Qualtrics International Inc. (NASDAQ:XM) Q3 2022 Earnings Conference Call October 24, 2022 5:00 PM ET
Rodney Nelson - Head, Investor Relations
Zig Serafin - Chief Executive Officer
Chris Beckstead - President
Rob Bachman - Chief Financial Officer
Conference Call Participants
Kirk Materne - Evercore ISI
Gabriela Borges - Goldman Sachs
Keith Weiss - Morgan Stanley
Robert Dee - Truist
Mark Murphy - JPMorgan
Keith Bachman - BMO
Raimo Lenschow - Barclays
Arjun Bhatia - William Blair
Bhavin Shah - Deutsche Bank
Brent Bracelin - Piper Sandler
Brian Peterson - Raymond James
Ladies and gentlemen, thank you for standing by. Welcome to Qualtrics Third Quarter Fiscal Year 2022 Earnings Call. At this time all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to Rodney Nelson, Head of Investor Relations. Please go ahead.
Thank you, operator. Welcome to Qualtrics third quarter 2022 earnings conference call. On the call, we have Zig Serafin, CEO; Chris Beckstead, President; and Rob Bachman, CFO. Following prepared remarks, we will open the line up to answer questions. Our results, press release and a replay of today’s call can be found in the Qualtrics’ Investor Relations website.
During today’s call, we will make statements that represent our expectations and beliefs concerning future events that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be relied upon as representative of our views as of any subsequent date.
We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations.
For further discussion of the material risks and other important factors that could affect our financial results, please refer to our filings with the SEC, including our quarterly report on Form 10-Q for the quarter ended September 30, 2022, that will be filed with the SEC.
With that, I will hand the call over to Zig.
Well, thank you all for joining us, and welcome, Rodney. We are grateful to have you on the Qualtrics team. So as you saw in the numbers, we delivered strong revenue growth and operating margin improvement in the quarter. This shows the critical role Qualtrics plays for our customers in this macroeconomic environment and the discipline our team is bringing to this moment.
Revenue for the quarter grew 39% year-over-year to $378 million, subscription revenue was up 43% year-over-year to $315 million and our current remaining performance obligations rose to $1.05 billion, a 34% year-over-year increase. Coming off of this strong quarter, we are raising our revenue guidance for our fiscal year to $1.451 billion at the midpoint.
Our customer relationships remain extremely strong and they continue to grow, which is highlighted in the 32% year-over-year growth and customers spending more than $100,000 annually.
Our Q3 non-GAAP operating margin rose to 6%, up 400 basis points from Q2. This is our third consecutive quarter of operating margin improvement. We have been investing with discipline as we continue to deliver top line growth.
Against the backdrop of macroeconomic and geopolitical uncertainty, we are seeing a more measured buying environment and increased executive scrutiny on purchase decisions, particularly with new customers. Our current expectation that this challenging macroeconomic environment will persist through 2023.
At the same time, we see compelling opportunities to deepen relationships with our customers and expand the ways that we support them. Our existing customers are continuing to invest more deeply with Qualtrics even with constrained budgets and you can see that in our 124% net retention rate.
I was out on the road again in Q3 meeting with executives all over the world. And while everyone has a slightly different view of where the economy is headed, one thing is universal. They are all focused on making the right investments across their business to win in this downturn. They cannot afford customer churn or low employee productivity, knowing what matters most to their customers and employees is mission-critical.
Globally, $4.3 trillion in customer spending is at risk each year due to poor customer experiences and it costs an organization six months to nine months of an employee’s salary to replace them. The impact of losing a high performer is far greater, but knowing how to avoid these types of risks can be difficult, especially with competing priorities and intense pressure and that’s where Qualtrics gives organizations the ultimate advantage. Our platform helps them quickly identify and resolve points of friction across the customer journey from the website to the contact center.
We also help organizations understand exactly why employees are frustrated and what’s preventing them from being successful, so they can take real-time action to reduce unwanted attrition and increase productivity. And we help our customers do it with empathy, speed and scale.
In Q3, global leaders like Domino’s, L.L.Bean, KB Bank in Korea, U.S. Centers for Medicare and Medicaid, City Football Group, Intermountain Healthcare and the State of Missouri, all chose Qualtrics to improve their most critical employee and customer experiences. We expanded our relationship with one of the world’s largest financial services companies to transform the way that they deliver care to their millions of customers worldwide.
Qualtrics XM Discover’s advanced AI capabilities will analyze every customer care conversation with a focus on resolving issues faster and with more empathy. Qualtrics will help them boost agent productivity, increase customer satisfaction and reduce compliance risk, all at incredible scale.
We also formed a new relationship with Ascension, one of the nation’s leading health systems. They selected Qualtrics CustomerXM, including Engage and Discover, to get a single view of their patients and optimize their experiences across every digital touch point. We are proud to help Ascension deliver personalized and compassionate care to the diverse communities that they serve.
And in the quarter, we expanded with the U.S. Census Bureau, the nation’s leading provider of quality data about its people and the economy. They added new capabilities in DesignXM and chose EmployeeXM to increase their workforce productivity.
Stronger engagement from Census employees and external audiences will help the bureau better understand how the economy, employment, health and education impact the United States and all its residents.
