Zeta Global Holdings Corp. (ZETA) Q3 2023 Earnings Report, Transcript and Summary

Greetings, and welcome to the Zeta’s Third Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Scott Schmitz, Senior Vice President of Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us for Zeta’s third quarter 2023 conference call. Today's presentation and earnings release are available on Zeta's Investor Relations website at investors.zetaglobal.com where you will also find links to our SEC filings, along with other information about Zeta. Joining me on the call today are David Steinberg, Zeta's Co-Founder, Chairman and Chief Executive Officer; and Chris Greiner, Zeta's Chief Financial Officer. Before we begin, I'd like to remind everyone that statements made on this call as well as in the presentation and earnings release contains forward-looking statements regarding our financial outlook, business plans and objectives and other future events and developments, including statements about the market potential of our products, potential competition and revenues of our products in our goals and strategies. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. These risks and uncertainties include those described in the company's earnings release and other filings with the SEC and speak only as of today's date. In addition, our discussion today will include references to certain supplemental non-GAAP financial measures, which should be considered in addition to and not as a substitute for our GAAP results. We use these non-GAAP measures in managing the business and believe they provide useful information for our investors. Reconciliations of the non-GAAP measures to the corresponding GAAP measures where appropriate can be found in the earnings presentation available on our website as well as our earnings release and other filings with the SEC. With that, I will now turn the call over to David.

Thank you, Scott. Good afternoon, everyone, and thank you for joining us today. Our third quarter of 2023 was one of our most eventful and productive quarters yet, highlighted by key events including Zeta Live, our Customer Advisory Board Meeting, and our first Investor Day. Most importantly, we continued our track record of consistent execution, delivering results above our guidance for the ninth consecutive time. In the quarter, we delivered record revenue of $189 million, up 24% year-over-year, with adjusted EBITDA of $34 million, up 51% year-over-year. This translates to an adjusted EBITDA margin of 17.9%, up 310 basis points year-over-year. We generated $23 million of cash from operating activities, up 17%, with free cash flow of $13 million, up 43% year-over-year. On a year-to-date basis, our adjusted EBITDA and free cash flow have grown approximately 70% faster than our revenue. Our strong results reflect our growing impact in the marketplace, which was evidenced by the 50% increase in viewers for our third annual Zeta Live conference to over 12,000 people. This year's Zeta Live conference brought together thought leaders from around the world to learn about the growing impact of AI, discuss innovation that drives business growth, and hear from practitioners about the emergence of intelligence-powered marketing. A full replay of every session is available in the Resource Center section of our website at zetaglobal.com. With hundreds of new brands and existing customers added to our pipeline, Zeta Live continues to be an investment in accelerating our business and raising our brand awareness. The evolution of Zeta who to why Zeta was evident in record third quarter RFP volumes, with even greater growth in dollar values as we experienced an increase in more complex multichannel opportunities, which was further driven by Zeta Live. Growing deal activity is just one indication of the market moving in our direction. We were also recognized in key industry reports. In the third quarter, we were named a leader in the IDC MarketScape for omnichannel marketing platforms for B2C enterprises. The ZMP was recognized for simplifying the complex marketing ecosystem. While we still have further to go to achieve broader recognition across industry analysts, we believe our differentiated approach of bringing identity, intelligence, and activation together in a single platform position us well to win against our core competitors, including Oracle, Salesforce, and Adobe. Our industry recognition, along with our pipeline growth, is fueled by our innovative product roadmap, which was on full display at Zeta Live. With the release of the Zeta Opportunity Engine, or ZOE, marketers have the ability to ask critical marketing questions and receive real-time answers. And through new forecasting and recommendation tools, marketers can generate new ideas and strategies with speed and scale so they can deliver higher ROI and accelerate results. In addition, recent customer requests have highlighted an opportunity to innovate upon basic mobile capabilities that have been the status quo in the market. Similar to the enterprise market, moving on from its first generation CDPs sophisticated marketers are seeking mobile to be integrated into a more comprehensive platform rather than used as a point solution. To capitalize on this opportunity, Zeta is making investments into expanding our enterprise mobile capabilities to fuel conversational experiences. Feedback from customers and prospects at Zeta Live also reinforced our belief that we are at the beginning of a marketing cloud replacement cycle. In fact, at Zeta Live, we signed a multi-year, eight-figure deal with one of the largest discount retailers in the United States to replace their legacy marketing cloud and consolidate seven different vendors in their technology stack with just the ZMP. After an extensive search, they chose our next generation technology because of our identity, personalization, customer journey, and AI capabilities. This retailer is in the process of a multi-year digital transformation that has re-architected their entire tech stack to include our partner Snowflake, which is another key driver of our current record RFP volumes. This customer is an excellent example of our belief that Zeta helps marketers with modern data architectures to deliver better experiences for consumers and reduce the total cost of ownership for enterprises seeking to replace legacy technologies. One of the fundamental problems marketers face today is the inability to deliver what consumers want due to a personalization gap created by legacy systems. Even though data is abundant, intelligence is scarce because legacy systems lack the sophistication to turn data and insights into action. Our software platform solves this problem by unifying complex and disparate sources of data into a single view of the customer. Our proprietary AI synthesizes billions of behavioral signals and environmental data to create intent-based scores tied directly to the individual. We then activate this intelligence through marketing programs that combine precision and scale across every channel. This is intelligence powered marketing. Unlike legacy systems, the Zeta Marketing Platform has data and AI as native to the application layer, offering a differentiated approach for sophisticated marketers seeking to control their data and extract more value from each interaction. This quarter we also continue to grow our relationships with key players in the value chain, including agencies where our strategy is defined opportunities to partner to enhance their assets and capabilities so that together we deliver more to the world's biggest brands because this allows us to serve many brands through a single business relationship. This one-to-many strategy accelerates our market penetration and exposes Zeta to marketing decision makers across a broad range of the enterprise brands. As we discussed at our Investor Day, the number of brands we serve is nearly 40% larger than a reported scaled customer count. Looking forward, in addition to our continued growth with agencies, the emergence of the partner channel and the benefits of the replacement cycle, we expect the macro environment will continue to drive scrutiny on how and where enterprises invest in marketing technology. As the need for efficiency and effectiveness rises, enterprises are more likely to change to improve their marketing programs and lower their total cost of ownership. As we heard at Zeta Live marketers are looking to consolidate spend with fewer vendors and simplify their technology stacks. Marketing budgets must be tied to measurable outcomes that generate a strong verifiable return on investment, which Zeta delivers. In summary, I am incredibly proud of our team and what we have accomplished this quarter. We continue to be well positioned to capitalize on the need for more efficient and effective marketing technology. As always, I would like to sincerely thank our customers, our partners, team Zeta and all our shareholders for the ongoing support of our vision. Now let me turn it over to Chris to discuss our results in greater detail. Chris?

