Earnings Call Transcript - DOCU Q3 2020

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for joining DocuSign's Third Quarter Fiscal 2020 Earnings Conference Call. This call is being recorded and will be available for replay from the Investor Relations section of the website after the call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. I will now pass the call over to Anne Leschin, Head of Investor Relations. Please go ahead.

Anne Leschin, Head of Investor Relations

Thank you, operator. Good afternoon everyone. Welcome to DocuSign's third quarter fiscal 2020 earnings conference call. On the call today, we have DocuSign CEO, Dan Springer and CFO, Mike Sheridan. The press release announcing our third quarter results was issued earlier today and is posted on our Investor Relations website. Before we get started, I'd like to let everyone know that we will be participating in the UBS Global TMT Conference on December 9 in New York and the Needham Growth Conference on January 15 also in New York. As other events come up, we'll make additional announcements. 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. 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. Non-GAAP financial measures exclude stock-based compensation expenses, amortization of acquired intangible assets, amortization of debt discount and issuance costs from our notes and, as applicable, other special items. 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 or 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 information and most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release, which can be found again on our website at investors.docusign.com. I'd now like to turn the call over to Dan. Dan?

Dan Springer, CEO

Thanks, Anne and good afternoon to everyone on the call. I'd like to start today with some brief updates on two areas of our business: one, our positive financial results for the third quarter and how we are driving demand for the DocuSign Agreement Cloud led by our core eSignature offering; two, a quick recap of our vision and strategy since going public last year and how we've continued to execute against that for Q3. I will then hand it over to Mike for a deeper discussion of our financials, after which we can open up for Q&A. So first, let me start with some comments on our third quarter. As many of you know, DocuSign's growth is driven by three primary factors: increased adoption and use case expansion within our existing customer base, the acquisition of new customers, and the development of new solutions that help companies modernize their systems of agreement. We believe our Q3 results reflect ongoing progress across all of those factors. With strong demand for the DocuSign Agreement Cloud, we grew revenue by 40% year-over-year to $250 million and billings by 36% year-over-year to $269 million. We acquired 25,000 new customers, approximately 5,000 of which were direct, bringing our total number of paying customers to 562,000 worldwide, of which roughly 69,000 are direct. We were again profitable on a non-GAAP basis with operating income of nearly $17 million and this is our eighth consecutive quarter of positive non-GAAP EPS. We also saw a solid uptick in our dollar net retention rate to 117%. These positive results showcase the demand for our Agreement Cloud suite remains strong as we head into our largest quarter of the year. Next, I'd like to share how we are progressing on the vision and strategy we laid out when we went public last year and how we continue to execute in Q3. By now, you're probably familiar with our Agreement Cloud vision. It builds on top of our global eSignature leadership and helps companies automate and connect their agreement processes, both before and after signatures take place. We first discussed this during our IPO. And at that time, we reinforced the importance of our core eSignature business and clearly articulated the $25 billion opportunity which is still only about 5% penetrated. We also showed how that Total Addressable Market (TAM) could potentially double with the expanded opportunity for the rest of the Agreement Cloud. Over the past 18 months, we've taken several steps to deliver on that vision. We acquired SpringCM in September last year and we have integrated its technology and talent into our product line and operations. Our own product development team