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

Thanks for investors here for joining the Barclays TMT conference. Those who don't know me, I'm Ryan Mac, Barclays mid-cap analyst here at Barclays. With me today from Zoom, Tom Mcallum, Head of IR, Tom nice for being here.

Thank you for having me, Ryan. This is great. And thank you, everybody, for coming.

After that treacherous trip, I'm just glad you end up making it.

So I had to do the broken down plane in LaGuardia last night at 7:05. They deplaned us and somehow I managed to get to the 8:30 JFK flight out here last night and rolled in about 2 a.m.

Easy, right?

Easy.

Getting back in business traveling again. Like you never left. Anyway, just for investors who may be newer to the story just in the last quarter, right, would you mind just talking about kind of like what -- from your perspective, what you're most focused on, like what people came away from it and kind of like how people had a different opinion maybe of future growth.

Yes. We just did earnings a couple of weeks ago, and we also held an Analyst Day, our Annual Analyst Day about a month ago at Zoomtopia. So there's a lot of information out there on how the company is doing and our outlook and things like that. I think coming out of earnings, people were excited about the strength in the enterprise that grew 20%. I think the Zoom Phone continues to do really well. We didn't disclose a lot of metrics in the last quarter because we're sort of in between milestones, but we are clearly headed towards 10% of revenue soon. And we also had our churn on our online business as opposed to the enterprise business. The churn there has kind of come back to historic pre-pandemic levels of about 3%. It was 3.1% versus 3%. And I think people are excited to see that, something we had predicted at the beginning of the year, and it worked out. I think what we missed out on was a bit of the macro. The macro is actually having a little more impact on the top of the funnel on that part of the business. So that's sort of ongoing. So I'd say the quarter came in the way we expected it to. I mean it's definitely a different macro than a year ago. But it basically came in line with where we thought. FX continues to be a bit of a challenge. So as you guys look at our numbers, I would highly recommend looking at the constant currency as well as the as reported.

Perfect. And then your net new customers was similar to the quarter prior for the enterprise. And I get the question a lot like where does Zoom continue to grow? Like who isn't using Zoom, but you talked about Zoom Phone. Maybe Zoom Phone and some other growth areas, like where is Zoom interested in investing to that?

Yes. I think a lot of the -- and I know from the enterprise perspective, A lot of the net new is coming from Zoom Phone, Zoom Rooms, Zoom One, which is a bundle of Meetings and Phone together, that's really where some of the drivers are coming from on the net part of the business net growth. We still see decent growth on the meeting side of the world. It's really more of a share shift. I think you're right. I think a lot of people who have needed video conference and kind of have it today, it's not just Zoom. Remember, Cisco grew during the pandemic rising tide to raise all boats. So there's a big chunk of Cisco out there to go after as well as some of the smaller ones. I do think there's some consolidation of vendors in the space. And I think that helps folks like ourselves and Microsoft that people are looking for 1 or 2 solutions, not just 4 or 5 at this point.

And you know I do a lot of work in the channel. And as I talk to some of the master agents or some of the larger players, it seems like the Zoom Phone activity for them is picking up and picking up into much larger customers and what I think of a traditional Zoom customer. But I guess are there recent examples of things from the Zoom Phone side where like even you are surprised?

Yes. I mean the really cool thing is you all probably remember, after we went public, kind of people who knew where we were, you started seeing the financial services customers start picking up Zoom. Before, that was mostly tech companies, and it was mostly on the West Coast. And now we're seeing the same thing with Zoom Phone. So the large banks that own or bought Zoom Meetings are now buying Zoom Phone. And we have had, I think, the largest deal was well over 125,000 Phone host licenses. And we also see retail is another one that's always kind of interesting. We also had a very large retailer by Zoom Phone. And they're using Zoom Meetings. They may have like 20,000 Zoom Meetings in their sort of corporate offices in some of their sales locations. But at the retail store, they're using Zoom Phone on a small device and all the sales people on the floor will all have this device with the Zoom phone on it. And that's like 100,000 employees.

