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

All right. Welcome back, everyone. We're going to begin the virtual fireside chat portion of the program now. And to restart us, we have the lovely pleasure of having Kelly, the CFO of Zoom, join us. Good morning, Kelly, and thanks for joining us today.

Good morning. Thanks for having me.

Congrats first on completing the first year of being public. I know you just anniversaried that. And for what Zoom has accomplished thus far, I mean, it's been an exciting probably 9 months for you guys, given what's going on. And we thank you for all that you've done for all the organizations out there. I mean it's become a Zoom world.

But maybe just to start it off, Zoom was founded on the idea that it needs to be cloud, and it will be a video world 1 day, too. And clearly, the world shifted directly into this thesis. And so how far into the cloud and video transformation do you think we are? How much has the pandemic accelerated this? And are customers looking to move their on-premise conferencing and PBX systems to the cloud faster than the typical 5- to 8-year cycle that we see in -- that we've seen historically?

Yes. So absolutely, we believe that video is the future of communications. And what's happened over the last 6 months is nothing short of remarkable in terms of the adoption across this whole industry and that we've seen an acceleration that was unexpected but has been amazing as not only large organizations, but small businesses and individuals have really embraced video communications and integrated into all aspects of our lives. I'm sure all of you are seeing that not only for work, if you are now working from home, but most likely, your children, who are also learning remotely. Maybe your weekly, whatever it is, book club or poker game or piano lessons, which are all experiences that are going on in the household where I'm living now. And I think we've seen that people have just really realized how effective and efficient this way of communication is and how much better it is to actually sit here and see you, Jim. It's so much nicer than just being on a call together. And we've loved it, of course. We've loved it for a very long time, but are so happy to see people around the globe embracing it. And what we saw in the sort of second half of Q1 and early Q2 was really companies just focus on business continuity planning and thinking about how do we keep our employees safe and productive at the same time? Now what we've started to see is, okay, people kind of got those initial stages set and are really thinking more strategically about how is this going to be for a while. I think, first of all, we can talk more about the future of work, but I think organizations are really thinking about, this is something that's going to be embedded in our lives forever. And now how do they strategically build this into their workplace, how do Zoom Phone fit into that, and also webinars. Webinars, just like we're doing right now, have become a much more significant part of our business as organizations are looking for not only investor conferences like this but also users' conferences. You can see the dates for Zoomtopia behind me here, and that's going to be completely virtual. So really excited about that. We were on the forefront in terms of doing a road show and also our earnings call via Zoom. And already now, it's become the norm just in the last 6 months.

Great. As far as a permanent work from home-r in the last few years, it's definitely something that I've enjoyed of having more video chats, and it makes my life easier. And my wife actually gets to see me a little bit more, which is something that she enjoys, I guess. I don't know what. But -- and Zoomtopia, looking forward to it. It's a good event for anyone that hasn't ever gone before. But Zoom now has over 370,000 customers which, based on your prior trends, is about 6 to 9 years of growth being brought forward and accelerated actually. Very impressive. And the way we think about it is that you probably have between 500,000 to 1 million businesses out there, which is a wide range still. But what does Zoom need to do, given how much in favor of the market it is right now in order for Zoom to land the kind of remaining customers that are out there?

Yes. So there's a couple of things. We -- early April -- sorry, March, April, early May, we were just focused on keeping up with the demand as quickly as possible. Now we've had a chance to kind of catch our breath a little bit and really focus on, okay, to your point, what else do we need to do? And there are a couple of key growth drivers, which are mostly consistent from pre pandemic, but they continue to be expansion into the upmarket. And what that means for us is adding capacity in our sales organization in the U.S. and internationally as well. And we added 500 total employees in Zoom in Q2 and expect to continue hiring at kind of the same levels in Q3 and Q4. So part of that is, of course, our sales organization, which is really important to keep adding capacity into. International is a huge opportunity for us. International grew over 600% year-over-year. We saw that in Q2. And the accelerated brand awareness that Zoom has achieved during the last 6 months has been especially helpful from an international perspective because the way that we have historically gone into new markets is by seeding that market with marketing dollars, first by brand awareness, maybe digital advertising, so that when we put salespeople in there, they're going into a warm environment. And now because of the brand awareness, it's allowed us to really accelerate and put salespeople anywhere that we see demand. So we're going into markets like Latin America, for example, that probably wouldn't have been on our road map for expansion for another couple of years. So that's really, really important for us. And then Zoom Phone is also a really key opportunity for us. We have seen momentum in Zoom Phone over the last couple of quarters, but it hasn't grown at the same rate that Meetings has, of course. But as our strategy is to sell Zoom Phone into the existing installed base, all of those new customers just create an amazing opportunity for our Zoom Phone sales organization now to go back in and help them upgrade to Zoom Phone as well.