Being the leader in XM gives us and our customers a competitive advantage. We have more experience data than anyone else. Our platform brings together all of the feedback people have provided over time, billions of data points, and combines it with operational data such as digital click streams, call center frequency and customer churn, as well as intelligence data like effort, emotion and intent, and then we use sophisticated AI and automation to help our customers take the right action at the right time.
For instance, we help them discover and take action on things like, which service to offer a customer next or when to intervene with a frustrated caller. The actions that customers take with Qualtrics are critical to improving the experiences that they deliver.
Let me give you an example. When a flight is delayed, one leading global airline uses xFlow to automatically inform flight attendants when a passenger on their flight will miss the connection, then allows them to be able to help rebook and offer drinks or miles before the passenger leaves their plane. They use hundreds of thousands of these automated actions every month to deliver a superior customer experience.
I mentioned before that companies can’t afford to make the wrong decision right now. They have to be right and we have been innovating to unlock data across our platform to help our customers make smarter decisions across their business.
Our new products reflect this. We have been focused on customer-driven innovations critical to our key buyers with launches like the following, XM Benchmarks, which allows customers to uncover their biggest risks and opportunities based on the XM Platform’s billions of data points.
Another example is Real-Time Agent Assist, which uses AI and automation to deliver real-time coaching to contact center agents, so they can quickly take the next best action to solve customer issues.
We also launched Video Feedback, which helps organizations capture customer, prospect and survey responded feedback in their own words.
And we launched CrossXM, which enables leaders to see how their employee, customer and brand experiences impact one another, so they can take action to drive the business forward. A leading global retailer is already using CrossXM to powerfully correlate how employees drive customer experiences and simplify complex decisions.
With CrossXM, they discovered that when retail employees felt they had training to do their jobs and they knew what was expected of them and received regular feedback from their manager, those employee saw higher performance and better customer satisfaction. Be sure to watch our XM Innovation Event this week. You will see that there’s going to be a powerhouse lineup of new products that are especially relevant to what customers are needing today.
Our partner ecosystem is a powerful driver of customer success and it continues to grow in both breadth and depth. We have deepened our partnership with Amazon. Since launching in the AWS Marketplace in February, Qualtrics has become one of their fastest growing ISV partners in the horizontal business application space and a top five seller in the AWS Marketplace.
And the XM Platform becomes even more powerful, as we grow our ecosystem and increase our automations and workflows. Those connections with leading CRM, CDP and HRS systems bring more operational data on to the XM Platform and enrich Experience ID across our thousands of customers.
Experience ID captures customer’s feedback from call center transcripts, social media posts, product reviews and more, and it connects with the operational data from companies like SAP, Salesforce, ServiceNow and Genesis, and this helps companies take the right action in the context of their business across each customer’s journey with the company. In Q3, we reached 8.8 billion Experience IDs in the Qualtrics XM directory. This is the largest database of human sentiment.
Now before I close, I wanted to let you know that X4, the premier gathering of experience management professionals in the world is coming back in March in 2023 and you are all invited. This will be our first large in-person event since COVID and you don’t want to miss this one. X4 is our most powerful moment to launch products and to bring customers and partners together and I look forward to seeing you there.
Now to close, our results continue to demonstrate the durability of our business and the value of our platform in solving our customer’s most critical challenges. We are the only company that brings together employee, customer, product and brand experience management together on a single platform and we remain well-positioned to extend our market leadership through this cycle.
As we embark on the last few months of 2022, we will continue to be nimble and disciplined in how we invest for growth, while working toward our long-term financial targets of over 20% operating margin and over 20% free cash flow margin. I’d like to thank our customers and our partners for putting their trust in Qualtrics. In the midst of uncertain times, they are investing more deeply with us.
And finally, I am grateful for our employees all over the world who bring that customer obsession to the work that we do every day.
Now over to you, Rob.
Thanks, Zig, and good afternoon, everyone. As Zig said, we generated strong growth and profitability in the third quarter. Total revenue was $377.5 million in the third quarter, up 39% year-over-year. Subscription revenue in the third quarter was $314.8 million, up 43% year-over-year. Professional services and other revenue was $62.8 million for the third quarter, representing 22% growth year-over-year.
Our remaining performance obligations representing all future revenue under contract ended the quarter at $1.895 billion, up 39% year-over-year. This metric includes both new and renewal software contracts, along with our professional services business.
Current remaining performance obligations, which is all future revenue under contract that is expected to be recognized as revenue in the next 12 months was $1.047 billion, up 34% year-over-year.
Third quarter calculated billings were $331 million, up 17% year-over-year. FX movements resulted in a headwind of approximately 2.5 percentage points to calculated billings in the third quarter.
Our XM Platform is mission-critical for customers in these uncertain times, as demonstrated by our net retention rate of 124%, while gross retention rate remained consistent with historical levels. Customers spending more than $100,000 in annual recurring revenue grew 32% year-over-year to 2,199 customers.
Turning to margins, our Q3 non-GAAP gross margin was 76.2%, consistent with the prior quarter. Our non-GAAP operating profit for the third quarter was $22.6 million, resulting in a non-GAAP operating margin of 6%, compared to 4.9% in Q3 of 2021. The increase in our third quarter operating margin reflects our slowed pace of hiring and ongoing investment discipline, as we focus on durable and efficient growth.