We're almost getting like some of these numbers. And I only say that because like in 2019, the largest UCaaS deployment was like 40,000 seats, right? And now it's if we're talking about 100,000 seats quarterly for Zoom.

Yes. Yes. And if you look, we give out a number around deals with more than 10,000 Zoom seats and it continues to go up and I think it was up 100% year-over-year. So we're seeing some really, really good large deals. So financial services continues to do really well. And we have a very broad group of verticals. We've got everybody from mom-and-pop to Fortune 5, and we have financial services and tech all the way to, believe it or not, construction and retail, so.

And this is your -- for Zoom Phone, right? And you're already in the kind of the leader quadrant and fighting neck and neck for a number of those seats and going international, always in impressed, obviously, with Zoom's product development. Now that you announced contact center and that's starting to gain steam, I guess, how should investors think about that opportunity?

Yes. Obviously, one thing about Zoom Phone, we are growing much faster than other folks in the space. And we will, from a seat count be the #2 player, I think, in the next few quarters. So it's -- I think a lot of people way back when didn't think we could do much with Phone. I think we've come out and shown that we actually are growing really fast on that side. On the contact center, it's a product we released back in February. We've seen some decent traction there. A lot of the use cases are internal IT help desks, HR help desks. We really need to continue to build out that platform and add more capabilities, also integrations. So like you want it -- we have sales force today. We have a series of integrations, but you want even more integrations to make it more external, customer-facing. So it's on a good path. It's similar to Zoom Phone. We're 4 years in, and we're doing really well on Zoom Phone. We're sort of 10 months or so and 11 months into contact center. So you'll hear more as we go along, but we're happy with where we are right now. And we've invested a lot in engineering over the last 2 years. So I think you'll see a lot of that engineering prowess go into the contact center product.

Yes, seems really good, people move over to Zoom for contact center. Are the ambition similar like Zoom Phone as in like people, maybe initially, were like this is probably an SMB solution, now we're talking about 100,000 seats for Zoom Phone? Like is eventually same market enterprise with Zoom Phone?

Yes, we're definitely looking. I should say some people ask me like, when is it going to be enterprise-ready. It already has the underpins of an enterprise product. It already has the scalability. It's really just putting those capabilities into it and the integrations. I think at some point, we probably have to build out a systems integrator channel. Zoom historically has not been a big channel play because it's so easy to install. There's not a lot of value for a VAR or a reseller just because it's so easy to deploy it. But when you got to Phone, you definitely have a lot more input from carriers, from master agents and other channel partners. And I think when we get to bigger deals in the contact center space that are going to be externally focused and people have lots of different data sources inside of their company, they're going to want those integrated. So we'll probably want to building out a nice systems integrator channel as well. We've just hired a new person to run channels in the last 6 months. And I think they had 400 people or so, 450 people at our first partner conference as part of Zoomtopia, so channel will be more and more important as we kind of go along here. And not just contact center, just in general.

And Zoomtopia, you had the ServiceNow integration, do you think there's opportunities for Zoom Contact Center to leverage data models or leverage off things like ServiceNow or SalesForce?

Yes. You're going to want all of that for your agents to be able to access and then point-of-sales data, things like that as well.

Great. Look, I ask this question every fireside, I'm sure you get this question in every meeting. But just as we think about a more difficult macro in the next year, right, can you just piece together some of the things you're seeing now and maybe like what's concerning for going forward?

Yes, we started seeing the macro change last summer. A lot of it started in Europe. And some of it is more related, some of it's macro related. We also started seeing deals sort of lengthen more approvals, more CFOs getting involved. I think that's pretty broad right now that that's the way it's going. At Zoom, ourselves, we are looking at things like discretionary spending, travel. Yes, I'm here, but I consider to be talking to external people, so it's really any internal travel, Zoom first. And we're also looking at contractors and consultants and things like that. It's just good housekeeping. We've grown really quickly. Given where the growth rate is, it makes a lot of sense to take a look at every part of our spending and investing to make sure that we're getting the best we can from it.