Thank you, David, and good afternoon, everyone. During today’s call, I will focus on the drivers of our consistent execution along with key considerations for the fourth quarter’s outlook. Starting with the results, we delivered $189 million in revenue, up 24% year-to-year. On an organic basis, and adjusting from last year’s political revenue, growth accelerated from 24% in 2Q to 26% this quarter. I’ll note our growth rate also includes continued headwinds from the insurance and automotive verticals. Our reported growth would have been in the mid-30s plus excluding these two verticals. The strength of our revenue growth this quarter was once again driven by scaled customer additions coming in above the high end of the model, we updated that our Investor Day of 8% to 12% growth. We ended the third quarter with 440 scaled customers, up 15 from 2Q and up 13% year-to-year. We also saw healthy growth from our 1 million plus super scaled customers, which increased by six quarter-to-quarter to 124, up 17% year-to-year. The addition of scaled customers came from industries ranging [ph] from travel and hospitality to education to several across advertising and marketing. As such, we continue to see strong diversification across industries with six of our 10 largest verticals, once again growing more than 25% year-to-year. And for the 13 consecutive quarter, scaled customer ARPU with double digits coming in at 418,000 growing at the same 10% rate we’ve seen throughout the year and at the midpoint of our 8% to 12% growth model. Like we’ve discussed in calls earlier this year, ARPU growth is influenced by the success we’ve seen in closing pilots this year with half of the 51 scaled customers added in the last 12 months in the less than 500K revenue band. This is an encouraging data point for us. If you refer to Slide 28 in our earnings supplemental, we show a multi-year trend demonstrating how scaled customers reliably grow spend the longer they’re on data’s platform. As illustrated on the slide, scaled customers less than one year on the platform spend an average of 400,000 compared to the one to three year cohort spending 1.5 million and the more than three-year cohort spending over 1.8 million. Not only does this draw a trend line for the scaling potential of these less than 500 scaled customers, but it also bodes well for net revenue retention. To that end, on a year-to-date basis, total Zeta net revenue retention is within our 110% to 115% target range as we remain on track to generate half of our growth from new customers and half from existing customers. Now let me transition to the expansion opportunities we’re seeing with agencies and how their contribution this quarter is flowing through our metrics and results. Our early experience with agencies has affirmed the effectiveness of our one to many strategy to accelerate market penetration. I’ll outline in steps what we’re learning from those engagements. How those learnings manifest themselves in our results, and what it means to our P&L in the near, mid and longer term. Starting with less than [ph] one, by filling in intelligence and omni-channel engagement gap, we believe we’re providing the agency with a more comprehensive platform for them to win more business. Less than two, the agency’s success in our platform with a single brand can quickly lead to expansion into more brands. By way of example, the 15 scaled customers we added this quarter resulted in an incremental 45 unique brand. In 3Q most unique brands came from agencies and this should continue. Less than three. Because Zeta has close partnerships with social and search engagement channels, agencies can quickly pivot, already budgeted spend to Zeta as a starting point. The agency can leverage our data cloud and intelligence to build higher ROI campaigns inside the walled garden. This shows up as integrated platform revenue, which due to third party of media has a lower margin profile. This is where we stand today in the very early days of those engagements. So as we’ve ramped with agency customers, integrated platform revenue has been the first to grow up 63% year-to-date, and 44% in the third quarter. In less than 4, agencies need omni challenge agent strategies beyond just social and search. This is typically the next phase of data’s engagement. And it translates to the use of data’s owned and operated channels such as CTV, display, video messaging and email. These are proven to drive a better ROI and this shows up as direct revenue and as a margin profile in the low to mid-70s. In the third quarter, our direct revenue mix was 70% with our direct revenue growing 17% year-to-year, improving from 15% last quarter. By the way, direct revenue growth is also adversely impacted by the insurance and automotive verticals this quarter. Growth otherwise would’ve been in the mid-20s. And lastly, agencies are