ZM Stock | Zoom Video Communications Inc Q2 2022 Earnings Call

Thank you, Eric, and hello everyone. We had an eventful Q2 with several highlights. The first of which was the strength in the enterprise. We were able to grow the number of enterprise customers spending more than $1 million in ARR by 77% year-over-year. And the second highlight is the acceleration we have seen with Zoom Phone. We grew the number of customers spending more than $100,000 in ARR on Zoom Phone by 241% year-over-year. In August, we will reach—actually, right before this call, we reached 2 million Zoom Phone seats, only 8 months after reaching our first million. We added 8 Zoom Phone customers with more than 10,000 seats in the first half of FY22, bringing us to a total of 26. And in Q2, we broke our record for the largest Zoom Phone deal to date twice in the same day. It is important to note that as we've just lapped our first full quarter year-over-year compare since the start of the pandemic, we have seen customers return to more thoughtful, measured buying patterns. While revenue, profitability, and cash flow were strong in the second quarter and the first half, other metrics have begun to normalize, especially when compared to the unprecedented year-over-year comps. In Q2, total revenue grew 54% year-over-year to $1.02 billion, marking our first billion-dollar-plus quarter, only five quarters after reaching a billion-dollar annual run rate. The top-line result exceeded the high end of our guidance of $990 million. We saw strength in our direct and channel businesses, which grew at twice the rate of our online business. Zoom Phone, Zoom Rooms, and Asia Pacific growth also accelerated in the quarter. The year-over-year growth in revenue for the quarter was driven by a healthy mix between new and existing customers, where new customers accounted for approximately 74% of the incremental revenue, and existing customers accounted for 26% of the incremental revenue. Let's take a look at the key customer metrics for the quarter. We saw 131% year-over-year growth in the upmarket as we ended the quarter with 2,278 customers generating more than $100,000 in trailing 12 months revenue. We exited the quarter with approximately 504,900 customers with more than 10 employees, up 36% year-over-year, and representing 64% of revenue. In Q2, customers with 10 or fewer employees represented approximately 36% of revenue, in line with Q2 of last year but down from its high of 38% in Q3 of last year. As we discussed previously, this cohort, which comprises SMB and consumers who typically purchase online, is more volatile, and we expect it to continue to decline as a percentage of revenue as customers adjust to the evolving environment. Our net dollar expansion rate for customers with more than 10 employees exceeded 130% for the 13th consecutive quarter, as existing customers increased their spend with Zoom and upsells of Zoom Phone and Zoom Rooms picked up pace. Both domestic and international markets had strong growth during the quarter. Our Americas revenue grew 50% year-over-year. Our combined APAC and EMEA revenue grew 62% year-over-year to be approximately 33% of revenue, up from 31% a year ago. In recent quarters, we have made significant investments in our international teams. In Asia Pacific, our direct sales team drove several strong wins in the enterprise segment. However, in EMEA, we saw some headwinds, which were predominantly driven by declines in the online segment. Now turning to profitability, which is strong from both GAAP and non-GAAP perspectives. I will focus on our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, charitable donation of common stock, acquisition-related expenses, net, litigation expenses, and gains or losses on strategic investments. Non-GAAP gross margin in Q2 was 76.2%, compared to 72.3% in Q2 of last year and 73.9% in Q1 of this year. The sequential improvement in gross margin is mainly due to new data center capacity coming online and lower usage during the summer months, particularly with schools. We now expect gross margin outlook to be higher than previously discussed at approximately 75% for the remainder of the fiscal year, even while we continue to support free K-12 education. Research and development expense grew by 89% year-over-year to approximately $54 million. As a percentage of total revenue, R&D expense was approximately 5.3%, an increase from Q2 of last year, demonstrating our ongoing commitment to building out our engineering teams globally and maintaining best-in-class product and innovation. Sales and marketing expense grew by 72% year-over-year to $211 million. Sales and marketing expense was approximately 20.7% of total revenue, an increase from Q2 of