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

All right. We're back for our 12:35 session Eastern. I'm Walter Pritchard, software analyst here at Citi. Happy to be joined by Zoom Video Communications. We have Kelly Steckelberg, who's the CFO, here, and also Tom and Han on the IR team are connected in the background if we should need them. But Kelly, wanted to very much thank you for participating and joining us here and generally in the conference.

Of course, thank you so much for having us.

Great. So what I'm going to do is I'm going to go through some questions I have prepared. And we do have in the interface for everyone participating in the conference, there is a place to be able to ask questions. So if anybody wants to click on that, type in your question, that will get routed here, and I can incorporate that into the discussion.

So Kelly, where I wanted to start, I think at this -- September 2020, absolutely everybody at least that I know is aware of Zoom. There's been an incredible amount of growth at the company given the conditions in the world. I wanted to just have you start out talking about how you think about the path forward for Zoom given what's happened here in the last 6 months and how you're positioning the company to continue to deliver growth into the future.

Yes. So we certainly have seen an amazing increase in both our brand awareness for Zoom as well as demand. And we've really focused on ensuring that we can help keep people connected during this time of disruption. We've seen significant growth in kind of 2 different segments of our business. First of all, our upmarket business, which is customers with 10 or more employees, have seen significant growth. This started in the middle of March as companies were really thinking about how do they keep their employees safe and productive at the same time. That continued through Q1, and we saw a very strong start to Q2 as well because of that. And these are companies that are -- have accelerated their buying for Zoom Meetings. And now that they've kind of gotten through that accelerated stage, we're spending a lot of time with them thinking about what comes next for them. We've seen demand -- strong demand in that segment for webinars, for experiences just like this as people are moving what previously were in-person events to virtual, town halls -- we have Zoomtopia, which you can see in my background here, our users conference coming up in October that will be completely held via Zoom webinar. So there's lots of opportunities still in -- just in meetings and webinars. And then of course, we have our add-on products that now as companies are starting to think about, okay, what comes next, there's an opportunity there. And that includes Zoom Phone, our cloud PBX solution; as well as Zoom Rooms, our conference room solution. And then we also saw really significant growth in the segment with 10 or fewer employees. So just to give you perspective on that segment, in Q4, that accounted for approximately 20% of our revenue. In Q1, that grew to 30%. And in Q2, it was 36%. And so these are small business owners. These are individuals that are using the product. And many of them have transformed their businesses, whether it's piano lessons or yoga teachers that are now giving their classes online. And so this is really a newer segment for us, and it's been great to see all the unique use cases that are coming out of there. We've done some things to really cater to this part of the segment of the population. Fun things that we demoed on our earnings call, for example, like, are the filters. So if you're using this just to have fun time with your family or do happy hour, there's some fun added features there. And then this is a segment that typically buys on a monthly basis. So we're looking at opportunities to help them see the value of Zoom and convert them to annual subscribers. We've also spent some time focusing on our online buy flow. They typically buy online, so making sure that they have the opportunity to upgrade to -- either to annual or to add more products. So there's lots of opportunity both up and down the segment and globally as well.

Great. And then I think another question I get quite a bit related to this is, I don't think anybody has a crystal ball with the health care situation that's unfolding and so forth, but at some point, we'll be in a world where there'll probably be some school going on. We won't all be -- have all workers at home. How do you think about the -- both what you've assumed in like the guidance you've given relative to the way the world plays out? And then as you're -- you answered a bit in that answer there, but how do you think about just things like retention and keeping these experiences that are virtual moving forward beyond what's been sort of a crisis type of mode?

Yes. So first of all, we believe that video is the future of communication. And what's happened during the last 5 or 6 months has just really accelerated that. And I believe that people have seen now how this can be embedded in every aspect of our lives. So let's talk about the upmarket segment, first of all. I think it's unlikely that any of us are going back to work in the exact same way that we did before. I think it's going to be a very long time before we could all safely be in our office at the same density that we were before as well as the fact that employees really appreciate this flexibility. We did a survey of our own employees, and only 4% of them said they really want to go back to working in the office every single day. And when I've talked to peers with other companies, that's really consistent with what they're saying. And so I think that employers have seen that this platform allows them to still be productive and give their employees that choice. So I think this is -- we're going to start to see, as people are thinking about the future of work, that it's going to be more of a hybrid approach with more remote employees than we had before the pandemic. So I don't think that's ever going away. And then when you look in that fewer than 10 employees segment, I think it's very similar. For example, we have an employee that her son was taking tutoring lessons before. And now that they're doing it via Zoom, she's like, "I'm never driving an hour in Bay Area traffic to get into that tutoring lesson again. This has been just as effective doing it this way." So I think we're going to see for small business owners and their customers, this is also a very effective and potentially more efficient way of delivering those services. And then think about the times that we're all -- or the ways that -- times that we're staying connected with our friends and family using this as well. We often hear these stories, like people are more connected now, even though it's not in person, because they have regular cadence of whatever it is, poker games or wine clubs. And that, we really love to hear as well. So in that fewer than 10 segment, we certainly are modeling a higher than historical churn rate. In Q2, what we saw -- and some of the upside that you saw on the top line was due to the fact that, that came in -- that churn rate came in favorable to what we were modeling, but it's still multiples of what the historical levels have been. And that is subject still to, as you say, the uncertainty around the long-term nature of this pandemic or the potential long-term nature of this pandemic. But I think that Zoom is forever going to be embedded in the way that we communicate both in our personal and professional lives.

