Earnings Call Transcript
Docusign, Inc. (DOCU)
Earnings Call Transcript - DOCU Q3 2024
Operator, Operator
Good afternoon, ladies and gentlemen. Thank you for joining DocuSign's Third Quarter Fiscal Year '24 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. As a reminder, this call is being recorded and will be available for replay on the Investor Relations section of the website following the call. I will now pass the call over to Heather Harwood, Head of Investor Relations. Please go ahead.
Heather Harwood, Head of Investor Relations
Thank you, operator. Good afternoon and welcome to DocuSign's Q3 Fiscal Year 2024 Earnings Call. I'm Heather Harwood, DocuSign's Head of Investor Relations. Joining me on today's call are DocuSign's CEO, Allan Thygesen and our CFO, Blake Grayson. The press release announcing our third quarter fiscal year 2024 results was issued earlier today and is posted on our Investor Relations website. Now let me remind everyone that some of our statements on today's call are forward-looking. We believe our assumptions and expectations related to these forward-looking statements are reasonable, but they are subject to known and unknown risks and uncertainties that may cause our actual results or performance to be materially different. In particular, our expectations regarding the pace of digital transformation and factors affecting customer demand are based on our best estimates at this time and are therefore subject to change. Please read and consider the risk factors in our filings with the SEC, together with the content of this call. Any forward-looking statements are based on our assumptions and expectations to date, and except as required by law, we assume no obligation to update these statements in light of future events or new information. During this call, we will present GAAP and non-GAAP financial measures. In addition, we provide non-GAAP weighted average share count and information regarding free cash flows and billings. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing our performance. For information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's earnings press release which can be found on our website at investor.docusign.com. I'd now like to turn the call over to Allan.
Allan Thygesen, CEO
Thanks, Heather, and good afternoon, everyone. DocuSign's third quarter operating results reflect progress on our initiatives to expand beyond e-signature into agreement management. And our financial performance underscores our ongoing focus on driving profitability and sustaining healthy free cash flow. As I reflect on our journey over the last 12 months, the three key pillars of our strategic vision remain the same. First, to accelerate innovation towards agreement management, which we believe will further expand market opportunity; second, improving the reach and efficiency of our omnichannel go-to-market efforts; and third, strengthening our financial and operational efficiency. Now before we discuss each pillar in detail, let me first highlight this quarter's financial results. Total Q3 revenue came in at $700 million, up 9% versus prior year. We're particularly pleased with the improvement in our overall profitability this quarter against persistent macro headwinds and customer caution. Specifically, our Q3 non-GAAP operating margin came in at 27%, a 400 basis point increase versus prior year and non-GAAP operating income grew 27% year-over-year to $187 million. We also generated record free cash flow in Q3 coming in at $240 million, up significantly versus the prior year. We're focused on strengthening our profitability while making balanced investments in areas with strong long-term growth opportunities. We're also seeing encouraging signs of business stabilization with improvement in some metrics, notably customers with annualized contract value greater than $300,000. Blake will expand on the metrics further in his remarks. With respect to our first pillar, accelerating product innovation. Our focus is twofold. First, we continue to improve our core e-signature product capability. In Q3, DocuSign became the exclusive e-signature provider for Microsoft's Power Page Integration, making it easy for website makers to incorporate signatures and forms without code, improving the client signing experience and opening the door to building pre and post signature workflows. In November, we also launched a WhatsApp integration for e-signature. In an internal comparative study, we found that agreements delivered via WhatsApp are signed nearly seven times faster than those sent via email. Given the ubiquity of WhatsApp globally, it's an important update to bring e-signature to markets outside the US. In addition, IDC recognized DocuSign as a leader in its 2023 e-signature assessment. DocuSign continues to hold the leadership position of IDC for e-signature based on having a complete portfolio of solutions for customers. And we're seeing existing customers grow and expand their use cases. Hantz Group, a Michigan-based wealth management firm, is using e-signature to deliver a fully digital experience for its clients through a proprietary mobile app and is expanding their use of DocuSign products with notary, SMS, identity verification, and monitoring. Our APIs and strength in compliance made DocuSign the best choice for Hantz and they've made DocuSign the standard across their entire organization, which will approximately double their use of our products. Second, we're also investing towards broadening our value proposition beyond e-signature and into agreement