see good retention results. Our NRR is improving. And also, our gross retention is at record level historically. So, overall, we see better retention with small and larger customers. We do see a little bit less customer adds, but that's part of our price increase and part of our strategy, that we focus not just on SMBs, but also on large enterprises. So, overall, if I take everything, we see demand to be steady, pretty similar to what we saw in previous quarters in terms of retention of customers and also in adding new customers. Eliran Glazer -- Chief Financial Officer Hi, GiIi. This is Eliran. Maybe I will add one more thing is that with the new product that we introduced, service, we see also -- you know, with CRM and service, we see cross-sells in between our existing customers and new customers that continue to add additional potential momentum to our sales. Gili Naftalovich -- Analyst Perfect. Thanks. And when we think about your growth initiatives that you just mentioned, as well as the hiring uptick that we saw in this quarter and what we're expecting in 4Q, how are you thinking about that expansion versus larger new lands, especially in the backdrop of the second-largest customer, that you saw an expansion there? Eran Zinman -- Co-Chief Executive Officer Yeah. So, this is Eran again. So, the fact that we hire more salespeople is basically because we see a lot of demand and a lot of opportunity within our own customer base. So, it makes sense building toward growth for 2025. So, we're pretty confident on that and our plans for 2025 as well. And again, like, as we grow more revenues coming from existing customers as they upgrade, buying more product, and adding more seats, but our acquisition engine and bringing new customers, that remains a very strong part of the business, and we're investing a lot into that and growing that as well. So, I would say that both in expanding existing customers and acquiring new customers, it's according to our original plan, and the demand and the market looks very stable. Operator Our next question comes from the line of Pinjalim Bora with J.P. Morgan. Your line is open. Pinjalim Bora -- Analyst Oh, great. Thank you for taking the questions. It seems like you're seeing half of paying customers for service come from cross-sell, and I think the product is still in beta, right? So, do you think service might have a much bigger cross-sell opportunity versus CRM and that you might actually realize it faster than CRM? Roy Mann -- Co-Chief Executive Officer Yeah. Hi. It's Roy. So, we do see a great opportunity to cross-sell with service. It is, like you mentioned, still in beta and very early stage. So, like it's not something we see as a significant part of our, let's say, revenue next year. But we do see it as a huge growth potential going forward. Too soon to tell how it will measure up compared to CRM. Pinjalim Bora -- Analyst OK. Understood. I want to ask you on net retention as well, just as a follow-up. It seems like you're seeing an uptick, but it seems like the uptick is largely in the large customer segment. Maybe talk about how much of that is due to seat unlocks from mondayDB versus cross-sell. And maybe broadly, Eliran, has that metric turned the corner as we look, you know, into the next several quarters? Eliran Glazer -- Chief Financial Officer Yeah. So, hi, Pinjalim. It's Eliran. So, again, we are pleased with our NDR. You know, it increased to 111%. You know, this is ahead of our expectations, and I think that we expect it to be largely stable in Q4. To your question, if it's going to be a turning point going into next year, so we foresee opportunity for continued improvement in fiscal year '25. This is the result of the fact that we continue to grow upmarket. Potentially, the impact of the price increase is around 100 basis points to 200 basis points. And I would say it's also broad-based across all customers, with growth retention also getting to record high. Next question comes from the line of Brent Bracelin with Piper Sandler. Your line is open. Brent Bracelin -- Analyst Thank you. Good morning. I wanted to touch base on service again. What are the key kind of product milestones you're looking for that product to hit in order to GA? I know it's been a pretty successful beta, but what are the key last parameters that you'd like to see before that's released? And then one quick follow-up on guidance. Eran Zinman -- Co-Chief Executive Officer Yeah. So, hi, Brent. This is Eran. So, like Eliran mentioned, we're very excited about monday service. It feels like there's a huge opportunity there, especially cross-selling that product to existing customers. Because of that and because we see them and also from our larger customers, we just want to make sure that, you know, one, the product is mature enough so it can scale within our existing customers, not just the small ones, but also the mid-market and enterprise customers. And then there's a bunch of features that we're planning to finalize before the official launch. One of them is the customer portal, where people can create tickets, and also some AI functionality that we added into the product. We feel that we're pretty close to launching the full release of that product, and the feedback from customers is very good. So, overall, we're very excited. There seems to be strong demand in terms of go-to-market and also great reception from customers who already use the product. Brent Bracelin -- Analyst Helpful. And then, Eliran, the guidance here had been pretty consistent all year, 28% to 30% forward outlook here for four consecutive quarters now. How would you frame just the demand going into kind of year-end here? Eliran Glazer -- Chief Financial Officer So, demand environment -- hi, Brent. It's Eliran. As Eran said, demand environment has been very stable. It's broad-based. We still see, you know, strong momentum coming from SMB and continue to move upmarket. I would expect it to be, you know, getting slightly better going into next year, based on what we heard from other companies, but there are still some signs of choppiness in some segments. So, I would say, I don't want to tell you that it's going to be a dramatic change going into next year, but it's going to be a combination of we see a strong momentum on our business, but there is some choppiness in the market. Next question comes from the line of Ryan MacWilliams with Barclays. Your line is open. Ryan MacWilliams -- Analyst Hey, guys. Thanks for taking the question. Just to follow up on Brent's question, as we think about our models for next year and building up to our estimates for 2025, any early insight into things to think about as we continue on with the price increase into next year? Maybe should we look at 4Q as a reasonable starting point? Just any breadcrumbs we can use for our models for next year's growth. Thanks. Eliran Glazer -- Chief Financial Officer Hi. It's Eliran. So, you know, we will give our fiscal year '25 guidance as part of the next earnings call, but we remain optimistic that, you know, with monday service, with the price increase that we did, with the cross-sell opportunities, with the fact that, you know, momentum continues to be good, we are going to see some potential upside also next year. Ryan MacWilliams -- Analyst Excellent. And then you guys have seen really strong product development with the new product line releases, but any thoughts on M&A here? Like, would it make sense to maybe acquire some bolt-on AI capabilities? Just wanted to see if your thought process has changed around that at this point pretty much. We have an M&A team. We're constantly monitoring the market and looking for opportunities. Once we find the right one, we definitely, you know, try to explore that opportunity. But, you know, given the cash reserves that we have and the opportunity that we have as a company, we're definitely looking into that as well extensively. Operator Next question comes from the line of Brent Thill with Jefferies. Your line is open. Brent Thill -- Analyst Thanks. With Yoni's leaving, can you just talk through the transition? And ultimately, in past sales transitions, it takes some time to settle in. What gives you confidence maybe this isn't as big of a turbulence or perhaps it is, but give us a sense of how you're going to manage that? Eran Zinman -- Co-Chief Executive Officer Yeah, Brent. So, this is Eran. So, basically, Yoni will stay in his role until the end of the year. And then he will remain in the company as an advisor until we find a replacement for a CRO. We're pretty confident that we'll be able to find a new CRO of the company in the near future. We're looking for new candidates across the globe, and there's a lot of great talent out there. And we're doing, like, an orderly transition plan. We got everything covered, and we got great management as part of our leadership and leadership CRO in our organization. So, we're pretty confident that things will remain stable, and we have very ambitious plans for 2025. Brent Thill -- Analyst Great. And then can you just give us a quick update on the CRM traction? You know, what mile markers are you proud of and what are -- what's kind of the next chapter as we head into next year that you're excited to cross with CRM? Thanks. Roy Mann -- Co-Chief Executive Officer Yeah. Hi. It's Roy. So, within CRM, we are always looking to, like, scale it up a notch in terms of the sizes of business we're approaching. Part of it is, like, scaling the infrastructure like we announced to support large data sets, and also adding AI to many areas that really, you know, facilitate and make the sales process much faster and robust. So, we're super excited about CRM. It remains a very strong growth area for us, and keep investing in it. Next question comes from the line of Jackson Ader with KeyBanc Capital Markets. Your line is open. Jackson Ader -- Analyst Great. Thanks for taking our questions, guys. The first one is on the sales rep motion. Can we just kind of go over what that typical motion looks like? Are they trying to sell into, like, net new high-level purchasers? Is it rounding up kind of disparate teams that might be using monday across an organization and, you know, bringing them all together? And then I'm just curious, like, how this role might change with the leadership changes in that organization. Yeah. Hi, Jackson. This is Eran. So, very broadly, in general, the way our CRO organization is built is that we have different teams that focus on different go-to-markets, meaning SMB, mid-market, and enterprise customers. And then within each one of those segments, we have AEs and AMs. AEs focus on acquiring and converting new businesses to sign up or have interest in using platforms, and AMs, which is the most significant part of our CRO organization, are focused on expanding existing customers. What they usually do is either expand an existing use case or find new buyers within the organization to sell them additional use cases or additional products. We're planning to scale that. As part of the CRO transition, I think this also presents an opportunity. We're also going upmarket. And, you know, definitely, it's an opportunity to expand that motion. We're going to bring more seasoned sales reps and perhaps leadership that have expertise in scaling to the enterprise segment as well. So, all in all, this is how the team is built, and we're planning to scale that and invest more heavily into larger accounts. And then my second question is actually also on go-to-market, but it's more in down market, that kind of the funnel on the low end. Has there been any impact from your pricing increases on maybe the -- has there been a commensurate increase in performance marketing spend to try and land those customers in the funnel given that, now, you've got an increased lifetime customer value, you assume, from the higher prices, but I'm curious how that impacts the performance marketing spend? Thank you. Roy Mann -- Co-Chief Executive Officer Hi. It's Roy. So, our performance marketing, like always, is driven by results. And we've done the tests before the pricing and after. And obviously, what you see is less -- fewer number of customers, but higher quality ones that have more potential to scale upward. And this is in line with the strategy we have in the sales team, and, like, the whole company is geared toward, like, taking our sweet spot, if you like, higher. Next question comes from the line of Alex Zukin with Wolfe Research. Your line is open. Alex Zukin -- Analyst Hey, guys. Maybe just the very large customer expansion, can you talk a bit about what they adopted, was there a consolidation motion with respect to that, and maybe just the pipeline for those types of deals as you kind of go into the end of the year? And I have a quick follow-up. Eran Zinman -- Co-Chief Executive Officer Yeah. Hi, Alex. This is Eran. So, just to say, the company has grown a lot since 2023, over 24x increase. Just until recently, they had 25,000 seats. And now, we have this additional upgrade. What basically happened is they got more departments using the product across the team. We now have departments from consulting, infrastructure, finance, operations, and also the sales team. So, all in all, it's become a very significant tool within that company and also more room to grow. The feedback is great. And if you add that to the other large customers that we announced in the previous quarter, we see great traction in terms of not just landing larger accounts, but also extending them over time. So, we see more and more of those deployments that land within our platform. Alex Zukin -- Analyst Perfect. And then maybe just the -- with the management changes, what does Adi bring to the table that you didn't have before and maybe why was that the right time for this addition? And as you think about Yoni's replacement, how important is kind of larger enterprise sales experience in that -- with respect to that? Eran Zinman -- Co-Chief Executive Officer Yeah. So, this is Eran. So, first of all, we're very excited for Adi to join. I think he brings experience in two ways. One is scaling, building large organizations. He had experience managing a very big organization with a lot of people, a lot of departments and complexity, and I think his expertise and knowledge can really help us scale the organization, not just in terms of management, but also in terms of processes, business processes, strategic processes that we have. So, definitely, we already see a great impact from that. That's definitely very helpful. Also, he has a lot of technology expertise in different domains, but he really understand technology, he understands the SaaS business and know how to, you know, leverage and increase, also, you know, sales orgs. And he brings a lot of expertise around those areas as well. So, all in all, I think he will bring a lot to the table and will help us scale the company path at this point. Roy Mann -- Co-Chief Executive Officer Yeah. Hi. It's Roy. I can add that we -- Adi is someone we rely on a lot during this transition period, and he helps us across the company. Eliran Glazer -- Chief Financial Officer There was a second part -- this is Eliran. There was a second part of the question. I remind you, Eran, about the CRO, how important it is to have experience in going upmarket? Eran Zinman -- Co-Chief Executive Officer Yeah. So, definitely, in terms of the new CRO that we're looking for, we're looking for somebody that will help us go through this transition that we're going through as a company. We're investing a lot into that. And as part of that, Yoni has been busy transitioning the sales team. And in this new role, we also look for somebody to continue that momentum. We already made a lot of progress, great progress on that front, and I'm sure that once we find the right person to join the company, he or she will help us complete this transition. Next question comes from the line of Arjun Bhatia with William Blair. Your line is open. Arjun Bhatia -- Analyst All right. Good morning. Thank you, guys. I wanted to go back to monday CRM for a bit. I think you announced some pretty interesting new capabilities at Elevate. It sounds like there's campaign management capabilities that are going to be now built in-house. Can you talk a little bit about what your long-term ambitions are for monday CRM? And could we, in the future, expect this to become a full-on kind of sales and marketing suite that lives inside monday? And if so, how do you think about kind of the build versus buy versus partner motion for CRM, in particular? Roy Mann -- Co-Chief Executive Officer Hi. It's Roy. So, CRM is essentially built on monday Work OS, which gives it amazing capabilities in terms of flexibility and the complexity it can manage and also the connectivity to the rest of the organization. And so, I think this is something that our customers really appreciate and want, the connectivity across the organization, being able to do things collectively with other departments. And those additions you mentioned kind of connect to that as well and add more wholeness to the CRM suite that we see ourselves building over time. Arjun Bhatia -- Analyst OK. Understood. Thanks, Roy. And then if I can just turn to the quarter for a second, certainly, 32% growth is very strong. I think when I look at the sequential growth from Q2 to Q3, it looks a little bit lighter than we've seen historically. So, can you just touch a little bit on what happened this quarter, what trends you saw in the business, and whether there's any timing elements from the move upmarket that we should consider as we're just thinking about the financials this quarter and going forward? Eliran Glazer -- Chief Financial Officer Sure, Arjun. This is Eliran. First of all, we are pleased with Q3 performance. You know, we are still a Rule of 60 company. You know, we had an exceptional performance in Q2. It sets a high bar for Q3. And, you know, if we think about what we presented, even in the Investor Day, we are going to be above our expectations in fiscal year '24. Nevertheless, you know, in Q3, we saw some continued choppiness in the macro, including, you know, fewer enterprise customers, if you look at the total add, which was impacted, in part, by slower hiring in sales. You know, as I said, we had a very strong Q2, an outlier, and slower-than-expected growth in monday dev as we pivot to focus on developers. So, I would say all of the above created some light September, but we are seeing already strong momentum in October. Next question from Michael Berg with Wells Fargo Securities. Your line is open. Michael Berg -- Analyst Hi. Thanks for taking my question. Congrats on the quarter. I wanted to turn back to pricing real quick. There hasn't been much of an update in the last couple of quarters on contribution from pricing. Is there any incremental color there from the potential contribution in the quarter or in for the year or in the quarter, whether it be quantitative or directional? Thank you. Eran Zinman -- Co-Chief Executive Officer Yeah. So, this is Eran. So, just a quick update on pricing. The new pricing remained on target to be fully rolled out by July of 2025. So, we're still kind of in the middle of the process. So far, it's been rolled out to about 50% of our customers. We see about 30% impact -- 30 million, sorry, impact for fiscal 2024. And total impact from the price increase will be about 80 million between fiscal '24 and fiscal year '26. So, those are kind of the updated figures. But just to give you some more colors, we are very -- going really well with the price increase. Reception of customers is good. We don't see any kind of negative feedback. So, we continue to roll out the pricing as we planned. Michael Berg -- Analyst Helpful. And then a quick follow-up on service. It looks like it's expected to be GA here in Q4. We had heard through the grapevine that there might have been some delays. Any -- anything that points you there, any color versus potentially prior expectations around GA? Obviously, the feedback sounds incredibly strong from the ecosystem, as well as from Elevate. So, anything to help point us in the right direction there would be helpful. Thanks. Eran Zinman -- Co-Chief Executive Officer Yeah. So -- this is Eran. So, there's no delays. Basically, we plan to roll it out by the end of the year, and this is largely when we'll release the full version. Just to remind you, it's already available for customers in beta. There's great reception and feedback, and they use the product. So, around the end of the year, beginning of next year, you know, January, we'll announce the product to be GA and then kind of open it up for our entire customer base. But the product is up and running, and there's great feedback from customers. Yeah. We're waiting for the operator for the next question, so -- Our next question comes from the line of Mike Funk with Bank of America. Your line is open. Michael Funk -- Analyst Yeah. Thank you for the question today, guys. Just, you know, a quick one. Thinking about the revenue growth trajectory and the factors that go into that, you know, we did see either a flattening or, you know, decline in the customer net additions across CRM and dev this quarter. You know, you mentioned the price impact of 30 million for '24, a slight uptick from what you had before, and then not expecting a lot of contribution from service next year. So, maybe just help me think through those factors and how they're going to impact revenue growth, if I'm missing anything, and if maybe we are hitting a point when the law of large numbers is catching up to us in terms of maintaining 30%-plus. Eliran Glazer -- Chief Financial Officer Hi, Jason. It's Eliran. So, as we said in prior quarters, you know, as part of the price increase, we said that we expect a high single-digit add of new customers compared to prior year. However, the ACV and the land is bigger. And this is something when we already finished last year with 225,000 customers, obviously, the add in terms of percentage are going to be slightly lower of what you have seen in the past. With regards to service, strong momentum. We expect it to continue to next year. This is in line with what we saw with CRM. Great adoption between our customers -- or among our customers. So, this is something that we think will contribute to next year. And price increase, as Eran mentioned, will continue to contribute by -- between 2024 to 2026 around $80 million. So, nothing much has changed from what we have seen in the past other than what I mentioned earlier with regards to enterprise adds -- net add in Q3, as well as some softness in dev. Roy Mann -- Co-Chief Executive Officer And also -- hi. It's Roy. I can add that -- like, you mentioned, like, size. So, we have a very large amount of existing customers, and a large portion of our sales team is focused on increasing adoption within existing customers. And also, our product road map is geared toward growth within existing customer if that helps. Michael Funk -- Analyst OK. And just to confirm that my notes are correct, the 30 million impact for fiscal '24 from price, that was an increase from 25 million previously? Our next question comes from the line of Derrick Wood with TD Cowen. Your line is open. Derrick Wood -- Analyst Thanks, guys. So, you've been pushing upmarket pretty aggressively in recent quarters, and I'm just wondering if this is having any impact to deal cycle time frames. I imagine, you know, as you start doing more multithousand-seat deals, there's more buyers involved and a longer sales cycle. So, just wondering if perhaps there's a little more seasonality coming into the model because of these bigger deals and, you know, perhaps a little less activity in Q3 and a little more of a flush of activity in Q4. Is that the right way to be thinking about it and any comment of how you're seeing pipelines of large 1,000-seat-plus deals and -- heading into Q4? Eliran Glazer -- Chief Financial Officer Yes, Derrick. it's Eliran. So, you know, as I mentioned earlier, we came on a very strong -- we came on the back of a very strong Q2. And obviously, Q3, you know, you have July and August, which are traditionally months of vacations in Europe and potentially in the U.S. But I don't want to kind of provide this as a seasonality kind of dramatic changes we have seen. As I've said, potentially, with the fact that there is some still macro headwinds, to a certain extent, in some areas of the market, the -- you know, macro is still choppy, potentially this has contributed to some of the fact that we saw less enterprise customer add. And as I mentioned also, the monday dev, that was more soft than we anticipated. But again, looking at October, you know, we are seeing still momentum very positive. And, you know, I don't want to tell you that this was a strong seasonality trend in Q3. Derrick Wood -- Analyst Got it. And then maybe just a touch on just the competitive landscape. I mean, I guess, as you've pushed into new product areas, more upmarket, give us some stats in the past on like greenfield percentage of deals. Like, has that changed much as your market positioning has evolved? Roy Mann -- Co-Chief Executive Officer Hi, It's Roy. So, I think as we push toward larger deals, we see more competition on deals. If you look at the average, I'm not sure if it's changed or not, but definitely, within CRM, we are competing against other players. But while a lot of the new adoption comes from greenfield still, but they are comparing us to competitors. Next question comes from the line of DJ Hynes with Canaccord. Your line is open. DJ Hynes -- Analyst Hey, guys. Thanks for taking the question. Any updates on the partner ecosystem, especially as you go further upmarket, you know, growth there, contribution to the business, your ability to monetize that activity? Any trends emerging that are worth calling out? Eran Zinman -- Co-Chief Executive Officer Yeah. Hi, DJ. This is Eran. So, no major updates, but we continue to see great momentum with our partner ecosystem. What we see over time is more and more partners are also delivering services to our customers, not just helping them with the implementation, but also help them customize their platform even more. We're also starting to see more partners that specialize in each one of our specific products or more partners that are focused on CRM or partners that focus on dev products. And I'm sure, as we launched monday service, we're going to add more partners that have expertise in that. But overall, we continue to see great momentum with the partner ecosystem. They remain a significant part of our revenue composition and in terms of helping larger customers onboard and use the platform. DJ Hynes -- Analyst Got it. And then maybe a follow-up on service. Just based on the beta usage you've seen to date, how much of the demand has been for internal ticketing use cases versus customer-facing support, and do you see that kind of evolving over time with public availability here on the horizon? Eran Zinman -- Co-Chief Executive Officer Yeah. So, maybe -- this is Eran. So, maybe important to emphasize, we don't just see IT service. What we see currently from the different use cases that we have, we see obviously IT service, but we see a lot of ticketing around HR, around operations, all the way to finance, marketing teams, and customer support, internal customer support ticketing. Currently, we don't plan to position monday service as a outside-facing support platform, but mostly within the company. But given the current use cases, it's very broad across the company, not just for IT, but across almost any department. Next question comes from the line of Steve Enders with Citi. Your line is open. Steve Enders -- Analyst OK. Great. Thanks for taking the questions here. I guess I just want to ask on some of the choppiness that you're seeing and, you know, some of the impacts that you saw this quarter. I guess, maybe how is that being accounted for in the Q4 outlook? Is there maybe some incremental conservatism that's being baked in or accounted for here? Just can you help us think about maybe some of the moving pieces that you're kind of incorporating in the outlook? Eliran Glazer -- Chief Financial Officer Yeah. Steve, hi. It's Eliran. So, I think I spoke about it earlier, but I will repeat. I mean, you know, we continue to see steady demand across all business segments, and, you know, it's consistent growth rates. As we said, gross retention is at record levels, but there is some cautious spend environment with many of our customers. And in Q3, we saw some continued choppiness in the macro. So, again, we saw enterprise, although it's the fastest-growing segment that we have, we saw fewer enterprise customers in Q3. As I said, it was impacted, in part, by slower hiring in sales and on the back of a very strong Q2. So, I don't want to tell you that, you know, we baked some conservatism. As we always said, you know, when we provide guidance, we try to do it in a prudent way, based on all the information that we know in the quarter, and we account for all the things that we know today. In addition, you know, the company is growing and becoming more mature, and we wanted to make sure that we are providing the most accurate guidance possible while maintaining strong conviction in meeting our estimates. Steve Enders -- Analyst OK. Perfect. That's helpful context there. And then I guess, just following up on that, I think you said the sales hires was maybe a little bit slower. I guess I just want to clarify that comment. And I guess, secondly, just how are you kind of thinking about future sales headcount growth and maybe how that should kind of layer into the hiring plans going into next year? Eran Zinman -- Co-Chief Executive Officer Just, Steve, the last part of the question about hiring? You broke up a little bit. Steve Enders -- Analyst Yeah, just how you're thinking about future sales headcount adds and I guess the pace of that as we head into '25? Eliran Glazer -- Chief Financial Officer Pace of hiring. So, Steve, this is Eliran. I will take it. So, you know, sales -- as we said, sales hiring was slower than what we anticipated in Q3, but we expect it to rebound in Q4. And, you know, we plan to ramp up hiring for sales-quota carriers in Q4 and in fiscal year '25. The areas of investment will continue to be product, R&D, and go-to-market. Worth mentioning that, you know, as we look at the evolution of the business with all the changes that we are doing in the CRO, so obviously, Eran mentioned earlier, we're going to hire people in the segment of account management, enterprise to continue to deepen within existing customer base and -- but momentum will continue to be strong across hiring. Next question comes from the line of Scott Berg with Needham. Your line is open. Scott