ON24 Inc

NYSE:ONTF

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Greetings, and welcome to the ON24 Second Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Sayo Denloye, Investor Relations. Please go ahead.

[Olusayo Denloye]

Hello, and good afternoon, everyone. Welcome to ON24 Second Quarter 2024 Earnings Conference Call. On the call with me today are Sharat Sharan, Co-Founder and CEO of ON24; and Steve Vattuone, Chief Financial Officer of ON24. Before we begin, I would like to remind everyone that some information provided during this call will include forward-looking statements regarding future events and financial performance, including guidance for the third quarter and full fiscal year 2024, as well as certain third quarter and full year non-GAAP projections. These forward-looking statements are subject to known and unknown risks and uncertainties that could adversely affect ON24's future results and cause these forward-looking statements to be inaccurate, including our ability to grow our revenue, attract new customers and expand sales to existing customers, the success of our new products and capabilities, other statements regarding our ability to achieve our business strategies, growth, or other future events or conditions, such as the impact of adverse economic conditions and macroeconomic deterioration, including increased inflation.

ON24 cautions that these statements are not guarantees of future performance. All forward-looking statements made today reflect our current expectations only, and we undertake no obligation to update any statement to reflect the events that occur after this call. Please refer to the company's periodic SEC filings and today's financial press release for factors that could cause our actual results to differ materially from any forward-looking statements.

We'd also like to point out that on today's call, we will report both GAAP and non-GAAP results. We use these non-GAAP financial measures to evaluate our ongoing operations and for internal planning and forecasting purposes. Non-GAAP financial measures are presented in addition to and not as a substitute for financial measures calculated in accordance with GAAP. To see the reconciliations of these non-GAAP financial measures, please refer to today's financial press release.

I will now turn the call over to Sharat. Sharat?

[Sharat Sharan, executive]

Thank you, Sayo, and welcome to our second quarter 2024 financial results conference call. With me today is Steve Vattuone, our Chief Financial Officer.

I'm excited by our results in Q2. I'm pleased to report another quarter of solid momentum. We delivered Q2 revenue and non-GAAP EBIT above guidance and executed on our profitability targets, achieving positive adjusted EBITDA and positive non-GAAP EPS for the fifth quarter in a row and also achieved positive free cash flow for the second consecutive quarter. Revenue from our core platform, including services, in Q2 of 2024 was $36.5 million, and total revenue, including Virtual Conference was $37.3 million. Of total revenue for the quarter, subscription and other platform revenue was $34.1 million and professional services revenue was $3.2 million. We remain laser-focused on returning to ARR growth. We ended Q2 with $131 million of ARR related to our core platform, a decrease from Q1 of $2.2 million, which is meaningfully better than the expectations we provided on our last earnings call.

What really excites me are the dynamics behind these metrics. Importantly, our focus on improving our in-period gross retention rate is bearing fruit. The changes we have made organizationally and execution-wise are resulting in an improvement for the third quarter in a row, gross retention trended much better than the average rates we've seen for each of the past 3 years. In fact, Q2 gross retention improved sequentially from last quarter, and we posted close to double-digit improvement from Q2 of 2023.

Disaggregating gross retention into churn and down-sells, we saw a huge improvement in churn in Q2. And in fact, it matches the best it has been in the last 3 years. In addition, we saw meaningful reductions in down-sells as a percentage of the renewal base in Q2. Finally, we are pleased that large customer renewals that came due in Q2 were better than expected, with half of them resulting in growth.

It is great to see the results of our strategic priorities beginning to pay off. And I'm really proud of the team's successful execution, especially as we have navigated through a tough macro environment over the last 2 years. While we are controlling what we can control and improving our execution, the macro had prioritized AI technology, such as our AI-powered ACE short-for Analytics and Content Engine solutions. We continue to see traction with our AI-powered ACE solution with AI-powered ACE ARR growing to the high-teens as a percentage of growth ARR during Q2. This rate has nearly doubled since last quarter. We are establishing our digital engagement. And AI-powered ACE is helping us across 3 vectors: New business acquisition, customer expansion, and improved retention. We expect AI-powered ACE to continue to ramp throughout the year, giving us a tailwind to drive ARR growth in the future.

