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

All right. Awesome. Thanks, everybody, for being here joining us for day 1 of our Emerging Tech Summit. Here for this session, we have Kelly from Zoom. Kelly, thank you so much for being here.

Of course, thank you for having us.

Yes. I guess maybe just to start off, I think everyone knows Zoom at this point. But I guess now that we're beginning to return in-person events like this one here, what's kind of your perspective on the future of hybrid work and things returning to in-person? Are there kind of any early learnings that you've had from things beginning to change and open up last fall and so far this year?

Yes. So we have, are and continue to spend a lot of time with our customers and hear feedback from them about the future of work. And you back up, right, 2 years ago, we all knew how to work together in person and then there was this mad rush, and we all learned how to work together remotely. And now we're trying to figure out how do we come together in this hybrid environment. And it creates different challenges, right, especially how to make it to be inclusive. So we've all gotten used to this experience of seeing everybody's face on the screen. You can see their names. It's very, very clear who is talking. And if you're the person now that has this experience of not being in the room, it might not be as great. We've also heard from people that Zoom meetings give a voice to people that often didn't feel comfortable speaking up in person. And so how do we help solve all that. So there's a couple of things that we're doing around Zoom Rooms specifically. So Zoom Rooms is our conference room strategy. And there are a couple of new features and functionality we've developed during this time, one's called Smart Gallery. And what Smart Gallery does is it recreates that experience of if you're not in the room, if you're the person on video or if you're joining a video, you can see everybody in the room. So it's a combination of a hardware and a software, and it's great. It like slices up the room, if you will, there's 5 people in there, what you see is you see a view of the room, but you also see them all individually, which is really great. So if you're not in the room, you can tell who's speaking, you could see their facial expressions. And then we have a thing also called companion mode. And what companion mode does is if you walk into that conference, and so if you're attending the meeting in person, you can silently join your meeting from your mobile device or from your laptop. And silent is important because, you guys probably all experience, when you walk in the room, you turn on your device and it -- the speakers -- the mic goes crazy and you have that terrible experience. And so joining silently but giving you access to chat, to pulling the other ways you can interact with the meeting, really helps build that productivity. So these are the few things because we've heard from people that like invited their employees back to the office, and they had the terrible experience of saying, now, please go to your desk and Zoom from your desk, which is terrible, right? You're certainly defeating the whole purpose of bringing people together. And so these are the early learnings we've had so far, and I'm sure they're going to continue. We are actually reopening our headquarters on Tuesday. So I'm excited to see. I've actually moved. I've moved to Texas. So I'm going to be the experimental case for this, and we're going to see how it goes. We'll experience it right along with all of you.

No, that's great to hear, and it's a good overview there. I want to touch base a little bit on earnings call from the recent one. You changed how you're segmenting your customers as part of it. I guess what led to this change in customer disclosures? And how should we kind of think about the '22 year outlook and kind of the puts and takes across the customer bases there?

So for -- if I could just give a quick overview for everybody here who weren't on the call. So when we went public 3 years ago, we came up with this metric that we were disclosing, which is the number of customers with greater than 10 employees. And we use that at the time for a proxy with customers greater than 10 correlating to our direct business, and customers fewer than 10 -- with fewer than 10 employees, correlating to our online business. And if you go back pre-pandemic, the online segment of our business was 20% to 25% of revenue. Now fast forward to the last 2 years and the online business grew dramatically during this time. And what started to happen is that customer with more than 10 or fewer than 10 metric got really mishmashed, if you will, because we saw larger customers buying online. So it wasn't really working any longer as a proxy. So what we have now changed to is a metric we're calling Enterprise. And the definition of Enterprise is customers that are touched by either a direct rep, a channel rep or an ISV partner. And so they're being physically -- they've gotten a quote, they're interacting with someone on our -- one of our sales teams or partners. And then online is exactly that. Customers are now coming through the online channel. And the reason that we change this is because this is how we're thinking about the business now, where online has really emerged as a much more important part of our business in general. So pre-pandemic, it's 20% to 25% of the business. It peaked at 56% of our revenue at some point during the pandemic. And Q4, it was 50% of our business. And as you can imagine, the customers in these businesses are very different. They have different lifetime values. They -- like the enterprise customers buy annual or multiyear agreements. They tend to start smaller deployments and grow over time. Versus online, a lot of them buy monthly. They come and go. They typically buy up to 50 licenses online and more than that, they're probably talking to a rep. And so we really are managing these businesses differently and thinking about them differently internally. And so if this is how we're thinking about it internally, of course, we want the investors to have the opportunity to evaluate and think about them the same way.

