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

Okay. So the vision of Zoom is we are successfully transforming from becoming this killer meeting app that everybody came to know and love during the last few years to a true collaboration platform. And over the last few years, we've announced many new products and the expansion of the platform. Maybe some of you have seen our new marketing, which we call the [ Zlinky ], which is the Z with many, many, many Os in there. And that really highlights the expansion of our platform. And of course, we've seen lots of progress and strength in Zoom Phone, which we're very excited about. We can talk more about that. We have some newer products, including Zoom Contact Center and Zoom IQ for Sales. And then we just recently announced our 2 newest products, which are E-mail & Calendar. So E-mail & Calendar for the upmarket are E-mail & Calendar integrations, which the goal of this is really building out our client so that you can really spend your day within Zoom and be as efficient as possible. And then in Beta, we have Zoom E-mail & Calendar services. And these are designed for smaller organizations that may not have a dedicated IT option and/or need a higher level of security as they are and then encrypted. Of course, the platform is rounded out with Zoom Rooms, which we've had for a long time. But as we're thinking about the future of work, it's becoming even more strategic as -- every organization, if they have employees outside and inside the organization want to be as inclusive as possible. We all got very used to seeing everybody on the screen every day when we were working from home and bringing that same experience into the conference rooms. We have [ Zoom Spots ], which is our hybrid event platform that -- I think we want to talk about Zoomtopia, but we just ran Zoomtopia on that. And then we also have Zoom Chat. And this is our integrated chat functionality, which comes bundled with our meetings.

And so coming off of Zoomtopia. I was wondering if you could talk a little bit about the products you just mentioned -- and where the buzz is amongst the customers? Where are you seeing more customer pull from some of those new products. And then with regard to Zoom Events, wondering how many people attended and how that product scale?

Yes. So let's talk about that first. So we were really excited to really launch Zoom Events with Zoomtopia, which was a truly hybrid experience. Hopefully, some of you got to join either online, where we had tens of thousands of attendees. So that was really exciting to see. And then many of you also joined us in person, and that was able to -- you're the first one we've had in person in many years, and it was great to see [indiscernible] all of our partners, and there were thousands of in-person attendees. We also had some additional events that aligned with Zoomtopia, including our first Partner Connect. So we have a new partner leader, Todd Serdy, and he brought together over 400 partners that came together, and that was really exciting to hear from them how Zoom is helping grow their revenue, how -- what they're looking forward to in our product portfolio and hearing feedback from them how we can further enable them as that's a really important strategic growth driver for us in the future. In terms of the products themselves, so continued excitement around Contact Center. So Contact Center, for those of you, as a reminder, it's very early, it's young, but there is lots of momentum around that already. And -- if -- for those of you that are -- for those who aren't familiar with the story, Zoom Phone was launched in a very similar way. When we launched Zoom Phone, it had limited features and functionality, but the idea is to get it out there. You want customers and prospects to know it's in your pipeline. It's the same with Zoom Contact Center. And now we're really working on building out that feature and functionality and identifying opportunities for integrations around kind of the -- we call them the adjacent functionality that you need, like workforce management, CRM, knowledge base. So there's a lot of excitement about that and the coming features and functionality. And then E-mail & Calendar. I think -- making sure that everybody understands what the intention there is. And again, in the Enterprise, it's creating efficiency. So you don't have so much context switching moving back and forth. Not that we expect large enterprises to switch off of their large third-party E-mail & Calendar that they're using today, but providing an integration into the Zoom platform and then an alternative service for smaller organizations potentially.

So I have to admit, when we first saw your Zoom Contact Center, we knew it was early, and we weren't sure the trajectory it would take and the uptake by customers. Over the past 6 months, our checks have been incredibly positive over Contact Center. So how should all of us think about pricing in that -- for that product specifically? And also with your other products, coupled with your core offerings, how do we think about pricing and what the total spend per se can be?