built and delivered several new agreement cloud solutions and we partnered with specialist companies to resell select additional products that expand our offering. We then brought all this together under the Agreement Cloud umbrella. Our suite of more than a dozen products now includes over 350 prebuilt integrations that help organizations connect and automate their agreement processes. We also collaborate with systems integrators like ATG, Simplest, and Spalding Rich, who are building out Agreement Cloud practices and broadening our ability to drive success for our joint customers. Amid all of this, we have continued to enhance the functionality of our core eSignature offering, with features like responsive signing, where the Agreement automatically adapts its formatting to the size and type of the device that the signer is using. In Q3, we continued this momentum by announcing two new Agreement Cloud products. The first is DocuSign Negotiate, which helps companies that don't yet need a full-blown Contract Lifecycle Management (CLM) solution to simplify and accelerate the process of generating, redlining, and negotiating agreements. We just launched the initial version in November and it's optimized specifically for the Salesforce ecosystem. The second is DocuSign CLM, which is the next generation of SpringCM's flagship product, including all the capabilities of DocuSign Negotiate plus an end-to-end workflow builder, a centralized contract repository, and a clause library. It is targeted at upper mid-market and enterprise customers. But we are still in the early stages of our Agreement Cloud journey. We are pleased with our progress to date. By expanding our portfolio, we are motivating customers to automate more of their agreement processes, which in turn drives even more eSignature. This virtuous cycle is illustrated by some interesting customer expansions we had in Q3. One of the global leaders in ridesharing has used both DocuSign eSignature and CLM in their sales, HR, and business operations for many years. Building on that success, the company expanded its use of CLM in Q3 to include departments for commercial transactions, emerging technologies, and legal. This significantly increased the size of our commercial relationship. Additionally, a large U.S. credit union increased its eSignature usage by 300% this year and in Q3 also made a commitment to use our API to integrate eSignature into its other systems. This company plans to expand eSignature to 10 additional business units next year and will also evaluate using DocuSign CLM for potential implementation. A mobile analytics company expanded its use of eSignature into HR, leveraging our integration with the recruiting software provider, Greenhouse. This is a great example of how the Agreement Cloud integration drives departmental expense, which in turn drives revenue from greater usage. As I bring my remarks to a close, I want to reiterate, when we went public, we had a strong eSignature business and a vision to expand our offerings for the entire agreement process. We have executed on that vision and the customer response has been strong. Based on our progress, I believe we are in a unique position to create and be a leader in the next big platform category, the Agreement Cloud. Just before I hand over to Mike, I also wanted to share two quick executive team updates. The first is that our Chief Product Officer, Ron Hirson, will be taking a mid-career break to focus on a health issue in his family. Ron and I have talked about this transition at great length and he's going to stay with us through the middle of next year. Even though we're incredibly sad to see him leave, we support his decision. We really appreciate his incredible impact during his six-year tenure, and we're proud of the team he's built to continue the innovation at DocuSign. The second update is our creation of a new Chief Trust and Security Officer role, which former United Airlines CISO Emily Heath is taking on. Emily has an incredible pedigree in the InfoSec industry and she will oversee information security, application and physical security, and trust services for the company out of our San Francisco office. We're thrilled to have someone of Emily's caliber join us in this vital role. That's it for me. Thanks for joining us today. And now Mike will walk you through the Q3 financials.