Sure. It makes complete sense. I guess with the online business specifically, how are you thinking about kind of the churn in cohort dynamics for this next year? I think we've talked about 15 months, 18 months kind of being when -- there is a big change in terms of continued adoption there. But how are just kind of thinking through these dynamics for the outlook?

Yes, so again, if I can just give an overview for everybody. If you weren't at our Analyst Day last fall, we had -- we shared 2 really important charts and 1 talked about what are the retention rates at different ages of these cohorts. And when you hit 15 months, there is remarkable stability in those retention rates, even when there's a lot of volatility in the 1 through 14 months, once they hit 15 months, it's remarkable how stable that becomes. And then we showed another chart that shows how these pandemic cohorts are aging through. And what's going to happen is when we get to sort of the back half of this year, the large cohorts we've acquired through the pandemic, all of them are going to have hit kind of their 15-month birthday, and that will bring a lot of stability to the overall business. Of course, we're continuing to add new customers along the way, but the size of the cohorts is not as meaningful as those pandemic cohorts. And so what we invited to specifically is that we expect the overall guidance for FY '23 is 11% year-over-year growth. And we've said that the enterprise business will be growing approximately 20% and online will be flattish with some variability within the quarter. So that tells you that as we get to stable, that we're -- there's some churn in there still, but that the new customers that we're adding are making up for that. And then we have a lot of initiatives around the online business to continue to stabilize and the goal would be to return that business to growth in the future, which includes things like localized pricing and packaging, additional payment currencies, additional payment types, and then coming up with also -- and making sure that we have optimized the website for customers to buy additional products, et cetera.

Okay. That makes sense. On the enterprise side, I mean, it grew 38% in 4Q. I think you talked about net retention of 130% for the year, and you are guiding to 20% for this next year. What are kind of the dynamics that you're thinking about that comes in at that 20% number?

Yes. So a couple of things have changed pretty noticeably in the last couple of quarters. First of all, starting with customers, and we talked about this in the Q3 and the Q4 call again, which is customers have really returned to normalized buying cycles, which means they're doing RFPs, they're doing proof of concept. So there were about 6 quarters in there where sort of -- they were just making decisions very quickly and buying whatever they needed to keep their employees safe and efficient. And now they're really stepping back again and being more strategic about that. And that -- we see that in terms of elongated sales cycles, we see that in terms of linearity within our quarters. So we had a period of time during the pandemic where we had 1 quarter where like 50% of our bookings were done in month 1, which is amazing, right? Because it has a big impact to your revenue as well. We're back to sort of Q4 was, as you would expect with a SaaS company, much more back-end loaded. And then we're also seeing sales rep productivity change. It's not back to where it was pre pandemic because they have the benefit of brand awareness, they have more products in their bag, but it's certainly not where it was during the pandemic. Which was not sustainable any way, like that there's no way they were working around the clock. And so we knew this was going to happen at some point, and that the outlook for FY '23 is built upon all those assumptions that we're seeing in the market.

Okay. No, that's very helpful. I guess part of the sales rep productivity kind of part of it, you did talk about there's more tools in the bag for them to go sell. How are you thinking about what could be an incremental lever to growth for this year? Is it primarily around Zoom Rooms coming back to in-person, Zoom Phones has been getting really good traction and Contact Center is brand new out there? So yes, can you help us walk through those?