Yes. So I'm so glad to hear that. Thank you for saying that. I think what's amazing about Zoom Contact Center again, while it's early, it looks like Zoom, right? It's very simple, it's very intuitive. And because it's natively built on our platform, it's all easily integrated. And so for Zoom Meetings and Zoom Phone customers, it's a very natural extension that feels easy to make that transition and that jump. In terms of pricing, just like our approach to all of our products, we, by design, are very disruptive in pricing. So the list price for Zoom Contact Center on a per-seat basis is around $70, which is 1/2 to 1/3 of the pricing for other competitors in this space. And we've done the same -- we did the same with Meetings. We've done the same with Phone. And the idea is for the company, we continue to grow revenue per account by adding on these additional services. And we also do that as we want our customers and our prospects to see a lot of value in Zoom. People love Zoom, and we want them to see it being an integral part of their day. And especially if we talk about the economy and kind of what's happening right -- it's a very compelling price point and attractive bundle when you bring together compared to others, especially when you think about moving potentially your on-prem solution into the cloud, whether that's Phone or your Contact Center, getting rid of those on-prem servers potentially being able to reduce headcount that's dedicated to it because it's very simple. It's just one more icon in your Zoom client. And then that change management transition is also much easier than moving to another third party.

And how about pricing for Zoom Phone? Another area, by the way, where checks are incredibly positive. I think I mentioned in our call back. How are you pricing that product? And is there a big discrepancy between SMB versus Enterprise pricing?

So thank you, again, for that. We are really excited about the momentum that we continue to see in Zoom Phone. And the pricing for Zoom Phone also very competitive. So it starts at -- from a list price, it starts at $10, if you're paying for metered long-distance, $15 for all in. You can imagine for Enterprise customers, there, of course, are discounts for volume for willingness to pay up front for annual or multiyear deals. So we don't talk about ASPs necessarily, but you can -- at some point, you're going to be able to sort of back into it once we start disclosing the revenue, which we said we would do when it gets to 10%, but we're very pleased with that. And we're able to be so competitive because of the very efficient platform and financial structure that we have.

So we've heard a lot about the light training requirements, the simple integration, just having launched the product in 2019, it's pretty incredible that you have 4 million lines today. How confident are you in that trajectory of that uptake?

Well, everything that we do at Zoom, right, is focused on our customers. And so focusing on keeping it simple, as you just said, making sure that it integrates and works seamlessly together. That's the benefit of having a natively built application. And we don't -- we've done some M&A, but it's been M&A to augment and accelerate features and functionality, not sort of at the core itself, and that has worked really, really well for us. So again, as organizations, as my peer CFOs are thinking about how do we all be more efficient as we're especially potentially facing recessionary times. Zoom is very compelling. We have Zoom One, which is the bundle, which combines Meetings, Phone, Whiteboard, chat and so sort of the core products that you would need at a very compelling price point and that is doing well. So we continue to be excited about the prospects of Zoom One.

So shifting gears a little bit over to the online business. It still represents about 44% of revenues -- we saw good stabilization in turn the last month we turn last quarter. Big picture question. How penetrated is that space, including free users? Where are we kind of in that S curve of addition...

So yes, we're really looking forward and optimistic about the stabilization of online. As you said, churn came down to 3.1%, which is in line with pre-pandemic levels, where we see continued opportunity for online is especially in international markets. And there's a lot of initiatives that we're thinking about how do you continue to grow the top of the funnel for online. That includes adding currencies, adding international payment types as well as adding international packages. So today, our approach in many international markets has been to take the list price of $14.99 and translate that into local currency. And that works in certain markets, in Western Europe, for example, maybe Tokyo or Japan, but it doesn't work in other more cost-sensitive markets. And so one of the key things that we're really thinking about is what would a localized price and package look like, especially and again, some of these more price-sensitive markets. And those are some of the initiatives that we're looking forward to FY '24. And I think there's a lot of opportunity still out there. If you can get that packaging rent like maybe a mobile-only package, for example, for certain markets would make more sense. And those are some of the things that are really going to be necessary to continue that growth at the top of the funnel.

So the online business has obviously been an area of focus for investors. One of the things -- one of the questions we've been getting inbounds on is with regard to steady-state MRR, gross MRs... And what -- because it's moved back and forth a little bit over the past couple of quarters. What do you think is a steady state gross MR sequentially?

