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Friday, September 17, 2021

Zoom Video Q2 2022 post earnings breakdown, a semantic network analysis

Zoom Video: With it being down 18% in my portfolio it is time to question my beliefs and decide whether to add, hold, pare or get out. The following post is a step-by-step walk through of my process, reasons and conclusions. Brace yourself, its a long one. TLDR at bottom. 

Lets begin,

On Zoom developments:

Figure 1: Zoom Apps discussion

Zoom apps section of Zoom has nicely thought out plan with an internal and external work force (Start ups, zoom apps fund). I think this will continue to crank out developments given its set up. The network model is shown in the figure (Fig. 1). CEO called this "internal innovation engine".

Figure 2: Zoom events discussion

Zoom events is presented as a step above webinars and meeting with its USP being a solution for mass reach to host and produce events. This is not experimental, but a fully functioning product which the company has tested on its own event 'Zoomtopia'. See figure 2 above.



Figure 3: Zoom 'wins' this quarter

In the sales (Figure 3), they made some good sales with both new large customers as well as up-sells to prior customer. Main emergent theme, I got was 'Zoom phone' is being offered as 'Chef's special' and is likely being pushed hard. If this is the case, then zoom phone numbers will improve QoQ and people will start seeing traction in addition to zoom meetings. More interestingly is the partnership with Telkomsel which is Indonesia's largest cellular/internet Telecommunications provider.

Figure 4: Zoom has identified a clear need that enterprises have

The CEO has nicely outlined what they see as their target audience. It is the offices, organizations they are going after and filling the enterprise need for a digital platform that does communication (Figure 4)

Chief Finance Officer's section

1. Enterprise customers spending more than $1 million in ARR up by 77% year over year
2. A lot of Zoom phone numbers - see the comment above on pushing this product.
    - number of customers spending more than $100,000 in ARR on Zoom Phone by 241% year over year.
    - 2 MM Zoom Phone seats, eight months after reaching first million.
    - Eight Zoom Phone customers with more than 10,000 seats in the first half of FY '22, to a total of 26.
    - largest Zoom Phone deal to date twice in the same day.

Cautionary comment (I): customers return to more thoughtful, measured buying patterns. While revenue, profitability, and cash flow were strong in the second quarter and the first half, other metrics have begun to normalize, especially when compared to the unprecedented year-over-year comps.

3. total revenue grew 54% year over year to $1.02 billion,
4. Strength in direct and channel businesses, which grew at twice the rate of online business.
5. Zoom Phone, Zoom Rooms, and Asia PAC growth also accelerated in the quarter
6. healthy mix between new (74%) and existing customers (26%) of incremental revenue.
7. Approximately 504,900 customers >10 employees, up 36% year over year and representing 64% of revenue.
8. Net dollar expansion rate for above group exceeded 130% for the 13th consecutive quarter as existing customers increased their spend
9. customers < 10 employees down to 36% of revenue (from 38% highest)

Cautionary comments (II): Small and medium sized businesses and consumers < 10 employees are expected to continue to decline as a percentage of revenue.

10. Regional news: Americas revenue grew 50% year over year. Combined APAC and EMEA revenue grew 62% year over year to be approximately 33% of revenue, up from 31% a year ago. significant investments in Asia Pacific, our direct sales team drove several strong wins in the enterprise segment (See NEC).'

Cautionary comment (III)
: headwinds in EMEA (Europe, ME and Africa) declines in the online segment.

On Their Spend :

1. Research and development expense grew by 89% year over year – needed for innovation. At present 5% of rev target is 8% (See below section)
2. Sales and marketing expense grew by 72% year over year to $211 million - plan to increase investment in global sales capacity, as well as digital marketing and events,
3. G&A expense in the quarter grew by 73% to scale and invest in systems, automation, and compliance to meet our new scale.
4. Remaining performance obligation (RPO) totaled approximately $2.3 billion, (up 66%) of which 69% will be collected over 12 months. Q1 represents largest renewal quarter.

Cautionary comments(IV): Zoom expects that front-weighted seasonality will persist and potentially become even more pronounced given the scale of user base. They expect total deferred revenue and RPO to be modestly down from Q2 to Q3. RPO serves as a proxy for future revenue, the RPO growth rate provides a leading indicator of growth but Zoom indicates that may not be the best measure to gauge one aspect of their growth.