Operating cash flow for Q3 was negative $29 million compared to flat in the year ago period. Free cash flow in the quarter was negative $39 million compared to negative $13 million for Q3 of 2021. As a reminder, free cash flow may fluctuate on a quarterly basis due to the timing of cash collections and we believe it’s best to assess our cash flow performance over an annual cycle, given the billing seasonality in our business. We ended the quarter in a strong cash position with approximately $732 million in cash and cash equivalents and no debt.
Moving now to our Q4 and fiscal year 2022 business outlook, we are seeing a more measured buying environment, as management teams apply more scrutiny to budgets and spend. We continue to remain disciplined with our investments and our business is demonstrating both durable growth and improving profitability, which is reflected in our outlook.
We expect total revenue for the fourth quarter to be $380 million to $382 million, representing 21% growth year-over-year at the midpoint. Within this, we expect subscription revenue to be in the range of $323 million to $325 million, representing 25% growth year-over-year at the midpoint. We expect non-GAAP operating margin in the range of 5.5% to 6.5% and non-GAAP net income per share of $0.02 to $0.03, assuming 595 million weighted shares outstanding.
For fiscal year 2022, we expect total revenue in the range of $1.45 billion to $1.452 billion and subscription revenue in the range of $1.219 billion to $1.221 billion. At the midpoint of the ranges, this represents a subscription revenue growth of 40% year-over-year and a total revenue growth of 35% year-over-year, respectively. We expect non-GAAP operating margin of 4% as implied by our Q4 guide. We expect a non-GAAP net income per share between $0.04 and $0.05, assuming 590 million weighted shares outstanding.
As we wrap up 2022 and plan for 2023, we are excited by the opportunity to take share as the category leader in experience management, while delivering consistent progress toward our long-term financial targets of 20% plus operating margin and 25% plus free cash flow margin.
With that, Zig, Chris and I are happy to take your questions and we will turn it back to the Operator.
Thank you. [Operator Instructions] Our first question comes from the line of Kirk Materne with Evercore ISI. Your line is open.
Yeah. Thanks very much. Zig, could you just talk about the operating environment today versus maybe 90 days ago, and what you are seeing in particular in terms of some of the softness in terms of new deals and maybe how that changes when you get into an expansion opportunity? And then if I could just add one for Rob as well. Rob, could you just talk -- I know you don’t like a -- you don’t really -- you don’t guide to billings, but could you just talk a little bit about the gap between billings in CRPO this quarter just because it’s a little wider and I am sure we are going to get some questions on that? Thanks.
All right, Kirk. Thanks. I will start off and then hand it over to Rob here just in a second. So first off, this is much more in what Rob and I just talked about here and connected to that, which is, look, there is levels of uncertainty that continue. I think that’s consistent with what we have seen in the previous quarter. And as a result of that, it’s more challenging as far as the buying environment. There is increasing scrutiny that’s in the decision-making cycle.
And I think, in particular with respect to new logos, new customers coming on. But at the same time, I would say, we have been quite pleased with the execution of our sales team, win rates remain high.
And I think in particular, the reason behind that is, there’s a movement by customers to be able to understand what’s right around the corner with their own customers and their employees and being able to make sure that they are maintaining their existing customer base, knowing where to be able to invest products, know what customer journeys will matter the most, know how to focus on being able to retain their customers.
And as uncertainty continues, people tend to zoom in and say, okay, let’s make sure that we are paying as most attention to our existing base of customers. This is where our platform has been quite relevant.
And so as a result, you are seeing win rates remain strong. You are seeing that showing up in our NRR. And so by and large, it’s a continuation of themes that we have seen before and I will let Rob expand.
Yeah. Thanks, Kirk. And I want to start and baseline a little bit on calculated billings, give you a couple of other points that I think are important, and part of that, we will then share the difference, the primary difference that you are seeing between the CRPO and the calculated billings.
So a couple of things on the calculated billings. We highlighted that we did see the FX headwinds, about 2.5% on the calculated billings this quarter as you compare that growth rate to the prior year.
And I would note on that FX that, we don’t have a crystal ball, but if those FX movements remain consistent with where they are at today relative to prior year, you could anticipate similar type of headwinds for our business into the next couple of quarters.
Then you have got a couple of other factors. This is, as you likely know, the last quarter where we don’t have Clarabridge in the prior year. The Clarabridge acquisition closed October 1, 2021. So that has an impact on your calculated billings if you are looking at a normalized versus the current comparable.
And then we did see an increase in delayed billings in the current quarter compared to prior period. That’s primarily in multiyear deals, where the first year billing amount is set to an amount that’s lower than those future years. That’s your primary difference between the CRPO and the calculated billings.
But I wanted to give you these factors because when you take the Clarabridge impact into account and the delayed billings into account, those two factors somewhat offset each other. And what you are seeing in calculated billings is reasonably representative for what we are seeing in the business on a growth rate perspective.
That’s super helpful. Thanks, guys.
Thank you. Please standby for our next questions. Our next question comes from the line of Gabriela Borges with Goldman Sachs. Your line is open.