Mike Sheridan, CFO

Thanks, Dan, and good afternoon everyone. As a reminder, our non-GAAP financial results exclude stock-based compensation, amortization of intangibles, amortization of debt discount, and employer payroll tax on employee stock transactions. Also, having acquired SpringCM in September last year, this is the first quarter that will include SpringCM in comparable periods from a year ago. Our third-quarter results reflect solid execution, delivering strong top-line growth and profitability while continuing to drive customer success. Total revenue rose 40% year-over-year to $250 million, and subscription revenue grew 41% to $238 million. Total international revenue grew over 40% year-over-year to $43 million. Total billings increased 36% year-over-year to $269 million. On a four-quarter rolling average basis, billings growth was 35%. Strong demand from our core eSignature solutions coupled with growing adoption of our broader portfolio of Agreement Cloud products continued this quarter. We added approximately 25,000 new customers this quarter, 5,000 of which were direct customers. This drove a 30% year-over-year increase in our commercial and enterprise installed base. This brings our total customer base to 562,000 with roughly 69,000 direct customers worldwide. We saw notable strength in upsells into our installed base, with particularly strong contribution from our North American business. We also continue to see progress in upsells of DocuSign CLM into our installed base. The combination of these factors increased our dollar net retention to 117% this quarter, within our historical range of 112% to 119%. Customers with Annual Contract Values (ACVs) greater than $300,000 grew 41% year-over-year to a total of 401 customers. Non-GAAP gross margin for the third quarter was 79%, consistent with a year ago. Subscription gross margin was 84% compared with 85% a year ago. Total non-GAAP operating expenses for the quarter were $180 million or 72% of total revenue, compared with $142 million or 80% of total revenue for the third quarter of last year. With the settlement of the RPost litigation, G&A returned to more normalized levels in the third quarter. Non-GAAP operating profit was $17 million or a 7% operating margin in Q3. This compares to a $1 million non-GAAP operating loss or negative 1% operating margin in Q3 of fiscal 2019. We ended the quarter with 3,723 employees, a year-over-year increase of 28%. Operating cash flow was negative $2 million as we paid out the RPost settlement in the third quarter, this compares with a positive $4 million in Q3 of last year. Free cash flow came in at negative $14 million, compared to negative $4 million in the prior year. As anticipated, the RPost litigation payment together with planned real estate investments, including our office in Dublin and our Fed data center, impacted our cash flow in the quarter. Turning to our guidance, we estimate first-quarter revenue of $263 million to $267 million in Q4 and $962 million to $966 million for fiscal 2020. In addition, we expect billings of $346 million to $356 million in Q4 and $1.083 billion to $1.093 billion for fiscal 2020. We are maintaining our guidance for non-GAAP gross margin of 78% to 80% for Q4 and fiscal 2020. For Q4 and fiscal 2020 non-GAAP operating expenses, we are maintaining our guidance of sales and marketing in the range of 48% to 50% of revenues, with general and administrative expenses in the range of 10% to 12% of revenues. For the fourth quarter, we expect $3 million to $4 million of non-GAAP interest and other non-operating income including interest income and expense associated with our convertible debt. For fiscal 2020, we expect non-GAAP interest and non-operating income of $16 million to $17 million. We expect the tax provision of approximately $1 million to $2 million for the fourth quarter and $5 million to $6 million for fiscal 2020. We expect fully diluted weighted average shares outstanding of 190 million to 195 million shares for Q4 and fiscal 2020. In summary, we are off to a great start in the second half of fiscal 2020 and look forward to executing on our strategic and financial goals. Thanks again for joining us today and we can now turn to Q&A.

Operator, Operator

Our first question comes from Pat Walravens with JMP Securities. Please proceed.

Pat Walravens, Analyst

Okay, great, thank you very much and forgive the background noise and congratulations. Hey, Dan, do you mind commenting to start out just on sort of what you saw from a macro point of view, is there any weakness anywhere domestically or internationally? And then also I'd love to hear your thoughts on how the channels delivered during this quarter?

Dan Springer, CEO

Absolutely Pat. So from a macro standpoint, we haven't seen anything very different really across the geographies. One of the things we talk a lot about is – I'm not sure DocuSign will be the best bellwether for understanding economic change as our customers have such a high ROI with our product. I think it would not be the initial sort of expenditures that would be cut, but we haven't seen anything really across any of the markets where we operate that is different this quarter compared to the last few quarters. We continue to think it's a strong market for our products and services. From the channel standpoint, we have many strong channel relationships with key players, and interestingly, we've become much more focused on the partner side in terms of systems integrators. We've seen good strength in both areas, particularly the progress we've made in going to market with systems integrators. I think that's a really positive indication of the Agreement Cloud as a whole broadening, particularly in the DocuSign CLM side, which requires more integration opportunity. We're super excited about the progress there.

Operator, Operator

Our next question comes from Dan Ives with Wedbush Securities. Please go ahead.

Dan Ives, Analyst

Yes, thanks. Can you talk about international in terms of what type of growth you're seeing there? I mean there's really feel like it's starting to inflect in terms of what you're seeing in the field? Thanks.

