Earnings Call
Zoom Communications, Inc. (ZM)
Earnings Call Transcript - ZM Q3 2022
Operator, Operator
Hello everyone, and welcome to Zoom's third quarter fiscal year twenty twenty two earnings release. I'd like to remind everyone this call is being recorded. At this time, I'd like to turn it over to Tom McCallum, Head of Investor Relations.
Tom McCallum, Head of Investor Relations
Thank you, Matt. And let me welcome everyone as well to Zoom's earnings video webinar for the third quarter of fiscal twenty twenty two. I’m joined today by Zoom’s Founder and CEO, Eric Yuan, and Zoom’s CFO, Kelly Steckelberg. Our earnings press release was issued today after the market closed and may be downloaded from the Investor Relations page at investors.zoom.com. Also on this page, you'll be able to find a copy of today's prepared remarks and a slide deck with financial highlights that, along with our earnings release, includes a reconciliation of GAAP to non-GAAP financial results. During this call, we will make forward-looking statements, including statements regarding our financial outlook for the fourth quarter and full fiscal year twenty twenty two; Zoom’s expectations regarding financial and business trends; Zoom’s growth strategy and business aspirations to help customers embrace change, enable hybrid workforces, and grow their businesses; product features and the expected benefits of such features; and Zoom continuing to fortify its position as a leading brand in its industry. These statements are only predictions based on what we believe today, and actual results may differ materially. These forward-looking statements are subject to risks and other factors that could affect our performance and financial results, which we discuss in detail in our filings with the SEC, including our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. Zoom assumes no obligation to update any forward-looking statements we may make on today’s webinar. And with that, let me turn the discussion over to Eric.
Eric Yuan, CEO
Thank you, Tom. In the spirit of the upcoming holiday season, I want to recognize the hard work of Zoom’s global workforce and thank our customers, partners, and investors for their steadfast trust and support. We continue to fortify our position as a leading brand in our industry. We are honored that Gartner named us a Leader in the twenty twenty one Magic Quadrant for Meeting Solutions for the sixth consecutive year and for Unified Communications as a Service for the second consecutive year. Zoomtopia twenty twenty one was bigger and more successful than ever before. We hosted nearly thirty four thousand live virtual attendees on our platform and two hundred seventy seven speakers, including customers like Choice Hotels, Ally, and Hubspot. And we did it on Zoom Events, our all-in-one solution for virtual and hybrid events. Zoom Events allowed us to streamline event preparation, enhance audience engagement, and conduct better post-event communication and analysis. Its multitrack functionality enabled us to roll our Analyst Day directly into the Zoomtopia agenda so that participants could move seamlessly across the Analyst Day track, other tracks of Zoomtopia, and the all-connecting lobby. At Zoomtopia, customers shared how they use Zoom to enable flexible co-located workforces and grow their businesses. We demonstrated how Zoom Apps, which already has sixty seven apps after only a few months, has the potential to enhance meeting productivity and collaboration. More and more businesses are building products on our platform that connect interrelated work streams to the Zoom client, both inside and outside of the meeting. We were also super excited to unveil the Zoom Video Engagement Center, which enhances our customers’ ability to communicate with their customers through our omnichannel solution and shows our broader commitment to the contact center space. It is expected to be generally available early next year. Whether it’s the ability to virtually whiteboard in and around the meeting, or utilize AI to transcribe or translate a meeting live, Zoomtopia demonstrated that previously futuristic capabilities have arrived. We are working hard to develop and deploy the technologies of the future to address current business needs and reimagine how we communicate and work in a flexible hybrid world. Now let me recognize a few big wins for the quarter. We are excited to have Carrier Global Corp, the leading global provider of healthy, safe, sustainable, and intelligent building and cold chain solutions, as a long-standing Zoom Meetings customer and now a new Zoom Phone customer as well. Following several months of extensive vendor reviews of leading UCaaS vendors, Carrier selected Zoom Phone to modernize their phone systems for a large portion of their nearly fifty three thousand employees across one hundred eighty countries. We are so thankful that Carrier chose Zoom to deliver an increasingly comprehensive, secure, innovative, and integrated set of communications services. In addition to Carrier, we had many other upsells this quarter. For example, one of the world’s largest global retailers decided to add twenty thousand Zoom Phone licenses to their existing Meetings, Rooms, and Webinar footprint in order to better manage their global offices, distribution centers, and retail locations. This demonstrates our strong value add to the retail vertical and builds upon previous success stories like Tapestry and Target. We also had several notable Zoom Meetings wins in Q3, including a large expansion for a leading Federal System Integrator which puts them at forty five thousand users, demonstrating the security and reliability of our Zoom For Government Platform. A competitive win with a global technology firm for sixteen thousand five hundred meeting licenses to modernize the way their employees communicate, and expansion within our big four audit and big three consulting clients, which added more than thirty five thousand meetings licenses in the quarter to their existing strong meetings footprints. Thanks to our customers, investors, and the hard work of our approximately six thousand three hundred employees, we’ve grown over the past decade from a video conferencing solution to a communications platform that encompasses unified communications, as well as developer and event solutions. All these services provide an indispensable platform for individuals, enterprises, and developers to connect, collaborate, and build in the hybrid world. And with that, let me pass it over to Kelly.
