Tech Giants Embrace AI in Q4 2024 Earnings: DXC, Paycom, Upwork, and PTC Highlight AI Integration and Growth

DXC Technology (DXC) Q3 2025 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 DXC Technology third quarter fiscal year '25 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] And I would now like to turn the conference over to Roger Sachs, head of investor relations. Roger, you may begin. Roger Sachs -- Vice President, Investor Relations Thank you, operator. Good afternoon, everybody, and welcome to DXC Technology's third-quarter earnings call. We hope you had a chance to review our earnings release in 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 fourth quarter. Raul and Rob will then take your questions. Certain comments made during today's call are forward-looking and subject to risks and uncertainties that could cause actual results to materially from those expressed on the call. You can find details of those risks and uncertainties in our annual report on Form 10-K and other SEC filings. We do not commit to updating any forward-looking statements 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 that are in today's earnings release. And 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 third quarter fiscal 2025 earnings call. I'm pleased with the third quarter performance. Our operating model changes and focus on disciplined execution is reflected in our results. Revenue, adjusted EBIT margin, and non-GAAP EPS all came in ahead of guidance. We also delivered strong free cash flow. Our revamped go-to-market approach is paying off, driving a meaningful uptick in bookings. Reflecting on my first year as CEO, I'm more convinced than ever that we are on the right path. Our top priority is to drive profitable and sustainable revenue growth. Our evolving leadership team is establishing a culture grounded in client-centricity, performance management, and accountability. As a result, we're becoming more innovative, faster, and better positioned to win in the market. We have a strong portfolio of complementary and transformative IT services, all of which we plan to invest in and grow. Specifically, during the quarter, total revenue declined 4.2% year over year on an organic basis. Adjusted EBIT margin equaled 8.9%, expanding 140 basis points year over year. Non-GAAP diluted EPS was $0.92, up 7% year over year. And we generated free cash flow of $483 million for a year-to-date total of $576 million, exceeding our full-year fiscal 2025 guidance. Global uncertainties ranging from trade policy, geopolitical conflicts, inflation, and labor costs continue to pressure corporate spending for discretionary projects. At the same time, clients are balancing cost optimization with investments in AI-driven transformation programs. We also see some clients committing to projects for the full year ahead. Our revamped go-to-market approach is beginning to deliver results. As expected, bookings across our offerings improved significantly over the last quarter with gains in both large and shorter-cycle projects, a clear sign we're connecting better with customers. This momentum is evident in our book-to-bill ratio of 1.3x, the highest in eight quarters. Our pipeline continues to grow, including a higher mix of a number of deals in consulting and engineering services. While these engagements have less near-term revenue impact, we believe they build on a solid foundation for future growth. We continue to invest in training our client partners and refining our performance management processes to drive the continued expansion of our pipeline and grow future bookings. Additionally, during the third quarter, we continued to progress on the tactical actions we began earlier in the fiscal year. In our Global Business Services segment, where we help clients accelerate digital transformations, we continue to drive more scalable and standardized solutions to support growth. Specifically in consulting and engineering, first, we expanded our enterprise application capabilities that help clients leverage AI, driving increased bookings. Examples include collaborating with SAP to incorporate their business AI solutions into our industry frameworks and helping clients accelerate their SAP S/4HANA cloud projects as well as the formation of a new center of excellence with ServiceNow, combining DXC's deep IT industry expertise with ServiceNow's GenAI solutions creating a powerful platform to help clients increase their AI adoption. And second, we are also helping clients unlock the full potential of GenAI by ensuring their data is clean, current, and reliable, paving the way for secure deployments and scalable solutions tailored to their evolving needs. Let me highlight details of two examples of recent GenAI engagements. We worked with Singapore General Hospital to create an AI-powered solution to help doctors quickly analyze clinical data to improve patient treatment plans and alleviate the overuse of antibiotics. With just a few clicks, doctors can access if antibiotics are needed and recommend the right treatment and dosage quickly. Next, building on DXC's deep automotive expertise, we expanded our partnership with Ferrari to the software that powers the next-gen infotainment system for the recently launched F80 supercar. The new digital cockpit delivers an enhanced user experience, providing real-time performance data through seamless high-speed displays for public road use that transforms into a racing display when the drivers are on the track. Our capabilities in the insurance business remain strong. We are the category-leading software and services provider for life and wealth, global specialty, and reinsurance industries. We continue to invest to grow our cloud-based software solutions and are well-positioned to help clients migrate their workloads to the cloud for scalability and cost efficiency. At the same time, we're exploring new markets to drive further growth. In our Global Infrastructure Services segment, which represents our portfolio of technology solutions, we focus on delivering secure cutting-edge services to meet our clients' evolving needs. During the quarter, we laid the groundwork for the redesign and expansion of our AI capabilities in the software platforms across our cloud and ITO security and modern workplace offerings. We are partnering with clients to design and build industry-specific AI accelerators that will drive innovation in cloud infrastructure, security, and data management. We continue to improve our delivery metrics and overall quality of service, leading to record Net Promoter Scores. These efforts reflect our commitment to driving innovation and measurable value for our clients. I'm also excited to announce that Brad Novak has joined our leadership team as our new CIO, bringing over 30 years of experience in data architecture and technology strategy. Brad's mission is clear: increase AI usage across DXC's infrastructure and operations, advance our data strategy, and deliver on our ERP consolidation road map. Brad is the latest example of top-tier talent DXC is able to attract. I am pleased with our ability to bring in new leaders, both on my executive team and throughout the organization, to help execute on our strategic priorities. To conclude, we believe that our biggest near-term opportunities lie in our initiatives to improve effectiveness across the full cycle of capturing new business including better solutioning, using the right pricing models, and driving better economics on renewals. With revenue growth being our clear goal, I'm encouraged by the positive progress we've made in expanding our pipeline and bookings. Looking back over my first year as CEO, I've gained a deeper appreciation of the essential services we provide. We play a pivotal role in driving global commerce. We have strong and lasting relationships with clients that view us as strategic partners, leveraging our global delivery capabilities to help them with their transformation journeys. That said, our goal remains clear: to drive profitable revenue growth. Together with our experienced leadership team, I'm confident we have a strong portfolio of complementary and transformative IT services to deliver long-term success and continue building strong value for all stakeholders. The past is history. Today, we are a coordinated team running fast, breaking out of silos, and bringing out the best in each other. With that, let me turn the call over to Rob for a detailed review of our third-quarter results. Rob Del Bene -- Executive Vice President, Chief Financial Officer Thank you, Raul, and good afternoon. Today, I'll go over our third-quarter results, provide our view for the fourth quarter, and update our full fiscal year 2025 guidance. While facing incremental FX headwinds, 3Q total revenue of $3.2 billion fell in line with our expectation, while organic revenue declined 4.2% ahead of the top end of our guidance range. As Raul mentioned earlier, our book-to-bill ratio significantly improved to 1.33x, driving the trailing one-month ratio to 0.96, up from 0.88 last quarter. Adjusted EBIT margin expanded 140 basis points year over year to 8.9%, ahead of our expectations. This performance was primarily driven by higher yields from cost management initiatives as well as the deferral of certain planned marketing and IT investments to ensure they're more closely aligned with our evolving business priorities. In the quarter, we also recognized a 50 basis point benefit from equity compensation savings associated with executive leadership changes made during the quarter as we continue to reshape and strengthen our senior team. These tailwinds were partially offset by a $10 million charge related to the disposal of hardware assets as we consolidate data centers. Non-GAAP gross margin for the third quarter came in at 25.1%, an improvement of 150 basis points year to year. This expansion was primarily driven by savings from disciplined resource management practices and the impact from restructuring more than offsetting lower revenue and the data center hardware asset disposal. Non-GAAP SG&A as a percentage of revenue increased 70 basis points year over year to 10.3%. This was primarily driven by lower revenue and investments in our sales team as well as IT infrastructure related to our ERP consolidation efforts. These impacts were partially offset by the equity savings from recent executive leadership changes. As a reminder, the year-to-year changes in our non-GAAP gross margin and non-GAAP SG&A are normalized for the reclassification of certain business development costs to SG&A that I discussed last quarter. Non-GAAP EPS was $0.92, up from $0.86 in the third quarter of last year. The $0.06 increase was primarily driven by higher adjusted EBIT of $0.10, lower net interest expense and taxes of $0.02 each, and the impact of a lower share count of $0.03, partially offset by an $0.11 decline to noncontrolling interest that included a nonrecurring benefit in the third quarter of last year. Now, turning to our segments. GBS, which represents 52% of total revenue, was down 50 basis points year to year organically. The GBS profit margin increased by 150 basis points year to year to 13.4%, largely due to more efficient resource management. Within the GBS segment, Consulting and Engineering Services organic revenue declined 2.2% year to year. This is primarily driven by ongoing market pressures affecting custom application projects which account for roughly two-thirds of CES revenue. However, this decline was partially offset by momentum in our Enterprise Applications business as we continue to increase our capabilities. The book-to-bill ratio improved in the quarter to 1.28 due to third-quarter seasonality and our improving go-to-market execution. The trailing 12-month book-to-bill ratio remained stable at slightly more than 1.0. Insurance and horizontal BPS organic revenue grew 5.6% year to year. Our Insurance Services and Software business, representing approximately 80% of the total, continued to deliver mid-single-digit growth. This performance was driven in part by expanding software license revenue that increased at a mid-teen rate. The book-to-bill ratio for insurance and horizontal BPS was 1.05, including a higher mix of new work compared to bookings during the first half of the year. On a trailing 12-month basis, that book-to-bill ratio was 0.82. GIS, which represents 48% of total revenue, declined 7.8% year to year organically and services revenue was down approximately 7% and resale fell approximately 16%. Profit margin declined 50 basis points year to year to 6.5%, reflecting the impact of lower revenue and the hardware asset disposal charge that I referred to earlier. These headwinds offset the benefit of our ongoing efforts in resource management and optimizing software and data center costs. On a sequential basis, the GIS profit margin declined 170 basis primarily due to the hardware asset charge and last quarter's discrete benefit related to the settlement of a legal matter. Within GIS, Cloud/ITO security organic revenue declined 6.6% year to year, with services down approximately 7%, narrowing the rate of year-to-year decline by two points from last quarter. 3Q resale was down approximately 2%, improving from steeper declines in recent quarters, and we continue to be selective on our resale opportunities based on deal economics. The book-to-bill ratio of 1.51 was driven by timing of renewals and our improving go-to-market effectiveness. The trailing 12-month book-to-bill ratio equaled 0.90. Modern Workplace declined 11.3% year to year organically, with services revenue down approximately 5% and resale revenue down about 30%. The book-to-bill ratio equaled 1.25 and the trailing 12-month book-to-bill ratio was 1.04. Turning to our cash flow and balance sheet. During the quarter, we generated $483 million of free cash flow compared to $585 million in the same period last year, with the delta primarily driven by working capital. Additionally, capex increased by $46 million to $167 million, largely reflecting efforts to reduce new financial lease originations, which were limited to just $3 million in the quarter. Taken together, capex and lease originations as a percent of revenue equaled 5.3%. As a reminder, financial lease originations are not included in free cash flow. Fiscal year-to-date free cash flow through December 31, 2024, totaled $576 million, exceeding our prior full-year guidance of approximately $550 million. This outperformance was primarily driven by adjusted EBIT for the first nine months of the year exceeding our expectations, along with anticipated restructuring charges. Our disciplined resource management practices, which have driven a net head count reduction of nearly 5,900 since the start of the year, have enabled us to remain on track to meet our cost savings targets for the year. With our measured and deliberate approach, undoing actions to the right areas across our organization, we are now expecting restructuring charges to be a maximum of $100 million above last year compared to the $250 million we initially outlined. We will continue to drive targeted restructuring reductions across our operations into fiscal 2026, utilizing the remaining funding planned for fiscal '25. Total debt at the end of the quarter was equal to $3.8 billion, reflecting approximately $80 million of capital lease paydown and the currency impact on our euro-denominated bonds. Total cash on our balance sheet increased by approximately $480 million quarter over quarter. This was driven by strong free cash flow and asset sale proceeds of more than $80 million from facility sales and the divestiture of a noncore business in Asia Pacific. Through December 31, we've generated approximately $150 million of cash through dispositions and sale of other assets with line of sight to additional transactions. As a reminder, these proceeds are not included in our reported free cash flow. As a result of our strong free cash flow generation, asset sales, and debt reduction over the first nine months of the fiscal year, we have lowered net debt by more than $750 million to $2.1 billion. With approximately $1.7 billion of cash on hand, we have delivered on our objective of strengthening our capital structure, and we'll update our capital deployment priorities as we enter the new fiscal year. Now, let me provide you with a view of our fourth quarter. We expect total organic revenue to decline 5.5% to 4.5%. We anticipate adjusted EBIT margin to be about 7%, reflecting the expected sequential decline in revenue, the impact from merit increases, and increased investments in sales, marketing, and IT. We expect non-GAAP diluted EPS of about $0.75. And now, for the full year. We now expect total revenue to decline between 4.7% and 4.9% year to year organically compared to the prior guide calling for a decline of 5.5% to 4.5%. We continue to anticipate full-year GBS revenue to decline slightly year over year and GIS to decline at high single-digit rates. We now expect our full-year adjusted EBIT margin to be approximately 7.9%, up from our prior guide range of 7% to 7.5%, this being the third time this year that the guide has been increased. We now expect a full-year non-GAAP effective tax rate of approximately 33%, bringing our full-year non-GAAP diluted EPS to be about $3.35, an increase from our prior guide of $3 to $3.25. Free cash flow for the year is now expected to be approximately $625 million, an increase from our prior view of about $550 million. This improvement is largely due to the increase in our adjusted EBIT guidance and the lower anticipated restructuring spending. And with that, let me turn the call back over to Roger. Roger Sachs -- Vice President, Investor Relations Thank you, Rob. We'd now like to open the call for your questions. Operator, can you please provide the instructions? Thank you. We will now begin the question-and-answer session. [Operator instructions] Your first question comes from the line of Bryan Keane with Deutsche Bank. Please go ahead. Bryan Keane -- Analyst Hey, guys, thanks for taking the question. Just wanted to ask about the organic growth in the third quarter, kind of beat expectations in your guidance. But for the fourth quarter, as we jump over to that quarter, it's a slight decrease from where we did in the third quarter, and I know the bookings are up, so just trying to reconcile the increase in the book-to-bill and what that means for organic growth, especially as we turn into the fourth quarter and into next year. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah, Bryan, it's Rob. Thanks for the question. The reason for that slight decrease in quarter-to-quarter guidance is related to the bookings in the first half of the year. If you recall, our bookings were in the range of 0.8 for the first half. And that takes time to flow through bookings into the pipeline, into the backlog rather, into revenue. So, that will be a bit of a drag for the next couple of quarters. And the better bookings that we experienced in third quarter will start to layer in over time. So, it's primarily the first half that causes the decrease. Bryan Keane -- Analyst Got it. That's helpful. And then just obviously, turning to the adjusted EBIT margins, quite a bit above our expectations in the quarter, and you're raising guidance again. Just trying to make sure I understand the puts and takes between where we were in the third quarter to the fourth quarter because it's a little bit lower level, even though we're increasing the full year. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yep. So, the drivers, the 8.9%, we referred in the call to some equity comp benefits that we experienced in the third quarter, which were one-time in nature. So, that drove about a 40-basis-point help. So, the bridge is really going from about 8.5% to 7%. And the primary driver of the reduction is going to be the revenue decline quarter to quarter dropping down to the bottom line. And along with that, we have merit increases that we've given to employees where we had one month in the third quarter and three months' worth in the fourth quarter. So, those are the two primary drivers of the margin degradation. Bryan Keane -- Analyst OK. That's really helpful. Thanks for taking the questions. Your next question comes from the line of Jonathan Lee with Guggenheim Partners. Please go ahead. Jonathan Lee -- Analyst Great. Thanks for taking my questions. Tremendous to see the book-to-bill strength in the quarter. How much of the bookings momentum was driven by seasonal budget flush activities? And how would you characterize the deal environment into fiscal 4Q? Raul Fernandez -- President and Chief Executive Officer So, Raul here. Thank you for the question. Look, the demand environment is not a big factor for us because we've got to execute operationally across the board from pursuits through pitches and conversion, etc. And really, that is what had a big impact in terms of getting that book-to-bill up. It starts with people, right leaders in the right place. Pipeline, obviously, bigger is better, and better quality is better. We're working on that and making progress. Conversion rate increasing, another factor, again, getting better, but still a lot more to do. And then we did some revisions of comp plans within the year, and we're carrying that forward as we're smarter about what we need to get out of our sales force. But across the board, better proposals, better sales, and marketing material, all had an impact on that. Jonathan Lee -- Analyst Thanks for the detail there. Well, as you think about calendar year '25, and I know it may be early, is there anything in your customer conversations that would give you confidence that perhaps calendar '25 should be better than calendar '24 for you from a demand perspective? Raul Fernandez -- President and Chief Executive Officer I think the demand for the set of services that we have is very solid. We are operators and we're trusted partners with global companies that make multiyear commitments to us to help them run their businesses. And that is longer term, multiyear, larger. Then on the other side of our business, on consulting and engineering, they're shorter term. They're more transformational. They get booked and they get burned on a quicker sequence. So, for us, it's more of the mechanics of getting the right combination of those in place so that we can have more predictability and see an upward slope. But I'm more focused on internal operations management, measurement performance. The external environment is good. I mean, look, technology is changing every industry in every country everywhere. And it's not going to stop. If anything, it's going to get faster. Pace of change increases. AI adds another dimension of complexity. Complexity means that our customers need people who are experienced and can bring very relevant and current expertise to the table. So, demand environment is solid. But we also, looking across all of our verticals, had a pretty solid across every single vertical performance in the last quarter. And again, I don't see anything today that shows a blip. Obviously, as you can read in the newspaper every day, there's trade policy that can change certain industries and have big impacts and could impact demand. But right now, our execution and our performance against the backdrop of demand that we have and then being successful in new pursuits. Your next question comes from the line of Tien-Tsin Huang with JPMorgan. Please go ahead. Tien-Tsin Huang -- JPMorgan Chase and Company -- Analyst Hi, Rob. I wanted to ask on the margins. I heard that there was a deferral, I think, of some marketing expenses, just curious if I heard that correctly. And could you size that? And is that going to be pushed out into fiscal '26? And same question on the restructuring charges, the $100 million max now that's below the $250 million. Is the $250 million target now lower? Or is it just a pushout as well? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. So, we had some investments included in the guide for 3Q and a modest increase in 4Q as well. And I just want to take back, Tien-Tsin, we've had new marketing leaders added, a new CIO added, new leaders in our go-to-market in both Europe and the Americas. And these leaders, we're being really deliberate and thoughtful on where we make our investments. So, while we left room in the guide, they're onboarding, they're evaluating what we have in-house. And again, we're being very deliberate and a little slower than I originally plugged into the guide in terms of the incremental investments. So, we'll continue to be extremely thoughtful and prudent as we go forward with the investments. We do expect an uptick. We're basically rebuilding our marketing function. So, we are expecting increased investments over time. And we have system consolidations in IT that we're going to be investing in, along with providing much better AI capability in-house to become more efficient and streamlined. So, the IT investments will increase modestly over time. And then perhaps, once we get past the bubble, they'll come back down. And from a sales perspective, we'll continue to build our capability and an effort to drive future revenue growth. Raul Fernandez -- President and Chief Executive Officer Yeah. Just a data point to back that up, our marketing leader came in, in June, right? So, we're talking about six, seven months of effectively being on the ground and rebuilding the team. So, a relatively new team, getting a handle on what we had and what we need to do and just taking a little bit more time, but I'd rather be thoughtful and deliberate and use the dry powder at a later date. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. And so, Tien-Tsin, on your question on restructuring, I mentioned in the prepared remarks that we've been able to execute on our cost reductions with less restructuring. Similar to the investments, we're being extremely targeted and thoughtful about where we deploy the restructuring dollars. So, we do plan on continuing that effort. We are going to keep drilling down and rationalizing our spend profile, our overhead, become more efficient, and carry that $150 million into fiscal '26, which on the surface would be a $50 million year-to-year increase. So, that's our current plan. And we'll add more to that 90 days from now when we do the year-end call. Your next question comes from the line of Bryan Bergin with TD Cowen. Please go ahead. Bryan Bergin -- Analyst Hi, guys, good afternoon. Thank you. I wanted to dig in on the free cash flow outperformance here. And first, Rob, just to clarify on the margin that rolls into that, was the 8.5% the clean op margin relative to your plan for the quarter? And then as we think about the sustainable versus the transitory factors that you're talking about here, things like timing on some of the restructuring and these margin items versus more efficient working capital and capex, like what are the puts and takes as we look forward here and consider your prior view of returning to a foundational level of roughly $700 million of free cash flow? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. No, thanks for the question, Bryan. So, let me step through this. So, our guide for the full year is now $625 million, up from the $550 million. If we think of that, the two primary impacts to that, which we have gone through all year, is the incremental restructuring, which is now targeted at a max of $100 million, and then the shift of capital leases to capital expenditures. If you make those two adjustments, our free cash flow for fiscal '25 is right on top of where we were in fiscal '24 at around $750 million, in that ballpark. So, our underlying free cash flow generation is stable. Now, going from 2025 to '26, I would think of that $625 million as a good foundation. We will continue to minimize capital leases, which will put a little pressure on capital going forward, and we have to work through the dynamics going forward, 90 days from now. The restructuring right now, what I'm suggesting is we are holding that $150 million, and we'll spend that as needed in fiscal '26. So, that would be a $50 million worth of pressure on the $625 million. But we have working capital. We have our EBIT profile. We have cash-out. So, we have a number of significant drivers of free cash flow that we'll be working through during the fourth quarter before we set our guide for next year. Bryan Bergin -- Analyst OK. That's helpful. And then as we kind of marry the cash flow and the balance sheet, your net leverage looks like it's down to about one turn, gross debt down. Just how are you thinking about capital allocation here? I know there wasn't much buyback in the quarter. I'm curious if anything would preclude you to start becoming more active there. Or are you reaching a point where M&A starts to become more of a priority? Raul Fernandez -- President and Chief Executive Officer We're going to give an update on capital allocation for next year at the next call. We're going to evaluate what we have in terms of opportunities to get the biggest return for our investments. As you know, part of what I've been doing with the team is making sure that we've got an operating system that is effective on a stand-alone basis. But more importantly, if we were to do any sort of smaller M&A that we can be super accretive, both in terms of revenue, clients, people, etc. So, those are not fully aligned yet, and we'll give you more color on capital use in the next quarter, but we're making progress along that front so that we have the optionality. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. And Bryan, I would just add that we're executing exactly as we told you we would at the beginning of the year. We suspended the buyback. We focused on improving our balance sheet this year. We've accomplished that, and we're going to reevaluate our priorities next quarter as we head into fiscal '26. All three levers are still important to us. Having the right capital profile, investment in the business, and return to shareholders are all important to us. Your next question comes from the line of Matthew Roswell with RBC Capital Markets. Please go ahead. Matt Roswell -- Analyst Yes. Good evening. Congratulations on a good quarter. I guess could you talk a little bit about what you're seeing in terms of win rates and pricing, and for pricing, especially around renewals, and whether you're kind of through most of the legacy, not very profitable contracts? Thanks. Rob Del Bene -- Executive Vice President, Chief Financial Officer Thanks, Matthew. It's Rob. So, I would describe our pricing dynamics this year as being stable, and that is across the board. Now, with regard to renewals, this is a very targeted conversation, contract by contract. We have renewal strategies for each of our contracts. And in cases where we set out to have better economics going forward, it's both economics and terms going forward, we have been able to accomplish that. Our intention is to go into every renewal, coming out of it with good economics for us, having a customer who is equally happy with the outcome of the discussions and the negotiations, and have a win-win. So, we've done a good job in the contracts we've targeted for better terms and better prices. And we'll continue to operate that way at each renewal with the intention of renewing that contract. Matt Roswell -- Analyst And I guess in terms of the win rates, are you seeing them improved? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah, they've been very stable. The first half of the year is stable. In the third quarter, we actually did better. So, we had improved win rates in the quarter. And it's another indication that the go-to-market changes that we're making are taking hold. And along with the pipeline generation and the bookings improvement, the win rates have improved. And I'd also add, I mentioned it earlier, that our pipeline in the fourth quarter is also positioned very well for us. Your next question comes from the line of Jamie Friedman with Susquehanna. Please go ahead. Jamie Friedman -- Analyst Hi. Good evening. Raul, I was hoping to get your perspective as to which of these segments have the most opportunity for improvement. The book-to-bills by segment really vary or they diverge from the reported revenue growth rates. So, maybe that's part of the answer. But from your perspective, which of these segments do you think is under-indexing either the market or your objectives? Raul Fernandez -- President and Chief Executive Officer Yeah. So, look, one point I want to make is that now having been here a full year, operating all of the units that we have, that I feel that we've got a very solid portfolio that is in current demand and that is well positioned for future demand. So, we are focused on building across every one of our segments, our two offerings in the geographies, building on top of the great clients that we have today, and then being worthy of competing and winning on net new accounts. And we're starting to get great early indicators that as we bring the new face of DXC into the marketplace and tell our story in a more efficient and effective way that we can click up on our conversion rate. So, I'd say across the board, they all have room to improve. And that improvement is in execution. That improvement when you get down into the ingredients of what it takes to win, it's the right solution, it's the right sales and marketing material, it's the right pitch, it's the right price. So, I don't have a segment where, oh, gosh, that's a big turnaround there. They all have room to grow, and they all have room to improve. Insurance is performing very, very well and will continue to perform well. And I think we're very well positioned globally in multiple areas there. And so, I'm excited to continue to build upon that success. But my approach is holistic and there's upside across the entire portfolio. Jamie Friedman -- Analyst Thanks for that. And then if I could just ask Raul or Rob, how should we be thinking about the opportunities between revenue growth and margin, between GBS and GIS? Is there a zero-sum there? Or can they both move in the same direction, hopefully up? But how do we think about the dynamic of those two, revenue and margin? Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. So, Jamie, it's Rob. Look, I think we have opportunity across the board for improvement, as Raul mentioned. From an opportunity standpoint, the dynamics of the businesses are different, as you know. CES is more project-oriented, with the GIS business units being longer term in nature in terms of the contracts, longer-term outsourcing contracts. So, the dynamics are different in that regard. There's opportunity for improvement in both. There's margin opportunity also across the board. So, we're going after all of it. We're going after all of it. And we'll give you more color for '26 as we get to next year's guide. Your next question comes from the line of Keith Bachman with BMO Capital Markets. Please go ahead. Keith Bachman -- Analyst Hi. It's Keith Bachman from BMO. Sorry about the background noise. I wanted to ask about dispositions. You've been doing a nice job of paring back in some businesses. You did some more this quarter. Is there more room to run? And I have to ask about managed services, which has been a drag for years. And I understand that the book-to-bill is positive. But mainly, when your revenue is declining 10%, it's easier to have a positive book-to-bill. But is there more that you can do on, more broadly, paring back on areas that you don't see performance improving? And is there a magnitude that you can help us think about? Thank you. And that's my first question. Rob Del Bene -- Executive Vice President, Chief Financial Officer Let me take the first one on the dispositions. We've had $150 million in dispositions so far this year. And we do have a list of other opportunities that we're actively pursuing. So, there is more room to run. And I'm not going to quantify that. But I think, yes, at the beginning of the year, we set out to get a couple of hundred million dollars of dispositions. And the timing is uncertain with these, especially when you're trying to sell facilities. But we're happy that we're at the $150 million mark. I've got an opportunity list that would be in excess of what we originally were earmarking. And I think we'll be successful in executing on that list, but the timing is uncertain. Raul Fernandez -- President and Chief Executive Officer Yeah. Just on the managed services, one of the areas of investment has been in bringing talent that has great track records of success in building SaaS products in scale in various industries. They're here less than six months. They're actively working on the internal offering that we currently have today that supports our existing managed services account. And they'll be having a rollout of new features, functionality, essentially a relaunch of the whole product set, in the next six to nine months. So, that's an area that we're investing in. It's an area that I expect to see improvement, and it's an area where the talent that we brought in is making an impact, but a little bit too early to roll out today. Keith Bachman -- Analyst That leads into my second question. How stable do you think your very senior leadership team is? Do you think there's more you need to add? Or do you feel like you have the team in place? And related to that, I'm not quite clear, there was a gain on your margin from equity. Does that mean that some folks didn't stay who were recently hired? I wasn't clear what the genesis of that was. And that's great. Yeah. I'll let Raul take the question. But just on the financial impact in the third quarter, the benefit was just a reversal of equity that we had accrued that the executives left, and we reversed those accruals. Raul Fernandez -- President and Chief Executive Officer Yeah. And I'm super happy with the velocity that we've been able to bring in super experienced talent that I've worked with, in many cases, across different companies over the last 20, 25 years, having them join, having them have an impact has been terrific for me personally. And so, the good news is that that network is in place. That network still has more to go, if needed. But as you know, as you bring on every team, you get everybody settled and you get everybody going in the same direction. And that's what's happening today. So, I'm super happy on the talent side, and we'll make changes as needed, but very satisfied with where we are today. Your next question comes from the line of Jason Kupferberg with Bank of America. Please go ahead. Tyler DuPont -- Analyst Good afternoon. This is Tyler DuPont on for Jason. I wanted to start by touching on bookings. It was nice to see positive bookings on a quarterly basis for both GBS and GIS for the first time in quite a while. Can you maybe discuss how much of that was due to large deal wins versus the smaller deals? I guess what I'm trying to get at is the duration and ramp timeline and what that looks like for these new bookings as well as the potential ability to backfill as we move through calendar '25. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. Thanks for the question, Tyler. We did have a significant renewal in the third quarter. And we mentioned it in the call at the end of the second quarter that there was a big opportunity that slipped out of the quarter, which we ended up booking like the next week or within 10 days of the beginning of this quarter, and that was approximately $400 million. So, our book-to-bill, without that big renewal, was still very healthy, in the 1.2 range approximately. The rest of the bookings, they were healthy across the board. There was a good mix of project-based services and longer-term outsourcing services. So, the strength of those bookings will start manifesting themselves as we progress through fiscal '26. And as I mentioned earlier, the pipeline looks good for the fourth quarter, and we're expecting another good bookings quarter in the fourth. Tyler DuPont -- Analyst That's helpful, Rob. Just shifting gears a bit. I also wanted to ask about margins. I know it's been brought up a couple of times. It's nice to see the outperformance in the quarter. But just wanted to get your take on the sustainability of the margins by segment. I know 4Q is taking a step down. And in 3Q, we saw GBS really outperform on the segment level. But just as we look through 4Q and we look through calendar '25, just sort of what sort of dynamics are you expecting? What segments do you anticipate will drive further expansion? Anything along those lines would be helpful. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. Again, we'll pass on commenting on fiscal '26 expectations. But on the fourth quarter, the items we mentioned earlier, both the revenue declines and the merit increases will be across the board, so they will impact both of the segments in the fourth quarter from a quarter-to-quarter perspective. Your next question comes from the line of James Faucette with Morgan Stanley. Please go ahead. James Faucette -- Analyst Great, thank you very much. You guys have answered a lot of my questions today, and I appreciate all the details. Just wondering if you can give us a little bit of incremental color on what industry verticals you see delivering kind of better-than-expected growth versus maybe which ones were weaker than maybe you would have thought. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah. So, James, let me take that and address that for both GBS and GIS separately. But from a GBS perspective, we had strength in the quarter in the insurance sector. Public sector was strong, did well in communications and media and in healthcare as well. So, those were our better performers, growth sectors for GBS. And in GIS, we did well in travel and transportation and healthcare, energy. Those were primarily the better-performing sectors. And from a quarter-to-quarter perspective, we had kind of broad broad-based improvements quarter to quarter in both GBS and GIS. James Faucette -- Analyst Got it. Appreciate that. And then when you think about particularly the public sector, how should we think about potential benefits or disruptions, at least what you've seen thus far, from a public policy standpoint and intentions under the new administration? Raul Fernandez -- President and Chief Executive Officer Yeah, I'll take that. Just to be clear, when we talk about public sector, it's public sector outside the United States, so heavy in the U.K., Ireland, Australia. So, U.S. domestic cuts or changes in budgets, etc., do not have an impact on us here. James Faucette -- Analyst That's great color. Appreciate that. Thanks so much, guys. Your final question comes from Rod Bourgeois with DeepDive Equity Research. Please go ahead. Rod Bourgeois -- DeepDive Equity Research -- Analyst Hey. I want to ask a big-picture question here. I think in three months, when you guide to next year, I want to talk about investment priorities. But for now, I guess I'd like to ask, are you approaching a new stage in your turnaround effort? Perhaps you could characterize the phase that you've been in over the last year and if you're seeing a new phase that's on the horizon. It seems like you've been working on a lot of the blocking and tackling in the last year. So, if you could just give us a big-picture perspective on the overall turnaround trajectory there. Raul Fernandez -- President and Chief Executive Officer Sure. Let me give it a shot first. Look, we've changed behavior, and now we need to sustain that behavior change and continue to get better along the way. We're getting better wired to win on a consistent basis, but it's still early, and there's a lot of work left to be done. So, I think it's about consistency and scale on the positives and then getting to the next set of items that needed to be fixed on the checklist. It's big, it's global. It takes a little bit of time, but we're very happy with the progress that we're making, and we're very happy with the plans that we have to make continued progress in the upcoming year. Rod Bourgeois -- DeepDive Equity Research -- Analyst OK. All right. Well, maybe more to come on that in three months. I want to ask about your Q4 revenue guidance. I know you addressed that some earlier. But since you're implying a sequential revenue decline, I want to ask more about that. Because there is considerable history for positive quarter-to-quarter revenue seasonality heading into the March quarter, so I'm wondering if your guidance is conservative or if there are some above-normal revenue runoffs occurring on existing deals. I mean, I know you had weak bookings in the first half of last year, but you've also had years in the past with weak bookings, but still positive seasonality in the March quarter. So, just maybe your guidance is conservative, or maybe there's another factor that's at play. I just wanted to ask on that. Thanks. Rob Del Bene -- Executive Vice President, Chief Financial Officer Yeah, Rod. I'd describe our guidance is right down the middle. I would not characterize our revenue guidance as conservative. So, that's for starters. In terms of dynamics, the overwhelming driver of the revenue decline is the first half bookings and that bleeding through the second half of the year and into the fourth quarter. So, that is the primary driver. It's not new runoffs or other exposures. Rod Bourgeois -- DeepDive Equity Research -- Analyst OK. Well, what I'm not following is bookings is adding to backlog. So, in order for revenues to decline, there has to be some form of runoff on your existing run rate, particularly in a quarter where there's positive seasonality. So, I know the bookings were weak, but that's translating into a net runoff, it appears. Yeah. Look, not all bookings are equal in terms of period of performance for burn, etc. So, while it's an important number, the ingredients of the number, what can get burned within the next two quarters, within the first year of the signing, varies. In some very large deals, the ramp-up is slow and then hits. On smaller ones, you book, bill and you burn, right? So, it's all in the nature of what the booking was and is and how we're dealing with two or three quarters ago. But part of what we need to do is to increase the top line, the revenue side, and that will help smooth these sorts of transitions out over the next quarters. And that concludes our question-and-answer session. And I will turn the conference back over to Roger Sachs for closing remarks. Roger Sachs -- Vice President, Investor Relations I want to thank everybody for joining us today, and we look forward to speaking with you next quarter.

