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

All right. If everybody can please go ahead and take their seats. We're going to go ahead and get started shortly with our lunch keynote with Zoom. We're very pleased to be joined by Zoom CFO, Kelly Steckelberg.

Thank you. Thrilled to be here.

Good. So maybe just from a high level, to start, can you talk about your top priorities, what you're most focused on right now as we head into the second half of Zoom's fiscal year?

Yes. So hi, everybody. Nice to see you all. We are really in the midst of this transformation of moving from being the meetings company that everybody grew to know and love during the pandemic to a true unified communications platform. And the platform very broadly includes a whole suite of products, of course, and we can talk more about all of these in detail, but Zoom Meetings, Zoom Chat, which is a product that has been included with Meetings for a long time. But I would say it's probably been a little bit underloved. And this is our persistent chat product, and we're spending a lot more time and attention and it's becoming much more strategic for us. Of course, Zoom Phone, which had an amazing Q2. Zoom Contact Center, which is showing a lot of promise very early in its life. It's only 6 months old, but very pleased about how that product is progressing already. And then Zoom IQ for Sales; as well as Zoom Events and Whiteboard. So we have this whole suite of products. And so the platform is front and center. And the platform then goes on to serve -- and sorry, I failed to mention Zoom Rooms -- which goes on to serve 2 other key areas of focus for us, which include hybrid work. So ensuring that as organizations are thinking about the future, and I think we were just having this discussion, right, like it's probably never going back to the way that it was before. What does that look like? What do organizations need to keep their employees engaged, productive? And part of that is, of course, Zoom Meetings and Chat, but also Zoom Rooms and the proper technology there, and we can talk about that like things like Smart Gallery, we now have workplace reservations within the office. So really integrating those experiences. And then last but not least, the third pillar for us is workflows. So as you start to think about how do you spend your day. So at Zoom, I spend my day in Zoom. I spend it in Chat, in Meetings. But then there's also this other aspect of what if you're working on a project and you're working on Asana, rather than going outside of your Zoom client to go over here and to launch it, you can now launch it through Zoom Apps, and that becomes really important. And so in thinking about how Zoom continues to extend into like areas of productivity, and workflows, right now, we're doing that through Zoom Apps. So those are the high-level company initiatives that we're focused on. Of course, that distills down into very -- focusing for Q2 -- for the second half, I should say, which include continuing to focus on our Enterprise and Zoom Phone. And then for those of you that listened to the prepared remarks last week, Online was a disappointment for us as compared to our previous guidance. So there are a lot of initiatives there in terms of improving free-to-pay conversion as well as international expansion and really improving that new subscriber acquisition, which is where we saw the weakness as compared to our previous guidance.

Yes. And I want to sort of double click on that. So obviously, you updated annual guidance to reflect some broader macro headwinds alongside FX. Can you talk a little bit about these headwinds, what's changed and maybe the impacts they're having across the online and maybe even on the enterprise side of the business?

So first of all, at the highest level for the company, when you look at FX as well as revenue directly impacted by the war, meaning revenue in the Ukraine and Russia, it is having a 200 basis point impact on year-over-year growth. So straight off the top, things that are out of our control and that is disproportionately concentrated in Online because of Online has more international business concentration than Enterprise does. And the Online contracts themselves are shorter term, so they're being booked at these current FX rates versus a lot of the Enterprise contracts that were booked 6 months ago, a year ago are sitting on the balance sheet or in deferred at the rates that were current at that time. So that's what's happening sort of at the highest level. Then the other thing that we saw in Online, the challenges we saw was really about adding in new subscribers. The retention was strong, as was -- I'd say, in line with what we were expecting, if not slightly better. And what we're seeing is, again, on a more macro basis, impacts in Europe. So aside from directly Ukraine and Russia revenue, also more in the continent, either people being impacted by the potential of a recession. And I think that's more likely, potentially even there than here as well as people are just moving around the world again and especially individuals that previously were doing happy hours on Zoom, they're traveling now with their families, they're seeing their friends. And so that's pushing down some of that new subscriber acquisition.

So if we, in fact, head into a recessionary environment over here in the U.S., what gives you more comfort around the durability of Zoom's revenue streams and profitability?