My take

The market has reacted appropriately to the cautionary comments provided with gap down in the price of ZM stock after earnings. However, I believe this setback is transient and the business will get over the headwinds and declines noted. Based on the goal identified by CEO, they are going to target enterprises hence, they may not be planning to target the small <10 employees companies anyways. RPO is expected to be down from Q2 to Q3, due to seasonality..look at this as not QoQ but a Year over years comparison. 

Q and A highlights

"headwinds in the online segment (zoom meetings) of our business but continued strength in the upmarket enterprise in both Meetings and Phone."

General: The tone and sentiment of the earnings call was mixed which was aptly correspond with the drop in share price after the earnings conference. That being said lets dig in, I personally do not want to focus exclusively on online segment to decide Zoom's worth. The reduction in usage here, is expected, people are not "zooming" as much since they are going out and doing things in person. Also, individual users, smaller users are sort of the 'side shuffle'. This reduction in online segment is also what management thinks is the headwind for the Europe, middle east and Africa. 

The CEO has made it clear that zoom is targeting the enterprise segment which is doing very well. Areas of growth are Zoom phone (presently adding about 500K seats every Quarter), Zoom corporate licenses and Zoom Rooms all which are showing good numbers in growth. 

Zoom online had a different motivation when people jumped in on it, it was "desperation", but now with vaccine and better understanding of the situation, people can be deliberate in their purchases. The latter is whats happening to Zoom Phone, the fact that it is showing improvement, is telling  me, that the decision to increase corporate licenses and buying more seats on phone are deliberate decisions and not desperate actions. Deliberate actions provide a stable revenue, as opposed to volatility of desperate actions.

On Five9 acquisition: Current users (including enterprise customers) per zoom want to migrate from on-premise to the cloud. Having an integrated phone and contact center solution (Zoom + Five9) would be attractive to companies. This would be new revenue stream and grow Zoom business. Based on this assessment, CEO believes it is appropriate to double down on the cloud as the contact center of those.

On monetization of free users: Schools through K-12 will not be monetized. Kudos on firm moral compass and karmic gains on goodwill. Also, this is a long term investment, kids who use and are familiar with zoom tech are going to be adults who will use zoom tech. bravo! I also like the fact, they the leadership is acutely aware of where and when to monetize, for example, they felt that further monetization of online users (mom and pop store, smaller companies individual users) may not be the sustainable strategy. Hybrid adoption in EMEA is lagging APAC which is lagging US (my impression) when these pick up, these will be stimulants for higher growth.

On vision to sustain growth:
"Yesterday":    Zoom videoconferencing
"Today":         Zoom Videoconferencing PLUS Zoom Phone
"Tomorrow":     Zoom Videoconferencing PLUS Zoom phone PLUS Zoom platform/Full suite

On predicting user trajectory: One analyst asked when the zoom online (smaller users) will trough out and growth of enterprise segment will dictate the discussion. This was an unfair question since boom in online users was pandemic driven, and attempting to answer this question is akin to predicting future course of pandemic.

On relationship of zoom phone and zoom meeting numbers: Analyst at Piper-Sandler asked a good question IMO. They wanted to know if zoom phone is leading to a greater number of seats at existing customer. The CEO's answer was not as clear on this one. It may seem that one year ago, Zoom did not expect it would up sell phones to existing base in amount that it did. They were anticipating new customers to bundle video and voice through phone. But it seems that more customers are going to deploy video first and then deploy Phone.

On competition from other services: Future work will be hybrid work and mainstream. Embracing hybrid work by employees, students, WFH, will require a solution. Per Zoom, a 'good enough' solution will not do well (which Zoom claims are other services). Zoom claims it is best-of-breed with better IT support and productivity tools  (which others do not have same level of). 

On expenses: Zoom was not able to hire and invest in proportion to revenue growth. They are under-invested in our R&D (5%), with goal of 8%. Continue to spend on marketing.  G&A is in range of where it needs to be. Cost of good sold (COGS) will reduce as services move from public cloud to Zoom data centers. As K-12 schools go back to campuses, expect to see  improvement in our gross margins.

On Zoom events: This was a redesign of OnZoom to meet the demand of enterprises for corporate events. Consumers (like online fitness or cooking class) are expected to catch on.

Approximately a 1/3 of the analysts were focused on the online meetings, and small users segment which may have given an overall disappointing tone to the discussion. There are however quite promising pieces of information which are reassuring.

Verdict: I will hold on to my Zoom shares, as of time of this note they were down ~18%, if they drop more, I will add to lower the cost basis and to keep the draw down around 20%.