Zoom Video Communications, Inc. (NASDAQ:ZM) Q2 2024 Earnings Call Transcript

Zoom Video Communications, Inc. (NASDAQ:ZM) Q2 2024 Earnings Call Transcript August 21, 2023

Operator: Okay. Hello, everyone, and welcome to Zoom’s Q2 FY ’23 Earnings Release Webinar. As a reminder, today’s webinar is being recorded. And now I would like to hand things over to Tom McCallum, Head of Investor Relations. Tom?

Tom McCallum: Thank you, David. Hello, everyone, and welcome to Zoom’s earnings video webinar for the second quarter of fiscal 2024. I’m 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’ll 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 third quarter and full fiscal year 2024; our expectations regarding financial and business trends; impacts from the macroeconomic environment, our market position, opportunities, go-to-market initiatives, 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, that we discuss in detail in our filings with the SEC, including the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. Zoom assumes no obligation to update any forward-looking statements that we may make on today’s webinar. And with that, let me turn the discussion over to Eric.

Eric Yuan: Hey. Thank you, Tom. Hey. Thank you everyone for joining us today. So before starting, I’d like to welcome Dr. Xuedong Huang as our CTO, who joins us after a successful career at Microsoft, where he most recently served as Azure AI CTO and Technical Fellow. Dr. XD joins us at an optimal moment in our AI journey. In the past few months, we brought several new AI innovations to the market and announced an aggressive roadmap aimed at empowering our customers to work smarter and serve their customers better. And, as we develop and deploy AI solutions, we strongly believe that technology should advance trust. We are privileged to have countless customers rely on us for their communications needs. We don’t take that for granted.

Earlier this month, we took the additional step in stating that Zoom does NOT use customer content to train our AI models or third-party AI models. I’m proud of the approach we are taking. By putting customers’ privacy needs first, Zoom is taking a leadership position in ensuring customers can use our AI features with confidence that their content is protected. Now, let me share how we have advanced in our mission of: One Platform Delivering Limitless Human Connection. We launched Zoom Scheduler, which serves to reduce the hassle of scheduling with people outside your organization, and Intelligent Director, which uses AI and multiple cameras to provide the best image and angle of participants joining from a conference room. We also launched many new offerings like Zoom Clips, which enables asynchronous video conversations.

And more and more customers are getting on Zoom Team Chat, driven by increased adoption of Zoom One and new features like Continuous Meeting Chat, which connects the transient in-meeting chat feature to the persistent Zoom Team Chat product. Currently, we have two fortune 15 companies, one major consulting firm, a global F&B brand and a leading law firm using Zoom Team Chat as a core means of text-based communications. Our Contact Center product has surpassed 500 customers and we are rolling out about 90 new features and enhancements per quarter. We launched Workforce Management in early July to help customers streamline customer communications, manage agent needs, and transform their customer experience all from a single, unified platform.

WFM is already off to a great start and we look forward to adding additional products to this suite to expand our native customer experience capabilities and revenue streams. We have progressed rapidly in our integration of Workvivo. After rolling it out internally, I could not be more impressed with the product and confident in the value it will bring to our customers in terms of building culture across a distributed workforce, ultimately delivering upon our strategic pillar of enabling hybrid work. Speaking of which, a few weeks ago, we announced internally a structured hybrid approach — asking our Zoomies that live within commuting distance to come into their local office twice a week. Zoom is purpose-built for hybrid work and it is on us to understand what our customers are experiencing in their hybrid journeys and what works and does not work for them.

We believe that this approach will enable us to continue to innovate for our customers and deliver what they need to succeed. Now moving on to some of our customer wins. First, we are excited to expand with the United States Postal Service. In Q2, the postal service added Zoom Team Chat for 21,500 users to their existing Zoom for Government deployment. Let me also thank Brookdale Senior Living, the largest operator of senior housing in the United States. Brookdale started as a Zoom Meetings customer in FY20. A year later, they began evaluating Zoom Phone. And in Q2 they went all-in on the cloud and upgraded to Zoom One, in order to unify their communication needs under one integrated product. Let me also thank Perdue Farms. Like many of our customers’ journeys, Perdue’s started years ago with an initial Zoom Meetings deployment.