Kelly Steckelberg, CFO
Thank you, Eric, and hello, everyone. Let me start by reviewing our financial results for Q3 and then discuss our outlook for Q4. In Q3, total revenue grew thirty five percent year over year to one point zero five billion dollars, exceeding the high end of our guidance of one point zero two billion dollars. The growth was primarily driven by strength in our direct and channel businesses, which grew at twice the rate of our online business, as well as improved churn in both online and direct segments. From a product perspective, we saw strong demand for Zoom Video Webinars, Zoom Rooms, and Zoom Phone. Zoom Phone had year-over-year revenue growth in the triple digits and reached thirty customers with over ten thousand paid seats. The year-over-year growth in revenue for the quarter was driven by a healthy mix between new and existing customers, with existing customers accounting for twenty six percent of the incremental revenue, up from nineteen percent a year ago. Let’s take a look at the key customer metrics for the quarter. We saw ninety four percent year-over-year growth in the up-market as we ended the quarter with two thousand five hundred and seven customers generating more than one hundred thousand dollars in trailing twelve months revenue. These customers represented twenty two percent of revenue, up from eighteen percent in Q3 of last year. We exited the quarter with approximately five hundred twelve thousand one hundred customers with more than ten employees, up eighteen percent year over year. In Q3, customers with more than ten employees represented sixty six percent of revenue, up from sixty four percent last quarter, and sixty two percent in Q3 of last year. These trends suggest that our customers with more than ten employees are expanding their use of our platform and adding more products and seats, aligned with our go-to-market strategy. Our net dollar expansion rate for customers with more than ten employees exceeded one hundred thirty percent for the fourteenth consecutive quarter as existing customers increased their spend with Zoom and we saw strong upsells of Zoom Phone and Zoom Rooms. For Q4, we expect this metric to be modestly below the one hundred thirty percent mark as the denominator of this trailing twelve-month metric reflects a significant growth in our customer base. Both domestic and international markets had strong growth during the quarter. Our Americas revenue grew thirty percent year over year. Our combined APAC and EMEA revenue grew forty seven percent year over year to be approximately thirty three percent of revenue, up from thirty one percent a year ago. On a quarter-over-quarter basis, Asia Pacific had another strong quarter driven by growth in Australia and Japan and bolstered by the investments we have made in our international team. However, as we discussed in Q2, we saw headwinds to our online business in EMEA, mainly related to summer seasonality. Now, turning to profitability which was strong from both GAAP and non-GAAP perspectives. I will focus on our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, charitable donations of common stock, acquisition-related expenses, net litigation settlements, net gains on strategic investments, and undistributed earnings attributable to participating securities. Non-GAAP gross margin in Q3 was seventy six percent, an improvement from sixty eight point two percent in Q3 of last year and stable with Q2 of this year. We remain committed to our multi-year strategy of building out our data centers to support further improvements in gross margin. Research and development expense grew by one hundred sixty nine percent year over year to approximately sixty eight million dollars. On a sequential basis, we added over thirteen million dollars in R&D expense, primarily due to expansion within our engineering and product teams globally. As a percentage of total revenue, R&D expense doubled year over year to six point four percent demonstrating our commitment to innovation and product development. Sales and marketing expense grew by sixty eight percent year over year to two hundred thirty seven million dollars or approximately twenty two point six percent of total revenue, primarily driven by increased marketing programs and sales headcount to drive future growth. We remain committed to investing in global sales capacity and marketing across our core and new products. G&A expense grew by twelve percent to eighty two million dollars or approximately seven point eight percent of total revenue. This was lower than Q3 of last year as we expanded our G&A functions prudently to meet our new sales. The revenue upside in the quarter carried through to the bottom line, with non-GAAP operating income of four hundred eleven million dollars exceeding the high end of our guidance of three hundred forty five million dollars. This translates to a thirty nine point one non-GAAP operating margin for Q3 compared with thirty seven point four percent a year ago and forty one point six percent last quarter. Non-GAAP diluted earnings per share in Q3 was one point one one dollars on approximately three hundred six million non-GAAP weighted average shares outstanding. This result is zero point zero three dollars above the high end of our guidance and zero point one two dollars above Q3 of last year. This result includes a seventy million dollars provision for income tax, a significant increase from last year, mainly due to fully utilizing our NOLs as well as a decrease in our stock-based compensation for tax purposes. Turning to the balance sheet, deferred revenue at the end of the period was one point two billion dollars, up thirty nine percent year over year from eight fifty five million dollars, and slightly up quarter over quarter. Looking at Q4, we expect the year-over-year growth rate in deferred revenue to be in the mid-twenties. This is driven by the cyclical decline in the average remaining term of our annual customer contracts, which are front-half weighted. Looking at both our billed and unbilled contracts, our RPO totaled approximately two point five billion dollars, up fifty one percent year over year from one point six billion dollars. We expect to recognize approximately sixty seven percent of the total RPO as revenue over the next twelve months, as compared to seventy two percent in Q3 of last year, reflecting a shift back towards longer-term plans. We ended the quarter with approximately five point four billion dollars in cash, cash equivalents, and marketable securities, excluding restricted cash. We had operating cash flow in the quarter of three hundred ninety five million dollars, as compared to four hundred eleven million dollars in Q3 of last year. Free