Makes sense. That was a pretty comprehensive answer. And then just around -- you have countries in the world at different stages of open, reopening, closing back down. And we were talking to somebody here in the U.K. earlier in the day today that was highlighting some of the sort of steps backwards they've had to take recently. I'm curious what the sort of geographic -- you have broad geographic exposure. What the trends in some of the countries and how it's impacted your business tells you about what -- really what you've already articulated there. Maybe you can just give folks a little bit more detail around what you're seeing.

Yes. So in the upmarket, the buying patterns of those customers haven't changed. They typically buy on annual or multiyear agreements. So we aren't seeing changes in their behavior or retention or churn based on what's happening in their markets. Where we do see some of that volatility is in the 10 or fewer. And it -- we do see it. As markets kind of open, we see those churn rates go up. And as they come back down or as they kind of tighten up their shelter-in-place restrictions again, we see it go back down. And this is the approach it has always taken with especially our online customers, is we make it really easy for them. We want the product to be available when they need it, and that's exactly how they're using it. So it's there to support them when they need it, but we do see that in correlation to how things are going in these markets.

Got it, got it. And then there's been a few markets. I mean you highlighted the tutoring lessons, the piano lessons, things like that. What sort of markets have you seen and the opportunities that you've seen that rise to the level of being really meaningful that you hadn't predicted maybe 6, 12 months ago that you would be garnering a significant amount of revenue from?

Yes. I mean we can certainly talk about the verticals that you would expect, and there's some great stats there. But I think some of the things that weren't being leveraged for Zoom before are things like virtual real estate tours. Like this has become very common that companies or brokers are holding virtual tours. And we have a customer in Singapore that actually, 50% of their properties that were brought to market last quarter were sold using the virtual tours via Zoom. And so that is an amazing use case that -- yes, I don't think anybody ever contemplated that before. There was such a strong feeling that you needed to go see it in person, and yet now it's been highlighted that virtual tours can be really, really effective in that arena.

Got it, got it. What about the education market? I know in that market, you've -- you did a great thing, I think, earlier in the pandemic and just offered it for free very generously for schools and I think anybody who has kids. I have 3 of them, are spending a lot of time there. But how is that materializing to a revenue opportunity? How do you see that playing out into the future? And especially there in the context of, I think we will have, at some point, students going back to schools, at least for part of the time and so forth.

So education has been an area that we -- as you mentioned, and we've been really focused on. We've had over 100,000 K-12 schools around the globe sign up to use Zoom for free. What we have seen, especially as they've come back to the fall, that some of these schools have decided they want to go ahead and upgrade to the paid version because it gives them stronger controls in the admin and security functionality. In the -- for example, in the U.S., both New York and LAUSD, which are the 2 largest school districts in the country, are paying customers of Zoom. And that happened over the summertime as they realized looking forward to the fall that they were going to at least go back for at least initially using this product. And so that's been great. Education was the fastest-growing vertical in Q2 on a quarter-over-quarter basis. And so we see strength in both higher education as well as K-12. And Q3 is off to a very strong start as well as I think some schools are still figuring this out. And unfortunately, we probably all heard examples of our friends or even family that have taken their kids to college and have already gone and picked them up. A friend of mine took his daughter 2 weeks ago and a week later had to go pick her up because unfortunately, COVID has reemerged in some of these campuses. And so those universities are now looking for options.

Got it. And you highlighted things like poker games, and then you've -- which is, I guess, high value to some people, but it's more of a consumer-oriented interaction. And you have interactions where potentially the value of what Zoom is delivering in, like, let's say, the real estate market, coordinating open houses and things like that, probably far outstrips the value of just a monthly or annual subscription that you're selling. How do you think about the business model on sort of both ends? Is there an opportunity long term for Zoom to have like a consumer play that aligns to the value there and then maybe an offering to have something that more aligns with high-value use cases that aren't captured by your current way of selling?