great long-term customers. Their platform evolution from integrated to direct channels can take place over many quarters, resulting in both positive mix shift and increased spend. As an example, Zeta’s first large agency customer in 2020 started at a 7% direct mix and $3 million in revenue growing to 76% direct mix and over $20 million in revenue over a three-year period. And the pipeline of agency customers we’ve signed and expect to sign have the potential to do the same and more. Bringing this back to third quarter’s results, our success in adding new agency business is the driver of integrated platform mix being up and for GAAP cost of revenue of 38.9% being up 110 basis points year-to-year and 280 basis points quarter-to-quarter. I want to reiterate the margin profile of our direct revenue continues to hold firmly in the low-to-mid-70s. So the change in margin is principally driven by how early we are in the lifecycle with new agency customers. Because we have visibility into the mix and margin dynamics of our agency growth strategy we had plenty of runway to optimize operating expenses without having to compromise new product investment, growing Zeta Live or increase in quota carriers. To this end, total OpEx growth slowed to 11% year-to-year excluding stock-based compensation on a dollars basis, and is down 490 basis points as a percentage of revenue. We're seeing expense to revenue leverage from two primary drivers, first, savings in G&A, and second, from wrapping on prior years sales and marketing infrastructure investments. On a combined-basis these two drivers accounted for 420 basis points of the overall 490 basis point reduction year-to-year in operating expense to revenue efficiency. As we sit here today, our quota carrier headcount is at 132, and we anticipate ending the year in the high 130s to low 140s roughly in line with our updated Zeta 2025 model. Our disciplined expense management and better productivity resulted in an acceleration of our adjusted EBITDA growth to 51% year-to-year or $34 million, compared to 45% growth last quarter. In fact, adjusted EBITDA margin of 17.9% increased 310 basis points year-to-year; this is the 11th straight quarter in which we've expanded adjusted EBITDA margins year-over-year. On a GAAP basis, third quarter net loss was $43 million, which includes $58 million of stock-based compensation. Excluding the accelerating expensing related to our IPO, stock-based compensation would have been $25 million. We continue to drive strong cash generation. Cash flow from operating activities was $23 million, up 17% year-to-year with free cash flow of $13 million, up 43% year-to-year. Now, let me transition from the results to our outlook. The big picture first. We're fully flowing through our third quarter revenue and adjusted EBITDA beats and raising the fourth quarter as seen on Slide 13 in our earnings supplemental presentation. Speaking first to revenue, we're increasing the midpoint of full-year revenue guidance by $10 million to $725 million representing 23% growth. And we're taking fourth quarter guidance up $500,000 at the midpoint to $207 million or 18% year-to-year growth. As a reminder, our fourth quarter revenue growth rate includes a 3 point headwind from last year's political revenue and faces continued pressure from automotive and insurance verticals. As we look around the corner to 2024, we expect these industries to become tailwinds, with the insurance and automotive headwinds likely persisting into the first quarter and then turning positive in 2Q with political being most prevalent in the second half of 2004. Also relevant to revenue, we expect 4Q direct mix to look a lot like the third quarter, with a similar cost of revenue profile as well. In terms of adjusted EBITDA, we're increasing the midpoint of full year guidance by $2.1 million to $126.6 million, an increase of 37% year-to-year or 17.5% margin, up 190 basis points year-to-year. The fourth quarter adjusted EBITDA midpoint of guidance is $42 million, an increase of 29% year-to-year or 20.3% margin, up 180 basis points year-to-year. Before turning to Q&A, let me quickly close with a couple of final thoughts. We're growing revenue rapidly even in the face of industry specific headwinds with over 90% of the portfolio growing in the mid-30-plus year-to-year. We're growing customers rapidly. The 15 scaled customers added this quarter resulted in 3 times as many unique brands added evidence of the very early days of scaling of our new agency customers. And we're rapidly expanding adjusted EBITDA and free cash flow. We're striking a balance of expanding adjusted EBITDA margins, while managing for agency customer mix and gross margin dynamics with disciplined expense management and investment prioritization. Now let me hand the call back to the operator for David and me to take your questions. Operator?