Yes. So the great thing about Zoom is we bring a lot of value to our customers. First of all, they love us, but secondly, we bring a lot of value to them. And as we continue on this platform approach, if you look at our list prices, first of all, for any of those products that I just mentioned, we are very competitively priced on a list basis. And often, customers come to us and see savings, especially if they're moving a phone system or a contact center system off -- if they have an on-premise solution that they're now going to move to the cloud with us, they will see savings, and we saw that actually cited as some of the reasons for the Contact Center wins that we had in Q2. So as organizations are looking forward and thinking about how to manage expenses moving forward, consolidating on vendors is important to them. And think about phones, if you can get people to use a $75 headset for a softphone rather than $1,000 handset that's sitting on the desk, like there are real opportunities for savings across the board, and that's what we hear from our customers.

Got it. Got it. Let's dig in a little bit to Enterprise and upmarket. So you actually increased your outlook for Enterprise growth last week. Now you're expecting, I think, low to mid-20% growth for the year there. Within that, can you help us think about what's driving that strength, whether it's additional products, more meetings licenses? And I guess really -- maybe I have a part 2, which is how durable is that double-digit growth opportunity in Enterprise?

Yes. So we had a strong Q2 and stronger than we anticipated coming into the quarter in the Enterprise. And as a reminder for everybody, we see these seasonal trends now of Q2 and Q4 being our highest bookings periods because our upmarket reps in Enterprise and majors have 6-month quotas. So we expect to see those trends, and that's what we saw. We had a phenomenal quarter for Zoom Phone. So Zoom Phone, it was in August, it was in this month, but crossed over that 4 million seat mark and broke records twice for our largest deals with 2 deals having over 125,000 seats. So really thrilled with the momentum we're seeing there. Zoom Rooms was also a strong contributor during the quarter as, again, everybody is still thinking about what does the future of work look like and making sure they have the right technology in their conference rooms. And then Meetings continues to be -- kind of combined with some of those newer products, continues to be a driver as well. We see, of course, as you can probably imagine, more saturation in the U.S., but internationally, there's still a lot of opportunity for Meeting seats.

One question we got a lot last week in light of results was around new Enterprise customer additions. That's moderated in recent quarters, I think you were at about -- you had a little over 5,000 last quarter. Is it a slower pace of gross additions? Is churn a factor? Maybe if you can help us unpack that.

So our selling strategy for all of our additional products, Zoom Phone, Contact Center, Rooms, et cetera, is to sell into the existing installed base. And that has been our strategy from the very beginning. And it often stems from these customers have seen how we have transformed their meetings experience, and now they want to extend that to the platform. So in that case, as more of our growth is coming from new products, Phone and Contact Center, by definition, that means more of the growth is coming from expanding existing customers. So this is a trend that you should continue to see for a while. We have been talking about this for a few quarters. So it's not a surprise to us, and hopefully, it shouldn't be a surprise to you that we are still focused on new logos. We have absolutely have teams that are focused on acquiring new logos. But as our expansion is driven more and more by expansion of existing -- sorry, of new products, that means expansion of existing customers, and you should expect to see that number continue to moderate a bit.

Okay. Okay. Makes sense. Just one more in terms of just thinking about go-to-market. As we think about channel strategy, do you sense the company maybe needs a little bit more in the way of reliance on channel partners relative to direct sales as you attempt to scale the business?

I think that channel is -- not I think, I know, channel is a very important part of our growth strategy. So to take you all back when we were a meetings company, we were 90%-plus direct-led. Meetings just is a product that was -- lent itself very well to being sold by our direct sales organization. As we moved into Phone, we realize the importance of the channel, largely thanks to Ryan Azus, our Chief Revenue Officer, who helped educate all of us. And now we have a new president. Some of you may know Greg Tomb, who has taken over all the go-to-market teams, and we have a new head of channel, Todd Surdey. And they both are big advocates of the importance of the channel. I think we've done a relatively decent job of building out the channel in the U.S. and Canada. About 30% of our Q2 Zoom Phone deals were touched by a channel partner, but that is not the case internationally. We have a lot of opportunity there. And that will continue also with Contact Center, where the channel will play an important role. So you should expect that -- it is an area we have been focused on expanding, growing over the last couple of quarters, and that will continue.

