Zoom Communications, Inc. (ZM) Earnings Call Transcript & Summary

Good afternoon. Thank you all for being here. This is William Blair's 40th year doing the Growth Stock Conference, so we're very, very proud of what we've achieved. My name is Bhavan Suri. I'm the analyst that has the pleasure of covering Zoom at William Blair. You can find all the appropriate disclosures on our website at www.williamblair.com. It's great to have the team from Zoom here. Kelly Steckelberg, who's the CFO; Tom McCallum, who's in IR, who I've known for probably 15 years to this point. I have to apologize. I tried to control everything, but I couldn't control the construction next door, so there is this pounding going on.

Usually, I'd ask you to give an overview of what the company does, but I think it's pretty clear that everyone understands what Zoom does. What I'd love to do is understand you as a clear leader in this space, like millions of users by far beyond anyone else. What is the differentiation? And what do you think allowed you to build something that is so scalable and differentiated than every other video conference solution that's been out there in the market, for you?

Yes. First of all, thanks for having us. We're really honored to be here today. And I think that the biggest differentiator for Zoom is both the user interface, the usability as well as the reliability of this platform. When Eric founded the company 9 years ago, I think there was a lot of skepticism around the need for another product in this space. And yet, he had a very clear vision for what video communications could really be. And I think he's been completely committed to making that come through today and really thinking about everything from the perspective of the customer, the usability of the platform. And we see it, we saw through this increase in demand in Q1 where I'm sure you've heard the stat. But in December of last year, our daily meeting participants was averaging 10 million a day, and in April that peaked at over 300 million a day. And so we were able to scale and respond to that increase in demand due to this infrastructure that he built from the very beginning, which everything around it, everything around Zoom was built to be video first. And that really takes a lot of thought and planning, which is what he designed. It's very different than how competitors in this space have approached it historically where video was kind of an afterthought that came later. But because he put that foundation in place and everything is really focused on being video first, it allowed us to scale up during this period of time and respond to the customers' needs without disruption.

Yes. Yes. I mean I think it's amazing. If you think about 400 million sessions, and you think about maybe -- I don't know, pick a number. 70 million, 80 million subscribers, users, whatever you want to call it in terms of that. You look at Netflix, 120 million. But Netflix is one-way streaming, right? And it's high quality, it's not like Netflix doesn't have great technology. They do, but it's one way. There's no interaction. There's no back and forth. You're not relying on someone else's camera which you don't control. And so when you look at this and you look at the ability to do this, how would you think about the moat you have built? This idea, the idea of saying, "I can scale out, it's easy. It's mathematical." But it's not because in real life, when you're connected to one home with 4 devices all using different things and the latency. When you and I first met, Kelly, I was on a phone -- on my phone, doing a Zoom video, driving through Palo Alto with this terrible connectivity at work. How do you think about the moat that has allowed you to build vis-à-vis sort of everyone else?

Yes. Well, I think a couple of things is that, Eric, when he started this company, he took many of the talented engineers and spent 2 years building this product from the ground up. So there's a moat in terms of just the lead in which Zoom has in terms of its technology, and again, building it from the ground up so that everything is focused on this purpose of being video first as well as we believe that we have some of the top talent in this space. Obviously, Eric himself is recognized as a visionary, but we also have a lot of the engineers that have been recruited and/or educated and grown up within Zoom to really be the leaders in this space.

No. That's really helpful. And talent is amazing, right? Great software engineers are worth, whatever, 1,000 average ones, right? All of the investors understand what a great portfolio manager is vis-à-vis an average one. So sticking with COVID for a second, the -- some of the areas of the economy has started to open up. People have started going to the offices. I was talking to a company earlier today. They're actually talking from their Waltham office. How do you think you expect user behavior to change? And then have you seen any changes in the last couple of weeks relative to March and April?