Yes, absolutely. So it's a combination of all. So this is really a transition year for Zoom as we're moving from being this killer meeting app to a platform. And you just outlined many of the products that are contributing there. I just want to touch on Zoom Phone for a quick minute. I mean we had an amazing Q4, 550,000 seats of Zoom Phone sold. That's not only a record for us, but that has never been done in the industry ever, that number of seats sold in a quarter. And that just shows the momentum that we're seeing. And then Zoom Rooms, absolutely, as -- we were just meeting with investor right before this. And she was talking it out like going back to office like, "Oh yes, I can tell already, we're going to have [ back the ] Zoomers," right? And we're going to see more and more of that as people start to really have this experience. And then Contact Center is brand new. As you said, it became GA 2 weeks ago. So we have very conservative contribution assumptions for that in FY '23, as this will really be a learning year and I think a building year in terms of features and functionality, but certainly excited about the prospects of that product for the future.

Sure. I guess what are you seeing in the dynamics with -- around Zoom Phones in the market that led to Zoom moving into the contact center market? I guess how often are you missing out on opportunities by not having a bundled solution out there?

Yes. I mean I don't know that we were missing out on opportunities because we had great partnerships with all of the contact center providers out there. But if you step back and think about the power of having a natively-built, fully-integrated, modern-architected video, voice, chat and contact center solution, nobody has that. And it really -- for the long-term growth of this company, it's a really big differentiator. And that's why we ultimately decided this was the next leg in the stool, if you will, from a unified communications perspective and are really excited about the future and what we can offer to our customers.

Okay. No, that's great to hear. Maybe shift gears a little bit, touch a little bit on competition. I think one of the things we typically hear from investors is concerns around Microsoft Teams and competing with them in the market. I think people view Teams as kind of a free solution. How do you kind of view them as like an either/or proposition where customers are choosing one or the other? Or how are you kind of viewing the competitive landscape with Microsoft there?

So first of all, in most markets, 2 leaders emerge, and we have always expected that it was going to be Zoom and Microsoft. So this is playing forward exactly as we expected, and they are absolutely a great partner to us, and we can talk about that in a second, but the most formidable competitor for sure. And where we partner with them is we do often hear from customers, they want to use Zoom for certain things, most commonly Phone and Meetings, and they want to use Teams for other aspects of it and that's usually chat. So we have an integration where you can one-click launch a Zoom Meeting or a Zoom Phone call from within the Teams user interface. You can also launch a Zoom Meeting from within a Microsoft-enabled conference room. And this is really evidence that it's working. If you go look at the last Okta report which highlights what software people are using, so 45% of the Microsoft-enabled accounts have Zoom in them, and that's up from 42% the previous report. So that shows you this strategy of being compatible is working and giving customers a choice to use what they want. And customers want choice, right? They don't want to have only one. And that's where I think the usability, the reliability of Zoom really is a differentiator. And yet for some places, Microsoft is good enough. And yet you're going to continue -- I think -- so I think you're going to see this dance that we're going to keep partnering and competing and that delivers happiness to our customers, it's what we're really focused on.

Yes. I mean I guess it comes down to a best-of-breed versus kind of the platform approach. And I think we've historically seen best-of-breed really works.

Yes.

First, to maybe switch gears a little bit again. I think Zoom has been pretty disruptive from a pricing and contracting perspective out of the market. Do you foresee kind of any shifts in the pricing or contracting philosophy going forward, particularly for some of the new areas like Phones and in Contact Center?

Yes. So our internal philosophy is always we win based on product and we don't lose based on price. And we have a very efficient gross margin structure that allows us to be able to do that. And to support free customers as well as being very aggressive on pricing when we need to be. So this is -- we started this with Meetings and with Phone. If you look at our list price for both of those 2 products, we're about half of that of our competitors in the space, and we've also announced a very aggressive price point for Contact Center. And that is absolutely indicative of our strategy of bringing high value to our customers. We want them to see a tremendous ROI on our products. I often hear from customers, "We would pay more for Zoom," and we love to hear that because that means they are seeing high value. And the way that we want to continue to grow our revenue per customer is by selling them additional products. And when they see a high degree of value, when they trust us in what we've delivered before, that gives them confidence that they should continue to expand. And we see it happen. Like one of the slides we showed at Analyst Day showed that the land and expand strategy, which we often use. We had 2 examples, one customer from their original deployment to 4 years later were spending 4x what they had started with; and the other one was, I think, 3.5 or 3.7, something like that. So they do. They build over time, and it's just worked really well. So we like this approach, and we think it works really well for our customers and for Zoom.

