Earnings Call Transcript - ZM Q1 2023

Operator, Operator

Hello again, everyone, and welcome to Zoom's Q1 FY23 Earnings Release. As a reminder, today's earnings release is being recorded. And now, I will hand things over to Tom McCallum, Head of Investor Relations. Tom, take it away.

Tom McCallum, Head of Investor Relations

Thank you, Kelcey. Hello everyone, and welcome to Zoom's earnings video webinar for the first quarter of fiscal 2023. 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, include 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 second quarter and full fiscal year 2023; our expectations regarding financial and business trends; impacts from macroeconomic developments and the Russia-Ukraine war; our market position, opportunities, growth strategy and business aspirations; and product initiatives and the expected benefits of such initiatives. These statements are only predictions based on what we believe today, and actual results may differ materially. These forward-looking statements are subject to the 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. Thank you everyone for joining us today. As we continue to execute on the strategic pillars I shared with you last quarter, we are grateful for the support and trust we have received from our customers and investors. Let me start with some recent news, then touch on our new product launches, and finally discuss some exciting customer wins, before handing it over to Kelly. Just last week, we closed our acquisition of Solvvy, which we believe will strengthen our capabilities around conversational AI and accelerate the adoption of our contact center product. The nature of the customer experience is undergoing a fundamental transformation, as enterprises increasingly look to engage their customers in exceptional, personalized, and effortless ways. We recognize this shift and saw in Solvvy a team laser-focused on providing the very best conversational technology and empowering customer support leaders to deliver better experiences. We believe Solvvy’s technology will broaden our contact center offering with scalable self-service and AI capabilities that truly enable fast and personalized customer resolutions, improved agent productivity, and valuable insights. We are very excited to join forces with Solvvy and help our growing number of contact center customers set new standards for customer service. A key part of our strategy is to enable more and more business workflows within our platform, and I am super excited about our recent launches of Zoom Whiteboard and Zoom IQ for Sales. Zoom Whiteboard is arming teams with the power of continuous collaboration in an easy-to-use solution that provides a virtual space to collaborate before, during, and after a meeting. And to help sales teams reach their full potential, we have launched Zoom IQ for Sales, a conversational AI solution that analyzes customer interactions to surface key insights, actions, and content from sales meetings. These new product launches encapsulate our strategy to move into adjacent workflows, both horizontally and vertically, in order to ensure our customers are getting more out of our platform. Now moving on to customer wins. We are happy to share that Humana, one of the nation’s leading health and well-being companies, has expanded their relationship from Zoom meetings to include approximately 24,000 Zoom Phones to integrate voice and video in their communications platform. Thank you, Humana. I also want to thank Avis Budget Group, a leading global provider of mobility solutions, operating three of the most recognized brands in their industry through Avis, Budget, and Zipcar, for expanding from being a Zoom Meetings and Zoom Rooms customer to being a broader UCaaS customer. They continue to stay seamlessly connected having added approximately 10,000 Zoom Phones across many of their global offices and car rental locations. In addition to Zoom Meeting and Zoom Phone, our UCaaS solution includes a very robust persistent team Chat product that further drives collaboration in a seamless and integrated way. Our Chat product is used by a number of large enterprises, including a Fortune 10 company with over 130,000 users. I also want to thank Lumio, a preeminent leader in residential solar and home experience. Lumio is a happy Zoom Meetings customer, who recently enabled their 4,000 employees to enjoy the use of Zoom Chat. Lumio chose Zoom Chat for its ease of deployment and to enhance communication and collaboration across their team. The next two wins are very special because they demonstrate the strength of our platform offering and how the contact center is a critical component of the platform. I want to thank TeamHealth, the leading physician practice in the U.S., for their trust in Zoom. Their innovation-focused team is committed to delivering the best quality experience possible for their employees, healthcare providers, and customers. A longstanding, avid Zoom Meetings, Zoom Webinar, and Zoom Rooms customer, TeamHealth recently expanded their services with thousands of Zoom Phone licenses across their organization. Their journey did not end there. Given their seamless experience across our platform, they saw potential value in adding our Zoom Contact Center to modernize internal IT support services across their tens of thousands of employees and healthcare affiliates. Last but certainly not least, I want to thank Franklin Covey, a leading provider of leadership, individual effectiveness, and business execution training and assessment services. Franklin Covey started as a Zoom Meetings and Zoom Events customer. In Q1, recognizing Zoom’s expansion into the contact center and proven UCaaS capabilities, they decided to deploy Zoom Phone together with Zoom Contact Center. They saw them as going hand in hand to support many of their external call center needs in the U.S. including voice and video channels as well as skills-based routing. We look forward to continuing our journey with Franklin Covey by delivering additional capabilities as we enhance and expand our contact center offering. Thank you, Humana, Avis, Lumio, TeamHealth, and Franklin Covey. I am so grateful to have such a great group of customers. We hear every day from our customers about just how much impact Zoom’s unified communications platform has had on how they communicate internally and externally. Recently, we commissioned Forrester Consulting to quantify Zoom’s business value and provide a framework for organizations looking to understand their unified communications investment. The study indicates that Zoom’s unified communications platform could provide a 261% return on investment over three years for a composite organization in their model, with a payback in just less than six months. This did not come as a surprise to us or our customers, who see and feel the value of Zoom every day, but it does set a healthy bar for what organizations can strive to accomplish with our flexible, scalable, and growing suite of communications solutions. As companies look to empower hybrid workforces, Zoom can drive further efficiency gains through our robust Zoom Rooms offering. There are intangible benefits as well. A new study from Gartner found that employees with more flexibility in terms of work style and location felt more connected to their organization’s culture. We have found this to be true at Zoom, and are working to help our customers realize similar goals by enabling productivity and belonging across their teams, whether they are in-person, remote, or hybrid. As always, let me also thank our global Zoom team, customers, partners, and investors for their great trust and support. And with that, I’ll pass it over to Kelly. Thank you.

