VTEX

NYSE:VTEX

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for standing by and welcome to the VTEX First Quarter 2024 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.I'd now like to turn the call over to Julia Vater Fernandez, Investor Relations Director. You may begin.

[Julia Fernandez, executive]

Hello everyone, and welcome to the VTEX earnings conference call for the quarter ended March 31, 2024. I'm Julia Vater Fernandez, Investor Relations Director for VTEX. Our senior executives presenting today are Geraldo Thomaz Junior Founder and Co-CEO and Ricardo Camatta Sodre, Chief Financial Officer. Additionally, Mariano Gomide de Faria, Founder and Co-CEO and Andre Spolidoro, Chief Strategy Officer, will be available during today's Q&A session. I would like to remind you that management may make forward-looking statements related to such matters as continued growth prospects for the company, industry trends and product and technology initiatives.These statements are based on currently available information and our current assumptions, expectations and projections about future events. While we believe that our assumptions, expectations and projections are reasonable in view of the current available information, you are cautioned not to place undue reliance on these forward-looking statements. Certain risks and uncertainties are described in the Risk Factors and Forward-Looking Statements sections of VTEX Form 20-F for the year ended December 31, 2023, and other VTEX filings within the U.S. Securities and Exchange Commission, which are available on our Investor Relations website.Finally, I would like to remind you that during the course of this conference call, we may discuss some non-GAAP measures. A reconciliation of those measures to the nearest comparable GAAP measures can be found in our first quarter 2024 earnings press release available on our Investor Relations website. Now, let me turn the call over to Geraldo. Geraldo, the floor is yours.

[Geraldo do Carmo Thomaz, executive]