Okay. We have about 10 minutes left, I want to make sure that we get to some questions from the audience. But before jumping into that, I just want to talk about the investments in the go-to-market that you're making. I guess what are kind of the core opportunities that you're seeing today to put incremental dollars to work? And how does the channel fit into those investments?

Yes. That's a great question. So especially for FY '23, we see tremendous opportunities still outside of the U.S. International is a really big growth driver for us. So in terms of go-to-market, specifically sales capacity, we will be adding more -- on a year-over-year basis, more will be devoted to international than U.S. And then the international channel is also really important investment area for us. So we spent kind of the last 2 years building out the U.S. channel. We have 18 master agents, and that has worked really, really well for us. But the international channel is in very nascent stages, so really focused on that. You -- on the call, we announced the partnership with Deutsche Telekom, and you should expect to see both more carrier partnerships as well as master agents outside of the U.S. coming. And then on the marketing side, really focused on -- we historically spent a lot on brand awareness. But we're in a fortunate position not to have to do that any longer. And so really focused on more targeted product marketing. So making sure that everybody knows about Zoom Meetings, knows about Phone, knows about Events, knows about Contact Center, knows about Rooms, and that's where you should see the investment going forward.

Okay. That makes sense. Just on the contact center side, how does the go-to-market for that differ from what you've seen from your other products so far? I guess what can you learn from Zoom Phone and the early success you've had there to drive some of those Contact Center conversations?

Yes, yes. So I feel really great about the go-to-market strategy for Contact Center, meaning we are ahead of where we were like when we were introducing Phone, because the approach will be similar to Zoom Phone and we've learned a lot over the last couple of years. So it's an overlay team. So we have our core Meetings account execs, they all know very well how to sell Meetings. And then because Phone and Contact Center are more technical sales, we have these ninjas that come in and help them when they need to. The great thing is that a lot of our Zoom Phone overlay team has sold Contact Center in the past. So there's a lot of overlap there. In fact, the leader Graeme Geddes, who -- he runs both the overlay team for Phone, Rooms and Contact Center, he's very knowledgeable in this space. So while we have more investment to do in building out that team, we already have a head start because we have that knowledge in-house, both from a structure as well as the specific product knowledge.

Okay. No, that's great to hear. It seems like a great jumping off point for those people to go sell. I want to ask about capital allocation, made a few tuck-ins in the past, tried to do a bigger deal last year but also focused on internal investments. How are you thinking about the incremental dollars and where you're going to put capital to work going forward?

Yes. So there are a couple of really important areas of investment that we're focused on. R&D being one of them. We are -- in my view, we were underinvested in R&D. We have been for the last couple of years. Just because of the rapid acceleration of revenue, we haven't been able to keep up with the hiring and the investment. The long-term target for R&D is 10% to 12%, and we were under 7% last year. So that's a really big area of focus. Sales capacity that we just talked about is really important. And then M&A, we are focused every day on thinking about how could we accelerate either talent acquisition or technology acceleration as well. So I would expect that M&A will be a much bigger part of our strategy. We've done 3 acquisitions in the past, mostly focused on talent. But going forward, you could expect to see technology tuck-ins that make sense in terms of accelerating technology. And then also, I don't know if you heard on the call, but we have -- the Board authorized a share buyback program as well, up to $1 billion over the next 2 years. Given where the stock price is, we think that makes a lot of sense.

Okay. And I guess how are you thinking about the buyback part of it? Is it going to be pretty opportunistic? Is it kind of set cadence? Yes, is your philosophy then...

Yes, we implemented a trading plan so that there's consistency in that, and we -- it's actually already -- it's already executing.

Okay. No, good to hear there. I want to ask a little bit around the -- some of the contracting and billings. It's not a great forward-looking metric there. I guess you're guiding to 1Q billings being down year-over-year. I guess what are kind of the dynamics that are playing out there that's leading to this? And on the other side of that, what are the metrics that investors should be looking at to think about the forward-looking business?

