Zoom Video Communications, Inc. (NASDAQ:ZM) Q4 2023 Earnings Call Transcript

Zoom Video Communications, Inc. (NASDAQ:ZM) Q4 2023 Earnings Call Transcript February 27, 2023

Kelcey McKinley: Well. Hello, everyone, and welcome to Zoom’s Q4 FY ’23 Earnings Release Webinar. As a reminder, today’s webinar is being recorded. At now, I will turn things over to Tom McCallum, Head of Investor Relations. Tom, over to you.

Tom McCallum: Thank you, Kelcey. Hello, everyone, and welcome to Zoom’s earnings video webinar for the fourth quarter and full year of FY ’23. 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 first quarter and full fiscal year 2024, our expectations regarding financial and business trends impacts to the impacts from the macro environment, our market position, opportunities, go-to-market initiatives, growth strategies 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 the risks and other factors that could affect our performance and financial results which we discussed 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 show you a quick video highlighting our exciting technologies before turning the discussion over to Eric. Kelcey, please queue up the video.

Eric Yuan: Wow, that’s amazing. Thank you, Tom. And thank you everyone for joining us today. So FY23 was truly a pivotal period in our evolution into a full collaboration platform. As you saw in the video, we launched multiple innovations to help transform work and expanded our product portfolio to open new markets. Since Zoom Contact Center’s release early last year, we have worked hard to expand its features, functionality and integrations. In Q4, we landed a 2,000 seat contact center deal, our largest to date, it truly demonstrated the rapid progress we have made towards becoming a full-fledged contact center solution. The success of our Zoom One bundle, which we launched last June, contributed to the strong performance of Zoom Phone, which in Q4 exceeded 5.5 million seats, making us a clear leader in the space.

We closed out the fiscal year with the release of Zoom Virtual Agent, an intelligent conversational AI and chatbot solution that we believe will transform the way businesses assist their customers and employees. FY23 was not without its challenges. We experienced headwinds in terms of currency impact, online contraction, and deal scrutiny which continued into Q4. And a few weeks ago, we made the very tough but necessary decision to reduce our team by 15% and say goodbye to around 1,300 hardworking, talented Zoom colleagues. I want to extend to them my heartfelt appreciation and deepest gratitude for their crucial contributions to Zoom. This painful exercise has been a tremendous learning experience for us. It allows us to look inward to reset ourselves, so we can weather the economic environment with greater focus and agility, deliver for our customers and achieve Zoom’s long-term vision.

Now, let me discuss our strategic focuses in FY24 and beyond. First, we’ll help redefine teamwork through offering new immersive experiences that improve employee engagement and modern collaboration tools for ideation across locations and modalities. And we will give teams everything they need through a single pane of glass. Second, the age of AI and large language models has arrived and we want to empower smarter experiences and workflows that truly enable our customers to benefit from these transformational tools. By embedding AI into more workflows, we can provide our customers with richer, more actionable insights that empower them to work smarter and serve their customers better. Zoom IQ, Zoom Virtual Agent, as well as our translation, captioning, and meeting summary tools are just the beginning.

We will layer more AI technologies into our products to truly help our customers maximize their ROI on our platform and thrive in this new era of computing Third, we will offer more and more departments tailored solutions to meet their nuanced digital transformation needs. We constantly solicit feedback not only from CIOs, but also heads of sales, customer experience leads and many other leaders across various industries. Zoom IQ for Sales was built in this collaborative fashion and has already added tremendous value to many sales teams. You can expect additional industry-specific and department-specific applications developed both by us and our third party partners. All of this comes together as a collaboration platform that unites people to unlock their potential, enables more dynamic and intelligent experiences and allows us to reimagine productivity and work.

As we navigate this period of technological and economic volatility, our role as a trusted partner providing best-in-class unified communications services has never been more crucial. Again this is a tremendous opportunity in front of us, and we are very confident that our strong foundation, ambitious vision and customer-centric culture will enable us to seize this opportunity and continue to lead the way in the unified communications and collaboration space. Now moving on to some of our customer wins. I want to thank Aramco, one of the world’s leading integrated energy and chemicals companies, for establishing a strategic partnership with Zoom. This is a landmark multi-year partnership where we will provide a full-suite of collaboration services including Zoom Meetings, Team Chat, Phone, Events and Zoom Rooms.

Photo by Compare Fibre on Unsplash

In addition, we will work together to build a data center in the region and explore the joint development of innovative technology solutions. We are so grateful that Aramco has chosen to partner with Zoom on their digitization strategy. I’d also like to thank NASDAQ, my favorite company, who has been a Zoom customer for several years. Recognizing Zoom’s strong reliability, security and ease of use, they expanded to Zoom One, our all in one unified communications and collaboration bundle. As part of this expansion, NASDAQ will be deploying Zoom Phone and also adding capabilities like Translation and Advanced Whiteboard to their Zoom Meetings. I want to also thank Raymond James, a leading financial services company, for expanding their relationship with us by integrating Zoom Phone to their Zoom Meetings implementation for a more complete communications package.