Paycom Software (PAYC) Q4 2024 Earnings Call Transcript | The Motley Fool

Good afternoon. My name is Cameron, and I will be your conference operator today. At this time, I would like to welcome everyone to Paycom's fourth quarter and full year 2024 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Thank you. I will now turn the call over to James Samford, head of investor relations. You may begin. James Samford -- Head of Investor Relations Thank you, and welcome to Paycom's earnings conference call for the fourth quarter and full year 2024. Certain statements made on this call that are not historical facts, including those related to our future plans, objectives and expected performance are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of the date of this conference call. While we believe any forward-looking statements made on this call are reasonable, actual results may differ materially because the statements are based on our current expectations and subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the SEC, including our most recent annual report on Form 10-K. You should refer to and consider these factors when relying on such forward-looking information. Any forward-looking statement made speaks only as of the date on which it is made, and we do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law. Also during today's call, we will refer to certain non-GAAP financial measures, including adjusted EBITDA, non-GAAP net income, free cash flow, and certain adjusted expenses. We use these non-GAAP financial measures to review and assess our performance and for planning purposes. A reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today, and is available on our website at investors.paycom.com. I will now turn the call over to Chad Richison, Paycom CEO and president. Chad? Chad R. Richison -- Chairman, President, and Chief Executive Officer Thanks, James, and thank you to everyone for joining our call today. We ended 2024 with strong momentum, thanks to focused execution, organic sales growth, and operational efficiency gains. Before diving in, I want to welcome our next CFO, Bob Foster. Bob joined Paycom over two years ago after working within the industry as the CEO and chairman of a payroll company for eight years. Prior to that, he served as a senior partner at Ernst and Young, managing several of the firm's largest accounts. He brings industry experience, process expertise, and a strong financial pedigree to lead our financial team. He will assume the role of CFO effective February 21st, when my longtime friend and colleague, Craig Boelte, officially retires. After my opening remarks, Craig will review our fourth quarter and full year results and Bob will provide comments on our full year guidance. We will then take your questions. With that, let's get started. Our performance strengthened throughout the year as we diligently executed our 2024 plan. We expect to fuel our momentum in 2025 by maintaining our focus on full solution automation, client ROI achievement, and delivering world-class service. 20 years ago when we sold our software, user buyers bought the product because they wanted to do more with this software. And today, they want the software to do more for them. We already have the most automated solution in the industry, and we are rapidly moving toward full solution automation, driving even more ROI for our clients. Simply put, our software vision is that people shouldn't do tasks that systems can safely automate. On the payroll side, Beti continues to eliminate non-revenue-generating tasks, which allow clients to shift resources to more profitable activities. Beti is a highly differentiated automated solution that delivers strong client ROI. Having employees do their own payroll is the most effective way to do payroll, and we are seeing this validated daily. Take, for example, a client of ours in the professional sports industry. Prior to Beti, this 500-employee organization worked through payroll issues for days leading up to their submission deadline. They ran separate reports and supervisors chased down employees to fix time and attendance issues. With Beti, their employees ensure their check is correct, which has significantly increased employee trust and the client has automated 85% of the time and effort previously wasted on payroll. We onboarded a 2,000-employee retail client that operates in multiple states. This client raved about their seamless transition process, and they confirmed they have also reduced their payroll processing time by nearly 85%. In addition to the payroll savings, their HR team saved an additional month annually of unproductive time to automations outside of the payroll process. Clients continue to see strong ROI from our automated time and labor management solutions. For many clients, unproductive time represents roughly 10% of labor costs. With GONE, clients can eliminate unnecessary interaction points by providing a consistent and fully automated experience for employees, managers, HR administrators, and the business as a whole. A recent Forrester study found that GONE can generate an ROI of up to 800%. Through the automation of time-off decisions, managers saved nearly a week of unproductive hours annually. And on average, companies save nearly five weeks of unproductive time in the areas of HR, finance, and accounting every year. We were pleased that GONE received the Business Intelligence Group's Innovation Award, which is awarded to the organization's changing how employees experience the world. Internally, we are experiencing increased efficiencies through product automation. Paycom's AI agent, which was rolled out to our service team six months ago, utilizes our own knowledge-based semantic search model to provide faster responses and help our clients more quickly and consistently than ever before. As responses continuously improve over time, our client interactions become more valuable, and we connect them faster to the right solution. As a result, we are seeing improved immediate response rates and have eliminated service tickets by over 25% compared to a year ago. We remain committed to having a high-touch service model, which means we'll always have a single point of contact for our clients to provide them with personal service. But with automations like AI agent, we are realizing internal efficiencies, driving increasing client satisfaction and seeing higher Net Promoter Scores. Through our internal automation efforts, we are identifying opportunities to automate even more processes that currently require a necessarily human interaction, and this is having a positive impact on our service initiatives and margins. Thanks to these efforts, we ended the year with roughly the same headcount as last year, while continuing to attract talent in the key areas of service, sales, and R&D. Demand for the most automated solution in our industry provided by Paycom is stronger than ever, and sales is having record success as more businesses experienced the benefits of solution automation. With greater success among our sales organization, we have more individuals ready to be leaders. And with a deep bench of sales leaders, we opened three new sales offices in January. These are located in Raleigh, North Carolina, Los Angeles, California, and Providence, Rhode Island, which brings our total outside sales teams to 57. Our culture was highlighted by comparably in Q4 as Paycom was the top company for compensation and best company culture. Additionally, Newsweek recognized us as one of America's greatest workplaces for diversity. With the most automated product, consistent retention, and kicking off the year with record sales growth, we are set up to perform well in 2025 and beyond. Thanks, Chad. Before I review our fourth quarter and full year results for 2024, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. Also, in our income statement, we have broken out total revenue into recurring and other revenue and interest on funds held for clients. In our earnings press release today, we provided 2024 quarterly revenue amounts to conform to this presentation. This change has no impact on total revenue or any other line item in our income statement. We ended the year with solid results with full year 2024 revenue of $1.88 billion, representing 11% organic growth compared to 2023. Full year recurring and other revenue was $1.76 billion, also up 11% compared to 2023. And interest on funds held for clients of $125 million was up approximately 16% year over year. Fourth quarter results were better than expected with total revenue of $494 million, representing growth of approximately 14% over the comparable prior-year period. Recurring and other revenue in the fourth quarter was $465 million, up 14.5% compared to 2023. We generated $29 million of interest on funds held for clients, up approximately 2% year over year on an average daily balance of approximately $2.5 billion. Our strong top line results and recent operating efficiency gains translated into even stronger bottom-line results. Full year GAAP net income was $502 million or $8.92 per diluted share based on approximately 56 million shares. Non-GAAP net income for 2024 was $462 million or $8.21 per diluted share. In the fourth quarter, GAAP net income of $114 million and non-GAAP net income of $130 million represented $2.02 and $2.32 per diluted share, respectively, based on approximately 56 million shares. Full year adjusted EBITDA was $775 million, representing full year margin of 41.2%. Fourth quarter adjusted EBITDA was $215 million representing a quarterly margin of 43.5%, up 290 basis points year over year. We continue to invest in automation across our software. Adjusted R&D expense was $61 million in the fourth quarter of 2024 or 12% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $89 million in the fourth quarter of 2024 compared to $73 million in the prior-year period. Our tax rate for 2024 was 23% on a GAAP basis. For the full year 2025, we anticipate our effective income tax rate to be approximately 29% on a GAAP basis and approximately 27% on a non-GAAP basis. In fiscal year 2025, we expect stock-based compensation expense as a percent of revenue to be approximately 8%. Cash flow from operations in 2024 was $534 million, representing 28% margin. Total capex of $197 million in 2024 represented approximately 10% of total revenues compared to approximately 12% of total revenues in 2023. We estimate total capex as a percent of revenues to be below 10% in 2025. Free cash flow, defined as operating cash flow less capex was $337 million in 2024, up 17% year over year. Free cash flow margin expanded 90 basis points year over year to approximately 18%. In 2024, we repurchased over 900,000 shares of common stock, or approximately 2% of our shares outstanding for a total of $145 million, and we paid over $84 million in cash dividends. Since the beginning of 2023, we repurchased over 2.4 million shares or approximately 4% of shares outstanding for approximately $445 million. We still have approximately $1.48 billion remaining under our buyback authorization as of December 31st, 2024, and the board has approved our next quarterly dividend of $0.375 per share payable in mid-March. Turning to the balance sheet. Even after returning capital to shareholders through buybacks and dividends paid in 2024, we ended the year with a very strong balance sheet, including cash and cash equivalents of $402 million and zero debt. We ended 2024 with approximately 37,500 clients, representing a growth rate of 2% compared to 2023. On a parent-company grouping basis, we ended the year with approximately 19,400 clients. And of those, clients with greater than 1,000 employees were up 12% year over year. Total employee records stored in our system in 2024 was 7 million, up 3% year over year. Paycom's annual revenue retention rate in 2024 was 90%, which was consistent with 2023. 2024 was a solid year of execution with strengthening fundamentals as the year progressed. I want to thank our employees for all the hard work that is paying off. With that, I'll turn the call over to Bob for guidance. Bob? Bob Foster -- Incoming Chief Financial Officer Thanks, Craig, and thank you, Chad, for the opportunity to take the financial reins of such an innovative and profitable company. For the near term, the plan is to continue to fuel the momentum we have been building in 2024 in the areas of R&D, sales, and investing in automation to benefit our clients, as well as us internally. Our approach to guidance remains consistent as we guide to what we can see today, and factor in relevant trends, opportunities and potential constraints. With the goal of aligning our guidance with our long-term focus and consistent with how we run our business, we are transitioning to an annual revenue and adjusted EBITDA guidance framework. For fiscal 2025, we expect total revenue to be between $2.015 billion to $2.035 billion, or approximately 8% year over year at the midpoint of the range. We expect full year recurring and other revenue to be up approximately 9% year over year. We expect full year adjusted EBITDA in the range of $820 million to $840 million, representing an adjusted EBITDA margin of 41% at the midpoint of the range. This represents one of our highest initial margin guides. Included in total revenue outlook is interest on funds held for clients of approximately $110 million, down 12% year over year. Looking at the shape of the year, we expect first quarter growth to be the low point of the year. We expect recurring and other revenue growth to accelerate to consistent double digits every quarter thereafter, as we benefit from record sales and consistent retention trends. We have positive momentum and are positioned well in 2025. We have an organic growth model that produces high-quality revenue and profit. We also have the talent and the product vision to build on our success. Before taking your questions, I want to thank Craig for what he has meant to Paycom, our clients, and our employees over the last 20 years. From all of us, Craig, thank you. With that, let's open the line for questions. Operator? Operator [Operator instructions] In the interest of time, we ask that you please limit yourself to one question and one follow-up. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Raimo Lenschow with Barclays. You may proceed. Raimo Lenschow -- Analyst Hey, perfect. Congrats on a great Q4 and Bob, all the best in your journey with Paycom as a CFO. Two quick questions. Bob, first on guidance and guidance philosophy, what drove the decision to kind of not do quarterly anymore? I mean it does feel like Paycom is a very predictable business, so that's a little bit surprising there. Maybe talk a little bit about your thinking? And then, Chad, can you talk a little bit about the renewal rates? You mentioned they were stable last year. But in the past, we've seen large numbers and like the whole Beti uncertainty kind of obviously created headwinds and so I'm thinking like is this level like the new level? Or are your ambitions to bring it back to the levels we've seen in the years prior to what we've seen before? And many thanks and congrats on the good Q4 again. Bob Foster -- Incoming Chief Financial Officer Yeah, Raimo, thanks for the question. As you know, we run our business with a long-term focus, and we invest in things that will help our clients and Paycom along the way, and this aligns with how we run our business. And when you look at our guide, it's a very strong guide accelerating through the year with high EBITDA margins, and we feel this is better aligned with just how we run our business. Chad R. Richison -- Chairman, President, and Chief Executive Officer I'll take the renewals. We did see stability last year being that it was the exact same number that it was from the year previously. I will say, I mean, we had strengthened in that number as we move throughout the year -- as we move throughout the year, and we expect that to continue into this year. And yes, I mean, I would hope for stronger retention as we move throughout the year, I would every year. But I will say it was consistent last year with the year before. The next question is from the line of Samad Samana with Jefferies. You may proceed. Mason Marion -- Jefferies -- Analyst Hi, this is Mason Marion on for Samad. Thanks for taking our questions. I want to dig into guidance here a little bit. Can you provide some commentary on the building blocks you're embedding within that 9% recurring and other guide? What are you expecting from a macro standpoint? And then any commentary around like pay per-control, price realization, or retention. Yeah. I mean, the 9% are recurring and other, and so that would be revenue ex interest, right? And so, we've now broken out what our interest is. And so, that would be us onboarding new business clients at higher rates as we've continued to do, higher revenue rates, and that will impact us as we move throughout the year. So, no new components or assumptions go into that calculation for us. Craig E. Boelte -- Chief Financial Officer Yeah. And I would say kind of consistent with how we've always done guidance. I mean, we don't count on the macro either positive or negatively impacting us during the year. Mason Marion -- Jefferies -- Analyst OK. That is helpful. And then it seems like the CRR team improved performance throughout the back half of '24. What are your expectations for this team as we move into '25 in the context of your guidance? Chad R. Richison -- Chairman, President, and Chief Executive Officer We're all focused on client satisfaction. We're focused on making sure our clients are getting the ROI in the service that can be delivered to them. So, that's what our entire organization is doing. CRRs help with that definitely. And when able, definitely, they are upselling clients' products that they need. And so, it's a group effort across the board. I'm very happy with what our group did this year again, we saw continued strength into the back half of the year. That's continuing as we start off the year now. And so, for us, it's just focusing on doing the right things for the right reasons. Operator The next question comes from the line of Mark Marcon with Baird. You may proceed. Mark Marcon -- Analyst Hey, good afternoon, and thanks for taking my questions. Craig, it's been a pleasure working with you. Congratulations on a great career, and Bob, look forward to working with you. With regards to the revenue performance that you ended up having throughout the year, could you compare and contrast that relative to the total client growth? Because the client growth was a little bit on the lower side. Obviously, you've been moving toward bigger clients, but I'm wondering if you can fill in some of the gaps because it also looks like you're probably selling more modules. I'm wondering what's going on with pricing. I mean how does the module build factor into next year? So, that's the first question. And then the second question has to do with the margin improvement. It was really nice to see, particularly in terms of gross margins, how are you thinking about the balance between gross margin improvement versus sales and marketing, R&D, and G&A as part of your guide? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah. I mean, sales and marketing has done well all year. We did call out some of our largest month of sales ever. Actually, this January, the month we just finished was our largest sales month. I mean, blew out any previous sales month. None of those deals have started. Throughout the year, I did talk about increasing new unit growth for new business sales, which we had. But also, I would say we haven't been selling as many maybe small businesses, as we did. We ramped up that group during COVID. It's a smaller group now. So, we might be losing $0.40 out of our pocket, but we replaced it with $2 bills. So, there's a little bit of that going on in client mix. I know Craig did mention on the call that clients above 1,000 employees grew. That market grew 12%. So, there's a little bit of that of where our focus is. We do have the most automated solution. We're having a lot of success with that out in the field. Our sales reps are having a lot of success. That's why we've opened up three new offices. And so, I would say that we've had a very strong growth year, and you're going to see that continue as we move into next year. Yeah. I would say on the margin side, I mean, some of the things that impacted the gross margin kind of the back half of this year was that new building that came online. We had additional depreciation on that, as well as the cost of opening a new building. Eventually, we'll grow into that. And that will start to improve on those margins. And then kind of throughout, we mentioned we're continuing to invest in R&D. And then those other line items, we continue to look for efficiencies throughout. Operator The next question comes from the line of Kevin McVeigh with UBS. You may proceed. Kevin McVeigh -- Analyst Great. Thank you so much and let me add my congratulations, Craig, it has been great working with you. In terms of the new office openings, is there any way to think about how those should scale over the course of '25 into '26? I know, Chad, you have a pretty deliberate approach in terms of staffing, and then as they scale, just anything to help us dimensionalize how they should kind of scale and maybe what's factored into the guidance? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah. It takes 24 months for those offices to be fully staffed with the backlog pipeline. So, those offices will carry a full team quota beginning first quarter 2027. This year, they will contribute to revenue in a smaller capacity because they're just now selling, and so those deals have to start. But as we move throughout 2026 and beyond, obviously, they'll have a more meaningful impact on that. Kevin McVeigh -- Analyst OK. Great. And then just it sounds like, Chad, the retention improved over the course of the year. Was that kind of just the runoff of anything Beti-related or the mixed effect of larger clients? And any way to think about like what retention levels are embedded in the '25 guidance? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah. I mean, Beti improves retention. And so, I would say that the more usage that our clients get out of our system to where they're getting the full ROI out of it. That helps us. And it's not just Beti, a differentiated strategy also allows us to win clients back a lot faster. I mean, we've got clients that leave one payroll, they're right back with us. And so, that helps as well. But I would say it's all of the technology that we're bringing into the market right now through automation. Beti obviously being a big part of that, that's really helping us win deals. Operator The next question comes from the line of Steve Enders with Citi. You may proceed. Steve Enders -- Analyst OK, great. Thanks for taking the questions here. I guess maybe just to start, just want to get a better sense for maybe what drove the upside here in Q4. What drove the revenue strength? And I guess, maybe how should we think about the puts and takes between the strength here versus what might impact Q1. Craig E. Boelte -- Chief Financial Officer Yeah. I would say Q4, as we go into Q4, it's usually the hardest to really predict in terms of unscheduled runs and things like that. And I would say those came in strong. And so, overall, there was strength in the quarter, as well as good starts in Q4 as it relates to new clients coming on board. Steve Enders -- Analyst OK. Thanks. And then on the booking strength that you've been seeing lately, I know there's been a lot of changes in the go-to-market over the past year, a year plus. I guess, what do you feel like is working right now? What's resonating? And then I guess maybe where do you feel like there still are some areas where you can see improvements or some incremental things that you can improve upon? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah. And so, I would say what's working is the fact that we have the most automated product in the industry and people want to do less these days. Like I said before, 20 years ago, I sold our product because people wanted to do more with it. Today, you sell the product because they wanted to do things for them and it's automated. And so, that's where we're having our most strengths going out there talking about those things and obviously delivering the ROI that's available to our clients. And we have our entire company focused on client satisfaction. That's pretty important. Our clients are the reasons why we're here. And so, we're all focused on that as well. It's hard for me as I look at 2024 to see any area where we weren't successful in our initiatives. So, we continue on with that as we go into 2025 and beyond. Operator The next question comes from the line of Jason Celino with KeyBanc Capital Markets. You may proceed. Jason Celino -- Analyst Great. Thanks. Craig, it's been an absolute pleasure. I hope retirement with the grandkids and the wheat farming goes well. My first question on the sales offices. Can you just remind us when the last time you opened sales offices, I think it's been a few years and I think you typically only open them when you find the leadership bench to be ready, but certainly a good sign. Maybe the internal macro, your views influence the decision to expand at all. Or is it just typical planning? Thanks. Chad R. Richison -- Chairman, President, and Chief Executive Officer No. I mean it's probably been a couple of years, I would say, since we opened our last office. I want to say -- James is looking it up, but I want to say it may have been first of 2023 or end of 2022. But for us, that's internal, I mean we only have 5% of the market right now as a company. So, the demand is there. You want to make sure that you have 100% success every time you open an office, which we have. And that's really dependent upon the manager that you put in there. And then we've obviously got a backfill that manager with a rep that's ready to be manager. So, we do those things when it makes sense to us, and we have the bench strength to do it. I would say we were better at opening up offices this year than what we've been in the past, meaning we opened up the office and already had reps ready to go in them and already trained and identified. So, I would say that these offices, I would expect to have more success earlier maybe than what we've had in the past. A lot of that is due to the way we've made changes to our training and I wouldn't necessarily say we changed our go-to market. I would just say we changed the way we are prepared to go at it. And that's been very successful. You have a very strong successful sales and marketing program. That's coupled with the strongest product out there in the industry with good messaging and we're having a lot of success there. Jason Celino -- Analyst OK. And then just my quick follow-up. I don't know if this was part of Steve's last question, but I guess, what did you see in terms of workforce levels in Q4? Just one of your competitors mentioned some weakness, but obviously, you had a strong quarter. And then, I guess, what are you baking in, in terms of workforce expectations for the 2025 guide? Thanks. Chad R. Richison -- Chairman, President, and Chief Executive Officer Just stability. I mean, I can't say we saw anything unique in Q4, and we're not -- we don't have anything forecasted for anything unique going into 2025 as far as macro employment changes. Operator The next question is from the line of Jared Levine with TD Cowen. You may proceed. Jared Levine -- Analyst Can you discuss your thoughts on additional sales offices over the rest of the year? Is that contemplated in the guide currently? Chad R. Richison -- Chairman, President, and Chief Executive Officer I mean we don't disclose -- any offices we would plan to open this year would be already in our guidance, but we haven't disclosed what our plans would be as we move through the year to open up additional offices. Jared Levine -- Analyst Got it. And then for my follow-up here, can you disclose what the 4Q revenue benefit was from that pull forward of that extra payroll processing day from 1Q? Chad R. Richison -- Chairman, President, and Chief Executive Officer There are always calendar issues within a year or a quarter. And if you're able to look at it on a weekly basis or even longer normalized basis, you're going to see the strength that we had in the back half of 2024 continues into 2025 and actually accelerates as we move throughout the year. The next question is from the line of Bhavin Shah with Deutsche Bank. You may proceed. Bhavin Shah -- Analyst Great, thanks for taking my question. Bob, I appreciate kind of the change in guidance philosophy, but kind of taking your commentary around the full year for recurring revenue with 1Q at the low point and then double digit thereafter. I guess it's like 6%-ish recurring revenue growth for 1Q. Am I in the right ballpark there? And kind of if so, what are the factors impacting 1Q? Is it just a calendar timing issue? Or is there anything else? Thanks so much. Bob Foster -- Incoming Chief Financial Officer Yeah. Thanks for the question. Yes, we're not -- we don't comment on the quarter since we've changed our guidance. There are a couple of things that we'll talk about shape the quarter. The year-end forms filings don't grow as fast as our core business and there's a little interest headwind because we were up 30% last year in interest and will be down 11-or-so-percent in the first quarter. Bhavin Shah -- Analyst That's helpful there. And then just kind of following up on the EBITDA guide for '25, just given what you're seeing on the flip side, it's very healthy. Where are you seeing the efficiencies, is it across the board? Are there certain areas where you're kind of being able to leverage AI or anything else to really provide a lot more productivity within your sales force? Chad R. Richison -- Chairman, President, and Chief Executive Officer Well, first, I appreciate you appreciating adjusted EBITDA. When you start a company with 13 credit cards and an SBA loan, profit kind of matters and being efficient and actually having high-quality revenue that produces income. Those are pretty important. So, we focused on that. And we're getting a lot of benefit through automation. Obviously, we're getting benefit through our sales department going out and selling good deals, fair deals. And then we're also having success through automation on the back end. And that's something that's been -- when I look at our company, I mean, the only thing I'm really trying to fix on it right now is the valuation. I mean, it's difficult. We're seeing somebody that -- companies that started two years before us, our closest comps comparables, I would say. And as I do my calculation into what our growth and adjusted EBITDA is into next year and I look at theirs, it will take them over a decade to catch us in revenue, 12 years to be exact, and almost three decades to catch us in adjusted EBITDA. So, I'm glad that people do appreciate high-quality revenue. We've grown our business organically, and we do have a focus on full automation of our system. And as we move into the future, I do believe that's going to put us in the area of being the highest margin company in our industry, I think we're second now with our current guide. And I also expect that our growth will continue to be strong because again, we've got the best sales force out there. We have the best product, and we have got consistent retention with our client base. The next question comes from the line of Daniel Jester with BMO Capital Markets. You may proceed. Daniel Jester -- Analyst Great. Thanks for taking my question. I know you don't comment too much on the product roadmap, but philosophically, we've been talking about Beti for a few years. I think GONE has been -- you announced that in late 2023. So, as I think about 2025, does your guidance or does the playbook assume that you're going to be launching new products? Or maybe just any sort of guidance in terms of thinking about the road map and the direction on the product side would be helpful. Thank you. Chad R. Richison -- Chairman, President, and Chief Executive Officer Well, I will tell you that there's not a moment that I'm awake and probably half the times I'm asleep that I'm not thinking about our product and how can we make it better and how can we enhance it. And so, I took over the product back again in November of last year. I've worked very closely with that group. We're doing very well over there. We've got a lot of initiatives in flight right now all around automation of our product. Again, I think that any time that you can automate human interaction safely, you want to be able to do that. You can't do that everywhere, yet, but I do think that there's all those opportunities. And so, we've been focused on that. I believe that we've led that charge more than anybody else. And I think you'll continue to see that momentum continue into this year. And absolutely, there will be product announcements in 2025. Daniel Jester -- Analyst Great. I appreciate that. And sorry if I missed this, but on the $110 million of interest income this year. Did you share what your expectations were with regards to interest rates or average daily balance to get that number? Thank you. Craig E. Boelte -- Chief Financial Officer No, I would say on the -- I mean, on the interest rates, I mean, we kind of look at the Fed funds rate. And so, we're looking at something in that range, and then we baked in a couple of potential rate cuts in the middle of the year and then one toward the end of the year for 2025. Operator The next question comes from the line of Michael Funk with Bank of America. You may proceed. Michael Funk -- Analyst Yeah. Thank you for the questions tonight. First one, competitive environment. I'd love to get your thoughts on the Paychex acquisition of Paycor and what that means for the industry and kind of more broadly to the overall competitive environment. No. I would say no changes in our view to competitive environment. It's always been a competitive field in our industry. I think when you have a lot of competition, the client wins. I think we're all trying to differentiate. And I believe that our plan is very strong in that. But no, you've had different times, companies consolidate and combine together. And I mean I'll let them talk for themselves on that. Michael Funk -- Analyst OK. And then I think earlier, you mentioned that you think about product every minute being awake, half time being asleep. How do you think about the longer-term evolution of pricing in the industry as automation becomes more part of the product AI become more part of the product, how do you see pricing evolving over time? Chad R. Richison -- Chairman, President, and Chief Executive Officer Well, pricing has evolved from value received from a client. You don't really just set a price. How much value is something truly creating for someone and then you hope to be able to share in that as time goes forward? So, as time goes on. So, I would say for us, we look at that, how can we create value for a client? How can we help them? What in their business can we automate fully so that it removes their efforts, exposure and labor costs in many cases in order to get that same result? And so, that's really what we focus on. And absolutely, our product road map does include things that drive additional value in very large ways. I will say this, clients who utilize our product correctly today realize a lot of that full value. So, it would just be an extension on top of that. Operator The next question comes from the line of Joshua Reilly with Needham. You may proceed. Joshua Reilly -- Analyst Yeah, thanks for taking my taking my questions. Can we get some updated commentary -- well, I guess, some maybe just initial commentary on how client retention trended here in January and February relative to your expectations exiting the year? And any thoughts around the 90% revenue retention and the puts and takes investors should be considering for that figure here in 2025, given that it seems like you've kind of bled off some more of those smaller, lower-value customers from the metric and how that's calculated? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah. I mean, I'll remind again that retention, we report retention once a year. We did report it this year, and it was 90%, consistent with the prior year. I also believe that as more and more businesses receive the benefit of automation and as we head toward full automation, that we would expect to be able to do better in retention on a go forward. We haven't been guided to a retention number, but we're very pleased with how we finished the year, and we see strong trends continuing so far this year. As I mentioned, January, even from the sales side was our largest book sales month by far, and not any of those businesses have started yet. So, we're really excited about what the rest of the year looks like for us. Joshua Reilly -- Analyst Got it. That's super helpful. And then if you look at the EBITDA guidance of 41% margin, how do we think about how much of the R&D being expensed versus capitalized in 2025? Is there an impact there on the margin? And should we kind of think about the 11.5% non-GAAP as a percent of revenue for R&D consistent again in 2025? Thanks, guys. Craig E. Boelte -- Chief Financial Officer Yeah. I mean we didn't really make anything different than what we saw this year in terms of the capitalization rate on R&D. As a reminder, it's really the projects we're working on as to whether it's capitalized or expensed, but really no change from 2024 as it relates to the rate. Operator Next question comes from the line of Jake Roberge with William Blair. You may proceed. Jake Roberge -- Analyst Yeah. Thanks for taking the questions. You've referenced that really strong January a few times. Curious, what drove that. Is that all kind of internal execution and just sales teams being a little bit more focused here after noisy few years? Or are you also kind of starting to see HR budgets open up kind of post-election? Chad R. Richison -- Chairman, President, and Chief Executive Officer I mean I would say that's internal to Paycom as far as what happened in the first quarter. I've been talking about increased sales. I've been talking about strength of our sales group. We're stronger in January. We're stronger in February than we were anytime last year. And we had record-breaking months last year, too. And now we're at a point where we've even opened up three more offices. So, really, I would just say that's the preparation of what we did last year to get prepared as we move through this year and then having success, success kind of breeds more success, and that's really what's happening for us right now. No, I was just saying that that was made possible due to our product. They're doing a great job selling the product and clients know their value. Jake Roberge -- Analyst Helpful. And then I know of the priorities in '24 was just getting a lot of the product that you already sold live rather than just sitting on the shelf. Curious how that kind of trended in Q4. And then will there be any new priorities for the CRR team moving forward? Chad R. Richison -- Chairman, President, and Chief Executive Officer Yeah, the CRR priorities are the same as all of our company's priorities and that's focused on client satisfaction. Everyone at the company regardless of your job, that's what we're here for, that's what we're doing, but CRRs have definitely helped with that. When able, CRRs continue to sell clients products that make sense for them and expand their ROI case, so that they can get full value of the software, and they're continuing to do that now. Operator The next question is from the line of Siti Panigrahi with Mizuho. You may proceed. Unknown speaker -- -- Analyst Hey, this is Phil on for Siti. I just wanted to ask, are there any updates to your strategy on the international front? I know you guys live in four countries, but are there plans to add more countries over the next couple of years? Chad R. Richison -- Chairman, President, and Chief Executive Officer We continue to build out our international strategy. We also have our global HCM product that all clients internationally use. And then we have built out for other countries. We continue to work with clients as we move into other countries and identify which are the ones to move into, as well as we've developed certain things within our product that allow us to connect to other partners to help fulfill certain needs. The next question is from the line of Zachary Gunn with FT Partners. You may proceed. Zachary Gunn -- Analyst Hey, there, thanks for taking my question. I just wanted to ask on the EBITDA margin. So, I think fourth quarter here exiting was 43%, 44%. And the guide for the full year is 41% similar to where it was this year. I'm just trying to understand what the mechanics are of that delta between your exit rate this quarter versus what you're expecting for full year next year. Bob Foster -- Incoming Chief Financial Officer Yeah. Thanks. We guide to what we can see, and we usually start out with a lower EBITDA margin at the beginning of the year as we accelerate through to the rest of the year. Craig E. Boelte -- Chief Financial Officer Typically, the first quarter of the year, as well as the fourth quarter are going to be the largest EBITDA margins because of the forms filings in the first quarter and then the unscheduled in the fourth quarter. And as we mentioned, this is one of the highest starting EBITDA guides we've had in the history of the company. This concludes the question-and-answer portion of today's call. I will now turn the call back over to Mr. Chad Richison for closing remarks. Chad R. Richison -- Chairman, President, and Chief Executive Officer Well, I want to thank everyone for joining our call today. I want to congratulate the 2024 Paycom Jim Thorpe Award winner, Jahdae Barron from the University of Texas. This award recognizes the most outstanding defensive back in college football and also memorializes one of the greatest all-around athletes in history and a fellow Oklahoman Jim Thorpe. Bob and James will be on the road meeting with investors this quarter, including hosting meetings at the KeyBanc and Morgan Stanley conferences in San Francisco in March. I'd like to thank all of our employees for their contribution to Paycom's success. Much of our success over the last 20 years was due to the financial stewardship and leadership of Craig Boelte. He helped to build a high-growth and profitable business that many others have tried to emulate. I'm thankful for his contributions, and I'm excited for him to get to enjoy working on his farm and playing with his grandkids. Craig's career achievements will forever stand as an example of what can be achieved with hard work and grit. With that, I'm going to hand the call over to Craig to close us out for the last time. Craig E. Boelte -- Chief Financial Officer Thanks, Chad. First, I'd like to say thank you for asking me to join you in this amazing company over 20 years ago. Together, we accomplished a tremendous amount in working at Paycom has been the most rewarding and fulfilling experience in my career. I will miss walking the halls and collaborating with the talented people who make Paycom so great. I've made lifelong friends during my time here. I am Paycom's biggest fan and as one of its largest shareholders, I'm confident I'm leaving the company in very capable hands, and I know this company will continue to do great things. With that said, operator, you may end the call.