cash flow was three hundred seventy five million dollars, as compared to three hundred eighty eight million dollars in Q3 of last year. It’s important to note that as we progress beyond the initial phases of the pandemic growth and continue to invest to support our new scale, our working capital is normalizing. In Q4, we expect to incur a one-time eighty five million dollar cash outflow related to a legal settlement, which we disclosed and booked as a GAAP expense in Q1. As a reminder, due to the seasonality of renewals being front-end loaded and tapering through the year, our collections will follow the same trend. We also expand CapEx investments in building out our data centers to support future gross margin expansion. Now, turning to guidance. We are pleased to raise our outlook for FY twenty twenty two. This outlook is based on our current assessment of the business environment. Specifically, it assumes that our direct and channel business will continue to grow, while our online business will be a headwind in the coming quarters as smaller customers and consumers adapt to the evolving environment. For the fourth quarter of FY twenty twenty two, we expect revenue to be in the range of one point zero five one billion dollars to one point zero five three billion dollars. We expect non-GAAP operating income to be in the range of three hundred sixty one million dollars to three hundred sixty three million dollars. Our outlook for non-GAAP earnings per share is one point zero six dollars to one point zero seven dollars based on approximately three hundred seven million shares outstanding and a tax rate of approximately ten percent. Due to our multi-year history of profitability, we have fully utilized our NOLs. We expect our tax rate to approximate the U.S. blended tax rate in FY twenty twenty three. For the full year of FY twenty twenty two, we expect revenue to be in the range of four point zero seven nine to four point zero eight one billion dollars, which would represent approximately fifty four percent year-over-year growth, up from our previous guidance of fifty one percent issued in August. We expect non-GAAP operating income to be in the range of approximately one point five nine eight dollars to one point six billion dollars, which would represent approximately sixty three percent year-over-year growth. Our outlook for non-GAAP earnings per share is four point eight four dollars to four point eight five dollars based on approximately three hundred six million shares outstanding. As always, Zoom is grateful to be a driving force enabling connection and collaboration worldwide with our high-quality, frictionless, and secure communications platform. Thank you to the entire Zoom team, our customers, our community, and our investors.
Operator, Operator
Our first question is from Sterling Auty with JP Morgan.
Sterling Auty, Analyst
Yeah, thanks. Hi guys. Eric, you mentioned you kind of evolving into a communications company. And I'm wondering if you think about the over four hundred million business phone users that are on legacy technology. How do you anticipate capitalizing on that opportunity? Meaning, do you expect a big portion of those will end up coming on to either a video platform like Zoom, Zoom Phone? Or will they start to just rely on their cell phones to make communication calls?
Eric Yuan, CEO
Yeah, Sterling. That's a great question. As you see right in Q3 and a greater customer is like Carrier. And they expanded to deploy Zoom Phone and it’s not a hundred and thousand, tens of thousands deployment, right? So you look at the phone industry, right? I mean the cloud-based PBX industry, I think it's growing very well to replace legacy on-prem systems. Also, you look at those existing cloud-based phone providers, most of them developed a technology stack many years ago. However, will those especially for large enterprise customers, when they migrate from on-prem to cloud, they do not want to deploy another solution because the combination of video and voice into one service is particularly appealing. For customers who already deployed Zoom Video, our Cloud’s PBX system is already in place; we just need to enable and configure that. Otherwise, they are two fabulous solutions. That's why we have high confidence that a lot of enterprise customers, when they look at all those cloud-based phone solutions, Zoom is always the best choice. That's why I think there's a huge growth opportunity for our unified communication platform, combining video and voice together to capture this wave of migration from on-prem to cloud.
Sterling Auty, Analyst
Got it. Thank you.
Operator, Operator
Our next question is from Parker Lane with Stifel.
Parker Lane, Analyst
Thanks for taking my question. I was hoping you could dive into the video engagement center a little bit. The initial reception that customers have had to that solution and who do you ultimately envision the target customer will be here? Is it going to be more of lightweight small business, medium sized business that are looking for contact that you are offering or do you envision taking it stream over time?
Eric Yuan, CEO
Yeah. This is a good question. We are very excited at Zoomtopia to announce our Zoom Video Engagement Center. The reason why we decided to invest resources in that is based on our customers' feedback. In terms of growth trajectory, I would say it’s very similar to what we did for our Zoom Phone, right? We built a greater solution to leverage the same platform, and you can start with existing SME customers. Soon, you can expand it to many enterprise customers following our contact center vision. Essentially, I think this market—the contact center market—is growing very well. However, many enterprise customers still deploy on-premise solutions. For the next several years, I feel the opportunity is huge for us, especially for customers deploying Zoom Video and Phone together as a natural extension of our unified communication platform to help provide a very secure and effective solution in the contact center space.
Parker Lane, Analyst
Got it. Thanks, Eric.
Eric Yuan, CEO
By the way, we do have quite a few great customers in the pipeline.
Operator, Operator
Next question is from Taz Koujalgi with Guggenheim.
Taz Koujalgi, Analyst
Hey, guys. Can you hear me okay?
Eric Yuan, CEO
Yep.
Taz Koujalgi, Analyst
I have a question for Kelly. Kelly can you give us some more color on your mix of different products? We have had strong growth in Zoom Phone, Zoom Rooms for the last couple of quarters. Is the combination of phone plus rooms now more than ten percent or is that still below ten percent of the overall business?
Kelly Steckelberg, CFO
Sorry, it’s a combination of Phone and Rooms.