Got it. And so last quarter -- I do want to touch on the international piece in a little bit, but last quarter, the churn was better than you anticipated, though you remain conservative on it, picking up with kind of the commercial base that you have. I mean how much of the base should we think about as at risk of churning off in a return to normal environment? Do you expect a return to kind of what used to be normal at this point over the next couple of months, quarters? I mean is it like the wine -- I do a wine virtual tour now on Thursdays, and like, does that go back to normal? Or do we have the virtual offering stack?

Yes. So I think that in order to talk about this, we need to think about it kind of in 2 different segments of our business. So we have our small business, commercial and upmarket teams, which in Q2 was 64% of our revenue came from that segment. Historically, it's been about 80%. And this is the segment of our customer base that is typically served by our direct sales organization. And over the last 6 months, the buying patterns of that segment of customers hasn't really changed, meaning they historically have bought on annual and multiyear agreements, and that hasn't really shifted. So I don't expect changes in retention rates in that segment, even post pandemic, someday, when we hopefully go back to having more opportunities to meet together in person. And the retention rates in that segment of our customer base is much, much higher than the segment of customers with 10 or fewer employees. So customers with 10 or fewer employees, historically, has been about 20% of our business. It was 30% in Q1 and 36% in Q2. And this is a segment of customers, which most typically buy online, and a lot of them have monthly subscriptions. And this is a segment, the only segment we've actually talked most specifically about churn, which was in our S-1. We disclosed it at that time. The churn rates for this segment, so really specifically, customers with fewer than 10 employees, was 4% per month. And what we modeled as we were coming out of Q1 into Q2 was we modeled that churn at a much higher rate. So we -- what -- the way we've talked about is we model it in multiples of that rate. And what we saw actually happened in Q2 was that the churn was better than that. Retention was better. Everyone talked about it, retention was better. And so churn was lower. And it was lower than we had modeled, but much higher than historic rates. So somewhere in between that. So we keep playing forward while we're still in this stage of pandemic, where we have limited in-person interactions. We are kind of thinking it's going to sort of stay at that Q2 level or a little bit higher, but certainly not going back to where it was historically. And why this is important is because obviously, this is becoming a much more significant part of our business, and it's the most volatile. Now if you want to fast forward a year, 2 years, when hopefully, things are in a much more normal state, what do we think about that segment? And I think that Zoom has forever become integrated into our lives. And unfortunately, the longer the pandemic goes on, I think the more true that is going to be. We're all becoming accustomed to what you just -- you talked about using it for your weekly wine tasting. In the household where I live, it's weekly piano lessons that are now happening this way. And it's very effective, right? And that piano teacher, he used to drive here, I mean, Southern California. He used to drive here to come and deliver lessons and then have to get his car and drive somewhere else. And now he can just keep doing these lessons. And I don't know if he's doing it, but he could just line up lesson after lessons after lesson. It's a much more efficient way for these small businesses to be conducting their services. Also, like one of my employees was talking about her children taking tutoring lessons via Zoom now, where they were driving historically to a Sylvan Learning center. It's like, I'm never spending another hour in Bay Area traffic to take them to that lesson because this is just as effective. So I think that certain industries, certain businesses are going to adapt to at least having this be a hybrid approach. They might -- they might return to having some provided in person, but I just can't imagine that we're ever moving away or coming to a day where video communications is not part of all of our daily lives in some aspect or another.

Got it. Yes. I mean we talked about saving on cost, but I mean, saving on time, you can't buy time. It's really hard to, at least. So it's -- definitely agree with you there. And that was great color on the commercial customers. One vertical that we maybe haven't talked about though is school's back in session. Although the school buses, I think, I've seen one go down my street, and some of the universities have already experienced some issues, including those nearby as me. What are you seeing from the education vertical at the start of the school year now compared to what we saw back in March and April? And how should we think about the company being able to monetize across education? Is it just the big universities that seem to be paying for it? And there's some confusion out there with investors as to where does Zoom give it away for free versus where does Zoom have to monetize?