Thank you Julia. Welcome everyone and thanks for joining our first quarter 2024 earnings conference call. As we step into 2024, despite macroeconomics uncertainties, our GMV continue to outperform the market, growing 22% year-over-year. Slightly above that our revenue grew 25% year-over-year in the first quarter of 2024. We remain encouraged by new contract signatures and the operational leverage of our business model, resulting in significant operating margin expansion. In today's retail landscape, seamless integration of software solutions, content creators and suppliers within an efficient architecture is imperative for low maintenance costs and rapid revenue generation.Commerce has evolved into an ecosystem-driven play and VTEX is at the forefront of connectivity. With an extensive network comprising over 1000 system integrators and independent software vendors and over 6000 VTEX IO extensions by third parties, we deliver comprehensive solutions with remarkable speed and efficiency. Our ecosystem extends beyond that. Our customers can easily become marketplaces and connect to external marketplaces. Sales rep also play a crucial role in the consumer journey and we're investing in connecting them across all channels.Additionally, this year we're strengthening connections through data, leveraging AI to extract valuable insights. We envision VTEX as the source of true for sales attribution data, which is vital for developing AI models in commerce. At VTEX, we are delivering significant year-over-year operating margin increases while also launching products that reshape commerce for IT and business teams, driving sustainable growth with compelling ROI. Introducing new revenue streams paves the way for our long-term expansion while enhancing operational efficiency and margins. We're excited about VTEX's future, focusing on growth, margin optimization and customer success. Positive feedback from customers and industry experts reaffirms our position as the global leader in connected commerce.We're leveraging these strengths to drive significant sales momentum. Our recent expansion into Germany underscore our commitment to global growth, while sustaining sales momentum in Brazil highlights our long term growth potential. In the first quarter of 2024, we celebrated successful go lives of new customers, including Keune Haircosmetics manufacturing in Belgium, the Netherlands and France, Arado, Cruzeiro do Sul, PetYard in Brazil, Tres Montes in Chile, OBI in Germany, PagineGialle Shop in Italy, KFC in Romania and HMart in the US.Furthermore, we have strengthened our relationship with existing customers such as Grupo Soma, who added a new store in Chile, expanding its presence to more than ten stores across Latin America and the U.S. Hinode Group, who added a B2B store in Brazil, now operating both B2B and B2C models across two countries in LATAM. [ Hugo Boss ] who added a new store in Colombia and Peru, increasing its footprint to four stores across Latin America and Nike, who added a new store in Colombia, extending its reach to three countries in Latin America.This year, VTEX achieved a significant milestone in its journey of growth and innovation by successfully launching the OBI operation in Germany. These moves marks a pivotal moment in our commitment to the European market. Talking about milestones, I would like to draw attention to a significant event in the first quarter of 2024 that happened right after [indiscernible].VTEX Connect Live's New York City made a resounding debut as the first U.S. based event of its kind, drawing over 1000 influential in person attendees eager to immerse themselves in the latest trends and strategy shaping digital commerce. The event was a hub of inspiration and network opportunities for commerce leaders seeking to navigate the evolving retail landscape. In addition to featuring the renowned entrepreneur and basketball Hall of Fame Magic Johnson, our event included a panel discussion with Hearst. They shared insights into their decision to partner with VTEX, highlighting how this choice enabled them to significantly decrease their total cost of ownership transitioning from a TCO of high single digits after GMV to low single digit with VTEX.The event highlighted the significance of equipping retailers and brands with the essential tools in today's high interest rate environment. As global interest rates remain high, business must optimize organic sales channels and enhance margins. The event demonstrated that VTEX strikes the balance between flexibility and low maintenance commerce technology, enabling its customers to stay ahead in the dynamic world of retail. Additionally, as mentioned, we started 2024 with strong momentum, with industry analysts firms recognizing VTEX as top performer.In January, we were recognized as the Customers' Choice in Gartner Voice of the Customer for Digital Commerce. By February, we also earned the top spot in the IDC marketplace worldwide B2C digital commerce platform for mid-market growth vendor assessment study. With this strong start, 2024 is shaping to be an even more remarkable year for VTEX. Now, let's focus on what matters most, our customers. Here are just a few customer success stories that exemplify our platform capabilities and the remarkable outcomes they achieved. OBI, one of our newest customers this quarter is a titan in Europe's home improvement sector, with more than 640 stores scattered across ten European countries with headquarters in January.By migrating away from the previous legacy platform and choose VTEX over the others, OBI can now leverage the VTEX composable and complete commerce platform, marketplace capabilities and unparalleled automation processes. OBI seamlessly integrated to its e-commerce operation 349 Germany located physical stores and third-party sellers into a unified transaction platform, expanding product offerings and providing customers with a seamless shopping experience across various delivery and pickup options.With integrated physical stores nationwide, customers can now pick up online orders within just 2 hours, showcasing the platform efficiency and effectiveness and meeting consumer needs. Since migrating to VTEX, OBI has experienced significant enhancements, including unified franchise management, smooth ramp up of platform traffic, improved front-end metrics and increased agility and development processes. This collaboration not only enhances OBI's current operation, but also opens door through a world of future possibilities. It's a testament to VTEX enabling commitment to driving profitable growth and fostering innovation for enterprise brands globally. [indiscernible] the most relevant leather good brand in Mexico, partnered with VTEX to lead through omni-channel strategies and its international expansion.VTEX composable platform helped them reduce implementation costs and streamline processes. Among its standout feature, Personal Shopper emerged as a game changer, offering customized shopping experiences with interactive, innovative solutions Cloe achieved remarkable results, a 14% increase in digital sales by the end of 2023. Standout features like Personal Shopper reduced returns and improved decision making while enhancing checkout performance and diverse improvement methods boosted offline sales. Cloe's e-commerce success, evidenced by a 60.5% conversion rate increase and a 12.5% growth in average order value underscores the impactful collaboration between VTEX and [ Cloe ].Future plans include adding the cross-border functionality for expansion into new markets and personalized