Perfect. Thank you, guys. Chris, I just wanted to clarify a little bit more detail on gross margins. You indicated ZMP mix for Q4 would be pretty similar to Q3. Look, I know it's too early to give a guide for 2024, but I'm just curious what that progression looks like. Do you think next year looks more like the second half of the year? Do you think it looks more like the first half of the year? Or do we just start to kind of see a progression in between those two figures?

Hey, Jason, thanks for the question. I appreciate it. I don't want to get too far into 2024 yet, but I think you can draw a trend-line for we're in the early days with a lot of these agencies. I do believe that as we work across 2024 that mix will then begin to become, there'll still be an integrated component, but there'll be more and more direct mix over time. So I think you said it well that the first half of 2024 could look more similar to the second half of 2023. And then improving in the second half of 2024 as that direct mix and those agency relationships get bigger and a positive mix shift happens.

Appreciate the detail. And then, David, we've talked for a few quarters on bigger deal sizes. Obviously, we're seeing that happen in the ARPU growth figures. Can you just dissect that in terms of what you're seeing from customers today? Just new channels that are being added, new use cases or any changes that you're noticing that are driving that bigger ARPU growth and bigger deal size?

Yes. First of all, thank you very much. I appreciate the question. I think what we're seeing first and foremost is as we've switched from Zeta who to why Zeta? We're seeing much bigger RFPs, much larger organizations that in the past might not have chosen us. They might have put us in the RFP. We might have gotten a good look at it, but we wouldn't have won because we didn't have the reputation and we didn't have the brand. We're now winning those. So it's not just channel expansion and use case expansion, it's just substantially larger organizations with substantially larger budgets choosing us. Now what we're seeing a lot is connected messaging. We're seeing messaging connected to CTV, and we're seeing messaging connected to social, both of which are very, very powerful when you look at the return on investment through our use case capabilities.

Appreciate it. Next question comes from Ryan MacWilliams with Barclays. Please go ahead.

Hey, Chris and David, this is Aiman [ph] on for Ryan. From a macro perspective, would you say that the environment was consistent from 2Q to 3Q? And what are you baking into guidance in terms of holiday season span at this point?

Well, first, yes, I mean, we saw some headwinds in automotive and insurance in the first three quarters of the year or the first two quarters of the year prior to this quarter. So that was pretty consistent. The good news was all of our other verticals really hung in there and we saw most of them growing in the mid-20s and some growing in the 30s. So we continue to see a tale of two nations. The good news is there's far more good than bad, which is why we continue to over deliver. But there's still some choppiness in the marketplace and we continue to grapple with that. I think, yes, there is a – it's a good illustrative. It also goes to Jason's question around bigger deals. We included a new slide in the earnings supplemental you'll find in Slide 20, where a lot of the feedback we received coming out of the Investor Day was continuing to clarify the competitive universe. And what we've done is we've broken down how that marketer buys into categories around data management or CDPs, marketing automation or the marketing clouds if we will, and then paid media. What's interesting about the eight figure deal that David mentioned, the discount retailer in his prepared remarks, here you had Zeta's marketing platform that was able to address what seven vendors were doing in one. We replaced salesforce for the marketing cloud. We replaced Acquia [ph] for the data management CDP, and we replaced five other activation vendors on the engagement channel side. So a good illustrative why deals are getting bigger because we can consolidate all that. But there is still a need and a push with the replacement cycle and Zeta is filling that through, lowering total cost of ownership and creating a better ROI. So it just kind of brings those two questions together.

Yes. And quite frankly, as you're seeing choppiness in the marketplace, we're seeing deals close faster. And I think that was one of the reasons you saw our scaled customer count and our super scaled customer count grow faster than expected. Clients are willing to take more risk in this environment, especially now that we're more of a known entity. They know who we are. They see us winning in the marketplace. They see the amount of savings we're able to drive to them through the elimination of point solutions and the ability to get to that very high level of intent quickly. And we're seeing enterprises move faster to go through that pipeline.

Got it. Perfect. And how do you guys think of enterprise customers and their budgets for 2024? And would you say there's any difference between the buying patterns of normal customers and skilled customers?

Yes. Interestingly enough there's always been this narrative that marketing is one of the first things you can cut in a down environment. We are not seeing that. Now we're seeing some headwinds in certain industries and we're trying to be very transparent about that. Some of that had to do with strikes, which fortunately have now settled and some of that had to do with under reserving for coming out of COVID as it related to how people were going to drive in and get into accidents. We do believe those headwinds become tailwinds going into some point next year. And quite frankly, we're not seeing enterprises cut marketing. We're seeing enterprises invest the same if not more, but at the same time we're taking substantial market share in a growing market, which is once again not to say that we're not without challenges as we've been very open with. But on the most part we're seeing enterprises investing in their marketing and growing it.

Yes. The only clarification Aiman in your question, maybe you didn't mean it, but if I'm interpreting correctly, the scaled customers, all 440 of them, these are very large enterprises and obviously large agency as we've been discussing. So the difference between if you're at a 100K to a 1 million and a 1 million plus is really the time you've spent on Zeta's platform, your tenure with us. And there's a slide in the earnings supplemental that shows those less than 12-month enterprise scaled customers that have been with us again less than a year, spend an average of 400K. The one to three year cohort then accelerates to an average of 1.5 and then the greater than three-year cohort grows or spends more than 1.8. So it's not really kind of a normal and a super scaled customer. They're all large enterprises. Just time on the platform drives net revenue retention growth.

Thank you. Next question Arjun Bhatia with William Blair. Please go ahead.

Perfect. Thanks guys, and congrats on the execution and organic acceleration here. Chris, it seems like, or maybe for David, this one, but it seems like the agencies still continue to be a strong growth driver. As you're thinking about just how the business evolves and how you dedicate your own go-to-market resources over the next year or two. How do you think about balancing how much you're focusing on the agencies versus which customers you want to have a direct relationship with? Like are there pros and cons and how do you allocate sales and marketing – your own sales and marketing resources to reflect that?