Last fall, they went all-in with Zoom One Enterprise Plus. However, the story does not end there. In Q2, Perdue added Zoom Contact Center due to its native integration with their existing Zoom Phone deployment and our ambitious innovation roadmap. Let me also thank Valmont Industries. Valmont came onboard as a Zoom customer a little over a year ago with Meetings and Phone and quickly became a major platform adopter, including Zoom One and Zoom Contact Center. And in Q2, with the goal of utilizing AI to better serve their customers and also their employees, they added Zoom Virtual Agent due to its accuracy of intent understanding, ability to route issues to the correct agent, ease of use and quality of analytics. We are so delighted to see our partnership with Valmont grow so quickly and are committed to innovating further to support their operations.

Finally, let me thank Dollar General, America’s general store, for choosing Zoom’s Workvivo to connect employees as the digital heartbeat for the company. Dollar General will rollout Workvivo’s employee engagement platform for its roughly 190,000 employees to enhance the employee experience at the individual, group and district levels, drive employee dialogue, and reinforce its strong culture. Again, we are so excited to welcome and expand with USPS, Brookdale, Perdue Farms, Valmont, Dollar General, and all of our customers worldwide. And with that I’ll pass it over to Kelly. Thank you.

Kelly Steckelberg: Thank you, Eric, and hello, everyone. We are pleased that we beat our top line and profitability guidance in Q2. Here are a few milestones. First, operating cash flow grew 31% year-over-year to $336 million. Second, Zoom Phone reached roughly $0.5 billion in annualized run rate revenue. And finally, we are excited that Zoom Contact Center has surpassed 500 customers in only six quarters. In Q2, total revenue grew 4% year-over-year to $1.139 billion, which includes $10 million of pressure from foreign exchange. This result was approximately $24 million above the high end of our guidance. Our Enterprise business grew 10% year-over-year and represented 58% of total revenue, up from 54% a year ago. We continue to see improvement in Online average monthly churn, which decreased to 3.2% from 3.6% in Q2 of FY ’23.

The number of Enterprise customers grew 7% year-over-year to approximately 218,100. Our trailing 12-month net dollar expansion rate for Enterprise customers came in Q2 at 109%. We saw 18% year-over-year growth in the upmarket as we ended the quarter with 3,672 customers contributing more than $100,000 in trailing 12 months revenue. These customers represent 29% of revenue, up from 26% in Q2 of FY ’23 and include some of the amazing names that Eric highlighted earlier. Our Americas revenue grew 6% year-over-year, while EMEA and APAC declined by 1% and 3%, respectively. Absent currency impact, both EMEA and APAC would have been approximately flat year-over-year. On a quarter-over-quarter basis, all regions grew 3%. Moving to our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, acquisition-related expenses, net gains or losses on strategic investments, restructuring expenses and all associated tax effects.

Non-GAAP gross margin in Q2 was 80.3%, an improvement from 78.9% in Q2 of last year. We are pleased with the strength of our gross margins as we continue to optimize usage across the public cloud and our co-located data centers for both existing and emerging technologies. For the full year, we expect non-GAAP gross margin to be approximately 79.7% as we make additional investments in new AI technologies. Research and development expense grew by 6% year-over-year to approximately $104 million. As a percentage of total revenue, R&D expense increased to 9.1% from 8.9% in Q2 of last year, reflecting our investments in expanding our product portfolio, including Zoom Contact Center, AI and more. Looking ahead, investing in innovation will remain a top priority for Zoom.

Sales and marketing expense decreased by 3% year-over-year to $276 million. This represented approximately 24.2% of total revenue, down from 26% in Q2 of last year. As a reminder, Zoomtopia will be held in Q3 of this year and will drive incremental marketing investment in the quarter. G&A expense declined by 19% to $73 million or approximately 6.4% of total revenue, down from 8.2% in Q2 of last year, as we continue to achieve greater efficiencies and experienced onetime savings in the quarter. Non-GAAP operating income grew by 17% to $462 million, exceeding the high end of our guidance of $410 million. This translates to a 40.5% non-GAAP operating margin, a meaningful improvement from 35.8% in Q2 of last year. Our effective tax rate in Q2 was 18.5%.