Hi. Good afternoon. Thanks for taking the questions. Both of my questions are for Chris. So Chris, firstly, any color on regions, end markets or parts of the organization that are more willing to invest versus less willing to invest? And then as we think about the environment persisting through 2023, talk to us about your areas of focus within the sales organization from a trading and enablement standpoint? Is there anything that you are doing differently or what are you focused on as you think about operating in a harder selling environment?
Thanks, Gabriela. Happy to answer both of the areas. So one of the benefits of the Qualtrics portfolio is just the diversification that we have across geographies, across industries and honestly, across customer size.
And I think that puts us in a position where we could pivot towards areas that -- towards customers that are stronger and less impacted by the current environment. So we saw some ebb and flow across different areas of our customer base in the current quarter.
Clearly, as an example, Europe is a little bit stronger impacted due to the war in Ukraine and some of the challenges in that environment as one example. Another one is areas that are more in regulated industries may be a little bit stronger, for example, in the U.S.
And so that diversification, I think, helps provide stability in our results, as well as what was discussed previously about existing customers versus new logos, where our existing customers who are currently getting value from the platform and seeing the ROI from putting in programs, those customers are more likely to be stable and to expand their spend at Qualtrics because of that confidence and newer logos are taking increased deal scrutiny to be able to pull the trigger because they don’t have the history with us during this current period of economic uncertainty.
On your second question about what we are focusing on with the sales organization, definitely adapting to the current environment of focusing on near-term pain for our customers is one area that we are focused on ramping our existing sales organization.
And honestly, just taking advantage of this opportunity to gain share in these times of economic uncertainty, given the strength of the Qualtrics brand, our strength as the leader in the space and consolidations that are coming our way to be able to really view this as an opportunity to gain share, so we can emerge stronger once economic uncertainty starts to subside and we can accelerate off of this.
Thanks for the color.
Thank you. Please standby for our next questions. Our next question comes from the line of Keith Weiss with Morgan Stanley. Your line is open.
Excellent. Thank you, guys, for taking the question. Maybe carrying on a little bit from Chris’ comments, I think, one of the advantages Qualtrics has in this type of environment is the breadth of your portfolio, right? It’s not just a solution for your marketers, it’s for HR, it’s about your employees, your customers, your partners. Does that breadth of platform in this type of environment, do you start to see some consolidation benefits of that people say, “Listen, this is a platform we have used for multiple use cases, so we could push out some of the point solutions?” So one, do you see that as a potential or by any means coming into the story as of yet? And sort of part two on that question is, does that give us an ability to stabilize that NRR number anytime soon? Because we have seen it tick down for a couple of quarters now and I think investors are interested in kind of where would that flatten out or where could we see some support on that metric?
Thank you. Great question. Thank you. This is Zig and I will answer the first part and then Rob comment on the other piece of it. So, I mean, first off, you are absolutely right. The diversification of the product portfolio, the data sets, frankly, plays right back to the origins of how we build our systems, a single platform, a single system that allows companies to quickly find and understand where their experience gaps are, fix them, automate, scale and create advantages in their marketplace.
And these days, it’s also turning into how to take friction out of their business, where to become more effective and efficient in how they interact with their customers, but in ways that are more personal and how to connect that with the employee and workforce that they maintain and want to retain.
Innovations like CrossXM, I think, really shine a beautiful light on this, which is when you have a purpose built technology around employee experience, you have a purpose built system that spans digital to customer care and everything in between in terms of journeys and how people interact with the business and you marry those two together, you create significant advantages over and above anything else in the marketplace.
And it is part of what fuels why companies want to naturally invest more with Qualtrics, especially as they are increasingly trying to make mission-critical decisions in the way that they are running their companies.
So you are absolutely right and we are seeing that play out in the mix of our existing customer base, and then even though there’s more deal scrutiny and process involved in bringing on the next new customer, they are also very much attracted by the nature of what our system can do and actually helps to drive consolidation effects moving away from single-point solution vendors or ones that are much more outdated in their approaches. Rob?
Yeah. We are certainly pleased to deliver another strong quarter on the net retention rate of 124%. Historically, that metric has stayed above 120% for Qualtrics and it’s clearly indicative of that strong upsell and expansion motion that we have.
Now during these times of economic uncertainty, we have highlighted, just as Zig talked about, that the new logos are under more pressure on the deal scrutiny, but it can also have some impact on the existing logos and on the net retention rate. And then I would additionally add that the FX headwinds can and will have some impact on the net retention rate. So you are seeing that impact on the net retention rate.
I will go just a little bit beyond that, Keith. I think it’s really important for those on this call to understand how we think about and are operating the business. This is a combination of durable topline growth and expanding bottomline growth.
So as you see the topline growth and the impacts that we are experiencing there, you are also seeing us grow the operating margin and the profitability. And we believe that its core to running a great business that there’s stability in the topline growth and from where we are today, increasing operating margin, increasing profitability. That’s how we think about it and that’s how we are driving forward.
Outstanding. Hey. Just one clarification. Am I right in thinking Clarabridge isn’t part of that NRR metric yet because it hasn’t been around for a year, correct?
Yeah. Yeah. The next quarter -- first quarter that it will be included.
Perfect. Thank you so much guys.
Thank you. Please standby for our next questions. Our next question comes from the line of Terry Tillman with Truist. Your line is open.
