Zoom Video Communications - Earnings Review Q2'23
Zoom Video Communications Inc., $ZM reported its fiscal Q2’2023 results on 22 August 2022. Although $ZM is not in our portfolio, it is a company that we closely follow. The below commentary is a review of its Q2’2023 earnings.
Zoom missed guidance for Q2’2023 and reduced its guidance for fiscal 2023 (this was the first quarter the company missed guidance!). The unsatisfactory results were reflected on Zoom’s stock price which closed down by 16.5% the next day of the announcement.
RESULTS Vs GUIDANCE
Kelly Steckelberg, CFO, 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.
Revenue up 8% year-over-year to $1,100 million. Revenue growth was driven by the increase in enterprise revenue (up 26%) and partly offset by the decrease in revenue from the online business (down 8%).
Kelly Steckelberg, CFO, Our enterprise business continued 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.
Revenue from Enterprise customers grew 26% year-over-year and represented 54% of total revenue, up from 46% in Q2‘22. Revenue from Enterprise customers is expected to be the chunk of total revenue over time.
The number of Enterprise customers grew 18% year-over-year to approximately 204,100.
Customers contributing more than $100,000 in trailing 12 months increased by 37%. These customers represented 26% of revenue, up from 20% in Q2‘22.
Trailing 12-month net dollar expansion rate for Enterprise customers was 120%, down from Q1’23 of 123%.
Zoom strategy is land and expand.
Kelly Steckelberg, CFO, the selling strategy for Zoom Phone, for contact center or Zoom IQ sales is to sell into the existing installed base.
Revenue from online business was down 8% year-over-year (management was expecting flat Y/Y growth of the online business) and down 2% quarter-over-quarter compared to -4% quarter-over-quarter in Q1’2023 showing signs of stabilization.
According to management, stability of retentions rates is achieved once a customer reaches 16-months of subscription. Currently, 70% of online business has now crossed that 16-month mark which further implies that we might see stabilisation.
Kelly Steckelberg, CFO, We have implemented initiatives focused on driving new online subscriptions, which have shown early promise but were not enough to overcome the macro dynamics in the quarter.
As we transition to a post-pandemic period the online business (which constitutes of mainly small businesses and individuals) is more likely to churn. Even though management sees improvement in retention rates and conversion rates, the Company still strives on new additions.
Kelly Steckelberg, CFO, 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 surpassed 4 million seats in August.
Zoom does not report Zoom Phone results separately. However, based on information provided in previous earning calls, the number of seats increased by 100% as of August 2022.
Zoom Phone revenue will most likely surpass 10% of Zoom’s total revenue in FY’24. Based on our estimates, Zoom Phone could be over 450 million in annual revenue run rate.
Kelly Steckelberg, CFO, from a revenue perspective, we will start to bring out – break out these products when they hit their 10% of revenue. You can imagine, we are getting very close on Zoom Phone.
Kelly Steckelberg, CFO, We are also seeing early traction for Zoom Contact Center and Zoom IQ for sales. Zoom Contact Center is only 6 months old, but has already had deal sizes reach seats that we did not expect until its second year.
Gross profit margin was 75% compared to 72% in Q2’22. The improvement was due to optimizing usage across the public cloud and increasing number of co-located data centers. Gross margin is expected to improve further for the remaining of the year, and be around 78% (similar to pre-pandemic levels).
Non-GAAP operating income of $394 million compared to $425 million in prior year, and non-GAAP operating income margin of 35.8% compared to 41.6% in prior year. Non-GAAP operating income does not include Stock Based Compensation (“SBC”) which in the case of Zoom is accelerating and increasing shareholder dilution.
GAAP operating income of $122 million compared to $295 million in prior year, and GAAP operating income margin of 11.1% compared to 28.8% in Q2’22.
While revenue grew by 8%, operating expenses increased exponentially with R&D up 110%, S&M up 36% and G&A up 17%. We presume that the increase in R&D and S&M is associated with the new product launches and early lifecycle stage products like Contact center, IQ for sales and Zoom Phone as the majority of the increase comes from additional headcount and expanded equity programs. We believe that to some extent the noteworthy increase in operating expenses is reasonable as Zoom developed new product categories internally instead through significant M&A activities.
Kelly Steckelberg, CFO, 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.
FINANCIAL POSITION, SHARE BUYBACKS AND CASH FLOWS
Cash and marketable securities as at 30 July 2022 are $5.5 billion with zero debt. A clean balance sheet with plenty financial resources to support investments.
Free cash flow was $229 million (21% of revenue) compared to $455 million in Q2’22 (45% of revenue). It should be noted that FCF does not include the impact of SBC (if included the margin turns negative).
After announcing $1 billion share buy-back plan last quarter, the company purchased $294 million of stock, representing 2.9 million shares, implying an average cost of $102 per share. As of July 2022, $574 million of the authorization remains available. Although the company repurchased stock, the impact on shares outstanding was offset by the dilution of SBC.
In our opinion Q2’23 was a mixed quarter for Zoom as it missed guidance for the first time in its history and reduced its guidance for fiscal year 2023.
Zoom’s profitability is weakening, online business is deteriorating and SBC acceleration is diluting shareholders. Nonetheless, we believe that the deterioration in profitability is the price to pay for growing organically and developing new products without pursuing significant M&A strategy. As a result, a lot depends in the future performance of products such as Zoom Phone and Zoom contact center.
The positive tone of the latest quarter was the growth in Enterprise business in the mid-twenties while conversion rates and retention rates of the online business improved. Additionally, Zoom Phone is growing exponentially and Contact center is seeing early traction with deals in the quarter exceeding management’s expectations.
Thanks for reading StockOpine’s Newsletter! Subscribe for free to receive new posts and support our work.
Disclaimer: The team does not guarantee the accuracy or completeness of the information provided in the newsletter. All statements express personal opinions based on own financial and business analysis. Any estimates or forward looking statements made are inherently unreliable. No statement of opinion is an offer or solicitation to buy or sell the financial instruments mentioned.
The content of our newsletter is not a trading or investment advice and we do not provide any personal investment advice tailored to the needs of any recipient. The information provided should not be considered as a specific advice on the merits of any investment decision. Securities trading involve risk and you might lose your capital and/or incur other damages. Investors should make their own research and consult their registered investment advisor or financial advisor before taking any investment decision.
Neither the team nor any of its affiliates accept any liability whatsoever for any direct or indirect loss however arising, from any use of the information contained herein. Any unauthorized copy of this newsletter or its contents is illegal.
By subscribing / reading our newsletter or any affiliated social media accounts, you indicate your unconditional acceptance to the above and your unconditional acceptance to our terms and conditions.