I'm definitely glad you're here, but I feel bad about the way you got here. I should head over to JFK. At least you didn't go to JFK, vice versa,-- I'm thinking here of the other one.

I can tell you some travel stories, not all of them are pretty.

Just when it comes to -- you mentioned one of your larger verticals is technology, right? That makes sense just given Zoom's background. As we see more headcount reductions just across the broader space, how do you think that could play out? And are you seeing that today?

So we've seen more challenged headcount in general. A lot of people thought that when people got back to the office, they wouldn't need their Zoom license. It turns out that wasn't the case. But we did see, with the great resignation, some companies downsize a little bit. And we're seeing it a little bit more with layoffs. The good news is we have additional products we can sell in. So it's not just Zoom Meetings, we can sell them Zoom Phone and show them how to use money. I'm bewildered why people are still running hardware-based PBX systems. It just doesn't make any sense. They're very expensive. They're hard to maintain. They're not flexible. I always like to say, it reminds me of the move from UNIX to Linux that where -- at this point, where even the legacy players you're seeing are really having a lot of challenges, which means people will start to move more. And I think there's a very compelling return on that. We also have -- we had one large customer, a tech company who had layoffs, unfortunately, but they came back and they bought a lot of our translation services. So we wound up not only whole, but it's slightly over that. So because we have additional products to sell in, I think we're in a much better situation we would have been in if this happened, say, 4 years ago.

That's a good point. Like during the pandemic, there were businesses that were shut down, and they were replacing their phone systems with UCaaS products, right, for that reason because it's cheaper more on a monthly basis. Like are you starting to see more inbounds of that nature of like more ROI-based sale?

I think so. I think so. I think -- and we've changed our messaging. We're still talking about the platform. We're still talking about innovation. But when you get into time like this, you kind of shift the messaging a bit to talk more about ROI, about TCO. And so we're out there doing that as well. So there is a lot of outbound around that. I think with Phone, you saw, early in the pandemic, people couldn't get into the office. So there was very -- sort of Zoom Phone kind of leveled off a little bit for a while. And then once people, not so much could get back in the office, but started thinking more holistically about their communication, you start seeing Zoom Phone pick up. And I think you see that with Microsoft as well. They're doing very well in the phone space as well. So there's like I said, I think there's a big push towards now saving money on phone.

And just since you brought it up, I mean, I get the competition question a lot, but I'm sure you answered all those meetings as well. But what's a good way to think about like the present state of the competition between you guys and Microsoft?

Yes. I don't think it's changed much. I mean you go back to our IPO, and for those of you who don't know I joined Zoom pre-IPO. And we talked about the world being kind of us and Microsoft that we feel like is a reasonable world for the whole communication space. And again, the communication space is not just video conferencing. It's not just video conferencing and phone. It goes to chat, it goes over to contact center productivity tools. There's so much that can be done in the communications space. It's a big broad space. But at least in those first 2 categories of phone and video that we are 1 and 2, together. We also have a nice integration. We have a nice coopetition and that is good for customers. We spend probably more time thinking about how we can work with Microsoft and compete against them because we want to make sure customers have access. For those who follow Okta Octopus out of a report every year, and if you look at it, the instance of Zoom and Microsoft environments has gone up over the last couple of years, it clearly went up during the pandemic, that's a given, right? But even today, it's still -- the last time it was reported it's still going up. So we have this nice sort of integration with teams that you can go from a Team's meeting to a Zoom video. But it is competition. I don't mean to make it sound like it's all hugs and kisses. It's really -- I don't know if that's appropriate. I'm sorry if I offended anyone. But it's a competition, but it's one of those typical Silicon Valley coopetitions.