As we look to the second half of the year, we are balancing our enthusiasm around the progress we have made in the first 2 quarters with the reality that forecasting ARR in this environment more than 1 quarter ahead remains challenging. We expect sequential improvement in ARR performance in Q3 with net new ARR of breakeven to negative 1% and anticipate a similar performance in Q4 assuming there is no further deterioration in the macro. We believe we are turning the corner towards the achievement of positive ARR. We are making progress towards reaccelerating our business, especially in the enterprise, due to the success we are seeing across our strategic growth priorities, which are: One, innovating our platform with our AI-powered ACE solution; two, executing our enterprise go-to-market focus, especially in highly regulated investments; and three, delivering on our profitability targets while returning to growth.

Let's start with an update on our platform's AI innovation and the momentum of our AI-powered ACE solution. In June, we hosted our annual user conference, The ON24 Experience, where we gathered thousands of our customers and prospects across the globe, including half of our enterprise customer base with industry leaders like Grand Thornton, a provider of audit and assurance, tax and advisory services; Guardian, a modern mutual insurance company; SAP, a multinational software company; and SunLife U.S., one of the largest providers of employee and government benefits and more, who shared the exceptional customer experiences and significant revenue impact they are delivering through our plan.

We are extremely excited by the positive feedback on our platform road map and the customer success stories being shared by our early adopters of AI-powered ACE. One of our customers, a multinational, $5 billion software company, shared how they can now target and personalize for different countries, just one experience, promoting the different products that are available and applicable to different markets, and even translate them into a number of different languages, providing significant time savings to the field marketing teams.

Another customer, IT services and consulting company with over 1,000 employees, spoke about how AI-powered ACE has tripled their reach and engagement year-over-year and helps them create content 4x faster. A similar result was shared by one of the nation's top accounting firms who said AI-powered ACE helps them speed up their entire content process, get campaigns to market much more quickly, and tailor their certified professional education programs for different verticals through different share from the competition.

These stories are just a sample of how AI-powered ACE is delivering tremendous value and benefit to our customers, helping to improve retention and fuel expansion within our installed base.

Let me explain further the power of AI-powered ACE. AI ACE helps uniquely solve some of the biggest challenges that enterprise sales and marketing teams face today. As of Q2, the percentage of our installed base that has used or tried our AI capabilities is in the high-teens. First on this list is the need to personalize at scale. Nearly every CMO I talked to has a goal to deliver a more personalized, intelligent, and differentiated digital experience to their customers and prospects. Yet, most currently lack the resources, the data, and the technology to do so. Our AI-powered ACE solution gives an immediate and simple way for their team to target and engage at scale their business' highest priority audiences, such as top accounts, important channel partners, and executive decision makers.

Our ability to meet the imperative of personalization is giving us a way to further differentiate our platform for mission-critical go-to-market use cases like demand generation, customer marketing, professional certification and training, partner enablement, and compliance-driven digital transformation use cases.

One is a multibillion dollar global telecom provider. After standardizing their marketing teams on our platform last year, their partner enablement team came to us to help them personalize the way they educate their network of resellers and channel partners on specific product offerings, helping to strengthen a critical revenue stream for their business. By upgrading to our AI-powered ACE solution, their team can dynamically personalize content experiences based on partner peer and type. Their adoption of AI-powered ACE has increased their investment with us by more than 25%, while saving them hundreds of thousands of dollars in agency man-hours and consolidating on solutions in their tech stack onto our plan.

AI-powered ACE also helps reduce the burden of content creation, a common pain point across each of the industries we serve. Whether it's enabling investors and financial advisors, the financial services and asset management space, delivering medical education to healthcare professionals in the life sciences sector, or certifying business professionals in the professional services vertical, content is the lifeblood for B2B sales and marketing teams.

It's also where organizations often are not resourced with sufficient head count and budget to keep up with the speed and scale their business needs. AI-powered ACE is solving this problem head-on by automatically turning one webinar experience into AI-generated content and videos, multiplying content production by at least 5x, and according to some of our customers' feedback, reducing workloads by 80%. Importantly, our platform provides enterprises these powerful AI solutions in a manner that supports security and compliance. As a trusted and proven provider to our installed base, we are hearing from our customers for being able to use AI within the platform they already have is preferred to acquiring net new technology.

