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

Good afternoon, everyone. Before we get started, if you are a member of the press or media, please disconnect at this time. This is a restricted line. Any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time, please disconnect. Please note, today's call is being recorded.

Hey there, and good morning. Thanks, everyone, for joining us. This is day 3 of the Wells Fargo TMT Summit. I'm Michael Turrin, Software Analyst here at Wells. We're very pleased to have a great list of software companies, including our next session. This is with Zoom. We have CFO, Kelly Steckelberg, with us here today.

I'll start off with some questions. If anyone tuned in does have something they'd like for me to ask, you can shoot an e-mail over to [email protected]. I'll do my best to layer those into the conversation as well. First, Kelly, thank you for joining us and for keeping your best of background into the holiday season.

Thank you for having us.

Excellent. I mean, there's a lot to discuss. We've only got 30 minutes. You've put in Q3 results. Before we go into some of the details, I do want to congratulate you on the success you've reached thus far. I want to make sure it's not lost on everyone here, you're lapping 300% comps. We come into the second half of this year, and I think that's certainly important to highlight. But maybe we'll just start with Q3 because it's still fairly fresh and relevant, and I'll let you just kind of start with some of the major highlights, takeaways from your end. And then I can ask some follow-on questions from there.

Yes. So first of all, thank you. And just to remind everybody, we did announce results of over $1 billion. So very proud of the fact that we've become a $1 billion-a-quarter revenue company, and that was 35% year-over-year growth. But I think even more exciting is to talk about some of the things that are happening in the platform. We recently announced Zoom Events, which is our -- your event software platform, and very excited about the early results there. It's very early, but I think that that's really exciting. We're just talking about before this, the opportunity to start to have events like this, both in person and virtual in the future and Zoom Events will be a really important part of that. And then we're starting to see organizations really think about what is the future of work, and Zoom Phone and Zoom Rooms play a really critical part in that as, especially the conference room. Having a really strong conferencing strategy as organizations think about how they're going to keep their remote employees and their on-prem employees, if you will, together in an inclusive way becomes really important. So excited about the momentum that we're seeing there as well.

Yes. No, that's great. That's great. One of the things that came up on the call was just what's the expansion rate. And it's been -- I mean, it's been -- I mean, you just had to say greater than 130% since you've been a public company and call it a day. You're running into just a few different moving pieces in the model, and so maybe you can characterize what's happening in your expectation for that metric on a go-forward basis? So we can just talk about the mix between new and existing customers and how that's likely to trend into the coming year.

Yes. So just to remind everybody on the call, we said that in Q4, we expect the net dollar expansion rate to be modestly below 130% for the first time. We've had it the above 130% for 14 consecutive quarters. And there -- one of the main reasons for that is just to think about this metric is a trailing 12-month metric. And the denominator itself is becoming very large, right? We just gave full year guidance for over $4 billion, so now that's the -- effectively almost the denominator that we're working with here to get over 130%. So just the law of large numbers is starting to impact us. And then when you look back during that period of time, this is -- depends on whether -- how you're looking at it exactly, but it's for customers with greater than 10. And some of them, we -- in that cohort, we've added new customers a lot, but we have seen also expansion through Zoom Phones and Zoom Rooms. It's just that, that denominator itself, and when you -- when we're growing, say, 35% year-over-year, which is what we did in Q3, that's coming from a mix of new customers and expansion both. So expecting the net dollar expansion itself to maintain over 130% is probably not realistic.

Yes. And then the other attribute, I think just worth highlighting, is just the renewal base and the shape that you're seeing as you roll things forward. Can you just help characterize the shape of what you're expecting there as well?