last year, mainly due to investments and hiring to drive sustainable future growth. We plan to increase investment in global sales capacity as well as digital marketing and events to drive additional leads for our sales teams across meetings, phones, rooms, and events. G&A expense in the quarter grew by 73% to $89 million, as we continue to scale these functions and invest in systems, automation, and compliance to meet our new scale. G&A expense was approximately 8.7% of total revenue, a slight increase from Q2 of last year. The revenue upside in the quarter carried through to the bottom line with non-GAAP operating income of $425 million, exceeding our guidance. This translates to a 41.6% non-GAAP operating margin for Q2, steady with both Q2 last year and Q1 of this year. Non-GAAP diluted earnings per share in Q2 was $1.36 on approximately 306 million non-GAAP weighted average shares outstanding. This result is $0.21 above the high end of our guidance and $0.44 above Q2 of last year. Turning to the balance sheet, deferred revenue at the end of the period was $1.2 billion, up 59% year-over-year from $743 million. Looking at both our billed and unbilled contracts, our RPO totaled approximately $2.3 billion, up 66% year-over-year from $1.4 billion. We expect to recognize approximately 69% of the total RPO as revenue over the next 12 months, as compared to 72% in Q2 of last year, reflecting a shift back to longer-term plans. It is important to remember that because over 40% of our business is billed monthly and typically bought online, deferred revenue and RPO trends are not reliable predictors of future revenue growth. As I mentioned last quarter, the timing of our renewals has increasingly shifted to the beginning of the fiscal year, with Q1 now representing our largest renewal quarter. This shift in seasonality is a result of the significant growth we experienced in the first half of FY21. We expect this front-weighted seasonality will persist and potentially become even more pronounced given the scale of our base and practice of upselling coterminously with existing contracts. As such, we would expect total deferred revenue and RPO to be modestly down from Q2 to Q3. We ended the quarter with approximately $5.1 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. We had strong operating cash flow in the quarter of $468 million, up from $401 million in Q2 of last year. Free cash flow was $455 million, up from $373 million in Q2 of last year. The increase is primarily attributable to the top-line growth and disciplined spending. Looking at the remainder of the fiscal year, we expect to increase our capital expenditures related to ongoing data center expansion to support our growth outlook. Now turning to guidance, please note that the ever-changing nature of the global pandemic continues to impact our segments and regions in different ways. Our outlook is based on our current assessment of the business environment. Specifically, our outlook assumes that our direct and channel business will continue to experience robust growth, while our online business will be a headwind in the coming quarters as smaller customers and consumers adjust to the evolving environment. For the third quarter of FY22, we expect revenue to be in the range of $1.015 to $1.02 billion. We expect non-GAAP operating income to be in the range of $340 to $345 million. Our outlook for non-GAAP earnings per share is $1.07 to $1.08, based on approximately 309 million shares outstanding. For the full year of FY22, we expect revenue to be in the range of $4.005 to $4.015 billion, which would represent approximately 51% year-over-year growth. We expect non-GAAP operating income to be in the range of approximately $1.5 to $1.51 billion, which would represent approximately 53-54% year-over-year growth. Our outlook for non-GAAP earnings per share is $4.75 to $4.79, based on approximately 308 million shares outstanding. Before concluding, I'd like to welcome everyone to join us in two weeks at Zoomtopia, our two-day immersive experience that is packed with exciting product updates, guest speakers, and virtual networking opportunities. And on day one, please join us for our financial analyst briefing, where we will be providing you with greater detail on Zoom Phone, the platform, our channel partnerships, and much more. And as always, Zoom is grateful to be a driving force enabling connection and collaboration worldwide with our high-quality, frictionless, and secure communications platform. Thank you to the entire Zoom team, our customers, our community, and our investors. If you have not yet enabled your video, please do so now for the interactive portion of this meeting. Matt, please queue up our first question.

