Zuora Stock: More Pain Likely Ahead (NYSE:ZUO)

Zuora, Inc. (NYSE:ZUO), a company that provides a platform to help companies implement recurring revenue business, has come under pressure recently as it works to cut costs while boosting revenue.

It has done fairly well on the revenue side, but on the earnings side, it continues to take a big hit, resulting in the company needing to cut 11 percent of its workforce in order to lower costs.

The share price of the company has fallen off the cliff over the last year or so, dropping from a high of approximately $23.00 per share on November 15, 2021, to close at $7.21 on December 6, 2022.

With companies taking longer looks at spending in the current economic environment, it has either taken longer to get new deals in place, or they have been temporarily put off until there’s more clarity concerning the economy.

In this article, we’ll look at some of the recent numbers from ZUO’s earnings report, steps the company is taking to lower costs, and what the next year looks like.

Some of the numbers

Revenue in the third quarter was $101.1 million, up 13 percent year-over-year. Subscription revenue accounted for $86.6 million of the total, and Professional Services the remaining $14.5 million, which was down 6 percent from the same quarter of 2021.

The company expects Professional Services revenue to be about 13 percent to 14 percent of total revenue going forward. That’s not bad considering its subscription revenue should continue to grow, so if it’s able to keep pace, the 13 percent to 14 percent should represent consistent growth over time. On the other hand, it’s not going to improve earnings because the company has stated it will continue to run Professional Services at or near breakeven, which is how it played out in the quarter, with a negative gross margin of 1 percent.

Subscription gross margin in the quarter was 79 percent, down by about 90 basis points from the same reporting period last year, primarily from investing in infrastructure to accelerate scale.

ARR in the reporting period was $350.7 million, up 19 percent year-over-year. Free cash flow in the quarter was negative $7.2 million.

At the end of the quarter, the company had cash and cash equivalents of $401 million, down $48 million, primarily from the acquisition of Zephr. Management updated its free cash flow outlook for the year, changing it from the prior negative $13 million to negative $16 million, to a negative $33.5 million to a negative $36.5 million.

In response to the losses, the company decided to cut 11 percent of its workforce, resulting in a one-time expense of about $9.5 million. Cost savings on an annual basis will be around $29 million.

No matter how things play out, the company says it’s committed to a non-GAAP operating margin of a minimum of 6 percent in 2023.

At the end of the quarter, the company had cash and cash equivalents and short-term investments of $400.6 million

Growth challenges over the next year

Management noted that in the third quarter, things had significantly changed in how companies were looking at spend in regard to upsell.

It was stated that its install base customers were becoming a lot more cautious concerning increasing volumes for 2023. So not only are things slowing down in the near term but they are expected to remain under pressure throughout 2023.

On the positive side, retention rates remain high, but that is becoming less likely to translate into upsells over the next year.

The level of the impact on ZUO will be determined by how the economy performs in the months ahead, and how much clarity companies will have as they consider spending decisions.

With that in mind, looking at ways to rein in costs is probably the best way to go forward in the near term, while at the same time getting as much out of its installed base as it can.

Subscription services are going to continue to grow over the long term, but they’re going to slow down in adaptation in 2023 until the economy improves, inflation goes down, and the Federal Reserve provides more clarity concerning its interest rate policy.

Lack of economic clarity a major issue

On the part of its existing customer base and potential new customers, the major problem ZUO faces in winning new business is the lack of clarity concerning the economy that has made it harder for businesses to make long-term predictions concerning the demand for their products and services.

Until that is resolved, it’s going to continue to be difficult to increase revenue at meaningful levels. I think it’s probable that it’ll continue to boost revenue in the quarters ahead, but at a smaller percentage than it has been.

The question now is whether its recent 52-week low of $6.135 is the bottom, or it has further to fall. The answer to that I think is at what level the company improves earnings and free cash flow. If it shows improvement even if revenue slows down, I think the stock should be able to bounce off its recent lows in the quarters ahead, assuming revenue doesn’t contract too much.

If losses remain substantial while revenue slows down, we’ll probably see ZUO’s share price test new lows.

Conclusion

ZUO is in a difficult place at this time because it’s operating in a trend that should continue to grow but is doing so while generating significant losses.

Taking steps to mitigate losses by reducing its workforce was a good step, but it does bring about the question of why it took so long to do so when the company believes it’s not going to be negatively impacted by the lower number of workers.

The company has plenty of available liquidity to ride through a difficult economic storm if that’s what’s coming in 2023, but its major challenge is in driving revenue when many companies are starting to tighten up on spending and/or delaying investment until there is more clarity concerning the economy.

While the company was able to deliver on the high end of its revenue guidance in the third quarter, I think it’s going to struggle to grow at the same pace it has recently.

Because its installed base is getting more nervous about the economy over the next year, the consequence should be less spending in the quarters ahead, which will put downward pressure on revenue. If it can execute on cutting costs and improving losses and free cash flow, its share price could find support, if not, it’s going to be a tough year for shareholders until the economy improves.

As for an entry point, this isn’t a bad one for investors looking to take a new position or add to their existing positions. I would dollar-cost average as an investing strategy because of the lack of visibility heading into 2023. Even though the share price has plunged over the last year, it could definitely fall further under the current market conditions.

Over the long haul, I believe ZUO will continue on in its upward growth trajectory, but it’s going to take some time to regain momentum. In the meantime, if it improves its bottom line, it’s going to be well-positioned to take advantage of the market when it starts to sustainably recover.