Yes. So I think that what the last few months have done, the video communications has been amazing accelerant. Video is now integrated into every aspect of our lives, all of our lives, right? Work, personal, probably children's schools, children's piano lessons, fitness classes, like it's been how we have continued to carry on and develop and have some routine in our lives during this time where we can't meet physically together. And so I don't think that is going to change completely even as we start to potentially go back to our offices. I think what we've all seen is this can be a very effective and efficient way to continue to come together and be productive. And I can tell you anecdotal stories that I hear from our employees, we hear from customers all the time around things like taking their children to tutoring lessons in the Bay Area, right? Taking your children to a civil learning center in the Bay Area means you probably have an hour in traffic on either side of that. And of course it's after school, probably in between dinner time and homework. So really challenging to try to fit that all in, and you don't need to anymore. Like we have seen how effective this can be for people to continue to provide these services with their customers sitting at home at their dinner table or the dining room table. As well as they drive a great opportunity to take advantage now of talent pools around the globe. So if you go back to that example of tutoring, the tutoring center is not limited to providing talent for only those that are available in the Bay Area. They can now start to leverage tutors around the U.S., even around the globe. And so it really diversifies the opportunity. And then -- sorry, what was the second half of your question?

No. So have you seen any changes relative to March in the last...

Yes. So March and April were really the peak of demand where we saw organizations around the world coming to us and trying to figure out how they were going to keep their employees safe, but also keep them productive as well. We have continued to see elevated demand as we come into Q2 starting in May, it's not at the same level that Q1 was, for sure, but still organizations either realizing that the solution they have in place isn't really scaling under the demands of this work-from-home situation that we're all in right now, or just thinking about strategically how are they going to carry this forward. So we have continued to see demand. It's just not at the same level that it was in March and April.

Yes. So maybe drilling down a little bit, and this comes up a lot with investors because obviously the stock has done well and you've delivered on everything else too. But there's this fear that a lot of these users disappear. It's a onetime temporary use that's offset, at least in my view, that it's so early. Like I can name you 5 large global multinationals that are billions of dollars of revenue in Chicago that are not customers, right? And so when you think about sort of the ability to grow and deploy and understand that people will probably realize collaboration is going to change for the ones there versus the ones who lose, how do you think about that balance, let's say, in the medium term?

Yes. So let's talk about what happened in Q1 and then talk about the potential ahead. So in Q1 when we upped our guidance, we doubled our guidance for the full year. And that was comprised of a lot of different segments of success that we saw in Q1. So first of all, in the upmarket, we added more than 500 customers with greater than $100,000 of annual recurring revenue. So that is a onetime metric that we're giving to show you the progress that we made in that segment of the market. And the great thing about that is those customers are really sticky, right? They typically buy annual or multiyear contracts, and we didn't see any change in their buying patterns as compared to historical. Now 50% of our sales in Q1 did come from monthly users and that we've disclosed, we've talked about their churn in the S-1 has a higher rate of churn than say the upmarket. And this is the area of opportunity for us to now show them the value of Zoom and encourage them to buy annual contracts, which of course we are focused on. Our marketing team as well as our sales organization is really wanting to use to those customers and encouraging them, helping them see the value of Zoom and encouraging them to upgrade where it makes sense for them. So we, in our guidance which we gave, we assumed that there was a high level of churn in that piece of the customer base, but we're doing what we can to convert them to annual contracts obviously and retain them. And then -- sorry, I think there's also the other -- I just want to talk about -- touch on internationally quickly, which is also a great opportunity for us. And this has created a remarkable opportunity around the globe in that we are now able to put salespeople in markets where we probably wouldn't have done it for years. But because of the advancement in our brand awareness, now we're seeing the demand pull in some of these markets that again, we wouldn't have put sales people in for a few years.

No, I think the international churn is going to be so compelling. And sort of the way you've built at the valid approach of, "I can just bring on someone else. We all use them." And we realize, it works, et cetera, is critical. I wanted to touch on the guidance since you brought it up. You suggest -- it suggests sort of that you could almost triple relative to 2019. But it's been pretty conservative in the back half of the year. You touched a little bit about the monthly guidance, and I think it's good to be pretty conservative about what that churn might look like. But what other key assumptions did you build into that?

So when we gave guidance and we look at the full year guidance and also the Q2 guidance, it implies that we are expecting Q3 and Q4 revenue to be approximately flat from Q2. And the reason that we think that is appropriate is because while we -- what we expect in the back half of the year is that our upmarket teams start to go back to a more normal level of productivity. They're obviously working at high levels of productivity in Q1, and expected some of that to continue to Q2. But we've modeled Q3 and Q4 that they're back to a more normal level of productivity. There is enhanced capacity or expanded capacity in our model because we have really hired aggressively during this period of time, so expanded capacity. But what we've modeled is that all of that could be offset by the churn that we see in the mass market that we just talked about. So what that could leave us with for Q3 and Q4 is kind of net bookings that is just -- it's evening out. So what you're seeing in the top line sales from the upmarket is being offset by the churn in the mass market. And that could leave you with Q2 revenue continuing at the same rate for Q3 and Q4.