We are excited to work with Raymond James to provide a highly-reliable and secure system, enabling their employees to communicate, collaborate, and ultimately thrive in the hybrid work world. I want to also thank Barracuda Networks, which builds cloud-first, enterprise grade security solutions, for expanding with Zoom. A longstanding Zoom Meetings customer, Barracuda saw the value of having a single platform for all their communications needs, and upgraded wall-to-wall to Zoom One Enterprise Plus in Q4. In addition, Barracuda also chose Zoom IQ for Sales to enhance sales engagement and Zoom Contact Center to elevate the customer experience. Again, thank you Aramco, NASDAQ, Raymond James, Barracuda Networks, and all of our customers worldwide.

And before closing, let me express my warm welcome to Cindy Hoots for joining our Board of Directors. Cindy brings a wealth of experience and currently is the Chief Digital Officer and Chief Information Officer at AstraZeneca. We are so excited to work with her. I also want to welcome our new Chief Product Officer, Smita Hashim, who joins us from a seasoned executive career at Microsoft and Google. We are also super excited to work with her. And with that, I’ll pass over to Kelly. Thank you.

Kelly Steckelberg: Thank you, Eric, and hello, everyone. Let me start with a few of the financial highlights for FY ’23 and the results for Q4 and then provide our outlook for Q1 and FY ’24. We delivered solid results in FY ’23. Here were some of the highlights. Our Enterprise business grew 24%. Our non-GAAP operating margin was 35.9%, and we achieved a free cash flow margin of 27%. In Q4, total revenue came in at $1.118 billion, up 4% year-over-year and 6% in constant currency. This result was approximately $13 million above the high end of our guidance. The growth in revenue was primarily driven by strength in our Enterprise business, which grew 18% year-over-year and represented 57% of total revenue, up from 50% 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 contribution from Zoom Rooms and other products. Online average monthly churn decreased to 3.4% from 3.8% in Q4 of FY ’22 and increased slightly from 3.1% in Q3 as expected due to seasonality. The number of Enterprise customers grew 12% year-over-year to approximately 213,000. Our trailing 12-month net dollar expansion rate for Enterprise customers in Q4 came in at a healthy 115%. We saw a 27% year-over-year growth in the upmarket as we ended the quarter with 3,471 customers contributing more than $100,000 in trailing 12 months revenue. These customers represent 28% of revenue, up from 23% in Q4 of FY ’22 and span diverse industries such as healthcare, education, government and more.

Our Americas revenue grew 10% year-over-year. EMEA continues to be impacted by the stronger dollar, macro headwinds and online performance, which combined led to a decline of 9% year-over-year. APAC also impacted by the stronger dollar declined 5% year-over-year. Now turning to expenses and margins. A quick note on our GAAP results. In Q4, they included a onetime stock-based compensation expense of $208 million due to the sunsetting of our supplemental grant program, which carries neither dilutive nor tax deduction impacts. Moving on to 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 Q4 was 79.8%, an improvement from 78.3% in Q4 of last year and 79.5% last quarter. The sequential improvement was mainly due to optimizing usage across the public cloud and our co-located data centers. For FY ’24, we expect non-GAAP gross margin to be approximately 79.5%. Research and development expense grew by 43% year-over-year to approximately $103 million. As a percentage of total revenue, R&D expense increased to 9.2% from 6.7% in Q4 of last year, reflecting our investments in expanding our product portfolio. Looking ahead, innovation will remain a top priority for Zoom. Sales and marketing expense grew by 20% year-over-year to $301 million. This represented approximately 26.9% of total revenue, up from 23.4% in Q4 of last year.

As part of our restructuring, we are optimizing our go-to-market strategy to better support our enterprise customers and drive additional productivity. G&A expense declined by 12% to $84 million or approximately 7.5% of total revenue, down from 8.9% in Q4 of last year as we focused on achieving greater efficiencies in our back office. Non-GAAP operating income was $405 million, exceeding the high end of our guidance of $326 million as we took actions to reprioritize our investments in Q4. This translates to a 36.2% non-GAAP operating margin for Q4 as compared to 39.2% in Q4 of last year. Non-GAAP diluted earnings per share in Q4 was $1.22, $0.44 above the high end of our guidance. Due to our share repurchase program, our Q4 weighted average share count has decreased year-over-year by approximately 5 million shares to 301 million.

Turning to the balance sheet. Deferred revenue at the end of the period was $1.3 billion, up 11% year-over-year from $1.2 billion. This is above our guidance as we saw increased commitments from customers and extended contract durations. Looking at both our billed and unbilled contracts, our RPO totaled approximately $3.4 billion, up 30% year-over-year from $2.6 billion. We expect to recognize approximately 56% of the total RPO as revenue over the next 12 months as compared to 63% in Q4 of last year. As a reminder, our annual seasonality of renewals is weighted towards the first half of the year. We expect Q1 deferred revenue to be up zero to 1% year-over-year partially due to the strengthening of the dollar starting late in Q1 of FY ’23. Since then, the major currencies we do business in are down 5% to 10% vis-a-vis the dollar.