To give you more color on this, one of our long-standing financial services customers with over $1.5 trillion in assets under management, upgraded to AI-powered ACE this quarter. It's so much time and effort spent by their subject matter experts, developing fund updates and market analysis, getting more from the highest value content without additional head count was a big benefit. And the ability to use generative AI from an already approved platform within their existing compliance process helped to further accelerate their decision to upgrade to ACE given the faster and easier path towards adoption. We are among the first technologies chosen for the company's cross-functional AI road map, resulting in over 20% expansion.

The third main benefit of AI-powered automated content mergers. To successfully win and keep customers, companies need to manage a mix of many digital channels. Just having a website and sending one-off e-mails won't cut it anymore. Using multiple digital channels takes a lot of effort, and constant hands-on maintenance. Our platform helps alleviate that resource drain with quickly populating, building, and delivering streams of digital content and videos and dynamically personalizing the experience for audiences.

Moving to our second strategic priority, our enterprise go-to-market. When it comes to our enterprise go-to-market strategy, we continue to focus on mission-critical use cases in regulated industries, including life sciences and financial services. Because our enterprise-grade platform supports stringent compliance standards, we believe we have a differentiated solution with an ideal product market fit for these verticals. And our results are validating our strategy as we saw sequential and year-over-year core ARR growth in the life sciences and financial services verticals in Q2.

I'm especially excited about the momentum we are seeing with life sciences. So let me give you some more color. There's been a massive acceleration of digital transformation in this category, especially in pharmaceuticals. And we believe this trend has been and will continue to be a growth vector for our business. We've put a specific focus on our go-to-market execution in life sciences and pharma and have dedicated some of our product development to address their specific needs. As a result, our life sciences segment is one of the highest performing parts of our business. As an example, one of our strategic customer relationships is with one of the world's top 5 pharmaceutical companies, where we power their digital healthcare professional engagement strategy. To give you a sense of the scale we are driving for them, last year, they engaged hundreds of thousands of healthcare professionals in more than 10 languages across 50 countries through our platform. Our breadth of capabilities and depth of pharma expertise also puts us in a strong position for new business acquisition.

In Q2, we brought on an over $10 billion animal healthcare and pharmaceutical company who needed to centralize the global healthcare professional engagement strategy onto one platform that's purpose-built for the enterprise. Because their legacy system lacks the deep engagement and first-party data, they were spending weeks and weeks trying to manually analyze and manage customer engagement there. By moving on to our platform, we will be able to scale their program efficiently. And with our engagement data and integrations, we will be able to automate their marketing and sales processes while gaining insights they can't get on any other digital channel. Outside of regulated industries, we continue to provide a differentiated solution that drives value for our customers.

One of our largest new deals in Q2 comes from a nearly $700 million global technology company that provides marketing automation to e-commerce. After a period of rapid growth, their team was looking to advance the marketing maturity to an enterprise-grade platform. They're investing in our full platform suite because of its ability to help them deliver consistent, data-driven, and personalized experience across the entire customer journey. We will utilize our platform to power with lower demand generation, customer marketing, and partner marketing teams, which is especially important as the organization moves up market and focuses on sales-led growth.

Next, I'll turn to profitability. As I mentioned at the start of my remarks, we are pleased to achieve our Q2 profitability targets again, delivering positive adjusted EBITDA and positive non-GAAP EPS for the fifth consecutive quarter. We expect to be adjusted EBITDA-positive for 2024, exceeding our breakeven target. We remain committed to our long-term profitability target of generating double-digit EBITDA margins.

Coming off our Q2 performance, I believe we are making progress towards reaccelerating our business, especially in the enterprise. AI adoption is a business imperative, and our AI-powered ACE is a differentiated solution that has a strong product market fit due to its enterprise-grade capabilities and its ability to improve efficiency and increase revenue results.

Q2 marked performance gains for our enterprise business. The average core ARR per customer in Q2 was consistent with the higher watermark we reached last quarter. In addition, our percentage of ARR and multi-year agreements, the percentage of customers using 2 or more products remained at record levels.