Kelly Steckelberg, CFO

Thank you, Eric. And hello everyone. Let me start by also extending my warm welcome to the Solvvy team. We are thrilled to have you join the Zoom family. I’ll first discuss the results for Q1, and then provide our outlook for Q2 and FY23. In Q1, total revenue grew 12% year-over-year to $1.074 billion, near the high end of our guidance. The growth was primarily driven by strength in our Enterprise business, which saw a steady increase in customers as well as improved renewal rates year-over-year. We also saw ongoing success in Zoom Rooms and Zoom Phone, which reached 3 million seats during the quarter. Renewals in Online improved sequentially, but growth was impacted mainly by international headwinds, including the strengthening of the dollar and the Russia-Ukraine war. Revenue from Enterprise customers grew 31% year-over-year and represented 52% of total revenue, up from 45% in Q1 of FY22. The number of Enterprise customers grew 24% year-over-year to approximately 198,900. We expect revenue from Enterprise customers to become an increasingly higher percentage of total revenue over time. Our trailing 12-month net dollar expansion rate for Enterprise customers in Q1 came in at 123%. This was in line with expectations as existing Enterprise customers continued to expand their investments in the Zoom platform, with growth rates beginning to normalize following the very high rates of expansion previously. We saw 46% year-over-year growth in the up-market as we ended the quarter with 2,916 customers contributing more than $100,000 in trailing 12 months revenue. These customers represented 24% of revenue, up from 19% in Q1 of FY22. Our Americas revenue grew 15% year-over-year. Our APAC revenue grew even faster at 20% year-over-year. The performance in Americas and APAC was partially offset by flat year-over-year growth in EMEA. This was primarily due to continued headwinds in the online business. On a quarter-over-quarter basis, we believe the Russia-Ukraine war has broadly impacted our online business in Europe and is expected to weigh on the balance of FY23 as well. 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, acquisition-related expenses, net litigation settlements, net gains or losses on strategic investments, income tax benefits from discrete activities, and undistributed earnings attributable to participating securities. Non-GAAP gross margin in Q1 was 78.6%, an improvement from 73.9% in Q1 of last year and 78.3% last quarter. The sequential improvement was mainly due to optimizing usage across the public cloud and our increasing number of co-located data centers. Given the improvements we are seeing so far this year, we expect gross margins to be in the range of 76% to 78% for the remainder of the year, which is higher than our previous view of the mid-70s. Research and development expense grew by 105% year-over-year to approximately $85 million, driven by our focus on innovation. As a percentage of total revenue, R&D expense increased to 7.9% from 4.3% in Q1 of last year. Our new product launches reflect our ongoing investments in expanding Zoom’s platform and our commitment to delivering on our customers’ evolving needs. We plan to further invest in R&D to reach our long-term target of 10% to 12%. Sales and marketing expense grew by 40% year-over-year to $267 million. This represented approximately 24.9% of total revenue, up from 20% in Q1 of last year. We remain committed to investing in worldwide sales capacity, channel partners, and product marketing across the Zoom platform. G&A expense grew by 26% to $93 million or approximately 8.6% of total revenue. Non-GAAP operating income expanded to $400 million, exceeding the high end of our guidance of $350 million as we are seeing the benefit of efficiencies in our cloud operations. This translates to a 37.2% non-GAAP operating margin for Q1, compared with 41.9% a year ago and 39.2% last quarter. Non-GAAP diluted earnings per share in Q1 was $1.03, on approximately 307 million non-GAAP diluted weighted average shares outstanding. This result is $0.15 above the high end of our guidance and $0.29 lower than Q1 of last year. Turning to the balance sheet. Deferred revenue at the end of the period was $1.3 billion, up 22% year-over-year from $1.1 billion. Looking at both our billed and unbilled contracts, our RPO totaled approximately $3 billion, up 44% year-over-year from $2.1 billion. We expect to recognize approximately 63% of the total RPO as revenue over the next 12 months, as compared to 72% in Q1 of last year, reflecting a shift towards longer-term plans. As a reminder, our seasonality of renewals is front-end loaded and tapers through the year, and therefore our collections follow the same trend. This leads deferred revenue to peak in Q1 and moderate over the rest of the year reflecting the smaller renewal base. As such, we expect Q2 deferred revenue to grow at approximately 9% to 10% year-over-year. We ended the quarter with approximately $5.7 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. We had operating cash flow in the quarter of $526 million, compared to $533 million in Q1 of last year. Free cash flow was $501 million, up from $454 million in Q1 of last year. Our margins for operating cash flow and free cash flow remain strong, at 49% and 46.7%, respectively. For the fiscal year, we would expect free cash flow margin to be roughly 3 to 5 points lower than our non-GAAP operating margin, taking into account the lower deductions for stock-based compensation caused by the recent stock volatility. The Section 174 requirement to capitalize and amortize R&D expenses could further impact our free cash flow if Congress does not defer, repeal, or otherwise modify the existing legislation. Over time, assuming a more normalized SBC environment, we would expect our free cash margin on an annual basis to track approximately at or above our non-GAAP operating margin. Last earnings we announced our billion-dollar share buyback plan. As of the end of Q1, we had purchased $132 million of stock, representing 1.2 million shares. Now, turning to our FY23 guidance. This outlook is consistent with what we are observing in the market today. Specifically, it assumes that our Enterprise business will grow substantially faster than our online business. It also assumes that our year-over-year total revenue growth rate will modestly accelerate in the fourth quarter FY23. For the second quarter of FY23, we expect revenue to be in the range of $1.115 billion to $1.12 billion. We expect non-GAAP operating income to be in the range of $360 million to $365 million. Our outlook for non-GAAP earnings per share is $0.90 to $0.92 based on approximately 308 million shares outstanding. As mentioned last quarter, due to our multi-year history of profitability, we have fully utilized our NOLs. We continue to expect our tax rate to approximate the blended U.S. federal and state rate in FY23. For the full year of FY23, we expect revenue to be in the range of $4.53 billion to $4.55 billion, which would represent approximately 11% year-over-year growth. We are raising our non-GAAP operating income to be in the range of approximately $1.48 billion to $1.5 billion, representing a non-GAAP operating margin of approximately 33%. Our outlook for non-GAAP earnings per share is $3.70 to $3.77, based on approximately 309 million shares outstanding. Before we conclude, I’d like to update you on our recently issued inaugural ESG report. The report includes information regarding our ESG initiatives and policies, environmental performance and targets, details of Zoom’s and our employees’ charitable contributions, diversity metrics, and an index providing standardized reporting according to the SASB framework. 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. Kelcey, please queue up our first question.

