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

Welcome to the Wells Fargo TMT Summit 2020. Your session will start momentarily. Please note, this session will be recorded.

Hello, and welcome to the 4th Annual Wells Fargo TMT Conference. My name is Phil Winslow. I'm a software analyst here at Wells Fargo. I'm very excited to have executives from Zoom join me today. So as I said, this is very meta, Zoom on Zoom, very exciting. So Tom and Kelly, thank you for joining us.

Yes, thanks for having us. And thanks to Wells Fargo for being one of our earliest financial services customers. We really appreciate your ongoing support and thrilled that you're running your conference on us today.

Yes. And well, thank you for making it happen. I'm not sure if you know 10 years ago, we would have been able to do this, so thank you. The -- and so I guess, obviously, lot to talk about today. I mean 2020, sort of what a year has been. I mean, dare I say, sort of the year of Zoom. We've seen quite a shift in digital and cloud this year, and Zoom has obviously been a key ingredient in facilitating this evolution.

I guess the first question is, a, how do you respond internally at the onset of this pandemic? What steps did you, Eric and the leadership team take to scale the business? And now that we're 10 months into it, what have the learnings been that you think you're going to apply going forward?

Yes. So I can remember the day. It was kind of March 15 when the world changed for Zoom. We had already been working at home for almost 2 weeks at that point. So that transition was easy for us because we already lived in this technology every day. But the dramatic increase that we saw in demand, first of all, it's a true testament to the sheer will and commitment of our Zoom employees because they rose to the occasion without question. And that kind of March 15 to May 15, I think was sort of a blur for all of us. It was just constant working for everyone to make sure that everybody that had a need for Zoom, our customers, our prospects had access to it. And we also turned quickly to some partners. We saw this spike in demand, and we were unable to keep up with the capacity in our data centers on our own. And so we turned to some of the public cloud providers, and they were amazing in terms of responding to help us meet the demand and even prioritizing our capacity, which was amazing to see. And then in other parts of the business where we started to see immediate need like the teams that do the provisioning, which is actually turning on the service, or the team that was responding to technical support questions, we also brought in third-party resources as we really needed -- we couldn't scale up our own head count quickly enough to keep supporting our customers in the right way. So we turned to other third-party resources to help us with that. Now as we progressed past May, gotten through the summer, what we've been able to do is start now to build out our own head count. We've added over 1,000 employees during -- since March. So it's also a really interesting fact when you think about it that about 1/3 of our workforce today now has started during this period of time where they've never stepped foot in an office, and they've never met their manager in person. So we've had to really think about how do you onboard a team and how do you create community in this environment. But we're doing it. And we continue to be committed to delivering happiness to our customers' employees, right? That's always at the forefront of everything that we do at Zoom. And so thinking about, okay, meeting the scale but also, of course, balancing out -- delivering happiness to our investors as well. And so you've heard some of this talk about on the call last night as we are now focusing on a longer-term project to build out more capacity in our own data center infrastructure, really focusing on hiring and investing in R&D and sales, which we can talk more about, but now shifting from some of those short-term decisions that we made in terms of augmenting talent to making sure we have the right team, full-time head count to meet those demands.

Yes. Actually, let's focus on it because, I mean, the timing is kind of interesting today, with having reported earnings just last night. Kelly, from your perspective, what would they sort of jump out of you this quarter from the CFO seat about Q3 when you obviously compared them with the past couple of quarters?