So I think in terms of the expansion rate you're talking about, the implied expansion rate that you calculated, I just want to remind you first of all that when you calculate that, it includes all of our customer base. And as we mentioned, we are seeing headwinds in the online segment of our business for sure. So that's what I would say. We see strength, continued strength, in the upmarket enterprise in both meetings and phone. And where you're seeing that challenge in the implied metric, it's really coming from the online segment of the market.

Yeah, so remember, the online business is primarily, not exclusively, but primarily small businesses and individuals. And I think what we've seen is, well, while the future of Delta is still unknown, we do see individuals especially moving around the world and feeling comfortable. Like I think we were talking about, most of us are probably socializing in person now, doing fewer things like Zoom happy hours, and that's where we're starting to see some of the challenges. So the net dollar expansion in the online segment is what's driving that number down.

Yeah, so again, we continue to see strength in our upmarket. We're excited about what we're seeing in the enterprise and phone internationally. International we all saw growth accelerate. When we look out though, what we have seen is a slowdown in the online segment of the business. Again, even though the pandemic seems to be far from over, we are happy that people are feeling more comfortable being out traveling, and that's really where we're seeing this slowdown. If you back all the way up to when we gave guidance at the beginning of the year, we had expected that towards the end of the year, but it's just happened a little bit more quickly than we expected. And of course, we feel good that people are out moving around the world, but it's certainly creating some headwinds as we said in the online segment of our business.

Absolutely. So we saw Zoom Rooms start to accelerate again in Q2, which was very exciting as our customers are planning and thinking about it. They more than doubled quarter over quarter from Q1 to Q2. So absolutely, companies are preparing and planning for welcoming their employees back to the office.

Yeah, thank you Steve.

No, it's almost exactly the same time frame. Because I think we had announced in December that we hit a million, and then we announced 1.5 on our call in April, and then 2 million on this call. So it's almost exactly the same pace.

It's a little bit of both. As we mentioned, we specifically saw some challenges in certain regions like EMEA, where the world, at least for a period of time, was a little more open again and people were moving around. And that's where we see people taking advantage of being out in the world and seeing some slower top-line bookings as well as accelerated churn.

Thank you. We saw this start a little bit in Q1 and continue into Q2. I think it's not necessarily measured in terms of how much they're buying, but more measured and thoughtful in how they are buying. They want to take their time. They're doing more complete concepts, for example, versus if you think about a year ago, they were in this sort of stage of trying to keep the lights on almost and buying very quickly. Now they're taking the time to really be thoughtful. It's back to kind of the way they used to buy pre-pandemic, which is just a much more normal buying pattern. So the sort of four quarters we saw last year was really the blip, and now we're back to a more normal, measured approach.

I think the phone is a different buying cycle, but usually by the time they get to the phone, they already know you. So it's not that that is necessarily slowing it down; it's just that they're taking their time to think about these decisions that they're making.

Hi, Matt. I actually don't know exactly off the top of my head the specifics around that. Having an integrated phone and contact center solution is really important to many companies, which is why we're excited about the deal we're working on with Five9. We've been partnering with them, and we also have other partnerships in place as well. There's nothing different about that that has changed. I'd have to go back and look; I don't know exactly what the typical attach rates are between those two. Eric, if you have a perspective on that?

Yeah, so in terms of what you're seeing in Q4, it is continued uncertainty around headwinds in the online segment. Absolutely, that is driving that. And in terms of what that implies for next year, we're not ready to give FY23 guidance today, unfortunately. So we'll be prepared to do that when we get on the Q4 earnings call, and of course we'll have a lot more learnings at that point to share with you. But that is exactly what continues to drive that.

Well, that's like the pandemic question, right? Because what we've seen is this varies depending by region and by segment, depending on where each of those countries or markets is in their pandemic life cycle. And we've seen it ebb and flow over the last 18 months by market. So it's the challenge that I think all businesses are having right now in thinking about the future with so much uncertainty around the pandemic. It's just difficult to forecast exactly.

So we are absolutely continuing to invest in our sales capacity. We are focused on certain regions, especially where we see lots of opportunity, like Asia Pac. We recently hired a new leader there and are really excited about the progress we're already seeing with his leadership. And then we are continuing to invest in marketing. So as we've moved into the post-pandemic era a little bit, in terms of not post-pandemic but sort of what we saw from last year with the lift in brand awareness, we're continuing now to think about how we invest more in specific product marketing around phone, around Zoom Rooms, as well as digital marketing campaigns, helping to communicate and drive additional leads for all of our teams on a global basis. And then also the channel continues to be a really important aspect of our go-to-market. So the channel was responsible for approximately 27% of our Zoom Phone sales in Q2. We added six additional master agent partners during Q2, so really excited about continuing to invest in the channel on a global basis.

