Zoom Video Communications, Inc. (NASDAQ:ZM) Q3 2023 Earnings Call Transcript

Zoom Video Communications, Inc. (NASDAQ:ZM) Q3 2023 Earnings Call Transcript November 21, 2022

Zoom Video Communications, Inc. beats earnings expectations. Reported EPS is $1.07, expectations were $0.84.

Operator: Over to Tom McCallum, Head of Investor Relations. Tom, over to you.

Tom McCallum: Thank you, Kelsey. Hello everyone. And welcome to Zoom’s Earnings Video Webinar for the Third Quarter of Fiscal 2023. I am joined today by Zoom’s Founder and CEO, Eric Yuan, and Zoom’s CFO, Kelly Steckelberg. Our earnings press release was issued today after the market closed and may be downloaded from the Investor Relations page at investors.Zoom.us. Also, on this page you will be able to find a copy of today’s prepared remarks and a slide deck with financial highlights that, along with our earnings release, include a reconciliation of GAAP to non-GAAP financial results. During this call we will make forward-looking statements, including statements regarding our financial outlook for the fourth quarter and full fiscal year 2023.

Our expectations regarding financial and business trends; impacts from macroeconomic developments and the Russia-Ukraine war, our market position, opportunities, growth strategy and business aspirations; and product initiatives and the expected benefits of such initiatives. These statements are only predictions that are based on what we believe today, and actual results may differ materially. These forward-looking statements are subject to risks and other factors that could affect our performance and financial results, which we discuss in detail in our filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. Zoom assumes no obligation to update any forward-looking statements we may make on today’s webinar.

And with that, let me turn the discussion over to Eric.

Eric Yuan: Thank you, Tom, and thank you everyone for joining us today. So last week, we hosted our first fully hybrid Zoomtopia using Zoom Events and it was great. We unveiled new innovations like Zoom Mail and Calendar, which enable users to frictionlessly navigate across their email, calendar and other Zoom products all within the same client. At Zoomtopia, many of our customers highlighted how they use our expanding platform to do more in the world of flexible work. At our first partner connect event, we hosted hundreds of channel partners, who are very excited about working with us to drive adoption of the Zoom platform globally. And our developer partners showcased add-on apps that connect interrelated workflows to the Zoom client.

As global organizations adapt to how, when and where work happens, human connection remains paramount. Zoom is purpose-built to make all kinds of connections possible, effective and meaningful. We have developed and launched more than 1,500 features and enhancements on the Zoom platform this year, advancing how people connect with each other, their organization and their customers, ultimately, opening the doors wide for creativity and collaboration. Of course, even as we celebrate our innovations and customers, we still face the backdrop of a challenging macroeconomic environment. We continue to see FX pressure and heightened deal scrutiny for new business, but remain focused on delivering happiness to our customers by innovating our platform and expanding our go-to-market capabilities.

Zoom provides a full suite of communications solutions at an attractive total cost of ownership that enables Teams to do more with less and our new products like Zoom Contact Center and Zoom IQ for Sales enable revenue generation and drive productivity. The continued strength of our Enterprise growth is a testament to how the value proposition of our platform resonates with customers even in tougher economic environments. As we enable customers to drive greater efficiency, we also are focusing on our own efficiency. We have always been judicious with investments, prudent about spending and we have commanded robust margins since our IPO, so this is not a major shift for us. We will continue to drive innovation, customer value and platform expansion, balanced with an increasing emphasis on efficiency and profitability.

We continued to see strong traction with customers spending greater than $100,000 in trailing 12 months revenue, which was up 31% year-over-year. What’s more, these customers are increasingly seeing value in buying the whole platform, with thousands of customers already buying Zoom One packages. From an industry perspective, the largest deals came from tech, media and financial services, and we also had notable wins in retail, transportation and pharma. On the tech front, let me first thank Qualtrics, the leader and creator of the Experience Management category, for expanding their partnership with us. Qualtrics recently upgraded to Zoom One Enterprise, which provides the full power of the Zoom platform to their users and allows them to make meaningful connections with Meetings, team chat, whiteboard, phone and more in one offering.

We are delighted to offer Qualtrics a broad set of communications products integrated into one secure and easy-to-use platform. Our Enterprise segment comprises not only large publicly-traded companies, but also many private companies of all sizes, who see great value in enhancing their Zoom implementations by moving towards our full UC platform. Let me give you a few examples. First of all, I’d like to thank Vensure Employer Services, a privately-owned professional employer organization for placing their trust in Zoom. In Q3, they added 5,500 Zoom Phone seats and 650 Zoom Contact Center seats demonstrating the promise they saw in adopting a modern, integrated solution for their teams to interact. Let me also thank Chime Solutions for establishing and already expanding their partnership with Zoom, which includes Zoom One and Zoom Contact Center.