Yes. So this is really important because this is very counterintuitive to the trends that you're probably all used to seeing in every SaaS company and the way that Zoom was before. So if you think back to what happened during calendar 2020, we had this huge influx of customers in Q1. And then the largest -- our largest period of bookings was in Q1. And then it was a smaller set of bookings in Q2 and Q3 and in Q4. So now we have this huge renewal base that is exactly the inverse that you would expect at most companies. In addition to that, we have a selling practice. When a customer comes to us, like, if they were a new customer in Q1 and in Q3, they come and they want to either add more seats as they add Zoom Phone, we make that contract be coterminous back to Q1. So it's kind of continuing to build on this trend of Q1 being our largest renewal period. And what that means is that is now the largest renewal period. It sets the largest billings period. It sets the largest period for additions to deferred revenue, which are then amortized through the year. So it's creating a lot of trends that are very contrary to most companies. And it's going to be like that for a very long time for Zoom because of this period of co-terming against it, the way to shift that trend is to be adding new customers that are adding in like Q2, Q3 and Q4, and that is happening. But it's going to take many, many, many years to offset that this trend that we've created last year.

Yes. No. I mean, I think it is important to highlight because, to your point, it's different, it's nuanced. Has that created a recalibration internally? Like, for Zoom maybe it's nice you get the holiday period, not the same Q4 and then you have Q1 on the back and everyone comes back fresh and ready. But have you kind of internally recovered?

No. I wouldn't say that, but yes. I mean, Q4 is still very, very important to us. We're rounding out the year, of course. And we have a -- we're a January fiscal, so we get the benefit of having the December year-end for companies that might be closing up budget cycles and then also the impact of January where our reps are really running to achieve their quotas and that they're accelerators. So no, we -- I don't want to give any impression that we take any of that for granted.

I would say that.

It does -- it is interesting in that Q1, the focus on renewals is a really -- is absolutely important for us, and we then really aligned as a company. We have our reps aligned to that. They have a component, a bonus component aligned to that because it's really important. And we make sure that everybody in the organization is ready for that period of time, absolutely.

Yes. You also had Zoomtopia in September, and you hit on some of the product announcements at least on events early on, but maybe you can also just provide us with some of the highlights there. I mean, obviously, there's a lot to talk about on the product side, but maybe we can just start with your impressions of the event and the takeaways there.

Yes. So the first thing I would say about Zoomtopia that was really exciting was that it was run on Zoom Events, our new events platform. So it was really, like, its debut and trial run, and it went really well, so that's very exciting. Also, just the reach. We had over 30,000 attendees, which is always amazing to see that many people coming together to not only celebrate Zoom, but also to learn and to hear from customers and speakers. So that was -- we're really pleased with the outcome of that. And Zoom is at this -- we're at this really interesting phase of transitioning from being this killer meeting app to a platform, and I think Zoomtopia was a really amazing time to highlight that and to highlight all the opportunities for the products ahead. And this includes not just Zoom Meetings, but also Zoom Phone, Zoom Rooms, Zoom Events. And then, of course, we announced Video Engagement Center as well, which is a really important part of our future strategy. And Video Engagement Center is our answer to the contact center solution, and we expect that to be GA in the first half of next year.

Yes. Let's start with Phone, 2 million seats in fairly short order. So I mean, that's a tremendous uptake as a starting point. When you think about the what's next, I mean, you have a tremendous base that you can continue to bring Phone into. But where are your efforts going? Are they kind of continuing to shore up the partner base? Is there more you can add on the product side? Or what are the main drivers of Phone success in the coming periods?

Yes. So we are very pleased with the momentum of Zoom Phone, but there's still a huge opportunity ahead. So our strategy for selling Zoom Phone is to sell into our existing installed base. And when we looked at it earlier this year, when you look at it on a deal basis, the attach rate for Zoom Phone was single digits. So that tells you there is a huge opportunity to continue to sell into our installed base. And then, of course, the TAM itself is very large. And as organization -- the pandemic has really been a compelling activity for people to think about getting their phone systems of -- they're on-prem into the cloud. So we're excited about that. And then the channel absolutely is really important for us. So we spent, let's say, the last 18 months, really focused on building out a partner program in the U.S. It's been very effective for us. And now we have a very concerted company effort to take that program and expand it internationally. And that is really important to the future growth of the company. When you think about Zoom when we were primarily focused on meetings, we were primarily a direct-led organization. And we've learned Ryan Azus, our CRO, has been very helpful in helping us all understand how important the channel is to the growth of Phone as it's often a different buyer that is used to partnering with someone in the channel and so we're investing in building that out internationally now. And that's an effort that will be -- really a big focus for FY '23, and we're excited about the opportunities there.