Yes. I think there's -- first of all, the growth was stronger than we expected, and that is kind of the difficulty of forecasting in a pandemic, right? It is -- there are certainly unknowns out there, but we were very pleased with the top line performance that was driven by better-than-expected sales execution, deals better than they've already done earlier in the quarter as well as improved retention as we see people hanging on to their licenses. That's been one of the challenges for us as well is trying to get a handle on -- especially the segment of our customer base which has fewer than 10 employees, which has been the most volatile during this period of time, a lot of them, about 50% of them, are paying us monthly, so they're monthly contracts, and trying to understand exactly what that retention ratio looks like, but very pleased to see it improving during the quarter. So that was great. And then if we look to the P&L side, further down, there were a couple other things we talked about in the call in detail last night, which is gross margins. So we saw impact to gross margins due to 2 things. One of them is an increased percentage of free users as compared to paid. This we see though as our responsibility and actually our honor to be able to provide, for example, Zoom for free to 125,000 educational institutions around the globe. And we saw a spike in demand as they all went back to school in the fall. We had seen a decrease during the summer. And then it was very obvious they were back, and they were back in a more structured way than they were in the spring. So we saw an increase in demand, even with the same number of schools online. And then also the increase in brand awareness has just driven more people to our platform. And we're continuing to do things. Like here in the U.S. on Thanksgiving, we lifted the 40-minute limit to allow individuals, families, anybody to come together over Thanksgiving and feel connected. And then the other part of the impact to the gross margin is, as I talked about, the leverage of the public cloud and that we're on a multiyear journey, I would say, to add capacity there. It's just going to take some time. We really appreciate the flexibility we get with the public cloud providers. So as it gives us flexibility to scale up and down, again, as we saw the decrease in demand in the summer and then scale back up in the fall, the cloud providers were really key in helping us meet that. So that's part of what the impact was as well. And then the other area we talked a lot about is R&D. So R&D as a percentage of revenue was 3% for Q3, which is much lower than our target -- our long-term target of 8% to 10%. And so we are really focused on committing to increasing hiring there, diversifying our talent pool, looking globally for the best talent possible. And that will be a significant area of focus for us for the next couple of quarters.

Yes. And somebody -- I was talking with somebody after you hit the numbers last time, he's like probably just too much revenue. I mean I don't think many CFOs would -- and people will take that problem, I will put it that way.

Yes. Believe me, these are high-quality challenges that we have ahead of us. I absolutely agree with that. But yes, there is a little bit of that. But like keeping pace with the investment that we want to make for the long term, we just haven't been able to do it at the same rate of the revenue -- that the revenue is growing.

Exactly. Now let's drill down to the gross margin for a minute because that's also a question I've been getting last night and today. I mean, obviously, you talked about sort of your responsibility -- or you view your responsibility as good global citizens but also you have the business objectives, too. Why don't you provide us just more sort of color on the path of gross margins because -- provide us some color on sort of longer term. But can you just walk us through that, just give us some more?

Sure. So what we talked about last on the call is that we expect our gross margins to be consistent with Q3 levels into the foreseeable future as we don't expect any dramatic changes. And as I said, we are -- the thing that's within our control absolutely is this build-out of the data center infrastructure, which we are working on, but that takes time. And so we are continuing to do that. But again, we will always continue to partner with the public cloud providers. And then on the free service provision, again, we are really committed to supporting the global community in this -- especially in this time of disruption and have made no clear decision about when and if is the right time to potentially not be providing engagement. Hopefully, it's at a time when it's safe for them all to return to the campus, right? That's what we're really striving for to happen as quickly as possible. Even with that said, though, I think that they will likely go back, even in schools, in some sort of a hybrid approach. Like I think the joke of the day, we've heard it a couple of times, is like there's going to be no more sick days for like your kindergartener, your daughter, right? If she's 6, she's going to get on a Zoom and be able to attend class but not be there infecting her classmates. I also think that we're going to see opportunities for pockets of paid usage even in those free schools for things like PTA meetings or parent-teacher conferences. They're going to see efficiencies that they get from the platform in other aspects of the administration of education.

Yes. I will say just from my perspective, I was on a Zoom with one of my daughter's schools, and it was a PTA meeting. Like well, we've never had as many people show up before because before, you had to go there. But now it's sort of like they took the friction away, next thing you know, I think it was 4x the number of people that they've ever had. Good stuff.

Yes. See, that's so great to hear because that's exactly what we're hoping for is that they're going to find the right balance here. I mean everybody wants their kids to go back to school and be able to be with their friends again and the classmates but, certainly, we see an opportunity to leverage Zoom even in those models along with them being in a classroom.

Got it. So yes, a shout-out from Far West K and my daughter's kindergarten at Grayling. So thank you for that.

That's great.

And so she might bust through the door at any moment, you never know. School's out. But I really want to dive into now the product side, your comments on R&D, because Eric has long talked about his vision of unifying video communication and phone. At Zoomtopia, you shared more of a complete vision of sort of video as a foundational platform for unified communications as an ecosystem really. So a few questions here, just kind of in this theme. First, can you provide us an update on Zoom Phone? How is adoption progressing? It's been out there for actually a while now. But similar as my initial question, what have you also learned over the past several quarters in terms of Zoom Phone?