As usual, Arjun a great, great question. It is a bifurcation. It is a different team of salespeople who sell into agencies and then go in to work with the enterprises as a subset of the agency, than it is the salespeople who go directly to an enterprise. And I think the truth of the matter is we're trying to staff up in both. We have far more enterprise salespeople than we have agency salespeople by the vast majority, because that's what we've been doing for many years. But like a lot of sort of baseball franchises, we're trying to bring in the world's best free agents in the agency space who can really bat cleanup. And the people we're bringing in and you guys have heard me talking about this, I've been laying groundwork in the agency ecosystem for four or five years now. And the sales cycles there took a long time to crack the code, they're cracked, and we're now seeing that scale. But I want to be very, very clear, when we partner with an agency, we are partnering with that agency and the enterprise client directly. The agency is not hiring us and saying go across our customer base, they are bringing us in to the enterprise as the partner to the agency to either fill holes for product categories they do not have or help them scale certain components faster. But in 100% of the cases, we're directly working with the enterprise in partnership with the agency. So when you look at it, one sales rep can close multiple brands simultaneously by working with an agency, whereas on an enterprise basis, it's one to one. I would say that we want to continue to focus on both. We're going to continue to staff up in both. And the good news about being ahead, which is where we are, is we're in a position to hire the world's best sales people on both sides of the house.

Yes, I think bringing – it's a great point, David, bringing the math to it, I think there's an interesting sales productivity statistic on how we're investing in our go-to-market origin. We tend to be led by quality over quantity. And when we add it, it's very data-driven. For example, last quarter, we talked about on a trailing 12-month basis we'd added 52 scaled customers while adding 15 quota carriers over that same period of time, so roughly 3.5 quota carriers per scaled customer added. This quarter, we saw that improved pretty meaningfully quarter-to-quarter where we've added 51 scaled customers over the last 12 months while adding 11 quota carriers. So, going from a 3.5 times to a 5 times leverage. And those 15 scaled customers this quarter alone equated to 45 unique brands, each of which fit the scaled customer definition of spending at least 100K on a trailing 12-month basis. So productivity continues to be in our favor. We get really good leverage, as David mentioned, from the agency relationship in addition to what we're seeing on the enterprise side.

Perfect, that's a very helpful color. And then, Chris, for you, I think you had mentioned that the headwinds in auto and insurance have kind of continued this quarter and maybe sometime in 2024, those flip and become a benefit. Can you just give a sense for how the magnitude of the headwinds are trending quarter-to-quarter from Q2 to Q3? And what visibility you have into any improvement with those verticals? I mean, what might those customers be saying qualitatively that gives you some conviction that they might improve from a spending perspective next year?

Sure, mathematically, the third quarter was a little bit worse in terms of an aggregate headwind than the second. Fourth quarter will be better than the third, but it will still be with us as a headwind and it will still be with us, although less so in the first quarter of next year. And we expect that headwind to then turn into a tailwind going into second quarter and beyond of 2024. Quantitatively, or I should say, from what we're hearing from our public company customers, we all are also seeing them from financial metrics they're posting, what they're saying in their earnings calls that they are also seeing the environment improve. So I think we're at the – I think we're on our way kind of upward again versus still on that downward trend.

It's also conversations we're having. Remember, we have a tremendous number of success oriented people in our organization that are helping our enterprise clients to figure out how to better manage their marketing. And we're embedded with most of these clients. They're very large customers on a historic basis. And we're getting buying signs that are very clear, asking for plans, talking about the future for the first time in quite some time. So I think it's quantitative and it's qualitative that we do believe this will go from being a headwind to a tailwind here sometime in the near future.

Thank you. Next question comes from Elizabeth Porter with Morgan Stanley. Please go ahead.

Hi, guys. This is Chris Quintero on for Elizabeth Porter. David, maybe one for you. I know you all have talked about getting more at-bats can lead to accelerating growth. So just curious, when you think about the new at-bats that you're getting today, what go-to-market channels are those mostly coming in through? And where do you think more of those at-bats can come from over the next year?

Yes, great question, thank you. I think that first of all, people are undervaluing our relationship with Snowflake. It's really been an important component of our RFP strategy, both when they're bringing clients to us from a partnership perspective and when we are bringing clients to them, where we're able to do more as a collective and we continue to see a large number of at-bats. In my prepared statement, I did say that RFP volumes hit an all-time record in Q3, which was up from a record in Q2. So we continue to see a lot of at-bats. We're also really focused for the first time on building channel partnerships in addition to agency relationships, where we could potentially be partnering with professional services firms and working with them for more at-bats. But on an absolute gross basis, I have never seen our pipeline go up more than I did after Zeta Live. We just had an incredible group of potential clients come. We had an incredible group of existing clients come and came out saying, wow, what – how do we do this together? Or how do we do that together? And we were really, as it relates to at-bats, I think we're starting to see a really exciting number of them. And quite frankly, I think that we're continuing to win a disproportionate percentage of the RFPs and engagements that we get invited to do, which is why we had such a large growth in scaled customers and super-scaled customers in the third quarter.