Berg -- Analyst Hi, everyone. Thanks for taking my questions. First one I wanted to jump on was your R&D spend took kind of an abnormal increase quarter over quarter, especially relative to historical seasonality between Q2 and Q3. Can you help us maybe unpack and understand what's driving the big R&D increase? Is there a specific product or something else in the strategy or is it just general hiring for R&D? Eliran Glazer -- Chief Financial Officer Yeah. Hi, Scott. It's Eliran. So, you know, over the last few quarters, we continue to say that an area of investment for us is going to be R&D and product. Having in mind everything that we are doing, innovation is in the core of everything we do in monday. You know, introducing a new product, investing in existing product, mondayDB, AI capabilities, feature, and functionalities, all of these things require talent, and this is something that we continue to do proactively. So, we had strong overall hiring trends in Q3 and particularly for product and R&D and as well as operations. So, all of that is contributing to the fact that, you know, R&D is becoming more significant quarter over quarter. Scott Berg -- Analyst Helpful, Eliran. And then as you think about your sales and marketing hiring, you've talked to a couple of times how that was a little bit behind in the third quarter. Do you catch up on the hiring there in the fourth quarter or is this going to be an item that persists into maybe early '25? Eliran Glazer -- Chief Financial Officer Yeah, so we expect it to rebound in Q4. Again, with all the changes that we are doing, obviously, we are looking at all the plans. And also, going into fiscal year '25, we would like to make sure that we will ramp up hiring for sales-quota carriers. Next question comes from the line of Taylor McGinnis with UBS. Your line is open. Taylor McGinnis -- Analyst Yeah. Hi. Thanks so much for answering my questions today. The first one would just be in thinking about the 5 million raised from price to the full year rev guide, can you maybe provide a little bit more color on how much of the upside came from outperformance on price in 3Q versus what you are expecting for 4Q? And just the reason why I ask is you've mentioned some of, like, the macro choppiness. Just curious if, you know, some of, like, the sales hiring or that macro choppiness was a bottleneck to 3Q and if there's any, you know, areas on that choppiness that you'd call, in particular? Thanks. Eliran Glazer -- Chief Financial Officer Yeah. So, hi, Taylor. It's Eliran. If you recall, when we did the price increase, it actually was launched at the end of February, early this year. And we said, at the time, that we don't know what would be the impact, what would be -- because this is the first time we do it, what would be the churn of the customers in accordance with the price increase. Overall, it became better than what we anticipated. For most customers, this has been largely a nonevent. You know, gross retention has been improved. So, I would say that the 5 million extra is the fact that the profile of the customers and the momentum is better than what we anticipated. So, this was a good surprise for us. Taylor McGinnis -- Analyst Perfect. And then just as we think about the 1 point uptick in NRR, could you maybe, like, unpack that a little bit more? So, was that largely due to price or are you seeing cross-sell or seat expansions actually drive some of that upside? Is this more work management stable? And then I know you're talking about expecting NRR to be stable in the outlook for 4Q. I think you made a comment earlier about seeing some good momentum in October. So, is that just really prudence or anything to keep in mind there from a seasonal perspective? Thanks. Eliran Glazer -- Chief Financial Officer Yeah. So, I think it's all of the above. All of the above, meaning price increases contributed around 100 basis points to 200 basis points to the reported NDR in Q3. You know, we expect pricing that -- will continue to positively contribute approximately 200 basis points for the reported NDR in fiscal year '24 as a whole. We said that, you know, it's going to be stable in Q4 around 111%. There is potentially some upside in -- next year. Too early to say, but, so far, we're seeing good momentum going also into October. Operator And our last question comes from the line of Ittai Kidron with Oppenheimer. Your line is open. Ittai Kidron -- Analyst Thanks. I made it. A couple of questions for me. First, on dev, it's been somewhat underwhelming since you've announced it. Can you talk about, from a either a feature or go-to-market standpoint, what needs to change in the product for you to get better and more consistent contribution here? Eran Zinman -- Co-Chief Executive Officer Yeah. Hi, Ittai. It's Eran. So, first of all, we have -- with the progress with the monday dev, it might not grow as fast as CRM, but the growth, we're very pleased with it. With monday dev, we're very focused on software developers. So, it might be just the product takes a little bit longer to scale compared to CRM, which is kind of more of a broad use case. But we kind of now in the -- we finalized the kind of refocusing of our go-to-market. We added specific features that are more tailored toward developers. It might be more slowed down in the net adds in the short term. But in the long term, we're pretty confident in the product. We see great feedback about using the product, great use cases, and retention of the customers who do add. So, overall, we're happy with the progress, and we continue to invest into that product. Ittai Kidron -- Analyst That's great. And then for you, Roy, in your prepared remarks, or I think it was Eran, I'm sorry, you talked about that AI blocks up quite significantly quarter over quarter. Can you talk about evolution here? How do we think about AI blocks? First of all, how would this change, let's say, a year from now? And what you expect it to do to customer pattern in the context of expansion and moving up price tiers? How do you see this impacting that? Eran Zinman -- Co-Chief Executive Officer Yeah. So, yeah, the adoption -- we're very pleased with the adoption. Like I mentioned, in terms of total AI actions, it grew for more than 250% compared to Q2. And the AI blocks grew 150% from Q2. So, overall, we see more and more customers adopt those blocks. People incorporate them into their automations. They create a lot of processes within the product that involve AI within that. And over time, we are planning to roll out a monetization tied with AI, where we're going to generate a clear and efficient value for our customers. So, definitely, we're very happy to see the progress with the AI features, the adoption of AI features. And over time, we're going to add the ability to monetize that as well. Ittai Kidron -- Analyst And, Eran, is that a '25 time frame for monetization on AI? Eran Zinman -- Co-Chief Executive Officer Yeah, we don't have a specific date, but it might be in 2025, but we can't commit to that. Ladies and gentlemen, that concludes the question-and-answer session. [Operator signoff]

Zeta Global (ZETA) Q3 2024 Earnings Call Transcript

Greetings, and welcome to the Zeta 3Q '24 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Madison Serras, investor relations. Thank you, Madison. You may begin. Madison Serras -- Investor Relations Thank you, operator. Hello, everyone, and thank you for joining us for Zeta's third quarter 2024 conference call. Today's presentation and earnings release are available on Zeta's investor relations website at investors.zetaglobal.com, where you will also find links to our SEC filings along with other information about Zeta. Joining me on the call today are David Steinberg, Zeta's co-founder, chairman, and chief executive officer; and Chris Greiner, Zeta's chief financial officer. Before we begin, I'd like to remind everyone that statements made on this call, as well as in the presentation and earnings release, contain forward-looking statements regarding our financial outlook, business plans and objectives, and other future events and developments, including statements about the market potential of our products, potential competition, revenues of our products, and our goals and strategies. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. These risks and uncertainties include those described in the company's earnings release and other filings with the SEC, and speak only as of today's date. In addition, our discussion today will include references to certain supplemental non-GAAP financial measures, which should be considered in addition to and not as a substitute for our GAAP results. We use these non-GAAP measures in managing our business and believe they provide useful information for our investors. Reconciliation of the non-GAAP measures to the corresponding GAAP measures, where appropriate, can be found in the earnings presentation available on our website, as well as our earnings release and other filings with the SEC. With that, I will now turn the call over to David. David Steinberg -- Co-Founder and Chief Executive Officer Thank you, Madison. Good afternoon, everyone, and thank you for joining us today. The bets we made seven years ago on artificial intelligence, the investment in a one-of-one marketing platform, and our commitment to our customer's success has resulted in record-setting third quarter financial results, above our previously raised guidance. In this quarter, we generated revenue of $268 million, up 42% year over year, with adjusted EBITDA of 54 million, up 59% year over year. This translated into an adjusted EBITDA margin of 20%, up 210 basis points year over year. Once again, we are raising our full year 2024 revenue outlook by $61 million to $986 million at the midpoint, representing 35% year-over-year growth. Not only did we break the rule of 60 for the first time as a company, but we were above the rule of 50, excluding political candidate revenue. In addition to our financial achievements, we also strengthened our foundation. In Q3, we raised over $900 million in capital, including the undrawn loan facility. We had record in-person attendance for our annual Zeta Live event. We announced our new intelligent mobile product and our next generation of generative AI, in addition to expanding our partnership with Snowflake and onboarding Yahoo as a major new customer. And on the heels of the third quarter, we announced and closed the acquisition of LiveIntent, with the integration already underway and synergy realization ahead of schedule. Our momentum can be directly linked to the acceleration of the AI revolution, where marketing is at the forefront. This is creating unprecedented opportunity for disruptive technology, like the Zeta marketing platform, which is winning in the marketplace and winning big. Here is a snapshot of three transformative, seven- and eight-figure deals we closed in the third quarter. First, for an iconic global retail brand, Zeta was awarded an eight-figure deal over five years, beating out a legacy marketing cloud to create a true 360-degree view of their customers and to deliver better experiences at every touchpoint while lowering their total cost of ownership. This requires powerful AI agents across productivity, personalization, and predictability, which only Zeta can do. Second, Zeta expanded its footprint in sports and entertainment by securing another major professional sports league, one of the fastest-growing properties globally in a multiyear seven figure deal. This organization had outgrown its previous vendors capabilities and needed sharper identity resolution for a 360-degree customer view, deeper insights into purchase intent and more sophisticated attribution. Among the enterprise grade platforms they evaluated, only Zeta delivered all of this in a single platform and met their stringent time-to-value requirements. Third, Zeta showcased the strength of its One Zeta model by securing an all-in-one platform agreement with a leading e-commerce company. This agreement integrates acquisition, growth, and retention into a single platform powered by proprietary data and AI, reducing complexity, boosting productivity, and driving higher ROI, all core to Zeta's value proposition. Only Zeta can meet all of these needs in one platform. During the third quarter, Zeta deepened its relationship with its five agency holdco customers to bring multiple new brands, including a global automotive brand into our direct channel. Platform engagement like these are representative of customers utilizing the full breadth of Zeta's data, AI, and direct channels for activation. In addition to key wins, Zeta is also building upon its existing assets through the acquisition of LiveIntent, which expands publisher monetization, elevates Zeta's newly released mobile and retail solutions, and enhances Zeta's data cloud. Our increasing capabilities are being recognized by industry analysts in the marketplace. We were named a leader in marketing automation software by Forrester and a strong performer in the CDP Wave also by Forrester, the only enterprise-grade platform to be cited at these levels for each category. We also created and expanded partnerships this quarter with Yahoo and Snowflake. The Yahoo partnership announcement had multiple facets. First, we announced that Yahoo selected Zeta to deliver intelligent-powered marketing. This means they will migrate their email marketing, which includes hundreds of millions of people to the AI-powered Zeta marketing platform. Second, the Zeta marketing platform will be integrated with the Yahoo ConnectID, which will allow Zeta to enhance the Yahoo DSP with Zeta's advanced audience targeting capabilities. As a result, the new integration will position both of our companies to expand market share, streamline benefits, and drive higher return on investment for joint clients. And last, we announced the Zeta Data Cloud will be interoperable with the Yahoo Connect ID, which unlocks comprehensive insights and allows for the creation of unique intent-based audiences. The second announcement was our joint efforts with Snowflake. We unveiled a new solution, the Zeta Media Engine powered by Snowflake. The Zeta Media Engine brings the power of the Zeta marketing platform to where Snowflake's customer data resides, enabling marketers to enrich, expand. and activate their first party-data and deliver richer personalization across all paid media. This represents a significant milestone in our collaboration with Snowflake as we join efforts to bring an enhanced solution to marketers seeking to improve precision of their marketing programs without sacrificing scale. The momentum we've had in 2024 was a catalyst for our most successful annual Zeta Live conference yet. More than 1,100 visionaries, business leaders, and practitioners from more than 400 enterprises attended in person, doubling attendance year over year. Most notably on display were Zeta's launch of our AI-powered intelligent mobile solution and the expansion of the AI agent lineup. With Zeta's new intelligent mobile solution, marketers will be able to leverage AI to better activate and coordinate personalized cross-channel campaigns that deliver enhanced customer experiences and persistent identity across all touch points, resulting in better consumer interactions and better business outcomes. In addition, building on our earlier launch of intelligent agents this year, Zeta launched an expanded lineup of generative AI agents on the Zeta marketing platform, unleashing powerful, first-of-its-kind capabilities for marketers. While others are trying to roll out their first version of their AI agents, we are already on version three. This game-changing event further bolstered our business momentum as already evidenced by record pipeline demand and commitments from customers, a testament to Zeta's roadmap and strategic vision resonating. And we are succeeding in our evolution from Zeta who, to why Zeta, to, ultimately, must have Zeta. In closing, I'm excited about what the Zeta team has achieved and the opportunities ahead of us and our ability to execute in the marketplace so consistently. As always, I would like to sincerely thank our customers, our partners, Team Zeta, and all of our shareholders for the ongoing support of our vision. Now, let me turn the call over to Chris to discuss our results in greater detail. Chris? Chris Greiner -- Chief Financial Officer Thank you, David, and good afternoon, everyone. The third quarter can be best summed up by the momentum that began in the first quarter and accelerated in the second quarter, continued into the third quarter with even some notable improvements. Revenue growth accelerated to 42% and, excluding the benefit from political candidate, once again top 30% year to year. We set another scaled customer ARPU record with 33% year-over-year growth. Direct revenue was up 41% year to year, reflecting agency adoption of direct channels. On the back of this positive mix shift operating leverage flowed solidly to the bottom line with adjusted EBITDA and free cash flow margins up 210 and 250 basis points, respectively, year to year. All told, it was our 13th consecutive beat-and-raise quarter. I'll focus today on three topics. I'll dive into the KPIs driving third quarter performance. I'll dig further into the agency opportunity by discussing how early we are in ramping with large and independent agencies, and sharing examples of the positive direct mix shift we're starting to see. Finally, I'll close with our increased fourth quarter and full year guidance, comment on 2025 consensus estimates, and preview the duration of our next long-term model. Let's start with the drivers of the third quarter's results. Revenue of 268 million grew 42% year over year; or 31%, excluding $21 million of political candidate revenue. On both dimensions, our results exceeded recently updated guidance of at least 255 million; or $245 million, excluding political candidate revenue. Strength was broad-based. On a year-to-date basis, net revenue retention is at the high end of our 110% to 115% model. We had another productive quarter of sales hiring. We're up to 155 quota carriers, a 20% increase from last year. Reaccelerating sales headcount comes at an opportune time, with the RFP pipeline up 60% from just 90 days ago, which is attributable to Zeta Live and multiple industry analyst reports naming Zeta as a leader. Total scaled customer count grew to 475, up 8% year to year and 7% quarter to quarter, with scaled brand count up 25 versus 2Q. Super-scaled customers of 144 was up 16% year to year and flat quarter to quarter, with super-scaled brand count up 9% quarter to quarter and 29% year to year. Scaled customer ARPU of 557,000 was a standout, growing 33% year to year, which compares to the previous high watermark of 22% growth achieved last quarter. The force is continuing to drive strong ARPU growth, our channel adoption, use case expansion, scaling with agencies and political candidate contribution. From an industry perspective, five of our top 10 industries grew faster than 35% year over year, with insurance, technology and media, and consumer retail leading the way. On the back of 41% year-to-year growth, direct mix climbed to 70%, up from 67% the first six months of 2024 and on par with 3Q last year, reflecting positive mix shift from our agency customers. The improved mix resulted in lower GAAP cost of revenue quarter to quarter, coming in at 39.4%, or 60 basis points better than 2Q, and 50 basis points higher year to year. Strong leverage in operating expense resulted in our 15th straight quarter of expanding adjusted EBITDA margins year over year. We generated 53.6 million of adjusted EBITDA at a 20% margin, 210 basis points higher year over year and 3.4 million better than the midpoint of our recently updated guidance of 50.2 million. Our third quarter GAAP net loss was 17.4 million, which includes 47 million of stock-based compensation. Excluding the accelerated expense recognition related to our IPO, stock-based compensation would have been 31 million. Finally, cash from operating activities was 34 million, up 51% year to year, with free cash flow of 26 million, up 93%. This translated to a free cash flow to adjusted EBITDA ratio of 48%. It's worth noting this includes a $10 million working capital headwind from our growth with agencies and the industry's longer payment cycles. Absent this, cashflow conversion would have been 67%, which is a good segue to the broader agency opportunity ahead of us. The same forces driving Zeta's growth with enterprises are propelling Zeta's growth with agencies. Those being a shift to addressable marketing. And this is the importance of people-based marketing and the ROI our customers realize from working with Zeta. Second, the emergence of first-party data as an enterprise or brand asset. This is the rise of customer data platforms as foundational to personalization. Only through Zeta's data cloud and CDP can a brand see its existing customers and prospects in one platform. And third, the replacement cycle. Zeta is enabling CMOs and CTOs to achieve their strategy of modernizing their tech stack and eliminating features and numerous point solutions. This is creating significant opportunity for Zeta with large agency holdcos and a newer segment of independent agencies. I'll start with the five largest holdcos. Today, Zeta is working with just shy of 100 scaled brands compared to the thousands in their combined portfolios. And this only considers the volume of brands as an opportunity set. On the value or wallet share side of the equation, the total spend Zeta is capturing with the five large agency holdcos today barely registers with the tens of billions each holdco deploys in digital media, the bulk of which is addressable by the Zeta marketing platform. Last year, we began prospecting a new segment of independent agencies, featuring one such customer at our investor day in September. Since then, we've expanded our agency sales team to go after more of the independent agency market, encompassing well over a thousand stand-alone agencies who deploy billions in digital spend annually. We're growing our footprint within the agency ecosystem and shifting mix to direct channels. Here's a few examples just from the third quarter alone. In first quarter, a large agency holdco awarded Zeta one of the largest automotive service centers with 2,000 locations nationwide. The engagement began with one integrated channel and scaled quickly to over 500,000 by 2Q. In the third quarter, we upsold two additional direct channels, increasing direct mix from zero to 30% while growing revenue by 6x to a super-scaled brand in just nine months. In a second example, an agency awarded Zeta one of the most recognizable office supply retailers in the U.S. This brand started omnichannel and has maintained a 70-30 direct versus integrated mix, while growing spend with Zeta more than three times in six months, also recently becoming a super-scale brand. And lastly, Zeta was awarded a national pizza chain in the middle of 2023. For the first 12 months on the ZMP, this brand focused on social as their primary channel. During the third quarter, we added a direct channel, which increased revenues by 3x and increased direct mix to almost 50%. The punchlines are straightforward. First, the same structural forces driving demand from enterprises are also influencing agencies to expand with Zeta. Second, we're very, very early in penetrating this opportunity, both in terms of brand count and wallet share. And third, we have a repeatable and scalable model to land new brands and expand with higher ROI direct channels. I'll wrap up with guidance, covering details for the remainder of 2024, while also touching upon 2025 and our next long-term model. Starting with 2024, we're raising 4Q and full year revenue, adjusted EBITDA, and free cash flow guidance. Details can be found on Slide 16 in our earnings supplemental. For the full year 2024, we're increasing the midpoint of our revenue guidance issued on July 31st by 61 million to 986 million, representing 35% growth year over year. We've outlined our increased guidance into three steps, given the moving parts associated with LiveIntent, political candidate revenue, and our equity raise. You can refer to Slides 18 and 19 that are earning supplemental for ease of tracking. Step one is LiveIntent. Fourteen million of the 61 million raise is related to approximately two months of fourth quarter stub period revenue. Step two is political. Twenty-six million of the 61 million raise is related to higher political candidate revenue. Our prior full year guidance of 15 million included 1.5 million in 2Q, 5 million in 3Q, and 8 million in 4Q. Our updated full year guidance now has a total of 41 million with 1.5 million in 2Q, 21 million in 3Q, and 18 million in 4Q. Step three is the rest of Zeta. The remaining 21 million of the 61 million raise is related to flowing through Zeta's third quarter overachievement of 13 million versus our original guidance of 239 million, plus our 8 million raise to fourth quarter guidance. You recall we were not able to flow through our increased third quarter revenue guidance through to the full year during our equity raise in September. From a full year growth rate perspective, excluding the contribution from LiveIntent and removing the benefit from political candidate spending, we expect revenue to be up 28%, better than our prior full year guide of 25%. The increase in fourth quarter revenue guidance of 32 million to 295 million at the midpoint is driven by 14 million from LiveIntent, 10 million in additional political candidate revenue, and 8 million from the rest of Zeta. Fourth quarter year-over-year revenue growth, excluding LiveIntent and removing the benefit from political candidate revenue, is expected to be 25%. In terms of full year 2024 adjusted EBITDA, we're raising the midpoint of 2024 guidance by 13 million to 188.5 million, representing a year-over-year increase of 46% or 19.1% margin, an increase of 140 basis points year to year. In a similar vein as revenue, half of the raise stems from flowing through third quarter upside versus our original guidance, while the other half is in connection with our fourth quarter raise. We're increasing the midpoint of fourth quarter adjusted EBITDA by 6.5 million to 65.9 million, or 22.3% margin, up 105 basis points year over year. We're also raising the midpoint of full year 2024 free cashflow guidance to 90 million from 85 million in our prior outlook. This represents a cash conversion percentage of 48% versus 42% in 2023. Two items worth noting on this point. First, in connection with the third quarter's equity raise and acquisition of LiveIntent, we incurred 6.2 million in one-time charges, the bulk of which is related to acquisition-related expenses, which will be paid in the fourth quarter, the savings being realized in higher free cashflow in 2025. And second, we continue to be conservative in our assumptions for net working capital related to longer payment cycles agency customers adhere to. Selection risk with these customers remains extremely low. Before we take your questions, I'll close by previewing our thoughts on 2025 in our next long-term model. We'll provide full details on each during the fourth quarter conference call in February. As we sit here today, we're very comfortable with 2025 consensus revenue growth, adjusted EBITDA margin, and free cash flow estimates. As it relates to consensus revenue growth of 17%, this excludes the contribution from LiveIntent, but includes what is likely a 4 to 5 point growth headwind from 2024 political candidate revenue. So, on a pro forma basis, 2025 consensus revenue growth is effectively 21 to 22% next year. Once again, we're very comfortable at these levels. Second, we're looking forward to sharing our 2025 guidance and the details of our next long-term model, Zeta 2028, in February. Along those lines, we plan to outline new growth opportunities in verticals, new products, new partnerships, and new geography, in addition to conveying drivers of continued operating leverage. Now, let me hand the call back over to the operator for David and me to take your questions. Operator? [Operator instructions] Our first question comes from line of DJ Hynes with Canaccord Genuity. Please proceed. DJ Hynes -- Analyst Hey, guys. Thanks for all the color on the guidance. I appreciate you breaking all that stuff out. And obviously, the agency color as well, super helpful. David, I want to ask about a completely separate topic, which is publisher cloud. Right? It's newer to the business. Can you talk a little bit about your vision there? How to think about? How do you think about sizing the potential for that opportunity? I just don't have a good feel for how material that effort might be. David Steinberg -- Co-Founder and Chief Executive Officer Well, thank you, DJ. I'd start by saying we see the publisher cloud as sort of our next really meaningful growth opportunity. We've got, obviously, CTV which is growing very, very rapidly at scale. And then we've added mobile which we're very excited about. Mobile, we expect to scale very, very quickly over the next few years. As you think about the publisher cloud, today, the vast majority of publishers are not able to build deterministic marketing capabilities to an individual that's visiting their portal. Because you've got a third-party SSP, the third party SSP has to connect to a third party DSP, and the third party DSP has to come up with a deterministic data set. Most of the DSPs do not have that. Our vision is to put everything into one set. Just like when we launched the ZMP, we put AI and data as native to the application layer, it eliminated latency and allowed us to disintermediate and continue to grow against legacy tech clouds. We believe by putting our SSP fully integrated into the DSP, fully integrated into the data cloud, fully integrated into the publisher, will allow us to massively drive up the yield of marketing dollars to the publisher that will flow to them through the publisher cloud, which will allow us to take a sizable exhaust rate off the top. So, I think it's a big opportunity on platform with high gross margin that will scale quickly in the years to come. DJ Hynes -- Analyst Yeah, super helpful color. Chris, maybe a follow-up for you. Can you just help us think about scaled customer ARPU growth if we were to exclude the political candidate revenue, if we were excluding the agency customers, or maybe looking at them at like a brand level? I mean, obviously the agencies knew that metric a bit, which is a good problem to have. But just trying to think about kind of underlying trends in customer spend on a cleaner basis, if that makes sense. Chris Greiner -- Chief Financial Officer