management. In Q3, we shipped embedded agreements that deliver a seamless signing experience directly on our customers' websites and applications. In addition, we launched Microsoft Power Automate for the generation of personalized, professional-looking documents for signing directly from Microsoft Power Automate flows. We also launched foundational features and functionality that help us expand beyond e-signature into wide-scale agreement management. These features deliver customer delight and remove friction from all aspects of the agreement process. We see the success of CLM as a proof point that there are broader agreement management use cases to address customers of all sizes. CLM continues to grow well, particularly with North American enterprise customers. And for the fourth year in a row, our CLM solution was recognized as a leader by Gartner in contract life cycle management, noting our strong market understanding, product strategy, and road map vision, including upcoming Generative AI enhancements. This quarter, we expanded a relationship that began more than five years ago with Veeco USA, a leader in workplace innovation. Veeco began using DocuSign e-signature and has added CLM as part of its transformation into a digital services company. Our AI solution will help Veeco streamline and enhance search and review of executed customer contracts with actionable insights to better serve its customers. Thank you to our partners at Spaulding Ridge, who are helping to strengthen our commitment and partnership with Veeco. As we look ahead, we envision serving similar customer needs not addressed by CLM via a broader agreement management platform designed for all of our customers in all segments. We are previewing with select customers now and will have much more to share on our product road map and strategic vision at our Momentum User Conference in April 2024. Across both our e-signature core and future agreement management products, we believe our investment will lead to even further differentiation in a competitive market. We're encouraged by steady win rates and excited for the impact we can create for customers. This past quarter also demonstrated execution against our second pillar, improved omnichannel go-to-market where we gained traction across our direct sales, digital, and partner engagement. Our international business spans all channels as an important part of our addressable market. It's really an untapped opportunity for DocuSign's expansion. In Q3, our international revenue grew approximately three times faster than our North American business. We also saw traction in the adoption of our identity education solutions, which meet stringent regulatory standards in the EU and elsewhere. And in Q3, we launched a Japanese localized version of our CLM product. The recently launched WhatsApp integration also highlights our international ambitions. Our digital channel once again grew at a faster rate than our direct business during the quarter, a strong sign that our product-led growth initiative continues to drive new customer acquisition and top of funnel activity. We continue to optimize our site and remove friction from the try-and-buy journey while creating a more personalized experience with improved localization. We're seeing particular strength in new customer acquisition in our international markets as well as improved conversion rates in the trial to pay license purchase conversion rates. Our trusted brand and product strength continue to be assets for our direct sales team. Mountain America Credit Union, one of the biggest credit unions in the US, has reduced the time it takes to close a credit card application by 30% by integrating DocuSign with its proprietary loan origination system. Mountain America switched to DocuSign from a different electronic signature provider in part because our strong brand reputation inspires confidence from its members, but also because our rich catalog of best-in-class APIs give its developers the flexibility to create solutions that are customized to its exact needs. That is enabling Mountain America to deliver a seamless, minimal click experience that aligns with the standards members expect from their financial institutions. An important pillar of our go-to-market plan is strengthening our partner ecosystem. In October, we hosted our first-ever partner day. It was fantastic to meet with our system integrators, resellers, and software vendors from around the world, sharing our commitment to growing our business together. As an example, the ISV Embed pay-as-you-go initiative we announced in Q2 is accelerating and driving new customer wins. Before I pass it to Blake, I want to address some progress on our third strategic pillar: our company's focus on financial and operational efficiency. In the quarter, we delivered record operating margin and free cash flow. While we continue to invest for long-term growth, we will also continue to be strong financial stewards of the business. We still have a lot of work to do, but I am pleased with our progress over the past 12 months. I am more confident than ever in the value we can create for our customers, our business, and the scale and strength of our customer base. We're in the early stages of our journey to expand beyond e-signature into agreement management. But there is very concrete customer validation of the market opportunity and meaningful progress towards our goals. Thank you to the DocuSign team who've inspired me with their commitment to this transformation. With that, let me turn it over to Blake.