Mike Sheridan, CFO

Hi. I'll start. Yes, we saw good growth globally, with international revenue growing over 40% again this quarter. Most of that, of course, as you can imagine, is new customer logos in emerging markets compared to the U.S., where we had a lot of upsell contributions as well. In terms of CLM, we're seeing good growth in the U.S. on CLM. We are also focusing internationally, but we haven't made as much traction internationally as we have domestically.

Dan Ives, Analyst

Great. And then can you just talk maybe just from a sales cycle perspective how things are changing? Does it just feel more strategically in terms of how the conversations are going with enterprises, the upselling? So maybe, obviously, we see the numbers, maybe you could just talk about it in terms of the type of conversations you're having with customers and now it's changing compared to over the last three, six, nine months. Thanks.

Dan Springer, CEO

Yes, I think the vast majority of our business is still eSignature-heavy. As such, that hasn't changed. But we have seen changes, particularly in the mid-market and enterprise, really in line with your question where people are asking for broader conversations about the overall Agreement Cloud. As we discussed previously, this approach sometimes elongates those conversations and sales cycles, but can lead to larger overall deals, and we've seen that reflected in our dollar net retention increasing. We're seeing some nice uptick in this area because we believe we can continue to broaden and upsell there. Interestingly, we noticed an intriguing phenomenon during the early rollout. We had sales cycles getting delayed, but now that we're a few quarters into this, some deals get pushed from one quarter to the next, and others are being delayed further out, resulting in a balanced view. Our ability to understand and forecast that has improved as we move through the year.

Operator, Operator

Next question comes from Sterling Auty with J.P. Morgan. Please go ahead.

Sterling Auty, Analyst

Yes, thanks, quick question, how did you do in federal and how is the traction given the opportunity that you see there?

Dan Springer, CEO

So I think federal continues to be one of the areas we spend a lot of time focused on because we think it's a significant opportunity. We had a very exciting, big-ticket win last time. As we've mentioned, those will come from time to time. However, similar to our core business, it is more about steadily growing those core relationships. One thing that we're quite excited about is our IL-4 investment that Mike talked a lot about, and we now have that active. Our first customer is using that platform, and it's still early; it’s not close to its full potential, but it’s indicative of the progress we see there and our expected growth in that vertical.

Operator, Operator

Next question comes from Alex Zukin with RBC Capital Markets. Please go ahead.

Alex Zukin, Analyst

Hey guys, thanks for taking my question. Maybe just the first one, if I look at the Negotiate product that you announced at Dreamforce, what's the opportunity set within your customer base? How big is that opportunity to sell Negotiate? Is there an opportunity to announce something similar with some of your other partners like SAP? I’ve got a quick follow-up.

Dan Springer, CEO

Yes, I think of Negotiate in the context of customers who don't necessarily need the entire CLM solution, given the nature of their business and complexity or scale. So we built Negotiate specifically for those customers. We are really pleased with the initial reception we received at Dreamforce; there was significant demand for understanding how they could leverage our eSignature solution, which they already love, to address a broader piece of their agreement cloud needs. We feel good about that. The primary demand will likely come from mid-market and smaller businesses, which is where we see the most potential. We will also, as you mentioned, aim to continue developing our capabilities across other partners — primarily in the CRM area, like Salesforce, where managing sales processes is crucial.

Alex Zukin, Analyst

Perfect. And then Mike, just a question on the favorite topic of billings. Different quarters have different dynamics with both pushes and pulls of deals or durations. Anything that you’d comment on either as a headwind or tailwind for billings in the quarter? How should we think about that as we look at next quarter with the guidance?

Mike Sheridan, CFO

Yes, I would tell you, Alex, that billings this quarter and for next quarter, the dynamics are the same. There aren’t any underlying changes in the business. If you look at Q1, Q2, and Q3, you go from 27% to 41% to 36%. As we’ve talked about over time, the fourth-quarter rolling average provides a better view, and I think if you look at our guidance, it’s consistent with that. We’ll continue to have that statistic subject to fluctuations that are more related to timing than growth.

Operator, Operator

Next question comes from Stan Zlotsky with Morgan Stanley. Please go ahead.