It does make sense, DJ. Thanks for the question. If you take the 33% ARPU growth and you were to exclude political candidate revenue contribution, the growth rate would still have been higher than the growth rate we saw in the second quarter, which was 22% ARPU growth in total. So, you know, take a growth rate that's in the mid-20s ex-political candidate revenue contribution, and you then break that down between channel adoption, use case adoption, and agency customer mix, it's actually very similar to what we saw in the second quarter, where about a third of the growth is attributable to each one of those drivers. So, over 30% of our total scaled customers are now still using over three or more channels. Use case growth was again consistent across the acquired, grown, retained level. And as we mentioned and highlighted, brand adoption within the agencies continue to scale rapidly even at that super-scaled level. So, brands that meet that greater-than-a-million-plus threshold, that was up 29% year over year. Thank you. Our next question comes in the line of Arjun Bhatia with William Blair. Please proceed. Arjun Bhatia -- Analyst Perfect. Thank you, guys, and congrats on a very strong quarter here. Maybe if I can start with the agencies again. It sounded like the mix shift in terms of the channels agencies are using is starting to move a little bit more toward direct, which certainly is a big benefit. Can you just talk a little bit about which channels on the digital side that you're seeing early adoption from and, you know, where kind of we are in that overall journey of agencies moving more and more of their spend onto the Zeta platform? And then, for Chris, maybe you can talk a little bit about where we should think about gross margins going just from that impact. David Steinberg -- Co-Founder and Chief Executive Officer So, thank you, Arjun. I appreciate the congratulations. What I would say is as our favorite tag line of "We are just getting started," it is perfectly encapsulated in the migration of our agency clients from integrated platform to direct. What I would say is the three biggest wins we're seeing right now are connected television, online video, and mobile. We're seeing the mobile adoption rate happen, perhaps, a little bit faster than we originally expected. It's been exciting because not only have we been migrating some of the existing customers over. But as new brands have come on, as I think Chris did a really good job of outlining in his prepared remarks, we're seeing them start on direct. And I think that's a trend that will continue. If you look at our most mature agency client, who by the way is still growing nicely, but our most mature, I'll remind you, the first year they worked with us, they were approximately 93% integrated and 7% direct. In their third year, that was over 50-50 for direct versus indirect. We don't need to move from, you know, 10% to 90% to continue to move the mean up, which continues to move on platform versus integrated, which continues to drive gross margins, which I'll let Chris talk about. Chris Greiner -- Chief Financial Officer Yes, starting, Arjun, with the 41% direct revenue mix, if you're to break down which channels drove that and then why we saw a benefit of mix, you had email growing almost 30% at 29%, display video growing 46%, and CTV growing north of a 150% year to year. And by the way, that still has social growing over 50%. So, when you have that type of positive mix shift like we saw a quarter over quarter, we effectively moved the gross -- you know, the implied gross margin of the business, up around 100 bits. As I think about what it could look like going forward, obviously, direct mix shift, as David mentioned, is now beginning to happen more consistently across our enterprise brands, which should begin to chip away. It's not going to be moving 200 to 300 basis points at a time quarter to quarter, but we should be able to continue to, in a very moderated way, move the cost of revenues of the company down or the gross margins up. Arjun Bhatia -- Analyst Wonderful. That's great to hear. Thank you for that. And, Chris, if I can follow up one for you. I saw the guidance for political contribution in Q4 had implied that it might be down from where Q3 shook out. Can you just maybe give a little color on what we should expect in political on the fourth quarter? And, you know, is that just -- is that conservatism, or is there kind of anything else that we should be aware of given the last few election cycles of playing out for political revenue? Thank you. Chris Greiner -- Chief Financial Officer Yup. Thanks, Arjun. Look, I think it's nothing really more than you've got three full months of political candidate revenue contribution across the duration of the third quarter and effectively one month in a week in the fourth quarter. I do think that there's upside to the 18. I don't think it's going to be as significant as what we saw when we updated the third quarter. But I do think we've left some room as there's still some political and advocacy spending trickling in. Arjun Bhatia -- Analyst All right. Understood. Thank you. Congrats again, guys. Thank you. Our next question comes from the line of Richard Baldry with ROTH. Please proceed. Richard Baldry -- Analyst Thanks. Can you talk about any early feedback you've gotten sort of in the open market, post the LiveIntent acquisition? And then, maybe with that as a backdrop, your cash stepped up, you know, significantly, even once you paid the cash component of LiveIntent. So, how's your appetite, you know, looking forward for acquisitions, or how does that play into your back now, history of doing sort of buybacks on an ongoing basis? Thanks. David Steinberg -- Co-Founder and Chief Executive Officer Well, so let me start with your first question first, Rich. We are seeing a faster-than-expected synergy recognition between the two organizations. Now, a lot of that was Steve Gerber and his team really had been working on what we call quick wins. And we're seeing a number of them really flow through. And quite frankly, we're also seeing, in addition to cost savings, we have executed already a number of cross-selling relationships between the organizations. So, we're very excited about that. And we should have it fully integrated by the end of this month into the data cloud from a signal recognition perspective. So, really puts a belt and suspenders, and suspenders on the data cloud by adding all of those signals and all of that data. Oh, yeah, we were even surprised. We're generating meaningful free cash flow as a company. Yes, we will be up even after paying the cash portion of LiveIntent. And we will continue to look for very opportunistic acquisitions with great teams, great technology, great data, where we believe that we can implement our four main pillars of M&A. We're going to stay disciplined to that. But what I would tell you in the current environment, I believe we'll be able to continue to add great companies to Zeta in the coming months and quarters. Thank you. Our next question comes from the line of Ryan MacDonald with Needham. Please proceed. Ryan MacDonald -- Analyst Hi. Thanks for taking my question, and congrats on a great quarter. Maybe to start on the independent agency channel opportunity that you talked about. Obviously, going after about a thousand of these opportunities and have expanded the sales force. Can you just talk about, one, have you won any of these independent agencies thus far? And if so, you know, what does the size potentially or revenue mix of those customers look like when you initially land them? And then, just anything you could comment on sort of sales cycles of these types of opportunities relative to, say, the direct business or maybe the top five agency holdcos. Thanks. David Steinberg -- Co-Founder and Chief Executive Officer So, thank you, Ryan. Let me start by saying we have a number of executed contracts in the independent agency space and have more than one customer generating meaningful revenue. The beauty of these relationships is they are all, for the most part, I would say the vast majority are on platform. It's a platformization of the ZMP to the independent agency that allows them to be hands on keyboard for their customers. So, they are very high gross margin, they are on platform, and they can scale very quickly. From a sales cycle perspective, I would say it's sort of in the middle. If we can generally close an enterprise client in a faster period of time and a very large agency holdco, these are sort of in the middle. But I would tell you, in particular, coming out of Zeta Live, the pipeline for these independent agencies is up multiples. I expect we will have very good news on more than one of these to grow that this quarter. Ryan MacDonald -- Analyst Super helpful. Maybe just then on a -- second question on the LiveIntent business, as you start to get that integrated and go to market there, is there any difference in sort of how the go-to-market motion or the seasonality of that business operates? Or is that more of a ratable revenue stream that we should expect as we move forward? And then, any differences on the margin profile relative to core Zeta? Thanks. David Steinberg -- Co-Founder and Chief Executive Officer To answer your last part first, yes, it's an exhaust rate business where you're taking a percentage on both sides of the transaction. So, you take a percentage from the advertiser, and you then take a percentage of that net from the publisher. So, it's a very high gross margin business, all of which is on platform. So, I think that that should be additive as we're able to really scale that business in the years to come. As it relates to cycle, you know, it'll have a slightly higher Q4 only because add dollars tend to come in at a slightly higher growth rate in the fourth quarter, just across the ecosystem. But I expect it to continue to be a very solid, very steady channel for us in the years to come. And, you know, quite frankly, one of the things I love about the business is that we're going to is they have a bunch of blue-chip clients that don't buy our products and we have a bunch of blue-chip clients that don't buy their products. The ability to cross sell here is very unique. And i will tell you, we've already executed a number of contracts to cross-sell and are generating revenue from their customers in. So, it's an exciting deal for us. Chris Greiner -- Chief Financial Officer Ryan, they also have a consistent go-to-market sales model like Zeta does, meaning a hunter-farmer. So, it really kind of folds in very nicely. Thank you. Our next question comes from the line of Terry Tillman with Truist Securities. Please proceed. Terry Tillman -- Analyst Yeah, I'll echo congratulations as well. Hi, David, Chris, and Madison. Some of my questions have been answered. But one of the statistics that I think, David, you had discussed was 60% plus RFP or RFP pipeline growth. I hope I got that right, but from 90 days ago. That seems pretty dramatic. I'm curious if you could kind of double-click on that in terms of, is this the replacement cycle that's accelerating, or was it some of the sales reps that Chris was talking about that you added and they're just having an effect and becoming productive? Maybe the timing of Zeta Live. I just want to unpack that a little bit more because it sounds like that was a standout. Well, thank you, Terry. Actually, Chris said it, but I'll take the question. Yes, the pipeline is up -- The pipeline is up 60% that -- we're very excited. It's probably the biggest pipeline increase we've ever seen, and we're already at scale. I think it was a combination of all of the above, right? But what is the goal? The goal for Zeta is to go from Zeta who, to why Zeta, to must have Zeta. And as we bring in substantially more senior sales reps than we ever have before, they bring books of business that help us evolve with that process. Zeta Live was a 100% grand slam this year. Even I was happy with our performance, and I joke I generally tend to be our biggest critic. And that was a massive growth to pipeline. As we publicly disclosed, over 400 enterprises came and were represented at Zeta Live this year. That was a big part of it. In fact, we've already executed a multiple of the cost of Zeta Live in contracts from a lifetime value perspective. So, really excited about that. And, of course, we're continuing to evolve the brand with Forrester and IDC and others rating us a leader or one of the leaders in categories across the board. It's great to hear it. And I guess, yeah, sorry for my confusion earlier. I guess it's been a long earnings season. Yeah. Well, on the sales reps, one of the questions, I think, people are going to ask you all, it seems like you're at an inflection point here. What about maybe stepping on the gas more in hiring? And I know you're looking for the best of the best, but I think Chris had said about 150 or 155 reps and like up 20% or up 25%. I'm just curious how you're thinking about as you go into the new year, kind of steady growth potentially if you can find it, pick up the pace of growth. And this long-winded question, I'll end it with, does that include the 25 to 30 folks from LiveIntent? Thank you. Chris Greiner -- Chief Financial Officer Hey, Terry. No, it does not. That's still core Zeta. We'll add probably around 25 to 30 LiveIntent reps when we reproduce the results next quarter when we blend the two businesses together. Look, it continues to be, as you said, really measured by quality over quantity. We continue to be very nicely diversified. In fact, half of our top 10 verticals grew over 35%. That's the first we've had that type of balance at that growth rate. And we do try to hire industry vertical expertise. We're still trying to maintain the right ratio of hunters versus farmers. The hiring approvals are in full form. I mean, there is no -- there's no holding back in that area with our sale leaders. But it is very much a focus on quality over quantity. David Steinberg -- Co-Founder and Chief Executive Officer And, Terry, those 25 LiveIntent salespeople are going to be selling core Zeta. So, this is -- it's going to be a meaningful step-up in salespeople right there. And as Chris said, we will hire every good salesperson we can get our hands on. Thank you. Our next question comes from the line of Jackson Ader with KeyBanc. Please proceed. Jackson Ader -- Analyst Great. Thanks for taking our questions, guys. Good evening. Can we actually follow up really quickly, David, on what you just said about the LiveIntent sales reps? Would the expectation be -- or I guess, has it been, you know, your experience that when you make an acquisition, bring on some salespeople, do they ramp as quickly or as consistently as net new hires that come from, you know, other competitors or other areas of software? Or does it take them a little bit longer to get used to selling core data? Thank you. David Steinberg -- Co-Founder and Chief Executive Officer So, the answer is it depends on the business. It depends on the product line they're used to selling. In this case, Jackson, there are tremendous similarities between the products they're selling and many of the products we sell at Zeta. So, there are products that are on platform, high gross margin that I would expect them to hit the ground really running. And then, there'll be products that it might take them a little longer to scale up on. But we're very excited and very bullish on this group of salespeople because there's so many similarities between their current products and what we sell. Jackson Ader -- Analyst OK. All right, great. Got it. And then a quick follow-up on the agencies. I guess, I totally understand the leverage and the benefit from those top five agency holdcos. But I am curious, you know, what kind of multiplier effect do the independent agencies have? And is there -- like, does that multiplier effect in terms of brands that you can attack per agency? Does that dwindle as you go out to the long tail of like the thousand that you're trying to target? Thank you. David Steinberg -- Co-Founder and Chief Executive Officer Yeah. I mean, yes, if you get out from number one in scale to number thousand in scale, it will dwindle just, you know, statistically. But what I would tell you is there are hundreds of independent agencies that represent billions of dollars in spend per year each. This is a meaningful opportunity. And we would expect each one of these independent agencies to be on platform, and we expect each one of them to be a super-scaled customer at launch. Thank you. Our next question comes from the line of Matt Swanson with RBC. Please proceed. Matt Swanson -- Analyst All right. Thank you, guys, for taking my question. And my congratulations on the quarter. In a rule of 60 quarter, it feels weird to be asking about a potential headwind. But across the lobby advertising ecosystem, we've heard about kind of this political crowding effect for nonpolitical spend, just brands kind of pulling back because the CPMs got high around political. Do you think there was any headwinds, I guess, to any of the holdcos or your nonpolitical spend from the ramp-up of political? And then second was just on the data cloud and really kind of that 360 view of the customer that you talked about, specifically with LiveIntent. Can you just talk about kind of the compounding value of bringing differentiated data sets and how that kind of brings a more holistic view, kind of that one plus one equals three dynamic? Yeah, so one of the great things about LiveIntent is number of emails -- hashed emails they see every month. You're talking over 240 million deterministic individuals that they're seeing across the entire Internet. We're able to see that across a very large number of publishers. They're able to see it across the 2,000 top and most premium publishers in the country. So, by adding those incremental data sets, it's going to be a very, very additive signal to the data cloud. What I would also say is I do expect us to increase the number of individuals we see in the data cloud from, you know, call it around 240 million to as many as 245 million. Might not sound like a humongous jump, but it is when you look at the additional signals and the additional people who are added into the data cloud. As I earlier said, too, it also puts a belt and suspenders, and suspenders on the data cloud. It's another massive importation of opted-in first-party data in addition to the other data sets we're already ingesting. In some cases, it's duplicative, but it's nice to know you have a belt and suspenders on that. Thank you. Our next question comes from the line of Jason Kreyer with Craig Hallum. Please proceed. Jason Kreyer -- Analyst Great. Thank you, guys. And congrats again. I'll echo, you know, great quarter. Just the success you saw in political in this season, wondering if you think you can translate that into other verticals or maybe like the broader advocacy spend over time. David Steinberg -- Co-Founder and Chief Executive Officer You know there's always a halo effect Jason, first of all thank you. You know, you interact with these campaigns. When campaigns win, those individuals go into government and they join other PACs and they join other ecosystems. And when those campaigns we work with lose, they go to other enterprises and agencies where we can work with them. So, there is a nice halo effect that comes out of that component of the business. Jason Kreyer -- Analyst OK. And then, maybe I'll just follow up for Chris. Appreciate the color on agencies and how that has impacted that EBITDA to free cash flow conversion. Do you think we're primarily -- like do you think that's trough by now? Do you think we're through, you know, kind of the majority, the headwind there? Because it sounds like you've penetrated the big five agencies reasonably well, and as you go after that mid-market or independent agencies, probably less of that free cash flow conversion or less of that gets trapped in, in that conversion there. Chris Greiner -- Chief Financial Officer You know, Jason, it was a 20-point headwind annualized all of last year, and that translated to like a $25 million deficit between working capital, so cash taken in versus cash paid out. It was about the same percentage point headwind in the third quarter, right? We reported 48% conversion from EBITDA, but it would have been 67 if not for a $10 million working capital headwind. The growth with the five large agencies, as we said in the script, is still in its very, very early days. And then, when you add on top of it the new opportunity we see with an even bigger by count independent agency marketplace, I still expect us to have those headwinds, again, based purely on our growth rates and the industry's payment cycles. These are -- you know, we have no bad debt with any of these accounts, not even on the fringe of having to explore such a scenario. So, it's just pure timing of when we get paid. Thank you. Our next question comes from the line of Elizabeth Porter with Morgan Stanley. Please proceed. Elizabeth Porter -- Analyst Great, thank you so much. I first wanted to ask about the mobile product where you highlighted some faster-than-expected traction. And I believe LiveIntent also has a mobile product. So, I'd just love to better understand the capability of Zeta's mobile product versus LiveIntent and what the go-to-market strategy is between the two products and how we could think about mobile adoption scaling into next year. David Steinberg -- Co-Founder and Chief Executive Officer Thank you, Elizabeth. Yeah, no, we are seeing mobile scale faster than expected. We have multiple enterprise clients and agency clients already on it. The real breakthrough for us was the ability to put AI at the heart of the mobile product as well, which allows us to target deterministic individuals wherever they are. That's a big differentiator from others who are not able to see the the deterministic level inside of that mobile environment LiveIntent has a number of identifiers into that mobile environment, including mobile ID number on, you know, millions and millions of people. So, the ability to put their capabilities together with our best-of-breed AI intelligent mobile product is scaling faster than expected. I think it'll be our next meaningful product line after connected television Elizabeth Porter -- Analyst Great. And then just as a follow up, I wanted to ask about the collective contribution between political and advocacy. I believe last quarter it was referenced that it was less than 10 million collectively between political and advocacy. So, is there an update that you could provide for Q3? And then, looking ahead, the color on the halo effect was super helpful. And I just wanted to know if there's any cyclicality to keep in mind for the advocacy group as we think about next year. Chris Greiner -- Chief Financial Officer Yeah, it's interesting. If you compare the -- let's kind of take them in piece parts. Compare what we're seeing in 2024 to the 2022 cycle, the growth in political candidate revenue is substantial. It was about back in -- looking at notes here, back in 2022. we're up over 440% in political candidate revenue, and it represents 56% of the total. Back in 2022, like 90% of the combined revenue is advocacy. In fact, advocacy on a third quarter basis versus the 2022 cycle is only up 3%. So, it just so happened that this cycle, again, working across both sides of the aisle, political name, political candidate contribution was much higher. I think advocacy not only will it be a good contributor this year, but we're building a practice around it so it can sustain itself in 2025 as well, building people in addition to building capabilities into that ecosystem. But overall, political candidate contribution was a heavier part of our overall total advocacy and political candidate revenue this year. But as a mix, advocacy was actually down pretty substantially. Thank you. Our next question comes from the line of Koji Ikeda with Bank of America. Please proceed. Koji Ikeda -- Analyst Yeah, thanks for taking the question, guys. Two for me. And the first one, it's about the 2025 commentary, Chris. You know, I totally understand this year is gonna be great from a growth perspective, exit rate 40%. You know, but then, excluding political and inorganic contributions, more like 25%, and when we look at the organic side of the performance over the past two quarters, you know, 30% plus. But when I think about the commentary that you have for 2025 on the organic standpoint, it looks like it's, you know, low 20s. And so just, is there anything we should be aware of in the business or the way you're thinking about the business in 2025 or organic growth wouldn't reach a similar type of performance that we've been seeing here? Chris Greiner -- Chief Financial Officer Koji, I think what you're hearing from us directly is just Zeta wanting to continue to be conservative. And we have a cadence where we provide a significant amount of detail on the February call, which we'll do again, talk about not only the updated model for next year, but what's included in the new long-term model. We continue to see ourselves as being a 20%-plus organic grower. You know, my commentary would obviously imply that would be the case next year when you normalize for political candidate revenue, but we believe we have a great sales pipeline. We're building the sales force, many new products to bring to the market, which, again, 2025 is about setting a -- you know, understanding of what we're comfortable with but continuing to be conservative. And we plan to update that in February. David Steinberg -- Co-Founder and Chief Executive Officer And remember, Koji, we came into this year below 20%. And here we are, right? So, we're not suggesting we're going to continue to do it in that way, but there's nothing we're seeing in the business that's problematic. We're just trying to level set expectations. At the same time, a lot of people have said, "Oh, are they going to hit next year?" So, we want to make it clear. We see next year as a starting point, and we'd have beat and raised 13 quarters in a row. Our goal is to be sitting here a year from now and, you know, saying it 17 quarters in a row. I guess that would be 16 statistically, but you understand my point. Koji Ikeda -- Analyst Yup, totally get it. And just one follow-up here. On LiveIntent, you know, when I look at the acquisition deck, it did mention pro forma revenue of around 76 million for this 2024. Any sort of update into the growth rates or growth rates you're seeing there, you know, post close? And any sort of purchasing accounting assumptions that we should be thinking about with this acquisition? Thanks, guys. Chris Greiner -- Chief Financial Officer Hey, Koji. Just in terms of growth rates, what we said back when we acquired is as similar growth rate as Zeta's historically had. So, call it right around, you know, 20%, a bit over that. And it's -- you know, we're still in that kind of integration phase. We're excited about the synergies we're seeing. We'll give very specific guidance on the February call and what we're presuming for that business. But it's -- you know, it's got a very healthy growth rate out of the gate. Thank you. Our next question comes in line of Zach Cummins with B. Riley Securities. Please proceed. Zach Cummins -- Analyst Hi. Good afternoon, David and Chris. Congrats on another strong quarter. David, I just wanted to ask about your expanded lineup of gen AI agents that you rolled out at Zeta Live. I mean, can you give us a sense of the interest you've been seeing from both agencies and enterprise clients? And any sort of update on adoption trends as you think about expanding out that lineup? David Steinberg -- Co-Founder and Chief Executive Officer Yeah, so when we rolled out -- I don't know if you were there, Zach, but when we rolled out the new AI agent studios, we did it on the innovation stage, which was a smaller stage. It was opposite like a rock star panel on the main stage. And the innovation stage was standing room only. We couldn't get people to go back to the main stage from the innovation stage because people were so excited about the rollout of the AI agent. So, what I would tell you is. The adoption rate of our AI agents is bigger than anything I've seen us do as a company yet. Clients are in the studio. They are building their own agents, they are using the collected agents that are available there. I think it's one of the reasons you heard Chris say that we are now at the top of our 110 to 115 net retention rate as a company and, you know, could conceivably continue to go higher. We're seeing clients use these agents at an unparalleled pace, both agencies and enterprises. Zach Cummins -- Analyst Understood. And my one follow-up is really around partnership channel. Great to see expanded relationships with Snowflake, also a new relationship with Yahoo. But any update you can give us on the system integrator channel? I know you had plans of building out a practice on that side, so just curious of how you're thinking about that as a lever for growth moving forward. David Steinberg -- Co-Founder and Chief Executive Officer Yeah, I mean, interestingly enough, we've already got two up and running. So, we're just -- we're just trying to make sure that we really crack the code before we start really talking about it again. You know, it was always meant to be a growth channel. And we've been pretty clear, it's not even in the numbers for 2025. But at the same time, it's working. So, it's interesting to see the adoption rate. You know, it's something that -- it's a very long sales cycle to get these guys up. So, we're happy to have two. Our goal is to get two or three more in the coming quarters. And that's when I think it'll become a meaningful driver to the business. Zach Cummins -- Analyst Understood. Well, thanks for taking my questions, and best of luck with the rest of the quarter. Thank you. Our next question comes from the line of Clark Wright with D.A. Davidson. Please proceed. Clark Wright -- Analyst Awesome, thank you. Can you talk about the LiveIntent deal and how this will impact some of the KPIs like the scaled customer count? And then, additionally, do you believe that the 17 times uplift in ARPU from scaled customers to super-scaled can be applied to the customers who started with LiveIntent and adopted other data offers? Chris Greiner -- Chief Financial Officer Hey, Clark. We're still -- we'll give the LiveIntent figures. You know, obviously, you know, having acquired it post the end of third quarter, we'll do all the inclusion of their metrics at the end of this year, so in the February call. But broadly speaking, from an ARPU perspective, their combined ARPU as a company is closer