Great. Thanks much for taking the questions. This is Robert Dee on for Terry. With the understanding that it’s quite early, hoping to get some color in KPIs surrounding the new real-time contact center solutions announced earlier this month. What have uptake and win rates been like so far for the solution to that, particularly versus more contact center focused competitors? And more broadly, how is the contact center vertical performing in general versus other verticals and then I had one follow-up. Thanks.
Hey, Robert. I will take that. So, I mean, at a high level, it is an area of importance for our customers. I think it massively shows the importance of how our system allows companies to change the game in the way that they have use -- they can use intelligence to operate customer care contact center environment.
The beautiful thing about Qualtrics is, you are bringing advanced AI and machine learning into that environment. It has the ability to not just support capabilities in the context of the customer care experience, but along the entire continuum of the journey that a customer has in the way that they interacted with the product, the way they interacted with an in-person interaction inside of a store or the way the business takes delivery.
And our approach to the intelligence in that system, the approach to data and the fact that it’s all running on a single platform is a game changer. And as a result, we see a fairly significant opportunity and already traction in what we are doing in that space and hence why you see the types of innovations or things like Agent Assist is one of many innovations that we have underway.
And again, I will call out what I said during the call, be sure to join the innovation event, which is in the U.S. coming on on Wednesday to take a deeper look at not only that capability but several which are customer driven and are very much of significant importance to people during this particular point in time when the economy and these innovations are particularly relevant to people in ways that help to be able to sharpen the focus on things that are most important in their companies.
Awesome. Appreciate that detail. And then just following up, great to see the CrossXM announcement last week, definitely seems like a logical next step in bringing together the CX and the EX worlds. Zig, I think, you touched on this briefly, but curious to understand what kind of upsell opportunity CrossXM presents and whether the solution could help bridge the gap for some customers currently sitting only on the CX or only on the EX side? Thanks.
Well, I mean, look, it -- one of the thing important is, it plays in along the same themes that we have had all along, which is that we are relevant to multiple buying centers, multiple budget centers inside companies.
We gain the benefit as a result of variation, diversity there, but there’s also strategic advantages. And so this is a place where when you are creating the union of capability that helps to create a little bit of a springboard effect across multiple departments and companies.
But probably most important, back to the big theme, which is helping companies to get closer to their customers, closer to the way that employees affect how customers interact with their business, getting much more personalized, whether it’s digitally accommodated, whether it’s a person directly involved, whether it’s a full digital interaction and we have a very unique advantage in how we do that.
It’s hard -- it would be hard for independent individual vendors to try to stitch together the capabilities that we have all under one roof and the agility that we provide for a company, the ability to dynamically adjust, given different trends.
All of that plays into the opportunity that we see with CrossXM. But at the same time, it’s also continuing to build on the themes you see all along with selling to multiple buying centers and then unlocking areas of capability that customers can’t do with existing vendors.
Makes sense. Thanks.
Thank you, Robert.
Thank you. One moment for our next questions. Our next question come -- comes from Mark Murphy with JPMorgan. Your line is open.
Yeah. Thank you very much. So, Zig, I was trying to parse what you said earlier, what -- did you observe that the demand environment steps down in Q2 and then held steady in Q3 or are you trying to say that the -- some of the pressures in the demand environment abated a little bit or maybe continued to mount here in Q3? And then for -- maybe for Rob or Chris, I am wondering what is your assessment of the setup for this Clarabridge Q4, which I think is a seasonally very huge quarter for that business, is there a pipeline there to finish on a pretty solid note and maybe how did you feel about the kind of the likelihood of converting on that pipeline in Q4 on the Clarabridge side?
Hi. Let me start with the first part of the answer to that and then I will let Chris elaborate. I mean, look, there’s an important set of themes. We haven’t seen demand change. It’s really important. The nature of what we do, people want to get behind the use of the technology and there’s an adoption curve. But that demand look so it continues to grow, continues to expand for us.
At the same time, we are seeing a continuation of a more challenging buying environment. That sort of shows up in more deal scrutiny, more deal cycles, more deal cycling in the buying decision itself and it particularly manifests with new logos, which is not unexpected, right? It just takes longer and you can’t necessarily tie in everything out perfectly.
But at the same time, the fundamentals of what we provide, people want to get involved and they want to take advantage of the capabilities, which is partly why we see what we see within the existing customer base and what we see as new customers do come in with their entire new logos. They come in for a lot of the same reasons, which is why demand continues to remain consistent.
Win rates continue to remain high and these are important. And the thing I will sort of reinforce here is that, when there’s uncertainty, we help companies navigate their businesses. And we also matter a lot with things that really affect how they ultimately perform on topline revenue and how they perform on bottomline, because they end up putting their resources in the right places, they end up automating things that maybe are taking too long using the capabilities of our workflow and xFlow platform or that part of our platform. So those themes are why we see the dynamic, both more increased scrutiny but also continuation of demand and that growth all along. Chris?
Yeah. To take your question regarding kind of the Discover Clarabridge technology that we have incorporated into many of our solutions, we are really pleased with how we have executed on the integration of that team.
And during early quarters post acquisition, we were closing a lot of the deals that existed prior to the acquisition, but over the course of this year have been the broader Qualtrics sales force has been trained and out there evangelizing and has been resonating with our broader customer base, as well as prospects.