Upwork (UPWK) Q4 2024 Earnings Call Transcript | The Motley Fool

Good day, and thank you for standing by. Welcome to the Upwork fourth quarter and full year 2024 earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Samuel Meehan, vice president of investor relations. Thank you, and welcome to Upwork's discussion of its fourth quarter and full year 2024 financial results. Joining me today are: Hayden Brown, Upwork's president and chief executive officer; and Erica Gessert, Upwork's chief financial officer. Following management's prepared remarks, they will be happy to take your questions. But first, I'll review the safe harbor statement. During this call, we may make statements related to our business that are forward-looking statements under federal securities laws. Forward-looking statements include all statements other than statements of historical fact. These statements are not guarantees of future performance, but rather are subject to a variety of risks, uncertainties and assumptions. Our actual results could differ materially from expectations reflected in any forward-looking statements. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings available on the SEC website and on our investor relations website, as well as the risks and other important factors discussed in today's earnings press release. Additional information will also be set forth in our annual report on Form 10-K for the year ended December 31st, 2024, when filed. In addition, reference will be made to certain non-GAAP financial measures. Information regarding non-GAAP financial measures, including reconciliations to their most directly comparable GAAP financial measures can be found in the press release that was issued this afternoon on our investor relations website at investors.upwork.com. Unless otherwise noted, reported figures are rounded, comparisons of the fourth quarter of 2024 are to the fourth quarter of 2023 and comparisons of the full year 2024 are to the full year 2023. Adjusted EBITDA, adjusted EBITDA margin and free cash flow are non-GAAP financial measures and all other financial measures are GAAP unless cited as non-GAAP. Now I'll turn the call over to Hayden. Hayden Brown -- President and Chief Executive Officer Good afternoon, and welcome to Upwork's fourth quarter and full year 2024 earnings call. Upwork had a record year in 2024 with all-time highs for full year revenue, adjusted EBITDA and adjusted EBITDA margin. The strategic foundation for Upwork has never been stronger nor more timely. As the AI work type builds, organizations of all sizes are seeking out more flexible talent models that match their needs for new and emerging skills with partners who integrate cutting-edge AI technology and valued human workers seamlessly and at scale to rapidly deliver on their priorities. At the same time, professionals across geographies, specialties and industries want digitally powered ways of working that give them easy access to more autonomy, flexibility and earning power. Upwork is uniquely positioned to capitalize on these massive work trends. We are delivering new and exciting ways for businesses to access the expert global talent and work outcomes they need and for highly skilled professionals to find lucrative work opportunities and grow their independent careers. Last year was a year of transformation for Upwork. We achieved a record performance in the face of a challenging macroeconomic environment. We optimized the organization to increase efficiency and execution velocity, creating a leaner, more agile company that is moving faster and operating more profitably than ever before. We gained market share and substantially outperformed the incumbent staffing industry, a testament to the inherent advantages of our business model, the resilience of our platform and Upwork's industry-leading innovation and scale. We grew revenue 12% year over year in 2024, compared to an estimated 9% in year-over-year decline in the broader staffing industry. This was the sixth consecutive year of double-digit growth outperformance for Upwork compared to the staffing industry, and we expect the strategic moves we made in 2024 to fuel our continued industry outperformance this year. 2025 will be a year of accelerated execution around our focused portfolio of growth catalysts. AI, enterprise, and ads and monetization. I'll discuss each of these catalysts and how they load the spring for 2026, setting us up for long-term success. First, AI. We've rapidly unlocked demand for AI-related work on our platform. GSV from AI-related work grew 60% year over year in 2024, lifted by subsets of AI work like prompt engineering, which was up 93% year over year in the fourth quarter. AI-related work is substantially higher paying with freelancers working on AI-related projects, earning 44% more per hour than those working on non AI-related projects across the platform in 2024. And a number of Upwork clients engaging in AI-related projects grew 42% year over year in 2024, an encouraging signal about the ability of our model and the talent on Upwork to continuously address critical skill gaps and business needs at the most advanced technology frontiers. We're also leveraging AI on our platform to underpin the evolution of predictive and delightful conversational customer experiences. In 2024, we improved customer productivity, engagement and work outcomes with Uma, Upwork's Mindful AI. For example, more than 70% of new clients are opting into using our Uma-powered job post generator and its use is increasing job post activity, job post quality and job fill rates. For example, our high-value jobs from new clients are filling at an 8% higher rate since the introduction of Uma. We added additional capabilities to Uma over the course of 2024 such as proposal writing for talent which lifted bid volumes by 2.5%. Our fourth quarter acquisition of objective AI and AI-native search as a service company is already enhancing our search and match results helping us end the year with all-time high fill rates. As we accelerate execution of our AI road map in 2025, Uma and our other AI innovations will continue to drive our flywheel with even better matching experiences, more productivity for customers and higher quality work outcomes. Second, enterprise. In Q4, we outperformed our enterprise targets, which was one of the main reasons for our overperformance in the quarter compared to our overall revenue guidance. We saw increased engagement from retained customers in the quarter with GSV per active enterprise account growing year over year for the first time in recent quarters. Managed services revenue also grew 12% year over year in 2024, reflecting increasing demand for delivery of fully managed work outcomes among some of our largest clients. Overall, enterprise was a $107 million business for us in 2024, growing 4% year over year against an incredibly challenging macroeconomic environment in which enterprise companies were trimming budgets across the board. We have taken further steps to capture the enterprise opportunity with the announcement of Upwork Business Plus in October. Business Plus is a premium plan that provides a smoother glide path for larger clients and is closing the gap between our current marketplace and enterprise offerings. The launch of Business Plus is unlocking a higher velocity approach to the enterprise market with both sales and self-service channels working in tandem to activate and retain high-value clients. We acquired over 1,000 active users of Business Plus since launch and are seeing higher conversion rates of clients using Business Plus, moving from registration to job post and registration to project start when compared to our overall marketplace clients. Business Plus is just one of multiple expansion opportunities underway for us to take increased wallet share in enterprise, including ongoing product work and integrations with several partners as we pursue new growth opportunities. Finally, our ads and monetization business continued to provide a substantive revenue tailwind while enhancing marketplace quality, efficiency and take rate. Ads and monetization of revenue grew 51% year over year in 2024 with Freelancer Plus revenue increasing 58% year over year as we further augmented the value of that subscription package for talent. We continue to introduce new ads and monetization products and capabilities and make our existing options more effective for customers. We expect ads and monetization to drive continued take rate increases in 2025, albeit at a more modest pace as we let changes made in 2024 continue to settle and optimize current ads and monetization products. 2024 was a transformational year for Upwork as we injected for their discipline and agility into the business. 2025 will be marked by accelerated execution as we build on last year's progress, executing with the speed of a start-up and the scale of a market leader to deliver record profitability now and durable growth in the years ahead. This year, we intend to gain further market share from traditional staffing firms, leveraging our competitive edge as a source for the most in-demand talent, including those with AI skills and notching bigger wins for our enterprise business. We are investing in AI innovation to rapidly reimagine the way our business operates, every corner of our platform experience and how our customers achieve outcomes with our continued advances of Uma as an always-on work agent and integration of objective AI, AI first search technology, serving as prime examples. These accelerated priorities, combined with the inherent size, scale and yield advantages of our business, will allow us to continue to lead our category. As we build the future of human and AI-powered work, we are excited about the strategic plan we are rapidly executing to deliver a powerful combination of growth, profitability and shareholder value in the quarters and years ahead. With that, I'll turn the call over to our CFO, Erica Gessert. Erica Gessert -- Chief Financial Officer Thanks, Hayden. Upwork finished 2024 in a position of strength within a tough operating environment. Our pace of execution continues to accelerate. And despite the headwind environment over the past couple of years, our financial position has never been stronger. For the full year and the fourth quarter of 2024, we delivered record revenue and profitability, and our growing free cash flow profile and strong balance sheet give us tremendous flexibility, even as the operating environment for our industry remains challenging and unpredictable. The strong profitability characteristics of our marketplace model give us confidence that we will continue to increase margins and generate value for our customers and shareholders while investing in growth over the next few years. We have been building the growth levers Hayden just outlined to be catalysts for our business over the medium to long term. And when macroeconomic conditions improve, these catalysts will be additional growth drivers for us. As we head into 2025, our outlook reflects our caution with regard to the current macroeconomic environment. While some of the indicators we watch for our business, such as the JOLTS report and other macro data, showed signs of stabilization in Q4, they remain at multiyear lows. Historically, these indicators tend to have a six- to nine-month lag effect on our business. The current macro uncertainty makes us cautious about the outlook for 2025. But despite that, upward continues to perform well, and we are executing across every area of our business. Now on to our results. As I mentioned, we are ending the year with record high revenue and profitability. Our gross margin was 77.7% for Q4 and 77.4% for the full year 2024. Adjusted EBITDA margin was 26.2% for Q4 and 21.8% for the full year 2024, both all-time highs. Our adjusted EBITDA margins have expanded by 26 points in the last eight quarters, and we remain on track to hit our five-year 35% adjusted EBITDA margin target. Revenue grew 4% year over year to $191.5 million in the quarter and 12% for the full year to a record $769.3 million, above our previous guidance and driven by stronger-than-expected engagement from retained enterprise and marketplace clients. When normalized for the Sunday effect, Q4 revenue growth was 8% year over year. As a reminder, GSV and revenue growth rates were impacted by fewer Sundays in the fourth quarter in 2024 versus 2023. Excluding the Sunday effect, GSV declined 3.6% year over year in Q4, and has been relatively stable for three quarters now, following the top-of-funnel pressure we experienced in the second quarter. In Q4, we drove better-than-expected performance across both our marketplace and our enterprise business units. Fourth quarter marketplace revenue was $163.7 million, a 4% increase, compared to $157.5 million in the fourth quarter of 2023. And we continue to grow our enterprise business in a challenging market with total enterprise revenue increasing 5% year over year to $27.8 million in Q4 and 4% year over year to $107.2 million for the full year. As I mentioned last quarter, Business Plus is reported as marketplace revenue, and we expected our traditional Enterprise Plan deal number to decline in the fourth quarter as we shifted our focus to the growth of Business Plus and higher value, more strategic accounts. During the fourth quarter, we closed 21 traditional enterprise deals. Managed services revenue grew 8% year over year for the fourth quarter and 12% to $59.4 million for the full year, reflecting steady demand for outcome-based delivery of work and our focus on expanding share of wallet among our largest enterprise clients. Our active client base at the end of 2024 was 832,000 and reflecting top-of-funnel weakness experienced earlier in the year. Our average spend or GSV per active client showed continued strength in the fourth quarter, increasing sequentially across every business segment, the second consecutive quarter. We are very pleased with this progress, which is a reflection of the substantial customer experience improvements we've invested in over the past several quarters, including the launch of Uma and the AI enablement of our platform. Our marketplace take rate was 18.1% in Q4 2024, compared to 15.9% in the fourth quarter of 2023, driven by pricing improvements and continued growth in our ads and monetization business. In 2025, we expect more modest take rate accretion, driven by the ongoing growth in our ads and monetization businesses rather than wholesale pricing changes. We continue to focus on introducing new and innovative ways to bring value to our customers in our marketplace, and we expect to continue to launch new experiences that will drive meaningful take rate expansion in 2026 and beyond. Non-GAAP gross margin reached a record high of 78% as we continue to execute disciplined cost management across every part of our business. Non-GAAP operating expense was $102.7 million in the fourth quarter. For the full year, non-GAAP operating expense was $442.3 million or 57% of revenue, a 9-percentage-point improvement over 2023. This reflects our continued focus on cost management, and we expect to see additional cost savings in our operating expenses in 2025 as the actions taken at the end of last year flow through to our full year results. Adjusted EBITDA was $50.2 million in the fourth quarter, representing adjusted EBITDA margin of 26.2%. Adjusted EBITDA in the fourth quarter excludes the impact of a $19.2 million charge associated with the operational realignment that we announced in October. For the full year, adjusted EBITDA was a record $167.6 million and well ahead of our guidance range of $155 million to $159 million, reflecting our commitment to prudent cost management and profitable growth. In the coming years, we will continue to raise the bar on our yield expectations for this business. We reported GAAP net income of $147.2 million for the fourth quarter, which included a $140.3 million tax benefit due to a valuation allowance release. Excluding this benefit, we reported non-GAAP net income of $42.4 million for the fourth quarter. For the year, non-GAAP net income was $147.1 million, a historic high. Stock-based compensation of $68.4 million in 2024 declined 8% from the year prior and was well below our guidance of less than $20 million per quarter for the year. This decline is a result of the proactive steps we have taken to reduce stock-based compensation. These actions will have a lasting benefit on our recorded stock-based compensation and GAAP profitability. Free cash flow for the fourth quarter was $34.7 million, including the impact of restructuring-related charge of $17.1 million. Excluding this charge, free cash flow was $51.8 million, an all-time high. We generated $139.1 million in free cash flow in the full year, which we expect to strategically use to drive long-term shareholder value by supporting the development of our business and share buybacks in 2025. Cash, cash equivalents, and marketable securities were approximately $622 million at the end of the fourth quarter. Now turning to guidance. For the first quarter of 2025, we expect to produce revenue in the range of $186 million to $191 million. For adjusted EBITDA in the first quarter, we are guiding to a range of $46 million to $50 million, which represents an adjusted EBITDA margin of 25.5% at the midpoint of the range. Our disciplined execution in 2024 gives us high confidence that we will make strong and steady progress on our 35% margin goal over the next few years, while investing in important growth levers that will reignite top-line growth in our business. For the full year 2025, we anticipate revenue between $740 million and $760 million. We are investing in growth catalysts, including the continued AI enablement of our platform, the advancement of premium products like Business Plus and new strategies in enterprise and ad and monetization, which we expect to bear fruit in 2026. Our pace of execution and the multiple growth levers that we have give us confidence that we will resume revenue growth next year. Stock-based compensation is expected to be approximately $15 million per quarter in 2025, a significant reduction to 2024 levels. We reduced stock-based compensation in 2024 and our results for the full year were well below our guidance range, reflecting our disciplined approach to SBC and our reduction in force. We have taken proactive steps to adjust the balance between stock-based and cash compensation and this will result in beneficial trends on stock-based compensation going forward. As a result of our ongoing discipline and the strength of our business model, we expect our full year adjusted EBITDA will be in the range of $180 million to $190 million or 25% adjusted EBITDA margin at the midpoint. Our ability to meaningfully expand margins, even in a tough operating environment, reflects our commitment to profitability and driving shareholder value. We expect Q1 to be the high point for adjusted EBITDA margin in 2025 as we make some minor additional investments in growth levers throughout the year. We expect full year 2025 non-GAAP diluted EPS to be between $1.05 and $1.10, up from our 2024 results. For the full year, we expect weighted average shares outstanding between 138 million to 142 million, excluding any potential impacts from stock repurchases. A bit more on our share count outlook as it relates to our repurchase authorization and capital allocation strategy. Given the durable profitability and strong cash generation of our business, we have a capital allocation strategy in place that is intended to fully offset dilution from stock-based compensation through stock repurchases. And with continued confidence in our ability to execute on our long-term plan, we intend to opportunistically utilize share repurchases to reduce our total share count over time. I'll close by saying that we are excited about the opportunities for this business, and we are very proud of our ability to execute strongly in this challenging environment. 