Yes. So today, that would be captured through our app marketplace. So we have about 700 apps there today, and that has grown significantly since March. Right now, the focus on the app marketplace is really letting the developers have access to the platform and seeing what they do to it. But absolutely, there's an opportunity longer term to think about how do we monetize that. And if you think about these use cases, for example, whether piano lessons, there -- it's a highly disaggregated experience today. You're typically like going one place to sign up for your lesson, maybe going to Venmo or somewhere else to pay and then getting an e-mail link to your meeting. So thinking about how do we make that easier for both the businesses and the consumers. So that's what we're thinking about today. Nothing to announce yet, but certainly an area of opportunity for us in the long term.

Got it. And in the -- I guess in the consumer market, to some degree, like this is nothing new, but because you have had kind of free joiners on the meetings and so forth. But there are offerings out there, I mean, in the consumer market. Apple has FaceTime. Facebook has a video product. How -- you could see there's an upsell path for consumers. You could also see that like awareness building and so forth are important for a free offering there. And then maybe there's more of a monetization offering. Specifically in that segment, how attractive is that market to you from those variety of different ways of looking at it?

Yes. So as you mentioned, free users, free hosts have always been a very important part of the Zoom ecosystem. They are really the key to the early viral growth of this company and continue to be very important because every time, even if a free host starts a meeting, they have the opportunity to expose someone to Zoom. And I think what's happened in the last kind of 5 or 6 months is because of the awareness of Zoom grew so significantly and the ease of use, that it has been adopted by individuals that historically might have been using one of those 3 products that you mentioned. And yet they are -- because we also have a free offering or it's very attractively priced -- even if you have a one-host license, it's $15 a month, and you can have up to 100 people in your meetings. So I think because of that and then the reliability, it's -- I mean we have an enterprise-grade platform that even individuals understand. They're like, "Okay. It's so easy to use. I can launch this. I can have my friends join or have my family join." And then they know they can rely on the fact that they're going to have a really great experience. And it's really easy for everyone to use. We've heard anecdotes about meeting -- in these meetings where an investor told me that their 5-year-old was showing them how to mute and unmute themselves because they've been using it for school, like it's that easy to use, all the way up to people really happy that they can get their grandparents on Zoom to have birthday parties with them. And I think that ability to connect people like that is, first of all, it makes us very happy and proud to hear that. But I think it really makes people feel good that they know they can rely on Zoom to do that.

Got it, got it. And I've had a couple of questions come in here, and I had one on my own list here to ask you. And so I want to just maybe move that forward. There's obviously other -- forgetting the consumer market, which I think we covered, right, there's other corporate enterprise video options. The -- 2 of the big productivity suites have an offering there with Microsoft and Google, and there's some legacy offerings out there. How would you sort of break down the competitive advantage that Zoom has from the technical side? There's various aspects of your solution. You highlighted just end-user experience, but there's the hardcore compression and video engineering and so forth. How would you sort of break down the moats from a technical perspective that you see the company having?

Yes. So I think the key to remember about this is that Zoom was built from the ground up to be a video-first application. And when Eric founded the company, he spent 2 years with some of the best engineers in this industry focusing on building it. So everything from our data center strategy to the hardware that we're using to the technology and the user interface is oriented towards that, which is very different than how some of the competitive products were built, which they were built for a different purpose, and then video came later. As we've continued to progress and add things like Zoom Phone, it's all built with that same idea in mind, which is key to, first of all, delivering happiness to the customers and our employees. That's everything that we do at Zoom. And if you think about that, that means you have to deliver a product that is really simple to use, and it just works. And that is really at the core of everything that we do. And we've seen competitors react, absolutely. We have some very formidable competitors in this space that we respect. I think a couple of things we would say is it's a huge market, so there's a lot of opportunity for many of us to be successful. And we welcome that competition. It's good for the customer when there's a competitor. It makes us be better. It helps us -- prompts us to keep investing and innovating with the platform, which is what our customers deserve.

Got it. And when you think about the sort of the -- I mean I can think of a couple of angles here on -- you mentioned Eric spent 2 years on the design from the ground up. There's the sort of video sort of innards of the product that's obviously very technically challenging. There's computer science problems there that you're sort of solving new problems and doing it in a way that no one's done it before. You've got the UI side of it, which is -- that I think is a different discipline, less of sort of a hard science, more of a design and so forth differentiation. How do you think about sort of -- maybe that's not the right 2 angles to think about the -- how far ahead you are of the competition, but how do you articulate that from a competitive perspective in the various aspects of the offering?