Awesome, very helpful. And then I also wanted to ask on the mobile opportunity, I know you all have talked about it being a key channel and one where you're looking to improve your capabilities there. I guess how big of an opportunity could this be for you? And what do you need to exactly improve upon? And could M&A be a part of that solution there?

Yes, we always look at buyer built, but the truth of the matter is that today, we have a series of partnerships and we have a series of products in mobile. We believe with the elimination of Apple's IDFA, which I will remind everybody again, we never used in the first place. There is now a unique opportunity in the mobile environment for the first time to really consolidate and grow our business. And we are starting to see meaningful RFPs as it relates to connected campaigns that include not just messaging and not just CTV and not just social and other, but mobile. And we continue to have the right products at the right time. We are continuing to build out our own products and we continue to partner where we think there are best of breed partners that we can work with. Quite frankly, we have bought some of those guys in the past and we might in the future, but as I always say, I believe that "transformative deals transform both companies for the worse." So we will continue on with our discussed M&A strategy that we talked about at length at our Investor Day, where we'll continue to do smaller tuck-in deals where we think we can pick up great people, great technology, great data, and can syndicate those products or can – I should say, integrate those products into the ZMP and then allow all of our clients to use them.

Excellent, thank you so much.

Next question DJ Hynes with Canaccord Genuity. Please go ahead.

Hi, good evening, guys. Congrats on the nice quarter. Chris, one for you on the direct revenue mix as it pertains to the agency customers. As those customer relationships mature, would you expect that mix of direct and indirect revenue to start to look like your direct enterprise relationships over time? Or will it always be kind of structurally a little bit higher indirect revenue?

No, I mean, look, I think you got to learn from experience. And in our case, we have a number of examples. The most material of which, as I mentioned in the prepared remarks, the first large global agency we began working with in 2020 spent $3 million with us and only 7% of that was direct revenue. If you fast forward to ending 2022, it was an over $20 million a year customer and 76% of that spend was using our direct channels and as you'd expect, the margin profile of that business evolved half of our direct revenue mix and it's been holding steady [ph]. The gross margin profile there is between the low 70s and mid 70s and this quarter was closer to the mid 70s. So yes, we do expect that as Azure's relationships get more tenured, not only do they get bigger, but the mix starts to balance out and look a lot like our first example with that large global holdco in 2020.

Yes, okay. Got it. Makes sense. And then David, maybe a high level question for you, so I'm sure you're early kind of in the planning cycle for 2024, but as you think about the sequencing of investment dollars, like what are your highest priority initiatives at this point as you look out to next year?

Well, as Chris said, it's a little early to get into 2024, but I mean, I think, you will see us continue to invest heavily in generative AI where our goal is to automate everything. We'll continue to invest heavily into salespeople and high quality engineers, right, that can help us to do those things which quite frankly were also things we talked about on our Investor Day. I do think mobile is going to be a bigger and bigger part of what we do. And I think we're going to start more heavily investing in the partner channel where we are working with larger professional services firms that have direct relationships with enterprises where we can partner with them to bring our products through them into the enterprise and roll out a suite of analytics products as partners roll out different deliverables that the professional services firms can build on top of the ZMP. We've already begun meaningful conversations in that ecosystem and we'll be investing in that as we continue to grow the business.

Yes, very, very good. I appreciate the color. Thank you guys.

Thanks DJ.

Next question Ryan MacDonald with Needham & Company. Please go ahead.

Hi, congrats on a great quarter and thanks for taking my questions. Maybe piggybacking off of the agency question from before from DJ I'm curious, as you continue to add brands and deepen those relationships, do you expect that when you start with a new brand that it will continue to be at that heavy mix of indirect or will the agencies as you grow with them, have better experience saying as we add on an incremental brand that that each incremental brand will start with a greater mix of direct versus indirect? Hopefully that was clear.

No, it was clear and it's a great question. And the answer is absolutely the latter. As the agency gets more comfortable with the platform, they start with new brands already on platform. And we are seeing a lot of that where when they jump from social, which is integrated to CTV or online video or integrated messaging, all of that is on platform. So what happens is usually it’s a nose under the tent and it's not usually with one brand, it's usually with two or three where you're starting un-integrated. And as we get to know them and they start using the platform, they see the power of being on our platform. So one of the most interesting things about this is why did that other agency go from 7% on platform to 76% on platform? It wasn't just because they liked us, it's because the power of being on platform is very evident and very clear when you begin to use it. The return on investment, the attribution capabilities, the ability to access data assets are substantially higher. Therefore, once they start using it, they want to use it for all their clients, which is why you see that accelerate as a percentage of revenue as they grow to new brands.