And so, I would characterize the pipeline build as strong over the course of the year, setting us up for a good strong fourth quarter performance as we would want to, given the seasonality of that business and what we would have expected. We are in a good [Audio Gap] position [ph] and that solution is just resonating and the differentiation that it has of that is strong in the marketplace and our customers are excited about it.
Yeah. Thank you.
Thank you. One moment for our next questions. Our next question comes from the line of Keith Bachman with BMO. Your line is open.
Hi. Many thanks for taking the question. I wanted to ask a little bit about the cadence of free cash flow and how we should be thinking about it. And more specifically, as we think about the progression in operating margin, is that going to be the primary driver as we look out over the next few quarters, more than just the fourth quarter, as to think about the potential improvement for cash flow? And my related question is on the billings, and the weakness at least relative to our model this quarter was the billings came in below where we were thinking. And so Rob, I think to an earlier question, you talked about, look more than one quarter, but any comments you make -- you want to make specifically about fourth quarter billings, and any kind of puts and takes that we should be considering as we try to model that? That’s it for me. Many thanks.
Yeah. Thanks, Keith. They are very interrelated. So the seasonality that we are seeing in the billings this year is moving more and more back into Q4 as very clearly, which historically has been our largest quarter from a billings perspective, but that seasonality is increasing even more so this year, and that’s a function of more and more enterprise and also a function of the macroeconomic environment that we are in.
As that’s occurring, the cash flow will be set up to where it’s more challenged in the Q2, Q3 and even a bit into Q4, where in Q1 a potential for a very strong cash flow quarter as you are collecting the billings that occur in Q4 in that Q1 timeframe.
So that’s why in my prepared remarks, you heard me talk about looking at cash flow over an annual period, because that will take out the seasonality of those billings that are occurring in that regard.
And then on the calculated billings, on the growth rate, a bit to my comment, I think, I believe, for the first question. Just to highlight again, we talked about the 2.5 percentage points impact from FX headwinds in the current quarter, as well as the delayed billings, where we saw an increase in delayed billings this quarter compared to prior periods. That again was primarily in multiyear deals where the first year is set to a lower billing amount than the subsequent years.
What I was calling out earlier, so I will go through briefly again here is, that delay in billings is a pretty good counterbalance or offset to what you might think of as the organic or normalized billings, because we have Clarabridge billings in this quarter where we didn’t in the prior quarter. So when those two things balance out, the growth rate that you are getting in calculated billings is reasonably representative for the business.
Okay. Rob, and just to clarify, when I was asking about kind of the longer term progression, which would be really year-over-year, so it relates…
… to 2023 free cash flow versus 2022 since presumably you normalize for that kind of billings seasonality…
Is the primary driver in that situation going to be the lift in operating margins or is there anything else to…
… think about and the question I should have said it more clearly was really related to 2023 versus…
That is absolutely the primary driver. The added factor I would tell you is that, as we are being disciplined in our investment decisions, we will also look closely at the CapEx part of free cash flow and where spend maybe or may not be needed going into next year, particularly that CapEx comes into play relative to real estate facilities and, to some degree, new employees as they are onboarded. So it’s the combination of those two factors.
All right. Thank you very much, Mr. Bachman.
Thank you. Please standby for our next questions. Our next question comes from the line of Raimo Lenschow with Barclays. Your line is open.
Thank you. You have talked already a decent amount about the XM Discover and the pipeline that is building for the fourth quarter. Can you talk a little bit about what you are seeing in the market in terms of, like, how that will change for you as you integrate it into the other products in terms of creating a slightly better linearity for that and if you think about more 2023 and 2024 ongoing or is this always going to be like a Q4 story? And then one follow-up question for Rob, like, when you talked earlier, I think, I understood that you said, the billings adjusted for currency is probably a good indication for like underlying business. I am just trying to compare that to the bookings I am getting when I am using CRPO, which is coming in at a better clip and I am just trying to understand the moving pieces there to see or maybe I misunderstood you in your earlier comments. Thank you and great quarter.
Great. I will start. This is Zig. I will comment and then Chris will add and then Rob. You are going to get all three of us here. So, briefly, the way to think about XM Discover is that, it is integral to our overall platform. What that means is that we are weaving in a very strong and differentiated capability into all of our product lines.
And it is fit-for-purpose to change the game across a whole variety of areas in which unstructured data and analytics around unstructured data and being able to detect sentiment, emotion, effort and a lot of other capabilities to substantially advance what multiple buying centers can take advantage of, especially in a time where some of the signals that, that system provides in these budget centers really matters. That’s how to think about that. So that’s the strategy and the direction. Chris?
Yeah. To talk a little bit about how XM Discover is getting incorporated and how that might impact seasonality, the primary reason historically why it’s been more fourth quarter is because of the larger deal size and the larger customers that they have historically sold into and that aspect will continue as part of the Qualtrics portfolio as we continue to focus on that area.
However, as we do incorporate that technology into our other solutions, including across employee experience and other areas, that it will start to have a benefit across the portfolio as we use it to continue to differentiate ourselves in the marketplace and so that will provide an overall lift as well, but the core aspect of it being a bit more of a solution that has larger deal size and focused a bit more on the enterprise space will persist as you think about kind of the seasonality of billings.
