🛑WATCH LIVE: Zoom ($ZM) Q2 FY23 Earnings Webinar - Aug 22, 2022 (5 PM ET)

Thank you Eric and thank you everyone for joining us today. Let me start with what's on everyone's mind: the macro environment. Zoom is not immune to the global downturn, but the situation is more complex than meets the eye. Our enterprise business continues to post strong growth, which we believe is because cloud migration and digital transformation continue to be a priority even when, and perhaps especially when, the economy slows. The headwinds we saw mainly relate to the strengthening dollar, new online subscriptions, and to a lesser extent, bookings linearity. We have implemented initiatives focused on driving new online subscriptions which have shown early promise, but we're not enough to overcome the macro dynamics in the quarter. We believe Zoom remains well positioned in this environment as customers look to increase productivity and collaboration while moving away from expensive legacy vendors. Our products are designed to drive efficiency and cost savings within organizations and are loved by both their employees and their customers. In addition, we have strong margins and cash flows as well as a large cash balance. Even still, we are taking a prudent and cautious approach in this environment with focused investments in hiring to drive innovation and customer happiness. Our platform strategy is playing out very well and Zoom Rooms and Zoom Phone are critical components of that strategy. In fact, Zoom Phone was a real star in Q2, hitting several milestones. The number of customers with 10,000 or more paid seats increased 112% year-over-year. In addition, we broke our record for the largest Zoom Phone deal twice in the quarter, first with a global retailer and then with a global bank, both with more than 125,000 seats. Deals like these led Zoom Phone to post a record quarter and surpass four million seats in August. We are also seeing early traction for Zoom Contact Center and Zoom IQ for Sales. Zoom Contact Center is six months old but has already had deal sizes reach seats that we did not expect until its second year. And customers value the user-friendly interface, efficiency gains, and savings they see in shifting to our modern cloud-based AI-driven contact center solution. We are proud of the team that drove these results and I'm thrilled to have Greg with us today. Greg joined last quarter as our new President leading our go-to-market teams and the office of the Global CIO. He brings a wealth of leadership experience scaling bellwether internet and enterprise companies. Greg, welcome to our call today.

We'd love to have you introduce some customer wins for the quarter.