Operator, Operator

And our first question will come from Meta Marshall with Morgan Stanley.

Meta Marshall, Analyst

Perfect. Thanks so much, guys. Congratulations on the quarter. Clearly, you guys are seeing a lot of traction on the Phone front. I just wanted to get a sense of, as you look into fiscal '23, just what you think could be other categories of kind of ancillary products that could contribute to growth and just when you would expect kind of those categories outside of core video to be more than 10% of revenue. Thanks.

Kelly Steckelberg, CFO

So, we're super excited, of course, about our recently launched products, including Whiteboard and Contact Center. We saw some Contact Center deals. You heard some of those names that Eric talked about at the beginning of the call. And then, of course, Zoom Rooms continues to be a really important part of our strategy going forward, especially with the ever-evolving status of what flexible and hybrid work is going to look like in the future. In terms of when I expect any of those products, I think on a combined basis, we do see the combination of those products exceeding 10% of revenue today. We've always committed that as soon as any individual product gets to 10%, of course, we'll start disclosing that. I think that's likely not to happen in FY23, but probably in FY24, FY25, you'll start to see some of those product lines coming into their own and producing at least 10% of revenue.

Operator, Operator

And our next question will come from Matt Stotler with William Blair.

Matt Stotler, Analyst

Maybe just one on contact center for me. Obviously, good to hear some early wins there. Would love to get an update, I guess, more broadly on kind of the adoption, overall demand that you're seeing for that product, specific use cases that you're seeing customers kind of roll out for. And then as you think about the functionality roadmap from here, what are the most critical pieces? Obviously, nice to see Solvvy coming in. But on that side, we'd love to get your thoughts on that going forward as well.

Eric Yuan, CEO

Yes. Matt, that's a good question. First of all, very, very excited to already have several contact center paid customers, right, because their trust in our proven UCaaS capabilities. And for those customers, they either already deployed Zoom Meetings and also either already deployed Zoom Phone or they are going to deploy Zoom Phone. They prefer deploying Zoom Contact Center as well because we already built a very scalable call routing engine – already, right, and a lot of core contact center features already built in. And also, we try not only just to focus on one use case like enterprise IT services. Broadly speaking, this is a much bigger opportunity for us. We keep adding more and more features, like recently acquired Solvvy composed of AI capabilities and even some non-core features like workforce management, Q&A model, like CSAT, all those features we are going to add to the Zoom Contact Center. We are going to become a very, very, I would say, very meaningful contact center service provider. We're very excited. The team is working extremely hard and very excited.

Operator, Operator

And our next question will come from Michael Funk with Bank of America.

Michael Funk, Analyst

So, in a similar vein, considering the additional capabilities such as Zoom Phone or the contact center, how is this impacting your sales strategy and your interactions with customers? Additionally, how should we view this in terms of the sales cycle, especially in relation to potentially lengthening it as you incorporate more complex solutions? Thank you.

Eric Yuan, CEO

Yes. Kelly, feel free to chime in. I think first of all, I do not think it's complex because the trust is established. Customers always ask about our product roadmap. They want us to offer more value to them. Based on the very consistent front-end experience and seamless back-end architecture, and the cost to deploy Zoom Meetings, Zoom Chat, and also deploy Zoom Phone and Zoom Rooms. Now given the contact center is a no-brainer to customers. Yes, I trust your brand, I trust your capabilities, and we would like to test your contact center as well. That's the reason when we announced the Zoom Whiteboard, we also see the early adoption. It is pretty good. Not to mention Zoom IQ for Sales because we received a lot of feedback from customers. They trust Zoom. They want us to offer more value. Looking at all those use cases, starting from a sales department, support department, contact center, and maybe other departments, working to add more and more value in new services and new product innovations and features because I do not think that will introduce any complex process sales because the trust is already established. It's more like an upsell. Even for new customers, when they do a reference check with other very happy customers, I think it is again a pretty straightforward sales process.