So the way that we're thinking about it is in terms of when are we going to see stabilization from a dollar amount? And the way -- based on our current outlook, which includes taking into account the stabilization of the churn rate and the cohorts, plus all the initiatives and the impact we saw them have for FY '23 and what's in the road map for FY '24, we currently are forecasting that online will stabilize from a dollar amount in Q2 to Q3 of next year. So that's when we -- we've seen -- unfortunately, we've seen this kind of ongoing sequential decline in dollars and now expecting that to be flat to potentially slightly up as we start to exit FY '24. So I think that's the best way to think about it.

Okay. And then I had a question on your monthly churn is at 3.1%, which is in line with pre-COVID levels. At the same time, about 70% of your online ARR base has been with you for over or around 1.5 years. So what that implies, in that metric was 40% pre-COVID -- so what that implies is that given the older cohorts have a low propensity to churn, the churn rates on a per cohort basis remain elevated relative to pre-COVID levels. Am I getting the thinking right there and what's causing that?

What we've seen is there are larger cohorts in that earlier stage and that where there is a lot of volatility. So as you move up to that 18-month period, there is volatility and bouncing around. We have done a lot over the last year to work on the free-to-pay conversion. One of the interesting things that Wendy talked about if you saw Zoomtopia was the implementation of a 40-minute limit on one-to-one meetings, and that had a step function conversion for older cohorts. So this is really interesting because I think what -- this is about to potentially change again because what happened was the older cohorts, these are people that were running their businesses basically on Zoom and all of a sudden they have a 40-minute limit. It was a step function up in terms of conversion to pay, and then that conversion came down over time. It didn't mean they churned. It just means the conversion of those decline, which would be natural, right? You'd go up and then it started to come up. But if you think about this, those are older cohorts, starting already, they've already been using Zoom for a long time. And so now I think what we're going to see is potentially those churn, even though they're paying, they're going to churn at a lesser rate because they already know the value of the product, if that makes sense. So you're bringing them in as new paying, but they've already been with the company as a customer, just a free customer for a long time. So I think that we're going to continue to see that sort of balance out as we're going through this. Churn rates just do bounce around depending on seasonality, breaks, people are back to life. I think there was sort of a boomerang effect after COVID, right, when people were able to go out in person again, and then they settle back into, "Oh, know I do need a Zoom license for whatever, I don't want to go to the PTA meeting. So I want to have a Zoom license, right." Those kinds of things. So I think we're going to see that continue to balance out over time.

And so that little tweak that you made with regard to free to paid, were the results in line with expectations or...

Yes. They were better.

They were better.

They were better than expected. We really realized like how much value customers and free customers even derive from the platform. And that's why I think people that have been using it for a long time, that huge conversion was because they know they've been running their businesses for free likely for many years on Zoom. And so $15 a month was a small price to pay to continue that.

And can you help us quantify a little bit how -- or what the conversion rate has been from free-to-paid over the past few years, what we saw in Q2, Q3 this quarter? And then also what you expect over the next few years?

Yes. We don't disclose our conversion rates. We just don't talk about it in that level of specificity. But I will say, if you remember, like there was this really big uptick that Wendy shared on her graph. And she's continuing now to look at new initiatives that could have similar types of impact, things like we know that people are still having back-to-back 40-minute meetings. So do you impose a limit on the number of meetings per day? Do you put force breaks in between there? And then, of course, just continuing to add features and functionality that make -- starting to differentiate more between a free and a paid version, which historically we hadn't done as much. It was pretty much a full feature. It was only the 40-minute limit, and now you're starting to see that bifurcate a little bit more.

Great. So if you can shift gears a little bit to your competition. Sorry, just...

Are you okay?

Yes. Thanks a lot -- If we could talk a little bit about your competitor side.

Competition makes me busy too.

And just how that's evolved over the past few years and especially you shift into Phone and now into greater penetration to CCAS based on our checks at least, how things have evolved and what the impact there is on pricing perspective?

