Zoom rockets on in Q2 surge - where will it land?

Revenue up a remarkable 355% year-on-year. Zoom's stellar Q2 numbers attest that the boom in corporate video conferencing prompted by COVID-19 lockdowns continues to surge. So much so that the company lifted its projection for FY21 revenues a further 30%, on top of almost doubling the guidance last quarter, to around $2.38 billion.

Growth is so fast that spending can't keep pace. The company added $400k to its cash pile during the quarter as margins soared. In prepared remarks on the company's earnings call with Wall St analysts, Kelly Steckelberg, CFO, commented:

The significant margin expansion year-over-year is due to the steep increase in revenue in Q2, which outpaced the rate of investment, even as we added over 500 employees in Q2.

CEO Eric Yuan called out new contracts with oil giant ExxonMobil and gaming company Activision Blizzard for special mention, along with the rollout of Zoom Phone at longstanding customer ServiceNow. Zoom ended the quarter with 988 customers who spent more than six figures in the past 12 months, and added more than 100,000 customers with more than 10 employees. But the biggest surge came from smaller businesses, a segment that accounted for more than a third of revenues in the quarter (36%) compared to 30% in Q1 and 20% pre-COVID. This cohort pays monthly and is more volatile, so introduces some uncertainty into forecasting. Steckelberg elaborates:

While better-than-expected churn was one of the drivers to our Q2 outperformance, we did experience a significantly higher level of overall churn in Q2 as compared to historical rates. As customers with 10 or fewer employees have increased to 36% of our revenue, we are assuming a higher rate of churn due to this mix shift.

A quick summary of the topline numbers for both financials and customers:

• Total Q2 revenue was $663.5 million, up 355% on the same quarter a year ago and more than double the revenue in Q1 this year.
• GAAP net income was $185.7 million, or $0.63 per share, compared to $0.2 million, or $0.00 per share a year ago. The non-GAAP equivalent was $274.8 million, or $0.92 per share, up from $24.0 million and $0.08 per share a year ago.
• Cash holdings at the end of the quarter totaled $1.5 billion.
• Fiscal 2021 guidance sees total revenue reaching in the range of $2.38 billion, equivalent to around 282% growth for the year. This guidance is 32% higher than the $1.8 billion projected 3 months ago, and 2.6x the guidance given in March, pre-COVID.
• Zoom now has 988 customers who spent more than $100,000 on its services in the past 12 months, an increase of 219 over the prior quarter and more than double the same quarter a year ago (up 112%).
• It now has 370,200 customers with more than 10 employees, an increase of 105,000 over the prior quarter and 458% more than a year ago.
• New customers accounted for 81% of revenue growth during the quarter, with the remainder coming from subscriptions added by existing customers.

The quarter was light on product announcements, with a focus on hardware products, including the launch of a range of subscription options for phone and meeting room hardware, and new partnerships to deliver a range of devices suitable for remote work. Zoom Phone expanded its geographic reach and was authorized for FedRAMP. In part the lack of product news was due to Zoom's self-imposed 90-day focus on tackling security and privacy issues that had surfaced in the prior quarter. On that note, the company appointed a new CISO, Jason Lee, former SVP of Security Operations at Salesforce.

My take

While Q1 saw the impact of businesses switching to video conferencing as an emergency response to sudden lockdown, Q2 brings evidence that the trend is establishing itself as something more permanent. It seems lockdown's new ways of working are here to stay. But within the overall figures, there are some hints that Zoom's surge is starting to level off. Looking at customers with 10 or fewer employees, the share of revenue increased 1.5x in Q1, slowing to a 1.2x increase in Q2. The number of customers with 10+ employees saw a much bigger drop-off in the trend, rising 2.2x in Q1, but only 0.4x in Q2, although their tendency to spend more remained on track. The one segment that saw Q2 perform more strongly was in customers spending more than $100,000, but that's in part because this is a trailing indicator based on a whole 12-month period. However that's a good sign for Zoom's enterprise ambitions.

Nevertheless, leveling off at over $2 billion in a year that you started out expecting to finish below $1 billion is still a pretty spectacular performance — and the guidance includes a fair bit of caution, so expect the actuals to do a bit better unless the economy tanks or Zoom itself has a major mishap. The immediate challenge for Zoom is to recruit sales and customer success people fast enough to expand its footprint in those new customers and achieve upsells of Zoom Phone and other extras to its larger prospects. That 81% of revenue growth attributable to new customers has got to be a high water mark, and the sooner the company can start to build expansion in existing customers, the better.

The bigger challenge is to hold its own in an increasingly competitive market where no one is standing still. There have been significant announcements from powerful competitors, such as the innovative AI-powered Together mode in Microsoft Teams, or last week's acquisition of AI-enhanced noise reduction technology by Cisco Webex. While Zoom still has the edge in terms of ease-of-use and integration to other platforms, it needs to produce some magic of its own at its upcoming Zoomtopia virtual conference in October to show that its innovation can keep pace. CEO Eric Yuan hinted at some possible directions in his answers to analysts on last night's call, mentioning AI and augmented reality as part of the toolset to enable the virtual workplace of the future. Zoomtopia will also give the vendor a chance to show off how its platform performs in a virtual event setting.

For now, the market is growing fast enough to make room for all players to expand their presence. But Zoom still has a lot to do to build on its remarkable achievements of the past few months.