2024 was a record year for Upwork in terms of revenue, GAAP net income and adjusted EBITDA. We ended the year with all-time high adjusted EBITDA margins, and we are well on our way to our 35% adjusted EBITDA margin target. We have been hyper-focused on cost discipline and have successfully taken the opportunity to expand our profitability. We delivered growth well in excess of traditional staffing firms, and we continue to take market share from them. Looking ahead, we are investing in the right growth levers that we expect will pay off in accelerated GSV and revenue growth with an even greater velocity with the macro headwinds subside. As always, I want to close by thanking our incredible team at Upwork for their contributions this quarter and their unparalleled creativity, focus and pace of execution. With that, we'd be happy to take your questions. Operator Thank you. [Operator instructions] Our first question will come from the line of Maria Ripps from Canaccord. Your line is open. Maria Ripps -- Analyst Great, thanks so much for taking my questions. First, just in terms of your revenue guidance, it looks like your full year outlook implies modestly higher revenue declines after Q1. Can you maybe just talk about some of the dynamics driving that? Erica Gessert -- Chief Financial Officer Yeah. Sure, Maria. Thanks for the question. Obviously, 2024 was a really record year for us with huge all-time highs in revenue, adjusted EBITDA. But as we know, we as a business have encountered cumulative years of macro headwinds. And right now, as we enter 2025, I'd say that the dynamics on the top of the funnel haven't really changed, unfortunately. It's important to note, of course, also that there's a six- to nine-month lag in our business when the macro starts to change. So there's a lot of uncertainty out there, and we're -- our 2025 guidance reflects that. Maria Ripps -- Analyst Got it. That's helpful. And then, secondly, appreciate all the detail on Uma and -- but can you maybe share a little bit more color on AI and impact on your business, especially kind of in light of the recent industry developments? And I guess, what are some of the building blocks to perhaps accelerate AI-related GSV spend on the platform from 60% you reported last year? Hayden Brown -- President and Chief Executive Officer Sure, Maria. We are really excited about the advancements in AI and all of the new technology that's coming forward at such an incredible pace because we see that Upwork really benefits from this broader AI trends. Our platform is infinitely flexible and what we've seen is that it takes shift to whatever customer demand for work looks like including whatever combination of humans and technology are working together to deliver great outcomes for customers. In the past, we've seen Upwork shape shift very naturally and rapidly as work itself has evolved. So if you look back to the early 2000s, we had no social media managers or marketers then. Before the launch of the iPhone, there were very few mobile developers on our platform. But those roles and categories of today are thriving on our platform because Upwork grew rapidly when customer demand appeared. So what we're seeing today is a similar shape shifting as AI is evolving with the talent mix on Upwork really being remade before -- as AI skills are emerging. This is evident from the GSV that we saw in profit sharing grow 92% in Q4, the AI-related work growing 60% year over year in 2024, and this shift is really happening across not just the AI categories themselves we report on, but also in all 125 categories and 10,000 skill areas where workers are really adopting these new technologies and improving their value proposition to customers, delivering better, faster and more compelling work to customers at the rate of these technology changes. So this is a very positive trend for us. We're clearly benefiting already, and we are excited about this unlocks even as we ourselves are innovating on our own platform with the launch of Uma and the AI capabilities that Uma has that were advanced over 2024 and coming forward even more in 2025. So this is a fun and exciting thematic for us. Maria Ripps -- Analyst Great. Thank you, Hayden. Thank you, Erica. And that's very helpful. One moment for our next question. Our next question will come from the line of Andrew Boone from Citizens. Your line is open. Andrew Boone -- Analyst Thanks so much for taking my questions. I wanted to go to marketplace take rates. There was a sequential decline from 3Q to 4Q. Can you guys just help explain that? And then, talk about the trajectory of marketplace take rates as we think about 2025. Is there any reason to think that that would step down again? Or should we see more stability there? And then, thinking more broadly about Uma and the potential to improve liquidity on the platform, can you just speak to that? What does AI unlock as you basically improve the contextualization of matching freelancers to demand? Thanks so much. Erica Gessert -- Chief Financial Officer Hey, Andrew, I'll take the take rate question first. Yes, when we reported Q3 results, we actually did give an indication that we'd be doing some testing in Q4 that they could kind of have some effect on the sequential take rate accretion, but that's onetime in nature. We've been running some of this on the platform and we fully expect take rate to continue to grow as we go into 2025. That'd be it, albeit at a much more modest rate than, of course, the 260 basis points that we saw in 2024. We do -- take rate overall, we have a lot of headroom to go but the strategies that we do within for take rate take time to test and to learn and to release on the platform. So 2025 should be sort of a modest year, but we fully expect that some of the kind of promising take rate strategies that we've got that we're in development right now, we'll be ready to launch in kind of late 2025 and early 2026. Hayden Brown -- President and Chief Executive Officer Andrew, on the side of Uma and what it unlocks through better matching, let me give you a little color there. So our ability to invest into the AI thematic and launch AI work companion Uma last year in April and then enhanced the capabilities over the course of the year, including with our October release, is a big differentiator. The way it attracts and really drive better matching on the platform is, as an example, when we launched Uma capabilities with the job post generator, we've seen tremendous adoption of that. More than 70% of new clients are using the Uma power job post generator, which is then turning into more job posts per client, is turning to more job post quality, so better quality post coming into our marketplace and is increasing our fill rates. Matching specifically and fill rates specifically are moving because of things like the quality of the post that are being written. And on the other side of the equation, freelancers who have adopted Uma with the proposal writing capability are actually bidding at a higher rate. So their bid volumes are up 2.5%. So in the first phase of this work, we've basically been enhancing core matching components of our ecosystem with Uma capabilities. We're seeing the adoption. We are seeing that translate into gains on things like 80% of our -- 80% higher fill rates on our highest value jobs for new clients, which is again another great outcome of this. In the second phase of work, what you're going to see from us is Uma, the work companion, evolving much more into a fully blown AI agent. And that's where Uma will be able to take on even more tasks and work from our customers that they can offload to Uma to execute more for Upwork. But we're already seeing the wins from the first phases of this work and are excited about how we are accelerating that with the acquisition we made last year and with the road map that we have ahead. One moment for our next question. Next question will come from the line of Bernie McTernan from Needham. Your line is open. Stefanos Crist -- Analyst Hi. This is Stefanos Crist calling in for Bernie. Just wanted to ask on the $60 million of cost savings. I think they were announced mid-Q4, so it should be more room in '25. What areas can we expect to see those? And then, you also mentioned some minor investments to '25. Can you also just provide some more color there? Thank you. Erica Gessert -- Chief Financial Officer Yeah, sure. When we announced the cost reductions in October of last year, we outline them -- they were sort of across our business. We really took several quarters to think through the cost reductions that we made and is really an operational realignment of the business. The places that we're focused were on the enterprise business and kind of the new bifurcated strategy that we've got, focusing on our largest enterprise accounts for acquisition and then launching Business Plus in the marketplace, which, of course, opened up part -- some of the enterprise value prop to our marketplace customers. So that has greatly reduced both our cost to acquire and our cost of serve on the enterprise side. And then, we did also rationalize our R&D portfolio and really take a much more focused approach to R&D. G&A has relatively lesser benefits on a year-over-year basis than those two categories. However, we do see longer -- kind of longer-term opportunities in G&A as well. And what was the second question? Oh, minor investments in 2025? OK. In terms of the investments in 2025, this is really the three kind of growth catalysts that -- investment areas that Hayden outlined on the call. We're very, very focused on additional investments in AI enabler of the platform and in the advancement of our enterprise strategy. So some minor investment there. But these are relatively minimal and we'll just have a little bit kind of slightly lower margin in Q2 and Q3 versus Q1. One moment for our next question. Our next question will come from the line of Brad Erickson from RBC Capital Markets. Your line is open. Brad Erickson -- Analyst Hi, Thanks for taking the questions. First for Erica. I guess, with the GSV declines you've been seeing lately, obviously, you mentioned kind of no changes to the top-of-the-funnel headwind. There's a lot of what's behind that. But maybe speak to things that might be in your control for trying to get that GSV back to growth versus what's out of your control. And then, second for Hayden. You guys are talking about contemplating, call it, other products and services that could expand take rate over time. I wonder if you just could expand on that a bit. Obviously, we have ads and managed services and then the newer launches like Business Plus. Just curious to learn maybe a bit more about some of the adjacencies where you see opportunities for that as a driver? Thanks. Erica Gessert -- Chief Financial Officer Yeah, Brad, thanks for the question. In terms of GSV trends, we are seeing some ongoing capital funnel weakness that kind of we highlighted last year coming into 2025, and that gives us some caution on our outlook. Now that said, we have some very positive signals in our retained client base. In our enterprise customers, Q4 saw increased engagement. GSV for active enterprise increased 2% year over year in the quarter, and that's after multiple quarters of negative growth. We also saw our overall retained client base grew 9% year over year in Q4. And also, as I highlighted, GSV per active client increased across all business segments in the quarter for the second quarter in a row. So we are really pleased with some of the dynamics we're seeing under the covers there. And in terms of what we can control, we've outlined the kind of strategic investments we're making. I would add to that that in terms of our asset monetization strategies, we have multiple take rate strategies that we can deploy, including some that are very GSV beneficial like the Business Plus strategy of launching this tapering accretive product with enhanced value proposition in the marketplace. And there's more to come there as we develop kind of new strategies, new tiers for this going into 2026. Hayden Brown -- President and Chief Executive Officer Sure. And on the product and services on the take rate area, we grew take rate 260 basis points in 2024 to an all-time high of 19.4%. So we feel good about the pace of our execution and expansion in this area and are taking, of course, a more measured approach this year but there is a big portfolio of opportunity here in a long runway. So some of the specific opportunities for us are around, first of all, subscriptions. We launched the Business Plus subscription last year. And today, we have basically one subscription plan on the marketplace upgrade side for clients and one on the Featured side. So there's more opportunity for us to both enhance those plans, the value props, continue to refine pricing of those plans and add more subscription tiers over time. And another big opportunity for us is around our current advertising products. Just in Q4, we launched some client-side advertising products for the first time that were new, and there's more things we can do because we have so much audience inside of our marketplace on both the client side and the advertising side. So there's more runway there as well. The final thing I'd mention is there are places where we can monetize kind of ad hoc value propositions and paid services, either offered by us or our third-party partners. We've done a little bit of experimentation with this to date, but certainly, it's not something that is mature at this time. And so, there's a runway of opportunity there. So when we look at all of this together, we feel great about what the opportunity is ahead, even though we are gonna be more in some of the development phase on some of these things in this year and take the opportunity for our customers to absorb some of the price changes we've made over the last one and a half years. One moment for our next question. The next question will come from the line of Josh Chan from UBS. Your line is open. Josh Chan -- Analyst Hi. Good afternoon. Thanks for taking my questions. I guess, on the enterprise side, it sounds like that things are turning a corner a bit there. So I was wondering if you could give a little bit more color on why you think you're seeing the improvements that you are? And kind of what's driving the improved trajectory there? Thank you. Hayden Brown -- President and Chief Executive Officer Sure, Josh. I'd say, we've been focusing more of our resources in the enterprise area on our top biggest clients where they're really looking to expand wallet share of these customers. That was part of the focus and reorganization work we did in Q4, and that is certainly paying off, which I would note is remarkable given the amount of change that the team absorbed in the fourth quarter. We've also seen just these kind of signifiers here in our managed services offering continue to really resonate with customers. It grew 12% year over year in the quarter. We saw higher year-end spend in the quarter in terms of customers kind of running through the end of the year wanting to spend more with us as the year was closing out. And then, we also saw one trend that was interesting. Our GSV per active enterprise account actually did grow on a year-on-year basis for the first time in recent quarters. So we feel good about where this business is as we enter this year, building on that momentum and the Business Plus side of things where, again, there's a lot of activity happening, a lot of clients in the funnel. But again, this is kind of a year where we're building into these new strategies and we're really expecting a bigger growth for us in 2026 and beyond. Josh Chan -- Analyst Great. Thanks for the color there. And then, maybe one on margin. I guess, you achieved 26% margin in Q4 with not much help probably from the streamlining initiatives. So I guess, was there anything onetime in there? Or I guess, could there be some upside to what you're guiding for '25 because of the slowing through of the cost savings in '25? Thanks for the color. Erica Gessert -- Chief Financial Officer Thanks, Josh. No. So in Q4, yeah, I mean, we did -- we actually executed a little bit faster than we expected to in some of the cost savings in Q4 to get to that 26% margin. In 2025, our guide is our guide at this point. I think, we are constantly looking at cost optimization opportunities in this business. And we are, obviously, very, very committed to the kind of margin progress that we talked about and growing margins each and every year to the 35%. So we do see additional cost opportunities across the business. They are a little bit longer term in nature. So by and large, we expect this to hit 2026. I would just remind you as well that we did make the objective acquisition at the end of Q4 and that also has a slight impact on offset in -- on R&D in 2025. Josh Chan -- Analyst That's right. That makes sense. Thank you, both, for the color. Operator One moment for our next question. Next question will come from the line of Rohit Kulkarni from ROTH Capital Partners. Your line is open. Unknown speaker -- ROTH Capital Partners -- Analyst This is Jared on for Rohit Kulkarni. How would you anticipate your capital allocation philosophy to evolve now that you might be generating $25 million to $30 million in free cash flow every quarter going forward? And secondly, from an end market standpoint and with the macro stabilization seen in Q4, how would you characterize your visibility and your confidence in annual guidance? Thank you. Hayden Brown -- President and Chief Executive Officer Sure. On capital allocation, I would say, overall, our capital allocation strategy is to very judiciously invest in this very focused set of organic growth opportunities that we've been talking about on the call. But you're right, as we've really accelerated the profitability and free cash flow gains in this business, we're now able to drive long-term shareholder return with a very proactive capital allocation strategy. So we have now a track record of taking action on these kind of smaller tech and talent acquisitions. And so, we'll continue to look for M&A to enhance our road map and accelerate our strategic path as a market leader. But -- and lastly, I'd say, we are very, very focused on returning capital to shareholders. In 2024, we deployed our first-ever $100 million share repurchase that we used 72% of our free cash flow last year to repurchase shares. Going forward, we intend to fully offset dilution from stock-based compensation, and we also plan to opportunistically repurchase our shares over time. Erica Gessert -- Chief Financial Officer In terms of visibility and the confidence in guidance given the macro, we talked a lot about the macro, I think even this morning's inflation worries point to the fact that we won't see, unfortunately, interest rates coming down anytime soon. We're really focused on what we can control, and we are very, very confident in the guidance that we've given, that we should be able to perform as long as the macro kind of remains as it is. If there are shocks to the system, of course, that would affect all businesses. That said, if the macro were to start to improve, of course, we would expect that our business would follow that on a kind of six- to nine-month lag. One moment for our next question. Our next question come from the line of John Byun from Jefferies. Your line is open. John Byun -- Analyst Hi. Thank you. This is John, again, for Brent Thill at Jefferies. A couple of questions. First, I want to see if you can maybe talk about what you saw in terms of linearity on month-to-month trends. And related to them, I don't know if you saw any pause or acceleration around elections or inauguration, either positive or negative? And then, second one on the numbers. A big step down in sales and marketing in Q4, and I guess, it was post restructuring, but wondering if there was any other factors behind that because they had been running over $40 million for five quarters in a row. Thank you. Hayden Brown -- President and Chief Executive Officer Yeah. In terms of the most-to-month linearity, I would say that broadly, our month-on-month trends in Q4 and coming into Q1 have followed our sort of normal seasonality. We did see some unexpected strength as we've outlined in -- toward the end of Q4, really in our GSV per active client. But like I said, both on the enterprise and on the marketplace side. So we've seen growth in both business units. And that's kind of sequential growth that we have in -- or year-over-year growth that we haven't seen in several quarters. But I don't think there's anything particular of note in terms of impacts of the election and other things, we haven't seen a particular change in behavior within our client base coming from that. And I think it remains to be seen what will happen given all the pace of the policy decisions coming out of the administration. And then, on the big step down for sales and marketing, I mean, this really is the cost reductions that we've talked about, focused on the enterprise business. And we also did take some cost reductions. We talked about this on the Q3 call. We reduced nonworking marketing spend. We have not reduced spend on performance marketing, which remains a good channel -- acquisition channel for us and a high ROI channel. One moment for our next question. Our next question will come from the line of Marvin Fong from BTIG. Your line is open. Marvin Fong -- Analyst Thank you for taking my questions. Pretty much all have been asked here. I'd just like to maybe ask one on that increase we're seeing in the GSV per client. And could you maybe break that down a step further in terms of what's the components driving that? Is it hours per project, hourly rate? And relatedly, any -- are you kind of assuming like whatever you're seeing in terms of trends kind of persisting in 2025? Or what's sort of underpinning your expectations for your guidance with respect to those items? Thanks. Hayden Brown -- President and Chief Executive Officer Sure. In terms of drivers, we have not seen an increase in hourly rate. That's been consistent over the last couple of years. And I think that that's very much kind of a macro -- part of the macro headwind. I would note that there are certain categories on our platform, including our very highest growth AI category, that do get a higher rate within that category. So AI work gets about a 44% wage accretion versus non-AI work on the platform. So to the extent that that continues to grow as it has been the fastest-growing category in the platform, we should continue to see benefits there. Now for the remainder of the year, like I've said, given the macro headwinds, the multiple years of macro headwinds that we've been kind of enduring, we are looking with caution just simply because I think the future is a bit unpredictable with the macro environment. So right now, I think we're sort of looking at a relatively steady GSV per active client going forward for the rest of the year. And also, you have to take into account we do have seasonality in our business with Q2 and Q3 being relatively lower than Q1.