Blake Grayson, CFO
Thanks, Allan, and good afternoon, everyone. As I approach my six-month anniversary at DocuSign, I remain excited about the long-term opportunity and our team's execution against the three key pillars we've outlined previously: Accelerating product innovation, enhancing our omnichannel go-to-market strategy, and strengthening our financial and operational efficiency. We delivered solid results in Q3, demonstrating the stability of our business model. In the third quarter, total revenue increased 9% year-over-year to $700 million, and subscription revenue grew 9% year-over-year to $682 million. We continue to drive solid new customer growth during the quarter, despite the challenging macro and software buying environment, which is evidence of DocuSign's durable value proposition. In addition, I'm proud of our operational execution highlighted by strong profitability and free cash flow generation. While we have much work still to do, we are making progress. Third quarter billings rose 5% year-over-year to $692 million. As expected, expansion headwinds continued to impact year-over-year billings growth. These dynamics are also visible in our dollar net retention, which was 100% in Q3. Expansion rates continue to be tempered by spending optimization and IT budget scrutiny. We expect dollar net retention to trend downward in Q4. That said, we are encouraged by a few early data points evident in our results this quarter. First, we saw year-over-year consumption stabilization or improvement in a number of verticals, including business services, technology, and insurance. Financial services, by contrast, continue to be more impacted. Although real estate also continued to be pressured by the interest rate environment, it improved on a year-over-year basis for the third quarter in a row with significant opportunity for further improvement. We're increasingly operating in a post-COVID environment, and I'm pleased that our weighted average contract duration continues to remain consistent at 18 months. Also, by the end of this fiscal year, we expect only around 10% of our book of business to be from contracts signed during calendar years 2020 and 2021. DocuSign's value proposition is broad-based, and we benefit long-term by doing business with customers across a diverse set of sectors and segments. Second, we are pleased with the early progress we are seeing from our investments in the omnichannel go-to-market efforts. Driven by our direct sales efforts, the enterprise segment showed some early potential relative to performance in previous quarters. The number of customers with annualized contract values greater than $300,000 rose slightly to 1,051 from 1,047 in the prior quarter and was approximately flat year-over-year. This increase is an improvement after two quarters of sequential declines. Also, our CLM business grew double digits year-over-year. As enterprise customers continue to optimize their e-signature spend, we are seeing some customers taking advantage of our CLM product. Enterprise customer adoption is encouraging because CLM is the early proving ground for investment in a broader agreement management use case for our entire customer base. In addition, within our omnichannel pillar, international revenue grew 18% year-over-year, reaching $185 million in the third quarter, representing 26% of our total revenue. This was a slight acceleration in year-over-year growth from the previous quarter. Most international markets remain at an early adoption stage due to regulatory history and cultural habits. At the same time, however, international represents the largest portion of our TAM, and I'm pleased to see continued success of our hybrid go-to-market strategy. Related to the investments we're making in our PLG and self-serve motions, digital revenue growth outperformed direct. Digital remains the primary source for new customer acquisition, and we added approximately 36,000 new customers in Q3, bringing the total customer base to 1.47 million, up 11% year-over-year. This includes the addition of approximately 7,000 direct customers, bringing the total number of direct customers to 233,000, a 15% year-over-year increase. Turning to our third strategic pillar. We delivered strong margin expansion and healthy cash flow during Q3, highlighting our focus on operating and financial efficiency. Non-GAAP gross margin for the third quarter was 83%, in line with the prior year. Third quarter non-GAAP subscription gross margin was 86%, also in line with the prior year. Q3 non-GAAP operating income reached a record $187 million, representing a 27% margin, up nearly 400 basis points from 23% and $147 million in the prior year. During the quarter, we increased focus on investment prioritization, hiring plans, and operating expenses. There will be continuing opportunities for greater efficiency even as we invest to drive long-term growth. Q3 non-GAAP EPS was $0.79, a $0.22 per share improvement from $0.57 last year. We ended Q3 with 6,945 employees compared to 7,522 the year prior and up from 6,748 in Q2. We will remain disciplined with our headcount investment. Hiring will continue to focus on opportunities to drive sustainable long-term growth, like those in R&D. Operating cash flow for the quarter was $264 million compared with $53 million in the same quarter last year. While an ERP transition impacted last year's cash flow results, I'm proud of the significant free cash flow we generated this quarter. Third quarter free cash flow was a record $240 million, representing a 34% margin compared with $36 million or 6% a year ago. Over the last 12 months, we've generated over $750 million in free cash flow, underscoring the strong fundamentals of this business. With regards to the balance sheet, we exited Q3 with $1.7 billion in cash, cash equivalents, and investments. This includes the repayment of $37 million of convertible debt that matured during the quarter. Our balance sheet remains strong, and we have ample liquidity to address the remaining convertible debt of $690 million that matures next month. Turning to our share repurchase program, we redeployed excess capital during the quarter and repurchased 1.8 million shares for approximately $75 million. In addition to our share repurchase program, during the quarter, we used $36 million to pay taxes due on RSU settlements, reducing the diluted impact of our equity programs. We remain committed to opportunistically returning capital to our shareholders. With that, let me turn to guidance. For the fourth quarter and fiscal year '24, we expect total revenue of $696 million to $700 million in Q4 or a 6% year-over-year increase at the midpoint and $2.746 billion to $2.750 billion for fiscal '24 or a 9% year-over-year increase. Of this, we expect subscription revenue of $679 million to $683 million in Q4 or a 6% year-over-year increase at the midpoint and $2.670 billion to $2.674 billion for fiscal '24 or a 9% year-over-year increase. For billings, we expect $758 million to $768 million in Q4 or a 3% growth rate year-over-year at the midpoint and $2.835 billion to $2.845 billion for fiscal '24 or growth of 7% year-over-year. We expect non-GAAP gross margin to be 81% to 82% for Q4 and 81.5% to 82.5% for fiscal '24. We expect non-GAAP operating margin to reach 22.5% to 23.5% for Q4 and 24% to 25% for fiscal '24. We expect non-GAAP fully diluted weighted average shares outstanding of 207 million to 212 million for both Q4 and fiscal '24. In closing, we're pleased to report a quarter of consistent execution against our three strategic pillars: accelerating product innovation, enhancing our omnichannel go-to-market strategy, and strengthening our financial and operational efficiency. We have a strong foundation with well over 1 million customer relationships and improving product momentum. We remain focused on creating shareholder value by investing in durable long-term growth, delivering on our profitability goals, and generating sustainable free cash flow. We look forward to keeping you updated on our progress as we focus on helping our customers accelerate their business growth, mitigate risk, and enable customer experiences that are easier and more delightful. That concludes our prepared remarks. With that, operator, let's open up the call for questions.