Stan Zlotsky, Analyst

Hey guys, good afternoon, and thank you for taking my question. I wanted to come back to international because of the impressive results there. Within international, which geographies are you guys seeing the most traction? I have a quick follow-up for Mike.

Dan Springer, CEO

My perspective is that internationally, it's been strong across the board. There are definitely areas of focus where you'll see us talk more in the coming year about our investments and focus areas, where we see that enthusiasm. But the strategy has been consistent: we want to focus on a core set of countries. We initially had most of our success in common law countries like the U.S., UK, Australia, and Canada. Now we're also seeing traction in civil law countries like France, Germany, Brazil, and Japan — all exhibiting significant market traction.

Stan Zlotsky, Analyst

Got it. And then Mike, just a quick one more sanity check on the favorite topic of billings. Following up on the question earlier, did FX impact billings in the quarter? And on net revenue retention, a very nice 117% result there. How should we think about net revenue retention heading into Q4 and beyond? Thank you.

Mike Sheridan, CFO

Yes, Stan. So on FX, not really any material impact or trending change. The 117% figure is something we’re very happy with. I mentioned a couple of the contributing factors. I also laid out our historical range, and as I’ve said in prior quarters, right now, our business seems to perform in the mid-teens. We can have strong quarters or less strong quarters, but overall we feel good about staying within that range. I take this as proof that offering this broader portfolio of products is beginning to gain traction.

Operator, Operator

Next question comes from Rishi Jaluria with D.A. Davidson. Please go ahead.

Rishi Jaluria, Analyst

Hey, guys. Thank you for taking my questions. First, I wanted to ask a higher-level question about the idea of verticalization of your solutions. You've obviously had some success on the real estate and mortgage side. How do you think about future potential for verticalization to increase your footprint in verticals that you may not have a significant presence in today? I’ve got a follow-up.

Dan Springer, CEO

Yes, first and foremost, Rishi, this is a horizontal software platform and will remain so at its core for years to come. That applies not just to eSignature, but really across the overall DocuSign Agreement Cloud. However, we certainly have certain verticals where we've been successful and others where we've done additional software development, such as healthcare and life sciences, where we focused on specific use cases related to CFR Part 11 for drug development. In general, you'll continue to see us focus on how we go to market with verticals and build broader solutions through services and systems integrators, rather than developing separate software for each vertical. In terms of new verticals, we believe we have a broad presence already. However, government, particularly federal, was not a major opportunity for us before FedRAMP and IL4, so that represents potential additional growth.

Rishi Jaluria, Analyst

Got it. That’s helpful. And then I wanted to follow up on Pat’s question about the macro situation, wondering about customer buying behavior. We’ve heard a few SaaS companies indicate that customers have been shifting more to monthly rather than annual contracts. I know you've disclosed average contract length is typically 18 to 19 months. Is there anything you’re seeing in terms of this shift?

Dan Springer, CEO

We really haven’t. When it comes to the macro question, it’s certainly something we actively discuss. We meet with our sales leaders to understand if we’re noticing anything different in the marketplace. So far, we haven't observed anything significant. Specifically regarding contract duration, we have not seen it change notably. Mike, do you have anything else to add?

Mike Sheridan, CFO

Yes, just to summarize, the underlying billing patterns in the business today remain stable. While some customers prefer to push for monthly or quarterly billings, we generally don’t allow that except in rare cases. And just as a reminder, we still bill multi-year deals out annually.

Operator, Operator

Next question comes from Karl Keirstead with Deutsche Bank. Please go ahead.

Karl Keirstead, Analyst

Hi, a question for Mike. I’d like to ask you about the seasonality of billings. It’s common for SaaS companies past $1 billion in revenue to see traditional Q4 seasonality. Your billings guidance for this year aligns with last year’s 32.6%. I'm curious if we're seeing a potential inflection. While you aren’t going to provide billings guidance for fiscal 2021 now, could you comment on any anticipated seasonality changes?