I'll conclude by reiterating my enthusiasm for our performance in the quarter and the progress we have made in the first half of this year. We are encouraged by another quarter of improvement in the stability of our installed base, with gross retention improving sequentially from last quarter and trending much better than the average rates we've seen in each of the past 3 years. We are seeing traction around our AI-powered ACE solution with the percentage of growth ARR in Q2. On the operational front, we are successfully executing our strategy to focus on digital transformation use cases while making these achievements with a streamlined organization as meeting our profitability terms.

As we look at the second half of the year, we will build on the progress we've made in the first 2 quarters. We believe we are at the beginning of a turning point. We are laser-focused on execution and moving back to positive ARR. We expect continued improvement into 2025. Longer-term, we believe we are attacking a massive market opportunity by enabling B2B companies to leverage ON24 digital engagement platform to more efficiently grow revenue and engage and understand their customers and prospects. We believe the strength of our platform and the continued execution of our strategic growth priorities, we pave the way for success and enable us to ultimately reach our long-term targets of double-digit revenue growth and double-digit EBITDA margins.

With that, I'd like to turn the call over to Steve.

[Steve Vattuone, executive]

Thank you, Sharat, and good afternoon, everyone. I'm going to start with our second quarter 2024 results and we'll then discuss our outlook for the third quarter of 2024 and full year 2024.

Before I get into the numbers, I wanted to remind everyone of our core platform business as we have deemphasized the virtual conference product. We view the metrics from our core platform, such as revenue and ARR as the best KPIs to measure our performance. Revenue from our core platform, including services in Q2 of 2024, was $36.5 million, representing a decrease of 10% year-over-year. Total revenue for the second quarter, which includes revenue from our virtual conference product, was $37.3 million. Total subscription and other platform revenue was $34.1 million. Overages represented approximately 1% of total revenue in Q2. Total professional services revenue was $3.2 million, a decrease of 15% year-over-year, representing approximately 9% of total revenue, the same as in the year ago period.

Moving on to ARR. ARR represents an annualized value of all subscription contracts at the end of the period and excludes professional services and overages. Ending ARR related to our core platform totaled $131 million, a decrease of $2.2 million compared to Q1 of 2024, which is meaningfully better than the expectations we provided on our last earnings call and was driven by the continued trend of increased stabilization in our installed base over the past several quarters.

As Sharat discussed, impaired gross retention in Q2 improved by close to double-digits as compared to Q2 of last year and also improved sequentially from Q1. While customers are still being cautious about making new purchasing commitments, we are encouraged by the signs of stabilization we are seeing in our business. Total ARR, including the contribution from our virtual conference product, was $133.7 million at the end of Q2 2024.

Turning to customer metrics. The ARR contribution from the $100,000-plus customer cohort continues to represent approximately 2/3 of our total ARR, which is consistent with the prior quarter and demonstrates the continued strength of our largest enterprise customers and our commitment to our platform. The number of customers contributing more than $100,000 in total ARR was 319. As we have discussed on prior calls, enterprise customers continue to be our focus, and we have seen these customers continue to make longer-term commitments to our platform. The percentage of our ARR in multi-year contracts increased sequentially from Q1 and is now at record levels with over 50% of our ARR and multi-year agreements. In Q2, the average core ARR per customer was consistent with last quarter at approximately $78,000 per customer. Total customer count at the end of Q2 was 1,682.

Before turning to expense items and profitability, I would like to point out that I will be discussing non-GAAP results going forward. Our non-GAAP results exclude stock-based compensation, restructuring charges, impairment charges for real estate, amortization of acquired intangibles, shareholder activism related costs, as well as certain other items. Our GAAP financial results, along with a reconciliation between GAAP and non-GAAP results can be found within our earnings release.

Our gross margin in Q2 was 77%, consistent with the past 2 quarters and up 200 basis points from Q2 of last year. Our gross margins reflect the cost reduction actions we have taken to streamline our operations.