Super helpful. Thanks for the color there. And then David in terms of the priorities for next year you talked about having meaningful conversations and really investing in the partner channel. As we've been at industry conferences, it's clearly an area where the sis are, are putting a lot of focus in terms of making an investment. How competitive are the conversations, if you will, amongst the best of breed vendors like Zeta and others to try to be the established partner or CDP for some of these large SIs right now? Do you think it's, I guess, a winner takes all in terms of the partnership side or do you get the sense that it’s going to be sort of multi sourced opportunities? Thanks,

Unfortunately I think it's going to be multi sourced opportunities. I don't think you are going to see the large service providers consolidating behind one, which by the way is really good for us because they are already working with two or three of our competitors. So it allows us to get in there and get our nose under the tent. What I do believe is I believe that our products are best of breed. I believe we have the best CDP, I believe we have the best data cloud, I believe we have the best messaging system and I believe we have the best activation system in the world. So all things being equal, I believe that those service providers are going to recommend our products over our competitors because our products are superior. The other thing that, I think, is really important here is we've never really had a deliverable that the service provider could build on top of what we do before. And one of the things we learned is if they don't have a deliverable that can be built on top of your platform, when our platform doesn't really require the type of integration that most of our competitors do, right? Because if you choose Salesforce, Oracle, Adobe, you are going to have to spend millions of dollars on integrating those platforms with Accenture, Merkle, or others. With ours you don't need to do that. So that we were coming from behind, we've now built some direct deliverables that these service providers can build, build to their clients as added value on top of the ZMP, which are also subscription services to the service provider, which I don't know anybody else who is doing that. So as I talk to the service providers, they want to move as much of their revenue to subscription as possible, and the deliverables that we've built for them are recurring revenue in nature versus our competitors, which is integration revenue in nature. And we're getting a lot of excitement on that.

Excellent. Thanks for the color. Congrats again.

Thanks, Ryan.

Next question, Richard Baldry with Roth MKM. Please go ahead.

Thanks. If we look historically, 4Q is on a dollar basis, always been sequentially a lot stronger than what we see out of the third quarter. That's not implied in your guidance this time around. Sort of curious, is there anything we need to normalize out of there or do you think it's just your typical conservatism or is there something about macro that we should be thinking about? Thanks.

No, Rich, it's really – if you look at the starting point growth rate for the fourth quarter at 18%, I think, we've started every quarter's – next quarter's guide at a similar level, 18% or 19%. What you do and I think is a fair normalization is last year's political is a three point headwind. So you could say the 18% is really 21%. But no, I mean we're very comfortable with the guide, very comfortable with both the top and the bottom line guide. And as we look forward to 2024 the tailwinds we've had from some of these very strong signings quarters and by the way – when the queue comes out tomorrow, you'll see that, it's not cause for victory lap by any stretch, but it's a big improvement in RPO going from 135 million in RPO to 210 million this quarter. So I think that tailwind kicks in next year. Political kicks in, as I mentioned, auto and insurance, we think in second quarter turn positive. So we think fourth quarter is going to be a nice running start into the first quarter of next year.

And you talked about sales cycles accelerating, which is not the experience of a lot of other companies. Talk about maybe on the competitive win side of the table, the win rates, as you're getting into larger engagements and people are more, say, committed to legacy vendors, it obviously should be harder to displace those. So do you think there is some trade off over maybe the intermediate term where competitive win rates might come down a little, but it's still a net positive because you're getting into engagements you might not have previously, but just a little tougher to pull the legacy vendor out and maybe your first go around, but it might set you up to win at the next time around?

You know, it's funny you say that. We thought that would happen. I've said privately and publicly that as we dramatically increased RFPs, we would probably see our close rate go below 50%. We've not seen that Rich, we continue to close greater than 50% of the RFPs and engagements we get invited to. I think what's happening is we are really entering a cycle where people are looking to upgrade from their first generation marketing clouds, and their first generation CDPs, and they know that the large legacy vendors have not invested $0.01 into their products in the last few years. As I like to joke, right, Salesforce's side hustle used to be their marketing cloud, now their side hustle is Slack, and their marketing cloud is the side hustle to the side hustle. And as those organizations have cut investment, which we've seen across the board, we're seeing a lot of those cuts being done in marketing cloud, which is allowing us to further the distance in capabilities and quality of our technology to theirs. And quite frankly we're winning bigger deals than we've ever won before at the same percentage that we've – consistently won over the years, which even in some cases surprises us. I probably shouldn't say that on this call, but quite frankly it does.

Great. Congrats on a great quarter.

Thanks, Rich.

Next question, Zach Cummins with B. Riley Securities. Please go ahead.

Hi, good evening. Thanks for taking my questions. David, I know you outlined generative AI as one of the key areas of investment going into next year. Can you just talk about some of the early adoption you’ve seen from your ZOE product and how really that could transform into maybe driving even further adoption of your Zeta marketing platform over the next 12 months or 18 months?

Yes. It’s almost incredible how many people are using the ZOE component of the data analysis tool. It’s effectively today a generative AI platform that becomes your own internal data scientist. So you can ask real world questions. What are my most valuable audiences? Where am I losing money from a marketing investment perspective? What cohorts of my existing customers are buying more products from my competitors than they are from me? All of those are real world questions that people are using. And what we’re finding is clients who are using ZOE are spending substantially more money on the platform. And our goal is to roll ZOE out to all of our clients in the very near future. And we think that will continue to drive additional adoption rate and additional utilization of platform. As Chris points out all the time, if you look at the period of time that clients are on our platform, you can draw a line up into the right with the amount of money they spend. We believe ZOE will accelerate that and take the top of that line even higher.