Founded with an unwavering focus on bringing jobs and opportunities to underrepresented communities, Chime Solutions delivers high-touch Contact Center solutions for mid-sized companies and Fortune 500 corporations. After seeing how well Zoom Contact Center addressed many of their customer’s needs and gaining confidence in Zoom’s ability to deliver innovation at a rapid pace, they decided to replace their legacy solution with Zoom Contact Center. Executing our innovation roadmap for Contact Center will give us the opportunity to further enhance our partnership with Chime Solutions in the quarters and years to come. I also want to thank G-P, the number one SaaS-based global employment platform, for choosing Zoom Phone to transform their communication systems and support employees across their organization.

G-P understood the value of our integrated platform of communication products from their experience using Zoom Meetings, Zoom Webinars, Team Chat and Zoom Rooms. G-P ultimately opted for Zoom Phone, as the missing piece in their UC stack, in order to improve their customer’s experience, while also enjoying the savings benefits of a cloud-based PBX solution integrated into a full communications platform. Also, I’d like to add that G-P is Zoom’s global expansion employment partner and has played a critical role in our growth strategy, giving us the agility and speed to enter new markets very quickly. Again, thank you Qualtrics, Vensure, Chime Solutions and G-P, and all of our customers worldwide. And with that, I will pass it over to Kelly. Thank you.

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Kelly Steckelberg: Thank you, Eric. Let me now turn to the quarter’s results and guidance. In Q3, total revenue came in at $1.102 billion, up 5% year-over-year and 7% in constant currency. This result was approximately $2 million above the high end of our quarterly guidance. The growth in revenue was primarily driven by strength in our Enterprise business, which grew 20% year-over-year and represented 56% of total revenue, up from 49% a year ago. We expect Enterprise customers to comprise an increasingly higher percentage of total revenue over time. From a product perspective, we had strong growth in Zoom Phone coupled with contributions from Zoom Rooms and other products. At Investor Day earlier this month, we introduced a new metric, Online Average Monthly Churn.

In Q3, this metric continued to improve to 3.1% from 3.7% in Q3 of FY 2022 and 3.6% last quarter. We are pleased that this metric has now returned to pre-pandemic levels. The number of Enterprise customers grew 14% year-over-year to approximately 209,300. Our trailing twelve month net dollar expansion rate for Enterprise customers in Q3 came in at a healthy 117%. We saw 31% year-over-year growth in the up-market as we ended the quarter with 3,286 customers contributing more than $100,000 in trailing 12 months revenue. These customers represent 27% of revenue, up from 22% in Q3 of FY 2022. Our Americas revenue grew 11% year-over-year. EMEA continues to be impacted by the stronger dollar, the Russia-Ukraine war and Online performance, which combined led to a decline of 9% year-over-year.

APAC, which was also impacted by the stronger dollar, declined 3% year-over-year. 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 associated tax effects. Non-GAAP gross margin in Q3 was 79.5%, an improvement from 76% in Q3 of last year and 78.9% 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 this, we expect our full year gross margin to be approximately 79%. Research and development expense grew by 59% year-over-year to approximately $108 million.

As a percentage of total revenue, R&D expense increased to 9.8% from 6.4% in Q3 of last year. This reflects our ongoing investments in expanding Zoom’s product portfolio and delivering on our customer’s evolving needs. We expect to exit the year in the range of 10% to 12% of total revenue, consistent with our long-term target. Sales and marketing expense grew by 27% year-over-year to $301 million. This represented approximately 27.3% of total revenue, up from 22.6% in Q3 of last year. We continue to invest judiciously in sales capacity and channel partner expansion. G&A expense grew by 6% to $87 million or approximately 7.9% of total revenue, in line with 7.8% in Q3 of last year. Non-GAAP operating income was $381 million, exceeding the high end of our guidance of $330 million, as we continue to thoughtfully prioritize investments.

This translates to a 34.6% non-GAAP operating margin for Q3, as compared to 39.1% in Q3 of last year. Non-GAAP diluted earnings per share in Q3 was $1.07, $0.24 above the high end of our guidance. Due to our share repurchase program, our Q3 weighted average share count has decreased year-over-year approximately 4 million shares to 302 million. Turning to the balance sheet. Deferred revenue at the end of the period was $1.4 billion, up 14% year-over-year from $1.2 billion. Looking at both our billed and unbilled contracts, our RPO totaled approximately $3.2 billion, up 32% year-over-year from $2.5 billion. We expect to recognize approximately 59% of the total RPO as revenue over the next 12 months, as compared to 67% in Q3 of last year, reflecting a shift towards longer term contracts.

As a reminder, our annual 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 Q4 deferred revenue to grow at approximately 2% to 3% year-over-year. We ended the quarter with approximately $5.2 billion in cash, cash equivalents and marketable securities, excluding restricted cash. Year-to-date, we have purchased $991 million of our own stock, representing approximately 11 million shares. We had operating cash flow in the quarter of $295 million, as compared to $395 million in Q3 of last year. Free cash flow was $273 million, as compared to $375 million in Q3 of last year. Our margins for operating cash flow and free cash flow were 26.8% and 24.7%, respectively.