Yeah. And Raimo, in regards to the calculated billings and the CRPO or CRPO bookings, so what I have called out is three factors that are impacting the calculated billings or the growth rate, which again, are the FX headwinds, the normalization for Clarabridge, this is the last quarter where you have inclusion of the Clarabridge results in the current quarter, but you don’t have it in the prior quarter, and then, the increase in the delayed billings that we saw.
The primary difference, if you are just comparing from CRPO to calculated billings, is the increase in the delayed billings that we saw in the current quarter. But there’s a nice offset there for the current quarter relative to the impact of Clarabridge and the impact of the delayed billings. Those offset each other more or less. They work in opposite directions, if you are working back towards a normalized growth rate for the business. So that’s what I was highlighting.
Okay. Thanks. Thank you. Well done.
Thank you. Please standby for our next questions. And our next question comes from the line of Arjun Bhatia with William Blair. Your line is open.
Sure and thank you. Zig, it sounds like you are adding a lot of new capabilities to the platform. We talked about, I think, CrossXM already, but you have Benchmarks, you have Real-Time Agent Assist. It seems like there’s a little bit more to come in March next year when you will make some additional announcements, I presume. But how do you think about the additional -- how you capture some of this additional value that you are delivering to customers, their pricing power that you have, do these capabilities get monetized up early or is there more of an indirect benefit that you see to the business, as you continue to innovate and broaden the platform capabilities here?
Yeah. I mean, one thing I will highlight, Arjun, is that, that we are just getting started. It’s really important. When people think about the scope and size, and what’s possible at this category, we literally think that we are just at the very beginning of what the opportunity is ahead.
And these innovations that we have announced are, frankly, a good example of what customers are asking of us. A lot of these announcements and work that we have been -- that’s been underway have involved customers who have been closely involved with us and their priorities for them and that will continue, and you are right about what’s to come, there will be more.
And when you think about monetization, it does reflect in what people are asking for over and above what they are buying today. So it does create an uplift of opportunity. Doesn’t all come overnight, just super clear about that as well.
But it naturally sort of follows this continuum of what they want to understand of their customers, how they want to interact with their customers, and frankly, the actions that people want to take across many different departments inside of a company.
Call center is one example of that, but the unique nature of our system is that we help to automate and create efficiency in many other departments inside companies in ways that were very difficult to do before across existing investments of technology.
You take a CRM system, for instance, and now we are lining up capabilities that weren’t possible before because we have a stronger signal of understanding the intent behind their customer. And that opens up the door for use of data, like, Benchmarks, for instance, or capabilities like Agent Assist in the call center and so forth. So that’s how to think about the work that’s underway here, but again, I will reinforce the fact that this is just the beginning.
Okay. Got it. And then just maybe for Rob, as you think about some of the changes that you have made in the business to drive more operational discipline, how should we think about maybe the progression of your operating margin and your free cash flow margin to some of the long-term targets that you have out there if we look beyond Q4 into more of a medium-term timeframe?
Yeah. We are as you would imagine pleased with the improvement that we see in the operating margin, the 6% in this quarter. It’s clearly another indication of the overall operating margin that we see in the business and we see that significant operating margin along those long-term targets.
As indicated by the Q4 guide, we see this as sustainable operating margin improvements that we have made and the continuation on our path to those long-term targets, which as we have previously mentioned, we believe we can achieve over the next four years to five years.
Perfect. Thank you.
Thank you. Please standby for our next questions. Our next question comes from the line of Bhavin Shah with Deutsche Bank. Your line is open.
Great. Thanks for taking my question. I guess we will start for Zig or Chris. Just talk -- you guys continue to find improvements from an operating leverage standpoint. Can you just talk about where within the company you guys are finding these additional efficiencies and how we should think about these operating changes being more transient and based on the macro versus more permanent?
Yeah. I will jump in first. This is Rob and then if Chris has any follow-on comments. There’s a couple of places that we are looking at. I think one of those areas that you are seeing is in the sales and marketing area and it’s an item that we have talked about with investors and analysts in the past.
We know that there is increased efficiency potential in our sales and marketing. It comes across a couple of points. One is partner ecosystem. As we continue to work closely with them and as that channel increases, it’s a very efficient channel for go-to-market.
And then as we have expanded internationally and significantly so since the time of the SAP acquisition back in 2019 through to today, there’s a certain ramp that occurs as you land people in key geographies in key regions. We have hit scale in many of those areas and now is a time where we will see increased efficiency come through, primarily in the sales and marketing, but also across other areas of the P&L.
As we move in the medium- to long-term and as subscription revenue becomes more and more of our total revenue, the strong subscription margins that we have will drive up gross margins, again, over the medium- to long-term and then there’s ongoing operating leverage opportunities in R&D and G&A as well. So all of those are the paths that we take from where we are at today to our long-term targets.
This is Zig. I only want to just summarize that, which is saying like, look, all along, this has been a part of our strategy, which is to build a great business and also not to take knee-jerk reactions to what we are doing, right?
There’s a strategy here where we think there’s compelling margin opportunity. We also think that thinking medium- and long-term, we also see a significant market opportunity. And we think there’s a responsibility here to be managing to both.