Okay. So great. So we started last spring when the pandemic hit, we announced that we would give Zoom for free to basically any K-12 around the globe that -- who had a need for it. And we've had over 100,000 schools around the world sign up for that. With that said, education was our strongest performing -- our fastest-growing vertical in Q2 on a quarter-over-quarter basis. And for example, in the United States, both New York and LAUSD signed up to be customers over the summer, and those are the 2 largest school districts in the United States, so. And the reason, the compelling reason for them to sign up even though they had the free version, but to move to the monetized version is the admin and security rights that come with that as well. And that is not inconsistent with what we've seen from other school districts. So we've come into Q3, and we've continued to see strong demand. As you say, we've probably all heard stories. I have a friend who dropped his daughter off at the university 2 weeks ago and a week later had to go and pick her up because her roommate had already contracted COVID that quickly. So unfortunately, we don't have this under control, at least in the United States. And we continue to see the need for K-12 as well as universities to leverage Zoom. And -- okay, so let's -- again, let's just be hopeful and assume that we're going to come to a place where students can start to go back to campus in some way. I think that for a long time, it's going to be a long time before they can go back in the density that we were experiencing before. We're going to talk about the workplace. I think it's going to be a very similar situation. But then a hybrid approach then works well, where some of the students are in the classroom, some of them are online, and they do that in conjunction. And I think this is how schools have to be thinking about it. I know I have a niece who's a teacher, and in her school, they're talking about this and trying to [ get around it ] because they just can't envision a way that they're going to be able to safely send all their students back anytime soon.

Got it. Got it. And so one of the things that is popping up kind of in the media side of things, more so than, I think, on the business side of things, is this idea of video fatigue. And so obviously, education is going to help kind of that video usage of the platform with the school being back in session. But how have you seen kind of the usage of video across Zoom over the last few months? Is video fatigue real or just hype and myth?

So I guess the way that I would say it is, I don't know that it's video fatigue. I think that we have all had to adjust to a new normal, which is not what we're accustomed to. Like, you were talking about you've been working remote. For many of us, this has been a very dramatic shift. And I think having to find the right balance in your life in terms of spending time with your family, making sure that you have a punctuation to your day, like, this is what we hear from our employees. It's very -- as we've all gone remote for a period of time, it's very easy for your day to just extend and extend and extend. And just because you're not going out to dinner with your family doesn't mean necessarily you should be available to be on a meeting at 7:00. And that's kind of, I think, what happened, at least in the early days of all of us working from home. So I don't know that it's attributable to being online. I think it's more attributable to we haven't quite all figured out what this new routine is. And what we're really focusing on at Zoom is helping our employees understand and set boundaries, think about what makes you happy during the day and carving out time for that, whether it's having breakfast with your children or one of my employees is going on for a run at lunch time. Again, where I am, I take my sister's dogs for a walk every day at 5:00, and that just gets me off the video, off the computer, out in the real-world for a little while. And I think that's what we all have to do, and making sure that you are taking time. It can be very easy to be back to back to back to back in meetings on this technology. And while that's very efficient, making sure that you are still having some communication, like, we were catching up right before we jump live on this. You got -- you have got to take some time to have that human connection and not have it be just about work and business all the time.

Right. Right. Well, you and I have other connections, like, we share the best day of the year being June 2 as our birthday. Isn't that right? And we also -- we have the same kind of getting off the desk, walking the dogs thing. But so we seem to share a little bit more, Kelly, the more we get to talk. So a question I've been getting since you reported is, what's next, right? Like, in our discussions following your report, we talked about phone, webinar, rooms and devices as a service now. I know it's hard to pick a favorite kid, but is there any way to rank which will have the most near term as well as the largest impact on the business?

Yes. So obviously, Meetings is the core of our platform and it's really the base of everything that we do. Well, I think a lot of our forward potential and growth potential comes from Zoom Phone. Our strategy around selling Zoom Phone is to sell into the existing installed base. So that's what's really, really core to that. I do think for the long-term growth, Zoom Phone is really, really important. So let's just talk about that for a quick second. We are very happy with the momentum we're seeing there. It hasn't grown as quickly as Zoom Meetings have during the last 6 months. But in Q2, we signed our 2 largest deals to date, and that was -- beat the record as the large deal that was signed in Q1. So that's really exciting. And we are now generally available in 40 markets around the globe. So we added 20 more during Q2 and already seeing momentum there as those 2 largest deals that we signed in Q2 were outside the U.S. So really exciting. And why that's really important is that for our multinational customers, this now allows them to have a true native end-to-end Zoom phone experience wherever their employees are. So we always had an approach where we could do a hybrid model with bring your own carrier. And for some customers, that was great. For others, they prefer to wait until they can have a true native experience, which allows them to have all the functionality on the platform. And so in 40 markets, we have most of the big ones covered. The goal is to get to 50 markets by the end of the year, and we're tracking to that. And then we feel like we'll be in an amazing situation to really compete for everyone's business on Zoom phone.

Got it. And so on the topic of Zoom Phone, because I agree, like, Zoom Phone is your bigger opportunity. I mean it's a huge market, and it seems like customers want to consolidate across the voice and video specifically, so. But the question really is always, well, what makes Zoom Phone different compared to what else is out there? What needs to be done in order to get more traction? And why couldn't we see attach rates be 100%, for example? And I know, like, you're going to give us an update here at Zoomtopia about where the attach rate is. So I won't press you on that, but any color on that would be appreciated.