Not all shiny rainbows. So just when it comes to your growth next year, that's a question I get a lot from investors, right? I know we're not going to guide to next year today, but there are concerns around like will Zoom grow organically next year? Or what's the potential it gets worse? Like is there anything that you can help frame from us here, like how they can get over that or feel better?

Yes. So again, stabilizing the online business is a huge priority for the company. Our last forecast that we gave at our earnings call a couple of weeks ago, reiterated what we had seen coming out of the second quarter. So still feel like we'll get to the first half, and we'll be able to, from a dollar basis, stabilize that part of the business. Again, it's not churn, it's really the top of the funnel and driving new business. The -- we're talking like, yes, people have video conferences, but there's a lot of free users out there, people running their businesses. And so we'll try to shift a lot of those that we can to paid. And it's more about nudging. We're not going to do anything draconian. It's more trying to nudge them over. We had a campaign over the summer moving people from unlimited essentially one-on-one meetings to 40-minute limit, and that brought in a number of new customers. And the good news is they bought annual deals. So these are customers who are now paying customers who saw the value in Zoom and were willing to sign up for a year. And that's what you want to see. You want to not only see them pay, but you want to see them pay for a long period of time. And so we're doing a lot of A/B testing on different ways to move people over, again, nudge them as well as reducing friction, having our website handle multiple currencies, local currency, I should say, local currency. We do multiple today, but local currencies, local pricing and local payment methodologies, just reduce that. Today, there's something like 12 currencies, the vast majority have the word dollar on them, Canadian dollars, New Zealand dollar, U.S. dollar. So then you get yen and euro. But there are so many currencies that we're using that are being -- using Zoom that we're not taking today that we can focus on. So even -- I know there's really kind of concerned about FX, and we are, too. there's also this friction that's been created. If you think about Zoom sort of pre-pandemic, if we went into a country, we would spend money on marketing and branding and try to drive a free base, and we would probably, at that point, have put the currency on our website. Because we grew so fast internationally and at the time we didn't need to do that, we didn't. And now we're at the point where it's like, okay, let's just do what is common. Let's just make sure the website can handle local pricing and packaging. Same thing on other parts of our business. We're doing the same thing a little bit more blocking and tackling, nothing that's like outrageously expensive, but proven things like bundling. We have a Zoom One bundle that has been a proven technology and software tech that if you have multiple products, you bundle them together into something that people can buy easily, they'll buy more from you.

Perfect. And the other question I get a lot is, where can Zoom go and M&A, right? Just given your balance sheet, given how much cash you generate. And for me, I think the Solvvy acquisition kind of flow into the radar because the follow-up was really slick chat and AI chat solution. But when we think about potential areas for this contact center, workforce optimization, collaborative or management, I guess, like how do you think about that mosaic?

Yes. So I would say a lot of the acquisitions we've done have been a little bit more acqui-hire focused, people with some code, really, really bright engineers, cutting-edge AI kinds of engineers. Those are all like fair game for us. Those are really hard people to find. If you can find a team, you might go for it. And we've done that in translation. We've done that in security, and now we've done it with Solvvy. Solvvy does have some revenue, but it's fairly small. It's a very early revenue company. And really, the product is going to be more embedded in the contact center. I think anything around the contact center, I think we'll be building out the core technology of the contact center. But some of the new like AI-type things, we would also look build versus buy. And then after that, there's -- if you go to our Zoom marketplace, there's all kinds of apps out there. And some of them are really interesting both on from an industry vertical perspective as well as productivity tools. It makes sense to have more productivity tools in the base. And that's the other thing. Is it a capability or is it something you can sell? Those are the other things we kind of take a look at. If it's something that might increase stickiness and make customers happy, but not be sold, we still might buy it, but we're not going to pay a lot, right? Something like Whiteboard, we built ourselves, we felt that it was not a product -- a stand-alone product, but it's something that people would use as part of a meeting.