Thank you Greg. Now let me turn to the quarter's results and guidance. In Q2, total revenue grew 8% year-over-year to $1.099 billion, approximately $16 million below the low end of our quarterly guidance. A stronger U.S. dollar, which had an impact of approximately $8 million, weaker new online sales, and to a lesser extent back-end linearity in the quarter were the biggest factors contributing to the miss. We recognize that the revenue results are disappointing and below our expectations as we navigate the current environment. It should be noted that while our online business saw lower new subscriptions, renewals and online continued to improve, and as we just discussed, we have launched a number of initiatives to drive new online subscriptions around local pricing, packaging, and free to paid conversion. The growth in revenue was primarily driven by strength in our enterprise business. Revenue from enterprise customers grew 27% year-over-year and represented 54% of total revenue, up from 46% a year ago. We expect revenue from enterprise customers to become an increasingly higher percentage of total revenue over time. From a product perspective, we had strong growth in Zoom Meetings and Zoom Phone, coupled with contributions from Zoom Rooms and other products. The number of enterprise customers grew 18% year-over-year to approximately 204,100. Our trailing 12-month net dollar expansion rate for enterprise customers in Q2 came in at a healthy 120%. We saw 37% year-over-year growth in the upmarket as we ended the quarter with 3,116 customers contributing more than $100,000 in trailing 12 months revenue. These customers represented 26% of revenue, up from 20% in Q2 of FY22. As the majority of our revenue has shifted back to the enterprise and we have moved beyond the pandemic buying patterns, we are returning to more normalized enterprise sales cycles with linearity weighted towards the back end of the quarter. This contributed to higher than expected deferred revenue in Q2 and as we believe this customer behavior will persist, we have factored it into our outlook. Our Americas and APAC revenue grew 12% and 10% year-over-year respectively. EMEA continues to be impacted by the Russia-Ukraine war, the strengthening dollar, and online performance, which led to an 8% year-over-year revenue decline. Now turning to profitability. I will focus on our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, acquisition-related expenses, net litigation settlements, net gains or losses on strategic investments, undistributed earnings attributable to participating securities, and all tax effects resulting from non-GAAP adjustments. Non-GAAP gross margin in Q2 was 78.9%, an improvement from 76.2% in Q2 of last year and 78.6% last quarter. The sequential improvement was mainly due to optimizing usage across the public cloud and our increasing number of co-located data centers. Given the improvements we are seeing so far this year, we expect gross margins to be approximately 78% for the remainder of the year, which is higher than our previous year. Research and development expense grew by 81% year-over-year to approximately $98 million, driven by our focus on innovation. As a percentage of total revenue, R&D expense increased to 8.9% from 5.3% in Q2 of last year. Our expanding product portfolio reflects our ongoing investments in building out Zoom's platform and delivering on our customers' evolving needs. We plan to further invest in R&D to reach our long-term target of 10% to 12% of total revenue. Sales and marketing expense grew by 35% year-over-year to $286 million. This represented approximately 26% of total revenue, up from 20.7% in Q2 of last year. We are committed to investing in growth areas including sales capacity, channel partner enablement, and product marketing. G&A expense grew by 2% to $90 million, or approximately 8.2% of total revenue. Non-GAAP operating income expanded to $394 million, exceeding the high end of our guidance of $365 million, as we continue to thoughtfully prioritize investments. This translates to a 35.8% non-GAAP operating margin for Q2, compared with 41.6% a year ago and 37.2% last quarter. Non-GAAP diluted earnings per share in Q2 was $1.05 on approximately 307 million weighted average shares outstanding. This result was $0.13 above the high end of our guidance. Turning to the balance sheet, deferred revenue at the end of the period was $1.4 billion, up 19% year-over-year from $1.2 billion. This result was meaningfully higher than what we previously forecasted due to the strong enterprise bookings which were back-end weighted in the quarter. Looking at both our billed and unbilled contracts, our RPO totaled approximately $3.2 billion, up 37% year-over-year from $2.3 billion. We expect to recognize approximately 61% of the total RPO as revenue over the next 12 months, as compared to 69% in Q2 of last year, reflecting a shift towards longer term plans. As a reminder, our seasonality of renewals is front-end loaded and moderates over the rest of the year, reflecting the sequentially smaller renewal base. As such, we expect Q3 deferred revenue to grow at approximately 13% to 14% year-over-year. We ended the quarter with approximately $5.5 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. We have purchased $426 million of stock, representing 4.1 million shares over the last two quarters as part of our billion dollar repurchase program. We had operating cash flow in the quarter of $257 million, as compared to $468 million in Q2 of last year. Adjusted free cash flow was $222 million, as compared to $455 million in Q2 of last year. Our margins for operating cash flow and adjusted free cash flow were 23.4% and 20.2% respectively. As previously discussed, these metrics include a large cash outflow from an increase in cash taxes starting in Q2. As we update our full-year outlook for the P&L and take into account the lower tax deductions for stock-based compensation caused by the lower stock price, we would expect adjusted free cash flow to be between $1 billion to $1.15 billion. Now turning to guidance. This outlook is consistent with what we are observing in the market today. Specifically, it assumes that our enterprise business will grow in the low to mid twenties, while our online business will decline seven to eight percent for the year as compared to the previously provided flat outlook. For the third quarter of FY23, we expect revenue to be in the range of $1.095 to $1.1 billion. We expect non-GAAP operating income to be in the range of $325 to $330 million. Our outlook for non-GAAP earnings per share is $0.82 to $0.83 based on approximately 306 million shares outstanding. For the full year of FY23, we now expect revenue to be in the range of $4.385 to $4.395 billion, which would represent approximately 7% year-over-year growth. At the midpoint, this represents a decrease of approximately $150 million as compared to our previous full year guidance. Of this decrease, approximately $35 million is due to the stronger dollar and $115 million is attributable to the broader macroeconomic environment. We now expect our non-GAAP operating income to be in the range of approximately $1.44 to $1.45 billion. We are still targeting a non-GAAP operating margin of approximately 33% as we have adjusted spending in the second half to focus on high ROI areas and have seen a modest benefit to expenses from FX. Our tax rate is expected to approximate the blended U.S. federal and state rate. Our outlook for non-GAAP earnings per share is $3.66 to $3.69 based on approximately 307 million shares outstanding. Before opening up for Q&A, we are excited to share our Zoomtopia event with you. It is our premiere user conference and will be run on Zoom Events. We look forward to sharing our platform strategy, new innovations, and customer testimonials. Please join us at Zoomtopia and our Investor Day on November 8th. Zoom remains focused on building out our platform, leading in the hybrid work world, enhancing the customer experience, and expanding into more and more business workflows. We will continue to make strategic moves to drive future growth as we navigate the current environment. Thank you to the Zoom team which has grown to 8,000 strong, our customers, our community, and our investors. Kelsey, please cue up our first question.