So I'll press on this a little bit. But why wouldn't -- and again, I think it's great to be prudent and just exceed expectations as opposed to missing anything. So totally with you there. But why would you build in something for the conversion of free to paid in almost every market out there, right? Like I think about education, okay, maybe all the kids will go to school at some point. But like hospitals where they're using it free today because you expose the platform free, thank you for doing that. But they're probably going to still have meeting rooms and conference terms of doctors and nursing all chatting over video. And we've seen the value of that in building trust and communications. So maybe that's upside and you don't want to count it in. You haven't seen that. I'd love to get a sense of your thought process around that free to paid conversion.

Yes. So I think you're right about the potential, the health care example you gave us. The challenge in predicting that today is it is an unknown. The pandemic itself is unknown. If we had more clarity around that, we might be able to think about, okay, when are people going to start to return to their offices or their hospitals for working. But it's just so early to tell right now because we don't have clarity around that, that we think this is the best approach.

Yes. No, fair enough, totally fair enough. Okay, enough with COVID. Let's talk about strategic things for a second here. You've grown ridiculously fast with amazing metrics. Two questions: one, with the type of growth you've seen, which has not happened really at these levels, how do you and Eric and the team think about culture and balancing and keeping the culture that was critical in building this company to what it is and define the product? And then how do you effectively operate at that scale?

So first, I mean that the -- our ability to respond to the increased demand in Q1 is a huge testament to the culture as well as our Zoom employees. Huge credit and gratitude to them where everybody really stepped up and stretched in this time, and everyone was really singularly focusing on doing what we needed to, to support our new and existing -- or sorry, new and yes, existing customers. In terms of how we're managing the culture, it is at the forefront and we're thinking about this, and trying to ensure that we are taking care of our employees, first and foremost. So we did some things to say thank you to them during the quarter in terms of monetary. And we gave a onetime bonus. Trying to ensure that we are also providing flexibility for our employees as it's really -- adjusts the position that was happening during this period of time and continues to be in terms of the demand that we're feeling and what we're asking of them, while they're all still trying to balance the needs of having children at home or potentially a partner or a spouse that might be having different challenges in the workplace in terms of furloughs or layoffs. And so really being thoughtful about what we -- how we support our employees during this time and giving them flexibility to take care of them and their family during this time as well.

Yes. No, I think it's great. Let's turn to security, and that's a topic that's come up, but I'd love to sort of drill into a little bit. Obviously, security concerns following on, a lot of it was -- 99% was user error more than anything else. Like don't paste your Zoom thing in Facebook, things like that. But as you've now started to work with federal agencies, the DoD, others, how has the security and the focus of security internally shifted? And is there stuff you feel like you still need to do? Obviously, you have to be aware and monitoring and sort of all that. But is there stuff you actually need to build to meet anymore?

So thank you for acknowledging for that was user error. I think the company also realized that as we were increasing the base of individuals that are -- and customers that were using the platform, that we could do better. We could do better around education. We could do better about serving up functionality. One of the things that I love that's come out of this is the security shield that when you're a host, it brings all of the features for you to control your meeting and ensure it's appropriately secure, front and center for you in a really easy -- the base of the meeting bar. And those are the kinds of things that we realize we can do, we could do better about. Something we could do better. We are almost -- a little over 2/3 of the way now through our 90-day plan. We have, during this time, we've created the CISO Council, which is a group of highly talented individuals who are providing input to us in terms of how our product can be better. Eric has been doing his weekly webinars and hearing directly from our customers and what would they need from us. And we have been focused singularly on adding product and -- sorry, features and functionality to the product itself during this period of time while we've halted all other development. And I think we've made a lot of progress. I think the amazing thing about this is that the company itself will be forever changed in terms of its stance on privacy and security. It's never something that we're ever going to say, "okay we're done," because we'll never be done. It will now be integrated in how we approach the development of our products and always balancing things like ease of use with privacy and security, and making sure that we find the right balance in there because they can both be accommodated. You just have to think about them both together and what the impact is on the user and trying to make sure we're doing that correctly.