Taz Koujalgi, Analyst
For the non-meeting business, is that less than ten percent or has it crossed the ten percent threshold?
Kelly Steckelberg, CFO
Well, none of our product segments on their own is greater than ten percent because it's likely that we would break that out if it were. If you add a few of them together, yes, there are a few of them that, if we put them together, would exceed greater than ten percent, but on an individual basis, not any of them is greater than ten percent at this point.
Taz Koujalgi, Analyst
Thanks. Thank you.
Operator, Operator
Next question is from Meta Marshall with Morgan Stanley.
Meta Marshall, Analyst
Great. Thanks. I wanted to ask just about the traction of customer adds. We've seen the customer adds slow down a little bit. Can you clarify how you think about sales and marketing resources, directing them more towards upsells, which is clearly showing a lot of traction versus new customer acquisition? How do you think about that in the budgeting practice? How should we think about that going forward?
Kelly Steckelberg, CFO
Yeah. So it's exactly the strategy that we've been planning for and thinking about, Meta, when you think about Zoom Phone, for example, and Zoom Rooms. The strategy is to sell to the existing install base, which by definition just means these customers are going to grow larger and larger and contribute more over time. Depending on which segment of our business, the upmarket business, the major enterprises work on an account basis, so they get to retain those accounts, which is great because they build these long-term multi-year relationships with them; they understand their needs and continue to grow those accounts as they continue to see what they need. In the lower segment, like the mass market, we do have both expansion and acquisition teams that have worked really well, allowing them to focus on growing certain teams while others focus on adding new logos. From a marketing perspective, we've grown so much in brand awareness, but now, we're really focusing on ensuring that everybody knows that meetings also include phone and rooms and other solutions we can bring to bear.
Meta Marshall, Analyst
Great. Thanks.
Operator, Operator
Next question is from Alex Zukin with Wolfe Research.
Alex Zukin, Analyst
Hey guys. Thanks for taking my question. So two—one question, but it's multi-part, Kelly, and it’s both for you. The question first is after the summer, how should we think about the visibility in the model, particularly around churn with the sub eleven cohort? If we look at the guidance that you gave implicitly for billings, it looks like it's about a six percent year-over-year growth. If I look at the guidance for revenue, it looks like nineteen percent growth; maybe there's some upside for that; maybe it's over twenty. It's your toughest comp. But as investors start to look at next year, the street has you at seventeen percent. So your implicit billings guide suggests potential for single-digit growth. Is next quarter the trough that we start to build off of? I think that's a question. I'm getting at least from lot of investors.
Kelly Steckelberg, CFO
So, in terms of—let’s talk about the churn versus visibility. As we talked about on the Q2 call, historical trends in our business have changed pretty dramatically, but what we saw as we came through kind of the second half of Q3 was that some of the churn we were experiencing earlier in the quarter was really summer seasonality. As we saw people move back to vacations in the back half of September, we saw that strength in usage returning. So these are all learnings that we would use now to apply to our modeling for FY twenty three as well. Also, if you remember, we looked at some of those detailed aging of the ten years of the cohorts at Analyst Day. As those continue to age, they add a lot of stability to the underlying business and by next year, over fifty percent of them are going to have moved beyond that fifteen month mark, which is where churn stabilizes. So that's good news in terms of volatility decreasing over time. In terms of FY twenty three, I know that's the big question on everybody's mind, but you're going to hold any comments in terms of FY twenty guidance until Q4, at which point, of course, we are ready to give Q1 and full twenty three guidance.
Tom McCallum, Head of Investor Relations
Who is next?
Operator, Operator
I'm, sorry. Matt Stotler with William Blair. I was on mute.
Kelly Steckelberg, CFO
Hi Matt.
Matt Stotler, Analyst
Hi, everybody. Good to see you. Thanks for taking the question. Maybe just one on the free user base. I know that you guys have always carried a number for free users and opened that up during the pandemic. You've talked previously about thinking through monetizing the space of users. Anything you can share in terms of, I guess, one hand, an update on the size of that base, potential opportunity, and then updates on how you're thinking about the ability to monetize it over time?
Kelly Steckelberg, CFO
Eric, do you want to talk about monetization of free users over time?
Eric Yuan, CEO
Yes, sure. So Matt, first of all, when we started the free user base, it was always like a marketing platform to promote our brand and give us a network effect of our service platform. That's how we introduced the free service premium and forty-minute limitation. For now, given the brand recognition and considering what happened last year, we think we need to take a step back to look at our free user online business. On the one hand, we'd like to double down on our enterprise market; that business is growing extremely well. On the other hand, we need to be proactive about leveraging our huge free user install base worldwide. We've started the advertisement program for free users in terms of international markets and downloading a work and looking at that as well because we need to fix the conversion rate from free to paid; that's not a traditional model. We need to think creatively about how to monetize that free user base differently. Our team has put a lot of efforts on that, and that's something we are very excited about.
Matt Stotler, Analyst
Thank you.
Eric Yuan, CEO
Thank you, Matt.
Kelly Steckelberg, CFO
Thanks, Matt.
Operator, Operator
Next question is from Siti Panigrahi with Mizuho.
Siti Panigrahi, Analyst
Thanks for taking my question. Just want to ask about your investment on the go-to-market side. As you are coming off of these two strong renewal quarters, what areas are you investing in right now? And as your growth rate normalizes, are there certain verticals? Could you give some kind of color on that?