Yeah, the majority of that is really coming from online, William. So when you look at the difference in the guidance, previously we had expected online to be approximately flat for the year and now we're saying it's going to be in the range of seven to eight percent down. That's really where the majority of that's coming from. On a base of about $2 billion, that's where we're seeing it. We continue to see strength in the enterprise, which you can see as the increase in deferred. We are moving more towards back-end linearity, which had some impact on the revenue, but we continue to see great work done by our sales team in getting those deals in just a little bit later in the quarter.

Yeah, Greg, do you want to talk about that? I can comment.

So I think we touched on this. I'm going to start with your second question first. We touched on this at the end of the Q1 call as well. We will continue as a company to focus on the areas that drive innovation, so that really means R&D, as well as driving growth, so that's sales. And we have taken the tack for a while now of trying to be as efficient as we can around cost of goods sold and of course G&A, to the extent that of course we always want to ensure the product and the platform is reliable and we're supporting our customers' needs, but trying to do that as efficiently as we can. And in fact, we indicate in the prepared remarks we expect gross margins to come in a little bit higher than where we had previously, at 78% for the rest of the year. And then in terms of online, Wendy and her team have just done an amazing job of really thinking about how do we continue to improve the conversion rate of free to pay. They've done that through different initiatives, especially including pricing packaging on a global basis, and we've seen retention rates continue to improve as well as conversion rates. We just, the challenge that we're seeing overall in the online business is new customer additions. But as they continue to focus on the initiatives, I'm sure that will improve over time as well.

Sure. So let me talk about the dollar expansion, then I'll let Greg or Eric talk about new customers. We have said for a while, when you remember that the strategy for selling Zoom Phone and Zoom Rooms, Contact Center, et cetera, is to sell into our existing install base. It's exactly as you said. We continue to see some of our largest customers continue to expand. Some of those Zoom Phone wins moved our customers. When you go back and look at the customer counts, the growth rates that we saw in greater than $100k trailing 12 months, it's really significant growth, which supports exactly what you're saying. And as a reminder, the net dollar expansion number now is focused on just the enterprise portion of our business, it doesn't include the online segment of the business. But Greg or Eric, would either of you like to just touch on new customers for the quarter?

You know, we're not going to break out FX down to that level of detail. But what I will say, if you step all the way back, and we talked about this on the Q1 call as well, if you look at the impact that FX and the war in Europe is having on the year-over-year growth, it's 200 basis points. So you can think about there's two full percentage points of impact coming from things that are kind of out of our control from both FX and the war on the total year-over-year growth rate.