That's helpful. Turning to another factor that's a little bit out of your control too is the China issue. So obviously there's the political rhetoric, but also questions about security related to whatever it is in the geopolitical tensions. Again, totally out of your control, but how do you think about these dynamics as it relates to the business? And what can you guys do to mitigate that, given like I said, some of it's -- much of it's out of your control?

Yes. So if we first think about the impact on our customers, we want to ensure that they are comfortable and confident in how we're managing the meetings and running meetings. So now one of the things that we added during this 90-day period was the ability for users to control which data centers their meetings are being routed through. And so that is putting some of that control back into the hands of the users, which we think is really important. And then we do have a large number of employees and engineers in China. And so ensuring that -- we've always said, your IP resides in the U.S., it’s always been owned in the U.S. So just ensuring that we have the appropriate controls in place, access controls in place, segregation of duties to ensure that all of our customers can feel confident that their data is secure and that our employees in China are able to do their jobs in an appropriate way.

So the success has obviously bred a lot of good things, but it's also -- maybe very physical. And so obviously, Microsoft has data centers in China. Oracle has data centers in China. It doesn't impact them because you are now visible to the consumer, so I get that. Let's touch on Zoom Phone.

Yes.

Yes. So on Zoom Phone, obviously a very interesting opportunity, but how important is the product to you? And sort of strategic vision-wise, how does it fit into sort of that long-term view of what Zoom will be 5, 10 years out?

Yes. So Zoom Phone is our cloud PBX solution that is about 5 quarters old now. And we are really excited about the prospects of Zoom Phone. It is a really important part of the strategy as we believe that video is the future of communications, and Zoom Phone is an important partner to that. If you think about it, what Zoom Phone does is you always have the ability to make a very high quality voice over IP call on the platform. What Zoom Phone did was add the ability now to have phone number support on either end of that and to easily escalate a voice call into a video call with one click. And so when you have both, and then you also combine that with our chat product, it allows you to seamlessly move through all of those modes of communication on one platform. And it's also a really easy upgrade. So our strategy around selling Zoom Phone is we are selling into our existing install base. And so for users that are used to the Zoom client, upgrading to Zoom Phone is very simple. It's one more iPhone on the base of the client, whether it's on your desktop or on your mobile device. And it's also been easy for organizations to transition as they've seen how Zoom transformed their meetings experience, and now they see the potential for us to do the same for them around their phone. Like PBX seems to be sort of the last area of IT that has remained on-prem. And as CIOs and teams at IT are really looking for a strategic way to get that into the cloud, they see Zoom Phone as a really seamless way for them to do that.

Got it. Got it. And so when you look at the cloud PBX part or the functionality you have, I guess where do you think you are in terms of like sort of full product feature functionality in the cloud PBX? And what are the key features in the pipeline that sort of get you there?

Yes. So we're really excited about the performance of Zoom Phone today. And so just to give you some of the stats from Q1, for example, we had our largest deal to date sold in Q1 with 18,000 lines to a biotech firm. We also talked about on our earnings call, Arm that bought meetings, phone and rooms. And so that was a really exciting deal for us as well. And I think what that indicates to you is that we have features that are able to meet the needs of large highly sophisticated buyers. And the biggest opportunity ahead for Zoom Phone is our continued international expansion. So the product is generally available in 25 markets today. And the goal is to be at 50 by the end of the year, which we're tracking to. And the reason that's really important is because when you have a U.S.-based company that has employees deployed around the globe, if they want to do a wall-to-wall native implementation in Zoom Phone, we really need to be generally available in all of those markets. Today, if we're not available in all those markets with our employees, they can do a hybrid approach where they can deploy Zoom Phone, say, in the U.S. and then bring your own carrier in other markets. But to you -- they get the full benefit of the features of Zoom phones, we need to be there. And so that's why we're really focused on international expansion as quickly as possible.

Got you. Got you. One of the things we've talked a lot about here at Blair and read about it is this idea of convergence. So it's the video, it's the voice, it's the chat, it's collaboration. And obviously there's a lot of workflow around that. But I think RingCentral's got the PBX piece. You guys, at least today, leading video but building a PBX piece. Slack obviously in the collaboration space is sort of really changing how work is done. How do you think -- and I've asked this question of you guys multiple times before. I know it's like a different answer, but I know the audience that cares. How do you think about some of that convergence? And where are your priorities in terms of expansion of the platform in that sort of convergence that's bound to happen over, let's say, 10 years?