Got it. Got it. And then I mean you hit on contact center, and so I think some investors thought, well, Five9 came and went, and so maybe contact center aspirations for Zoom subside as well. And it's certainly not the case. I think it's been clear from the commentary and the conversation that you're still focused on that market. So can you talk more about the aspirations there and where you see the opportunity for Zoom?

Yes. So that's exactly right. Well, we're certainly not -- we were disappointed by the outcome of that. It wasn't something that was critical to our overall future and we are focused now on building Video Engagement Center. It's really important. It is an important part of the platform itself. When you think about organizations, enterprises, medium-sized businesses, having a contact center that is also natively built and integrated with their phone system is a very, very powerful option, and that's what we're focused on. And when you bring video into that, you think about how you can absolutely change even the way that we all interact with support agents today. Think about having a repairment if there's something in your house that is broken, being able to show them so they see it. Having someone like if you're doing, wanting to buy furniture for your space, bringing in a designer or a sales rep into your home via Video Engagement Center, these are all the use cases where video can really accelerate that time and also make it much more efficient than having to go somewhere or having someone come into your home itself. And so the product is being developed today. It's in beta, and we expect it to be generally available in the first half of next year.

That's great. Yes. I mean, one of the other things that stood out to me on the call was you mentioned your belief that the R&D expenditure can just kind of step up as you focus on organic innovation here. And so is that tied to some of the contact center innovation you're describing here? Or can you just kind of speak more to the R&D efforts and your thoughts around what to expect from the financial side as well?

So our long-term target for R&D as a percentage of revenue is in the range of 10%. And ever since we had this dramatic revenue growth last year, it's been well underneath that. And in fact, it's still right around 5%. And so we are continuing to focus on hiring engineers as quickly as we can on a global basis. And there are many opportunities for them to focus on. Accelerating engagement center is absolutely one of them, continuing to focus on additional features and functionality for the core platform, including Meetings and Chat is a really important strategic focus for us. And while already made huge progress on Zoom Phone, there are -- there's opportunities to continue adding features and also international expansion. And then there's Zoom Rooms as well. Zoom Rooms, as we had customers reopen their offices, they're getting the feedback on the opportunities and the challenges that they are facing by having a hybrid workforce. And one of them, which -- and we've heard from more than one customer is they've invited their employees back to the office. And yet, we've all got very accustomed to this experience where, when you join a Zoom meeting, you can see everybody's face on the screen. And when they have some employees, they're seeing the conference room and some that are working remotely, it's not a great experience for those that are not in the room because they don't see that. And so we've been working on innovation in Smart Gallery, which creates this similar experience by showing a full view of the room, but also the individuals that are in it as well. So that it's creating inclusive experience for those that are not in the room. So there's a lot of innovation happening around Rooms today as we're really anticipating what are the needs of the future? What's it going to look like as we continue to evolve this hybrid work approach? How to -- what's the role that Rooms play in it? And how do we support that?

Yes. I mean it just seems like you have a lot of product optionality and potential to expand ahead. I mean, that feels like it could go directly into education, if you chose. So how do you prioritize the R&D road map? Because it seems like talking about phone contact center, I could see verticalized solutions falling into this or more in terms of the marketplace. So you have this amazing base and an R&D engine. And when you look at that list, what informs sort of the prioritization of what's next for you?

So a big part of prioritization is listening to our customers. There's always a portion of every release that is devoted to customer requests. And -- so specific customer request, but also just listening to them and hearing where there are opportunities and their challenges are helps us set our road map in general for them. So thinking about, okay, what do we need? And also making sure that we -- our platform itself is available in all the markets that we want to be able to offer. So listening to our sales reps. What do we need here or what is the request coming from them? So it's a lot of informed from our reps, our customer advisory board and information that's coming in through like our customer success management as well.

And when you think about organic versus inorganic, as part of that discussion, from your perspective and just your M&A framework and things that you might be looking for because we know it's a tight market for talent. And so there are ways to supplement that as well. Same question, just kind of your decision process and framework that you're using to kind of assess those options.