As previously discussed, this year we have seen larger cash outflows from an increase in cash taxes starting in Q2, which relate to the depletion of our NOLs and the lower tax deductions for stock-based compensation caused by the stock price decline. We now expect free cash flow to be at the high end of our range of $1 billion to $1.15 billion. As a reminder, our range assumes that the Section 174 tax legislation requiring capitalization of R&D expenses will be repealed or deferred by Congress by the end of this fiscal year. 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 20s, while our Online business will decline approximately 8% for the year.

For the fourth quarter of FY 2023, we expect revenue to be in the range of $1.095 billion to $1.105 billion, which at the midpoint would represent approximately 3% year-over-year growth or 5% in constant currency. We expect non-GAAP operating income to be in the range of $316 million to $326 million. Our outlook for non-GAAP earnings per share is $0.75 to $0.78 based on approximately 301 million shares outstanding. For the full year of FY 2023, we now expect revenue to be in the range of $4.37 billion to $4.38 billion, which at the midpoint represents approximately 7% year-over-year growth or 8.5% in constant currency. This represents a decrease of $15 million from our previous full year guidance, of which approximately $14 million is attributable to the continued FX pressure in Q3 and Q4.

We now expect our non-GAAP operating income to be in the range of $1.49 billion to $1.5 billion, representing a non-GAAP operating margin of approximately 34%, which is an increase of $50 million or 1%, respectively, as compared to our Q2 guidance. Our tax rate is expected to approximate the blended U.S. federal and state rate. Our outlook for non-GAAP earnings per share is $3.91 to $3.94, based on approximately 304 million shares outstanding. Zoom remains focused on thoughtfully balancing growth and profitability through platform innovation, customer value creation and partner ecosystem expansion. Thank you to the Zoom team, our customers, our community and our investors. Kelsey, please queue up our first question.

Q&A Session

Operator: Thank you, Kelly. And of course, our first question is going to come from Meta Marshall with Morgan Stanley.

Meta Marshall: Great. Thanks so much for the question and congrats on the quarter. Maybe just sticking with the Online business for a second and kind of the stabilization of that business. Clearly, you saw the churn statistics improve. But just wanted to get a sense of how you guys are thinking about stabilization there, how you guys are thinking about just initiatives on new adds, as well as just free topaid conversion? Thanks.

Kelly Steckelberg: Yeah. So we — as we shared at Analyst Day a few weeks ago, we’re really happy with the continued improvement in the churn, first of all, and it improved even further in Q3. And the fact that now 70% of those cohorts have moved beyond that 16-month period in which they really see stabilization and we continue to see that happen. Wendy and her team are really focused on continuing to look at initiatives for conversion. Those include things like adding local currencies, adding local payment types, as well as looking at packages that make sense. So all of that is still in process, and what we’re thinking and we had talked about before is we expect Online to stabilize from a dollar perspective in Q2 of next year and based on our most recent forecast, that is still the case.

Meta Marshall: Great. Thank you.

Operator: Moving on to Mark Murphy with JPMorgan.

Mark Murphy: Thank you very much. I will have my congrats. A very nice free cash flow performance. I wanted to ask you, Eric, the pace of warranty activity is so rapid at the moment. To what extent do you anticipate that perhaps some of the new product innovations and I am thinking of Zoom Mail, Calendar, Zoom Spots and others could perhaps enhance the stickiness of the usage patterns, right, or drive engagement and collaboration higher in a way that could maybe benefit your — either your dollar retention rates or maybe some of the premium plan adoption?

Eric Yuan: Yeah. So, Mark, that’s a great question. That’s the reason why we had a very successful Zoomtopia, because we announced so many innovations, almost every innovation. When we look at that what we can do to either add value to the existing paid customer to focus on stickiness or maybe the potential revenue opportunity, right? Look at area features, I think, we always follow that principle. Look at Email and calendar, look at Online paid users, the subscribers and we do not offer to free users, right? For all those Online, the pro buyers give Email, Calendar for free, they can use the Email, Calendar full another great service, which is an , right? Look at all other features, like, Spots and all those features certainly can help our integrated customers also make our services more sticky.

Not only do they use Zoom for schedule Meetings, but also can use that to mimic the office environment. So for free users, right, Email, Calendar, Spots client, right? So every feature , I think, for sure, will add more value to our customers, either drive stickiness or drive potential revenue opportunity like Zoom IQ, virtual agent and the Contact Center and virtual agent, Zoom IQ like virtual coach and a lot of features like that. So we are very, very excited, and again, and the feedback from customers are very, very positive and they are very excited about adopting those new features and enhancements.

Mark Murphy: Thank you.

Eric Yuan: Thank you, Mark.