Kelly Steckelberg, CFO

I just want to emphasize that the land and expand strategy has been a reliable sales approach for Zoom from the start. Our account teams, along with experts from our overlay team, effectively implement this strategy, and it is performing excellently. I fully agree with Eric that this approach does not add complexity; rather, it enhances our relationship with our customers, which has been our focus from the beginning.

Operator, Operator

Kash Rangan with Goldman Sachs has the next question.

Kash Rangan, Analyst

Eric, I was deeply intrigued by your launch of the conversational AI product through the acquisition, albeit. Can you just give us a sense as to the product roadmap? How does it integrate with the Zoom platform? And relative to embedded competitors in the conversational intelligence space, what would be Zoom's competitive differentiation in the industry? It feels like at one level, you're entering the CRM market, not in the way Salesforce.com and so on and so forth. But you're getting into a level of customer engagement, which is very different than the video meeting platform. Can you tell us a little bit more about that? Thank you so much.

Eric Yuan, CEO

Yes. Great question. So, first of all, if you look at the contact center, that's a huge market, right? A lot of use cases. Also, by the way, a lot of enterprise customers today, they still deploy on-prem contact center solutions. In the next several years, they are going to migrate to the cloud. And aside from that, I think to have a customer similar to those migrated to the cloud offering, we need to make sure there are no feature regressions, similar to what we did before to have a customer migrate from on-prem to the cloud. With that aside, a lot of features we have to add. That is one. It's more like a no-brainer. There's nothing that's a key differentiation, but we have to add that. That's one. Two is you look at the AI. AI is something new. You've got a lot of other contact center solution providers. They do not have AI capabilities before, right? Now this is something new, and we are doubling down on that. That is one key differentiation how to move faster with much better AI capabilities. In terms of overall key differentiation, I would say the video is a key use case, right, how to further improve the interaction between the customer or IT, the support with employees and how to turn on the video, how to analyze the video conversation like a speech-to-text transcription, right, and recently like Zoom IQ for Sales. That is very important for us. In terms of integration with ServiceNow, with Zendesk or others, I think this is just a feature. I do not think that's a key differentiation because every contact center solution has that. So, again, we think it has a huge opportunity ahead of us because customers also like the new solution, the modern solution, not like old architecture, very hard to innovate. Given the progress we made over the past seven years for Zoom Phone, we are going to do something similar. That's why I'm very excited.

Operator, Operator

And moving on to Siti Panigrahi with Mizuho.

Siti Panigrahi, Analyst

I wanted to ask you about your fiscal '23 guidance. You mentioned foreign exchange headwinds. Could you provide more details on the foreign exchange headwinds? Additionally, what is the impact of the Ukraine war on the EMEA side, particularly concerning the online segment? What should we anticipate for the growth rate or churn in the online segment compared to Enterprise?

Kelly Steckelberg, CFO

Yes. In terms of foreign exchange, we are observing effects primarily in the euro, pound, and yen. Looking at the trends from the first quarter, we are factoring in the strengthening of the dollar along with the impact of the war, which we anticipate will result in about a 1% effect on revenue. This impact is predominantly felt in the online segment, while we have not noticed significant effects in the Enterprise segment. The foreign exchange influences are evident in both segments.

Operator, Operator

And our next question will come from Ryan MacWilliams with Barclays.

Ryan MacWilliams, Analyst

Another one on guidance. Kelly, just how should we think about Zoom reaching your second quarter revenue guide from a segment standpoint? Just wondering here, given some fluctuations in your online business, maybe what we can see some strength in next quarter? Thanks.

Kelly Steckelberg, CFO

Yes. So, if you remember last quarter, we talked about that enterprise would be growing in 20% plus for the year, and that online would be flattish. We said that flattish meant it could be a little bit above zero, it could be a little bit below zero, depending on the quarter. And then the other thing we've talked about is that inflection point coming in Q4. So, you should expect that Q2 is also going to be another volatile quarter for the online segment, given all the factors we just talked about, but that we really continue to see strength in the enterprise, and that's where the growth for Q2 will be driven from. And then by the time we get to the back half of the year, that's where we're really going to start to see stabilization of the online business.

Operator, Operator

I'm moving on to Rishi Jaluria with RBC.

Rishi Jaluria, Analyst

I wanted to drill into the NRR that we're seeing across the board. Appreciate all the color. But maybe can you give us a sense for how have you seen the NRR for 100,000 customers generally trending? Have you seen that hold up? Has that gone down? And maybe just help us understand usage patterns for your largest customers. Thank you.

Kelly Steckelberg, CFO

Thank you, Rishi. Last quarter, we adopted a new metric of net dollar expansion for our enterprise customers. We are beginning to differentiate between our Enterprise and online segments, as we believe this is the best way to manage the business going forward. Historically, we reported a net dollar expansion rate of 130% or higher; however, it decreased to 123%, which aligns with our expectations. Considering the overall growth rate of the Company, we anticipate the Enterprise segment will grow by over 20%, and this net dollar expansion reflects that expected deceleration. Therefore, the rate of 123% is precisely what we anticipated.