Now turning to operating expenses. Sales and marketing expense in Q2 was $15.8 million compared to $18.3 million in Q2 last year. This represents 42% of total revenue compared to 43% in the same period last year and 43% last quarter. Our sales and marketing expenses have decreased in absolute dollars, both sequentially and year-over-year, largely due to the cost savings measures we have implemented, resulting in a more efficient go-to-market organization as we continue to focus on driving improved sales efficiency. R&D expense in Q2 was $6.7 million compared to $7.6 million in Q2 last year. This represents 18% of total revenue compared to 18% in the same period last year and last quarter. While our R&D expenses have decreased in absolute dollars over the past year, we continue to invest in product innovation to drive the next generation of our platform, which includes AI-powered ACE, which we launched earlier this year.

G&A expense in Q2 was $6.5 million compared to $6.7 million in Q2 last year. This represents 17% of total revenue, up slightly from 16% in the same period last year and down from 18% last quarter. We have taken actions to streamline our G&A functions and reduce our G&A costs. And as a result, our G&A expenses in absolute dollars have decreased as compared to the prior quarter and prior year.

Moving on to our bottom-line performance. I'm pleased to report that we exceeded the profitability targets that we provided in the prior earnings call. We achieved positive adjusted EBITDA and non-GAAP EPS profitability in Q2. This marks the fifth consecutive quarter of positive adjusted EBITDA and non-GAAP EPS profitability. As we enter the latter part of 2024 and head into 2025, we do so with a more efficient and streamlined cost structure, which will provide operating leverage to our business heading into 2025. Operating loss for Q2 was $0.3 million, or a negative 1% operating margin, compared to an operating loss of $0.9 million and a negative 2% operating margin in the same period last year. Net income in Q2 was $1.5 million, or $0.03 per share based on approximately 45.8 million diluted shares outstanding. This compares to net income of $2.1 million, or $0.04 per share in Q2 last year using approximately 50.7 million diluted shares outstanding.

Turning to the balance sheet and cash flow. We ended the quarter with $193.8 million in cash, cash equivalents, and marketable securities. In March of this year, we announced a new $25 million share repurchase program, which runs for 1 year until March 2025. This new share repurchase program follows the completion of 2 earlier capital return programs, which collectively returned $166 million to shareholders between December 2021 and February 2023. Under the new $25 million share repurchase program, we have utilized $8.3 million to date, with approximately $5 million utilized in Q2 of 2024 and approximately $3.3 million utilized thus far in Q3. With almost $194 million of cash and investments at the end of Q2, our balance sheet remains strong.

Turning to our cash flow metrics for Q2. Cash provided by operations in Q2 was $1.4 million compared to cash used in operations of $4.3 million in Q2 of last year. Free cash flow was positive $0.9 million in Q2 compared to negative $4.9 million in Q2 last year. This is our second quarter in a row of positive free cash flow. As a reminder, our cash flow in Q2 includes $0.8 million related to our restructuring efforts.

Before moving to guidance, I wanted to emphasize that, as Sharat and I have discussed, we continue to see improved stability in our installed base with improvements in gross retention and momentum from our AI-powered ACE solutions, which drove improved ARR performance in Q2 as compared to Q1. We expect to see further sequential improvement in ARR performance in Q3 as well. While we continue to see improved stability in the business, and we did make progress on new business performance in Q2, we also continue to operate in an environment where customers are deliberate about making new purchase commitments as marketing budgets continue to face pressure. This macroeconomic uncertainty continues to make it challenging to forecast ARR for the 1 quarter out.

Taking these factors into consideration, we anticipate net new ARR of breakeven to negative 1% in Q3 and anticipate similar performance in Q4, assuming there is no further deterioration in the macro environment. ARR from our de-emphasized virtual conference product is expected to reduce by approximately $0.2 million in Q3 compared to Q2 and is expected to be $2.5 million at the end of Q3.

Turning to Q3 guidance. We expect Q3 core platform revenue, including services, in the range of $34.2 million to $35.2 million, and total revenue, which includes our virtual conference product, in the range of $35 million to $36 million. Professional services is expected to represent approximately 7% of total revenue. We expect gross margins to be in the mid-70s in Q3. We expect a non-GAAP operating loss in the range of $2.3 million to $1.3 million and non-GAAP net loss per share of $0.01 per share to non-GAAP net income of $0.01 per share using 42 million basic and diluted shares outstanding and 46 million diluted shares outstanding, respectively. We expect a restructuring charge of $0.4 million to $0.7 million in Q3 related to our ongoing cost reduction efforts, which is excluded from the non-GAAP amounts provided above.