Kelly Steckelberg, CFO
Yeah. We certainly are continuing to invest in our sales organization, especially outside of the U.S. You’ve seen strong growth in international, and we really have the opportunity to continue to leverage the brand awareness and grow significantly not only in the U.S., but also globally. That's a huge opportunity for us as well as ensuring that we have the right sales team to support Zoom Events, Zoom Phone, and soon our Video Engagement Center as well. So those are all the areas we are thinking about, especially for FY twenty three.
Siti Panigrahi, Analyst
Thank you.
Kelly Steckelberg, CFO
Thank you, Siti.
Operator, Operator
Next we have Ryan McWilliams with Barclays.
Ryan McWilliams, Analyst
Hey, good to see you guys again. Kelly, just on your existing customer growth, anything to call out there maybe into the fourth quarter? I would imagine meetings still makes up the bulk of your growth with existing customers, but anything to call out maybe in the changing mix between meetings versus phone and rooms with these existing customers? Thanks.
Kelly Steckelberg, CFO
I mean, Zoom Phone continues to be a really strong growth driver in general, especially as organizations are thinking about what's going to be their future of work strategy and enabling their employees to work from anywhere over time. Zoom Rooms, of course, are also really important considerations now as companies are thinking about welcoming their employees back to the office. The conference room strategy has become even more important than it was pre-pandemic, as we get unlikely to have everyone sitting around in conference rooms together in the future. So having any sort of hybrid approach means that it’s vital to ensure inclusivity, and the best way to achieve that is through the Zoom Rooms technology, things like Smart Gallery which help our customers solve today's challenges.
Eric Yuan, CEO
So just quickly to add on what Kelly said, Ryan. If we look at hybrid work, the conference room is extremely important. That's why you can see that the Zoom Rooms are uniquely positioned, much better than any other solution to support a hybrid world. Not to mention that Zoom Events also support the new hybrid events service. That’s why we see a huge opportunity to support this paradigm shift in work.
Ryan McWilliams, Analyst
Yes.
Kelly Steckelberg, CFO
Thanks, Ryan.
Operator, Operator
Next question is from Tyler Radke with Citi.
Tyler Radke, Analyst
Hey, everyone. Thanks for taking my question. Kelly, I wanted to ask you about just some of your comments on the churn rates. I guess, first, did they perform in line with your expectations this quarter? Just kind of giving the moving pieces with summer seasonality. Then as you think about Q4, would you expect churn rates to get better because of less summer seasonality in Europe? And then I just wanted to clarify when you talked about the online business being a headwind; does that mean that you expect the online revenue to decline year over year, or does it just mean it's going to grow slower than the rest of the business?
Kelly Steckelberg, CFO
So, in terms of how the online churn performed in Q3, it performed better than our expectations coming in at the beginning of the quarter. We were happy to see that it was more seasonality aligned rather than true potential departures as people were making choices about going back to meeting in person. The seasonality nature of that was good news, and we saw a rebound in usage in mid to late September. We expect Q4 to be relatively consistent with Q3 in terms of churn. However, we do see some impact from the holidays towards the end of December, and those holidays vary globally, but we do see a kind of slowdown based on that. In terms of what we expect from online going forward, we do expect online revenue to grow more slowly than the direct and channel business as we look to the future, which is what we saw in Q3, for example, as well. But we'll give more specifics around that when we provide guidance on the Q4 call.
Tyler Radke, Analyst
Thank you.
Operator, Operator
Next question is from James Fish with Piper Sandler.
James Fish, Analyst
Hey guys. Nice quarter. I just wanted to go back to Matt's question on advertising. First, how would this actually work? Can you give more color there? Would it be kind of a banner within the application pre or post video and be more display-based advertising or performance based? And then also just wanted to understand how much of this is really to prevent some of your more commercial and enterprise customers from lowering their number of meeting seats to free seats, rather than just trying to monetize more on that online consumer base? Thanks.
Eric Yuan, CEO
James. So, for now we're just focused on the pure free meetings, right? Meaning that if we have a meeting with free participants, let's say if you and I joined the meeting because we already paid as enterprise customers, we will not show ads. It is more like a post-meeting page where we can encourage future usage. In the international market, we're starting the advertisement program for free users; that’s purely for free participants and to create awareness. Again, we need to be creative in many areas where we could explore monetization opportunities. We may not have traditional conversion rates, but we need to be creative about how to leverage that free user base differently. This is something we’ve put a lot of effort into, and we're excited about it.
James Fish, Analyst
Thanks, Eric.
Operator, Operator
Next question is from Rishi Jaluria with RBC.
Rishi Jaluria, Analyst
Hey, Eric and Kelly, good to see you both. Thanks for taking my question. I wanted to ask about Zoom Chat. I was really excited to see that launched at Zoomtopia two months ago, really kind of showing this vision of becoming this broader enterprise communication platform. I noticed that Zoom Chat is live; it's something people can deploy. I know it's an add-on feature. Can you give us any sense of color in terms of customers actually using it today, and what that sort of usage within your existing customer base looks like? What are you doing to drive usage of Zoom Chat among your customers to make the whole platform more valuable to them? Thanks.