Rishi Jaluria, Analyst

Yes. But sorry, just to quickly follow up. If we were to think specifically at the 100,000 level, right, because I'm sure there's more churn going on in kind of the medium level versus your six-figure customers. Without putting a number on it, how would you say that NRR for that cohort of your largest customers has trended over time, and how is it trending now?

Kelly Steckelberg, CFO

Yes. It's higher than the 123%. So, that's what I would say. As we really continue to see strength in both the new bookings as well as renewals in that segment of our customer base.

Operator, Operator

Citi's Tyler Radke has the next question.

Tyler Radke, Analyst

A question on the cost side of the equation here. So, you outperformed, I think, by 400, 500 basis points this quarter on operating margins. Yet it seems like it's still a decently strong hiring quarter. Can you just talk about if you're finding more efficiencies in the business or if there's something specific this quarter? And then as I look at your gross margins, again, it sounds like you're expecting them to come down between 76 and 78. You were above that this quarter. So, just anything in terms of new capacity or call center stuff being deployed that would impact kind of that trajectory?

Kelly Steckelberg, CFO

So actually, gross margins were stronger than we expected in the quarter. And if you remember, in Q4, the way that we talked about the outlook for gross margins, even though we don't explicitly guide to them, was we talked about expecting them to be in the mid-70s for the balance of the year. So actually, 76 to 78 for the rest of the year is higher than we were anticipating coming into the quarter. And that improvement as we really have made a lot of strides in terms of optimizing our cloud usage and getting that into the colo, thanks to our DevOps team, and that is really helping drive the improvement in the operating margins going forward. And as you said, we do continue to see strength in hiring, continuing to attract great talent, which we're really excited about, continuing to invest in R&D, which is really important for the long-term innovation and commitment to our platform.

Operator, Operator

And our next question will come from William Power with Baird.

William Power, Analyst

So, I guess, Kelly, for you, as you look at the fiscal Q2 revenue guidance, it came in a bit stronger than I think we and the Street might have been, yet the full year is still pretty consistent. Any other color just as to the puts and takes in the second half of the year? And I guess, just as part of that, just trying to understand the key drivers around your confidence of re-accelerating revenue growth in fiscal Q4. What are the key drivers to that?

Kelly Steckelberg, CFO

Yes. When we provided guidance for Q4, it remains true that we are seeing strong performance in our enterprise business, both in new bookings and renewals. We are particularly excited about the potential from our new product introductions, including Zoom events, Zoom Rooms, and the contributions from Whiteboard and Contact Center. We believe these factors will drive growth for the remainder of this year. In terms of our online business, we experienced some volatility in Q1, which we have discussed, and we anticipate some continuation of that into Q2. However, by Q3 and Q4, we expect several positive developments. Our team has implemented effective new initiatives around pricing, packaging, and localized payment options, which are boosting our performance, especially internationally. Additionally, we are seeing stabilization due to the aging of our customer cohorts. As we highlighted during last year's Analyst Day, once cohorts reach about 16 months of tenure, their retention rates tend to stabilize. This trend has persisted across various cohorts, even amid earlier volatility. By Q3 and Q4, we expect over 75% of our cohorts to be in that stable tenure range, which not only brings stability to our online business but also opens the door for potential growth in the latter half of the year, which is what we are forecasting.

Operator, Operator

And we'll move on to Parker Lane with Stifel who I think might be having some difficulties with his video, so he may not appear on video today.

Max Osnowitz, Analyst

Sorry about that. It's Max Osnowitz for Parker Lane. Yes. We're in transit today, both of us. So sorry for the no video. But just thinking about the customer announcements that you made, it feels like there's a good variety of industries. Is there any industry that you're noticing that you're seeing a lot of demand from that maybe lagged behind everybody else during COVID and is still going through the transition or has started to transition that others haven't?

Eric Yuan, CEO

Yes. I would say it's pretty consistent. Look at our installed base from allocation to health care, financial services. And it's consistent. Customers would like to consolidate, not only on Meetings but also Zoom Phone, the contact center, but also more and more customers are deploying Zoom Chat solutions as well. Data processing and team chat works extremely well. They like that solution. That's also free. That being said, I think I do not see any specific vertical industry that makes a big difference compared to other industries. Overall, it's very consistent. Look at our installed base and winning them all, and they need us to deliver more value, more service to them. Take Whiteboard, for example; look at the early adopters across industries. It's pretty promising.

Operator, Operator

We'll move on to Matt VanVliet with BTIG.

Matt VanVliet, Analyst

So, I guess, thinking about overall direct sales, headcount, investments that you look to be making over the next year plus, any specific SKU across various regions that you're finding you want to invest more heavily in? And then sort of alongside of that, on the channel side, how much of that is driving this pretty significant increase in Zoom Phone versus direct sales and kind of where investments are going to go around channel enablement as well?

Kelly Steckelberg, CFO

Yes. So we are continuing to invest in our sales organization globally, but you'll see, and as a percentage of year-over-year basis, greater investment happening internationally, including channels. We've made huge progress in our channel investments and contributions in the U.S., but that's largely nascent, still internationally. The team is doing a really great job of looking for not only master agents but carriers, and it depends on which works best depending on each of the regions. But that is a significant area of focus for us this year.