Yes. So Zoom Phone, just to remind everybody, is about 1.5 years old. And first of all, we're really excited that Zoom Phone was included in Gartner's latest UCaaS Magic Quadrant as a leader. So very excited to see that, and we have seen very strong progress. In fact, in Q3, Zoom Phone was the fastest-growing product segment quarter-over-quarter. So that's really exciting to see. We also continue to break records with our largest deal size for Zoom Phone in Q3 as well, so really continuing to see strong growth and momentum in that product and are excited about the future. As a reminder, our strategy around selling Zoom Phone is we sell into the installed base. So all of those new meetings customers that came to us in Q1 and Q2 now create a tremendous opportunity to upsell them into Zoom Phone. And that's what we're seeing, and that's what we predict for the future. And then one of the other aspects of that is the international expansion, so international availability. Zoom Phone is available in 44 markets around the globe, and that really is key for us as well as all of our multinational customers want to have -- they want to have a native Zoom phone implementation globally are able to do that. With 44 countries, we're hitting most of the major markets, so very excited about the international potential there as well.

Got it. And then sticking with Zoom Phone and actually going back to sort of the question I had on the call, too. And I know we talked about this on the call back -- last night. I thought your response was really interesting. But I just sort of thought maybe there'd be a difference between sort of the smaller customer adoption of Zoom Phone and maybe less friction there versus maybe the larger customers. But you made an interesting point about also those larger customers, nobody being in the office. And so maybe now [ it's time to change ]. So maybe if you could sort of dissect that for us.

Yes. What we've seen is, in Q1 and Q2, customers were really focused on business continuity planning, right, how do they keep their employees safe and productive at the same time. Now what we saw in Q3 and into Q4 early, we're starting to see them more strategically think about what is their future of work and what does that remote work environment look like. And Zoom Phone is a really important part of that. As you said, they have offices with desk phones sitting empty right now. And Zoom Phone is -- it's a perfect time to adopt Zoom Phone and to get rid of and move from that on-prem legacy PBX solution and give their employees access to the most current public -- sorry, most current cloud PBX solution out there. And it's such an easy adoption. If you're already using Zoom Meetings, it's just one more icon on your client, and it's integrated with the platform. They don't have to learn anything new. I mean we're actually all -- if you've used the integrated audio with a Zoom meeting, you have used the backbone of Zoom Phone. That's how simple it is. All you need is one more icon with the dial pad that gives you the ability to direct dial someone. That's really all it takes to learn how to use Zoom Phone. It's that simple. And so it simplifies things from the IT team's perspective. They get to consolidate vendors. It's much easier rollout. And Zoom Phone is very competitively priced. So we want them to see the value in it as well.

Got it. Now switching gears a bit, too, from an ecosystem perspective. You recently announced Zapps, effectively an app store that enables customers to leverage your other third-party applications: Atlassian, HubSpot, Box, ServiceNow, et cetera, within the Zoom client. How should we think about Zoom's intentions really to evolve as the big and enabled productivity hub? And maybe help us understand that opportunity.

Yes. So Zoom Apps are really -- I mean this is so exciting. So it's the ability now for developers to integrate their application into a Zoom meeting. So take the Dropbox one, for example, which is in a prototype right now. It would allow you to join a Zoom meeting but then go into a Dropbox space and share and collaborate with someone within that space within your meeting. And so this is different from the apps that were built previously in our Marketplace, which are really built to connect outside the meeting. This is really allowing you to collaborate. Or another one, for example, is Arianna Huffington's Thrive, which allows you to take a break during your meeting. And so these are really cool. There's about -- the goal is to have 30 of them generally available in Q1. So we're in early stages of this, but it's really, really exciting, and we're looking forward to all the amazing apps that are being developed. There's -- I think there's a waiting list of like 3,000 people -- or developers that have applied to be part of the Zoom Apps ecosystem.

Wow. A waiting list, that's a good problem to have. Another one.

Yes.

A similar question here but on OnZoom, which is your online event platform engagement, a marketplace where paid users can create, host and monetize virtual events. A similar question here, can you walk us through the strategy and monetization opportunity?