Operator, Operator
Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Jake Roberge with William Blair. Please proceed with your question.
Jake Roberge, Analyst
Hey, thanks for taking the questions. I understand NRR is a trailing metric and I appreciate the color that Q4 will see another decline. But are we starting to get visibility in the trough for that metric now that you're putting those headwinds from the multiyear COVID contract behind you and maybe the new product investments start layering in more meaningfully next year?
Blake Grayson, CFO
Sure, I'll address this and Allan can jump in as needed. Just to remind everyone, dollar net retention, or DNR, refers to our direct business for clients that have been with us for over a year. As you noted, we are seeing a downward trend, consistent with what we have shared before. As mentioned in our prepared comments, we anticipate continued pressure in Q4. The macro environment remains challenging, with companies closely examining their investments, which results in fewer expansion opportunities for us. This is somewhat of a lagging indicator. Therefore, my main focus, and the company's focus, is on what steps we are taking to stabilize and improve our situation in the long term. As mentioned, initiatives like intelligent agreement management and innovative product developments, including enhancements in CLM, pricing, and packaging, as well as stronger product-led growth in our self-service offerings, are vital for helping us boost our win and renewal rates over time. We have observed some early signs of optimism, such as increased consumption across several sectors. There has also been an improvement in sticky future adoption compared to last quarter on a year-over-year basis. The percentage of our direct customers using five or more additional features rose to 58% in Q3, an increase from Q2, marking a 12-point year-over-year gain. While these early signs of potential optimism are encouraging, it's still too soon for us to set any specific targets or timelines. However, we believe that by concentrating on our product management and go-to-market initiatives, we can look forward to a more promising future.
Jake Roberge, Analyst
Okay. Helpful. And then just a follow-up on those products you were talking about. When do you think CLM becomes a more meaningful part of the business where it actually starts impacting expansion rates instead of NRR just being really driven by e-signature consumption? It seems like you've been talking about the potential for that product suite for a few years. But what do you need to do to get that product the more main stage with customers?
Allan Thygesen, CEO
Yes, I'll take a shot at that. First, I want to emphasize that CLM is a key early example of our larger vision for intelligent agreement management, which is predominantly aimed at enterprises. We've faced challenges due to the extensive services and customization that current CLM products require. Our goal is to simplify this process, making it easier and more enjoyable for companies of all sizes to utilize the platform. This is a major focus for us right now. We're in the initial access phase for some crucial components, and over the coming quarters, we plan to expand this to a wider array of customers beyond just CLM and DocuSign or any other vendor's reach. We believe this will create significant opportunities everywhere.
Jake Roberge, Analyst
Helpful. Thanks for taking the questions and well done on the nice execution.
Operator, Operator
Thank you. Our next question is from Josh Baer with Morgan Stanley. Please proceed with your question.
Josh Baer, Analyst
Great. Thanks for the question. Wanted to dig in on margins and the margin outperformance. I was hoping you could provide a little bit more context on the source of upside in the quarter? And then how to think about the trajectory of investments going forward? Like the full year guide was raised. Just wondering if there's been sort of any changes in the investment philosophy, pulling back in any areas or just letting more of the upside flow through to the bottom line? Thanks.
Blake Grayson, CFO
Sure. I appreciate the question. So with regards to the outperformance on the operating margin, we made a concerted effort, I would say, starting kind of like late September to inspect and rationalize investments across the business. It's really just about increasing focus on, what I would call, disciplined spending while we continue to invest in the areas that have longer-term growth aspirations. During Q3, we prioritized investments. And so that includes the rate of hiring, the value opportunities for organizational efficiency, but then also overall operating expenses with a focus on leveraging existing resources where possible, but still being able to invest for longer-term growth. With regard to your question on the trajectory and the investment philosophy, we're all big believers here in a balanced outlook, which is we need to be able to invest to get the long-term growth and achieve those aspirations that we have. But at the same point in time, we need to be efficient and productive with the assets that we have. And so I really am proud of the team for embracing that. And so I don't think no investment, I would say, philosophy changes from our part. But I would just say a little bit maybe kind of more executed focus on that for us and we were able to show some pretty good performance, I think, this quarter and I'm really proud of the team for that level of execution.
Josh Baer, Analyst
Thank you.