experiences through live shopping, demonstrating Cloe's commitment to continued growth and innovation. Colgate partnership with VTEX is the embodiment of innovation in digital commerce. Recognizing a gap in the customer experience between dental professionals and their customers, Colgate got to work by building a unique B2C marketplace e-commerce model. With a network of consultants, covering diverse regions scalability of this digital transformation was vital. Colgate saw a platform accommodating complex B2B requirements, including a specialized logging system for certified dentists and seamless integration with partners. Leveraging the tech's natives capability, Colgate developed a pioneering marketplace for dentists, offering integrated distributor products and fostering sales growth without logistical expenses, streamlining implementation and reducing costs.Strategic enhancements like cashback promotions and the loyalty program further augmented its sales. Colgate started its operation with detecting Brazil and in the fourth quarter of 2023 it added two B2B sites in the US, PCA Skin and Colgate Professional, further leveraging our fully composable and marketplace enabled architecture. Dimak, a grocery distributor in Chile catering to over 24,000 customers across eight regions, partnered with VTEX to revolutionize their B2B operations. Embracing VTEX's innovative solutions, Dimak embarked on a digital journey to tap into strategic growth opportunities by expanding its sales channels.With the launch of the B2B website, Dimak established a 24/7 online stores ensuring seamless access to their products for customers around the clock. Utilizing B2B suite as the cornerstone of their architecture, Dimak implemented a closed website model offering product prices exclusively upon customers login while leveraging essential tools such as checkout, catalog and OMS. With VTEX's guidance, Dimak is streamlining its pricing strategy, condensing its price list from 600 to six tiers based on location and customer segment.Since the platform launched within swift four month implementation period, Dimak witnesses remarkable growth experiences, a 10x increase in GMV and orders, doubling their conversion rates and achieving a 4 percentage point boost in profitability compared to traditional channels alone. Hearst, the leading global diversified media, information and service company, chose VTEX for its extensive native capabilities, adaptable multi-site architecture and VTEX's IO development platform, enabling the integration of custom features. Leveraging VTEX, Hearst established a marketplace supporting multi vendor business models thereby seamlessly enhancing the customer experience across its publication and shoppable interfaces.Facilitating the easy purchase of featured products. With VTEX's out of the box features and flexible APIs, Hearst swiftly launched its platform and [indiscernible] new business models in the digital economy. Furthermore, Hearst serves as the flagship customers piloting VTEX data pipeline and VTEX Fast Checkout currently undergoing AB testing for their men's health website as the primary checkout experience. Interfood, a leading Brazilian beverage importing company with a global presence of over 100 locations, has been satisfied VTEX's B2C customers since 2020. Recently, they chose VTEX also to power the B2B operations, unlocking a new realm of opportunities.Leveraging VTEX's B2B suite, two Interfood seamlessly integrated APIs to create microservices, streamline customer's registrations and credit control processes for enhancing organizational management. Additionally, with VTEX IO apps, the VTEX team tailored tax requirements to met Interfood needs precisely exemplifying VTEX's dedication to meeting and exceeding customer expectations. KFC, a quick service restaurant giant, selected VTEX in Romania to power their B2C operations.Seamlessly aligning with VTEX's out of the box functionalities, KFC swiftly launched their website, a mobile app for both iOS and Android, all from a single code base. I am proud to say that VTEX's team was able to adapt, tailor ordering payment methods to meet KFC specific requirements and be ready to launch the products in only four months. Mezzo, a leading Brazilian demo cosmetics chain expanding nine states, partnering with VTEX to develop their B2C and B2B platforms, they swiftly launched two stores, Mezzo Cosmetics and Mezzo Professionals, leveraging seamless connectivity with physical stores and a unified data source for streamlining operations.Each franchisee account serves as a white label seller, representing individual physical stores and ensuring optimal inventory management across territories. Remarkably, the project was completed within a mere three months. New Balance the global brand catering the sneakers enthusiasts migrated to VTEX and doubled their website conversion rates in Brazil. With their previous e-commerce platform, New Balance has struggled to deliver innovative experiences limited to basic sales journey due to high development costs and resource allocation constraints.The tax composable platform, plug and play functionalities and extensive partners ecosystem caught New Balance's attention. Once manual and labor-intensive integration of pricing catalogs and XML automation became seamless with VTEX API integrations, empowering their teams to manage promotion and discounts autonomously. The migration to VTEX facilitated rapid results for New Balance's e-commerce, which led to a significant increase in product page visits, double conversions and revenue growth within a month was post-migration.Before handing over to Ricardo, I want to revisit some exciting announcements from VTEX Day. This year's event boasted over 20,000 attendees, highlighting the impressive reach of the VTEX ecosystem. Some of the announcements include the fresh store empowering brands with agile front-end solutions for tailored store experiences now available for both B2B and B2C use cases. VTEX ad network revolutionizing digital advertising through AI-driven targeting and auctions. VTEX data pipeline offering specialized APIs for seamless data retrieval and sharing. VTEX should safeguard against security threats and preserving revenue and trust, along with AI-powered features across the search engine like shopping and pick and pack operations, optimizing user experiences and boosting conversion rates and marketplace enhancements for streamlined operations and accelerated time to revenue.This represents just a handful of the training advancements we've reviewed on our innovation and growth journey here at VTEX. We're reshaping the commerce landscape with pioneering products, specifically designed for enterprise customers and their IT and business teams. Our solutions empower IT teams to with cutting-edge functionalities, while our intuitive interface empower businesses teams to implement strategies seamlessly. Ultimately, our products are geared towards optimizing end user retention and attraction, boosting conversion rates, helping our customers optimize their e-commerce platform to amplify their ROI.Moreover, these products will open up new revenue streams for VTEX. While the short term impact may not be significant, they could play a role in our long term growth trajectory. I'd like a moment to express my gratitude to our 1,334 dedicated VTEX employees whose unwavering dedication and commitment propel us forward as the backbone for connected commerce. I'd like also to thank our valued customers, partners and investors.I will now hand the call over to Ricardo.