Yes. So to get to how we came to think about OnZoom, you have to think about our broader customer segment. So we have seen tremendous growth during this pandemic in the customer segment with fewer than 10 employees. If you go back to Q4, it was 20% of our revenue. And we announced last night, it's up to 38% of our revenue on a much larger base. So there's a significant number of customers in there that are hosting thousands of events every single day. And you probably have all experienced this in your household, whether it's piano lesson, a fitness class, whatever it is, a cooking lesson, but it's a very disaggregated experience right now where you probably go somewhere to find the event information, you go to another location and pay for it, and then whoever the host is, he's going to send you a link to the event. And you also have no way of knowing what other events might be going on that you're interested in. And so the goal of OnZoom is to bring all of that together in a seamless experience so that the host can simplify their role in this, and we can take some of that administrative burden from them. And then the attendees, it's a seamless experience for them as well as a discoverable directory of other events that are out there. So if you guys haven't done it, you should just go look at the OnZoom website. It's still in beta, so we're in very early stages, but you can get an idea of some of the events that are out there. And eventually, it will be -- once we get to GA, it will be kind of a whole community unto itself of events. And then we have not announced what our monetization strategy is around this yet. What we're really focused on right now is ensuring that the platform itself is delivering happiness to both the host and the attendees. But certainly, we have lots of ideas around how that will eventually work. And just like our other approach to pricing, it will be priced to ensure that there's value for everybody in that ecosystem. So we're really excited about the potential there.

That's great. And then we've got 10 minutes left here. So if anybody listening also does have a question that you want me to ask Kelly and Tom, e-mail me at [email protected]. Now a few more questions from me as probably some of those questions start to come in. Kelly, you touched on the customers which have fewer employees. Obviously, been hugely successful, up again as a percentage of other businesses in Q3 here at 38% versus 36% and, as you mentioned, a two handle a year ago. How do you think about that segment? Because it historically had higher churn, but this is also, similarly, a very low penetration market, I mean, in terms of usage of video. How would you think about sort of the puts and takes here where it's like, okay, churn was high but it was also underpenetrated, maybe you had the channel in the past? Just walk us through just how you think about that.

Sure, yes. So first of all, this has been a great opportunity for Zoom during the pandemic to see the growth there. And this is where we've seen the most innovation from our customers in their usage of Zoom. So that's also been really exciting to see. They are -- about 50% of those customers are buying on monthly contracts. So by that nature, they have been the most volatile in terms of a cohort. They're also, though, very efficient for us because the majority of them are actually buying online without going through the touch of our sales organization. So it's a very efficient segment, customer segment, for us. We have been obviously paying a lot of attention to the trends that we see here. We've also been very focused on working with them, working with those customers, to help them see the value and potentially upgrading from a monthly to an annual contract. And we have seen some progress there. We've done a lot of work around optimizing our online buy flow to take out any friction in that buying process for them as well to make sure that's optimized. We want it to be easy and effortless for them to have access to the product whenever they need it. And then, of course, our sales team is there to support them if they want to upgrade or expand. But it is a really interesting channel for us that we really had very little previous to the pandemic and excited about the potential. I mean it's really why OnZoom was created, it was to serve that segment of the customer base.

Yes, interesting. I mean -- a follow-up to that, I'm actually a personal customer of Zoom, too, like obviously, less than 10 employees. I use it for my daughter's piano lessons, to your point, et cetera. One of the things I've noticed is, obviously, one of the issues you talked about was converting a lot of these monthly users to annual and receive those e-mails. But one of the things I've noticed, too, is also you've been marketing to me Zoom Phone. And so I guess 2 questions here on sort of a retention aspect. One is, to your point, converting those folks from monthly to annual, and there's a pretty distinct historical delta in churn there but also selling more products, i.e., attaching Zoom. How are you sort of approaching both of those when you think about sort of this less than 10 employee segment and not just retaining but growing and then upselling it?

Yes. So certainly focused on converting them from monthly to annual as they see the value there. That is our primary focus right now. But yes, the opportunity to continue to sell more product. This is how -- we talk about this a little bit, but we are very competitively priced in the market when you look at our list prices for both Meetings and Phone, and that is absolutely by design. We want people to see the value in Zoom and that the way that we grow revenue per account is by selling in additional products. So even to individuals, the opportunity to upsell Zoom Phone not only adds more revenue to the top line but it also increases your retention. When we see customers with more than one product, their retention rate improves pretty dramatically. And so that's what I mean by adding to the revenue but also increasing the stickiness factor by adding an additional product to your Meetings license as well.

Got it. All right. I'll pause for a moment as I've received a couple incoming questions here. The first one, I'm sure you going to be shocked by this one given the timing of some other things that are happening at this moment, but how does the recently announced Salesforce acquisition of Slack change the competitive landscape in your opinion? Do you feel the need to react or develop or enhance your offerings outside of video?

