Video conferencing platform Zoom (NASDAQ:ZM) reported results in line with analyst expectations in Q3 FY2023 quarter, with revenue up 4.86% year on year to $1.1 billion. However, guidance for the next quarter was less impressive, coming in at $1.1 billion at the midpoint, being 2.16% below analyst estimates. Zoom Video made a GAAP profit of $48.3 million, down on its profit of $340.3 million, in the same quarter last year.
Zoom Video (ZM) Q3 FY2023 Highlights:
- Revenue: $1.1 billion vs analyst estimates of $1.1 billion (in line)
- EPS (non-GAAP): $1.07 vs analyst estimates of $0.84 (27.2% beat)
- Revenue guidance for Q4 2023 is $1.1 billion at the midpoint, below analyst estimates of $1.12 billion
- Free cash flow of $272.6 million, up 22.7% from previous quarter
- Net Revenue Retention Rate: 117%, down from 120% previous quarter
- Customers: 3,286 customers paying more than $100,000 annually
- Gross Margin (GAAP): 75.4%, up from 74.2% same quarter last year
Started by Eric Yuan who once ran engineering for Cisco’s video conferencing business, Zoom (NASDAQ:ZM) offers an easy to use, cloud-based platform for video conferencing, audio conferencing and screen sharing.
The company became a household name during the Covid pandemic and today it's used not only for business meetings but also by teachers to conduct classes, by developers to write code together, and by lawyers in court.
Zoom didn’t invent video conferencing, it just made it a lot less painful. The platform works reasonably well even on a spotty internet connection, is easy to use, cheap and works across mobile and desktop. The company is notoriously customer obsessed and Yuan, the CEO, has been known to personally write to disgruntled users for feedback.
Work is becoming more distributed, both across geographies and devices. In order for businesses to keep functioning efficiently, they need to be able to communicate as well as they did when the teams were co-located, which drives the demand for integrated communication platforms.
And that is important because there is a lot of competition in the video conferencing space from products like Google Meet, Microsoft (NASDAQ:MSFT) Teams, Cisco (NASDAQ:CSCO) Webex or upcoming startups like Around.co.
As you can see below, Zoom Video's revenue growth has been impressive over the last two years, growing from quarterly revenue of $777.1 million in Q3 FY2021, to $1.1 billion.
Zoom Video's quarterly revenue was only up 4.86% year on year, which might disappoint some shareholders. But the growth did slow down compared to last quarter, as the revenue increased by just $2.44 million in Q3, compared to $25.6 million in Q2 2023. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.
Guidance for the next quarter indicates Zoom Video is expecting revenue to grow 2.67% year on year to $1.1 billion, slowing down from the 21.4% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 6.82% over the next twelve months.
Large Customers Growth
You can see below that at the end of the quarter Zoom Video reported 3,286 enterprise customers paying more than $100,000 annually, an increase of 170 on last quarter. That is a bit less contract wins than last quarter and also quite a bit below what we have typically seen over the past couple of quarters, suggesting that the sales momentum with large customers is slowing down.
One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.
Zoom Video's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 117% in Q3. That means even if they didn't win any new customers, Zoom Video would have grown its revenue 17% year on year. Despite it going down over the last year this is still a good retention rate and a proof that Zoom Video's customers are satisfied with their software and are getting more value from it over time. That is good to see.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Zoom Video's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 75.4% in Q3.
That means that for every $1 in revenue the company had $0.75 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a good gross margin that allows companies like Zoom Video to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity. It is good to see that the gross margin is staying stable which indicates that Zoom Video is doing a good job controlling costs and is not under pressure from competition to lower prices.
Cash Is King
If you have followed StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Zoom Video's free cash flow came in at $272.6 million in Q3, down 27.2% year on year.
Zoom Video has generated $1.18 billion in free cash flow over the last twelve months, an impressive 27.2% of revenues. This robust FCF margin is a result of Zoom Video asset lite business model, scale advantages, and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.
Key Takeaways from Zoom Video's Q3 Results
With a market capitalization of $24.2 billion, more than $5.16 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
We struggled to find many strong positives in these results. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations and revenue growth was quite weak. Overall, this quarter's results could have been better. The company is up 1.42% on the results and currently trades at $81.4 per share.
Is Now The Time?
Zoom Video may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although we have other favorites, we understand the arguments that Zoom Video is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last two years. And on top of that, its bountiful generation of free cash flow empowers it to invest in growth initiatives.
The market is certainly expecting long term growth from Zoom Video given its price to sales ratio based on the next twelve months is 5.2x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Zoom Video doesn't trade at a completely unreasonable price point.
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