[Ricardo Sodre, executive]

Thank you Geraldo, hi everyone. I'm pleased to share VTEX's Q1 2024 financial results as emphasized by Geraldo, our Q1 GMV hit $4.0 billion, marking a year over year growth of 22% in U.S. dollars and 20% in FX neutral. This led to a year over year revenue growth of 25% in U.S. dollars and 21% on an FX neutral basis, reaching $52.6 million. Although macroeconomic conditions impacted the same store sales of existing customers, the first quarter of 2024 witnessed relevant momentum in signatures of new annual contract value. That, coupled with significant gross margin improvements and a disciplined operational expenses approach, results in significant operational leverage and an encouraging sign for VTEX's profitable growth trajectory.Double clicking on our top line, our subscription revenue reached $50.4 million this quarter, up from $39.8 million in the first quarter of 2023, representing a year over year increase of 27% in U.S. dollars and 23% in FX neutral, while our services revenue totaled $2.3 million. Now, moving down the P&L, we have exciting updates. We are pleased to announce the positive operational leverage achieved even with the inherently weaker seasonality observed in our first quarters. This performance instills confidence in our sustainable profitability prospects. Our non-GAAP subscription gross margin reached 77.2% a 328 basis point year over year improvement compared to the 73.9% margin in the same quarter last year.This margin expansion our team's dedication to enhancing profitability and highlights our ongoing efforts to migrate non-core services to more efficient hosting providers and optimize support costs for operational leverage [Technical Difficulty] implying an year-over-year growth of 18% on a FX neutral basis in the middle of the range. For the full year 2024, we continue executing our strategy for profitable growth, recognizing heightened productivity in Argentina's macro situation. We are targeting FX neutral year-over-year revenue growth of 16% to 20%, implying a range of $234 million to $243 million based on April's average FX rate. Further demonstrating our operational leverage. We are targeting free cash flow and non-GAAP operating income margins of high single digits. We are excited about the future of VTEX. Our business model has proven its robustness and now our journey revolves around achieving business growth, expanding margins and generating cash.We anticipate in supporting our customers while extending our value proposition to more brands and retailers, to help them reach their financial and operational objectives in a high interest rate environment worldwide. Our journey so far has been filled with rewarding moments and we are encouraged about all that lies ahead to solidify our position as a global backbone for connected commerce.With that, let's open it up for questions now. Thank you.

[Operator]

Thank you. We'll now begin the question and answer session. [Operator Instructions] Your first question comes from the line of Thiago Kapulskis from Banco Itau BBA. Your line is open.

[Thiago Kapulskis, analyst]

Hi everyone. Can you guys hear me?

[Geraldo do Carmo Thomaz, executive]

Yes, we can hear you Thiago.