Allan Thygesen, CEO
Yes, I would just echo, if I can just echo Blake's point that the entire management team, not just like is very focused on this balance that he referenced. We absolutely want to free up capital and that is a team effort to look everywhere in the company to free up resources where we can then invest more particularly on the product side. We did some of that earlier this year, as you know, but it's an ongoing continuous effort, not just a one-time thing, and I think that's reflected in the results.
Operator, Operator
Thank you. Our next question is from Brent Thill with Jefferies. Please proceed with your question.
Luv Sodha, Analyst
Hi. This is Luv Sodha on for Brent Thill. Thank you, Allan, and Blake for taking my questions. Maybe first, just wanted to ask, obviously, you're guiding to 7% year-over-year billings growth for fiscal '24. I guess I know you're not guiding to fiscal '25 just yet, but how should we think of the growth trajectory for next year, especially as you come through some kind of trough on the NRR side?
Blake Grayson, CFO
Sure. I'm really proud of the progress we've made in a short time. This includes improvements in operational efficiency and accelerating product evolution and innovation. In the third quarter, we enhanced our operating margins and generated significant free cash flow. I believe we are shifting our mindset across the company. As I mentioned earlier, our long-term strategy focuses on balancing durable growth with operating efficiency. Our top priority is to make the right strategic investments to drive business momentum and billings in the coming years. This is particularly important given the scale of our business, and while it doesn't happen overnight, we're confident we have the right product focus and leadership team to achieve this. You noted that we are still in the midst of our planning and forecasting for next year, and we will provide our formal fiscal year '25 outlook during the Q4 earnings call in three months. As you consider next year, I suggest looking at the Q4 exit rate trends and the potential for improved efficiency in our existing business and operating expenses. Additionally, it's important to factor in historical seasonality as we move from Q4 to Q1, which includes fewer days in the quarter. We'll provide our formal fiscal '25 guidance during the next quarter's call.
Luv Sodha, Analyst
Got it. And one quick follow-up, if I may. Just wanted to ask about your philosophy around stock-based compensation? Thank you.
Blake Grayson, CFO
Sure. I believe the philosophy on stock-based compensation is to provide incentives that help attract and retain top talent, which is essential for achieving our growth goals. In the current quarter, our stock-based compensation represented 23% of revenue, showing a slight increase from last year. This rise is primarily due to the new management team and their compensation, rather than changes across the rest of the company. We are slightly above our peer average in this aspect, and we are mindful of it. Ultimately, it's a balanced approach, as we aim to attract and retain the right talent to facilitate our next growth phase at DocuSign, and we are closely monitoring this issue.
Luv Sodha, Analyst
Thanks.
Allan Thygesen, CEO
Yes, I would just add, we have that. We discussed that topic with the Board and the Compensation Committee and we will share our longer-term plans. But our goal, as Blake said, is to manage it down over time without fundamentally disrupting our ability to execute. It was necessary to attract a new management team and to rebalance our employees following the stock decline, but I think we're in a more normalized set now, and we should be able to manage to something more towards the benchmarks.
Operator, Operator
Thank you. Our next question is from Brad Sills with Bank of America. Please proceed with your question.
Bradley Sills, Analyst
Great. Thank you so much. I wanted to ask about a comment Allan you made earlier in the call that I think you're seeing increased conversion in the top of funnel business. Would love to get some more color on there. Do you feel like there's some learning there? I know this has been a priority for you since joining the company and building that top of funnel. So any color on that end of the business and the conversion uptick that you mentioned?
Allan Thygesen, CEO
Yes. Well, so I think you all know, we acquire a tremendous number of new customers every quarter. And most of those, the vast majority of those come in via our website and onboard themselves. And then over time, we grow them. And as they show potential and opportunity, then we engage them with our sales teams and our support to customer success teams. I would say that our digital motion has made significant improvements during the course of this year. So for customers that are in essence natively digital, we have improved that part of the funnel, not only can buy more things, you can upgrade your existing plans. All of that stuff is working much better now. We're adding more international currencies every quarter. So all of those things are helping improve the performance of our digital business. In addition to that, we are in the process of building out the ability for customers who are currently serviced through our sales teams to handle a number of activities themselves without human assistance. And that has very high leverage both in terms of providing a better offering to our customers and in terms of freeing up our sales teams to work on higher-value work. But I think we still have some quarters to go on implementing that and seeing the full benefit of that. So the benefits of this self-serve PLG project continue to accrue and will accrue into next year. But we're seeing really good progress in that business which is growing faster than our direct business. And it's improving on most performance metrics. So that's, yes, very happy with the progress there.
Bradley Sills, Analyst
Great to hear. Thanks, Allan. And then one, if I may, the net revenue retention, dollar-based net revenue retention coming down next quarter, could you just help unpack that for us a little bit on gross versus expansion? Is gross kind of holding and this is mostly expansion related? I know it's a backward-looking metric. But if you could just help us unpack that a little bit on the growth side? Thank you.