Eric Yuan, CEO
Yeah, Rishi, that’s a good question. First of all, I can tell you Zoom as a company, we're using our Chat functionality and many employees enjoy it. Overall, this is part of our platform vision because some customers do a good job integrating and promoting that. However, if we look at our chat usage—we haven't published specific numbers yet—it’s pretty healthy for both SMB individual users and enterprise customers. They deploy both video and phone, and Zoom Chat is one platform. In terms of functionalities and scalability, I think we have high confidence. On one hand, we collaborate well with other chat solutions and integrate seamlessly. On the other hand, some customers really want to deploy a single vendor solution for video, voice, and chat. We also continue to innovate, adding more exciting functionalities as we announced at Zoomtopia. Overall, this is something important for our unified communications platform, and we're going to invest more in it.
Rishi Jaluria, Analyst
Alright. Wonderful. Thank you.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Karl Keirstead with UBS.
Karl Keirstead, Analyst
Okay, Great. Maybe Kelly, metrics like deferred revenues and RPO are certainly not the most important to watch with Zoom, but they can be indicative of changes in the business, so it's still important to keep an eye on them. If you could elaborate a little on DR and RPO next quarter, I think on DR you mentioned that it'll grow mid-twenties due to a cyclical decline in average remaining term of annual contracts. I'm not sure I totally understand what that means, so I’d love to ask for clarification. Likely as well on RPO, you mentioned that we would see a shift back to long term plans. I'm wondering if you could elaborate on that as well. Thanks so much.
Kelly Steckelberg, CFO
Yes. So for deferred revenue, there are two things to remember: the seasonal trend of our renewals is that Q1 is the largest quarter for renewals and Q4 is the lowest. In terms of new deferred revenue coming onto the books, Q4 is the lowest quarter because of that. Q1 is the largest quarter when deferred revenue gets out of the balance sheet and the last bit of it is amortized by the time you get to Q4, where most of it has already been recognized. This leads to a cyclical decline in average remaining contract terms. Renewals will look the same as deferred and collection during Q4 as they are all based on that trend. Does that make sense?
Karl Keirstead, Analyst
Yes. And so the fact that DR growth would slow to mid-twenties is due to what?
Kelly Steckelberg, CFO
It’s due to the fact that Q4 is our lowest renewal period as well as all those renewals that came on in Q1 are now almost fully amortized and recognized.
Karl Keirstead, Analyst
Okay? That's helpful. Thank you on DR. And one last question about RPO, Kelly?
Kelly Steckelberg, CFO
This has a strong impact on billings and RPO as well because the same thing happens; anything added to the collection of the remaining term is being amortized throughout the year. So there’s a short amount of the contract left during Q4.
Karl Keirstead, Analyst
Okay. I think I got it. Thanks for the participation. I appreciate it.
Kelly Steckelberg, CFO
You are very welcome.
Operator, Operator
The next question is from Shebly Seyrafi with FBN Securities.
Shebly Seyrafi, Analyst
Yeah. Thank you very much. What is your latest thinking about possibly reviving the Five9 deal? What's your current thinking about the build versus buy decision in the contact center market?
Eric Yuan, CEO
Shebly, that's a good question and unfortunately Rowan is not on the call. That's why, it’s probably both of us to answer this question. Anyway, we look at everything from a customer perspective. Even though this field did not go through forever, we still have many mutual customers and we have a great integration with Five9. From that perspective, everything is the same as before. In terms of the deal, actually nobody knows at this time; let’s see, we do not know. However, as I mentioned earlier, we have a full stack to support unified communication. The important thing is that customers who deployed the Zoom Video already may want to deploy Zoom Phone. That’s the reason we’re doubling down on our Video Engagement Center, and we're also working together with other contact center solutions plus providers like Five9 for better integration; seamless experiences for our mutual customers.
Shebly Seyrafi, Analyst
Okay. Thanks.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Matthew VanVliet with BTIG.
Matthew VanVliet, Analyst
Yeah. Thanks for taking the question. I guess pertaining to the channel and especially with Zoom Phone, are you seeing much traction in terms of potential net new customers coming in where Zoom Phone is sort of the entree into that customer? Or even as a part of the initial deal, especially at the sort of mid-market enterprise level? Thanks.
Eric Yuan, CEO
Yes, go ahead, Kelly.
Kelly Steckelberg, CFO
Yes, we have absolutely seen the channel be a really important part and a substantial growth driver for Zoom Phone, especially. This is why focusing on the channel, both in the U.S. and growing that internationally, is a key aspect of our long-term growth strategy. We do have the ability to see customers that want to start off with Zoom Phone first; that's been a great opportunity for them. It’s a small percentage of our customers starting that way, but it’s a great starting point to get them accustomed to Zoom and then expand over time in terms of our full platform offering.
Matthew VanVliet, Analyst
Thank you.
Operator, Operator
Next question is from Matthew Niknam with Deutsche Bank.
Matthew Niknam, Analyst
Hey, thanks for taking the question. I want to go back to the question before that was asked. Not necessarily related to Five9, but having moved past that acquisition; maybe Eric, how you're thinking about inorganic opportunities on either the UCaaS or the CCaaS front to really consolidate the market and expand your platform inorganically relative to some of the organic investments the company’s talked about? Thanks.