[Thiago Kapulskis, analyst]

Great. So thanks, So I think the first one regarding the full year guidance right, I mean, the nominal numbers are the same, right. But the FX neutral growth is lower than the previous guide, right. So, you guys mentioned Argentina. Is there anything else in terms of the business that is going different or doing different than your previous expectations? And if you could guide -- if you guys could give us some color also in Argentina, if it's just FX related or how the business is there in terms of overall strength? I know that this was a concern back in Q4 and the other question is about the AI products that you are providing. I mean, there's a lot in the pipeline I think there was the shareholder letter too last quarter. So, if you guys could comment a little bit more on the roadmap that you have and how you think this could actually enhance your strategy or future opportunities that could come from your strategy there? Thank you.

[Ricardo Sodre, executive]

Great. Hi Thiago, Ricardo Sodre here. Happy to take the first two questions on the full year guidance in Argentina, and I'll pass it over to Geraldo to talk about AI. So, on the guidance for the full year, we are maintaining our annual guidance in dollar terms as you mentioned. This is supported by steady and robust performance observed in key markets such as Brazil, Colombia, Mexico, the U.S. and Europe. And although consumption in real terms is being severely impacted in Argentina, which impacted our FX neutral guidance, given that there hasn't been any significant change in the FX rates in Argentina over the past couple of months that also led us to maintain our revenue guidance in U.S. dollars for the full year.And it's important to recognize a certain level of risk in our guidance considering the volatility associated with the situation in Argentina, especially in Q2, given one, their current macro situation and consumption level, and two, their most relevant e-commerce event of the year called Hot Sales that will happen next week in the midst of these uncertain environment that they're going through. Now, going back to things that are under our control. Looking forward, we are encouraged by our meaningful new contracts sales momentum and on the operating margin front encouraged by our Q1 achievements we have also adjusted our full year operating income and free cash flow margins guidance, raising our forecast from mid to high single digits that we mentioned last quarter to high single digits that we gave this quarter.So, these adjustment reflects our unwavering confidence in our ability to navigate and improve our financial performance throughout the year and then just double clicking on Argentina. The macroeconomic situation in Argentina is challenging while FX rates have remained stable over the past few months. This stability has come at a cost of significant economic slowdown. Even though this slowdown was by design to control inflation, the extent of the decline in consumption has been severe and predicting the trajectory of this environment is difficult, as you can imagine, and it remains beyond our control. So with that said, our performance in Argentina, although weak, stands out as significantly better than the overall e-commerce market and other e-commerce reporting companies, largely due to the resiliency of our customers.For instance, if we look at Q1 performance on a year over year basis, our GMV increased above inflation in local currency and was down only single digits in U.S. dollars. Now, nonetheless, it's important to acknowledge the high level of volatility in this situation and that the situation may get worse before it gets better. And then finally, it's important to point out that Argentina's performance was the most relevant driver responsible for our Q1 revenue being closer to the bottom of the guidance and also the most relevant driver responsible for us reviewing down our FX neutral annual revenue growth guidance.With that, let me pass it over to Geraldo on AI.

[Geraldo do Carmo Thomaz, executive]

Thank you Ricardo. Thiago very good question. You know, like there's been this revolution about using AI as a new building block, right. We're getting so many new capabilities being created by LLMs and models and stuff like that. And we believe that VTEX is uniquely positioned to leverage these building blocks and give business meaning to the retailers and manufacturers and brands in the world. So that's why we're investing so much and leveraging the building blocks that people are creating all over the world. And you can see that I invite you to explore our latest VTEX Vision, spring 2024 edition.We talk a lot about the things that we did and the roadmap that we are heading to and we have product launches that are around four key directives, more than that, creating fast and high, converting composable experiences, empowering sales reps across all channels and ensuring faster and efficient fulfillment. All this boosting productivity through AI. We launched FastStore framework where we're revolutionizing the way we are letting our customers building fast experiences in the website. This is not completely related to AI, but we think it's very important to our customers right now.But the ad network, as you can imagine, is leveraging AI a lot and I think customers will leverage this a lot. Data pipelines. With data pipeline, we will enable our customers and partners to build AI models to leverage AI with to, you know create possibilities of their own, actually turn data into gold. We also launched a product called VTEX Shield security shields I think with these value -- with more value, people will capture more value being sure that the data is self-guarded is fundamental to a software like ours so we launched this product as well. And so we are investing a lot. And as I said, we're the right company to give business meaning to this AI revolution.