Now let me turn to our annual guidance. For the full year, we expect core platform revenue, including services to be in the range of $140.5 million. We expect total revenue to be in the range of $145 million to $147.8 million. Professional services is expected to represent approximately 8% of total revenue. We expect a non-GAAP operating loss in the range of $4.5 million to $3 million and non-GAAP net income per share of $0.05 per share to $0.08 per share using 45.5 million diluted shares outstanding. We expect gross margins for the year to be marginally better than 2023 gross margins, which were 75%. We are committed to achieving positive adjusted EBITDA for 2024.

Regarding the second half, we expect EBITDA will be modestly negative in Q3, but that it will be positive in Q4 and for 2024 overall, restructuring charges and amortization of acquired intangibles and certain other items are excluded from the full year non-GAAP amounts provided above. This guidance reflects a balanced approach between maintaining cost discipline while also allowing us to invest to return to growth.

In summary, we are seeing improvements in our installed base performance metrics and with the momentum of our AI-powered ACE solution. We have a strong customer base and differentiated products, and we are well-positioned to achieve our long-term goal of generating double-digit top-line growth and double-digit EBITDA margins.

With that, Sharat and I will open the call up for questions.

[Operator]

[Operator Instructions] First question comes from Arjun Bhatia with William Blair.

[Arjun Bhatia, analyst]

Sharat, I think you mentioned in your prepared remarks that it was about half of the customers that came up for renewal in the quarter resulted in growth. I don't know when the last time was that, that was the case. But can you just give a little bit more color on what are customers buying when they are expanding? Is it the core platform? Is it ACE? Where do you see most of that upsell and expansion coming from?

[Sharat Sharan, executive]

Yes. Arjun, let me first clarify, I think what we talked about last quarter, we had given guidance that we had some large renewals coming up, and we set the expectations appropriately. So the comment that I made about half of the customers that we got growth is for the large customer renewals that were coming up. These were 7-figure deals that were coming up for the quarter. That being said, after the clarification, let me give you a sense of what people are doing on the platform to expand because one of the things that we have talked about that our gross retention improved, our down-sells were probably the best as a percentage of renewal cohort close to the best in the last 3 years.

And when people are buying -- there are 3 different dynamics of buying. One is, as you've heard sometimes if we are going in technology, we're going from demand generation to customer marketing to partner enablement. So we are buying people buying different licenses. The other is related to our expansion and getting other additional product use cases, whether it is engagement hub and target for the always on and on-demand engagement use cases or whether they are things like go-live, which is for the event management use cases. So one platform for intelligent digital engagement. And then the third layer that we add on top of that is the AI-powered ACE platform now, which allows them to do hyperpersonalization at scale. And then the second area is allows them to do automated content creation and nurture.

So -- and on that, AI-powered ACE from a total growth ARR, both new and expansion, reached close to high-teens of total growth ARR, so we are very encouraged by that. It almost doubled compared to the first quarter. So hopefully, that helps.

So overall, down-sells in better shape than we were before, close to the best and continuing to see traction on expansion in AI-powered ACE and our other metrics. Would I like expansion to still be more? Yes. But in the current environment, I'll take it.

[Arjun Bhatia, analyst]

Okay. And have you -- and when you're coming up on these renewal conversations with customers, have you made any changes to how you're approaching pricing dynamics? And I think if I remember back, you kind of always viewed yourself as a premium solution in the market. With the marketing budgets the way they are now and the general kind of macroeconomic certainty, how are you approaching pricing?

[Sharat Sharan, executive]

Yes. I think there are 2 or 3 things that we are doing at a strategic level. So first of all, when things do come up for renewal and somebody wants a downsell, first thing that we would basically do is we would bring the other products and growth in other parts of that organization with the Engagement Hub product, the Target product, or the Go Live product. So we are trying to basically expand the use cases, bring others to basically take care of the downsell. And also AI-powered ACE helps in that also because you're basically giving them additional use cases.