PTC (PTC) Q1 2025 Earnings Call Transcript

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to PTC's 2025 first quarter conference call. [Operator instructions] I would now like to turn the call over to Matt Shimao, PTC's head of investor relations. Please go ahead. Matthew Shimao -- Senior Vice President, Investor Relations Good afternoon. Thank you, Sarah, and welcome to PTC's 2025 first quarter conference call. On the call today are: Neil Barua, chief executive officer; and Kristian Talvitie, chief financial officer. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today at www.ptc.com. During this call, PTC will make forward-looking statements, including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's annual report on Form 10-K, Form 10-Q and other filings with the U.S. Securities and Exchange Commission, as well as in today's press release. The forward-looking statements, including guidance provided during this call are valid only as of today's date, February 5th, 2025, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not presented in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website. With that, I'd like to turn the call over to PTC's chief executive officer, Neil Barua. Neil Barua -- Chief Executive Officer Thank you, Matt, and good afternoon, everyone. PTC started fiscal 2025 as anticipated with our first quarter results coming in slightly better than the guidance we provided which contemplated a difficult macro and our go-to-market changes. The consistency of our ARR and free cash flow underscores the strength of our diversified business model and our disciplined focus on execution. While we continue to see a sluggish selling environment in Q1, I am pleased with the intensity we have internally to ensure we exit fiscal 2025 with increased momentum. This includes the focus we have on our go-to-market transformation, as well as many important purposeful product releases, augmented by the work we are doing in AI. I'll share more on these key business initiatives during my comments today. For fiscal '25, we've reiterated our ARR and free cash flow guidance ranges, and we think the guidance we provided for Q2 and the full year is appropriate. Kristian will take you through the details. Turning to Slide 4. First off, I'd like to provide an update on the changes we announced last quarter to our go-to-market organization. We've made significant progress, reshaping our approach to be vertically oriented and the changes are energizing our team and customers. These efforts are designed to align us with our long-term growth opportunities and ensure we remain well-positioned to deliver value for our customers and shareholders. As part of this transformation, we welcomed Rob Dahdah as our chief revenue officer in December. Rob's reputation for excellence in enterprise software is already evident. His impact on the sales team and his focus on performance standards are in early stages and showing promise. Rob is also instilling greater alignment across our sales, customer success and marketing teams, setting the stage for sustained growth over time. In addition to Rob, we've added key leadership roles in growth marketing, technical enablement, sales enablement and customer success. These hires bring fresh perspectives and high standards and their mandate is to raise the bar across our organization. Our vertical approach and organizational changes will take time to bear fruit, and we expect to be hitting our stride as we exit the year. To be clear, these efforts are critical to delivering sustainable, low double-digit ARR growth. I'm encouraged by what I'm seeing so far. There is a step change in focus and speed, and we will not take our foot off the pedal. Let's move now to Slide 5, which highlights our product portfolio and strategy. Our customers need to introduce new products at a faster pace and with higher quality even as product complexity increases. That's not possible without digital transformation across their workflows, which is what our products enable. We're focusing our resources and attention on the five core areas of our portfolio that we believe can create the greatest customer value. As a reminder, these five focus areas are PLM, which is driven primarily by our Windchill product; ALM, which is driven by our Codebeamer product; SLM, which is primarily driven by our ServiceMax product; CAD, which is driven primarily by our Creo products; and lastly, our continued focus on SaaS. Today, I'd like to highlight some exciting new advancements across these focus areas. Starting with PLM with Windchill Navigate View Work instructions. We're extending 3D digital work instructions from PLM to shop floor employees, enabling our customers to get more value from their product data. In ALM, we're excited about the upcoming release of Codebeamer 3.0, which will further extend the scalability and capabilities of our market-leading ALM solution. In SLM, just this past quarter, we achieved FedRAMP certification for ServiceMax, a critical milestone that opens new opportunities in our FA&D vertical. In CAD, Creo 12 leapfrogs the competition in composite structure design and adds thermal physics to our AI-driven generative design engine. Both of these are embedded modules within Creo and open up new use cases for highly innovative designs. And also, in SaaS, Onshape, the industry's only cloud-native SaaS platform for CAD and PDM also continues to advance, delivering significant new releases at a remarkable place, 17 over the past year, including cloud-native CAM and advanced servicing tools. We are also further differentiating our core offerings with AI, and we're encouraged by the opportunity this presents. So let's get into this area. We believe the industries we serve over time will be fundamentally transformed by AI, and PTC is in a great position to be a leader on this front. The promise of AI is based on access to data and putting it to use. PTC solutions are used to create, manage and share the product data that is at the heart of our customers' businesses. This could be design data in Creo, requirements data in Codebeamer, bills of material data in Windchill or service history data in ServiceMax. We are advantaged in that we have decades of experience with how our customers use this data in their everyday operations and the impact that it has on workflows, speed of development, product quality and employee productivity. Our understanding of how this data store, access and use in our products has been our blueprint for applying AI. It's our secret sauce. Throughout 2024, I said PTC is taking a practical and value-based approach to AI for our customers. We've been hard at work on this front and have identified the most prominent applications and use cases for AI across our portfolio in concert with customer feedback. Our offerings operate in assistant-like capacities allowing customers to interrogate the data in their systems to confirm information, accelerate workflows and automate tasks such as proactively notifying engineers of a design or requirements change. These AI offerings will also have specialized AI agents embedded in them. These agents will map to specific domain workflows and data sources within engineering, manufacturing and service and they'll intelligently interact behind the scenes, connecting information across their specialty domains to serve out the best information or complete a task. I'm pleased to share that the first of these offerings will launch next week with ServiceMax. The ServiceMax AI offering includes several agents that assist with scheduling, service delivery and workforce enablement. This offering was in beta mode for much of 2024 with top ServiceMax customers, and now it's ready for everyone. These AI agents have access to all the data stored in a ServiceMax instance and technicians can interact with them through natural language. Using the latest GenAI technology, the agents can answer questions about a specific job or asset, automate manual documentation and scheduling tasks and review proactive recommendations for predictive maintenance. The main goal here is greater efficiency for technicians, doing more in less time. As part of this launch, we're introducing a new ServiceMax AI SKU, which will be the entry point for AI-powered features. This will be a per user per month subscription charge, which is what ServiceMax customers are used to. Our ServiceMax road map for fiscal '25 includes other AI-powered features and capabilities based on large language models that can be accessed by the same ServiceMax AI SKU. We believe that more ways of accessing AI-powered features will lead to more adoption and happier customers. This will allow us to learn faster and continue to improve the offerings and pricing models. In addition, we have been testing a beta version of generative AI features in Codebeamer with Volkswagen Group and Microsoft, which we demonstrated at Microsoft's Ignite event in November to much fanfare. Based on customer feedback, I'm excited around the real potential for AI here because of Codebeamer importance to software-defined product strategies for so many of our customers. These customers store their hardware and software requirements data in Codebeamer, critical for the overall product development process and for meeting regulatory and safety requirements. These new AI features will help engineering teams improve the quality of the requirements, remove duplicate requirements and compare new requirements against existing quality standards. We're also hard at work on incremental AI functionality within Windchill, Creo, Onshape, Arena, Servigistics and other products, and you can expect previews at upcoming events such as HMI and the Paris Air Show. Ultimately, the value they'll provide the goal of our AI offerings is to draw new customers, encourage upgrades with existing customers and become even more critical to day-to-day workflows. Turning now to some customer examples from Q1 that highlight our core offerings. Moving to Slide 6. We've previously talked about our opportunity to cross-sell Codebeamer ALM to our base of Windchill customers. As products of all types become increasingly software driven. The two products, Windchill and Codebeamer in a customer environment, working together is highly differentiated in our space, an area we are investing in. Today's first customer story highlights this theme. This medtech customer has been leveraging Windchill to help drive their business since 2017, deploying it broadly beyond core engineering as a platform to enable enterprisewide collaboration to accelerate time to market. Software-defined products are a focus area for this customer as software has become a key driver of their product differentiation. In fact, their main products are software upgradable and they are able to charge their customers for software upgrades that add value to existing products. At the same time, the opportunity for software-driven product growth comes with new challenges associated with managing the rapid expansion in the number of unique software configurations that need to be developed and updated over time. This customer needs help managing all of these software variants and releases and that is why they are now focused on modernizing their current fragmented ALM system and expanding their use of ALM. They decided to standardize on Codebeamer, displacing two legacy ALM vendors. Cross-selling was a key part of this deal. This customer is a happy user of Windchill and Codebeamer's future road map aligns with their future plans. Furthermore, the med tech vertical is similar to verticals, including automotive and federal, aerospace and defense in that there is an additional catalyst driving the adoption of Codebeamer, regulatory and safety compliance. With the rapid increase of software that is embedded in hardware components, companies are looking for tools to help ensure and automate their regulatory compliance processes. Traceability is required for safety-critical, highly regulated industries and Codebeamer is the most modern ALM product that enables this in an agile development environment. Beyond this specific customer example, 27 of the Top 30 public medical device manufacturers use PTC in some fashion, and we believe we are well-positioned to expand our footprint and grow our Codebeamer business in this vertical. ALM represents a really interesting growth opportunity across multiple verticals in alignment with our PLM focus. As such, we have been increasing our investments in Codebeamer, working alongside Creo and Windchill to accelerate our leadership. Turning to our next customer story on Slide 7. This customer is in the federal, aerospace and defense vertical and is a good example of a well-established company that continues to invest in digital transformation to drive market leadership in a competitive high-growth environment. This customer is seeing strong growth in demand and needs to increase production. In addition, their customers are asking for state-of-the-art products that are at the boundary of what is physically possible. We're talking about designs where a small amount of wind resistance makes a very big difference. To tackle these challenges, this customer needs best-in-class tools and that's why they chose Creo for design engineering and Windchill as their enterprise backbone for their product data. Design excellence is in focus for this customer because this is an R&D-centric enterprise and it depends on improvements in design engineering to stay competitive. To further add to their capabilities, they will continue to invest in advanced Creo modules, including Creo Simulation Live, Composites and Generative Design. These modules will help this customer produce lighter weight products with higher quality at a faster pace using less materials. This customer is also continuing to expand its Windchill system as an enterprise platform to drive collaboration around real-time trusted product data. They have provided Windchill product data access to operational functions, including supply chain, quality, sales and service, usage has gone viral, driving productivity gains. These outcomes are leading to a large follow-on order for more seats, as well as further expansion to employees on the factory floor. Currently, approximately 70% of this customer's employee base benefits from having access to product data in Windchill, and this customer's Creo and Windchill ARR has grown significantly with more room to run. In closing, I remain immensely optimistic about where PTC is heading. Our focused strategic initiatives are gaining traction, and we are driving purposeful innovations that are resonating with customers. Combine that with transformative go-to-market changes and to focus on accountability in everything we do, and you can understand why we are energized. Thank you for your support and interest in PTC. Kristian, over to you. Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Thanks, Neil, and hello, everyone. Starting off with Slide 9. Our ARR and free cash flow results in Q1 were in line with our guidance. As you know, we believe ARR and free cash flow were the most important metrics to assess the performance of our business. To help investors understand our business performance, excluding the impact of FX volatility, we provide ARR guidance and disclose our ARR results on a constant-currency basis. At the end of Q1 '25, our constant-currency ARR using our fiscal '25 plan FX rates was $2.277 billion, up 11% year over year. In Q1, we saw a continuation of the challenging selling environment we've been experiencing for a couple of years now, and this continues to impact close rates. Also consistent with our expectations from a quarter ago, our constant-currency ARR growth in Q1 was impacted by two factors, which we called out on our previous earnings call. The first factor was the linearity of deferred ARR in fiscal '25. And the second factor was a couple of contracts that resulted in churn in Q1, which are contracted to come back into ARR later this fiscal year. Moving on to cash flow. In Q1, our free cash flow was up 29% year over year as we continue to invest in our key focus areas at the same time. Note that the $236 million of free cash flow we generated in Q1 absorbed $11 million of outflows related to our go-to-market realignment, which is in line with our expectations. Turning to Slide 10. Let's look at our constant-currency ARR growth in more detail. Looking at our product groups, our constant-currency ARR year-over-year growth was 9% in CAD, driven primarily by Creo and 11% in PLM, primarily driven by Windchill, Codebeamer, IoT and ServiceMax. On a year-over-year basis, constant-currency ARR grew by 9% in the Americas and 12% in both Europe and Asia Pacific. Our ARR growth is based on our unique product portfolio, which aligns with the digital transformation needs of our customers. Despite the overall selling environment, our top line has shown good resilience, supported by our subscription model, low churn rate and the propensity for our customer base to prioritize their R&D investments through challenging times. Turning to Slide 11. We ended Q1 with cash and cash equivalents of $196 million. At the end of Q1, gross debt was $1.548 billion, and we were 1.7 times levered. We continue to diligently pay down our debt, and we started to buy back shares under our $2 billion share repurchase program. During Q1, we paid down our debt by $205 million and used $75 million of cash to repurchase 383,000 shares of our common stock. As you all know, we have a $500 million bond that's coming due in February, which we intend to retire upon expiration with cash on hand and by drawing on our revolving credit facility. Given the consistency and predictability of the business, we aim to maintain a low cash balance. As such, assuming we have excess cash, we expect to return it to shareholders. The authorization we now have in place gives us a lot of flexibility in how we do that. In line with what we've said previously, we currently intend to buy back approximately $300 million of our common stock in fiscal '25, with another approximately $75 million of repurchases expected in Q2. Our long-term goal, assuming our debt-to-EBITDA ratio is below three times remains to return approximately 50% of our free cash flow to shareholders via share repurchases while also taking into consideration the interest rate environment and strategic opportunities. Finally, our fully diluted share count in fiscal '24 was 121 million, and we currently expect fully diluted shares to be approximately flat in fiscal '25. With that, I'll take you through our guidance on Slide 12. All of the ARR amounts on this slide are based on our fiscal '25 plan rates as of September 30th, 2024. For constant-currency ARR, given our differentiated product portfolio, the resilience of our subscription business model, the actions we've taken over time to align our investments with market opportunities and allowing that our go-to-market changes are expected to take time to have their intended effect, we expect growth of approximately 9% to 10% for fiscal '25 and approximately 9.5% for Q2 of fiscal '25. I'll get into more detail on constant-currency ARR on the next two slides. On cash flow, we're guiding to free cash flow of $835 million to $850 million in fiscal '25, which absorbs the approximately $20 million of cash outflows for severance and consulting fees related to our go-to-market realignment we've discussed previously. We're not calling out a restructuring charge, so all of this will flow through the sales and marketing and cost of revenue lines on our P&L. As we've said previously, this is not a cost-cutting exercise. We're reinvesting in our go-to-market organization with a focus on the areas we believe deliver the greatest value to our customers. In fiscal '25, we expect largely similar invoicing seasonality compared to the previous four years. Based on this and our expected cash outflows, we expect approximately 60% of our free cash flow to be generated in the first half of the year and for fiscal Q4 to be our lowest cash flow generation quarter. For Q2 of fiscal '25, we're guiding for free cash flow of approximately $270 million, which absorbs approximately $4 million of the $20 million of total outflows related to our go-to-market realignment. Note that our cash flow guidance is not on a constant-currency basis. So FX fluctuations can have an impact in either direction. Approximately 45% of our ARR is transacted in foreign currencies and approximately 35% of our non-GAAP cost of revenue and operating expenses are transacted in foreign currencies. So we have somewhat of a natural hedge. That said, significant FX moves can have an impact, and we're seeing some of that pressure this year. We'll see how FX rates move as we progress through the year. But at this point, we still feel comfortable with our cash flow guidance for Q2 and for fiscal '25. While changes in FX, interest rates and tax regulations can be difficult to predict, we have a high degree of confidence in our free cash flow forecasting process due to the predictability of our cash collections and the disciplined budgeting structure we have in place. Importantly, we've maintained consistent billing practices over time. We primarily bill our customers annually upfront one year at a time, regardless of contract term lengths. So our free cash flow results over time are comparable. Furthermore, over the past five years, we've optimized our internal budgeting process. It starts with having a subscription business model that generates predictable cash inflows. Then we begin each fiscal year by funding our business for growth at the low end of our internal ARR forecast. As the year progresses, we maintain or increase that level of funding based on the growth dynamics we're seeing. By proceeding in this manner, we're able to match our investments to the market environment in an agile way, while also delivering predictable free cash flow. That said, we would not do anything that impacts the long-term prospects of the business because of short-term FX movements. Over the medium term, we continue to expect our free cash flow to grow faster than our ARR with non-GAAP operating expenses expected to grow at roughly half the rate of ARR. A basic tenet of our subscription business model and budgeting process is that there's natural operating leverage that we benefit from as our ARR grows. To help you with your models, we're providing revenue and EPS guidance. However, I'd like to reiterate my favorite reminder, ASC 606 makes revenue and EPS difficult to predict for PTC since we primarily sell on-premise subscription and the way revenue is recognized from these contracts can vary significantly based on variables that aren't necessarily relevant to the performance of the business. I did a teach-in on this subject on our Q4 fiscal '22 call that you may want to refer to if you're new to PTC. You can find the presentation on the investors section of our website. The summary is, we believe ARR and free cash flow rather than revenue and operating income are the best metrics to assess the performance of our business. Next, on Slide 13. Here's an illustrative constant-currency ARR model for Q2. This slide shows our sequential net new ARR over the past couple of years. And the column on the far right illustrates that we need $44 million of sequential net new ARR growth to hit 9.5% growth for Q2. Obviously, it's impossible to predict any given quarter with that level of precision, and we're being mindful of the macro environment and the go-to-market changes we're making. As you know, based on our results over the past few years, our net new ARR can be somewhat volatile in any given quarter, given dynamics such as the timing of new bookings, the timing of renewals, the timing of deferred ARR starting, how much of our new bookings in any given quarter starts in the quarter, how much churn we expect in any given quarter, etc. It's not unusual to see quarterly volatility in our sequential net new ARR results. Importantly, we expect churn to remain low throughout fiscal '25. Also, as we make incremental investment decisions over the course of a fiscal year, we continue to focus on our internal forecast for the full year net new ARR growth. Moving to Slide 14. Here is a similar illustrative model for fiscal '25. You can see our results over the past three years, and the column on the right illustrates that we need $214 million of net new ARR this year to hit the midpoint of our fiscal '25 constant-currency ARR guidance range. This range, along with our Q1 results and Q2 guidance, obviously, indicates a back-half loaded year, which is supported by our pipeline and our internal forecast. Our pipeline continues to grow, and we have a