Yeah, so thank you, Alex. First of all, we agree with you that we want everyone focused on the long-term potential of the upmarket. As a reminder, in Q2, that segment of the business grew at twice the rate of the online business, so that gives you some indication of how those two segments are diverging a little bit. And then as we look forward, I guess the best way to help you think about it is you want to look at the implied net dollar expansion rate that we were talking about earlier. You can think about what's happening there: the net dollar expansion rate for the online segment is under one, right? That gives you some idea of how to think about those two different segments of our business. In terms of where the trough is, I think it's back to trying to predict a pandemic, which is a difficult thing for obviously anybody in the world to do right now. And as much as we're excited about vaccines being more widely distributed, unfortunately, as we see Delta continuing to grow in certain parts of the world, we have even in the last few weeks seen certain pockets of strength. So I think that's going to depend on what we continue to see in terms of the spread of the variants around the world.

Yeah, in terms of net dollar expansion, we expected to stay above 130% certainly for Q3. And then in terms of Q4, we expected to be at least in that range. It's a quarter out, we don't know exactly, but we're predicting it to be right in that same range still for Q4. And then in terms of customer growth, I think what you're going to continue to see is ongoing growth driven by large deals. So the customer count may slow, but you're going to continue to see growth driven by these big deals as we see opportunities to continue to cross-sell with Zoom Phone. As you heard, we beat our two largest deals record in the same day this quarter, so really seeing opportunities there. And then as people are planning to go back to the office, also opportunities for Zoom Rooms, and then think about Zoom Events. So you're going to start to see opportunities for larger and larger customer wins. And I think the other thing to know, we talked about the quarter, but I just want to make sure everybody understands: we had a deal this quarter that became our new largest customer. Not a new customer, an existing customer, but with their upsell, they became the largest customer. So we're continuing to see these really significant large wins, and that I expect to continue.

Eric, you want to talk about competitors?

So I think we're seeing strength in our channel partners globally. But as you say, it's a much newer program and much smaller internationally. So we're excited to really focus on expanding outside of the US. It's a main focus for our channel team for the rest of the year. In terms of productivity, I don't think it really varies. We were really excited about the Telco sell deal, which is one of our largest channel partner deals to date. So that's really exciting, but we've had significant wins in the US as well. So not seeing dramatic differences in productivity on a global basis at this point.

Yeah, go ahead.

So we still see free users as a large group. They've really grown over the last 18 months, and they're about 30% of our minutes usage today, compared to like 10% pre-pandemic. So that gives you an idea of the number of free users. We don't talk about the number of users, but that at least gives you a relative understanding of how they've grown over time. And as we always say, as Eric mentioned about our value of care, we really care about all those free users, especially to keep people connected during these more difficult times. And there's always a hope that they continue to convert or that they have the opportunity to communicate and introduce new users to the power of Zoom.

Hi.

Yeah, so as we've been saying for the last several quarters, there are areas that we were not able to hire and invest in as quickly as revenue grew last year. So what we've been doing over the last couple of quarters is focusing on re-accelerating the investment, especially in the areas of R&D as well as for the quota-carrying heads. And we are absolutely continuing to do that. We are still under-invested in R&D at a little over 5% of revenue, and the long-term target is 8-10%, so we're continuing to hire as quickly as we can. And then similarly, in terms of quota-carrying heads, we're being very thoughtful about the segments and the regions in which we're hiring. But remember, stepping back for a minute, there is a huge TAM and a huge opportunity out there, and we want to continue to add quota-carrying heads and sales capacity into our system to take advantage of that. So as long as we continue to see opportunity for growth, we will continue investing in quota-carrying heads. We are also, as I mentioned earlier, accelerating our spend in marketing. We were able to pull back a little bit on that last year, but we think now is the right time to continue reinvesting there. And then the two areas that we always look to be as efficient as we can are our DNA and COGS. DNA is kind of right in the range of where we would want it to be for the long term. Over time, we do expect COGS to decrease as we continue to move more and more of our services out of the public cloud into our own data centers. We're always going to have a hybrid approach there, but also eventually, when K-12 schools are more free to go back to campuses, we do expect to see improvement in our gross margins. But we will absolutely continue to support those students and schools as long as we think it's needed.

No, I mean, what I would say is we are continuing to hire quota-carrying heads quickly and will continue to do so. That means there's a constant state of having ramping reps in the system. And since we have no plans to stop hiring quota-carrying heads in the near future, I can't say when all of a sudden they're going to necessarily be more efficient.