[Thiago Kapulskis, analyst]

Great. Thank you so much for the answers guys. And I'll definitely explore the video -- the content. Thank you.

[Geraldo do Carmo Thomaz, executive]

Thank you.

[Operator]

Your next question comes from the line of Maddie Schrage from KeyBanc. Your line is open.

[Madison Schrage, analyst]

Hey, guys. And thank you for taking my questions. Besides Argentina just kind of wanted to talk through maybe some of your other geographies, wondering if there are maybe any tailwinds in rest of world or anything like that, that could partially offset it? Thanks.

[Ricardo Sodre, executive]

Yes. Happy to start and then others feel free to chime in. Thanks Maddie. So, as I mentioned on my first answer, we saw this headwind in Argentina, but we saw the other countries performing well. Brazil, Colombia and Mexico, the US, Europe also, I would highlight that Brazil continues to show strong momentum in signing new contracts and new sales, even with the relevant market share that we have in the country. Our strong position and the strong ecosystem that we have is helping on that. And also the way we see our retailers, our customers in Brazil, integrating the fiscal stores, accelerating their same store sales has been a positive. So overall, we see good performance on our other geographies, which is encouraging for our year as well. Not sure if that answers the question or if others want to chime in.

[Madison Schrage, analyst]

Yes, I think I just have a quick follow-up for you as well. But wondering, if you could maybe talk about the sales motion right now. Kind of what's maybe the mix of revenue between existing and new customers and maybe if you could kind of size the backlog for us, I think that'd be helpful too.

[Mariano Gomide de Faria, executive]

Hey, Mariano here just to mention about a little bit on sales momentum if I understand correctly your question, we are seeing a consistent improvement in the pipeline, not one specific country, but globally. This is a consequence of VTEX's position in most of analyst companies such as Forrester, IDC and Gartner so we are receiving good reports, we are enhancing our positioning and we are invited to more and more RFPs globally.We are recognizing the good momentum. We are on track with the sales goals we plan for the year. However, we need to highlight the volatile period for retailers and manufacturers all over the world in this environment of high interest rates. So, this will bring some volatility and we might end up being a good solution for this world that will pursue more efficiency and it's going to be really tough years ahead for all retailers.It's not one year, it's going to be like 3 years, 4 years, 5 years in a shift. So, we are being very diligent in opening new organic channels and increasing profitability for our active customers and we are really focused on helping them to simplify their operations and deliver efficiency in the bottom line. In this high interest rate and high inflation environment, seamless integration, ecosystem ready software and efficient architecture are essential to minimize maintenance costs and accelerating revenue. So with all the more than 1000 system integrators and more than 6000 VTEX IO extensions by third-parties, VTEX provides a very comprehensive solution we call the complete and composable solution that can help retailers all over.Mentioning Brazil, we still have a lot of room to grow on the B2C and we have an enormous B2B market to be discovered. Latin America, we have significant groundwork to cover this quarter. Having the go live of Nike in Colombia is a significant milestone in Europe. Our expansion into Germany with OBI sets solid foundations for us to build up. So that's the summary. Mainly the recognition of the industry experts Gartner Customer Choice, we were the only company to achieve the Customer Choice award and the IDC acknowledgment VTEX as the main leader on B2C and a major leader for B2B also completes the good momentum on branding and positioning for VTEX.

[Ricardo Sodre, executive]

And maybe just to build quickly Mariano, I think there was a question from Maddie as well on the existing versus new customers. So we continue to see in our same store sales on the mid-teens level. If you look at on a GMV basis and on the overall revenue growth for the company, we continue to see that roughly one third of our revenue is coming from our existing customer base and roughly two-thirds of the revenue growth coming from adding new customers to the customer base.

[Madison Schrage, analyst]

Appreciate it guys. Thank you.

[Operator]

[Operator Instructions]. Your next question comes from the line of [indiscernible] from Bank of America. Your line is open.

