Zoom Q1 sees rocketing revenue as adoption soars, but what now?

Video conferencing platform Zoom reported a blockbuster Q1 this week as it revealed the financial impact of the COVID-19 lockdown on its business. Zoom has become a byword for video chat among people isolated by stay-at-home orders, sparking a surge in adoption. Revenue for the quarter was $382 million, up 169% on the same quarter a year ago, while customer growth almost tripled. Zoom expects the good times to continue through the year, almost doubling its revenue guidance this fiscal year from $910 million to $1.79 billion.

CEO Eric Yuan was also contrite for the company's errors when various security flaws came to light as Zoom use rocketed among individual consumers. "As a CEO, I think I should have done a better job," he admitted. "We should have played a role of IT for those first time users." But Zoom is attracting new criticism for Yuan's revelation on the call that users will have to pay for the end-to-end encryption (E2E) feature currently under development after its recent acquisition of Keybase. His framing that this would not be available to free users because "we also want to work together with FBI and local law enforcement, in case some people use Zoom for bad purpose" was not well chosen in the current civil climate.

The company also revealed that the much-vaunted figure of 300 million daily participants (not daily users, as originally reported) that it reached in April was a high-water mark, with a slightly lower average recorded in May (though still massively up on the figure of 10 million in December). Meanwhile, although the quarter was profitable on both a GAAP and non-GAAP basis, the surge in usage led to a significant spike in infrastructure costs, pushing gross margin below 70% compared to 81% a year ago and 84% in the prior quarter.

Zoom Q1 revenue and customer growth

Does all this mean Zoom's sudden rise has peaked? More thoughts on that below. First, a summary of the numbers:

• Total Q1 revenue was $328.2 million, up 169% on the same quarter a year ago.
• GAAP net income was $27.0 million, or $0.09 per share, compared to $0.2 million, or $0.00 per share a year ago. The non-GAAP equivalent was $58.3 million, or $0.20 per share, up from $8.9 million and $0.03 per share a year ago.
• Cash holdings at the end of the quarter totaled $1.1 billion.
• Q2 guidance sees revenue just shy of $500.0 million, with non-GAAP income from operations expected to be around $132 million.
• Fiscal 2021 guidance sees total revenue just shy of $1.800 billion, equivalent to around 187% growth for the year, and almost double the guidance given in the earnings call just three months earlier.

Reflecting Zoom's continued focus on the business market, the company quoted customer numbers for organizations with more than 10 employees, and those spending over $100,000 a year:

• 500 customers were signed in Q1 on contracts for more than $100,000 in annual recurring revenue.
• Zoom now has 769 customers who spent more than $100,000 on its services in the past 12 months, an increase of 128 over the prior quarter and 10 times more than in the same quarter a year ago.
• It now has 265,400 customers with more than 10 employees, an increase of 183,000 over the prior quarter and 206,000 more (up 354%) from a year ago. Continuing behavior that's been consistent over the past two years, this cohort increased their spend more than 130% on average over the year.
• New customers accounted for 71% of revenue growth during the quarter, with the remainder coming from subscriptions added by existing customers.

Examples of new customers included a banking firm that deployed around 175,000 new Zoom seats in the quarter, global law firm Baker McKenzie, and Arm Technology, which deployed 9,000 Zoom Phones, the cloud-based voice service Zoom is keen to push to its enterprise customers, alongside 8,000 Zoom Meeting licenses and 800 Zoom Rooms.

Nevertheless, the biggest growth was among individuals and smaller organizations with fewer than 10 employees, which accounted for 30% of revenue during the quarter, compared to a 20% share in the previous quarter. This also changed the billing mix, as these customers typically pay monthly rather than signing up for annual contracts.

Cautious guidance as crisis recedes

Although larger customers continued to sign longer-lasting contracts, that shift in balance towards shorter terms leaves Zoom cautious in its guidance for the rest of the year. CFO Kelly Steckelberg said it's not expecting either of the remaining quarters to exceed Q2 in revenue:

As governments start to ease shelter-in-place restrictions, we may see a moderation of demand for our services. Given our assumptions on higher churn rate as well as economic uncertainty, we are projecting Q3 and Q4 revenue to be relatively consistent with Q2.

Meanwhile, infrastructure costs are expected to subside as Zoom moves more volume back into its own datacenters and out of Amazon Web Services (AWS) and Oracle Cloud Infrastructure (OCI). Zoom had scrambled to scale its server capacity as consumption surged twentyfold from an annualized rate of 100 billion meeting minutes at the end of January 2020 to over 2 trillion in April. It turned to AWS to provision extra servers, "sometimes adding several thousands a day for several days in a row," says Yuan, and also "provisioned a number of servers in the Oracle Cloud". As Oracle had previously revealed, this was the equivalent of more than seven petabytes of capacity going through OCI. But Yuan said he doesn't regret that extra expense:

During this pandemic crisis, our top priority is to show our corporate social responsibility. Essentially, we do all we can to have people stay connected.

Despite its experience of the past few months, Zoom is sticking to its focus on larger enterprise customers as its major growth opportunity. Yuan reiterated his belief in extending into cloud-based PBX with the Zoom Phone service as a significant opportunity, building on the success of the video conferencing service. He cited a large global pharmaceutical company, already a heavy user of Zoom video conferencing, which deployed Zoom Phone to around 18,000 seats in Q1, the company's largest phone deal to date.

Zoom's strategy, he emphasized, is to be the go-to provider of video and voice for business customers. The company is happy to leave other aspects of digital teamwork — such as messaging and content sharing — to other best-of-breed partners that it integrates with, such as Slack, Microsoft Teams, Box and Dropbox. It's betting on a best-of-breed strategy, he says:

I truly believe the best-of-breed service provider will survive and thrive, because customers — when it comes to video and voice, you've got to make it work anytime, everywhere, any device. It's not that easy.

My take

Zoom has paid a high price for becoming a verb. There's been the reputational cost as a vast army of new users encountered the consequences of lax security. The damage to Zoom's brand won't have been helped by Yuan's throwaway comment yesterday about wanting security services to be able to view private conversations on free accounts. Then there's been the heavy expense of ramping up infrastructure to ensure Zoom remained available as adoption soared, though at least that has delivered a positive brand experience with an even wider reach than the security gaffes.

But Zoom probably isn't going to worry about the dip in usage going into May, which may in part reflect the reputational hit but more likely is the result of competitive action by Microsoft, Google, Facebook and others. I suspect Zoom is somewhat grateful to see those other vendors wade in and scoop up some of the volume demand for social videoconferencing and thereby relieve the load on its servers. The consumer market is not where its destiny lies.

The important question for Zoom is to what extent it can sustain and grow its presence in enterprise accounts, which is where there's even more money to be made. To have gone from fewer than a hundred $100k+ accounts in April last year to nearly 800 this year is a remarkable achievement in itself, but what will be even more interesting will be to see how that number grows in subsequent quarters as revenue builds from its most recent signings.

The best-of-breed strategy is a crucial element in supporting that growth. I've already noted elsewhere that there's a lot more to remote working than video chats alone. Zoom's tight integration with other best-of-breed vendors in the digital teamwork space gives it a significant competitive advantage as enterprises begin to grasp the importance of tying online meeting platforms into those other services. If Yuan is able to also make progress with Zoom's IP-based telephony ambitions on the back of its success in video, it has a lot of headroom to continue its growth. But while the most recent quarter has boosted Zoom's trajectory, there's still a long and uncertain road ahead. It must now hold onto its gains, hold its nerve, and continue to build its enterprise presence.