significant stable of large opportunities in our Q3 and Q4. At the midpoint of our range, we would be adding approximately $20 million less net new ARR in fiscal '25, compared to 2024 at approximately $5 million less than in fiscal '23 and '22, Note that fiscal '24 benefited approximately $10 million due to incremental deferred ARR in that year. Adjusting for that, our fiscal '25 guidance midpoint indicates approximately flattish net new ARR growth compared to fiscal '24, '23, and '22. I think this point highlights exactly why we're evolving our go-to-market organization this year. We're hard at work with this evolution, augmented with new product releases such as the ones that Neil outlined earlier, to ensure that we exit this year with momentum to drive net new ARR growth into fiscal '26 and beyond. In the meantime, our business model is resilient, and we continue to believe the right guidance range for fiscal '25 constant-currency ARR growth is 9% to 10%. In conclusion, PTC has a strong product portfolio and strategy, a track record of operational discipline and clear value creation opportunities. We're focused on what matters most for our customers, and we are aligning our operations so that we can scale our business in a consistent manner. With that, I'd like to turn the call over to the operator for today's Q&A session. Thank you. [Operator instructions] Your first question comes from the line of Jay Vleeschhouwer with Griffin Securities. Your line is open. Jay Vleeschhouwer -- Analyst Thank you. Good evening. Neil, your various comments on new products or product extensions are quite interesting to me. And one thing, I'd like to ask about, is your comments about the AI products, specifically. Maybe you could talk about how you're organizing and investing in those. Is this a segment or product-specific development effort? Is it a central AI group that is managing all of these developments. So there's some commonality within the company for your AI proliferation. And then, just to finish up on the product side, you alluded to some expansion into manufacturing process. This is something that two of your larger competitors, Dassault and Siemens have clearly been investing in and seeing new business in. Is this an incrementally important use case or application area for you? Neil Barua -- Chief Executive Officer Yes, thanks for the question, Jay. On that, I'll take the second piece. In fact, we had contingent of a number of people, partners, as well as employees today here at the Seaport this week working through the manufacturing process category and value that we've got. The way we're approaching it is we believe extending PLM Windchill data to the manufacturing floor is where our value resides. And we see that working in conjunction with the MES systems of the world that are deeper into that workflow, we will provide the PLM data to those systems and to ERPs is our approach on the manufacturing side. On the other piece on the AI, as you know, as we've talked about, with ServiceMax, we were letting 2024 be able for our teams to self-introduce and innovate and experiment with AI technologies over the course of 2024. You saw the ServiceMax team really doing a nice job. Onshape by the way, has also done a really nice job with that, thinking through all different technologies and approaches for working with customers on betas by which now, as I talked about, ServiceMax GAing on February 10th here, new ServiceMax AI piece, and that was done within the ServiceMax team. But what we've seen with Codebeamer now and the interest that we got out of the Ignite conference and the work we're doing with Volkswagen and Microsoft for the Codebeamer launch and subsequently, what we're doing with Windchill and Creo, we are now in the process and have already started an alignment of a group that is actually centered in on making sure there's alignment across all our AI innovations that are happening in our product segment. So we're evolving it. As I said, it was always going to be an approach that's valuable and practical and to make sure there's value for customers and over time can accrete to PTC. And I think, we're at the stage where we were crawling last year, we started walking and it's time to move into the jog to run pace based on the customer feedback we are getting around this. And this space is evolving very quickly and will be very nimble toward things that are changing around that manner. But we're energized, as you could tell, around the addition of AI capabilities into what is already great products for the company. The next question comes from Jason Celino with KeyBanc Capital Markets. Your line is open. Jason Celino -- Analyst Hey, thanks for taking my question. Actually, kind of building off of Jay's -- one of Jay's partners. Two of your competitors, your European ones seem to be really battling it out on the PLM side. Ironically, one seems to be taking share from the other. Where does PTC fall in all this? I mean, have you seen any changes to the competitive environment? Any changes to your win rates? Are you involved in some of these? Or are you happy to just be watching on the sidelines? Thanks. Neil Barua -- Chief Executive Officer So we are fully in the arena, no being on the sidelines here, Jason, as you know. And I think what I would say is, given we're three players in this really remarkable industry where all boats are lifting because of these digital transformation needs. I'm glad to see all of us kind of rising to the occasion here. And as I said, very optimistic around how this will translate over the next number of years in front of us for all three of us competitors. That being said, strategically, our focus from a PTC perspective, is that the nerve center is our Windchill and Codebeamer product capabilities. And we have amazing CAD tools like Creo, obviously, and Onshape, and we have really great aftermarket capabilities in our SLM suite. Our approach, which is differentiated versus the two that you mentioned is how do you really think about as a customer, the utilization of Windchill in coordination with your CAD systems, whether it be Creo or others. And how does software kind of get embedded into what's happening within product development cycles. And that's our approach. And the competitors, as you heard, this past week, they're battling it out in the manufacturing side, which Jay talked about. We're not there. We are not going there. We're actually just showing our PLM data to the manufacturing floor. So let our two competitors play out the manufacturing side. We're really focused on where does the product data actually need real-time understanding and democratization of that moving through the enterprise and our Windchill, Codebeamer in conjunction, strategic intent is very differentiated versus our other two competitors, and we feel good about how we're positioned there. The next question comes from Ken Wong of Oppenheimer & Company. Your line is open. Kenneth Wong -- Analyst Thank you for taking my question. Kristian, I just wanted to ask about the trajectory of NRR. When I look at kind of Q2 being a little subseasonal and then I maybe meld that with Neil's comments that you guys won't hit your go-to-market stride until Q4. Is it fair to assume that we should be looking at kind of slightly subseasonal net new ARR until you hit that fourth quarter? Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yeah. I think, we are not providing specific Q3, Q4 guidance at this point. But as we said in the prepared comments, we do have a maybe even slightly more than usual back half-loaded year, of course, back half loaded year is pretty typical for PTC, and we're kind of around the edges there. The next question comes from Siti Panigrahi with Mizuho. Your line is open. Siti Panigrahi -- Analyst Hi. Thanks for taking my question. Neil, on your comments about exiting fiscal '25 with momentum and maybe grow in '26, help us understand the progress you have made on the go-to-market alignment side given Rob joined recently as CRO. And also, on the macro side also, we recently saw manufacturing PMI bouncing back 50 -- above 50% after two years. Wondering what other metrics that you look at to feel comfortable on the macro side. Neil Barua -- Chief Executive Officer Thanks for the question, Siti. I'll take the first one, and thanks for it. I want to just level set again on reinforcing the two main reasons for why we're making in the process of all these go-to-market changes. First is to make us more effective at serving our customers. And the second is to make sure as we scale, we sustain our low double-digit ARR growth target over the medium term, right? So that's what we are like centered in on from all the changes that are being made. And in terms of the changes in Q1, we're showing early promise and I'm seeing the teams being motivated, customers reacting to this as well. But like three dynamics are the things we've already undertaken and are now well underway in executing. First is in Q1, as we talked about, we verticalized our go-to-market approach. Top verticals are industrial products, FA&D, automotive, med tech and electronics and high tech. So we did that and all the heavy lifting to make sure the messaging, the account transition, the plans to go execute as we're starting to do here in Q2 has been put in place. If you watch LinkedIn, you'll see the marketing messages very tailored around industry verticals. So point number one. Two is we brought Rob in, our new CRO in early December, Rob's acclimated real well so far. He's infusing a ton of discipline and depth into, as an example, our weekly pipeline management processes. He's working through the overall go-to-market operating rhythm, which should -- he's targeted to make sure we are getting a more consistent and predictable way to grow the business. He's also -- this is really great as Rob's working with CK, our chief marketing officer, to make sure they're combined in their efforts to execute across this vertical strategy. And lastly, just to give you the scope of the change that we are making, we've also levered up our overall go-to-market team by adding key leadership roles in growth marketing, enablement that I mentioned on sales and technical customer success. We've exited a number of people that we talked about in Q1. We removed layers. We're starting to add quota-carrying salespeople over the course of this year. And we've elevated really great veteran PTCers to prominent roles as well. All -- the reason I give you that backdrop, Siti, and the team here is because that work and the execution now of all the foundation laying that we did in Q1 will now allow for the next few quarters for us to start working that flywheel to get us running at the pace that I believe is the potential of this company. And so far, we feel good about it, but work is ahead of us, and we're feeling compelled around the opportunity around it. On your second question around macro, yes, of course, we look at the PMI. Of course, we wake up like it's Christmas morning where we see a PMI take over 50%. But that being said, what we look at is the pipeline, which Kristian talked about, we feel really good about the back half pipeline, the size of the deals, the quality of the deals. And I'm even more energized by the fact that now that we're putting a greater discipline around the go-to-market changes, how we could add even greater pipeline opportunities. And the summary of when the macro gets better, when I'll stop saying it's a sluggish sales environment, is when we could predictably have higher close rates on an already really good pipeline. That's what we are looking at. We'll, obviously, watch every metric out there from a macro perspective. But internally, that's the laser focus we continue to look at when we see the macro changing to our favor. Siti Panigrahi -- Analyst We appreciate that great color and all the LinkedIn posts. Operator The next question comes from Tyler Radke with Citi. Your line is open. Unknown speaker -- Citi -- Analyst Hi. Thanks. This is Peter on the line for Tyler. In your presentation, there's an example of a medtech Windchill customer expanding their seats from 10% to 15% to over 50%. Just curious how much of an opportunity is there still left like within the existing PLM customer base to see seat count expansion, like outside of that core engineering team and like dive deeper into other departments, whether that's like quality, supply chain and manufacturing. Neil Barua -- Chief Executive Officer Yeah. There's a reason why I start every call since I started last February around PLM and the opportunity there. The expansion of PLM in every call we've been talking about examples of customers that are now seeing the value of PLM being enterprise driven, not just a CAD depository -- a repository tool, a PDM-like tool. It is now becoming enterprise PLM. And we have a significant opportunity across our already existing base of customers that are still at early or mid stages of expanding PLM to all the seats, like this example the customer did. So that is the reason why we're pushing on all cylinders to get enterprise PLM known and integrated with what they could also do with Codebeamer, it is a very critical value prop to our customers. So this is the area that we feel very energized and it gets even better when we create the vertical approach to how automotive companies are using Windchill to expand their utilization of product data moving faster than the enterprise. How does federal aerospace company think about that. And we are really advanced in that, and we're just needing to prove it out to more customers to expand. That is a clear priority of the business. Operator The next question comes from Steve Tusa of J.P. Morgan. Your line is open. Stephen Tusa -- Analyst Hey, thanks. I wish I got as excited as you guys do about the macro data like Christmas morning with the ISM or the PMI. On the macro front, how are you seeing the focus on AI impact decisions and budgets more specifically than just what normally happens at this time of the year on budgets? Neil Barua -- Chief Executive Officer Within our space and I talked to this last -- I think last quarter or the quarter before, Steve, most of our customers still need to make sure that they have a structured data set by which you could apply AI tool. So like as for the prior question, when you don't have enterprise PLM and a number of your engineers and supply chain folks, procurement folks still use antiquated systems or spreadsheets for data flows around product data, it's very hard to apply generative AI. So we call it get your digital house in order. We really feel, Steve, this is why Kristian and I talked about the robust pipeline we see in the second half of the year, that is inspired by the fact that people need to get going on getting PLM systems across their enterprise, get Codebeamer deployed, make sure they have 2D models move to 3D and model-based definition across their CAD drawings. And what's really interesting is when we add the AI concept of Codebeamer as an example, that we are really going to be stoking the flames with to make sure people understand the real value here at HMI, it then creates a necessity for the customer to deploy Codebeamer on their underlying requirements management capabilities so that they actually can get the benefit of a generative AI tool like Codebeamer AI that we're launching. So Steve, I actually think it's a good benefit from us because it's creating our customer base to get their digital house in order. And now, with our additional AI offerings, which we have a secret sauce to give to them in concert with them, I think we are in a good spot. The next question comes from Joshua Tilton with Wolfe Research. Your line is open. Arsenije Matovic -- Analyst Hi. This is Arsenije on for Josh Tilton. I just had a question really on the net ARR performance. Look, it was within the range of guidance, but even after adjusting for the timing impact and deferred ARR, it looked like it was below year over year, irrespective of the environment, not really changing, still mixed. I guess, what occurred, is there some underperformance in the channel versus expectations? Or is it just kind of exactly within what you were expecting even on the channel front and expected still better visibility with growth recovery in the back half? Thanks. Neil Barua -- Chief Executive Officer Let me start and then, Kristian. This quarter, we guided toward the number and we came in thereabouts. Even from an internal expectation, we saw this. We took into account, the pipeline, the sluggish sales environment, obviously, all the changes we're making in go-to-market and we structured the guidance as such. So we are past Q1, it was as expected from our perspective. What we're really focused in on is let's get the machinery working, as I mentioned, on the go-to-market side. Let's get these product releases out, message and customers really buying into it, by which when Rob and CK get the go-to-market transformation really humming that I mentioned in the tail end of this year, second half of this year, we have a real rhythm to close out already a robust pipeline and keep adding to it by which we can now really see a sustainable path for low double-digits ARR growth as we go into next year, which has been our medium and long-term targets. Kristian, anything to add? Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yeah. Just reiterating what you said, we came in pretty close to the -- our internal targets. Channel, actually, had a strong quarter this quarter. So all in all, I think it was largely as expected. The next question comes from Nay Soe Naing of Berenberg. Your line is open. Nay Soe Naing -- Berenberg -- Analyst Hey, guys, thanks for fitting me in. I've got two questions, if I may. The first one is on the go-to-market changes. It sounded like you made quite a lot of good progress in Q1. I just want to get a sense of whether that was ahead of what you scheduled or is it pretty -- everything is pretty much on track? And then, a secondary question to that is that, Neil, I think if I remember correctly, you said last quarter that you weren't expecting any major disruption to sales from these go-to-market changes. Now that it's been a quarter, can we get an update on that front, please? Neil Barua -- Chief Executive Officer Sure. In terms of where we are in the transformation versus where we thought. I'm pleased with where we're at. Obviously, I would have liked Rob to join a month earlier when I did, some of the folks that moved out of the company come in, we had a month gap before he joined back in December, but he's hit the ground running in December, and the team didn't wait for him to get here, and he was really well acquainted with the plan. So in all, in general, I would say, a very specific project plan that we've had for this transformation, I feel good that we accomplished a lot of the foundation laying in Q1. Now we've had our kickoffs in January to get -- now that the account transitions are done, comp plans are out, we've really -- if you're watching LinkedIn again, we've really had a good time kind of launching all this in the January time frame. And as I mentioned, the reason for why we're talking about the next few quarters is now the framework, the operational discipline Rob's bringing to bear, the vertical approach, we believe that that just will take some time to catch rhythm. It could happen faster, but my experience would say it takes a few quarters to really get the machinery moving here. In terms of disruption, what I'd say is, we made a lot of changes in Q1. And the different approach that Rob is taking and CK is taking around this vertical piece is changed. And when we thought about this, this is why we proactively came out to you last quarter and said, look, like in our guidance, we are going to have a framework by which there should be a level of impact from the go-to-market changes in addition to our estimation that the macro remains sluggish, and that's why we came to that 9% to 10% ARR range that we reiterated again on the call today for the year. Nay Soe Naing -- Berenberg -- Analyst Got it. All makes sense. One quick question, if I could squeeze in, if that's all right. The AI product launches are upcoming, all sounds very exciting. But are they going to be limited to just Codebeamer and ServiceMax or will that be across your entire product portfolio? Neil Barua -- Chief Executive Officer Great question. Stay tuned. The ServiceMax is first one out of the gate. Codebeamer is a big element that we've been working on that at Hannover Messe, we'll be spending a lot more time on. Obviously, as you know, we've been spending time working on this with Volkswagen, Microsoft. We are working through a Windchill applied AI element around parts reuse. Onshape has been doing a lot of work on this. So stay tuned on that, and we got a few more in the hopper, but we're really focusing on the core areas right now and learning from a very innovative technologies that's moving. So we're learning around that in conjunction with our customers. That's really important here to show real value versus just a marketing message. The next question comes from Saket Kalia of Barclays. Your line is open. Saket Kalia -- Analyst Hey, guys, thanks for thanks for taking my question here and fitting me in as well. Kristian, maybe for you, and Neil, please feel free to chime in here, right? So I want to go back to kind of the five pillars that Neil, you talked about in your prepared comments, right? So clearly, there are a few higher growth parts of the business like an ALM or an SLM or a SaaS part of the business just because of their scale, right? I think there are -- the strong competitive position drives solid growth in PLM and CAD, but it feels like those three segments have the potential to grow faster. Maybe the question is, where are those businesses in their evolution in terms of being more additive to growth? And then, maybe the other side of that coin, how much of a drag are some of the businesses that maybe aren't those pillars anymore like in IoT, for example. There are a lot of moving parts in that question, but does that make sense? Neil Barua -- Chief Executive Officer Yeah. Well, let me take the front end and then Kristian can add any color here. I just want to be clear. The PLM and the ability for us to expand seats like we mentioned in this customer example, there's a lot of room for us to grow with the best-in-class PLM offering in the marketplace, bar none, in my opinion, and I think in our customer's opinion. When integrated with Codebeamer, our ALM suite, we believe that there is a real strong growth potential for those two boats to rise in a significant amount that really creates a differentiated value to the end customer. So I just want to be clear, PLM is part of a very strong growth driver of the business. And we just see many more potentials for that to increase in growth rate as we get this vertical approach, right, as we get the messaging around ePLM really structured in the marketplace. So I'm just not -- and we are not just relying on ALM, SLM and SaaS to be the inflector of accretive growth. PLM actually will pull its way and then some in our view, in terms of the approach that we're taking. In terms of the drag, you mentioned some of them. As I indicated on Windchill Navigate View Work instructions, where we're extending 3D digital work instructions beyond the shop floor, guess what, we are using ThingWorx technology to do that. And if you recall nine months ago, we took a number of resources from the stand-alone businesses and moved them to make sure the great technology of ThingWorx, actually, allowing customers to expand PLM and provide more value to different personas. We're doing the same on some of those other product sets that don't really do as well versus our core growth rates to make sure we augment our core growth rates with better capabilities using some of those technologies. That's how we're thinking about it from a perspective of how we're interfacing with our customers and organizing ourselves internally. Kristian? This concludes the question-and-answer session. Please remain connected as I turn it to Neil for closing remarks. Neil Barua -- Chief Executive Officer Thank you, everyone, for joining us and for your questions today. In February, Kristian will attend the Baird conference in Park City, Utah, and Matt will attend the Wolfe conference in New York. In March, I'll be in San Francisco attending the Morgan Stanley conference together with Kristian and Matt. Also in March, Kristian and Matt will participate in two additional conferences, the LOOP conference, which will be virtual and the Stifel conference in New York. Thanks again, and we look forward to engaging with you.