[Unknown Analyst]

Hi, good afternoon everyone. Thank you for taking my questions. I have two here on my side. First of all on gross margin, it was really strong this quarter and it's getting close to what you guys said as the target model for the coming years, even in a soft quarter. So we probably should expect gross margins to be higher for the full year. So I just wanted to see, when do you guys think you could be reaching this target model and looking forward, what do you think could be the gross margin for the company? Maturity or how can we think about that going forward?And then second, ties a little bit to the first question, but on service revenues it was down year over year and I just wanted to understand how we could think about this line going forward. Should it continue at similar levels in nominal rates, or should it also expand from current levels? Thank you.

[Ricardo Sodre, executive]

Thanks [ Luca ], thanks for bringing that up. I'll start with gross margin and then I'll pass it over to Mariano regarding services revenue. So in Q1 we achieved a non GAAP gross margin of 72%, marking a year over year expansion of over 600 basis points and despite the seasonal effects typical to Q1 as you mentioned, this brings us closer to our Investor Day target of 75% for our overall gross margin, and it's 80% for the subscription gross margin right? And we also achieved 77% on the subscription gross margin. So always also getting there as well. And approximately two-thirds of our subscription costs are related to hosting, and we have significantly enhanced our cloud efficiency.These efforts include migrating systems to Linux, optimizing CPU usage and reducing cost through caching and out scaling and all while maintaining or improving performance right. So that has been helping a lot our subscription gross margin. Regarding the services gross margin side, although some volatility has been observed, the improvement is primarily attributed to our strategic adjustment, away from the hyper care modes for key new customers in the U.S. and Europe as they go live.So we remain focused on the opportunity to enhance our subscription gross margin and the overall gross margin while some services gross margin volatility is inherent in our business, we anticipate further improvement in this area in the future and we're moving towards our goal that was disclosed in the last Investor Day of 80% subscription gross margin and 75% overall gross margin and that's a medium term goal for the next like 3 years to 5 years. It's not a terminal model growth. We don't have the visibility yet for the terminal model, but for these next 3 years to 5 years, that's what we are going after. With that, let me pass it over to Mariano to talk about services revenue.

[Mariano Gomide de Faria, executive]

Yes, clarifying a little bit more on the service margin our service revenue, which includes our solution architect offering during major customer implementations, naturally experienced some volatility as accounts goes live and the stage of development of new geos are expanding. So it's expected by design to have some volatility. This time last year, we had a few accounts in implementation phase, like for example OBI, that we just announced in a hyper care model. That said, we would expand a little bit more on hyper care so that volatility is expected.But while there are no significant changes in the model and design of the services to report, aside from what I already mentioned, that's expected volatility, we will continue to execute. We remain optimistic on service as we are increasing our system integrator reach and the system integrators are becoming more and more mature. So broader and more mature ecosystem will bring the volatility on the service revenue and service expenses of VTEX a little bit down. So, we will be able to scale the deliveries with less direct service of VTEX and that's by design, the ultimate goal for a platform like us.

[Unknown Analyst]

Perfect. Very clear. Thank you for the answers.

[Operator]

That concludes our question-and-answer session. I will now turn the call back over to Geraldo for some final closing remarks.

[Geraldo do Carmo Thomaz, executive]

In conclusion, it's evident that in today's high interest rate environment, retailers and brands urgently need effective tools to enhance margins and optimize organic sales channels. VTEX is fully committed to providing actionable strategies for B2B and B2C enterprise to maximize ROI and elevated e-commerce platforms. By integrating cutting-edge innovations, we're ready to unveil fresh audiences and insights, empowering our customers to achieve even more impactful consumer engagement.Our unwavering dedication to customer centricity and innovation-driven solutions is not merely shaping the future of commerce, it is redefining it. We are excited about the results of the first quarter, our gross margin and operating margin expansion was remarkable and sets a strong foundation for our sustainable, profitable growth. At VTEX, we stand stronger and more robustly positioned than ever before. We focus on growth and margins underpinned by a remarkably strong business model. This is our time and we are ready to seize it. Thank you everyone for being part of this exciting journey. We look forward to keeping you updated at our next earnings call. Have a wonderful week.

[Operator]

This concludes today's teleconference. Thank you for your participation. You may now disconnect.