For the remainder of the year, our tax rate is expected to approximate the blended U.S. and federal state rate. Non-GAAP diluted earnings per share in Q2 was $1.34 on approximately 306 million non-GAAP diluted weighted average shares outstanding. This result was $0.28 above the high end of our guidance and $0.29 higher than Q2 of last year. Turning to the balance sheet. Deferred revenue at the end of the period was $1.37 billion, down approximately 2% from Q2 of last year. This was in line with the high end of the expectations that we shared last quarter. For Q3, we expect deferred revenue to be down 4% to 5% year-over-year, partially driven by shorter billing frequencies on Enterprise deals arising from the high interest rate environment. Looking at both our billed and unbilled contracts, our RPO increased 9% year-over-year to approximately $3.5 billion.

We expect to recognize approximately 59% of the total RPO as revenue over the next 12 months as compared to 61% in Q2 of FY ’23 indicating lengthening contract durations on a year-over-year basis. As a reminder, our renewal seasonality peaks in Q1 and declines throughout the rest of the year. Operating cash flow in the quarter grew 31% year-over-year to $336 million. Free cash flow grew 26% year-over-year to $289 million. Both results include the approximately $60 million cash payment related to the legal settlement that we discussed last quarter. Our operating cash flow and free cash flow margins were 29.5% and 25.4%, respectively. We ended the quarter with approximately $6 billion in cash, cash equivalents and marketable securities, excluding restricted cash.

Given the strength in profitability and collections, we are increasing our cash flow outlook for FY ’24. We now expect free cash flow to be in the range of $1.2 billion to $1.23 billion. Turning to guidance. For Q3, we expect revenue to be in the range of $1.115 billion to $1.12 billion, which at the midpoint would represent approximately 1% year-over-year growth or 2% in constant currency. We expect non-GAAP operating income to be in the range of $400 million to $405 million. Our outlook for non-GAAP earnings per share is $1.07 to $1.09 based on approximately 309 million shares outstanding. We are also pleased to raise our top line and profitability outlook for the full year of FY ’24. We now expect revenue to be in the range of $4.485 billion to $4.495 billion.

At the midpoint, this represents approximately 2% year-over-year growth or 3% in constant currency, which we expect to be neutral in the back half of the year. Our increased total revenue guidance reflects a consistent view on Enterprise, with tempered expectations for Online for the remainder of the year. We expect our non-GAAP operating income to be in the range of $1.685 billion to $1.695 billion, representing an operating margin of approximately 38%. Our outlook for non-GAAP earnings per share for FY ’24 is $4.63 to $4.67 based on approximately 308 million shares outstanding. Thank you to the entire Zoom team, our customers, our community and our investors for your trust and support. Before opening up for Q&A, we are excited about our premier user conference, Zoomtopia.

It will be in person in San Jose as well as on Zoom Events. We look forward to sharing more about our expanding platform, new innovations and customer testimonials. Please join us at Zoomtopia on October 3 and 4. David, Please queue up our first question.

Operator: Thank you, Kelly. As Kelly mentioned, we will now move into the Q&A session. [Operator Instructions] Our question will come from Mark Murphy with JPMorgan.

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Q&A Session

Mark Murphy: Well, thank you so much and congrats on solid execution in the quarter. Curious, if you can comment on the Zoom Scheduler product. It looks like a very attractive add-on option and a clear efficiency gain. I understand that, that’s going to be free for some period of time and that looks like $6 per month for certain users. I understand it’s going to be included in some of the other bundles. But can you just comment on how that’s going to work or maybe Eric, you can touch on the efficiency gains from that product? And Kelly, any type of a framework for the revenue potential out of that particular product?