Yes. So we continue to focus on listening to our customers, right? So that means making sure that the features and functionality that we are adding is really driving great value for our customers. We -- because we have such an efficient platform on which we're building our gross margins at 79%, it gives us room, again, to be very competitive from a pricing perspective. We often hear from our customers that they would even pay more for us, which is why I think we saw that impact and online when we impose a 40-minute limit. We have some competitors that are not in a similar situation from a margin perspective, and they can't. They literally can't compete in the same way that we have been able to from a pricing perspective. We -- so there's that in terms of we can just continue to bring great value to our customers, which is what we're focused on. And then we also look at how do we continue to partner and/or strategically add to our platform. And one of the areas we've been focused on, especially over the last year is Zoom Chat. Zoom Chat is a product that we've had for many years. It comes bundled with Meetings. It has become much more strategically important over the last year or 2 as we hear, it is often the one product that the -- that our customers want to use another third-party for it, whether it's Microsoft or [indiscernible]. And that became something that was very apparent to us and that we want it to be a product that stands on its own merits, and we've really invested a lot. And I'm really excited to say that one of our absolutely largest customers, it's a Fortune 10 customer has deployed Zoom Chat now. So that shows you that it really can meet the needs of those sophisticated users, and it will be an area that we'll continue to invest in.

So shifting over to Enterprise. One of our thesis on the space is that during COVID, Enterprise acquired all kinds of cloud communications in order to just...

Stay connected.

Stay connected. Their entire workforce is going to remote almost overnight. And what we're picking up now is that these enterprises in the cost-cutting mode that they're in today are rationalizing -- there are companies that have Citrix, [ Linux ]. They have Microsoft Teams, they have Zoom, and they won't be paying for all 3, right?

I agree.

Over the next couple of years, we expect some kind of vendor consolidation. So big picture question on what Zoom brings to the table. How you beat Microsoft and how you beat Cisco in the Enterprise? And Yes...

So first of all, I would say that our customers and prospects love Zoom, I don't think that they say that probably about some of our competitors. An investor was telling us this morning that he -- when he sees an invite on his Calendar from another provider, he warns his team, like "Don't forget, you have to get in like 10 minutes early to make sure that you're there when the meeting starts." Right? Because I think people have become so accustomed to Zoom and just one click, you're in, literally. If you're a minute late to a Zoom meeting, you feel like you're late, right? Because it's -- you're just so used to everybody being there on time. And that is really, really a big differentiator. And -- so continuing to focus on building features and functionality that our customers love. And then we have this bundle like Zoom One, which I mentioned, brings all those competitive products together. So even as -- I agree with you, people are going to consolidate. We're doing it, that's it, right? We're looking across all of our vendors and seeing where we could potentially reduce them. I think Zoom is very well positioned to not only help with vendor simplification, but also cost reduction. When you look at each of those individual products, they're all priced competitively. When you put them together in Zoom One, there's even a further discount on top of that. And we love it because it builds retention. The lifetime value of a customer that buys Zoom One, is going to weigh -- outweigh that discount that we gave them because of the retentive nature we see when customers have more than one product in their portfolio.

And so when do we -- relate the question. So when do we kind of get past this what we call COVID hangover? I think the whole industry calls it bad. Your trailing 12-month dollar net retention number has gone from [ $130 to $170 ]. And so what's -- when do we kind of get past that part of hangover?

So Enterprise continue to be strong. Year-over-year growth was 20%. As we look forward to FY '24, one of the things that we're thinking about with Enterprise, though, is the impact of FX rates, which is very hard to quantify and predict. It's been -- FX has been a significant headwind for us in the business in general, but it was largely concentrated in online due to the more international exposure as well as the short-term duration of those contracts. However, remember that the dollar has continued to worsen throughout this year, and we are now coming into our largest renewal period in Enterprise in Q1 and then sequentially down in Q2. And so we potentially have more exposure in FY '24 to FX rates or the strengthening dollar in Enterprise than we had in FY '23. And so that is something that I just want everyone to think about and consider as they look forward to FY '24. Unfortunately, as one investor said is running well, that's annoying and I said, "Yes, it is actually annoying." But unfortunately, I can't control the dollar. So -- and what's happening in currency. So that's the challenge that we're facing right now. And then the overall growth of the business is also really contingent upon the stabilization of online that we talked about earlier.