Yeah, we definitely had a strong Q2 in terms of enterprise sales. You can see that reflected in the deferred. It just came later in the quarter, which is why it didn't really have impact on revenue within the quarter. But we continue, as all the things we've talked about, Zoom Phone having incredible strength and performance in the quarter, really already seeing momentum in Contact Center this early, six months in. We have some remarkable names that have signed up for Contact Center that we'll be excited to share with you at some point in the future, but already the seat sizes that we're seeing for Contact Center, I think we would not have expected them to come in their 18 to 24 months yet. So I think all of that shows that the platform transition is really working very, very well and that customers continue to love and see the efficiency they get from Zoom. And especially as they're thinking about, maybe Greg you can talk about this, what I've heard from the sales team is this transition of deals moving from the CIO to the CFO and customers really being thoughtful about the cost there. And Zoom competes very well when it's competitively priced.

So let's talk about that one first. In terms of online, we continue to see stability in the retention rates at that 16-month plus, and we'll show you that chart again when we get to Analyst Day in November. And we're at about 70% of our online business now has crossed over that 16-month mark, so it's bringing a lot of stability. What we had talked about previously was we expected to see an inflection point for online in Q4, and given the reduction in the guide, it's more likely that's going to come in the first half of next year. And then in terms of the traction of Zoom One, it's just one quarter in, but we have seen some great progress there. And I think it's serving the purpose that it needs. Greg, you can certainly comment on that, but it's really meant to ease the buying process for our largest enterprise customers and package up the platform in a way for them that really makes sense to meet their needs.

So I'll talk about the linearity first. I think that it's just as we said in the prepared remarks, there's two things happening. More and more of our deals are now coming from the enterprise, and the majority of our revenue is coming there. And we have definitely now moved beyond the pandemic buying patterns. So our linearity had been much more moderated, I would say, over the last two and a half years as the online business itself is more balanced within the quarter just by its nature. And then the enterprise business even itself during the pandemic buying periods didn't follow the sort of normal deal cycles that we had seen. There were less proof of concepts, there was less review honestly. And now that has really all shifted back. So it's just taken us a little bit of time to understand exactly where we were in that cycle, and we really saw that we're back to pre-pandemic linearity, which is very normal for an enterprise business. It just hasn't been normal for us for the last few years.

So as I said in the prepared remarks, we have assumed that the linearity that we saw occurring in Q2 is consistent for the rest of the year. So any of the back-end loaded deals will contribute less revenue to this year and in each of the individual quarters. So we've assumed that's a similar trend for the rest of the year. In terms of future growth, we're not prepared to comment on that. We'll do that when we give FY guidance later this year. And then the growth is honestly coming from both, as you heard earlier. Continuing to expand into our customers, so expansion with Zoom Phone, Zoom IQ, Zoom Contact Center especially, also Zoom Rooms had a fairly strong quarter as people are still thinking about the future of hybrid work and what that means for them. And we are continuing to see, at least in Q2, the percentage of ramped reps was higher than ramping reps, and that always is a positive contribution.

It's so early in the quarter that we wouldn't comment on that yet.

So in terms of churn, we have certainly seen that continue to improve and stabilize, as we said. We touched on this a little bit in the prepared remarks. It was a little bit better than expected. Where we saw the impact you're seeing in the forward-looking guidance is the acquisition of new customers. And again, Wendy and our team are doing an amazing job on initiatives to improve that. They just haven't had enough impact yet to offset what we're seeing in the quarter. The example you're talking about, the 40-minute limit, really did help in the free-to-pay conversion, and that is considered as you look forward in the rest of our full year guidance, as well as many of the other initiatives they're working on. But when you look at the especially in Europe, the impact we saw there as well as combined with FX, that is more concentrated, having a more concentrated impact on online than enterprise. That's what is driving the reduction in the year-over-year guidance.

Yeah, and then in terms of the growth of the enterprise customer base, as a reminder, the selling strategy for Zoom Phone, for Contact Center, or Zoom IQ for Sales is to sell into the existing install base. And so going forward, especially as you continue to see great progress in those products, you're going to see growth continuing to come from our existing install base with layering on of new customers on top of that. So you should not be surprised to see that customer count declining even while our revenue is growing.