Yes. So we have a whole framework across like all the categories of the platform and indications of whether our intention there is to build, buy or partner. And continuously looking proactively and reactively at opportunities to accelerate either the technology. So building that rather than building it, can we buy it and accelerate that, and also it add to our challenge. We have done a few acquisitions to date that we've gotten great teams out of. We're very excited about that and continue to look at that as opportunities as well. We recently added [ someone ] to my team that came from another bank, and he's been amazing in terms of helping us accelerate this. And I think you'll see it be a really key part of our strategy in FY '23.

Great. There is a question that came in from the audience. I want to loop into the conversation here. So I guess it's generally just around competition. I think this is specifically asking around Microsoft Teams, and there was an essential package that I think they announced. It looks like it was, I think, intended to come in at a lower price point. And look, you have tremendous ubiquity. And so I think part of the question is probably just how you think about competition, coopetition and coexisting with some of these other solutions. But the question here is on Teams specifically as well. So I'll let you answer however you choose.

Yes. Yes. So Microsoft, we absolutely see as both an amazing partner and our competitor. And probably for the future, we expect there to be Microsoft and Zoom that are really the key players in this space. And we hear from our customers that they want to use aspects of Teams and aspects of Zoom together, and we do have an integration with them where you can launch Zoom Phone and Zoom Meetings from the Teams' interface. In terms of kind of the point about price and competition, it's interesting because what we've done in Zoom, the approach that we've always taken is to create a price point that we think creates a lot of value for our customers. And we hear that from them often that they would be willing to pay more for Zoom than they do. And that's not our strategy. Like raising prices has not been what we've focused on in the past. It's always been building more revenue by selling more products over time, expanding the platform that's available to them. And we focus on bringing more value to our customers by adding features and functionality that we don't raise the price for. It just becomes included in that. And that's our focus. And we are differentiated in the marketplace by our usability, by our reliability. And there are, of course, other -- there are organizations that other products work well enough for either a free product. I think, specifically, Teams sometimes is perceived as being free. Although, of course, somewhere in the organization, someone's paying for that. But we want to make sure that our customers get to use the right products for them when they need them, and that's why we focused on this partnership approach that we have not only with Microsoft but with other competitors as well.

Yes. That makes sense. Here's the question that we're -- neither of us are expert enough to really give the fully informed discussion on. But I think everyone is thinking about, obviously, there's a lot of back and forth in the market. And so we see headlines on things like new variant. And I think everyone kind of wants to kind of understand the rush to a conclusion there. And so while you or I can never kind of predict where the world heads in that direction, I'm wondering if there are things you're watching or indicators you've observed or learned from given you have an international base? We've seen this a couple of different times. And so just in terms of how you're thinking about Plan A and some of the different scenarios that could play out here, are there ways that you're able to assess that and at least come to as informed a view as you could hope in that situation?

Yes. So [Technical Difficulty] our customer base, we really have -- the customers are served by our direct organization, our direct channel organization, and these are large organizations and we have not really -- over the last 18 months, we saw a huge influx of those customers early last year, but they have been relatively consistent in their buying patterns, in their renewal patterns, which have been very strong, and they continue to generally expand through new products. The online segment of our business which largely self-serve, and they tend to not buy as long -- many of them buy monthly contracts. They are the most volatile and the most reactionary to what's happening around the globe. And we see some evidence of -- we talked about this on the Q2 call coming into Q3, and then Q3. It's seasonality in this segment of the business, but also there is some response in there to COVID. And what's happening, though, which is good, is we talked about at the Analyst Day that once that tenure specifically gets past kind of 15 months of their life, they really tend to be much less volatile in terms of retention rates. They stay, they stabilize. And so that segment of our business specifically is aging very quickly and getting half kind of the cohorts that came to us during the early stages of pandemic, and they're stabilizing. So -- but I think that means as those are people that have just integrated Zoom into their daily life. They see the value in it, and they're going to keep using it for a period of time no matter what's happening around the globe. So I can't predict what's going to happen. All I can say is that we started to see stabilization in a certain segment of our business. I think in the earlier tenures, they tend to be the ones that are the most volatile and reactioners, and we'll just have to see. And we hope there isn't a major variance. Again, and in the meantime, though, we'll do everything we can to keep the world connected.