Operator, Operator

And moving on to Alex Zukin with Wolf Research.

Alex Zukin, Analyst

So Kelly, maybe just for you, can you remind us what the difference is in either the operating margin or free cash flow margin profile between the online and Enterprise business? Because it looks like you massively outperformed on cash flow. At the same time, as the online business actually declined 2%. And so, I want to understand just how much reliance is there. You gave a free cash flow margin target for the full year, at least a range. How much of that is based on the performance of the online business versus the Enterprise business? And then, Eric, if I think about the stock-based comp, what's the plan for the Company? How should we think about that on a go-forward basis in terms of either repricing people's RSUs, giving more shares, just curious how you're thinking about.

Kelly Steckelberg, CFO

Eric, do you want to go first?

Eric Yuan, CEO

Yes. You can address the first one.

Kelly Steckelberg, CFO

The impact we've observed and the forecast we're providing regarding free cash flow is primarily influenced by stock-based compensation rather than any shifts in the balance between online and Enterprise. Due to stock volatility, there have been significantly fewer stock-based compensation deductions, as employees are opting to hold onto their options or RSUs instead of exercising them, or the deductions themselves have diminished. This is the main reason for the discrepancy we've highlighted from Q1 performance to our outlook for the remainder of the year.

Eric Yuan, CEO

Yes. So Alex, back to your second question. I think our company culture is to deliver happiness, right? My number one priority is to make sure all Zoom employees are happy, right? Together, we make customers happy. Particularly, we had a little over 2,000 employees. Look at it today, almost 7,000 employees. We hired so many employees over the past two years. Guess what? When they joined Zoom, the stock price was too high. We cannot control the price, but we can control delivering happiness to our employees. Certainly, for all those employees who joined over the past two years, and the stock price is probably much higher than the stock price today, we did issue new stocks for them. Ultimately, how to make sure those employees are happy every time, every quarter, every week, we look at are there any things we can do differently to make sure our employees are happy. This is always an ongoing effort. That's our number one priority, as always.

Alex Zukin, Analyst

Good. And Kelly, just maybe just to ask the question. I meant in terms of the differential in terms of the margin profile of the two businesses, is one of them inherently more profitable than the other?

Kelly Steckelberg, CFO

Yes. The online business, as we've said before, contributes more substantially from an operating margin as well as cash flow perspective because they largely are untouched by our sales organization. So, they don't have the associated expense from a commissions perspective. They may have credit card fees associated with it, but that's a few points versus the commissions. That's the biggest difference you’re going to see between those two.

Operator, Operator

And moving on to Matthew Niknam with Deutsche Bank.

Matthew Niknam, Analyst

I'm wondering, have you seen any paring back or moderation of investment from some customers in light of growing macro concerns? And if so, has it varied by either geography or customer size? Thanks.

Kelly Steckelberg, CFO

I mean, we really have not, especially in enterprise, we have continued to see strength in renewals as well as additional new customers and expansion into additional products. So, we really haven't seen that impact today. I think we've heard from other people that what they're really focused on might be if they're limiting spending, it's focused more around potentially hiring or travel. And, of course, Zoom is a great alternative if they're focusing on limiting internal travel. And so, we really haven't seen that impact today.

Operator, Operator

James Fish with Piper Sandler has the next question.

James Fish, Analyst

Deferred revenue grew about 8, 9 points faster than you anticipated this quarter, but it did seem like durations extended a little bit. Are you guys incentivizing customers or the sales team to extend those durations, or is it more a factor of the product mix like Phone and Contact Center picking up, which if it's the latter and we're seeing kind of long-term RPO grow faster than current RPO, I guess, why wouldn't we see deferred revenue grow as you get more multiyear deferred revenue upfront and that help the free cash flow margins versus the operating margins?

Kelly Steckelberg, CFO

Our compensation structure and incentives for representatives and customers remain unchanged. We do offer discounts for customers who enter multiyear agreements, which has been consistent over time. With an increasing portion of our revenue coming from Enterprise, and as we move beyond the COVID buying cycles, we have noticed that customers are returning to longer-term agreements. Additionally, we have implemented various online initiatives encouraging customers to purchase annually instead of monthly, and our team has effectively incentivized this approach. Overall, we are witnessing a shift towards longer-term agreements across both segments of our business. You might notice an increase in noncurrent RPO without a corresponding rise in deferred revenue because not all multiyear agreements are paid upfront. For instance, a three-year contract might only be prepaid for the first year, and although it is less common, some customers might choose a monthly payment plan even with a three-year agreement. It’s typical to see a three-year deal with just one year’s payment made in advance.

James Fish, Analyst

Okay. So booking three years billing annually. Makes sense.

Kelly Steckelberg, CFO

Yes. Happy birthday next week.

Operator, Operator

Ittai Kidron with Oppenheimer has the next question.

Ittai Kidron, Analyst

Hey, guys. Nice quarter. Kelly, a couple of quick ones for you. On the Phone subscriber additions, it's great to see the 3 million milestone. But if my math is right, it took you kind of 9 months to get from 2 million to 3 million. It took you 7 to get from 1 million to 2 million. So, are we seeing a deceleration in the pace of Phone additions or maybe my math is wrong here? And then, on the duration of the Enterprise contracts, it's great to see that customers are signing longer-term contracts. Could you talk about duration, how that has changed quarter-over-quarter? And how do I think about the discounting that comes with the longer duration contracts in market?