Allan Thygesen, CEO
There's not much more detail that we will disclose publicly about it. It's a metric for us that we believe we can stabilize and eventually reverse if we successfully deliver on our product innovation, roadmap, and self-service initiatives. This is something we are focused on, although it is a lagging metric, so it will take time to see changes. There was nothing in Q3 that stood out as different from the previous quarters.
Bradley Sills, Analyst
All right. Thanks so much.
Operator, Operator
Thank you. Our next question is from Michael Turrin with Wells Fargo Securities. Please proceed with your question.
Michael Turrin, Analyst
Hey, great. Thanks. I appreciate you taking the questions. Blake, I wanted to spend some more time on the consumption commentary that you provided. Certainly helpful. I'm just wondering if there's anything else you can tell us in terms of the shape of those improvements. How that compares to prior periods? And when you're talking about consumption for DocuSign, is that mainly signature volumes? Or are there other attributes of customer profiles we should be considering as part of that commentary?
Blake Grayson, CFO
Sure, that's a good question. Thanks for asking. When we discuss consumption currently, it's mainly focused on the e-signature sector, particularly the envelopes used. We're looking at year-over-year usage by our customers. Some of the verticals I've mentioned have shown stronger year-over-year growth in consumption over the last couple of quarters. We remain cautiously optimistic about this. It’s important to note that some verticals are still facing challenges, like financial services and real estate, which is expected given the current interest rate environment. However, I find some optimism in that real estate has shown year-over-year improvement over the last three quarters. It’s an encouraging sign, but still not close to where it was before the interest rate challenges we’ve faced over the past year. We’re excited about this progress but also see significant remaining opportunities. As the macro environment begins to normalize in certain sectors, we believe we will benefit from that. This is relevant because we serve a wide range of verticals and have a diverse customer base. Therefore, when improvements occur, we expect to gain from them. Your insight on the timing of this normalization might be as good, if not better, than mine.
Allan Thygesen, CEO
I don't know if any of us can accurately predict when that happens.
Blake Grayson, CFO
Go ahead.
Allan Thygesen, CEO
No, that one maybe not. I would like to add to what Blake mentioned; we view consumption as an imperfect yet significant leading indicator of renewal. This is why we monitor it closely and discuss it. We're observing some modestly encouraging signs in consumption trends compared to the commitments made by customers. Additionally, as we approach the end of the COVID situation, we have a few quarters left of COVID-related renewals, but that has already declined significantly and is less impactful on our business, which is a positive development.
Michael Turrin, Analyst
That's all very helpful. I have another question regarding the leading indicators. I understand it's a bit noisy, but billings this quarter are down compared to the previous one. Last quarter, you mentioned that it wasn't about early renewals, but rather the timing of renewals had some improvements. Did that perhaps assist Q2 in comparison to Q3, or does it help clarify the seasonal trends and factors that can cause fluctuations in that metric from quarter to quarter? Thank you.
Blake Grayson, CFO
Yes, definitely. In Q3, we saw billings growth of 5%, compared to 10% in Q2 year-over-year. I'm pleased with our Q3 results, as we exceeded expectations. The differences from Q2 to Q3 are driven by three main factors. First, we faced a tough comparison in Q3, as historical data shows our billings growth in fiscal '23 was about 17% year-over-year, the highest of that fiscal year, largely due to strong early renewals boosting Q2 from the previous year. Although renewals are still strong this year, we are contending with a difficult comparison. Second, there is the impact of on-time renewals. As mentioned in previous calls, we've benefited from higher on-time renewals in the first half of '24, but this effect diminishes throughout the year. We're performing well with on-time renewal execution, but its impact on year-over-year growth becomes smaller in the later parts of the year. Lastly, lower expansion rates are affecting billings. With IT budget scrutiny, executives are focusing on doing more with less and finding cost management opportunities. This, along with broader macroeconomic factors, influences overall billings growth, as reflected in the DNR rates. However, as both Allan and I have pointed out, we're observing some improvement in consumption trends quarter-over-quarter. It's still early for us, and we hope to maintain this momentum in the coming quarters. Overall, these factors contribute to the deceleration in year-over-year growth between Q2 and Q3.
Michael Turrin, Analyst
Appreciate the details. Thank you.
Operator, Operator
Thank you. Our next question is from Tyler Radke with Citi. Please proceed with your question.
Tyler Radke, Analyst
Yes. Thanks for taking the question. I'm not sure if this is who this is for, but I guess as we think about the product set for next year, obviously, there's a lot of organic investments you're making on the Gen AI side. Can you just talk about how you expect that the product set available products and upsells to evolve next year? And with the launch of some of these generative AI services, how does that kind of change the philosophy around still kind of offering an envelope based signature product rather than something more subscription based that's not tied to envelope? Thank you.