The other thing that we're also doing, if we are confronted with a downsell, that's also where we are going to customers and saying, okay, you had an annual deal with us. Now, we will look at this, but we need a 3-year deal. And even there, we have a price increase on an annual basis. But that's how our multi-year ARR is the highest that it's ever been and north of 50%. So those are the 2 or 3 different dynamics that we play, and overall, very encouraged that in addition to churn, but our downsell performance as a percentage of renewal ARR was close to the best in the last 3 years.

[Arjun Bhatia, analyst]

All right. And last one maybe for Steve. Just as I'm looking at the margin trajectory, it seems like certainly you're making a little bit of progress here. But when I look at the sales and marketing line and what your spend is there, it still looks like a little -- it's a little elevated compared to some of your peers with similar growth rates. So when you think about sales and marketing spend, how long do you think that takes to kind of get to maybe 30% of revenue? And when you're thinking about your long-term targets, do you need to get the business to -- back to a certain growth rate to be able to hit your long-term profitability targets? Or can that happen at sort of flattish maybe revenue?

[Steve Vattuone, executive]

Well, first off, we're always prioritizing to return to growth and balancing profitability with that. Now, on the top line, as Sharat discussed, we are seeing positive trends in the business with ARR performance improving sequentially, and we expect further improvements in the second half, as we've discussed in the prepared remarks. We are expecting these positive trends in our business to continue into next year. We should start seeing these trends impact the top line in a positive manner.

Now, in terms of the expense structure, we have that where we want it for the second half of the year with gross margins, and we guided to the mid-70s. We're exiting 2024 with positive -- we expect to exit with positive adjusted EBITDA in Q4 and for the year. Now, we will continue to monitor the cost structure based on what we're seeing in the top line, and the go-to-market investments are part of that. We will continue to make select investments in things like product innovation, including AI-powered ACE, which we launched earlier this year. And we are making go-to-market investments in regulated industries like financial services and life sciences, and Sharat discussed the success we're seeing there. So we believe we can make key investments in the business, get back to positive ARR growth and show improved bottom line performance over time without significantly increasing the top -- the cost structure.

In terms of the macro, we obviously can't control that, but our guidance for 2024 assumes no improvement in the macro. And if it gets better, that will, of course, be a net positive for us.

[Operator]

Next question, Noah Herman with JPMorgan.

[Noah Herman, analyst]

Just coming back to macro a little bit, last quarter, you sort of layered in an incremental prudence within the guide and understandably with some of the larger renewals coming up in the quarter, but now that we're sort of through that, how are you sort of thinking about the prudence that you're layering to the guide at this point, considering all else equal with the macro? Are you starting to see some normalization? Or are you starting to see customers reinvest in some of the revenue-generating initiatives? And then, I have a quick follow-up.

[Sharat Sharan, executive]

Yes. Let me take that. Noah, one of the things is, for starters, we've been able to diversify our business over the last few years with an increased emphasis on industries that are still in the early stages of digital transformation, primarily life science and financial services, including asset management and insurance. In fact, these verticals have grown from 20% to almost 1/3 of our core ARR in just over 4 years. So we fundamentally have made broadband improvements to our business. Now, marketing budgets are still tight. We talked about Q2. We had some large renewals coming up, but marketing budgets are still tight, and we are not factoring any improvements of that in the second half. That being said, if you look at sales and marketing teams, they are confronting -- the issues are, hey, how can we do more with less? How can we consolidate point technologies? How can we address multiple go-to-market use cases? How can I prioritize first-party data, especially in the age of AI? So all these things help us, and we are seeing that in the gross retention improvement in AI-powered ACE adoption. So as I look going forward in the second half, we are not factoring in a macro improvement, but we expect sequential improvement in ARR performance in Q3 with net new ARR to be between breakeven to negative 1% of Q2 ARR. And it's the improvement that we are making on the gross retention, on the contribution from AI-powered ACE of our go-to-market focus on the digital transformation use cases in financial services and life sciences that is allowing us to make those estimates.

[Noah Herman, analyst]

Got it. And then, maybe just quickly on the ARR guide for the second half, is there any way to quantify how much of that hinges on the AI-powered ACE offerings?