Mike Sheridan, CFO

I would say, Karl, nothing appears to indicate a change. You’re correct; the natural trend for SaaS businesses is to see more traditional seasonality over time. Therefore, we will likely observe that going forward, but I wouldn't anticipate dramatic changes compared to what you observed this year.

Karl Keirstead, Analyst

Got it. And Mike could I ask a follow-up? I’m sorry, you went through it a little quickly, but do you mind going back to that 117% net retention number? It’s significant and the highest number since you went public. Can you repeat the factors that contributed to that and why it’s a leading indicator to pay attention to?

Mike Sheridan, CFO

Certainly! The 117% net retention is indeed significant, and I want you to recognize that it’s something to monitor closely. This quarter was strong, with the biggest contributors being exceptional upsells in North America. Our commercial business in North America had a stellar quarter, and we also saw increased traction with upsells of CLM into our installed base. All of these factors combined resulted in that uptick. As I’ve mentioned in prior quarters, we expect to remain within our historical range of 112% to 119%. Currently, we anticipate further stabilization in the mid-teens as we move forward.

Operator, Operator

Next question comes from Kirk Materne with Evercore. Please go ahead.

Kirk Materne, Analyst

Yes, thanks very much, and I'll add my congratulations on the quarter. Dan, were there any commonalities across the customer base that are adopting the CLM product currently? Which verticals are showing more interest in that product today? Additionally, are you engaging higher levels within the customer, leading to more senior-level discussions?

Dan Springer, CEO

Yes, a couple of thoughts: I wouldn’t say there's a dramatic trend from a vertical standpoint. However, we're seeing demand for CLM capabilities across several overarching verticals, including telecommunications, financial services, and government. The distinction from our broader eSignature mix is that there is a tendency for customers seeking CLM capabilities to have specific processes, particularly in sales. We've oriented our offerings, particularly with Nagotiate for the Salesforce ecosystem, because of its presence in managing sales workflows. While it helps to speak to higher levels occasionally, it remains consistent with our original model, primarily involving core leaders of business units or functions seeking to modernize their System of Agreement.

Mike Sheridan, CFO

Yes, regarding cash flow yield, just remember that we are on track for the long-term target model of 20% to 25% operating margin. Cash flow is projected to precede that as we’re a SaaS subscription business and bill upfront. You can expect a lag in operating margin, and cash flow will be overall above that.

Operator, Operator

Next question comes from Bhavan Suri with William Blair. Please go ahead.

Bhavan Suri, Analyst

Hey, thank you for taking my question. Like everyone, I want to echo my congratulations on a fantastic quarter. I wanted to touch on the analytics product. You've mentioned leveraging data to provide analytics, as many SaaS companies have. I’m curious about the timeline, potential use cases, and how you see this impacting your TAM.

Dan Springer, CEO

Certainly! When discussing analytics, we typically speak about several components. First, we have our analytics offerings centered on reporting, which allows administrators using DocuSign to understand usage and where in the organization it's utilized. Next, there's the opportunity for customers to extract insights from their agreements, aiding them in their operational decision-making. We’re also collaborating with Seal, a company we invested in, to create advanced search capabilities. This capability allows clients to manage their agreement systems better and glean insights. For example, our bank clients can quickly find agreements that reference LIBOR and manage their implications extensively. We believe these features represent growth opportunities for us.

Bhavan Suri, Analyst

Understood. The ability to analyze and manage contracts appears powerful. For competition, have you seen any changes? Are you observing more competition from HelloSign after its acquisition by Dropbox? Any changes on that front?

Dan Springer, CEO

There's nothing notably new in terms of competitive dynamics. We regularly review this aspect, especially before calls like this one. Our sales teams have not reported significant changes throughout the year. Competitive pressure typically arises not from competitors offering better solutions, but rather from lower-cost providers trying to lure users to switch. Such dynamics remain consistent with previous quarters. Thank you all very much for joining us. We'll look forward to seeing you out on the road and talking to you next quarter. Thank you.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.