Eric Yuan, CEO
Matt, again, actually, Five9 is still a great partner; Rowan and the team is great. They have a good— they’re friends, right? So we’re still working together and talking with our mutual customers. That’s for sure. Regarding our growth strategy for consolidating UCaaS and CCaaS, first of all, I think we are doing quite well in UCaaS. In terms of CCaaS, the reason we announced the Video Engagement Center is precisely for that. For some customers, they want to consolidate everything together, and we do have an offering. We’re also looking to accelerate growth in addition to allocating our own resources to grow that business organically, for sure, if there's any good, say, technology platform for next-generation functionalities or value-added features. Well, we’re open-minded. Kelly has a budget big enough to support that effort. If you know of any other technology companies that can help us beef up our investment on that front, we’re open-minded.
Matthew Niknam, Analyst
Great. Thank you.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Will Power with Baird.
Will Power, Analyst
Great. Good afternoon. Eric, you referenced a number of new customer wins. You really called out Carrier, I guess, in particular, and you suggested it was an extensive process, so I'd love to better understand the importance of the bundle video and Zoom Phone for Carrier and what your estimation really kind of set you apart from the other vendors they were considering?
Eric Yuan, CEO
That's a good question. First of all, I'd like to take a step back to share how we grow our platforms; it’s not like some other cloud vendors, where we target traditional on-prem solutions. Our Zoom Phone growth comes from not only on-prem, but also from other existing cloud-based phone solutions that they may also see with us. For a lot of enterprise customers, particularly for our existing Zoom Video customers, the phone deployment is very complex. They want a reliable partner with a vision. They need to have the reliability, security, and a vendor that can provide both video and voice under one service. After testing our service, many customers realize Zoom is the only solution that can truly satisfy their needs. The process, however, is pretty long, because enterprise phone deployment is very complex. Even for our existing customers, we need to be careful. However, after going through the RFP process, Zoom is best positioned. We think that's going to be the pattern for growth in the future because we have high confidence; as long as enterprise customers have complex existing on-prem phone systems, they're going to migrate to the Zoom platform.
Will Power, Analyst
Okay. Thank you.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Patrick Walravens with JMP.
Patrick Walravens, Analyst
Oh, great. Thank you. Hey Eric, what would you say was your primary source of competitive differentiation as a video conferencing solution a while ago? And what would you say it is today as a communications platform?
Eric Yuan, CEO
So, Patrick, that's a good question. When it comes to conferencing itself, I would say—sounds easy, but it's really hard. Because it just works, right? That's the reason why our customers like our platform. Even if some competitors try to add features, they struggle to make it work across any device. Take this earning call for example; how many of our competitors dare to host an earnings call on this platform? It’s reliable. The reason we have confidence is not only in Zoom, but also because some of our customers like my great friend, who also hosted an earnings call on the Zoom platform. The reason is that we have very reliable audio and video quality, along with a lot of other features. We will introduce more new functionality in the coming year. I think on one hand, reliability—making sure that it works anywhere, anytime—is critical. On the other hand, we always strive to be the first to come up with innovative solutions. That’s the reason we are succeeding in that space. In the future, I see more innovations and partnerships supported through our development platform in order to keep us ahead of competitors.
Patrick Walravens, Analyst
It just works?
Eric Yuan, CEO
It just works. It’s just three words. It’s not easy, but it’s an important point.
Operator, Operator
Next question is from Steve Andrews with KeyBanc.
Steve Enders, Analyst
Okay, great. Thanks for taking the question here. I just want to check back on the Carrier deal and how that came together. It sounds like on the front portion it got a large portion of the seat base. What would it take for Zoom Phone to be deployed within that customer? What are some learnings you want to apply to other customers that are considering Zoom Phone?
Eric Yuan, CEO
I think first of all, for very large enterprise customers, particularly those customers who deploy multiple, very complex on-premise systems, the sales cycle for Zoom Phone is lengthy. It's not only just one on-prem to cloud; there are a lot of solutions involved. Not to mention we need to support global participants. However, I think Zoom's solution is much better positioned. It's going to take some time, but interestingly enough, some of our customers didn't even know about the Zoom Phone platform before. However, after they test our solution, they realize our service outperforms conventional cloud solutions. We have high confidence that once enterprise customers see how complex their existing on-prem phone systems are, they're going to migrate to our platform.
Steve Enders, Analyst
Great. Thanks for taking the question here.
Eric Yuan, CEO
Thank you, Steve.
Operator, Operator
Next question is from Ittai Kidron with Oppenheimer.
Ittai Kidron, Analyst
Yeah. Hey, guys, good to see you. I guess I was hoping to focus on the Global 2000. Clearly, that was a big part of your focus going forward. That's where a lot of your sales resources have been invested in over the past year. Can you give us an update on how penetrated you are at this point with the Global 2000? Has the competition changed within that category? Cisco has made significant progress in the past year with Webex and they've shifted to be even more aggressive in protecting that space. How do you feel about the competitive landscape there? What has changed, and could you share your progress with the global 2000?
Kelly Steckelberg, CFO
In terms of the progress we’re making, we continue to make strides there. As we talked about earlier, we are devoting resources to international expansion and this remains an opportunity. We are still slightly under twenty percent of the Global 2000 spending more than one hundred thousand dollars a year with us, which just means that there's a huge opportunity ahead for us.