to what ours is for the 100k to a million category. Their million plus-customers are closer to like a million and a half. Compared to ours, it's almost 5 million. So, we've got some early reads into it, but we'll get the rest of the details in February. It will obviously result in a substantial number of incremental scale customers. David Steinberg -- Co-Founder and Chief Executive Officer Yeah. And I do want to point out, Clark, I think this is important note, we did close that deal in Q4. So, none of that deal, none of the KPIs, none of the revenue is in the numbers we just reported for Q3. Clark Wright -- Analyst Got it. Thank you. All my other questions have been answered. Thank you. Our next question comes from the line of Brian Schwartz with Oppenheimer. Please proceed. Brian Schwartz -- Analyst Yeah. Hi. Thanks for taking my question. I'll just ask one for the sake of time. David, I wanted to ask you where the spending is coming for these new -- your new agent studio product that you released. I know you talked to a lot of C-level executives. So, as we think about the spending for these types of products and these agent products next year, is it coming out of IT budgets? Or are customers, you know, building a second budget for these AI products? And then, you know, talk to us how you can make sure that you can continue to gain share in that one. What is that dynamic? What are you seeing in terms of conversation in regards to the budgeting process for these new agent products? Thanks. David Steinberg -- Co-Founder and Chief Executive Officer Thank you. Thank you, Brian. So, what I would say is like any new product, you're seeing it come out of multiple buckets, right? It's coming out of the IT budget, it's coming out of the software budget. And some of it, it's coming out of the marketing budget. But truthfully, I do believe, going into next year, enterprises we're talking to -- yes, we talked to a lot of CEOs, are setting up stand-alone AI budgets around innovation. And we believe with our proprietary data -- because as we've said multiple times, AI is only as good as the data you feed into it. So, when you put the CDP in place, you take their data, all of our data, that's where the magic happens. You've got all of their first-party proprietary data, all of our first-party proprietary data, and you begin to look at how the algorithms get smarter and smarter. The beauty and the thing I love most about this component of the enterprise budget, Brian, is its cost savings to the enterprise. So, we're able to put out an AI agent that can eliminate 10 $250,000 a year data science jobs, to put it in perspective. And in exchange for that $2.5 million in savings, they might be spending $200,000 or $300,000 with us. So, it's a really, really good return on investment. And then, from a growth perspective, what we find is our enterprise clients who use our CDPs, use our AI agents are substantially stickier. They scale faster. Brian Schwartz -- Analyst Thanks for that color. Congratulations on the results. Thank you. Our last question comes from the line of Ryan MacWilliams with Barclays. Please proceed. Ryan MacWilliams -- Analyst Hey, guys. Thanks for the question. Was curious just how the macro impacted data in the quarter. And I know it's early, but have you noticed any changes from customers post the election in terms of unlocking marketing spend? And any thoughts into your customers' plans for holiday season messaging at this point for the fourth quarter? David Steinberg -- Co-Founder and Chief Executive Officer Yeah, Ryan. So, yes, we're -- the certainty of the election with a winner without a long drawn-out process has led not just the markets to react positively but you -- we're also seeing advertisers unlock dollars that we might not have expected. That's it. Ryan MacWilliams -- Analyst Appreciate that. And anything on the holiday season at this point? David Steinberg -- Co-Founder and Chief Executive Officer You know, we put out our guidance. You know, we obviously feel good about it. We raised the year's guidance by $61 million, which is, you know, quite a bit against our current budget. And, you know, listen, our goal is to be sitting with you in February, talking about 2025 guidance, talking about our new 2028 long-term plan and announcing our 14th consecutive quarter of beating and raising guidance. So, right now, we're feeling very very good about the business. We're firing on 10 of 12 cylinders. And we really feel like the engine is doing well, and we're very bullish on Q4. Ryan MacWilliams -- Analyst Appreciate that. And just on the guidance for next year, have the top five agency holdco customers talked about their plans for Zeta next year? And would you expect your agency business to be a stronger contributor to your revenue growth next year compared to this year? David Steinberg -- Co-Founder and Chief Executive Officer I don't know about the last part. I think we'll have to see about that. The agencies have scaled very nicely. And we're very pleased, as I'm sure you heard in our prepared remarks, at how fast some of our new agency clients are migrating to direct, which showed a step-up in our direct versus integrated platform revenue. I think that's a trend that will continue as we move forward. What I would say is that our largest agency client just renewed for another two, three years. We're seeing very bullish signs out of them, and we're working on the plan for next year. But their minimum agreement is already in most of our plans in. And as i said, we're feeling very solid and having next year, be -- I forget if it's our fifth or sixth year in a row -- sixth year in a row -- thank you, Chris -- of 20-plus percent growth organic. Thank you. There are no further questions at this time. I would like to pass the call back over to David for closing comments. David Steinberg -- Co-Founder and Chief Executive Officer Thank you, operator. I will end on, I have never been more proud or more excited to be running this business. We are executing exceptionally well. We're working in lockstep with our clients and our strategic partners, and I think that has been evidenced by the organic growth in this business that we expect to continue for many years to come. So, thank you for attending the call, and we look forward to interacting with many of you again soon. Bye. Operator This concludes today's teleconference. [Operator signoff]

DXC Technology (DXC) Q2 2025 Earnings Call Transcript | The Motley Fool

Good afternoon and good evening. My name is Aaron, and I will be your conference operator for today. At this time, I would like to welcome everyone to the DXC Technology Q2 FY '25 earnings call. [Operator instructions] And with that, I would like to begin our call and I would like to turn it over to Roger Sachs, VP of investor relations. Roger Sachs -- Vice President, Investor Relations Thank you, operator. Good afternoon, everybody, and welcome to DXC Technology's second-quarter earnings conference call. We hope you had a chance to review our earnings release posted to the IR section of DXC's website. Speakers on today's call are Raul Fernandez, our president and CEO, and Rob Del Bene, our chief financial officer. Our agenda will be as follows. Raul will provide an overview of our results and an update on our strategic initiatives. Rob will then walk you through our financial performance for the quarter as well as update you on our full-year outlook and provide some thoughts on our fiscal third quarter. Raul and Rob will then take your questions. Certain comments we make on today's call will be forward-looking. These statements are subject to risks and uncertainties, which could cause actual results to differ materially from those expressed on the call. You can find a discussion of these risks and uncertainties on our Annual Report on Form 10-K and other SEC filings. We do not commit to updating any forward-looking statements made during today's call. Additionally, during this call, we will be discussing non-GAAP financial measures, that we believe provide useful information to our investors. Reconciliations to the most comparable GAAP measures are included in the tables included in today's earnings release. With that, let me turn the call over to Raul. Raul Fernandez -- President and Chief Executive Officer Thank you, Roger. Good afternoon, everyone, and thank you for joining us today for our second-quarter fiscal 2025 earnings call. I'm pleased to report a solid quarter, with adjusted EBIT margin and non-GAAP EPS exceeding our guidance and revenue coming in toward the high end of our range. Given this performance, we are raising our full-year guidance for adjusted EBIT margin and non-GAAP EPS. I'm proud of how our new leadership team has come together and the early momentum we've seen from our initiatives this year. While there is more work ahead, particularly in our go-to-market initiatives, we are focused on execution and building a solid foundation to support even stronger performance going forward. Specifically, during the quarter, total revenue declined 5.6% year over year on an organic basis. Adjusted EBIT margin equaled 8.6%, expanding 130 basis points year over year. Non-GAAP diluted EPS was $0.93, up 33% year over year. And we generated free cash flow of $48 million for a year-to-date total of $93 million compared to $16 million during the same period last year. While corporate spending on discretionary projects remains under pressure, we continue to believe our biggest near-term opportunities lie in our self-help initiatives that will drive a more significant impact on results. Our bookings remain an area of intense focus, and I feel we will make the progress needed in the upcoming quarters. We expect our book-to-bill ratio to improve in the third quarter. Our global delivery and sales footprint, complemented by a deep local presence, is a competitive advantage to serving clients. Being global and local allows us to understand and respond to regional dynamics by delivering tailored solutions that meet specific market needs while leveraging global expertise and resources. To drive improved sales discipline and execution, we implemented several new initiatives during the second quarter to augment our revamped go-to-market approach. These include a new client relationship training program with nearly 150 team members now certified; a regular cadence of sales team performance reviews, including detailed assessments of the value of the solutions we provide; and a new executive client sponsorship program to drive deeper client relationships. Additionally, during the second quarter, we initiated several tactical actions in our offerings to build on our progress. In our Global Business Services segment, where we help clients accelerate digital transformations, we continue to refine our delivery models and drive more scalable and standardized solutions. Specifically, in Consulting & Engineering Services, we hired a new global delivery leader to sharpen operations, keep projects on track, and ensure contract requirements are met. We are building more enterprise application capabilities, leveraging DXC Fast RISE with SAP service so clients can accelerate their SAP S/4HANA cloud implementations. And we are expanding our GenAI offerings using a center of excellence model to scale beyond proof of concepts to production. Let me highlight two examples of recent GenAI engagements. For Equitable Holdings, a leading financial services client, we built and deployed a GenAI-powered virtual service agent. This solution quickly analyzes thousands of documents, enabling customer representatives to respond 80% faster and freeing them to focus on more value-added activities such as complex financial planning. The success of this solution led to the creation of a GenAI Center of Excellence for the client, which has developed several more GenAI-based applications, growing the relationship by more than 10 times. We are also helping a large global bank accelerate time-to-market for new credit card products. Our GenAI-powered solution automates the conversion of hundreds of thousands of lines of legacy code into Java 50% faster with less errors. Expediting the time-to-market better positions the bank to capture market share in a highly competitive industry. By embedding AI across many of our solutions, we are sharpening our competitive edge. We are identifying numerous opportunities to help clients manage the full life cycle of GenAI from initial deployments to building complete solutions that grow with their businesses in a secure way. This includes matching the latest language models to meet client needs and ensuring GenAI solutions access data that is clean, current, and reliable. This approach is providing momentum in our data and AI practice within CES. We continue to invest in our insurance business to grow our software and reoccurring services mix as well as to expand geographically. We are being very thoughtful and deliberate in evaluating the range of opportunities we have to accelerate performance to deliver greater value for our clients and all stakeholders. To help drive long-term sales and improve profitability across our Global Infrastructure Services segment, which represents our portfolio of technology solutions, we took several actions during the quarter. We rolled out a new workforce management system to better manage resources. We brought in leaders to drive innovation in our software platforms, grow our public sector presence and enhance our security and Modern Workplace capabilities. And we streamlined Cloud and ITO, security, and Modern Workplace delivery under a single leader to improve consistency and accountability. We are realizing a notable improvement in our delivery metrics and overall quality of service, leading to a record Net Promoter Score. As a result, we have seen meaningful reduction in contract terminations. Our global shared services model is now fully implemented, consolidating, standardizing, and eliminating redundant processes across sales, business, and account operations. This increases our agility to better serve clients and optimize our costs. Our ERP consolidation plan remains on track, and we have successfully initiated the first migration wave from our legacy systems. We expect all these initiatives to lay the groundwork for margin expansion and revenue growth over time. With our partner ecosystem and top-tier engineering capabilities, we are well-positioned to capture opportunities, including migrating clients to cost-effective platforms to reduce software expenses, and maximizing returns on cloud migrations through cloud-native applications. Over the past 11 months, I've witnessed our global team's capability, resilience, and shared commitment to clients. We are not only capable but also worthy of winning. Now our focus is on doing so consistently and at scale. Our journey to realizing this vision will involve tactical execution, a firm commitment to accountability, and rewards tied to measurable success. To support this, we have recruited a talented group of proven, hungry, and innovative leaders with deep industry expertise, complementing our reenergized workforce and essential IT services portfolio. I am confident this combination is the right formula for success. As we execute our enhanced operating model, I firmly believe we are on the path to delivering stronger results as we move forward. Embracing each opportunity with the passion of a first-time entrepreneur and executing with the precision of an experienced global leader, we are building a solid foundation for enduring success. Now let me turn the call over to Rob for a detailed review of our second-quarter results. Rob Del Bene -- Executive Vice President, Chief Financial Officer Thanks, Raul, and good afternoon, everyone. Today, I'll review our second-quarter results and provide you with our latest updates to our full-year fiscal 2025 outlook, along with our view for the third quarter. Before discussing our performance, I want to point out a change in our reporting of adjusted EBIT. Starting in the second quarter, gains and losses on the sale of real estate and facilities will no longer be included in the calculation of adjusted EBIT as these transactions are considered to be non-operational. During the quarter, we executed sales of approximately $60 million with a loss of $27 million. To be clear, the cash proceeds from these transactions are not included in free cash flow and the losses, which were not included in any previous guidance for adjusted EBIT, are excluded from the reported second-quarter adjusted EBIT results. We have provided a historical view of our results reflecting the reporting change in our Excel data sheet that you can download from the IR section of DXC's website. And now on to our results. Total revenue of $3.2 billion declined 5.6% year to year organically, which was toward the high end of our guidance range. Our book-to-bill ratio for the quarter was 0.81, a modest improvement from 0.77 in 1Q. The trailing 12-month book-to-bill ratio was 0.88, the same as last quarter. Adjusted EBIT margin expanded 130 basis points year to year to 8.6%, above our guidance for the quarter. This performance was primarily driven by a higher yield from cost management initiatives and a non-recurring benefit related to the settlement of a legal matter, which added 30 basis points to the margin. Non-GAAP gross margin for the second quarter was 25.1%, expanding 170 basis points year to year; one full point of impact was due to a reclassification of business development costs to SG&A, which is a better representation of the nature of the spending. Absent this change, gross margin would have expanded 70 basis points year to year, primarily due to ongoing cost management within our GIS segment. Non-GAAP SG&A as a percentage of revenue was 10.4% compared to 9.4% last year. The 1-point increase was related to the reclass of business development spending. Excluding the impact, non-GAAP SG&A as a percent of revenue would have been flat year to year. Non-GAAP EPS was $0.93, up from $0.70 in the second quarter of last year. The $0.23 increase was primarily driven by higher adjusted EBIT and the impact of a lower share count, each contributing a $0.09 improvement. Now turning to our segment results. GBS, which represents 52% of total revenue, was down 1.6% year to year organically. The GBS profit margin increased by 30 basis points year to year to 12.8% largely due to more efficient resource management. Within the GBS segment, Consulting & Engineering Services declined 3.4% year to year organically largely due to market pressures impacting custom application projects which contributes about two-thirds of CES' total revenue. The book-to-bill ratio of 0.93 improved from the first quarter, while the trailing 12-month book-to-bill ratio remains stable at just over 1.0. Insurance and horizontal BPS grew 4.4% year to year organically. Embedded in this performance is our core insurance services and software business, representing close to 80% of the total, which was up 5% organically year to year. The book-to-bill ratio was 0.78 and on a trailing 12-month basis was 0.95. And as a reminder, bookings in this business tend to be lumpy with significant variation quarter to quarter given the higher concentration of large and longer-duration deals. GIS, which represents 48% of total revenue, declined 9.6% year to year organically as services revenue was down 8% in line with prior quarter, and resale declined 19%. Profit margin expanded almost 2.5 points year to year to 8.2% largely due to disciplined resource management, ongoing actions to optimize our data centers and networks, and the lower mix of resale revenue. Within GIS, Cloud, ITO, and Security revenues declined 10.1% year to year organically with services revenue down 9% and resale revenue down about 25% as we continued to reduce the number of low-margin deals. The book-to-bill ratio was 0.69 primarily attributed to the timing of certain large deal renewals and our disciplined approach to new deals. The trailing 12-month book-to-bill ratio equaled 0.71. Modern Workplace declined 8% year to year organically with services revenue down 7% and resale revenue down 12%. The book-to-bill ratio equaled 0.8 and the trailing 12-month book-to-bill ratio is 0.91, both in line with last quarter. Now turning to our cash flows and balance sheet. During the quarter, our free cash flow, defined as operating cash flow less capex, equaled $48 million compared to $91 million in the same period last year. The decline was largely driven by DSO performance which deteriorated in the quarter. Capital expenditures equaled $147 million, down $10 million year to year and new lease originations were about $10 million, down $14 million from last year. Taken together, capital expenditures and leasing originations declined $24 million for the prior period and as a percent of revenue improved by 50 basis points to 4.8%. Our free cash flow for the first half of fiscal 2025 equaled $93 million compared to $16 million for the same period last year. And as a percent of revenue, capex and lease originations improved 70 basis points to 5.5%. Now a moment on our restructuring efforts where we are taking a very measured approach. At the beginning of the year, we told you we would increase spending by approximately $250 million year to year. We are now revising that to a maximum of $150 million. This adjustment is reflected in our updated free cash flow guidance. With disciplined hiring practices, we have reduced our net headcount by approximately 4,500 since the beginning of the fiscal year, putting us on track to achieve our cost saving plans for the year. We currently anticipate utilizing the full $250 million into fiscal 2026. During the quarter, we reduced our debt through cash payments of approximately $227 million driven by retiring our outstanding commercial paper balance and paying down capital leases. This action was partially offset by the impact of the strengthening euro on our outstanding euro-denominated bonds. Now let me provide you with our latest thinking on our full-year outlook. As we have half the year behind us, we are tightening the range for revenue and now are expecting total revenue to decline between 5.5% and 4.5% year to year organically with the midpoint of the range unchanged. Given market conditions and somewhat longer conversion times we are seeing in our CES business, we now anticipate full-year GBS revenue to decline slightly year to year, offset by GIS performance slightly better than our prior expectation. As a result of our strong performance in the first half of the year, we are raising our full-year adjusted EBIT margin outlook to a range of 7% to 7.5%, up from our prior guidance of 6.5% to 7%. We expect our adjusted EBIT margin during the second half of the year to be lower than the first half. This is primarily due to merit increases and ramping investments in sales, marketing, and IT, all partially offset by labor efficiencies. We continue to expect a full-year non-GAAP effective tax rate of approximately 32%. Full-year non-GAAP diluted EPS is now anticipated to be between $3 and $3.25 compared to the prior outlook of $2.75 to $3. This update is primarily driven by the increase of our adjusted EBIT margin outlook. Free cash flow for the full year is now expected to be approximately $550 million, an increase from our prior view of about $450 million. This improvement is largely due to the increase of our EBIT outlook and lower anticipated restructuring spending to a maximum of $150 million. These cash flow benefits are being partially offset by the expansion of working capital. And now for the third quarter. We expect total organic revenue to decline 5.5% to 4.5% with a sequential improvement in our book-to-bill ratio. We anticipate adjusted EBIT margin in the range of 7% to 7.5%, reflecting the higher investment activity I just mentioned; and finally, non-GAAP diluted EPS of $0.75 to $0.80. And with that, let me turn the call back to Roger. Roger Sachs -- Vice President, Investor Relations Thank you, Rob. We now like to open the call for your questions. Operator, can you please provide the instructions? Operator Thank you. [Operator instructions] Our first question from today comes from the line of Zack Ajzenman with Cowen. Your line is live. Zack Ajzenman -- TD Cowen -- Analyst Hi. Thanks. This is Zack Ajzenman on for Bryan. Just first question on the free cash flow, wanted to dig in a little bit further. Nice to see the uptick for fiscal 2025. It sounds like this is driven by both profitability and the extension of restructuring. Just wanted to get a better sense on the sustainability and growth in the coming quarters and years. I know fiscal 2026, the goal was to get back to levels seen in 2024. As you extend the restructuring program, does that weigh on those goals? Or are there still margin upside and other levers to help you kind of get back from that free cash flow and continue to build beyond fiscal 2025? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yes. Thanks for the question, Zack. This is Rob. So let me just -- as a reminder, at the beginning of the year, when we set our free cash flow guidance. We said, without the restructuring and the change in lease originations. The approach of lease originations, our free cash flow for fiscal 2025 would be very consistent with the prior two years. So we have that strong fundamental base of free cash flow generation. And when you now look at the forecast or assessment here for the full year that is maintained. If you back out the restructuring and account for lease origination changes, we are also at a very similar level from the last two years. So that foundation in the 700s of free cash flow is maintained this year. And that foundation will be maintained into fiscal 2026. As we get closer to the end of this year, we'll give more precise guidance obviously. And we'll figure out whether how much of the restructuring will carry over or not. But you should think of the fundamental cash generation as being consistent with what I said at the beginning of the year and consistent with previous years. Zack Ajzenman -- TD Cowen -- Analyst That's helpful. And nice to see the revenue stabilization. Just wanted to dig in to bookings specifically. It sounds like an expected improvement in the coming quarters. Can you just kind of dig into the moving pieces by segment? GIS, any way to parse the company-specific factors, like the stricter go-to-market versus broader structural market dynamics? And anything you can say on GBS, the potential to return to 1.0 on the book-to-bill? Thanks. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yes. So we have confidence going forward that the bookings will improve from first half into second half. And we have that confidence in both CES on the project-based work and in our GIS segment as well. Insurance is a little lumpier so it's not as meaningful from a book-to-bill perspective. Now from a CES perspective, we have -- pipeline has been growing. So our go-to-market new organization, new management system, new leaders, is starting to take hold. And the first evidence of that is in our pipeline. And our closure rates have been consistent, ticking up slightly. So with better closure rates and better pipelines, it gives us confidence that the book-to-bill will improve going into the second half of the year. And as a reminder, it was 0.93 in the second quarter, so we expect improvements from there. In our CES business, that was both Modern Workplace and ITO, those are lumpy as well, dependent on large renewals. Again, based on the opportunities in front of us which, by the way, we're off to a good start in October, based on that, we're confident, in our third quarter, bookings will be in the 1-plus range, 1.0-plus range. And based on our pipe, we also expect to have better performance in the fourth quarter than we had in the first half of the year. So all of our internal indicators here are pointing to improved performance in both GIS and CES. Raul Fernandez -- President and Chief Executive Officer Zack, let me just amplify on one other point. For both GIS and GBS, we've been recruiting, and I've helped recruit or assist in bringing in 13 new senior leaders into the team. They have an average experience of 29 years, and many of them I've worked with in other companies, so I know they can deliver. They've only been here, on average, for about four and a half months. So while we worked on the mechanics very early on, while we worked on making sure that how we tracked, what we tracked was more accurate, we've also been adding new talent that is going to have an impact because, as you can see from the data I just gave you, they've just arrived. So I feel very confident, as I said in my prepared remarks, that those are areas where we'll see just better results. Thank you for your question. Our next question is from the line of Jason Kupferberg with BofA. Your line is live. Tyler DuPont -- Analyst Hi. Good afternoon, Raul and Rob. This is Tyler DuPont on for Jason. Thanks for taking the question. I wanted to start by asking about growth expectations, particularly within GBS. It was encouraging to see positive sequential growth in the quarter. But it looks like it decelerated around 200 bps on a year-on-year basis, mostly due to CES. And based on the prepared remarks, it sounded like -- correct me if I'm wrong, it sounded like growth is expected to be negative for the full year. What have you seen over the past couple of months that made you change this outlook? And is it more macro specific? Or are there certain individual clients that are potentially delaying implementation? Or just sort of it would be great to get a lay of the land of what you're seeing in GBS? Thank you. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yes. No, great question. So what we're seeing is it is tied to the economy. So it's macro, it's not company-specific or customer-specific. A little bit of color that I can give you is that in the CES business, it's hit us harder in custom application development as opposed to enterprise applications. And as I mentioned earlier, our pipelines have improved so we're encouraged by that. Our closing of deals, our close rates are good and healthy and improving. It's really just a slowdown in the rollout of projects in custom apps. And that's why we took the outlook down a little bit in the second half of the year. We were originally anticipating a little bit of an uptick in the second half, and we just don't see it yet and we took it down a bit. Raul Fernandez -- President and Chief Executive Officer Yes, let me just amplify on that as well. I believe that the self-help initiatives, as I've mentioned in the call, will have a far greater impact in the near term than the macro functions. We have plenty of opportunities. We can get more opportunities, especially with the new teammates that we have onboard, and we just have to convert them at a higher level. So I'm confident that, again, the fundamental changes that we've made, plus the new teammates that have come onboard, will give us the boost that we need in that area. Tyler DuPont -- Analyst OK. That's very helpful. I appreciate the color there. And then second, I wanted to ask about the go-to-market. It seems like it's been evolving over the past couple of quarters. And I was wondering if you could maybe just take a minute and discuss how this has changed since putting more of an emphasis on sales execution and focusing on geography. Sort of what are the stakes in the ground, for lack of a better phrase, that we need to see to make sure that we're moving sort of in the right direction that we're hoping for? Raul Fernandez -- President and Chief Executive Officer Yes. I think in the beginning, and again, Rob and I have been together here for 11 months, it was a focus on fundamentals and mechanics that clearly weren't at average, below average. So working on getting those to average, working on making sure that we've got a reward system in place for all of our sales executives across the world, that is both fair and positive but is also backed up by real success, measured success in terms of revenue and profitability. And that we have the right balance. I think one of the things that I've gotten a much better appreciation is our global footprint is terrific. Our global customer base is terrific. I've engaged with a lot of customers, many of which never had seen the CEO from DXC before. And I really get a much better sense, a deeper sense of the value that we provide. And that's a combination of the global offering, the skill sets and the local delivery, the ability to know the market, know the individuals, know the leaders, know the buyers, know the talent that we have on the ground to make it happen. So as we execute on those mechanics and get those mechanics at a higher level of throughput, I feel confident that we've laid the foundation for additional growth there. Tyler DuPont -- Analyst Great. Well thanks, Raul. Appreciate all the color there. Operator Thank you for your question. Our next question comes from the line of Jamie Friedman with Susquehanna. Your line is live. Jamie Friedman -- Analyst Hi. Thank you for taking my question. So, Raul, I wanted to ask about some of the comments you made in your prepared remarks with regard to the insurance business. You say you're growing the software and especially the recurring services mix. And the numbers look good in insurance. Congratulations on that. So what are some maybe the tactics related to those inputs like specifically related to the software and the recurring components of insurance? Raul Fernandez -- President and Chief Executive Officer Yeah. Great question. It's better execution. If you think about all the fundamentals we put in place, they affect the entire company. And while that segment or that business unit was, on a relative basis, doing a bit better, it still benefits from a smarter, more efficient go-to-market and all of the positive attributes that we're putting in place in terms of systems, rewards, etc. We've also spent quite a bit of time in looking at the portfolio, looking at our SKUs in terms of our offerings, looking at our pricing, looking at past price increases, looking at where price increases are necessary now and in the future. And so I have confidence that not just the IP and the services that we deliver through that segment but also the innovation behind that. We've been able to recruit some great talent to really boost the product portfolio and to really think about how we can take that to another level and shift more into higher-margin recurring revenue. So I think it's a good business that can be better and we're working on all the elements to make it better. Jamie Friedman -- Analyst OK. And then if I could just follow up on the GIS margin, good progress there as well. So, Rob, you did call out that a component of that is the lower reseller. I wasn't sure in the sequence of the inputs to the margin increase if those were in the order that impacted or otherwise. But anyway, if you could unpack like how it is that you're doing better on the margin there? Thank you. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yes. The resale element is a relatively small component of the improvement. The vast majority is because of the disciplined resource management and non-people related cost management by the team. They've done an outstanding job of lowering costs with the revenue declines. So Jamie, I'd attribute it to just very, very disciplined cost management. [Operator instructions] We have our next question from the line of Rod Bourgeois with DeepDive Equity Research. Your line is live. Rod Bourgeois -- DeepDive Equity Research -- Analyst Hey. Thank you, guys. Hey, I have a couple of questions that are structural related to the ITO business. The first one relates to the resale mix. Clearly, resale mix is dropping, which is great for margins but a bit of a headwind on the revenue side. My question is, how much that had started, I guess, over the last couple of years. So that's not a new trend. It's a trend that had already been underway before the new management team came into place. So my question there is, how much room is there to go on reducing the resale mix and having a business that's more based on services and less based on the product pass-through stuff? Thanks. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. Thanks for the question, Rod. We're going to continue to see a year-to-year decline into the second half of this year. And then I expect that decline to narrow through the first half of next year and then be more stable in the second half of next year. So we're through most of it. Last year and a half, we've gone through most of it. I think there's another six to nine months and then it's going to start to level off. Rod Bourgeois -- DeepDive Equity Research -- Analyst OK. And by the way, is a good portion of that tapering intentional where you're actively moving away from that business? Or is it sort of just -- Yes, Rod, it's definitely intentional. And the way I describe it is we're still bidding on work but holding to our margins, very disciplined on the margin thresholds we're willing to accept. So we're losing a lot of those deals because we're sticking to our margin thresholds. And that's driving the reduction in revenue. As I said, I could see kind of the end of the tunnel on those declines coming. Rod Bourgeois -- DeepDive Equity Research -- Analyst Understood. And then the other structural question is, as you move further into the AI era, is that prompting additional migration of legacy data centers to cloud? And it just would be helpful to get an update on what's happening on that front? Thanks. Raul Fernandez -- President and Chief Executive Officer Yeah. That's a great question. Look, the compute backdrop that you need for any GenAI activity today is very different than our legacy business and in even our business at GIS. And it's evolving. It's new, it's evolving. But one of the things that excites me in the projects that I've had a chance to look at, participate in, talk to our experts as well as the customers. Is the fact that kind of it gives us an opportunity to bring together our holistic set of services. That includes cleansing data, making sure that proprietary data is the correct data that we should be using, picking, obviously, the right language models to approach it. And then building fast prototypes, deploying them, learning from that deployment and then helping scale. And the first example that I gave, it was a terrific initial SaaS deployment that had bottom line ROI markers that then led to the incremental deployments. And, as I mentioned in my prepared remarks, a 10 times increase in fees from the first pilot through where we're at today. So that's definitely an area where demand will continue. And I think we're very well-positioned. Again, a theme for all of us here is consistency and scale. We just have to have a consistent approach and we need to scale it more effectively. Thank you. Our next question comes from the line of Tien-Tsin Huang with J.P. Morgan. Your line is live. Tien-Tsin Huang -- JPMorgan Chase and Company -- Analyst Great. Thanks. Just want to draw on your experience here, Raul, just thinking about visibility. And I know we have election certainty now in place, rates presumably falling further. Should we expect some improvement in visibility, generally speaking, relative to the secular question that Rod just asked? I guess I'm probably more focused on GBS here and that being more sensitive to demand changes. Any bigger-picture comments there? Thanks. Raul Fernandez -- President and Chief Executive Officer Yeah. Look, I think the commentary that I've heard from other CEOs in the space and the commentary that I hear from our end customers is consistent. So I have no outlier information there. The thing that Rob and I see, the whole team sees, is just an opportunity to execute on the fundamentals better. As I mentioned before, the self-help initiatives, some of which I listed in my prepared remarks, and many more that are ongoing globally, are going to have a bigger impact in the next 12 and 24 months than the macro environment. The macro environment is good. It can get a little better, it can get a little worse. But the biggest key to success in the near term for us is executing on every single opportunity that we get a chance with. I know that we've got the right talent, and I know that we've got the right references and I know that we have the right opportunities. And it's about putting all those together consistently and scaling it. Thank you for your question. [Operator instructions] Our next question comes from the line of Jonathan Lee with Guggenheim. Your line is live. Jonathan Lee -- Analyst Great. Thanks for taking our questions. Can you dig into some of the dynamics you're seeing around the softness in GBS versus the improvement in GIS? And how we should be tying that to, call it, the low end versus the high end of your outlook here? Trying to better understand what's needed to hit the higher end of your outlook? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yes. Thanks for the question, Jonathan. To get to the higher end, we would need a little better performance just from the economics on the CES business, having the customers on the custom apps just loosen up and accelerate some of the projects. So that would be the primary path for us to get to the higher end. So instead of low single-digit negatives, that it draws closer to flat in GBS, that would be the path. Jonathan Lee -- Analyst Understood. And just as a follow-up, can you talk through what you're seeing around some of the pricing dynamics, specifically in CES? Rob Del Bene -- Executive Vice President, Chief Financial Officer From a price perspective, I see stability in our deals, so I'm encouraged by that. As we migrate our offerings over to enterprise solutions, the price stability is encouraging. And those deals for us in the longer term will be higher margin than custom. So from my perspective, in the short term, prices are stable. And over the long term, the move to enterprise from customs will be beneficial to us. Thank you for your question. And ladies and gentlemen, that will conclude our Q&A session for today's call. And to close this out, I'd like to hand the call back over to Roger. Roger Sachs -- Vice President, Investor Relations Thank you, everybody, for joining us on our call today, and we look forward to speaking with you again next quarter.

Dynatrace (DT) Q2 2025 Earnings Call Transcript | The Motley Fool

Greetings. Welcome to the Dynatrace fiscal second quarter 2025 earnings call. At this time, all participants will be in listen-only mode. The question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Noelle Faris, vice president of investor relations. Thank you. You may now begin. Noelle Faris -- Vice President, Investor Relations Good morning, and thank you for joining Dynatrace's second quarter fiscal 2025 earnings conference call. Joining me today are Rick McConnell, chief executive officer; and Jim Benson, chief financial officer. Before we get started, please note that today's comments include forward-looking statements such as statements regarding revenue, earnings guidance, and economic conditions. Actual results may differ materially from our expectations due to a number of risk factors and uncertainties discussed in Dynatrace's SEC filings, including our most recent quarterly report on Form 10-Q that we filed earlier today. The forward-looking statements contained in this call represent the company's views on November 7, 2024. We assume no obligation to update these statements as a result of new information, future events, or circumstances. Unless otherwise noted, the growth rates we discussed today are non-GAAP, reflecting constant currency growth and per-share amounts are on a diluted basis. We will also discuss other non-GAAP financial measures on today's call. To see reconciliations between non-GAAP and GAAP measures, please refer to today's earnings press release and supplemental presentation, which are both posted in the financial results section of our IR website. And with that, let me turn the call over to our chief executive officer, Rick McConnell. Rick McConnell -- Chief Executive Officer Thanks, Noelle. Good morning, everyone. Thank you for joining us for today's call. Our second-quarter performance is the result of the strength of our platform and our ability to execute effectively in a dynamic market. ARR grew 19% year over year. Subscription revenues increased 20% year over year, and trailing 12-month free cash flow margin was 28%. We delivered a strong first half to the fiscal year. I believe the market is increasingly playing to our strengths in AI-driven observability, which we have been delivering for well over a decade, and our Q2 results offer a great proof point. Jim will share more details about our financial performance and guidance in a few moments. But first, I'd like to discuss the trends we're seeing in the observability market, our ongoing commitment to innovation, key customer wins, and the evolution of our go-to-market strategy. To begin, the world's reliance on software is greater than ever. Innovation, modernization, and business resilience are top of mind for business leaders. Downtime and instability can cripple businesses. Organizations are struggling to recruit the required resources to manage their software environments, driving a need for increased productivity. And finally, we all expect exceptional customer experiences, and we hold companies accountable for delivering them. Given this environment, the success and failure of any business today can hinge on its ability to observe and analyze an enormous amount of data and massive increases in its complexity. The staggering amount of data being generated each day estimated by IDC at over 2.5 quintillion bytes globally cannot be processed manually. Both the tools and processes that organizations use to keep software running with high performance have to evolve in parallel to keep up with this data explosion. In these incredibly complex environments, we believe that AI-driven observability is no longer optional. Organizations are expected to find issues and resolve incidents before they impact customers. This can't be done efficiently in complex environments through reactive dashboard monitor. Rather, organizations need to be able to trust answers from an end-to-end observability platform to action issues automatically. This is why organizations turn to Dynatrace. We are maniacally focused on ongoing innovation to deliver a highly differentiated AI-driven observability platform, one that we believe delivers unmatched visibility and substantive business value. We began with a massively parallel processing, highly performing data store called Grail to maintain all observability data types, logs, metrics, traces, really user data, and importantly, business events in context. Grail then enables us to uniquely apply a power of three AI to analyze billions of interconnected data points to deliver answers, not just data and not just dashboards. Finally, we leverage our contextual analytics and AI insights to automate responses and help avoid incidents. I'd like to expand on AI and its particular criticality to observability. In a world trying to understand how to harness the wide-ranging benefits of generative AI, it is important to clarify how our Power of Three AI works. We begin with causal AI, which analyzes billions of data points to help find the needle in the haystack. This isolates precise issues in software and infrastructure. Causal AI doesn't guess based on correlated data. Rather, it evaluates data points in context to deliver causation based answers and enables an automated response. Second, predictive AI applies machine learning to take causal AI on step further. It enables the Dynatrace platform to observe changes in the software environment and perform trending forecasting and anomaly detection to optimize performance and ideally prevent or resolve issues before they create business impact. And finally, generative AI brings the Dynatrace platform to a broader group of end users. In particular, it enables a casual user, rather than just a Dynatrace subject matter expert, to derive insights from the platform using natural language that then accesses deterministic answers derived from causal and predictive AI. It is this combination of AI techniques, working in unison and leveraging our underlying architecture, that truly delivers the power of Dynatrace. Causal and predictive AI have been at the core of the Dynatrace platform for over a decade. And every Dynatrace customer benefits from our continued advancements in these techniques. A final point on innovation is we strive to provide customers with the clarity and power to understand, act, and accelerate their business or mission. Increasingly, organizations aren't just seeking technical insights or root cause analysis. They want to uncover answers and insights locked in their data to transform them into a mission-critical asset. I had a CTO recently tell me that their CEO wanted Dynatrace on his desktop to help understand business performance. This is how Dynatrace can truly maximize customer value. We continue to be humbled by third-party analyst reports that recently have recognized Dynatrace as a leader. Dynatrace was positioned furthest for vision and highest in execution in the 2024 Gartner Magic Quadrant for Observability platforms. This is the 14th consecutive time that Gartner has named Dynatrace a leader. We ranked No. 1 across three of the five use cases in the 2024 Gartner Critical Capabilities for Observability platform support. We were named a leader in the inaugural 2024 Gartner Magic Quadrant for digital experience monitoring. And we were named at the 2024 Constellation shortlist for observability, AI ops, and digital performance management, recognizing Dynatrace as a leader in driving digital transformation. I'd also like to share a few customer wins from this past quarter that helped illustrate the transformational value we're providing to customers. We closed an eight-figure TCV expansion deal with one of the top U.K. banks to provide end-to-end observability. They are aspiring to be the U.K.'s leading digital bank, and they're standardizing on Dynatrace as the underlying platform to power their center of excellence with AI-driven insights that provide visibility across important business services. A major U.S. airline signed a seven-figure DPS expansion. They were looking to reduce the meantime resolution from over an hour to less than five minutes. With multiple tools across their IT ecosystem, they lack a single source of truth and struggled with blind spots. In collaboration with our partner, DXC, this customer chose Dynatrace to reduce the noise caused by dashboards, displace their legacy tools, and provide observability from the application layer to the infrastructure layer, including traces and logs. We closed a seven-figure expansion with a leading finance management platform. This customer had limited visibility into the thousands of incidents occurring in their production environment. They estimated that these incidents were costing them hundreds of thousands of dollars. By extending Dynatrace's AI-driven platform into their production environment, they gained substantive visibility and resultant business value. And finally, a new logo that highlights the evolution of our sales team in emerging markets represented a seven-figure deal with a government agency in the Middle East. These all examples of larger strategic transactions with customers looking for transformational benefits from an end-to-end observability platform. Next, I'd like to turn to the go-to-market changes we rolled out at the beginning of this fiscal year that focused on three primary areas. First, we adjusted our customer segmentation to increase focus on IT 500 and strategic accounts. This heightened attention to larger accounts enables us to drive more transformative platform to plans. Second, we have leaned in with partners through more effective enablement to make it easier to work with Dynatrace over 75% of anchor deals closed in the quarter involved a partner. Third, we have expanded our go-to-market motion beyond application performance to include end-to-end observability and cloud modernization. Several recent customer wins are a direct benefit of arming the sales force with a broader set of use cases including some of the deals I just noted. Overall, we are pleased with our progress in these go-to-market areas. At the same time, we're only two quarters into these adjustments, and we view ourselves as still being early in the pipeline development stages. We continue to support our go-to-market initiatives with increased awareness and customer engagement opportunities across multiple venues. Last month, thousands tuned in to watch our Power of Possible streaming event, which featured several locations around the world and included customers and partners like BT and DXC. We focused on customer success stories, highlighting our latest innovations in several areas. First is a dramatically involved user experience with simplified dashboards, streamlined navigation, and an updated interface that brings the power of Dynatrace to a wider audience. These advancements make it easier for users to access the insights they need to dive into their data, analyze it in context, and drive intelligent automation. Second is next-generation log management and analytics. With these advanced solutions, teams can derive greater value from logs faster and at enormous scale. Customers are now able to automatically ingest, manage, and analyze logs without manual setup and without the need to understand query languages, integrating logs in context with other data types such as traces and metrics dramatically enriches AI-driven observability insights. And third, our expanded capabilities for cloud native teams that make it simpler for operations, SREs, and platform engineering teams to access deeper ability insights within cloud workloads. These enhancements enable organizations to stand left from operations to development teams, to leverage the Dynatrace platform through purpose-built apps for Kubernetes and cross hyperscaler observability. In addition, these capabilities allow developers to drive automated actions through integrations with AWS, GitHub, GitLab, and others to build and maintain more resilient and reliable software. And finally, over the past two months, we had over 2,000 customers and partners attend our regional innovate conferences across six locations globally. These events always make us better by hearing directly from those who use our platform to ensure we best prioritize future investments. To wrap up, we had a strong first half, and we remain highly enthusiastic about the opportunity ahead. We believe the market is playing to our strengths by moving toward fewer solutions with a growing need for actionable insights and visibility. And we believe the power of our AI-driven end-to-end observability platform makes an enormous difference. Jim, over to you. Jim Benson -- Chief Financial Officer Thank you, Rick, and good morning, everyone. Q2 was another quarter of consistent execution by the Dynatrace team as we once again surpassed the high end of all our top-line growth and profitability guidance metrics. Our ability to execute successfully in this dynamic macro environment is a testament to the growing criticality of observability in the market. Our highly differentiated AI-driven observability platform, our global team's ability to demonstrate exceptional business value to our customers, and the strength and durability of our balanced business model with healthy growth and profitability. Now let's review the second quarter results in more detail. Please note the growth rates referenced will be year over year and in constant currency, unless otherwise stated. Annual recurring revenue, or ARR, was $1.62 billion, up 19% year over year. This is an increase of $273 million compared to the same period last year and above our expectations driven by solid expansion bookings, particularly in Europe, and an improvement in booking seasonality related to our move to six-month sales compensation cycles. Q2 net new ARR on a constant currency basis was $61 million, up 3% year over year, bringing net new ARR in the first half of fiscal 2025 to $106 million, up 10% year over year. In Q2, we added 143 new logos to the Dynatrace platform. As we've shared in the past, we target landing high-quality new logos that have a greater propensity to expand. In Q2, average ARR per new logo came in at roughly $130,000 on a trailing 12-month basis, in line with our target land size. Our experience has been that customers that land over $100,000 have the greatest propensity to expand. As Rick mentioned, we continue to attract enterprise customers that are looking to standardize on Dynatrace. They've outgrown their existing DIY or commercial tooling solutions and are coming to Dynatrace for the depth, breadth, and automation of our end-to-end observability platform. Turning now to retention. Gross retention rate remained stable in the mid-90s, demonstrating the strong customer value inherent in our offerings. Net retention rate came in at 112% in the second quarter, slightly above expectations, driven by early expansions incentivized by our move to six-month sales compensation cycle. Our DPS licensing model is rapidly gaining traction. We closed roughly 250 DPS deals globally in Q2. Total DPS customers now represent nearly 30% of our customer base and 15% of our ARR. We believe DPS customers with full access to our platform will trial more platform capabilities and adopt Dynatrace more broadly within their IT environments. This should lead to faster consumption, possibly an earlier expansion, and a future net retention rate accretion. And we're seeing early signs of this playing out with DPS customers leveraging twice the amount of capabilities and growing consumption at 2x rate compared to our SKU-based customers. We also see DPS as a catalyst for customers adopting our emerging and adjacent solutions. As Rick highlighted, a major U.S. airline signed a seven-figure DPS expansion this quarter. Through their original DPS contract, they were able to trial logs on Grail, which delivered immediate value from having contextual analytics across data types. The flexibility to trial through DPS led to their decision to deploy Dynatrace end-to-end and displace their existing log management and other open source tools. Moving on to revenue, total revenue for the second quarter was $418 million, up 19% year over year and exceeding the high end of guidance by $11 million, and subscription revenue for the quarter was $400 million, up 20% year over year and exceeding the high end of guidance by $10 million. The revenue upside was driven by strong bookings performance and a modest benefit from DPS on-demand consumption for customers reaching their annual spend commitments early. Shifting to margins, non-GAAP gross margin for the second quarter was 85%, in line with the prior quarter and prior year. Non-GAAP income from operations for the second quarter was $131 million, $15 million above the high end of our guidance range driven by revenue upside and lower payroll spend associated with the timing of hiring in the quarter. This resulted in a non-GAAP operating margin of 31%, exceeding the top end of the guidance range by more than 250 basis points. Non-GAAP net income was $113 million or $0.37 per diluted share. This was $0.04 above the high end of our guidance range. We generated $20 million of free cash flow in the second quarter. Due to seasonality and variability in billings quarter to quarter, we believe it is best to view free cash flow over a trailing 12-month period. On a trailing 12-month basis, free cash flow was $436 million or 28% of revenue. As a reminder, this includes a 600 basis point impact related to cash taxes. Pretax free cash flow on a trailing 12-month basis was 34% of revenue and up 39% year over year. Finally, a brief update on our $500 million share repurchase program. In Q2, we repurchased 835,000 shares for $40 million at an average share price of $47.90. Since the inception of the program in May 2024 through September 30, we repurchased 1.9 million shares for $90 million at an average share price of $46.71. We plan to continue to buy back shares opportunistically based on market conditions, underscoring our confidence in the business, our conviction in the long-term opportunity ahead, and commitment to delivering shareholder value. Moving now to guidance, let me walk through some of the key assumptions and insights underpinning our updated guidance. First, we do not assume a material change in the macro environment. While the observability demand environment remains healthy, enterprises continue to be cautious in their spending. Second, we continue to benefit from the growing trend of large observability architecture and vendor consolidation deals. As we have said in the past, these deals equally come with an increased level of timing variability. Third and most importantly, from a go-to-market perspective, we continue to work through the maturation of the go-to-market adjustments we made at the beginning of the fiscal year. Through the first half, we are pleased with how our team has executed while minimizing disruption as we implemented these changes. Having said that, this is still an ongoing progression. We are mindful that