Got it. Got it. Let's shift to Online. Maybe we can talk a little bit about the latest you're seeing in the business. You alluded maybe to some more headwinds in terms of new subscriptions relative to churn. But obviously, it's still important as we think about the business still being about 46% of [ reps ]. So maybe help us think through what you're seeing in terms of new revenue relative to churn there.

Yes. So and just to highlight for everybody, Online is a very important part of our long-term strategy. Historically, Online served really as a funnel to our enterprise business. That's really what it was. And when we saw this tremendous growth during the pandemic, we realized that there was a lot of opportunity going forward. We now have a GM assigned to this business, Wendy Bergh. She is amazing. She reports directly to Greg, our new President. And she has a whole team that is treating this like its own business. And so there are a lot of initiatives there that are really important to return this business to first being stabilized and then growing, which we absolutely expect it to continue to do in the future. And one of the huge areas of opportunity for Online is reducing the friction that an online, especially international buyer, sees. So lots of opportunities around adding currencies, adding payment types. So if you're sitting outside the U.S. as you come to the website and you see a USD price that makes you do math in your head. And then you're like, wait a minute, that's not a payment type that I'm used to because I [ don't always ] use my credit card. All of those create opportunities as well as pricing and packaging, meaning looking especially in cost-sensitive markets largely in Asia. I think Netflix, for example, has done a really good job of this, where they have mobile-only packages outside the U.S. that are at a very differentiated price point. Those are the types of examples of things that Wendy and her team are testing. So we're very thoughtful about how we do this. We do a lot of AB testing. And I think you're going to -- I know this from my previous company, just getting that friction out of the way of the buyer can have a huge impact on your conversion rates. The other thing that we've done recently, if you remember, at the end of Q1, our one-on-one meetings used to be virtually unlimited. And we added in that 40-minute limit to the one-on-one meetings that previously existed for the 1-to-many, but 1-to-1 was almost unlimited. And that had a very positive impact on conversion. Now we still see people that we know are basically running their businesses for free on Zoom because they're having these back-to-back-to-back-to-back to back 40-minute meetings. So looking at additional ways to incent them to convert. So those are the sort of the areas or the focuses that Wendy and her team have and just going to take a little bit of time to get those all in flight, but they can have a really big impact on that business.

Okay. So these seem like if we think about improving growth trends, churn seems like it's still on track. You've got a greater percentage of your base now hitting that 15, 16 months tenure. So for the year, I think you've talked about a 7% to 8% revenue decline for Online. You've got the benefit of maybe FX being less of a headwind next year, you're lapping the Russia-Ukraine impact. Any color or expectation in terms of when trends here maybe flatten or return to growth?

Yes. I mean previous -- to this previous -- this last quarter's guidance, we had expected that to occur in Q4 of this year. Given the change in the guidance and the outlook now, I expect that is more likely to occur in the first half. So at the earliest kind of Q2 of next year.

Got it. Okay. Okay. Great. I have a question about just broader growth potential TAM. I think a lot of investors want to know there's been this great debate of was growth meaningfully pulled forward during COVID, what's the long-term growth potential. How do you envision Zoom's opportunity and share potential? If I just think about -- I think at the last Analyst Day, you put out, I think it was about a $90 billion TAM. That it was inclusive of Contact Center. You've got your own product now that you're launching. You've obviously got a ways to go relative to that $90 billion. So maybe if you can help us frame the longer-term growth opportunity for Zoom.