Eric Yuan, CEO
So, Ittai, regarding our competitive landscape, purely looking at video conferencing services, I think Zoom is the go-to platform. I really do not see any other vendors, even ones that have gone public, that come close to what we can offer. In terms of unified communications—including not only video conferencing but also CCaaS—I think we have a significant opportunity. If you look at our phone growth, many enterprise customers are reluctant to deploy multiple solutions from various vendors, typically only using one or two. Zoom is well-positioned against competitors. I don’t believe anything has changed in the last two years; it's not easy to replicate our offering without significant investment in technology recovery and service reliability.
Ittai Kidron, Analyst
Very good. Thanks, guys.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Ryan Koontz with Needham.
Ryan Koontz, Analyst
Thanks. One for Eric if I could. With regards to the Ericsson acquisition of Vonage today, this brings APIs to the 5G network. Do you see this as disruptive to the CPaaS industry, and how does Zoom think about the evolution of video APIs with programmable 5G phone?
Eric Yuan, CEO
I saw that news last night, and I’m still digesting it. First of all, I would say congratulations to Vonage and the team; their hard work has paid off. Ericsson is a great company and I think this is a significant acquisition. We're still digesting this news, but from our perspective, our vision is clear: we're focused on enterprise use cases for a stack of video, voice, CCaaS, events, and Zoom Rooms to fully support a hybrid work environment. Ericsson is a great company and this acquisition may solidify their position for 5G and also bolster their cloud vision.
Ryan Koontz, Analyst
Thank you, Eric.
Eric Yuan, CEO
Thank you.
Operator, Operator
Next question is from Chaim Siegel with Elazar Advisors.
Chaim Siegel, Analyst
Sorry about that. I wanted to just talk to you about—you started talking about sequential growth a few quarters ago, and you talked about it last quarter, and just how you're thinking about that because this quarter was a little bit slower. I don't know how much seasonality plays into it, and I know you said you're not talking about next year, but since we have these crazy comparisons, I just wanted to know how to think about sequential growth and what's driving it?
Kelly Steckelberg, CFO
We will reiterate what we said earlier in the prepared remarks: We continue to see strong growth in our direct and channel business, which grew at twice the rate of the online business in Q3. The online business will continue to be a headwind as we're still having these online customers that are the most volatile. Many of them are still on monthly contracts and as they adjust to the environment, figuring out how the future of work is going to be for them, we expect that will be the challenging headwind.
Chaim Siegel, Analyst
Thank you.
Operator, Operator
Next question is from Michael Turrin with Wells Fargo.
Michael Turrin, Analyst
Hey there. Thanks for squeezing me in. Nice to see everyone. Clearly an extended period of impressive growth. I wanted to ask around what's next and how you balance staying efficient while still aggressive. You're spending around six point five percent in R&D; five point five billion dollars in cash on the balance sheet. So what's that profile? How do you balance staying on offense given the market opportunities you have in front of you? Does the mindset shift at all as some of the growth rates moderate? Thank you.
Kelly Steckelberg, CFO
I can tell you that in terms of investing in areas like R&D and products specifically, we're still not even spending at the level we would like to be. Our target is approximately ten percent, so we've still got a ways to go. They've come a long way in terms of hiring and investing there, but we still have more opportunities to expand both our products and engineering teams. Sales, as well: we see opportunities to continue to add sales capacity on a global basis. The areas where we are very thoughtful about adding additional investments but also wanting to ensure efficiency are COGS; we work closely to ensure we add capacity while minimizing costs. G&A is also something we focus on within its functions to support our internal and external customers while remaining efficient.
Michael Turrin, Analyst
Helpful. Thank you.
Operator, Operator
Our last question today is from Matthew Harrigan with Benchmark.
Matthew Harrigan, Analyst
Thank you. You pretty much elucidated the block and tackling you saw. I have one more expansive question for you. I know you're pretty constructive on AR and DR in the longer term, while recognizing all the limiting steps for consumer adoption. We've always talked about the metaverse; there's a lot of buzz and it really feels like sometimes people have no concept even what it is. Can you add any thoughts on that and what the potential opportunity for Zoom is over say three to five year period? Thank you.
Eric Yuan, CEO
Matt, that’s a great question. First of all, we like the metaverse concept because our team has been working on that for a while. Our vision is to deliver better video conferencing, even better than face-to-face meetings. AR and VR are part of that vision. We’ve been working on that for a while. It may take many years of effort to get there. For now, it’s a concept with a compelling narrative; for reference, we demonstrated that functionality at Zoomtopia. Next year, we are going to have something like that—more step-by-step to get there. We started work on this concept long before the buzzword emerged. Our main focus is on providing a software layer rather than a hardware platform, so we plan to partner with others, such as Facebook, for various offerings. Ultimately, we believe AR, VR, and the metaverse collectively present a wealth of opportunity for meaningful connections, as long enough as we remain diligent in our innovation strategies.
Michael Turrin, Analyst
Thank you.
Eric Yuan, CEO
Thank you.
Tom McCallum, Head of Investor Relations
Eric, that was our last question. So back to you.
Eric Yuan, CEO
Thank you all. Really appreciate your time, and I’d like to take this opportunity to thank all Zoom employees, all the customers, partners, and investors. I wish you all a wonderful holiday season. Thank you and happiest Thanksgiving. Thank you all for your time; I’m so grateful.
Kelly Steckelberg, CFO
Hi everybody. Thank you.
Eric Yuan, CEO
Thanks everybody.