more than 30% of our accounts transition to new sales reps, and it takes time to establish relationships and positively impact sales performance. In addition, the acceleration of hiring new sales capacity has resulted in a higher mix of less tenured and therefore, less productive reps compared to historic levels. Further, as part of our go-to-market changes, we introduced six-month sales compensation cycles. This resulted in an improvement in bookings seasonality in the first half, but it's unclear the magnitude of impact these semiannual sales plans will have in the back half of the fiscal year. Factoring this all in, we believe it is best to maintain a prudent posture on ARR guidance and not get ahead of ourselves until the benefits of these changes manifest in an improvement in sales productivity. And with that, let's start with our updated guidance for the full year with growth rates in constant currency. We are maintaining our ARR guidance of $1.72 billion to $1.735 billion, representing 15% to 16% growth year over year. For net new ARR, we expect Q4 to be higher than Q3, consistent with the second half of fiscal 2024. We are raising our revenue guidance by 100 basis points to account for the strength in our second quarter performance. We are raising total revenue by approximately $19 million at the midpoint to $1.67 billion to $1.68 billion, and we are raising our subscription revenue guidance by $17 million at the midpoint to $1.59 billion to $1.6 billion, both now representing 17% to 18% growth year over year. This ARR and revenue guidance factors in foreign exchange rates as of October 31, resulting in no material changes compared to our prior full-year guidance. Turning to our bottom line, the strength and resilience of our financial model are evident in our ongoing margin performance. We continue to invest in future growth opportunities while finding efficiencies in other areas. We continue to prioritize our investments in R&D innovation, customer success, and strategic go-to-market areas such as GSI partnerships, demand generation activities, and targeted sales capacity. With this in mind, we are raising our full-year non-GAAP operating income guidance by $7 million. This translates to non-GAAP operating margin guidance of 28% to 28.25%, up roughly 25 basis points at the high end of the range. We are raising non-GAAP EPS guidance to $1.31 to $1.33 per diluted share, representing an increase of $0.04 at the midpoint of the range. This non-GAAP EPS is based on a diluted share count of 303 million to 305 million shares. This EPS and share count guidance excludes the impact of any share repurchases in Q3 and Q4 due to the opportunistic nature of our program. We are raising free cash flow guidance to $393 million to $404 million, an increase of $6.5 million at the midpoint, representing a free cash flow margin of 23.5% to 24% of revenue. Excluding the expected 650 basis point impact from cash taxes, this represents a pre-tax free cash flow margin of 30% to 30.5%. As a reminder, our first and fourth quarters tend to be our seasonally strongest cash-generating quarters with our second and third quarters being our lowest. We expect third quarter free cash flow to be lower than historic levels due to timing of billings and cash tax payments. Looking at Q3, we expect total revenue to be between $425 million and $428 million. Subscription revenue is expected to be between $407 million and $410 million. From a profit standpoint, non-GAAP income from operations is expected to be between $117 million to $120 million or 27.5% to 28% of revenue. Non-GAAP EPS is expected to be $0.32 to $0.33 per diluted share. In summary, we are pleased with our second quarter fiscal 2025 performance. We have a proven track record of consistent execution. While we remain prudent in our approach to the near-term outlook, we continue to be optimistic about the growth opportunity in front of us and the maturation of our go-to-market evolution to go after it. And with that, we will open the line for questions. [Operator instructions] And our first question is from the line of Pinjalim Bora with J.P. Morgan. Please proceed with your questions. Pinjalim Bora -- Analyst Great. Thanks for taking the question, and congrats on a solid quarter. Jim, I just wanted to learn a little bit more about the ARR or decision to not raise the ARR guide. You had a pretty solid Q2. It seems like the unbilled RPO build sequentially seems massive. I understand the prudence stands, but it sounds like you're a little bit more cautious about the second half despite having completed kind of the first half of all the changes on the sales side and things are looking good. So I wanted to just understand if there is something in the sales cycle, pipeline conversion rates that you're seeing that gives you caution for the second half or maybe was there a pull-forward of deals into Q2 from the second half because of the half yearly quota structure? Anything -- any color would be helpful. Thank you. Jim Benson -- Chief Financial Officer Thanks for the question, Pinjalim. I tried to provide a bit of an outline of that in the opening remarks that I'll just start with. We had a very strong Q2. We had a very strong half one. Our sales team has executed very well. We've seen no disruption from the go-to-market changes. So certainly, you've seen companies that have gone through go-to-market changes where there's been disruption. I think we've executed very well through the first six months of the changes that we've made. So very pleased with that. Relative to maintaining the guide, I really would position it much more, as I outlined, as just being prudent, these changes that we made, while there's been no disruption, we do have a lot of reps with new accounts. And they've only had these accounts for six months. We have a lot more new reps in the company with the changes that we made. We made changes that introduced new reps that are now in some of these strategic accounts. So we have more zero to one-year tenured reps than we historically have. And you did mention an area that was also a benefit that we moved to two six-month compensation plans. And we do believe that we did receive some benefit from a linearity and seasonality perspective, whereas normally 40% of our net new ARR happens in the first half and 60% in the second half, I do think we got some benefit from moving to two six-month plans. It's difficult to completely size. But I would just say we don't want to get ahead of ourselves. We are very optimistic about, one, the changes that we've made, two, the opportunities that are in front of us. We're just being a bit cautious. Yes. Understood. If I can have a follow-up. Can you talk maybe about the adoption curve of the DPS customers across the portfolio? Just trying to understand how does the consumption curve look like for logs and AppSec related to your core products? Thank you very much. Jim Benson -- Chief Financial Officer So I think we shared with this before that one consumption on the platform in total is growing significantly faster than our ARR growth. So consumption in aggregate is very healthy. As you can expect, consumption for the emerging products is growing significantly faster than that. Now admittedly, it's on a smaller number. So good traction in aggregate. And then within our emerging products, we have very good growth. We are growing significantly faster in logs, which doesn't surprise us then in application security that we now have nearly 25% of our customer base on our logs products. We've talked about the adoption curve of customers that start small and then grow. We're seeing a building number of customers that are spending more with logs once they see the benefit of our log solutions. We did announce on some advanced analytics for our log products. We have announced kind of a new pricing model for customers that want -- think of it as more of an all-you-can-eat model. So we're very, very optimistic with the emerging products. And in particular, we think the logs market, in particular, is ripe for us to gain share. Thank you. The next question from the line of Brent Thill with Jefferies. Please proceed with your questions. Unknown speaker -- -- Analyst Hey, guys. This is [Inaudible] on for Brent Thill. Thanks for taking the question. I guess the first one would be, for the go-to-market changes, you talked about a lot on the Global 500 segment. But for the rest were covering the account slightly below that segment, any color on sort of what changes you've made there, maybe like the rep to account ratio for that segment right below and any productivity gaps that still need to be addressed there? Jim Benson -- Chief Financial Officer Yes. I think we talked about that a couple of quarters ago, but just to remind you that -- so with the changes that we made that -- we made the changes that the number of accounts per rep in the top of the pyramid. It used to be about 8% to 10%. With adding more resources into that area or that segment, we now have about four to five accounts per rep, which we think is the right ratio to get more depth of penetration with our installed base customers and in some cases, customers that we don't have in the IT 500 that we can go penetrate. Relative to the accounts below that, it hasn't changed fundamentally the number of accounts per rep. It's still a model you can -- that you have fewer accounts per rep top of the pyramid, much more of an account-based, account-focused, account plan-oriented model. And then below that is more of a territory oriented model. So no fundamental changes in that other than what I would say is we continue to look to that segment of the market and even below that to get broader penetration through leveraging partners. Hard to certainly help us in the IT 500 when you're working with the GSI, but some of the regional partners and our other partners can help us and get more tracking below the IT 500 as well. So those are just some of the changes that we made. Rick McConnell -- Chief Executive Officer Yes. This is worth highlighting that we focus on three areas, as I mentioned in the prepared remarks, segmentation, partners, as well as go-to-market motion, go-to-market motions. We're oriented around elements like end-to-end observability, of course, application performance monitoring and cloud native. And this is really a package of go-to-market motions that we're putting in place across the portfolio, including some of the enterprise accounts, as well as the IT 500 accounts. Unknown speaker -- -- Analyst Thanks. And then on DPS, I guess the question is you've seen consumption pick up for the customers who are on DPS. But any customer feedback or early feedback from customers on how DPS has been received among larger spending customers? And separately, on the net new logo side, the DPS have any impact to your average landing ARR? Rick McConnell -- Chief Executive Officer Yes. DPS continues to outpace expectations, to be honest. We have 30% of our customers, 50% of ARR now on DPS. We launched it just in April of last year. So we are on the order of 18 months in, and half of our ARR is on DPS. And it is driving around 2x consumption growth relative to non-DPS deployment of our legacy pricing model, which was SKU based. So we're very excited to see the DPS adoption and pick up. It gives customers much more flexibility to deploy more capabilities more rapidly and consume faster with less friction. Yes. The only thing I'd add to your last point about new logos that we still average about 70% of our new logos land with DPS. So we still have a very high percentage of new logos at land. And I'd say the land size isn't higher or lower because they're landing with DPS or non-DPS. That is -- it's much more a function of what customers are interested in. And what I would tell you is that it's important for investors to know that this is a journey to Rick's point, we started in April last year, a year and a half in. We had to go through an evolution of getting the sales organization comfortable going from a SKU-based model selling to a model where they're selling a completely different way of contracting. And the good news is, it is now muscle memory for the sales organization to sell DPS. So there's no more learning curve or obstacles. They're quite proficient at doing that. So this is likely to be the common contracting vehicle. And, again, we look at the demonstration of what we've shown is that if they can land with DPS, we find that they expand faster. Our next question is from the line of Sanjit Singh of Morgan Stanley. Please proceed with your questions. Sanjit Singh -- Analyst Thanks for taking the questions. I wanted to stick on DPS again. You mentioned that it's 18 months into the launch. In terms of customers renewing on DPS, what are the trend lines there after you get that first full year of experience under DPS pricing? Any trend lines that you've seen when customers start to renew? Is that resulting in an uplift of expansion given the stronger underlying consumption trend? Jim Benson -- Chief Financial Officer It's a great question. And the answer is that we have higher expansion rates for DPS customers than non-DPS customers. We'll start with that. So your comment about the cohort classes that were maybe from Q1 and Q2 of last year, those -- we have found that, in aggregate, our DPS customers just expand at a significantly greater rate. Now having said that, I have to be balanced that it is a bit of a skewed sample size in the sense that the customers that you move over to the DPS initially were probably customers that were already customers that love Dynatrace and would have expanded significantly anyways. But having said that, we've certainly seen that we're expanding faster. And more importantly, it's -- we're finding that more customers are leveraging more capabilities of the platform, which means they're trying things, they're trialing things. We talked about a couple things in the prepared remarks where the ability for them to trial without having to go through a sales cycle ultimately has led in a few cases to larger expansions. We mentioned one on the -- in the prepared remarks for logs. And I think we mentioned the logs one in our last quarter call. So we're very pleased with the traction with the DPS and do believe that this is the right contracting vehicle for most customers. Our next question is from the line of Jake Roberge with William Blair. Please proceed with your questions. Jake Roberge -- William Blair and Company -- Analyst Yes. Thanks for taking my questions. Just wanted to double-click on the sales front. Would that change to the six-month comp plans? Do you feel like anything was pulled into Q2 that may be causing a lower-than-normal pipeline heading into the back half? Or is pipeline still growing pretty healthy and those Q2 deals were more just a healthy result of the new comp plan? Just trying to understand the puts and takes around that. Jim Benson -- Chief Financial Officer No, it's a great question. I would say that the demand environment is still quite healthy. So when we look at pipeline and our pipeline coverage ratios, they're very consistent half one versus half two. So don't view it as there's really been a change in pipeline as a result of moving to two six-month cycles. I do think, as I said in my commentary, I do think we did see a benefit in the first half from deals that otherwise historically would have been booked in the second half were accelerated into the first half because it was an incentive for the sales organization to do that. It's difficult to size specifically because you don't know every deal and what would have moved. But I certainly believe we have seen a benefit in seasonality as a result of that, which is kind of one of the reasons why we're being a bit cautious for the back half of the year. But I would say we're certainly very confident with the changes we made. We think two six-month sales cycles was the right move. We think all of the other sales segmentation changes we made were the right moves. It's just a matter of allowing this model to mature before we get ahead of ourselves. Rick McConnell -- Chief Executive Officer Sorry, I might add just a comment on overall pipeline drivers. One of the biggest pipeline drivers is going to be the maturity of our reps. And the account execs that we have in place now, which we've added, and Jim alluded to this earlier, essentially an above-plan number of reps as we lean into this new segmentation model, we have about 30% of our reps with one-year tenure or less. And typically, we see lower productivity for reps with lower tenure. As those reps develop more tenure to get beyond the one-year cycle, then we would expect productivity to increase as well as pipeline. So this is precisely the game plan that we're putting in place associated with the go-to-market movement that we made earlier in this year. Jake Roberge -- William Blair and Company -- Analyst OK. That's helpful. And then great to hear partners now influence close to 75% of deals. I think that's uptick from about two-thirds last year. Could you talk about how -- what you're seeing on the partner sourced deals front and if they're actually starting to lead more of those deals through the funnel? Jim Benson -- Chief Financial Officer Yes, I'd say it's early. I think historically, we've seen about a third of the partner deals were sourced by the partner. In the first half of this year, that number was closer to half, not quite half of the first half. So we are seeing an increasing number of sourced deals. So I think again, talking about the maturation of the changes that Rick outlined with the segmentation changes, partners, and the go-to-market motions or sales plays that I think we're getting traction across the board. Obviously, our goal is to make sure that the partner source continues to increase, and their partners become more of a flywheel and an accelerant for growth in the company. Operator Thank you. Our next question is from the line of Raimo Lenschow with Barclays. Please proceed with your questions. Raimo Lenschow -- Analyst Perfect. Thank you. Can you speak to what is on the [Technical difficulty] Thank you. We'll move on, ladies and gentlemen, to the next question from Brad Reback with Stifel. Brad Reback -- Analyst Great. Thanks very much. Jim, can you give us a sense as we think about the back half guidance, is there much contribution from consumption in there at all? Or is that all upside? Jim Benson -- Chief Financial Officer When you say -- for the revenue guidance or the ARR guidance? Brad Reback -- Analyst Yes. Well, I was going to say in both, as well as NRR. Just how is all that captured in the P&L? Jim Benson -- Chief Financial Officer So obviously, we've seen the benefit of DPS already in our results. So you saw for NRR. NRR was actually when you -- other than a few bps, it was relatively stable Q4 through Q2. Call it 111 change in Q4. Now we're kind of 112. So NRR is already seeing some of the benefits of not just EPS, but just customers that are consuming more and consuming faster. So again, going to your point about the second half. I think, Brad, we're just being cautious, to be honest, that we don't want to get ahead of ourselves. I don't want to apply to anyone on the call that we're worried about the back half. The maintaining guidance is just more a function of we want to allow the sales changes we've made to continue to season a bit less we get ahead of ourselves. So it is not a matter of we think that it's going to be a poor back half. It's just we want to make sure that we allow the changes that we've made, one, to mature, and two, to Rick's point, we have more reps that are new in their roles, and it does take a while to ramp. And we just want to make sure that we're building some level of prudence in what we're outlining so that we don't disappoint. Obviously, our objective is to do better than 15% to 16%. Brad Reback -- Analyst Got it. And then, Rick, real quickly, we're hearing more about customers using Grail in the platform within line of business for actual operational analytics. Is that happening just organically? Or has that been a bit of a pivot by the sales force to pursue some of those opportunities? Thanks. Rick McConnell -- Chief Executive Officer Well, to start, Grail is used by essentially all of our cloud-based customers. If you're on AWS, you're on Azure, you're using Grail. So I'd like to piece apart any selection or election to use Grail for any customers who are SaaS-based customers because they're using it by definition. They then have more capabilities associated with Grail and especially if they're on DPS, they just have more capabilities to expand more broadly across the portfolio. So to get back to your question, I would say it really is organic expansion based on the notion that they're already used Grail. They have access to the breadth of the portfolio, and they're able to deploy it broadly from central IT all the way to developers and inclusive of departments. So the setup here enables precisely the kind of expansion that you're talking about. Thank you. Next question is coming from the line of Raimo Lenschow with Barclays. Please proceed with your questions. Raimo Lenschow -- Analyst Perfect. Let me try that again. I want to stay on that subject. If you think -- as part of Grail, you obviously will likely get more logs. What are you seeing on the log momentum for you guys? And what are you seeing there in terms of one of the things from your customer conference in February, where that there was a lot of unhappiness with the main log vendor out there that is now with a different entity? Do you see there more conversations already that because you are innovating more that you're seeing more traction toward that? Thank you. Rick McConnell -- Chief Executive Officer I love the question, Raimo. I'll take this one. The log area, we believe, absolutely to Jim's earlier point is very much ripe for disruption. I literally had a large bank out of Australia. The other day, CTO tell me that they were concerned about a meteoric rise in log price -- not pricing, but log cost overall from their existing vendor. This is an example, but a common piece of input that I get there is a strong desire to evolve logs in multiple dimensions. One of them is dimensioned toward integrating logs into AI-driven observability, which is to integrate it as part of your end-to-end observability platform, which gives you a better outcome based on AI analytics applied to all data types, and this is precisely the value add that Dynatrace brings. The second piece then is from a cost perspective, which is in many customer cases out of control. So what we can do there is essentially through some of our new pricing models provide essentially included queries for a period of time, which basically makes the cost much more predictable and gets it in line. And this is another point of excitement from customers. So overall, we are -- we like what we see in the log space. As Jim mentioned, we're now at about 25% of our customer base. This is up about 20% sequentially quarter over quarter for us in logs, and we see a huge opportunity ahead in this area to bring logs into the fray, more significantly for Dynatrace as we look ahead. Raimo Lenschow -- Analyst OK. Perfect. And then maybe one for Jim, maybe what did you see on new logos this quarter? Was there anything to call out for in terms of new logo momentum? Thank you. Jim Benson -- Chief Financial Officer I would say that new logos were -- I would characterize new logos as a little bit light if I'm kind of balanced about it. But not surprising that when we made these sales segmentation changes, it's not surprising that the first traction that you're going to get with the segmentation changes is going to be in the installed base, not so much for new logos because your people are still accounts transition and you're still going through the prospecting phase. So I'd say decent lands. I'd say the good news is we continue to land at a size that we believe has the highest propensity to expand, which is we know from experience that if we land over $100,000, that those customers tend to expand faster. And so good land sizes. I'd say the new logos on the unit side were just a little bit light. But again, I think that's a bit of a function of the maturation of the sales model changes and the building of pipeline. The next question is from the line of Andrew Sherman with TD Cowen. Please proceed with your questions. Andrew Sherman -- TD Cowen -- Analyst OK. Thanks. Congrats on the quarter. Rick, you talked about having a lot more newer reps with less than one-year tenure. Has the churn of more tenured reps been fairly stable, or is this just because of your hiring over the past few quarters? And, Jim, sales and marketing expense was down quarter over quarter. Anything to call out there? Thanks. Jim Benson -- Chief Financial Officer Yes, I'll take that. It's a good question. So I would say the -- this is not a churn in the sense of that we've seen this uptick in attrition. We've had to do a lot of new hiring. That's not what it's been at all. It's been more of when we made these account segmentation changes, it's a very different skill profile for someone that's selling into the strategic IT 500 accounts and someone that sells below that. So the adding capacity was more to fill roles. We certainly had some existing reps that could move up to do that. But we added capacity in that area largely from new capacity. So that's the change there. So we're in a good position. The fact that we have a bit of a less tenured sales force that, again, we've shown that as they progress that obviously productivity improves. And you couple that with the fact that they have very rich accounts that they're selling into. I'd say there's room for optimism that we'll see some productivity improvement. Relative to sales and marketing spend, it happens seasonally. Seasonally, Q1 to Q2 sales and marketing spend goes down. We have our sales kickoff event in our first quarter being the notable one. And so it's not a matter of anything else other than seasonally, that's what occurs. We still expect to probably have sales and marketing expense in the low 30s for the year. Andrew Sherman -- TD Cowen -- Analyst OK. Great. And then what are you assuming for a budget flush in December? How does it feel out there from the enterprise budget flush perspective versus last year? Jim Benson -- Chief Financial Officer Yes. We are not expecting any material budget flush this year. So we've -- this guidance assumes kind of muted budget flush, probably consistent with what happened last year. Thank you. Our next question is from the line of John DiFucci with Guggenheim Securities. Please proceed with your questions. Howard Ma -- Guggenheim Partners -- Analyst Hi. Yes. Thanks for taking my question. This is Howard Ma on for John. Rick and Jim, if you look at the deals closed in the first half so far, what you've been clear about was driven in part by the change to the six months of the comp cycle, which is -- I understand that's the intended effect. But how would you describe the quality of those deals relative to your expectations? And is there a step-up in observability deals? And could that lead to more avenues for expansion in the back half relative to last year. And also in the back half, as you're thinking about timing of renewal expansions, is there anything that would make you more cautious about timing of those deal closures? Jim Benson -- Chief Financial Officer Yes, it's a good question. I guess I hadn't thought about the deals in the first half kind of how are they -- I wouldn't say they're materially different the deals that I've seen in the first half from what they've been historically. So other than maybe we're a little bit more weighted on expansions, maybe than we've been before for the reasons that I outlined. And then relative to the back half of the year. I think I've talked about that at length around what we're expecting, which is we're just building a level of cautiousness. We're certainly optimistic with the changes that we've made. We're just being cautious relative to not getting ahead of ourselves with the changes. But I certainly don't want to convey that there's wary because there's not wary. It's a matter of just let's let the sales changes, mature more. Let's wait to see when we see the benefit of these productivity improvements before we start reflecting that in improving guides. Rick McConnell -- Chief Executive Officer I might simply add that we have seen an increase in number of end-to-end observability deals, which are the larger strategic transactions. They do tend to take a little bit longer to get done, and we've seen that increase because that is an accelerated go-to-market motion that we talked about a bit earlier. Howard Ma -- Guggenheim Partners -- Analyst That's really encouraging. If I could slip in a follow on to it. At this point in the DPS journey, how much of DPS growth is coming from organic expansions and new logos as compared to migrations? And are you starting to see more of a deal size uplift at the point of migration? So I understand the consumption of the 2x, but at the point of migration, are you seeing any uptick there? Jim Benson -- Chief Financial Officer Yes, it's a good question. I would say not surprisingly that -- if you think about it, that we're seeing good expansions on both existing customers and new logos. Relative to where we're seeing more on one versus the other, I'd say we're seeing it equally. We're still earlier in the journey on the new logo front because the cohort sizes that we had from back in Q1 and Q2 were a little bit less. It's been building, but healthy expansions for both. I think we'll try to squeeze in one more question, and then we'll close it out. Operator Sure. That will be coming from the line of Andrew DeGasperi with BNP Paribas. Unknown speaker -- -- Analyst Hey. This is [Inaudible] sitting in for Andrew. Thanks for taking my question. I was just wondering on the tweaks to the sales and go-to-market, have you guys like fully staffed the sales org? Or is there more hiring to be done for the rest of the year? Thanks. Jim Benson -- Chief Financial Officer So we're certainly staffed to where we expected to be ending the first half of the year. But as I mentioned in the prepared remarks, you can expect that we built optionality into our investment envelope for the back half of the year, and adding incremental capacity will be part of that. OK. Well, that brings us to the end. Thank you all for your engaged questions and ongoing support as usual. To close, it was a strong first half of fiscal 2025, and we're enthusiastic about the opportunity ahead. We look forward to connecting with you at IR events over the coming weeks, and we wish you all a very good day. Thank you.