Allan Thygesen, CEO
Yes, there's several points in there. First, I'd just say, look, our CLM business is growing faster than our signature business, and I expect as we launch this broader intelligent agreement management platform to a broader set of customers that pattern of that broader category growing faster will continue. The second point you made about the envelope versus subscription basis. We are, in fact, already experimenting with should we say, unlimited envelope billing models for a variety of customers. So for very large customers, we have entered into some enterprise license agreements. And those have been, I think, quite helpful at one very large bank that we did one with and they, after they signed that agreement, they proceeded to remove a competing solution from some of their workflows. And I think we have that opportunity across some of our very large customers. And then in the commercial segment, the mid-market and SMB segment, we're now competing more directly with some of our lower-priced competitors who have offered unlimited envelope packages. And not surprisingly, if you give people a competitive unlimited envelope from DocuSign versus a lesser branded, less well-featured product then they choose DocuSign. And so we're seeing really, really positive results and to the point where I expect that we will continue to broaden that rollout. So overall, I'm feeling quite good about our evolution and our response to competition on multiple fronts as well as the broadening of our product roadmap that you alluded to in the first part of your question.
Tyler Radke, Analyst
Okay. Great. And Blake maybe a question for you on free cash flow. So very, very strong here in the quarter relative to consensus expectations. How should we be thinking about just free cash flow for the full year, was there any one-time items in that number? And as you think about next year, what seems to be kind of an increased operational discipline, should we be thinking about free cash flow margins expanding kind of consistently with operating margin expansion? Just anyway to think about that medium-term framework. Thank you.
Blake Grayson, CFO
Sure. So, yes, really happy with the $240 million cash flow that was generated this quarter. It's a combination of just ongoing strong operating results. But we also did have some working capital improvements that impacted that number. When you look at the cash flow statement, you're going to see there the changes in operating assets and liabilities, and we've really had a strong improvement on the collection side on an AR. And so that's great. And so that it drives it. And then I said this in the prepared remarks, comparing to prior year can be a little tricky because of the ERP transition that happened prior year. So we had a more muted free cash flow generation number. But regardless of that, really excited about the free cash flow we got. Now to your question on the yield, it was really strong. It was 34%. And while I'm a big fan of the working capital tailwind and I'm really proud of the team for the discipline and the improvements there, that can be something that's challenging, right, to pile onto every year going forward. There's always some good working capital improvements you can make. But I think that if you think about this business in the long-term, it's probably fair to assume that your free cash flow yield trends a lot closer to your operating margin yield. So as long as you make operating margin improvements, you should be able to capture most of that right down to the free cash flow line. But then also in this business, the beauty of this business from a free cash flow perspective is that if you can drive operating margin improvement and you can drive reaccelerated billings growth because of the way our working capital works, your free cash flow generation can really accelerate. And so like this is a much longer-term period that I'm talking about, but it is the power of this model, which is super exciting. And so I do think, though, like, I mean I think in the span of time, you would think free cash flow yield should trend closer to your operating margin yield that we've been. We've done better than that and free cash flow pretty significantly better than that in free cash flow this quarter, but it's mostly on the back of those working capital improvements or not mostly, but a large chunk of it. And so you have to be cautious about assuming that you're going to expand on those every quarter.
Tyler Radke, Analyst
Great. Thank you.
Operator, Operator
Thank you. Our next question is from Karl Keirstead from UBS. Please proceed with your question.
Karl Keirstead, Analyst
Okay. Great. I'd love to go back to the comment when you were describing the puts and takes on the vertical side when you mentioned that FINS felt a little bit more pressured or impacted. Just curious, was that a comment about the more rate sensitive mortgage-related transactions or was that a broader comment on FINS? And I'm wondering if your fourth quarter guidance reflects any anticipation of the FINS vertical stabilizing? Thank you.
Allan Thygesen, CEO
Yes. I'll just start, and Blake, you can add. Look, I think in terms of the mix impact of financial services, I think that's mostly behind us, but we have experienced that over the last several years, both on the mortgage side and financial services industry. And we saw some in the smaller banks, for example, that IT spend froze with all the turmoil in the spring, some of the very largest banks have also had particularly aggressive cost management efforts. I'd say overall, we've seen some modest recovery. It's still growing a little slower than the business overall, but trending better. And we'll see what happens with interest rates. Our current forecast assumes that macro conditions continue as they are. I recognize there's optimism they may get better. We'd love that, but we don't want to move that in our guidance.
Blake Grayson, CFO
Yes. Just to follow up, my general philosophy is that I avoid making macro forecasts as a team because, as we've joked about earlier in the call, it's a challenging business to predict. Instead, we forecast based on what we observe. If circumstances were to change, we would address that variance.
Karl Keirstead, Analyst
Great. Thank you.
Operator, Operator
Thank you. Our next question is from Patrick Walravens with JMP Securities. Please proceed with your questions.