Yes. So both Slack and Salesforce are great customers and partners of ours. Our Slack API integration is one of the most downloaded integrations that we have in our Marketplace. And we -- if you look at all 3 of these companies, right, we're all focused on enterprise technology but just little different aspects of it. And I don't think that this acquisition change -- really changes that at all. In fact, in terms of the partnership, it probably simplifies it in a way because now there's really 2 parties coming together rather than 3 from that aspect. But we greatly respect both of those companies that are best-of-breed in their segment or in their product line. And we obviously believe in the best-of-breed strategy, which is why we have worked so closely with both of them in the past, and we expect to continue to do so in the future.

Got it. Another competition question. Microsoft Teams has seen significant adoption. How do you think about Zoom's positioning, including Zapps and OnZoom relative to Teams?

Yes. So we certainly hear from our customers that there are aspects of Teams that they want to leverage. Most commonly, what we hear is their chat functionality. But they also want to leverage Zoom for the areas that they see us do better, which is Meetings and Phone. And so we do integrate with Microsoft, and that works really well. We want to make sure that our customers are able to leverage the products that work best for them but do it in a seamless way. So we do have an integration on the interface to integrate Teams chat with our Meetings and Phone products. And you also can leverage Zoom, start Zoom from a Microsoft-enabled conference room as well. So that's just a couple of the examples of how we partner closely with them, even though we do see them, obviously, as a serious competitor as well.

Got it. And then one last right in here, then I'll go back to my questions, but it's about Zoom Rooms. With nobody being in the office, how are you thinking about enterprises changing to Zoom Rooms and the opportunity for that in '21 and beyond?

Yes. It's been really interesting. While companies have their employees outside of the office, they are taking advantage of this opportunity to upgrade their Zoom Rooms, to reconfigure the workspace. I think, as everybody is thinking about what does the future of work look like -- and I don't think that anybody thinks we're going back to the way things were before, and that's why I'm really excited about some of the technology that was announced at Zoomtopia, including things like the Smart Gallery. I think one of the biggest benefits that have come out of this pandemic is all of us getting used to the democratization of communication. Like, you look at the screen, right, all of our squares is the same size. And it more evenly spreads out the voice and the ability for people to contribute. And one of the things I think people have really been thinking about is, if you go back to an environment where some employees are working in the office and some are working outside of the office, how do you maintain this inclusivity that has been established rather than the problem that we've all experienced, right, of having people in a conference room and you're the one on the screen looking at the back of their heads, right? And Smart Gallery is the technology that solves that. It creates the same experience that we're having here today even when some of the meeting participants are together in a room. And so I'm super excited about that. There's other technology advancements that we're having like remote reception, voice commands, things that we really think about that, as we start to migrate back to an office environment, again, enabling our customers to feel like they're doing that in the safest way possible for their employees.

Got it. No, that makes sense. We've only got a few more minutes here, but I've been asking this question to everyone. And I guess, Kelly, this is sort of appropriate for you, too, as I mentioned, Zoom being sort of part and parcel to some of the transformations that we're seeing this year. But if you -- if we're sitting back here again maybe in person in Las Vegas, on the stage in 5 years, what do you think your -- you could look back on and say, hey, back in 2010 -- versus 2010, when I thought this trend or this technology or this product was either more transformative, happened faster, et cetera, than maybe you'd expected this year?

I think 10 years from now, what we're going to talk about is communication. It's not going to be video. It's not going to be voice anymore. It really is going to be this is the way that we communicate across all aspects of our business, our personal lives, our social activities and that we've realized how much video augments and adds to every experience and that we're not willing to have a communication without it any longer. And that when we stop talking about it being a phone call, it's really -- it's a video. It's a video that we're having, and this is how we communicate. And I think -- I feel like the pandemic has certainly accelerated that. And I think we're -- once we get out of this and we're all at a different place where we can meet again, I don't think we'll ever go back to an experience where we'll be satisfied with just talking on the phone, like this is just so much better.

Yes. Well, my daughters and I are big fans of Star Wars, so we're looking forward to Zoom holograms.

Okay. All right. We'll work on it.

I will gladly pay for that offering when it's time. All right. Well, our time's up. I mean these 30 minutes went superfast. I have probably 10 more questions I could ask you all. But Tom, Kelly, thank you for your time. And like I said, thank you for making this event happen.

Well, thank you. Thank you for the support. We really appreciate it.

Thank you, Phil.

Okay. Talk to you all soon. Thank you.

Bye, everybody.