Axon Enterprise (AXON) Q3 2024 Earnings Call Transcript | The Motley Fool

Hello, everyone. Thank you for joining Axon's executive team today. I hope you all had a chance to read our shareholder letter, which was released after the market closed. You can find at investor.axon.com. Our prepared remarks today are meant to build upon the information in that letter. During this call, we will discuss our business outlook and make forward-looking statements. Any forward-looking statements made today are pursuant to and within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These comments are based on predictions and expectations as of today and are not guarantees of future performance. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. We discuss these risks in our SEC filings. We will also discuss certain non-GAAP financial measures. A description of each non-GAAP measure and a reconciliation of each non-GAAP measure to the most directly comparable GAAP measure can be found in our shareholder letter as well as in the Investor Relations section of our website. Now, turning to our quarterly update. First, we'll start off with a quick video showing you an awesome example of one of our customers using products across our ecosystem. It'll about five minutes. So you get a chance to take a minute. All right. Thanks, Eric. And I want to thank all of you. Look at I would thank all of our shareholders for joining us here today. So welcome to Axon's third-quarter 2024 earnings call. It is truly humbling to come back to you with another fantastic update and to show you these videos that capture what we've been working on and the relationships we strive to build with our customers. These calls are a great opportunity for us to reflect on our recent momentum while thinking about what's next. As I've shared with you in the past, I spend the majority of my time with our customers and with our product teams, ensuring that we are inventing and focused on the right things and aligning our efforts where our customers need us, where they need us to be for their future. I've been able to lean in with hundreds of our customers over the past few months between the AUSA, which is the Big Army show, IACP, the Chiefs of Police Conference, and several events at our offices and internationally. Our customers are as excited as we are about what's ahead and it's energizing to see them ready to move forward with us on this journey together. There's no place where this is more clear to me than the area of artificial intelligence. The interest is immense here and we are already building a suite of products for our new AI Era plan, providing access to an expanding set of solutions. Our strategy here is twofold. First, we understand and believe that AI innovation is moving at a breakneck pace. It would be almost impossible for us to continually update our go-to-market offerings at the speed that AI is moving. With this plan, we get to deliver an ever-changing and expanding offering that drives increased value for our customers over time. Second, we want to partner with our customers by offering them access to the solutions we have today and those we are building for the future. We can work together on this, adapting to deliver what they need as technology improves and evolves. We know the best way to win is by putting our customers first. This is going to be how we help them harness the power of AI as we launch many exciting products over the coming years. AI is one of the many areas that excite me about our business, but it's not the only one. Taser 10 combined with the power of our expanding virtual reality or VR training portfolio continues to gain traction as a disruptive force to how we de-escalate in difficult situations. Real time capabilities enabled with Axon Body 4 and Fusus have advanced response and communication in ways that are finally modernizing public safety communication tools that have been a bit stagnant for decades. And our momentum in newer categories like drones and robotics continues to accelerate with our recently closed acquisition of Dedrone, which helped enable Campbell PD as you saw, to gain the first FAA approval waiver for 24/7 drone operations as first responder. To summarize, I'm very excited about what we are seeing in the market today and the energy our customers have put behind what we are doing. We're on a multi-year journey to modernize the way public safety operates and the opportunity in front of us is to drive real improvement in outcomes that matter to our communities and to our customers who work tirelessly every day to make the world safer. While we report our results to you on a quarterly basis, I believe our success is measured in years and lives saved. We remain focused on our moonshot goal and our mission to protect life and we're thankful to have you on this journey with us. Thanks a lot, Rick and good afternoon everybody. This week we are participating in a core element of our culture at Axon, putting our customers first together. It is the week of the customer internally where we invite customers into work to share their stories, recognize our internal support teams, and double down on employee in on employee training to ensure that the customer remains at the center of our universe. I'd like to share a quick anecdote to that end. In response to the devastating hurricanes that impacted the southeastern U.S. in September and October, we deployed our Axon Aid emergency Response Team to work alongside first responders around the clock for 16 days. Our team got to witness the magnitude of customer's efforts firsthand. At Axon we know our customers are heroes and being a small service to them in this mission was an honor and nothing short of inspirational. We work every day to help our customers achieve better outcomes and when we put their needs first, we get to share in their successes. Understanding this is something I have spent a lot of time on and it percolates into how we've built our team. When I look at what our team is working on with our customers and the results we are delivering because of our strong partnership with them, I continue to be excited and impressed. I'll briefly share a few updates that build my confidence. First, our record results. We just delivered our 11th consecutive quarter, growing above 25% in our third quarter this year growing above 30%. That growth puts us at a level where we are accomplishing in quarters what took us years to do only a few years ago. Second, while we've been growing fast, we still have line of sight to a multiyear growth opportunity that continues to build. We closed Q3 with record bookings in excess of $1 billion on both an absolute and normalized five-year basis. That's our strongest normalized booking quarter in history outside of Q4 last year. As we move to close out this Q4, which has historically been our strongest bookings quarter, we are already executing against the largest pipeline we've ever had and we fully expect to post an exceptional and record result again. Third, what's really encouraging here is that we are seeing strength across the board. Our state and local business is firing on all cylinders, led by Jessica Duncan and the early interest we are seeing in our AI Era plan signals to me that this new offering could be one of the more meaningful drivers for us in the year to come. Beyond our state and local business, our U.S. Federal bookings came in higher than what we did in a full year just a few years ago, with four of our top 10 domestic deals in the quarter coming from federal customers across several agencies including DHS, IRS, and Amtrak. Looking ahead, we have a clear path to surpass the Q3 federal bookings again in Q4 for our strongest year yet. International bookings came in at near record levels, matching Q4 of last year up 40% sequentially from Q2 and our year-to-date international bookings are up 40% from last year. Similar to federal we see a clear path to surpass Q3 bookings again in Q4. Finally, we saw strong bookings from corrections customers from our in our justice segment continued to grow and we have several Fortune 500 companies conducting retail security trials with Axon products in the Enterprise segment. As is the case every Q4, we must do two things well. Number one, close out the year with maximum intensity and flawless execution and number two, ensure that we are well prepared to drive a record 2025. We have a lot of sharp, adaptable, and unstoppable teammates that are embracing this challenge. I know I say this a lot, but I truly believe Axon is in the strongest position we've ever been. We have an immense opportunity ahead to grow our business and continue to progress toward our moonshot goal, which we will pursue with vigor. Now I'll pass it over to Brittany to go over everything in more detail. Brittany? Brittany Bagley -- Chief Financial Officer Thank you, Josh. This quarter marks two years for me at Axon and the business has certainly been incredible. I couldn't be more pleased to share the results of another great Q3. We grew revenue 32% year over year and delivered strong adjusted EBITDA with a 26.7% margin. We achieved this margin expansion while driving over 30% top-line growth and we continue to successfully prioritize balancing the bottom line with achieving that strong top-line growth that we promise. As Rick and Josh both talked about, the focus on product innovation and delivering for our customers remains our north star and is what enables us to keep delivering these types of results. Thank you to everyone on our team who drives that focus. As we get into the details, I am particularly excited that the revenue growth is broad based in terms of products and customer verticals. Josh spoke to the strength we're seeing across different customers. The strength is across our products as well. For example, our acquisition of Fusus has been very positive across a number of our verticals and Taser 10 also continues to exceed our expectations on its adoption. Taser revenue was a standout in the quarter, growing 36% year over year, the strongest growth in our Taser segment in more than two years on the back of increased capacity and broad based demand. Cloud and services was up 36% year over year with software revenue as the primary driver. ARR of $885 million is up 36% year over year and our net revenue retention, an indicator of growth with our existing and new customers, increased to 123%. Sensors and other revenue was up 18% year over year with strong demand for Axon Body 4 partially offset by Fleet. Fleet continues to be a very strong product, but given RFP timing and customer deployment schedules, we expected to have inconsistent hardware revenue quarter to quarter. Overall, our future contracted revenue sits at approximately $7.7 billion exiting the quarter which is up 33% year over year. As a reminder, this is a gap definition of our remaining performance obligations and will not tie exactly to commentary we share about bookings. Bookings are also seasonally strongest for us in Q3 and Q4 and as Josh shared, we're continuing to see that this year with a strong Q4 in front of us. Adjusted gross margin of 63.2% was stable sequentially and up approximately 50 basis points from last year. Overall, as we have ramped automation and efficiency in our Taser 10 manufacturing, we have stabilized our margins and expect to maintain these approximate levels subject to the usual business mix dynamics. Adjusted EBITDA margin of 26.7% was a three-year record driven by operating leverage as we delivered scale on strong revenue. One note on our financials that you will see in our forthcoming 10-Q is that we have made a revision to our historical financials to reflect corrections of certain areas related to the categorization of some of our partner relationships as principal instead of as agent. We concluded that these were not material to any previously issued financial statements. Our current period reported financials and revised historical financials reflect revenue and expense recognition consistent with the corrections we made in the revision. Now turning to our guidance, we are pleased to raise guidance again on both revenue and adjusted EBITDA. Our Q4 revenue guidance is a range of $560 million to $570 million representing more than 30% growth at the midpoint. This implies approximately $2.07 billion in full-year revenue or greater than 32% annual growth, up from our prior guidance of $2 billion to $2.05 billion or 29.5% growth. Our adjusted EBITDA guidance for the fourth quarter is a range of $130 million to $135 million or approximately 23.5% adjusted EBITDA margin. This implies full-year adjusted EBITDA dollars of approximately $510 million or 24.6% margin. Note that Q4 implies lower adjusted EBITDA margins than we were just able to achieve in Q3, which is a result of timing on some of our expenses and also reflects a full quarter of our now closed Dedrone Acquisition and costs to integrate. We continue to have conviction in our margin target of 25% for 2025 which continues to show nice leverage over full0year 2024. Overall, we are very pleased with our progress against the 3-year targets we set out for 2025. We are on pace to deliver our initial $2 billion revenue target for 2025 a full year early and remain confident in our extended target of 20% or greater annual growth, all while increasing our adjusted EBITDA margins and achieving the 25% target next year. With that, I'd like to turn the call over to take any questions. Erik Lapinski -- Senior Director of Investor Relations Thanks, Brittany. We can all get up into gallery view. We'll take our first question from George Notter at Jefferies. Hey, George. George Notter -- Analyst Hi guys. Thanks very much. Congratulations on the strong results. I wanted to ask some questions about Draft One. I'm curious if you can give us an update on your progress in the September quarter there. In terms of pipeline, was there any revenue recognition tied to Draft One, any significant contributions to your ARR? Rick Smith -- Founder and Chief Executive Officer So thanks a lot for the question. I really appreciate it. In terms of Draft One, yes, we did receive some orders in Q3, from kind of early customers. So there was some impact on revenue from Draft One. But I would still say we're in like the top of the first inning on what that's going to look like moving forward, especially as we go into next year with Draft Rule One being the anchor product of our AI Era bundle. And so certainly we're very, very bullish on Draft One and all of our AI products contributions to both revenue and profitability over time. But we're still not yet seeing a major impact on the quarter-to-quarter results which is expected due to the SaaS accounting. George Notter -- Analyst Last quarter. I think you guys mentioned $100 million pipeline. I think in six or seven weeks of selling on Draft One, is there an update to that number? Rick Smith -- Founder and Chief Executive Officer It continues to grow, especially after IACP. So we're again and we're converting some of that pipeline into the new kind of AI Era bundle that we're coming out with next year as well. And again, Draft One is really the kind of central driver of interest in that bundle along with a number of other AI features where developing right now. So certainly safe to say that the interest is the most we've seen out of any, year-one product. George Notter -- Analyst Got it. One last follow up and I'll pass it on. Where are we going to land in terms of pricing on that? I realize it's going to go into the bundle. I know you guys have been selling it Ala carte to some degree to early customers. We had heard price points of $30, $40 amonth. But is that, is that kind of the right zip code in terms of where this is priced or where maybe the incremental bundle would step up to in terms of pricing? Any sense there? Rick Smith -- Founder and Chief Executive Officer Sure. So right now Draft One alone is $65 a month and it requires transcription on top of that for another 20. So at 85 a month for just Draft One, we're looking at the AI Era bundle price of 199 and the sum of the parts of that bundle is expected to be somewhere around $250 or $350 in terms of everything included in it. So good economics for buying, as a group of features instead of individual stand-alone features. And those are just the launch features. Of course, the features in the AI Era plan are going to grow, rapidly. And I would probably just note that we'll, we'll probably. You'll hear us talking more and more about the AI bundle plan and less and less and about Draft One as sort of an individual product or an individual data point. It's really going to, as Josh said, be the anchor product in the new AI bundle. We'll continue to add features there, but that's what you'll hear us talking about quarter to quarter. Rick Smith -- Founder and Chief Executive Officer That's right. And of course, pretty much everything in that plan are pure SaaS software additions on top of our overall software. ARR. Of course, they build upon people who have our hardware like cameras and TaserS and the like. Thanks, George. Up next, we've got Jonathan Ho at William Blair. Jonathan Ho -- Analyst Hey. Good afternoon. Just wanted to get a sense from you. As you start to think about sort of the broader opportunity around drones. As a first responder, how should we think about, maybe the ability to monetize this, the ability to see broader adoption, and, what sort of has to happen for that to take place. Thank you. Sorry, I have myself on mute. First, Jonathan, are you cheating on us with the headphones listening to another earnings call at the same time? Awesome. Hey, so, yes, we see drones as a huge opportunity. The Dedrone acquisition, we think, is a real key part of that. Because before you can start flying drones without extra humans standing around watching them, you've got to be able to see your airspace. And an array of sensors can see the airspace far better than a human on a rooftop. And so part of our assessment in making the Dedrone acquisition was a dual bet, number one, that it would be a key enabler for DFR. To be able to fly your own drones, you got to be able to see the airspace well. And then the second is that we're going to see increased interest in counter drone capabilities. I just learned this past week that apparently somebody in Pennsylvania put a pipe bomb on a drone and is going to fly it into critical infrastructure or something. We'd be glad to see, there has not been that much of that kind of activity here in the U.S. but it's certainly growing all over the world and we certainly hope it doesn't come here. I think it is something that's likely to get more nefarious use. And right now, counter drone is really limited to federal agencies, meaning, state and local cannot interdict the drones themselves. So Dedrone is helpful in that case because it will tell you where the pilot is and you can go deal with the pilot directly. However, there was a bill in Congress, I believe, this year. I don't think it's going to make it through, but there have been some efforts to give state and local law enforcement the ability to interdict drones. Not to get into politics, but my assessment of the shift of the election we're coming out of is that that is likely to speed up law enforcement enabling legislation, potentially including the local ability for law enforcement to interdict drones. So Dedrone is a tech enabler. I think Skydio is a partner. We sort of made a shift with the shifting relationship. DJI, you know, is a Chinese drone manufacturer. We think there's legislation afoot that passed the House of Representatives unanimously that's going to be blocking DJI long term and frankly all Chinese drones. And so we shifted our focus really with Skydio, who turns out is the world leader in autonomy already for drones that can fly themselves effectively. So we think between the partnership, the acquisition of Dedrone and then some pending legislative changes, I would expect within 24 months we'll see a shifting landscape to where our state and local folks can begin using more aggressive counter drone capabilities. And by the way, last thing I'll say is we did a full scan of the, of the world's sort of counter drone providers a few years ago before we selected Dedrone. And we liked Dedrone strategy. They were very focused on detection and not getting too aggressive on mitigation. Knowing that, basically owning the detection space and being at a lower cost point than some of the competitors that have been out there focused on more military style interdiction efforts has given them a good footprint to scale from. And then the strategy has been able to plug in other hardware over time as the legal landscape changes. Joshua Isner -- Chief Revenue Officer And then Jon, I just add two things on Rick's great summary. One thing that we're super pumped about is how the market's evolving to think about the real time crime center space and the DFR space together, which we think is both right and good for agencies and communities. And plays right into our strengths and our differentiation as a solution. So the combination of fusus in the real time crime center deeply connected with all of our other devices, and then into the DFR partnership stuff that Rick was just talking about, agencies are thinking about buying those together and that's both great for them as they think about how they use this technology to keep community safe. And it plays right into all of Axon strengths. And the second, which is another example of that same thing, we just had a major agency who is in the middle of rolling out their DFR stuff the other day, talk unprompted about the notion of they would love to have an officer be able to press that watch me button that we have on our AB4 cameras and have that under the right conditions, automatically trigger the dispatch of a DFR drone to bring help and extra overwatch to that situation even faster than what any other human in the loop could be. And that's exactly the kind of solution that's powered by the combination of all the things we bring to bear for agencies. Jonathan Ho -- Analyst Excellent. And then just as a follow-up, I mean, Taser again had very strong quarter. We regularly receive the question whether, the Taser business can sustain this level of growth. And you just want to get a sense from, what gives you the confidence that we can continue to see Taser be one of the major drivers, drivers of the business. Or, maybe do you see, a shift in leadership where, things like Draft One will start to take over that growth over time. Thank you. Rick Smith -- Founder and Chief Executive Officer But they, they do compete for the top slot. And it does make me proud that the old warhorse that's Taser can still, can still run. So we -- I think we've got so many things that have the opportunity to continue -- to be disruptive and to grow. The big one for Taser, just to come back on that to me is really international. I think we are on the cusp and actually I'm getting text updates from my engineers that are in the lab today actually working on some pretty cool stuff related to Taser that we think we have the opportunity in the next couple of years to become the primary weapon internationally. Now in the U.S. the gun is going to remain primary for quite a while culturally because police are dealing with so many guns out in the public. But in much of the world, a gun is just if you had a viable, high reliability alternative and for within that 45 foot range, and I'll just tell you the last thing we're working on is clothing penetration. Once we get that dialed in, we've got a shot at becoming the primary self-defense weapon in international markets where there's not a high propensity of handguns out in the public. And I think that could be a real game changer for Taser. Joshua Isner -- Chief Revenue Officer And I might just add one or two more thoughts there about the question of is this sustainable for the Taser business to keep growing? In my opinion, the answer is absolutely yes. Like we're year two of five in an upgrade cycle right now. We continue to see exceptionally strong demand, literally double what it was, as we've said on previous calls, you know, with T7. And so certainly a lot of runway ahead to continue to grow the Taser business. And look like, as Rick said, the Taser business is going to solve one of the most critical issues in policing over the long-term, which is that these encounters can end in death either from a civilian or, a police officer. And if we can solve that problem, I still think we're scratching the surface of what the Taser business is capable of. Brittany Bagley -- Chief Financial Officer Just from a detailed sort of modeling perspective. I don't know that I would expect every quarter to be as strong as this quarter was. This was a particularly strong quarter for Taser and that is partly because we got more capacity online for the Taser business, which helps us go fulfill all of that demand. So just from a growth standpoint, I would say this quarter really stood out and it continues to be across both T10 and our T7 and legacy handles. So that was a little bit unique. But everything Rick and Josh said about the long-term trajectory the power of T10, the ability to sell it into different markets, holds over, over the long term. Jonathan Ho -- Analyst Excellent. Thank you again and congrats on the strong quarter. Erik Lapinski -- Senior Director of Investor Relations Thanks, Jonathan. Up next, we have Mike Ng at Goldman Sachs. Mike Ng -- Analyst Good afternoon. Thank you very much for the question. I wanted to follow up on a comment made about 4Q24. I think you said it would be likely a record bookings quarter, is that right? And was the year-ago 4Q bookings in that like $1.7 billion, $1.8 billion range just to make sure we're thinking about that the right way. And if you could talk about some of the visibility and the confidence that you have in those things that you mentioned, federal bookings increasing sequentially, international bookings, is it AI Era, is it, the pipeline growth that you've seen coming out of IACP would just love some color around the bookings outlook that you gave for 4Q. Thank you. Rick Smith -- Founder and Chief Executive Officer Sure. Yes. Certainly reiterating that I'm very confident and encouraged here in terms of what we're going to do in Q4 bookings. Probably won't give you a specific number other than we expected to exceed last quarter. And I think on the last call I said the sum of Q3 and Q4 this year will be comparable to what we did in the full year last year in terms of bookings. So we're very bullish on bookings. Part of what's informing that confidence is just tremendous execution across all four segments of the business, state and local, enterprise, federal and international. We have meaningfully meaningful deals in all four of those segments in Q4 and in a lot of them such that there's no, there's not, it's not like a huge percentage of the bookings would be concentrated on one deal. We feel really, really good about the foundation and we're excited to talk in more detail about our Q4 bookings in February. Brittany Bagley -- Chief Financial Officer There's been a couple of questions now about like, what's, what's going to do better or what's going to drive the growth going forward. I think one of the things that I like so much that this quarter demonstrates is the growth is across the board. So you, you might get a little more from one segment one quarter and a little more from another segment, another quarter, but really across the business. The devices on the strength of AB4, Taser on the strength of Taser 10, and then our software, on the strength of both our existing software businesses continuing to perform well, and then the very bright future that we think the AI plan has will continue to drive software. And so, you'll see a slightly different mix every quarter. But as you look long-term, you really should expect all three of those pieces to continue driving our growth. Mike Ng -- Analyst Excellent. Thanks. And if I could follow up on the earlier Taser question. The revenue, I counted this was the sixth consecutive quarter where Taser has hit a revenue record. You talked a little bit about faster than expected adoption. I think if we look back to Taser 7, it probably took you, I think, five years to get to 80% to 85% adoption. How much shorter can that be? And could you just remind us, like, what's the typical price mix or ASP uplift versus Taser 7? Thank you. Joshua Isner -- Chief Revenue Officer So, Mike, the question was how fast can we get to 85 adoption on T10 versus T7. OK, look, I think that would be setting our sights short, I would say. Our goal is to transition every T7 and legacy model Taser into a T10. And we, we think we have an opportunity to do that. I think this, this Taser 10, while, while each Taser is an incremental improvement over the last one, Taser 10 is just a fundamental, massive leap forward in the technology, in the de-escalation capabilities, in the officer safety features. We really believe that, every cop will be best served with a Taser set with a Taser 10. I'm sorry. And certainly, as we go into the next few years here of the, of the Taser 10 life cycle, the primary goal is upgrade and replacement of the current fleet. And again, we're very confident in our ability to do that. Thanks, Mike. Up next, we have Joe Cardoso at J.P. Morgan. Joseph Cardoso -- Analyst Hi. Thanks for the question, guys. I guess maybe just a quick clarification on the bookings. And Josh, can you just like quickly clarify if your comments today, are you guys on track to meet the bogey that you laid out last quarter and achieving bookings in line with full year 2023 in the back half of this year, or is it more like unknown? I'm just curious if you could just flush that out a little bit more because it does seem like perhaps you're a little bit off pace. And I just want to make sure that I'm not thinking about that incorrectly. OK. And then so when you, when you're going into the back half of this year, like, where are you actually seeing the growth and driving these bookings across the portfolio? Is it really all broad base in terms of the, the entire portfolio? Are you guys embedding any of the new AI suite in that, in terms of the releases there? Just curious in terms of like how you're thinking about the drivers and the rank ordering that. And then I have a quick follow-up. Joshua Isner -- Chief Revenue Officer Yes, sure. Look, I certainly appreciate the question, Joe. And these deals that are going to be closed in Q4 are deals that, generally a 6- to 12-month sales cycle at a minimum. Right. These things take the full year to come together. We talk in Q1 when bookings are seasonally light. Traditionally that part of that is the team is getting their arms around the new products and the new pricing, getting their arms around their new book of business as the territories can change and so forth. And so that's really where the groundwork goes into, like building the pipeline for the rest of the year. And naturally most of that closes in Q3 and Q4, especially when