Kelly Steckelberg, CFO

First of all, regarding Zoom Phone, we noted that we achieved 3 million during the quarter, not just at the end. We are above 3 million as we conclude the quarter. Therefore, you cannot calculate the exact figures based on the information we've provided, and I wouldn't assume there is a slowdown in that growth rate. As for the longer-term contracts, as I mentioned earlier, customers are moving beyond the pandemic and are considering how to support their employees in this flexible, hybrid work environment. They are committing to our platform for the long term, especially as they adopt multiple products and recognize the efficiencies they gain. Our approach remains unchanged; we continue to offer discounts based on deal size, multi-product purchases, multi-year commitments, and upfront payments. This remains consistent as customers increasingly see the value of Zoom and choose to commit for the long run.

Eric Yuan, CEO

Yes. Ittai, just quickly on the main hand, we've got to look at a number of the seats that previously sold. On the other hand, also do not forget the quality of service, right? We kind of deliver a platform to make the workforce happy. Let's say you target some other cloud-based service providers. You talk to their customers and talk with our customers. And as you know, we make customers happy. Enterprise is not only for all those on-prem, the Phone service customers, right, microphone on-prem and the cloud, but also some other cloud-based, the customer also migrate some other cloud-based from services to the Zoom platform as well. It further proves we deliver a better experience, make a customer feel happy. That's our momentum.

Operator, Operator

Shebly Seyrafi with FBN Securities will move on to the next question.

Shebly Seyrafi, Analyst

With your guidance for deferred revenue growth of about 9% to 10% in Q2, it seems like you expect to be slightly negative on a billings basis in that quarter. My first question is, do you believe this is the lowest point for billings growth this year? Additionally, do you think that deferred revenue growth can pick up significantly in the second half, especially considering the easier comparisons for deferred revenue at that time?

Kelly Steckelberg, CFO

Yes, our renewals tend to be heavily concentrated at the beginning of the year. This pattern dates back to early in the pandemic when we experienced a significant influx of bookings in the first quarter, which remains the peak for renewals, with a gradual decline over the year. Consequently, our collections and deferred revenue do not align perfectly, but they largely reflect a similar trend since we see a considerable amount of deferred revenue in Q1 that gets amortized throughout the year. As renewals decrease each period, they do not necessarily align with the rate at which revenue is amortized over the year. This explains the observed trend, and while it will evolve over time as we shift more new bookings toward a typical seasonal pattern in the latter half of the year, this transition will take time due to the significant bookings we experienced in Q1 a few years ago. Regarding Q2 as the low point, it is possible Q3 could be even lower as we continue through this renewal cycle.

Shebly Seyrafi, Analyst

And that's a billing statement or revenue...

Kelly Steckelberg, CFO

Billings. I'm sorry, yes, billings.

Operator, Operator

Patrick Walravens with JMP Securities. Please go ahead with your question.

Patrick Walravens, Analyst

Hi. I'm speaking on behalf of Pat.

Kelly Steckelberg, CFO

Patrick, how you've changed.

Unidentified Analyst, Analyst

Given the layoffs, hiring freezes, and hiring slowdowns we're seeing throughout the tech sector, can you give an update about what you're seeing on the hiring front and your hiring approach, any changes you've had?

Kelly Steckelberg, CFO

Yes. We had a very strong hiring quarter in Q1. We continue to attract great talent. As we mentioned in our prepared remarks, we are still continuing to invest in innovation. We're very focused on hiring in R&D as we continue to build on our platform and produce new products and then also very committed to continuing to hire in sales and marketing as we continue to expand our sales capacity on a global basis and focus on product marketing also on a global basis. So, while we are always focused on being as efficient as we can around G&A and COGS, we are continuing to invest there as well at the levels that we need to continue to support the expansion of the business.

Eric Yuan, CEO

Just quickly, Patrick, if you look at the revenue in the base, plus it's extremely positive in terms of cash flow, right? So, why not double down on R&D, new product and accounting executive? I think we're more flexible, much better positioned, given this sort of a great resignation and economic downturn. Yes, that's why we're very excited about the future, more innovative services, and more efficient.

Operator, Operator

And the next question comes from Ryan Koontz with Needham.

Ryan Koontz, Analyst

I wanted to ask you, Eric, about your contact center strategy. Was Solvvy a partner you worked with before the deal? Do you see Solvvy as a standalone solution that can enhance other contact centers, or how do you see Solvvy integrating into the Zoom platform to create a comprehensive offering?

Eric Yuan, CEO

Yes. First of all, we are very excited about the Solvvy acquisition. This is a great team, laser-focused on conversational AI with talent and technology. First of all, we are going to embed that into our overall contact center offering. That's number one for sure. In terms of if we needed to also keep making that product as a stand-alone product, keep adopting on that and sell that service as a stand-alone service, in the next few weeks or months, we are going to discuss that. But overall, we've got to look at the bigger picture, right? Customers need a full-blown great contact center experience from Zoom, right? And the Solvvy product will be part of that. Many customers already told us they're very excited about this acquisition.

Operator, Operator

You will now hear from Michael Turrin with Wells Fargo.