So as a reminder, the reason that billings is not a great forward-looking metric for us is because of this 50% of our business that's online and those customers, a lot of them, are buying and paying monthly. So they don't never show up in that metric. And -- so it's very different than most of the SaaS companies that you probably are familiar with and that use billings as a good forward-looking metric. And I get asked this a lot. And I think the best that I have to offer is the guidance that we give, which -- in trying to break out these metrics for all of you, you start to understand what's the growth profile that's happening in each of the 2 halves of the business today and why, and sharing with you how we're thinking about that is really the best we have to offer. Over time, billings may become a better metric. However, even pre-pandemic, it wasn't great when online was still 25% of our business, right? It just isn't the same. But because -- the other complication is the seasonality of our renewals right now that became very heavily front-end loaded during the pandemic, which is why what we're trying to do, we gave color around deferred. We don't haven't historically guided to deferred, but we gave color around deferred on the Q4 call and we gave it again on the -- sorry, the Q3 call and the Q4 call, because we understand that it isn't intuitive based on other companies and we want to make sure that we're giving enough color to help everybody model and understand what's going on in the business.

Okay. No, that's very helpful. I guess should RPO or current RPO be a bigger consideration? Or is it kind of similar dynamic...

It's the same. It's exactly the same. And again, over time, if the enterprise business continues to expand as an overall percentage of revenue, then it may become more relevant, but that's going to take some time.

Right Okay. We only have a couple of minutes left here. I want to make sure to touch on some of the margin profile and how you're thinking about that. I think we've talked about online being a really good cash flow generator and having some really good margin dynamics from there. As this kind of begins to shift away, how should we think about what the long-term trend would be for the margin outlook as enterprise begins to ramp up as a bigger part of the mix?

Yes. So we owe all of you an update on our long-term margin profile, which we will give at Analyst Day in the fall. We kind of planned that last year. Because of the potential impending acquisition that was happening, it's just going to make sense. So we will update that in the future. I think the bigger impact you should expect on gross margin -- sorry, on margin profile in the short term is absolutely the increase in R&D spend as well as the expansion in sales and marketing spend. That's what's going to have the immediate impact. And you've seen us -- we guided down on margins from where we were in Q4 to FY '23, and that's really the impact. Over time, if there were to be a significant shift in the business, what you can think about is online, the real difference is not the full sales and marketing but it's the actual sales commission portion and sales expense portion, right? Because the online team -- sorry, the online business generally doesn't have -- is that no one is getting paid a commission associated with that. And so that's the benefit and the differential you would see over time, it will become a much bigger part of the business.

But I guess on the free cash flow side, since those are shorter-duration contracts, there should be some offset there in terms of the enterprise being more annual and having more [indiscernible].

Yes, I mean, again, that it starts -- there's a lot of considerations in there because of the timing of renewals, like there's a lot to consider. But over time, if online -- what that would do, it would increase the duration of our contracts, which were -- would happen over time. And then it would potentially spike the cash flow depending on the renewal cycles.

Right. Okay. No, that makes sense. I guess just as we think about the broader portfolio of Zoom, have Zoom Chat in there, have other solutions like that. Where should we kind of think about the platform evolving from here? Because it seems like Eric talked about quite a bit around more investment coming from a product perspective.

So there's certainly the opportunity to continue investing in the existing products. So Contact Center is brand new. Chat, we have really been focused on the last couple of quarters increasing and improving that feature and functionality there. Phone continues to be a huge opportunity. Eric talked about on the call workflows as well. So integrations with other third parties, potentially, there's more work to be done there. And then there -- Eric also talked about wanting to increase the pace of new product introduction. We had previously targeted kind of a new product every 2 years, and he wants to accelerate that to 1 every year, 1 major product. So you should expect that there's investment happening in the background on new products as well. They just haven't been disclosed yet.

Okay. No, that's good to hear. I think we're running up against time here, but it sounds like there's a lot coming down the pipeline that we'll hear more about at Zoomtopia and the Analyst Day coming up in the fall. So Kelly, I want to thank you so much for being here. And I want to thank everybody in the crowd for being here today as well.

Thank you, everybody.