Yes. So of course, I'm not giving long-term guidance. We will give outlook on the Q4 call. But when you think about all the potential that is sitting out there, first of all, there's the TAM, there are all of these new products that we have brought to market as well as we are continuing to hire very thoughtfully in areas that can drive growth, including innovation. So our R&D teams have been heavily underinvested over the last couple of years. And then our sales and marketing team, focusing on sales capacity, especially internationally, channel and then very specifically opportunities around product marketing. Historically, we've done a lot of brand awareness building that exploded during the pandemic. But there are a lot of people that, again, know Zoom Meetings that don't know Zoom Phone, Contact Center, et cetera. So those are all the areas of investment opportunity. And we are building a company for the long term. And we absolutely -- right now, we've set our sights as a company on being $10 billion and when do we get there? So even -- what I'm saying is we don't see limitations to our growth. It's on our execution, and we are, in some areas, catching up; in some areas, still building and innovating or continuing to innovate and build. And we're excited about the future of Zoom. I think that's what I can say at this point.

Got it. Got it. Just 1 follow-up there. So there was an interesting comment last week Greg made. He said on the last call, I think it was around pricing. He said, we potentially maybe look to discount less and maybe highlight more of the value proposition Zoom brings. So can you talk about the opportunity you have with pricing? And I guess what I'm really wondering is how is this possible in such a competitive market?

Yes. Well, so our strategy, and those of you that I've met with [ you before ] have probably heard me say is -- has always been, we win based on product, and we don't lose based on price. And that has been our mantra always at Zoom. We also internally, if you understand sort of how Zoom operates, How Simple Wins is one of the books that we require new hires to read. So we internally have reduced friction with our sales organization, which means we've given them a lot of latitude. I think what Greg was responding to -- and also, we have a new head of North America sales, David Ruggiero, who had the very same response, coming from bigger companies that have a little more structure and maybe a little more GOAs, grants of authority, around their sales organizations was, wow, by giving our sales organizations this much latitude, have they potentially gone to the path of least resistance, which maybe means they're over discounting potentially in situations. So that's what they're reacting to. And I think just wanting to reframe for our sales organizations like, okay, maybe you can stand your ground at that last moment and not give in to an additional 1% to 2% of discounting. That's what it's about. And so we -- I certainly welcome it to have a partnership like that in the sales organization, with looking at it. And it's always a fine balance. We want our customers to see a lot of value in Zoom. We think that they do. And so maybe it's just training our sales orgs that you can hold your ground a little bit, even at the end of the negotiations and drive a little more value out of that deal for the company. And so that's what we're thinking about as an organization.

Got it. Got it. if we think about the different puts and takes here, we've talked about Enterprise growing a little bit better. We've talked about Online maybe lagging a bit. Obviously, both have different profitability profiles. So as you scale up market, you're investing in new growth opportunities, and obviously, we have that mix shift going on. How should investors think about the path for operating margins relative to that sort of upper 30% range you've posted in recent quarters?

Yes. So if you all remember, during the pandemic, we had this amazing expansion of our operating margins, right? The revenue was growing so rapidly. We could not keep up from a hiring and investment perspective. And that was amazing and phenomenal. However, as I said earlier, we have been woefully underinvested, for example, in R&D. Our long-term target for R&D is 10% to 12%. We were under 7% of revenue last year and under 4% of revenue the year before that. So we have been, as quickly as possible without disrupting the organization, the culture, et cetera, trying to hire and get back towards that 10% to 12%. We were a little bit under 9% in Q2. So we're getting there. We are gaining ground. I think what I understand, investors -- we have -- we owe all of you, and we will update in November our long-term target operating margin, what does that look like. Because the last one we put out there was 25% plus. I think it's higher than that. But I'm sure if you're sitting there looking at 33%, which has come down from, whatever, 41%, and the backstop level I'm giving you was 25%, you're like, well, there's a lot of range in there still, right? And I don't think the long-term target is 25%. Again, we'll update this in November. But I promise you all, we're not going to let margins just continue to drift. We are doing this in a very major thoughtful way and focusing on the areas that we think are the most important for the future. And that means we are as conservative as we can be around COGS and G&A, and we invest in sales and marketing in those areas that I talked about in R&D.

Got it. Okay. Okay. One other thing that's been very topical, obviously, stock-based comp has been top of mind for a lot of investors in the current environment. That line item, I don't know if it was brought up on the call, but I'll bring it up now. It ticked up fairly meaningfully last quarter. Any color you could share what's driving it? And then maybe broadly though, you mentioned investing in R&D and sales and marketing, what you may be doing to attract and retain talent with some of the stock volatility?