Yes. We really want to support our customers and having the product that suits their needs best. And we believe today that partnering in a best-of-breed approach is the way to accomplish that. So Slack, for example, is a really strong customer and partner of ours. We have a really tight-knit client integration with them so they can go and start [indiscernible] in one click launch a Zoom meeting. And we believe that, that is the best way to go up against our #1 competitor for both of us, right, today which is really Microsoft, and ensuring that our customers can use these products and feel like they are seamlessly integrated. And for the long term, we want to be the leader, obviously not only in gate of communications but also in voice as well through Zoom Phone.

Got it. Got it. Let's -- and again, we always talk about Zoom Phone and Zoom Video, but we don't really talk much about Zoom Room. So let's talk about the Zoom Rooms. How is the product doing in the market? And any specific initiatives or investments that are top of mind for that product?

Yes. So Zoom Rooms is our conference room solution. And it continued to see -- to grow in Q1, even though most of the growth in Q1 came from our Zoom Meetings platform. But what's great is as employers are thinking about potentially going back to the office, they're thinking about Zoom Rooms because especially like I think they'll probably at least at first going to go back to more of a hybrid approach. Zoom Rooms is a great way for organizations to continue to connect seamlessly the employees that are in the office with those that might be working remotely. And the thing about Zoom Rooms that we've been focused on lately is we've seen probably some of our partnerships as well as small investments we've made in hardware providers. And this is to ensure that we provide a seamless approach to hardware buying. We're not riding [indiscernible] ourselves, but we want to ensure that it's really easy and taking out the friction for our customers to get the hardware that they need. And then when they plug it in, it works with Zoom Rooms. That's the goal. That's the vision. And you've seen some great, for instance, the great announcements from people like me, like Polly, like Logitech that are focusing on these bundles that are designed specifically for Zoom Rooms. And they're really slick, really quick, easy setup so that you get -- it's kind of this one piece unit and then add a screen, add a controller and you're set, or even from like DTEN, which are these really amazing all-in-one devices that you just plug in, and you're going to be able to launch Zoom. Also, DTEN recently announced you can preorder now a 27-inch device, which is perfect for all the remote working that we're doing. And so I think what you're going to start to see is Zoom Rooms that are coming into the home, and we're excited about the prospect of that as well.

Yes. No, I personally believe that ultimately it becomes a consumer product, too, but we're not going to go there today. So one on go-to-market, I think it's probably our last question here. But around go-to-market, obviously you're seeing great viral adoption. But part of it is people coming home, their kids using Zoom. They're like "Why don't we have this in the office?" We get the question all the time. You've obviously invested heavily in enterprise. And I'd love to understand how you think the go to market might shift post this, like in the next 2 or 3 years as admiralty continues and it becomes sort of a no-brainer. Like there's not guys selling Google enterprise search anymore, it's just Google, right? They might be selling other pieces of Google that haven't been that successful, but how do you think about that balance? Because maybe you just don't need as many salespeople, or they become much more efficient or more productive, or you drive up quotas. Just some of the go-to-market things you're playing with as you look at the virality versus the sort of push.

Yes, it's a really good point. We have seen this viral approach and penetration into -- even Fortune 10 companies often haven't put their bubbles up inside. And so the way that we focused on this historically is ensuring that we did brand awareness so that the CIOs and VPs of IT knew about Zoom as it was bubbling app. As you've said, that has all changed really dramatically in the last quarter as the brand awareness for Zoom has escalated to a level that probably would have taken us years to accomplish if not for this pandemic. And so we are thinking about how do you make it really simple for buyers to buy the way they want, investing more in our online buying experience, for example. And you could see where users would be enabled or even the CIO would be enabled to go onto their portal, see the users they have and seamlessly add them as they want to there. I don't think we're ever going to move to a complete self-serve-type of model especially in the enterprise, given the suite of products that we have. And so I think we're always going to need that. But trying to augment it with -- you have a sales rep, you have an account manager, you have a customer relationship team. But also that you are able to self-serve as it suits you in case in the middle of the night, you can't get hold of someone or whatever your needs might be. So really making sure that it suits the needs of our buyers.

That was super. Thank you. We're out of time. I do want to thank you, guys. I want to thank you for your support. You've been tremendously supportive of William Blair. Thank you for being here, and I really appreciate it. Thanks, Tom. Thanks, Kelly. Thanks.

Thanks for having us.

Thanks.

Thank you.