Okay. So one other question related to the Contact Center because of Contact Center agents' user experience and spend a large portion of it with Salesforce, with Salesforce most recent announcements around CCaaS. How does that impact your overall strategy?

Yes. So we, again, always think about these things from the perspective of the customer. We want them to have the choice to either integrate or be all-in on Zoom. And if you think about that with Phone, we -- our Phone product integrates with all of the other Contact Center providers, and it will continue to do so. It will be the same with Contact Center. We integrate -- right now, we have integrations built with Zendesk, Salesforce and ServiceNow. And so we want to give the customers choice. We never want to force them into having to buy a product or having to move products because they buy one of our products that we don't integrate with whoever their provider of choice is. And I think we're going to continue to see this where we partner and compete with many different vendors in the market, and that's just how this is going to continue to evolve.

So we have a few minutes left. Are there any questions for Kelly? [indiscernible] wait for the mic, please.

Kelly, Fred, just one quick question coming off of Zoomtopia. This is more to get context on some of our long-term margins. I know we have a lot of exciting kind of opportunities in front of us in terms of what we can invest in. So -- and currently, we're a little higher than that. So just trying to get the context of what's the way to think about those long-term margins? Is that a range that we sort of expect to be in from now? Or is it something we might need to build up to? Or I guess, what's the right way to think about that?

Yes. So we had real significant margin expansion during the COVID -- during the Pandemic. And we have been playing catch-up in certain areas of investment, especially R&D. You saw the Q3 results were largely in line now with our long-term margin structure. And while there will be variability potentially quarter-to-quarter, I think annually so you think about that as being a good framework for what our margin structure could look like. And as a reminder, margins could vary quarter-to-quarter for example, Q1 is a difficult quarter for all SaaS companies because there are 3 fewer days for revenue recognition in the periods of that in itself could put pressure on your margins. But overall, the long-term margins are what we're committed to achieving at least on an annual basis.

Any other questions? But I should probably ask a question about how we're thinking about the use of free cash? You have a large net cash balance, you drive a ton of free cash flow. Your overall growth strategy as it relates to M&A. Has it remained in a little bit? Or are you still looking aggressively? How are we thinking about your evolving...

Yes. So M&A is something we think about constantly. Sanjay, who's part of my team is always looking for opportunities to accelerate technologies as we did with the Solvvy acquisition, for example. They brought the conversational AI functionality to our Contact Center. That's worked really well for us as well as potentially other -- think about adjacencies that might make sense. If we were to extend in something a little beyond what our core product has today, that is where we look for opportunities through M&A. We are -- as a reminder, we are in the process of completing a buyback that we just -- the Board authorized a few quarters ago for $1 billion. We -- through Q3, we're able to buy 11 million shares under that program. So that was really helping from a weighted average share count perspective. And then try to weigh as we look towards FY '24 thinking about what is the best use of that overall from an investor's perspective and how do we really focusing on how do we continue to drive market share and growth and invest for that. So that -- those are all the components that we're thinking about as we look forward to FY '24.

Okay. I did want to touch on stock-based comp as well -- if you could talk a little bit about the puts and takes on what's happening there over the next 12 months?

Yes. So we certainly have seen an elevation in our stock-based comp over the last couple of quarters. We implemented a program a little over a year ago, which was in order to retain talent that was hired during the beginning of pandemic when our stock price was $400 and $500 in those grants that maybe a year later where the dollar value was half of where they have been rented. We had a supplemental grant program to top off employees to get them back to that dollar value that had been in their offer letter. Given the recent stabilization of our stock price, we are in the process now of sunsetting that program effective February 1. So any grants made after February 1 will not be subject to the supplemental grant program. And what that means is while the supplemental grant elevate the stock-based comp over the vesting period of the underlying grant, you're going to see these elevated levels continue for -- because those underlying grants were 2 to 3 years left in duration, but it will start to run off after that. And you won't see the continuing addition, if you will, at the same levels to that as we expect much more judicious hiring at FY '24 and then combine that with the supplemental grant -- the elimination of that program, you should start to see those grant sizes come down pretty dramatically.

All right. Perfect. With that, we're just about out of time. Thank you so much for your time. And everyone, please enjoy the rest of the conference.

Thank you, Fred.