Yes, thank you for asking. So just as a quick reminder, we've actually never sort of officially guided towards free cash flow, but we understand this is very difficult to model, so we're trying to give more insights to it. The biggest change that we're trying to help everyone understand is that we have now fully utilized all of our NOLs and we are a full cash taxpayer. And so that is having a large impact. And in fact, in Q2, the way it normally falls, we actually paid two quarters worth of taxes in one quarter because you pay the Q1 estimated provision in April. So we had double the impact. So it's about $200 to $250 million worth of cash taxes that are now reflected in that. And the other thing to consider is there's one other impact that is driving up our cash tax rate, which is as our stock price has declined, we typically get a tax deduction for things called disqualifying dispositions, which is when employees sell their stock. As the stock price has declined, you can imagine employees are holding on until they see potentially greater value in their stock. And so our disqualifying dispositions have dropped at the same time we've used up our NOLs, which means our tax rate has gone up and our cash taxes have gone up a little bit. So we expect that to moderate as we regain value in the stock price over time.

Yeah, well, I think the biggest, I mean, we are going to be a cash taxpayer from now on, that is done. I think the question is what happens with the disqualifying dispositions, which is a variable deduction which will largely correlate likely with a potential increase in our stock price over time and how much employees are selling their stock.

Yeah, I mean, Zoom Phone was certainly the star, if you will, of Q2, but we continue to see strength in our core meetings platform. It had really strong growth in the period as well. And the majority of our business in online is still core meetings as well. So the majority of that business is coming from core meetings. And all the work the team is doing to continue to improve the free-to-pay conversion will continue to drive more strength in the meetings business as well.

You know, Kash, we don't break it out that way. What we've always said is from a revenue perspective, we'll start to break out these products when they hit their 10% of revenue. You can imagine we're getting very close on Zoom Phone, so I think in the next couple of quarters you'll likely start to see that, which will give you some insight.

Okay, let me take the last one first. So in terms of online, online certainly has been the most impacted in EMEA. So that's where, when we talk about the guidance, some of the impacts it's having there, between FX in general and the Russia-Ukraine war, it's having much more of an impact on online than it is in our enterprise business. And then I'm sorry, I didn't quite catch the first part of your question.

Yeah, I mean, Greg, feel free to join in, but yes, we did see strength, especially in Japan. We had a very strong Q2 there.

Yeah, it's pretty pervasive unfortunately across the continent that we've seen it, as you can tell based on the magnitude of the impact.

And then Kelly, anything on the seat count?

Yeah, what I would say is I think, I'm just looking at a list of deals right here on the screen, and I think that we probably moved into at least the average seat size being in the triple digits. So we have our largest deal approaching four digits, I would say, and then probably on average is in that triple digit size right now.

Sure. So as a reminder, our market teams, both Majors and Enterprise that Greg talked about earlier, are on six-month quotas. So again, now that we're sort of beyond pandemic buying periods and we've returned to a more normalized seasonality which sees peaks in bookings in Q2 and in Q4. So everybody should expect, for example, we had this discussion in Q1 as well. If you remember our last record quarter for Zoom Phone was in Q4, and then we talked about it that seat count was actually acquired during Q1 was down, and now we're having another record in Q2. So everybody should expect that that's kind of the seasonality we're going to see as we have these reps all running to achieve their accelerators in Q2 and in Q4. And again, that's just a typical enterprise seasonality that we're going to see based on the way our comp plans are structured.

Yeah, so the enterprise additions for the second half will not be just Zoom Phone. I mean, Zoom Phone is certainly very strong momentum that we are seeing, but we expect continued contribution from Zoom Rooms, we'll certainly be strong, Contact Center we expect to continue growing, as well as Zoom IQ. So all of those will continue to add to the overall growth in the enterprise, along with we continue to see additions in meetings as well. And then yeah, so in the maturing base, the enterprise meetings especially internationally continues to grow. Don't underestimate or don't assume that the maturity level of video adoption that we see here in the US is at the same level on an international basis. There is still significant opportunity outside of the US to continue to grow our core meetings platform.

Thank you. Thank you so much everyone for joining us today. We really appreciate all the support that you give us every day.