Eric Yuan: Yes. So I can talk on the product side. Clearly, Kelly, feel free to tell on the revenue potential. I think, Mark, you’re also right on. I guess probably you already tried it out is indeed very attractive. The reason why you look at the whole customers are — including Zoomies, right, how we schedule the meeting. Let’s see, Mark, I want to schedule a meeting with Zoom next week is so complicated, right? I need to [indiscernible] we think about calendar schedule is so hard, meaning across the company, scheduling is so complicated, right? How to have the customers and simplify that experience, that’s why I decided to introduce Zoom Scheduler, right? And also, there are some other start-up solutions out there. The customer, they would like to lever the Zoom platform because they already used Meeting and the Phone, Team Chat, one more click, they can schedule the meeting with somewhere from outside organization, really like that experience.

That’s why we decided to build that. And we already have a free trial and as a customer [indiscernible] customers already and also be part of the Zoom One as well down the road. And actually, it’s doing very well and really simplify the way for you to schedule meetings with any other side of your organization. We’re pretty excited about that opportunity.

Kelly Steckelberg: Yeah. I think in terms of its overall contribution, Mark, it’s at a very attractive price point and will grow over time, certainly. But also, we think that what it does is make the product continue to be where you live and make, especially our larger enterprise customers that much more retentive as it continues to spread the platform and how you spend your day.

Mark Murphy: Thank you so much.

Eric Yuan: Thank you, Mark. Hopefully you try that. Thank you. Appreciate it.

Operator: Okay. Our next question comes from Meta Marshall with Morgan Stanley.

Kelly Steckelberg: Meta, we can’t hear you.

Meta Marshall: Because I’m on mute. So one of the questions that I had was just, what you’re seeing in terms of the environment? I know that your upside kind of came from the Enterprise. Just wanted to get a sense of how the environment changed during the quarter, if there were any changes during the quarter? And just whether kind of that upside came as a result of kind of better upsells or just more deals kind of getting closing in shorter order? Thanks.

Kelly Steckelberg: Yeah. Thank you, Meta. So I would say in terms of Q2 versus Q1, the environment has been pretty consistent. We continue to see momentum in Zoom One, in Zoom Phone. There are still, I would say, lengthen sales cycles out there and customers really making sure that they take advantage of doing their full due diligence. But we’re really excited about the vision that we can take for them not only around, obviously, the existing platform but what’s also coming from an AI perspective. And I think our customers are finding that very attractive, as you’ve heard from the customers that Eric talked about seeing a lot of momentum of customers that were originally Meetings customers really moving either into Zoom One or adding on Zoom Phone and considering Contact Center as well.

Meta Marshall: Great. Thanks.

Eric Yuan: David, next.

Kelly Steckelberg: David, who is next?

Operator: Apologies. Our next question comes from Kash Rangan from Goldman Sachs.

Kelly Steckelberg: Hi, Kash.

Kasthuri Gopalan: It looks like the Enterprise business is seeing stability with respect to attrition, et cetera. I’m curious to get your thoughts on the Online business. So it’s still a substantial part of the revenue and anything that you have identified that could help stabilize the attrition levels? And also, just while we’re at it, what is the pricing power of Zoom? Like you talked about customers worried about inflation and doing shorter-term contracts, that I guess on the flip side means that you could raise prices. So wondering how much leverage we have at that. Thank you so much.

Kelly Steckelberg: Yeah. So in terms of the Online segment, we were really pleased with the continued improvement that we’re seeing in the [indiscernible] rates or the churn rates. They are really at historic lows. And so that’s really great to see. And when the interim team continue to innovate, we just saw a little more volatility, and that’s what we indicated in sort of tempered expectations for the rest of the year, but really pleased with the ongoing progress that we’re seeing in that segment of the business. And then in terms of the pricing power — I mean, Eric, feel free to chime in. But certainly, we continue to have a discussion with our customers when it comes up for renewals, looking for opportunities to potentially expand their usage of the portfolio, moving them from Zoom Meetings to Zoom One is a very common upsell mechanism or, I should say, movement that we’re seeing with our customers today and considering, is there an opportunity potentially given the value that they’re seeing in the platform potentially for a price increase at renewal as well?

Kasthuri Gopalan: Thank you.