Yes. You've done a great job with that, so it's amazing. I'm sure we all have many thanks for that for the continuity you've enabled. We touched on it from the R&D side, but you gave just tremendous growth and tremendous margin over the past couple of years. When you think about the balance from a CFO perspective of that going forward and you have all these growth opportunities in front of you, how attentive are you? Like, how do you prioritize the growth initiatives versus just keeping some degree of stay safe margin, given you put this amazing balance of profitability here as well?

Yes. So there are certainly areas that we are continuing to invest in. We're -- as a company, we are absolutely focused on top line growth and continuing to take market share and innovating around that. So the areas that we are focused the most on investing and prioritizing our R&D, as we talked about, and sales and marketing. We still see opportunities for adding to sales capacity around the world, as we talked about earlier, extending our channel program. And marketing, we are doing much less general brand awareness than we did before the pandemic, but there are absolutely opportunities for more concentrated product marketing around new products in the platform. The areas that we're very focused on being as efficient as we can is COGS, and thus the resulting gross margin and G&A. We want both of those areas to create opportunities for margin expansion and/or room for more investment in the growth areas. And that's how we prioritize spending. And as we're working on our FY '23 plan, how we are communicating that internally in the areas that we really want to focus on from an investor perspective.

Yes. No, that's great. I mean, we've seen just a lot of questions and conversations around just the labor market, the sort of the age of employee empowerment, the ebbs and flows of hiring in both technical and sales-related talent. I mean, Zoom has a household brand. I'm sure that helps. But in terms of characterizing both your ability to stay the course here today. And when you think about sort of planning into next year, understanding you're not guiding for that or anything at the current juncture, what are your observations of that environment? And if there are things that have helped Zoom stay diligent in the hiring process, I think that's interesting to hear as well.

So everything that we do at Zoom is focused on delivering happiness to our customers and our employees. And we make our decisions from that lens. And I think that's very helpful. It sounds very obvious, like most organizations -- I mean, who are the 2 most important constituents? It's your employees and your customers. However, that's not how everybody makes decisions, and that's a learning -- has been a learning for many of us as we come to Zoom. And I think the way you can see how that has served us and how we've been able to recruit. If you just look at R&D, if you look at the expansion of R&D spend over the last year, that is largely driven by expansion in our headcount. So continuing to focus on -- we hold a very high bar, and yet we have an amazing technology that people get to focus on and opportunities ahead, right? There's a huge future ahead for this company. And I think when prospects or future employees see that, they get excited about that. And we haven't changed as a company. We've been very steadfast in maintaining our culture during this time, even though we've grown to almost 7,000 workforce around the globe. We are still really focused on high degree of transparency in the organization, as I said, delivering happiness to our employees. And that is a very attractive thing to employees when they want to come to a company that feels like that and is really focused on delivering employee happiness.

Yes. Eric has done a great job of building goodwill there for a long time. The pre-pandemic cog was a very common thing that you would see Eric participating in, and that's admittedly unique. So I'm sure that's helped. I think we just have time for one more, and I'll kind of turn it to you for just closing thoughts as we're heading towards the end of the calendar year, at least. As you're kind of focusing your priority areas and investors are thinking about next year and the major milestones that might come along the way. What would you sort of steer the conversation towards and help investors take away?

Yes. I would just remind every we're excited about this transition that we're in, from going from meetings to platform. And there are new products that are just in such early stages, including Zoom Events, very excited about Video Engagement Center and what that's going to bring to the platform of the future. And then Zoom Phone and Zoom Rooms are a really critical part of our long-term strategy. And we're -- Zoom is going to be a very important part of the future of work. I often get this question, like, we were 18, whatever, 20 months into this pandemic, how is it that everybody that needs Zoom doesn't already have it, but they don't. When you look at our penetration rate of the Global 2K, for example, and less than 20% are spending more than $100,000 a year with us, that tells you that there's significant opportunity out there, both externally and internally, when you look at our attach rates with Zoom Phone and Zoom Rooms. So we're really excited about the future and how we're going to continue to support organizations as they make this transition and keeping the world connected.

That's great. Kelly, that's a great note to close on. Very much appreciate you taking time out of your busy schedule to spend time with us, and thank you to everyone for joining here as well.

Thanks for having us.