you see some of the biggest budgets in the country, the federal government, Florida, Texas, all ending on September 30th you get a lot of September action and then you get a lot of new budget dollars being spent in Q4. And so I don't know that the AI bundle is going to have a major impact on Q4 since we launched it in the same quarter. And we're still building the pipe for the long-term for some of our newer features and products. So the big driver of a lot of these deals is officer safety plan execution in the state and local market and some large deals and international, federal, and enterprise that have been coming together over the course of several quarters. So certainly expect, Q4 to really trump Q3 in terms of just the absolute dollars and the normalized bookings. But it's also the result of a lot of pipeline building that happened throughout the year. Joseph Cardoso -- Analyst No, got it. Very clear. Josh, thanks. Appreciate the explanation there. And then maybe a question for Brittany. Just margins have tracked nicely through the year and expanded each quarter and even outperforming kind of your expectations, if I'm remembering the guides correctly. So as we look here into the fourth quarter, the guide here for a sequential decline, can you maybe just walk us through what has been the driver of outperformance in margins over the past couple of quarters and then relative to your expectations going into this quarter, like what's different that's driving your expectation for the sequential decline to occur in the fourth quarter itself. Thanks for the questions. Brittany Bagley -- Chief Financial Officer Yes, so we've actually done a pretty good job hitting our expense targets and our opex targets. And then our revenue has outperformed. And so what you're really seeing is, some nice flow through on that higher top line revenue coming through to the bottom line. And it's been really nice to see how the team has been able to scale and get some leverage out of the, out of the opex and especially on the SG&A side. When we look at Q4 though, we also expect that some of the benefit has been timing right. Like we've been talking about timing. Not everything hits exactly the quarter. So we've been a little bit behind on some of our expense spend as we've gone through the first three quarters. We expect to catch up on some of that in Q4. And then the other thing is we expect to have a full quarter of Dedrone and some of the integration costs associated with Dedrone in Q4 now that we have closed that deal. Joshua Isner -- Chief Revenue Officer And I might just add one more thought on adjusted EBITDA, just high level, which is the thing I'm most excited about, is the fact that we are not sacrificing R&D to achieve these results. Right. Like that's that, it would be very easy to drive up adjusted EBITDA by mortgaging the future. And I don't think anyone feels that way right now. We're still in the place of just loading up on new opportunities and investing relentlessly in them. We're just seeing, like Brittany said, over delivery and a lot more discipline in SG&A as well. Joseph Cardoso -- Analyst Thanks, Brittany. Thanks, Josh. Appreciate the color. Erik Lapinski -- Senior Director of Investor Relations Thanks, Joe. Up next, we have Jamie Reynolds at Morgan Stanley. Jamie Reynolds -- Analyst Hey. Good afternoon, everyone, and congrats again on the quarter. Rick, I know you just mentioned there's probably some stuff to keep an eye on for the international market going forward, but just given the strength and bookings that you've kind of seen through the year, I guess could you give us a sense as to what's driving maybe the improved traction kind of near term and kind of as we go into next year? Rick Smith -- Founder and Chief Executive Officer It really is broad based. I think the about Jeff was at six, seven months ago, I just come back from a tech conference and told Jeff we need to pull the emergency brake and take a look at all of our product development plans and look at where AI would enable new features that weren't even on our, you know, on our visibility list a year ago. Not the emergency brake. Well, no, this is the one where you're in reverse and you pull the brake. It's like the Duke's a hazard. Anyway, it was, it was a pretty big shift and for example, one that came out of that. We also, I do these AI roundtables. Well, they're customer roundtables, but we did one really focused on AI and one thing that became very clear was being able to do real time translation on a body camera would be just insanely valuable. It rated at the top of the charts and so we pivoted. Jeff, basically, you can imagine like how disruptive this is to his days managing like a thousand 1500 engineers. And it's like, hey, hold on, I know we've got everything planned and everybody's working but let's like disrupt everything. And I think that enabled us to talk about six or seven major eight new AI features by IACP already. And I'm really proud, companies at our scale, it's hard to move like that. But I think that, so our customers are seeing again things that just feel almost magical, that are possible with AI and our investment in things like our EAC, our ethics Advisory Council to help us do safety testing on things like Draft One. Just simply running tests to see if you change the race of the subject. Does that pick up any historical bias from the global data set that these models are trained on? And, and we did pick up some things like word choice, if it says the man fled the scene versus the man left the scene, can really change the emotional perception of that statement. And so we did things like tuning down the word choice severity so that our AI writes the most boring police report it can write because it's a human's job to add emotion and tone to it. Anyway, I think that that focus has really rejuvenated interest in the real time connectivity of body cameras. You all may remember a few years ago we had this whole debate about when we were developing AB3, should we put a wireless chip, a cellular LTE chip in the camera? Our customers were telling us they actually, not only were they not interested in it, they were skeptical of it. We were hearing things like, oh, I don't want my boss watching me real time and micromanaging me from the field. And we still said, just, it may not be, maybe they don't want to real stream real time video, but there's going to be something they're going to want to do. And so not only did we decide to put the, the LTE chip in the camera, we decided to put it in every camera. We made a decision not to sell a camera without it because we knew our customers, if we had a cheaper camera without the thing they didn't know they needed yet, that's the one they would buy. And there was some short-term pain because our cost of goods crept up. And as maybe, our customers are on these upgrade plans where they get the next camera and we don't get to charge them anymore for it. So eating, an $80 bomb increase on the hopes and dreams that we would find, a value for that was a bit of a risky bet. Well, now that's really coming home to roost because things like Draft One are only possible because of that real time connectivity, real time translation, only possible because of that real time connectivity. So I think we're now reaping the gains of, of some of those bets we made historically. And it's across the portfolio. I don't think there's any one thing that's what makes this just so exciting. I mean, it makes Jeff's job so difficult and Brittany's, because I'm throwing a thousand features at Jeff and he's like, hold on, slow it down. We got to like rationalize the sequencing and when we're going to build things and what are the things that are going to be delightful to use out of the gate now that aren't going to overset customer expectations. And of course, Brittany is, well, making sure that we're holding the line on how much we're spending on all this stuff. Joshua Isner -- Chief Revenue Officer So it was one just thought, I think again, it's what so many of the things that are a Goldilocks and magical, I think about Axon's flywheel, for lack of a better phrase, connecting like the questions about what's happening with bookings or demand, like right now. And then everything Rick's talking about the future is. It's all of our new innovations are really leading indicators of this time, next year's growth. Not about this quarter's growth because of the sales cycle stuff, because of building stuff, but they feed into customers excitement about their bet on Axon for the long-term. But the bookings that are, this quarter, next quarter are about the pipe, as Josh talked about that got that got laid nine months ago. And it all connects in that ongoing sequence, feeding upon itself in a really virtuous, virtuistic way that we're super excited about. Rick Smith -- Founder and Chief Executive Officer Hey, Jamie, was your question specific to international at all or was that -- Jamie Reynolds -- Analyst Yes, yes, it was just kind of what's driving that improved uptake internationally. You're going to actually answer the question he asked. Rick Smith -- Founder and Chief Executive Officer Everything's optional, but we might as well answer that one as well. So on International, look, as you know, in searching for a new CRO, our big priority was upping our game internationally. And Cameron Brooks has come in really early on this year, hit the ground running and has really just helped up our game in terms of the quality of the team, the quality of the execution, how we're executing now, but also building for the future. And I think just across the board, we've got some new players on the team that, that are really good kind of free agent signings. We've got a lot of customer momentum from the work that's been done in the last couple of years. And we're starting to, frankly, just see things come together at a, at a more polished level. There's still a long way to go. There's still a huge tam out there. Everything's going to take time internationally, just due to the fact you're dealing with federal governments in all of these countries, not, state and local police forces that, that are able to operate semi autonomously. So it's still going to be a grind, but we really, really believe we're on the right track. And it's a tribute to kind of the team we're building here, led by Cameron. Thanks, Jamie. Up next, we have Jordan at Bank of America. Jordan Lyonnais -- Analyst Hey. Thank you guys for taking the question. On the administration change, how are you guys looking at the opportunities versus the risks involved, just with what plans have been said, if they come true or not, the increased emphasis on border security versus tariffs. Rick Smith -- Founder and Chief Executive Officer Yes, I appreciate the question, Jordan. I'd say the first thing that I want to make really clear is like, we have a very apolitical culture at Axon. We know we've got to be successful in a Democratic administration as well as a Republican administration. And, we've seen that over the last 10 years with both parties being in power and the business continuing to grow. Of course there are going to be some interesting opportunities for us in the new administration that's focused, primarily on border security. We're excited about how we can help there and new capabilities that we can bring to the table to offer support on that. But at the high level, certainly, we believe look like saving lives, driving transparency in delivering disruptive technologies to governments and public safety agencies around the world. Those are things that are really not specific to which party is in power. And we're really focused on just delivering the best products we can. Jordan Lyonnais -- Analyst Thanks. And then on just if tariffs are imposed, how are you looking at what levers you can pull to offset any supply chain component changes? Brittany Bagley -- Chief Financial Officer Yes, so we've certainly lived in an environment of tariffs before. And so I think our philosophy is generally to be pretty flexible. We've got multiple sources. From a supplier standpoint, we do, we manufacture our TaserS like in the U.S. so then it'll really be on component parts as those come in. So look, we'll just work through it and we'll be flexible and be nimble as those come through and as we see what they are. Thanks, Jordan. Up next, we have Josh Riley at Needham. Joshua Reilly -- Analyst All right. Thanks for taking my questions. Maybe just starting off, can you discuss how the FedRAMP status and your position as the, I believe the only cloud body cam vendor with the highest level FedRAMP status has been helping you win some of these U.S. Federal opportunities And how, just along with that, how, how is the growth in U.S. Federal been, I guess, relative to the broader business this year? Is it significantly above the consolidated growth rate? I know you don't break it out, but any color there would be helpful. Rick Smith -- Founder and Chief Executive Officer Yeah. Thanks a lot, Josh. On the first question regarding FedRAMP, look like we've invested a lot and we've put a lot of effort into being a FedRAMP high product in the federal government. No question about that. And that's certainly a differentiator for us. But I would be so bold as to say even if everybody was on FedRAMP, we're still winning the majority of deals in state and local where we're competing against the same companies without FedRAMP. And so I think it's more of a tribute to the team's quality product delivery and the federal team's phenomenal execution on the sales and more importantly, the support front for our, for our federal law enforcement customers. And so the team's done a nice job this year. There's, as I said, my -- in my remarks, there's a lot to still close in Q4. We could have a better Q4 than Q3, in the federal space, which is generally uncommon because of the end of the budget year at the end of Q3. And so we'll have to see where the dust settles. But certainly exciting double digit growth from federal and a lot of conviction that we're on the right path there. Joshua Reilly -- Analyst Got it. That's helpful. And then just going back to the Taser revenues, I think we all generally know that the capacity has been increasing sequentially, but maybe just over the next three or four quarters, should we assume that, I know you said that maybe the sequential increases in revenue may not be the same, but is it safe to assume there's still more capacity increases that will be coming in the next kind of three to five quarters as well? Thank you. Brittany Bagley -- Chief Financial Officer Yes, for sure. I mean, we, as we talk about capacity, we have both cart capacity and handle capacity. And as you can imagine we're working to bring both of those up to meet the demand. We see there are lead times. We do have automation equipment. So it's not, we can't always turn on as much supply immediately as we would like to. So you can see the results of us getting more supply on this quarter. And then again, the growth was particularly impressive this quarter. I want to temper everyone's expectations on that looking the same every quarter. But yes, we'll keep bringing capacity on as we continue to see demand increase. Great. Thanks, team for taking the questions. Maybe Rick or Josh, kind of high-level one for you. Circling back to the Dedrone or, or just general DFR opportunity. Can you does that seem to be in your minds kind of a state and local, U.S. domestic kind of initial push or is there international opportunities along the lines there? And I guess I ask from the standpoint of seems like the landing with Taser of any kind, whether it's Taser 10 or previous models is sort of the kind of the tip of the spear for the U.S. business and it seems to be following a similar type of path in kind of these international front. But just curious if there's, ways for DFR type of use cases to be more again that tip of the spear kind of on the international front with respect to Dedrone and the other things you guys are doing. Rick Smith -- Founder and Chief Executive Officer Sure, if I could start first just Dedrone by itself without DFR ton of interest internationally. I mean every country in the world is now thinking about how they're going to deal with drone threats in the past 24 months. And in many cases AD brought just a great capability. He's the CEO at Dedrone and he's brought us new customers too. Whether it was the World cup in Qatar, the NFL stadiums, critical infrastructure. And then we've seen the same thing with Fusus. I mean both of these acquisitions, these were two big bites for us to take, this closely together. And it's, it's been really just impressive how much customer interest there has been in those with Fusus that's really supercharged our enterprise customers. Enterprises want to be able to work collaboratively with public safety and Fusus becomes the backbone of doing that in real time. Dedrone, we think there's, there's more -- it's a new angle into military customers for us. Militaries around the world are very interested in how you deal with these small first person or Mavic style drones, critical infrastructure and then enterprise there as well. So I'd say Dedrone, even on its own is I think not only interesting to our existing customers, but frankly probably even more interesting to the new customer sets they're bringing to us. The DFR is what's making counter drone especially relevant. When I survey our customers in state and local, the responses are, yes, we're kind of interested in counter drone, but that's not really our mission set today to be dealing with hostile drones coming in. Now that for us is more of a future bet that that's going to come on your plate as those threats grow. But the DFR thing is here and now. That's where our customers really light up. Oh, if I can use Dedrone to enable DFR, I want to be able to fly my own drones. Not something I can do today, but I've got to do it in this awkward way where I've got to have people standing on rooftops and it's kind of this manual kludgy thing and we make it much safer and less kludgy by putting a Dedrone sensor up there. So I also am getting interest, where was it we had another DFR use case in one of our other markets. That's not drone as a first responder, but for competitive reasons. I don't want to name which sector it is, but this is a non-law enforcement sector and they don't need to be flying drones as first responder. But boy, they sure would like to be able to fly drones on an automated patrol around their facilities. And so our partnership with Skydio and the acquisition Dedrone and all that really come together naturally for us to be able to service a lot more than just drone as a first responder for police. If you want to fly a drone without having to have manual human overseers on site, like, we can take that. And by the way, Skydio is a partner as well. Brings us into potentially new customers in critical infrastructure and elsewhere where we haven't been historically. Erik Lapinski -- Senior Director of Investor Relations Thanks, Rick. Thanks, Trevor. Up next we have Keith Housum at Northcoast. Keith Housum -- Analyst Good morning, guys. I know we're going to run long here, so I'll try to make my questions quick. Just real quick, Brittany, you talk about the product pull forward or again, I can pull forward, but catching up with a T10 with your capacity, how much of growth in the quarter would you say was more of a -- catching up with capacity as opposed to normalized demand? Brittany Bagley -- Chief Financial Officer I would break it out. Necessarily, Keith what I would say is we've had incredible demand. Like, our demand has been outpacing our capacity. And so as that demand grows, every quarter, we need to bring more capacity on. And so what you saw this quarter was the combination of the two. But I wouldn't say, it's not like we chewed through backlog or something like that to deliver. You're just seeing the ability for us to ship more into that demand. Keith Housum -- Analyst Gotcha. Appreciate it. And then services, I know services can be lumpy, but if we look at sequential growth in services of about $6 million, probably the lowest, has grown sequentially for several years, if I look at it correctly. Anything happened in the quarter, or how should we think about services going forward? Brittany Bagley -- Chief Financial Officer Yes, great, Great question. I think there's two pieces in that one. There's a little bit of a lag in that step as you go through each quarter. So what we really booked in Q3 will show up in Q4. So a little bit of what you're seeing in the step in the quarter is sort of what was going on in Q2 from a booking standpoint. And that's because many of the bookings come in pretty late in the quarter. So the revenue from that doesn't necessarily get captured in our actual number. Then the other piece that's going on in there is that's both our software step and our services business. And so with some of the deployments of our fleet hardware being down in the quarter, which you can see in the fleet number, we actually had less professional services associated with fleet, and so that's actually offsetting some of the software piece. So if you were just looking at software, you would see a larger step than what's coming through and in the number you're actually seeing, because we actually had a step down in PSO, which is atypical. Normally, PSO is growing and software is growing, but because fleet came down this quarter, you're seeing that dynamic. Thanks, Keith. We'll try to get everyone in here. We have Will Power at Baird. William Power -- Analyst Awesome. Thank you all. Congratulations on a. Another strong quarter of execution. Question, probably for Brittany. The software and ARR growth continues to be very good. There was some deceleration from the trendline, you've been on there. So I guess I wondered if there's any other, color or impacts to kind of be aware of there and how to think about modeling that going forward is mid-30s kind of the right growth rate and what are the puts and takes there? Brittany Bagley -- Chief Financial Officer Yes, I mean, we really look at that sort of on an average basis. Like, I think because of the dynamics I just talked about of timing of when bookings come in a quarter, looking at any one quarter is not as good as sort of averaging out over the year. And you do have things like seasonality playing into that. So I would say nothing underlying it that would change our, sort of four to six quarter average on anything. The step on ARR growth on any of that. You're just seeing a little bit of timing and a quarterly lag is what's showing up in Q3 is really Q2. What will show up in Q4 is really what we're talking about with strength in Q3. And then what will show up in Q1 will be whatever we deliver in Q4. Thank you all. We have one left with Jeremy Hamblin at Craig-Hallum. Jeremy Hamblin -- Analyst Thanks and congrats on another fantastic quarter. I want to come back to Taser just for a second. Right. So I think 50% year over year growth, really impressive. And it sounds like getting great traction on the international front. I wanted to see if we could unpack the driver there. And it sounds like it's really picking up on the international piece of the business. We know that there's a lot of opportunity domestically still, but internationally, is this more about the capability? And I think just seeing what the device does versus, the prior version, it is a huge step forward from a technology perspective. But does this make you think that the longer term, potential is quite a bit bigger internationally than maybe what you'd seen before? That's part one of my question. The second part actually has to do with cartridge. Cartridge revenue relative to the growth in Taser was really not -- that that was. It was up, I think maybe about 10% year over year. And I was just curious if there was something in particular there of why that didn't grow a little bit stronger. Brittany Bagley -- Chief Financial Officer Yes, I can maybe start with cartridge because that's easy. And then if Josh wants to talk more about Taser, he can. So most of our Taser customers are on sort of a cartridge deployment plan, which smooths out, how you see cartridge revenue come in. But we do have international customers who are not on a plan. And so what you'll see is every now and then our cartridge revenue is particularly lumpy quarter to quarter. And so last quarter we had some big international customers come in and place cartridge orders, and then those didn't repeat this quarter. So again, I'd look at a longer trend line of cartridge growth versus last quarter to this quarter. And then I think the only other thing I would add maybe to give a little more color on Taser before I let it go over to Josh, is, last quarter, in his script, Josh talked a bit about how much demand we're seeing for Taser 10 relative to Taser 7. I think he said demand is sort of two times the pace. But we are still seeing really good performance from Taser 7. And so part of what you're seeing in this quarter is not only are you getting all of those benefits from Taser 10 that we've been talking about, but we do still have customers ordering Taser 7 and some of our other legacy Taser handles and products. And so, that that's sort of combining to give a particularly nice result. Joshua Isner -- Chief Revenue Officer Yes. And I just add, you know, Jeremy, I'd say it's in part due to international. Certainly it's a big TAM. We're getting better there. We're building relationships kind of with the right customers. We're doing a better job explaining and demonstrating the value that TaserS bring to police, both in terms of lives saved, but also in terms of officer safety increasing and workers comp decreasing and just some of the issues that come along with absence of Taser deployments. But I think the bigger thing is just very simple. We have phenomenal product market fit with this product. And that's really a credit to Rick. Like our customers are for the first time really seeing that, man, this thing is on track to outperforming a firearm in the field. And we had been talking about it for a long time, but for 30 years with only up to two shots that was still kind of a pipe dream. And now we're seeing it with 10 shots. And customers are saying, man, the increased distance of 45feet combined with the number of shots, combined with the better penetration, those are all things that I think are inspiring more confidence in the device from our customers, whether they be in state and local or federal or international. And so I think that's really it. It's like good sales execution with a product that has, you know, phenomenal product market fit. Thanks, Jeremy. It was nice to see many of you at IACP. Thanks for making the trip out there and always great to see you at the booth. Erik Lapinski -- Senior Director of Investor Relations Thanks, Jeremy, and thanks, everyone. That's it for us. We'll give it to Rick to close this out. Rick Smith -- Founder and Chief Executive Officer All right. So I have two things I want to conclude on. One, I want to be careful. In my previous statement when I talked about the election results, I'm not talking about which party won where. I'm talking about the overall political environment. For example, in California, voters approved Proposition 36 that basically raised the penalties for shoplifting in certain drug crimes. We're seeing a general shift that manifested in this election, swinging the pendulum, more supportive of public safety in general. And I would say at our company we are violently non-partisan. We have passionate gun control advocates and passionate second amendment gun owners who come to meetings together and are productive. And you could say that across all the divisive issue in politics, and I think Josh in particular has done a great job from setting the tone from leadership perspective that we want to be an intellectually diverse place that where everyone is welcome and we keep the divisive stuff out of the office because we've got a job to do and we do best when the best, brightest, smartest, most passionate people, no matter their political views, feel like this is a place where they can come and do their best work. And then the other thing I wanted to say was, you know, Brittany, two years. It's flown by the. What you're seeing right now. I mean, we see a lot of Britney's fingerprints on the P&L. She really does a great job of just driving both operating and financial rigor. I come back from customers with all sorts of ideas. Some people might say they're crazy and some of them are. And between Brittany and Jeff, they've got to figure out, OK, how do we. How do we sort through what we're actually going to execute on what's actually going to go into a product? You see Jeff give me a thumbs up. He said it's a great Rick, this is really fuzzy idea. And that his idea is to take it from fuzzy to concrete and for Brittany to work with the team, make sure we can make this stuff and execute and make money at it. And then, you know, Josh, the other key member of the team here, he's our Jimmy Johnson. And as a lifelong Cowboys fan, as I'm sure he'll appreciate that reference, he is our head coach and really focuses on just building the team and the people, and that is the magic that we're seeing now is we've got these awesome, productive, dynamic tensions between our team as we each have different strengths and weaknesses and that, through the whole organization you're just seeing a phenomenal execution. And I would also say, hey, you're the ownership is part of this team as well. So we appreciate our shareholders and the analysts who take the time to get to know us over the years and are supportive of us using our shareholders capital to go solve these problems that we're excited and interested to go do that fundamentally we believe make the world a better place when we're done. And that motivates everybody to come to work excited. Joshua Isner -- Chief Revenue Officer So, Rick, I would have appreciated a Belichick comparison over Jimmy Johnson, but we'll let that one slide. Rick Smith -- Founder and Chief Executive Officer Well, I should have made a bet whether I could get that by without comment. All right, so thanks, everybody. Thanks to our team, those people listening on the phone, what a phenomenal quarter. And we're really excited to talk to you after the first year. Everybody have a fantastic holiday season. Hug your kids and your family. Hopefully the world's going to get a little less crazy over the next couple years. And it's been over the last few with what's been happening in the Middle East and Ukraine and it's been just so much violence in the world. I self admittedly was maybe too optimistic in my 2017 or 18 book the End of Killing that thought we were at the end of war. Been proven, sort of. The thesis was wrong in terms of timing, but I do think humanity can do better and we can find ways to deal with threats while minimizing the loss of life. And we're going to stay true to that mission. So thanks everybody, enjoy the holidays, we'll see you next year.