Understood. That’s helpful. And Chris, just one question for me regarding free cash flow with the increasing traction with agencies in the near term. I mean, can you talk about the dynamics and how we should think about free cash flow conversion over the coming quarters?

I think the best example is if you look through our financial statements in the Q and what’s been published in the press release, you’ll see that there was about an $8 million working capital headwind. And that’s principally driven by the days sales outstanding going from 55 days to 68 driven by the agencies period. If you plug that back in, you would’ve been looking out of cash conversion to EBITDA in the 60s. So we – but it is a reality that we’re going to wrap on that we think by the second half of next year that normalizes. So we’ll live with it for another couple quarters. But you should start to see that cash conversion move up.

And we don’t expect it to affect our 2025 plan in any way, shape or form.

Got it. Well, thanks for taking my questions and best of luck with Q4.

Thank you.

Next question, Camden Levy with Oppenheimer. Please go ahead.

Hi, this is Camden Levy sitting in for Brian Schwartz. Thank you for taking my question. In regards to the updated 2025 guidance for direct revenue mix, is most of the expansion on a forward basis going to be coming from channel expansion or is it more so brand adoption? And I was wondering could you like stack rank the drivers for that metric as it relates to 2024? And then additionally did the mix shift impact your ARPU growth expectations directly? Anything there that you could provide would be helpful? Thanks.

Sure, thanks. And good to meet you. Good to get the question. If I go back to the Investor Day, when we adjusted the direct revenue mix to 75%, we really pegged it to what we’ve seen over the last 12 months. And if you think about the growth of the overall business, not just the direct revenue, but the overall business and the ARPU, it’s driven principally by three different forces continuing to do more with existing customers through a single channel they’ve chosen. Although now it’s more driven by multi-channel adoption. So this quarter, for example, our scaled customers, and there’s about a third of them now that are using three or more channels as up over 40% year-over-year. And then expansion of use cases. And when we look at our use case growth rates, the grow and retain and the acquire use case both grew well into the double digits year-over-year in revenue in the third quarter.

And by the way, we don’t expect our long-term direct versus indirect revenue to change. And we have not changed guidance for that for 2024 or 2025 at this point.

Okay. Awesome. Thank you. And then just thinking about the gross margin, do you guys expect gross margins to have troughed here and improve? I know you guys said that they should be more similar sequentially. But anything that we should keep in mind in regards to modeling 2024 gross margin and the considerations there? Thank you.

Yes, yes, of course. No, it’s a good question. I think there was an earlier question in the same realm. And how we answered that was the first half of next year probably looks a lot like the second half of 2023. And then in the second half of 2024, you’d start to see a sequential improvement from there, as the mix and the business grows with the agencies we’re working with becomes more and more direct.

Perfect. Thank you so much.

Thanks a lot.

Next question, Koji Ikeda with Bank of America Securities. Please go ahead.

Hey. This is George on for Koji. Thanks for taking my question. It’s great to hear encouraging about sales cycles improving and win rates kind of remaining strong. I was just going to ask, have you guys seen any notable changes in the competitive landscape? And kind of when did you notice the sales cycles kind of improving?

Yes. So good question. Thank you. I think starting earlier this year, we started to see a number of the big legacy competitors not getting invited into the final stages of RFPs. And that was a really interesting sort of turning point because it used to be a few years ago we would get down to the final three and they would choose one of the big legacy providers because they were the big known brand. Now what we’re seeing is we’re not even seeing a lot of the big legacy providers make it to the final round, even when they are the incumbent. And that has allowed us to shine in a very unique way, and it’s allowed us to continue to close at this greater than 50% rate, even while we’re seeing more at-bats, which once again is why we delivered so many scaled customers and super scaled customers in the second and third quarter combined.

That makes sense. And I know you called out kind of greater brand awareness. This is kind of one of the reasons you’re getting more RFPs, is there anything else to kind of call out there and what’s kind of driving the strength there?

Yes. We’re seeing a lot of analysts give us attention that we never would’ve gotten before. As I said in my prepared remarks, we were named one of the best CDPs in the world. I believe that was by IDC. Forrester continues to have us in the furthest rightest quadrant of the leader category in marketing automation, messaging, and a number of other categories. And I think that as they’ve evaluated our products, we’ve seen analysts which are very responsible for the RFPs, right? So a lot of these RFPs start with the analyst groups. We’re seeing analysts say, you have to talk to Zeta. We simplify complex marketing problems. And by putting data and AI as native to the application layer, not as step outs, we’re able to move at a substantially accelerated speed with substantially more intelligence behind the marketing decisions we’re making.

Thank you.

Thank you. I would like to turn the floor over to David Steinberg for closing remarks.

Thank you everybody. Obviously, an incredible quarter for Zeta in a very choppy market. I could not be more proud of our Zeta people than I am today because to get to these types of outputs, we must have the inputs. And as we look at our business and we look at our innovation, and we look at our product development and we look at the evolution of our sales motion, we’re really firing on all cylinders. And as we continue to drive through what appears to be the beginning stages of a legacy replacement cycle for marketing clouds, CDPs and marketing technology. Zeta is at the forefront from a product, people and innovation perspective. We expect to continue to win in the marketplace. So we thank you very much for your time today. And we look forward to speaking to you again in the near future. Thank you.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.