[Sharat Sharan, executive]

I think at this stage, we are not providing that guidance. But as I said, to repeat, we expect sequential improvement in ARR performance in Q3 with net new ARR to be breakeven to negative 1% of Q2 ARR. As we look at the second half, we are balancing our enthusiasm around the progress we have made this year with the reality of a tough macro environment for front-end software, and that it is tough to forecast ARR more than 1 quarter ahead in this environment. I can give you gross retention within the range, but growth ARR is difficult, especially with the business focused on enterprise business, about 70% of which -- of our business is that. So at this stage, we expect Q4 ARR to be between breakeven and negative 1%, similar to Q3. And we expect continued improvement in our stabilization in gross retention, both from a churn and downsell perspective. I think AI-powered ACE is going to continue to ramp in the second half, and we provide tailwinds into 2025, and we expect to continue to improve on the financial services and life sciences as a driver of our business. We believe we have turned the corner and remain laser focused on execution.

[Operator]

[Operator Instructions] Next question comes from Scott Berg with Needham & Company.

[Scott Berg, analyst]

I guess, I have 2. Sharat, in your guidance, you've mentioned a couple of times you're assuming ARR in Q3 and Q4 will be breakeven to maybe down 1% sequentially each quarter. But as you look back over the last maybe a couple, 3 quarters, I know you're hoping to be back to ARR growth here at the end of this year. I guess, what's been the difference between your expectation a couple of quarters ago and where the business is today? Has it been more on the net new side? Or has it been on some of the retention dynamics?

[Sharat Sharan, executive]

I think it's probably more on the net new side that we need to see more work, like, Scott, just to kind of give you a sense. You talked about the last 2, 3 quarters. We have seen -- in those 2, 3 quarters, we've seen improvement in our gross retention. Like I said, Q2 churn, if you just look at dollar churn, it was the best we had in the last 3 years. If you look at downsells, those were close to the best, and we expect those trends to continue. Yes, small up and down is fine, but we expect those trends to continue. I expect AI-powered ACE to continue to ramp, and that will help new and expansion and retention. I continue to expect that our focus on life sciences and financial services, the digital transformation use cases will help. But the challenge that it is tough to forecast ARR more than 1 quarter ahead in this environment. You know how the enterprise businesses -- over 2/3 or close to 70% of our businesses focused on enterprise really depend on the last month of the quarter a lot. So I'm encouraged. I'm encouraged by the progress that we are making. But it is hard for me to forecast more than 1 quarter ahead, and that's why we have provided the guidance that we have.

[Scott Berg, analyst]

Got it. Helpful. And then, from a follow-up, you talked about the customer conference that you held in June. I guess, what are your kind of key 1 or 2 takeaways from the conference in terms of what you're hearing from customers there? What should we maybe kind of look forward to over the next couple of quarters from a business perspective that you're able to come out maybe enthusiastic from the conference?

[Sharat Sharan, executive]

I think there are 2 or 3 things that we basically learned. Number one was the enthusiasm of the customers in getting their hands on our AI tools. And I was surprised that we just launched the product in January, AI-powered ACE, and when we did this conference in June, I think early June, we already had customers with a lot of use cases. If you look at the people who joined the call, larger companies with a lot of use cases, some doing it on the personalization side, some basically doing it on the automated content side, so on and so forth. And what that also allowed us to do, we also run something before the conference call, something called a master class for a day. We also were able to learn exactly what their feedback was, what part of the product was not working, where did they want us to see improvement, so on and so forth. So that was very helpful. And having other customers, Scott, hear from the people who have already implemented AI-powered ACE and the results they're getting on ROI, the results that they're getting on cost savings, and some of that I've talked about in our prepared remarks, was very helpful because customers like to learn from customers.

There's one other area of improvement that we learned. We learned that our AI-powered ACE platform is very powerful, but it has a lot of capability. So, people were basically saying, hey, if you want faster adoption, do we really need personalization tied to the automated content creation and nurture. So we took that feedback, and we are looking at, hey, should we decouple the product more for faster adoption in our platform? So we are looking at those capabilities because sometimes customers want to do personalization. Sometimes they want to do automated content creation. So we are trying to basically make those adjustments to get faster adoption of the product. So those are some of the key takeaways that we got.

[Scott Berg, analyst]

Very helpful. Congrats again on the quarter.

[Operator]

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