Patrick Walravens, Analyst
Great and thank you. Congratulations on the business turning here. It's great to see. So Allan, how is DocuSign's relationship these days with Salesforce? Historically, I know it's been really strong. The reason I ask is during Dreamforce. This year, they had a session on Salesforce contracts, and they sort of laid out the road map for Salesforce contracts where they have AI functionality coming in the spring and then obligation management in the summer and then redlining the year after that. So I'm just wondering how are things with Salesforce?
Allan Thygesen, CEO
I believe our relationship with Salesforce is as strong as it has ever been. We renewed our strategic partnership this summer, and I recently met with one of their senior executives. It's a very healthy relationship across all levels. We have a more Salesforce-enabled business than with any of our other software partners, including other large software companies. Salesforce continues to be a trading partner. Regarding the CLM side, they have a contract offering that they initially provided through their vertical products but are now generalizing. The challenge is that the market is shifting towards a horizontal model, as nearly two-thirds of all CLM RFPs we encounter involve a centralized contract management system across various departments like procurement, HR, and others. This focus could be difficult for Salesforce and other large companies that specialize in specific workflows. I anticipate continued close collaboration with Salesforce on both the signature and CLM aspects. While I am not particularly concerned about the Salesforce contracts element, it's important to remember that Salesforce is a remarkable company and partner.
Operator, Operator
Thank you. Our next question is from Kirk Materne with Evercore ISI. Please proceed with your question.
Kirk Materne, Analyst
Yeah, thanks very much. Allan, I was wondering, if you could just double-click a little bit on the international opportunity. You called it out in the prepared remarks. Is that largely sort of PLG-led right now, or are you thinking about sort of bringing more direct sales into play over in certain geographies? Can you just give us some sense of how you view that opportunity, given you're obviously less penetrated outside the US? Thanks.
Allan Thygesen, CEO
Yes, we are taking a comprehensive omnichannel approach that is specific to each market context. We have a robust team of direct sales representatives in key international markets such as the UK, France, Germany, and Australia, and we also serve Canada and Brazil, along with a few others. Traditionally, this was our main go-to-market strategy. Currently, we are balancing direct investments with a strong return on investment, along with a digital strategy that allows us to reach 180 countries. In certain countries, it makes sense for us to partner rather than deploy direct sales teams. For smaller emerging markets, having a direct sales presence may not be viable, but we also won't be able to take full advantage of the opportunity solely through digital means. We have significant potential in both areas, and we are witnessing growth in our digital channels, with international growth outpacing domestic, as well as in our direct channels. This trend will continue. As we consider our priorities for additional investment, both in direct sales and the supporting functions necessary for effective market strategies, we have focused on Germany and Japan. These markets had some direct sales presence, but we had not invested sufficiently in marketing or back-office areas like legal and finance, or product development. Since spring, we have prioritized our efforts there and are making solid progress. We opened an office in Munich and have one in Tokyo, and we have launched localized products, including the Japanese CLM product and various identity verification solutions, with more on the horizon, particularly aimed at the EU and Germany. We're aggressively investing in our direct sales efforts in our top ten global markets, along with a combination of partnerships and digital strategies in other markets. Some smaller countries will be served solely through digital means, and that's our approach.
Kirk Materne, Analyst
Perfect. Thank you very much.
Operator, Operator
Thank you. Our next question is from Mark Murphy with JPMorgan. Please proceed with your question.
Sonak Kolar, Analyst
Great. This is Sonak Kolar on for Mark Murphy. Thank you for taking the question. Allan, can you provide an update on any changes you may be seeing in the competitive dynamics for the e-signature market, particularly towards the lower end market that you called out in the past? Just curious if there's a sense that DocuSign e-signature efforts are helping with the retention and competitive wins, particularly within those users of basic e-signature use cases?
Allan Thygesen, CEO
Yes. As I mentioned in previous quarters, I don’t see a significant change in the competitive landscape. For larger clients, we might encounter local competitors in specific international markets, including Adobe and others. For smaller clients, there are various names that may not be as well-known. I have not observed any changes in our win rates for competitive deals. I am cautiously optimistic about some of the initiatives I previously mentioned, such as our new pricing and packaging, which appears to be resonating effectively at both ends of the market. Additionally, at the very low end, where products are being integrated into workflows, we have significantly improved our solutions for ISVs to embed DocuSign. We've also introduced a more flexible billing model called pay-as-you-go, which has shown strong growth since its launch in Q2. Overall, I believe we are doing quite well, and I don’t see a meaningful change in the competitive dynamics.
Operator, Operator
Thank you. There are no further questions at this time. I would like to hand the floor back over to Allan Thygesen for closing comments.
Allan Thygesen, CEO
Thank you. Thank you, operator, and thank you all for joining today's call. So this quarter, DocuSign was especially effective at making progress on our product initiatives while balancing those investments with operational efficiency. So we are continuing to build on our considerable scale as we expand beyond e-signature into intelligent agreement management. Thanks for your time. Look forward to seeing all of you next quarter.
Operator, Operator
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.