We ended the quarter with approximately $5.4 billion in cash, cash equivalents and marketable securities, excluding restricted cash. We had operating cash flow in the quarter of $212 million, up from $209 million in Q4 of last year. Free cash flow was $183 million as compared to $189 million in Q4 of last year. Our margins for operating cash flow and free cash flow were 18.9% and 16.4%, respectively. Because the Section 174 tax legislation requiring capitalization of R&D expenses was not repealed in FY ’23, we incurred an additional cash tax payment in Q4. Despite this payment, we still exceeded the high end of our previously provided range by $36 million for a full year total of $1.186 billion. For FY ’24, we expect free cash flow to be in the range of $1.2 billion to $1.25 billion.

Now turning to guidance. For the first quarter of FY ’24, we expect revenue to be in the range of $1.08 billion to $1.085 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 $374 million to $379 million. Our outlook for non-GAAP earnings per share is $0.96 to $0.98 based on approximately 304 million shares outstanding. This outlook reflects the three fewer days in Q1 versus all other quarters. For the full year of FY ’24, we expect revenue to be in the range of $4.435 billion to $4.455 billion, which at the midpoint represents approximately 1% of year-over-year growth or 2% in constant currency. We expect our non-GAAP operating income to be in the range of $1.606 billion to $1.626 billion, representing a non-GAAP operating margin of approximately 36%.

Our tax rate is expected to approximate the blended U.S. federal and state rates. Our outlook for non-GAAP earnings per share is $4.11 to $4.18 based on approximately 309 million shares outstanding. Zoom is dedicated to maintaining a careful balance between growth and profitability. We remain committed to innovating our platform, optimizing our go-to-market motions and evolving our culture to meet the dynamic needs of the market. We are confident that our continued investment in innovation will enable us to provide an even greater value to our customers, while also positioning us for sustained growth. Thank you to the Zoom employees, our customers, our community and our investors. Kelcey, please queue up our first question.

A – Kelcey McKinley: And our first question will come from Fred Lee with Credit Suisse.

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Q&A Session

Fred Lee : Kelly, just a question regarding the full year operating margin guide, which looks like it’s coming in around 5 percentage points above consensus. I was wondering if you could break down where those efficiencies are coming from, how much was coming from the RIF versus efficiencies in other operating expense line items.

Kelly Steckelberg : Yes. Thank you. So as I mentioned in the prepared remarks, we started really focusing on driving efficiencies across the business in Q4, as you saw in the results. This came from looking across all third-party spend and then as we moved into Q1, of course, the reduction. And so it’s really a combination of that as well as looking across all of our business processes, including go-to-market where there’s a restructuring happening to really focus the resources on our enterprise customers and be as efficient as we can in our commercial and small business teams.

Fred Lee : Got it. And a quick question for Eric. With regard to everything that’s happening around AI and generative AI, you’ve talked a little bit about some of the new product areas where you’re expecting some initial impact. So how would you — what kind of analogy can you draw for investors and for us with regard to the uptake of all things generative AI. A little bit of commentary around that would be greatly appreciated.

Eric Yuan : Sure. So yes, first of all, that’s a great question about AI. I think your question about AI sort of reminds me of 1995, 1996, when Internet was — the first wave of Internet revolution. I was so excited. That’s why I moved to Silicon Valley, right, to embrace that first wave of revolution. And since then I was a stuck for real-time collaboration until today. I can tell you, speaking of AI, I’m as excited as 1995, maybe sorry I’m wrong, maybe more excited than 1995, 1996, given my engineering and product background. I think AI sort of faces a challenge; at the same time, also have a huge opportunity ahead of us, right? Given our strong innovation culture, I think AI can truly help Zoom, right, to evolve us — to cut sort of part of the Zoom 2.0 journey, right?

I think Zoom may be the AI-first company. Speaking of specifically features how to leverage AI. And even before we talk about ChatGPT and talk about all those AI, actually, we already invest having on AI, right? So some customers may not see that, right? Like noise reduction, even with background, a lot of things like that. Even recently, we announced a feature called Zoom Smart and Meeting Summary where we already leveraged GPT-3 to augment our ML to improve that experience. And we are going to double down and triple down on AI a lot of features like Virtual Agent or Zoom IQ for Sales, our chat solution, even as well, I think AI can truly empower everything we are doing here and will benefit the customers. Plus we are taking a very open approach.

And we have our own AI engineers, a lot of talents working very hard and also are going to partner with other companies. OpenAI is a great company and just plugged recently. And this is great. Again, I can talk a lot about AI. I’m very, very excited.

Kelcey McKinley: And Michael Funk with Bank of America has the next question.

Michael Funk : Okay. First for you, Eric. cash balance is a huge strategic asset for Zoom, specifically today, when a lot of your competitors don’t have that optionality. So what is the argument in your opinion, against deploying that cash to further your advantage and improve your capacity?

Eric Yuan : So when it comes to money better to delegate it to Kelley, probably she is better to have managed that so.