Yes. There's a lot of competitive advantage built into, as you talk about, the underlying technology. So starting with our data center strategy, for example, let's just talk about that. So the data center strategy is built to reduce latency in the meetings. And the way that it does that is we have distributed data centers, we have 19 of them around the globe, and that each individual meeting attendee is routed to whatever data center is closest to them, and then that joins back to the meeting. And that's different than how the legacy providers do it from the standpoint of the way that they're set up, typically, the meeting is hosted in a data center, which is closest to the host. So if you start this meeting, Walter, it's going to be closest to you on the East Coast, but I'm all the way on the West Coast, so I'm going to have to connect all the way across versus the way it would work today on Zoom is you join our data center that's in New York, and I would join the one that's in San Jose. And that would optimize both of our experiences. And these are -- there's about 3 or 4 technology examples like that, that really, when you put them all together, make a huge difference in the latency and the reliability of our product. There's another thing which is about the adaptability of our platform so that every single attendee in a Zoom meeting has an individual experience that is optimized for their own network as well as their device. So you've probably all experienced this as you're at home especially and you're battling for bandwidth in your home. You probably see this, like Zoom will adjust in real time for either your capacity, your network capacity or whatever is happening on your device. And it'll in real time, like, adjust the size of your video. It'll indicate to you if your network is unstable, prompting you to maybe turn off your video for a little bit. And -- but you're having that experience yourself. It's not impacting anybody else on the meeting, and that's really different as well. It doesn't bring the whole meeting experience down to the lowest common denominator of the attendee on that meeting. And that's how the legacy providers did it because they looked at what was happening. And since they were only sending like a single stream, they had to reduce that quality down to whoever was going to need that modification, if you will. So when you look at all those things together, that's really what causes Zoom to have such a differentiated and higher-quality experience.

Great. And yes, I'll give everybody a little teaser from yesterday. We did have a CEO who was -- who joined who was in an area that was out of power, and he was on backup power and backup Internet and ended up actually having a session here that was okay. So I wouldn't say it was our best session yesterday, but it was okay. So on -- so I guess you've brought up Zoom Phone a couple of times and the video-centric sort of orientation that Zoom has around communications. As you're sort of furthering the rollout plans with Zoom Phone, how are you sort of mixing, bringing that differentiation of it? It ultimately is a video-first communications platform that's differentiated, but there are some customers where the requirement on the phone is just a -- pick up a phone, and it's a phone, and it has a dial tone. And that's been really the rules by which that UCaaS market has been written, even though you clearly have something different that you bring.

Yes. So Zoom Phone aligns to our broader strategy, which we believe video is the future of communications. And so what you get with Zoom Phone, first of all, it's integrated into your Zoom Meetings experience, which makes it really easy. If you've already been using Zoom Meetings, especially to roll it out to a new organization, and you have the client on your desktop or on your phone, it's simply a new icon. So it makes it really easy for IT organizations to roll it out. They don't have to deal with another vendor, and they can buy their -- now their phone solution from someone that they already know and trust. And then the -- what the experiences that you get is it creates another really simple way to have a video meeting. So you have not only, as you just highlighted, the very simple way to make a phone call, which is really important, but also then to accelerate that call into a video meeting with just one click. And so it's another way to start that very easily. And the other thing is we are now generally available in 40 countries around the world. And we've talked a lot about Zoom Phone in the past and said that one of the key opportunities for us was international availability. And we're very thrilled that we added another 20 countries in the last quarter. And we're seeing momentum already because of that. So in Q2, we had our 2 largest Zoom Phone deals to date, and both of them were outside the U.S. So really excited to see that international momentum. And looking forward, this is really key especially for our multinational customers that had the ability to -- before to do like a native Zoom Phone rollout wherever we were but then do a hybrid approach like a bring your own carrier in markets where we weren't yet GA. But now with 40 markets, we can cover the majority of where people are and allow them to do an end-to-end native Zoom Phone rollout.

And how has the pandemic over the last 6 months or so changed your -- how you're prioritizing phone and any changes it's had or evolutions it's had in terms of how you're bringing Zoom Phone to the market?

Yes. So our strategy around selling Zoom Phone is selling to our existing installed base. And that's been the approach we've taken since day 1. And certainly, in the early stages of the pandemic, organizations that were coming to Zoom were really focused on their business continuity planning, how do they get their employees home and how do they make sure that they can keep talking to each other. And that was largely focused on demand for our core meetings product. Now as companies are starting to think -- they've gotten that in place and starting to think a little more strategically about the rest of their internal infrastructure, we have the opportunity now to talk to them about Zoom Phone. And in our organizations, depending on the segment, some of our upmarket reps work on named account basis. So they have the opportunity to always be talking to them about the additional solutions that we have, including Zoom Phone. And then in our SMB and commercial teams, we have an upsell team. So they are the ones that now have the opportunity to go into that significantly increased base of meetings customers and talk to them about the advantages of now adding on Zoom Phone.

And do you envision a sort of a stage where you do start to sell Zoom Phone as a really start -- at least have Zoom Phone be like a front door to Zoom? Right now, you're doing the opposite, I think, quite smartly given how much attraction there is to the video offering. But do you think about an age where maybe it goes to reverse and you focus more on Zoom Phone as a starter?