Even though you can’t predict every single step along the way, there’s a bigger picture view that we have, which has built an incredibly compelling great business that we could be proud of on both top and bottomline basis.
Super helpful. And just a quick follow-up for Rob, just asking that calculated billings question another way and focusing on deferred revenue. DR was down 7% sequentially, which seems a bit unusual for us and something that we haven’t seen in the past. Can you maybe just help dissect that decline and how much of that was due to that delayed billings, in fact, you spoke about earlier versus maybe the macro impact in new billings? And then how should we think about these headwinds into 4Q from a deferred revenue and billings perspective?
Well, it’s a combination of both, obviously. It’s the macro as we have talked about and the scrutiny that exists on the new logos. And then it is the added factor is the delay in billings or the increase in delay that we saw compared to prior year.
So the reference point I have given you there is that, that delay is more or less an offset to the increase that we are incurring in the current quarter relative to Clarabridge. And you have got numbers that we gave at the time of the Clarabridge acquisition around the size and the seasonality of their billings.
And a quick reminder there, when we acquired them, they were about $100 million run rate business and about 50% of their billings happen on a somewhat equal basis over the first three quarters and then about 50% in Q4. So that can help you, I believe, get to what you are looking for in terms of breaking down or quantifying the impact.
Super helpful. And just quickly following up there, should we expect these delayed invoicing and billings kind of impact occurring in 4Q as well?
I think it’s certainly possible in the current environment. It’s important, though, we will partner with our customers and work with them to close deals where they have value and growth, and to do so in a manner that works for both sides. So I think that’s a possibility and should be appropriately considered.
Appreciate the insight and thanks for taking my question.
Operator, do we have any further questions?
We have a question for Brent Bracelin with Piper Sandler. His line is open.
Good afternoon. Thanks for taking the question here. Zig or Chris, I want to go back to Clarabridge now that you have owned this asset for a year, and specifically, dive into the cross-sell opportunity. On one hand, it is a more challenging macro environment. It’s a larger ASP deal. Should we think about maybe a slower cross-sell ramp heading into kind of next year or are there specific pain points around XM Discover that could maybe resonate in a recessionary environment that aren’t so obvious outside looking in here?
Yeah. The way I think we are going to think about this a little bit more internally is a little bit less of a cross-sell and more integrating the technology into the solutions we have, for example, in the call center solutions, in the digital solutions and even into employee solutions as an opportunity for us to sell larger deals and to be able to expand and grow with existing customers as well as have a more compelling proposition for new logos overall.
I do think you are spot-on that in the new environment, it does help us in areas that I think are going to be stronger in the environment, including call center solutions. We know that’s a focus area. It’s especially strong that technology is useful for that area, as well as the overall competitive environment.
It resonates with the increase in unstructured data relative to structured data, does play well into macro trends, as well as the upcoming impact, so I think it’s going to -- I think it’s part of our strength and we are really happy to have it as part of our portfolio.
Super helpful color there. And then just, Rob, one follow-up on the delayed billings just so we are clear here, short-term deferred did decline $51 million sequentially, I get FX, I get seasonality, the delayed billings. Is that a change in like renewal terms where they are pushing out the volumes, is it a change in just the payment timing around shifting from annual prepays to quarterly or semiannual? Just trying to get a little more color around when you say a delayed billings headwind?
Provide a little more color there…
… just given the drop…
…in short-term deferred.
Yeah. We thought primarily in some of our multiyear contracts that were entered into in the current quarter, where the first year of that multiyear contract is set to a lower billing amount than the recurring billing amount.
And when we talked about consolidation a bit on the call earlier, some of that is occurring when we are transitioning a current customer off of existing point solutions on to Qualtrics. So that first year billing amount maybe set to a lower amount to accommodate the customer’s budgetary concerns or budget that’s available as they transition off of old solutions, consolidate on Qualtrics and then the recurring billing amount in years two and beyond is set to a higher amount.
Got it. And that delayed billings, that’s happening for new lands or is it happening across renewals and new lands?
It’s primarily on those new multiyear that I talked about that we saw in the current quarter. That’s what we saw.
Okay. Very helpful color.
Thank you. Please standby for our next questions. And our last question comes from the line of Brian Peterson with Raymond James. Your line is open.
Hey, guys. Thanks for fitting me in. So just following up on the partner channel question, so that was mentioned as an area of efficiency. I am just curious where we are in maturity of that effort and can we really start to see much more material kind of bookings contributions from the partners, and I guess, does that come help from net new expanding, I’d just be curious to get your thoughts there? Thanks, guys.
Yeah. I’d say it’s been a focus for us in terms of building the ecosystem out and the efficiency that can come through that. I’d say we are still early days, however, in terms of where we want to go and where we see that opportunity. Therefore, as you saw the comments around our experience with the AWS Marketplace and the good performance we have had there, as well as with the major GSIs.
So I’d say, we are starting to see the positive impact, as Rob alluded to, in terms of impacting our operating margin performance. As you think about going forward, I think that is going to be a key driver in continuing to show operating leverage in the sales and marketing line. But there’s a lot more ahead versus where we have been so far in terms of that opportunity.
All right. This concludes today’s conference call. Thank you for participating. You may now disconnect.