Michael Turrin, Analyst

Kelly, you mentioned the outlook calls for a modest reacceleration of growth in fiscal Q4. Thinking through the drivers and assumptions there just beyond compares, is there anything you can add to help us think through how much of that comes from some of the online headwinds rolling off of the model, the seasonal profile of enterprise coming through as we get closer to the exit of the year, or just other pieces to be mindful of? And on the EMEA impacts and the flattish growth that you're seeing there in Q1, anything you can add just around if that's a change in terms of the fiscal year outlook and how much of that could be incremental versus the targets and what you're seeing when you frame the outlook in Q4 for us? Thank you.

Kelly Steckelberg, CFO

Sure. So the acceleration in Q4 is coming from both online and Enterprise. So, online is due to the great initiatives that they're working on in terms of pricing and packaging and payment types and local payment currencies as well as just the aging of the cohorts. So, they just get a lot more stable as they age past that 16-month term, if you will. And what we're seeing is by the time we get to Q4, we're going to have 75% of our online cohorts that have aged to that level. So that really brings a lot of stability to the online segment and to return it to not only being stable, but also growing. And so, that's really exciting. And then, the Enterprise, we continue to expect growth to expand due to just expanded sales capacities Eric just talked about, continuing to invest in AEs, investing in our international channel as well as contribution from all these amazing new products that are continuing to grow and find their sea legs, if you will, and will really contribute we get to the back half of the year, including Whiteboard, Contact Center, Events, all of those things that we'll start to see more and more contribution from those. And then — EMEA. So incremental EMEA, that is really, I think, difficult to predict right now given the state of what's happening in EMEA. As I talked about the impact from FX as well as the war is approximately 1% of revenue and counted in our current outlook and guidance that we've given. So, if things in any way were to improve dramatically sooner than that, there could be upside, but I think we're all in a wait-and-see mode there.

Operator, Operator

Moving on to Peter Levine with Evercore.

Peter Levine, Analyst

To follow up on the previous question regarding land and expand, you have various products like Phone, Contact Center, and core meetings, which suggest there are multiple buyer types to target for market share. On the Enterprise side, I assume you're experiencing longer sales cycles for contact center packages due to the need for approvals. How should we view your sales and marketing leverage and return? How do you align your go-to-market strategy now that you have the platform?

Kelly Steckelberg, CFO

Eric, do you want to talk about that? Do you want me to?

Eric Yuan, CEO

Sure, absolutely. To talk about go-to-market strategy, similar to what we did before, I think it worked extremely well, and to build trust with the customer. Given that we have so many very happy customers over the past two years, we truly have the word, happy people stay connected. For any new services, they are very happy to try and test the services. Because of that, our sales opportunity is huge, right? We're already stable in our trust. Customers are really not like just looking for other solutions, just the work; they really need to have some solution that can truly make an employee's workforce happy. Having said that, Zoom IQ for Sales, after we launched that, we already have several paid customers. The reason is that customers trust our brand and are doing the upsell. Period. We always talk to the customer, hey, we have this service, we have that service. Overall, I think if trust is already there, any new upsell opportunity should be relatively easier even if the buyer is different because the CIO, they only made a decision to standardize Zoom Meetings, the Phone, the Contact Centers, you might give for Whiteboard. And also, by the way, do not forget about the awesome position to Chat solution as well, right? And that's the reason why customers look at the full usage stack. Zoom has everything. That's the key. That's why customers trust us. We've built everything by ourselves. Very consistent front-end experience, very respectable backend, and also very efficient architecture as well. That's why we are very optimistic about our go-to-market strategy. In terms of marketing, for sure, we do not need to spend so much money to promote the Zoom brand. Zoom already became a word. How to make sure folks on it looks like the vertical market, some in-person events, and also stay as close as possible with the prospect and the customers, and that's our focus, right? Not like previously, we really focused on the brand, the marketing. That's not our focus, more of the enterprise market now.

Operator, Operator

And we have time for one additional question, which will come from Matthew Harrigan with Benchmark.

Matthew Harrigan, Analyst

Can you talk about how the advent of private 5G networks, especially relative to the limitations of Wi-Fi on the security side, really helped the Enterprise opportunity over a period of time, both as far as the TAM and the specific alternatives that you offer for that?

Eric Yuan, CEO

Matthew, first of all, thank you for waiting for such a long time. I think if you look at Wi-Fi or corporate LAN network or 5G, actually, from our perspective, as long as any technology helps improve customers' connectivity, making the connection stable, we are very happy, right, especially between 4G and 5G. 5G is great, but not in every country is 5G already deployed. We also look at our optimization technology and stable networks, even with 5G. We also optimize more if needed. Overall, I think anything infrastructure-related can help improve customer collaboration experience, we are all for it. That's why we can't have a 5G or 6G. We just make sure we build an application leveraging those advanced infrastructures to truly deliver happiness to our customers.

Operator, Operator

And again, this does conclude our Q&A session for today. So, Eric, I'll turn things back to you for any closing or additional comments.

Eric Yuan, CEO

Well, thank you all. Really appreciate it. Again, thank you for every Zoom's hard work. Thank you for every customer, partner, and investor. We are very, very grateful. We truly appreciate it. Thank you again. Thank you.

Kelly Steckelberg, CFO

Bye, everybody. Thank you.

Operator, Operator

And again, everyone, that does conclude today's earnings release. We thank you all so much for your participation. Enjoy the rest of your day, and we'll see you next quarter.