I do like how Eric really wants to stay -- want to stay around like what you're good at, right, stay within the communication vertical. And he's fairly protective about your engineering culture, right?

Yes. And culture in general. I mean I think Eric spends most of his time these days on culture and vision and engineering. He's still an engineer, software coder at heart. Very -- he can do the code himself, but he doesn't. But I'm sure he's involved in talking to all the engineers all the time.

And one question we received after your most recent earnings was about Section 174, right at that, gets repealed or doesn't get repealed. Can you just walk through us here what that can mean for R&D? Not only Zoom in particular, but just...

Yes. It's something that would affect any company that has R&D and expenses. It's part of the Trump tax breaks. You had the tough Trump tax program. and it's a balanced budget item that was in there. And it hits this year, and it's going to happen automatically unless Congress either repeals it or defers it. And we're still, we're getting the last couple of weeks, there's probably some omnibus bill that's coming up that may or may not be in it, maybe not voted on. What it would do is basically take your R&D expense today, any company and amortize it over multiple years. So what that does is clearly your expenses go down and taxes go up, right? And so I think a lot of companies are in the same boat as we are just kind of waiting to hear what happens on it. It's not an additional tax, it's just timing of taxes. So from an investor perspective, if you're looking at a lifetime of cash flows, I don't think it really should impact you all, but from folks that are looking at annual cash flow guidance and things like that. Yes, we have assumed that it will either be repealed or deferred. That was based on information from our consultants. I still think it's like a 50-50 at this point. A lot of that changed just because of the election. But if that does come through, there will be some impact to the cash flow for this year. But over time, it just -- it evens it how, so.

Perfect. And just when it comes to some of your geographic, you talked earlier about how -- like everyone else, you saw some impact on the EU side. Anything changed there over the last few months, just in geographies like impacting that macro?

Yes. I mean, FX is -- the dollar has strengthened against other currencies like the yen. I think we're some close to a record low of the yen to the dollar in the last decade or 2. So we definitely see more strengthening dollar challenges, especially on reporting these things out. But I think the macro is about the same as it was coming out of Q2, but maybe spread a little bit more in Asia, but not so much in Japan, except for FX. So I think some countries are a little bit more challenged, in general. But then there are countries like the U.S. that still seem to be doing really well, so.

And just given like the renewal shift because of COVID. Like do you think that FX will have an impact on the first quarter renewals?

It will. Yes. Yes. FX specifically will have an impact. If you think about it and just -- I guess, I should explain sort of our seasonality. Pre-COVID, we had a very similar seasonality. A lot of companies was driven by sales compensation. So we have a semi-annual quota for our upmarket reps. Those are the ones that are dealing with customers like with more than 1,000 employees. And so they work that much harder when their quotas do. It's typical sales behavior, same in other companies. They have an annual one, their fourth quarter. It's a huge hockey stick of renewals. Because of COVID and the early days, COVID happened around mid-March, we actually have the largest portion of our renewals are in Q1, something like 29% these days, I believe, and then it drops off. But other software companies, renewals are kind of flattish and then boom, you get to fourth quarter. So we will have a large group of renewals coming up, and that's when we build the vast majority of our deferred revenue in the first half of the year and then it kind of tapers off. So as deferred revenue rolls up, so even though we're generating new deferred revenue, it rolls off pretty fast as you get throughout the year. We also do what's called co-terming. And so say you had a Zoom Meeting deal in Q1 and then you went and did a Zoom Phone deal in Q4, well, part of that deal goes in the fourth quarter, but the vast majority of it goes into the first quarter. And what that does is that it creates 1 PO for the customer. And our salespeople are -- not our salespeople but our customer excellence people don't have to go chasing multiple POs. So that's a long-winded way of saying, yes, we've got -- want to explain to everybody that we have a lot of renewals in the first quarter. And that Q4 is actually the lowest renewal quarter. At the beginning of this year, the dollar was much weaker. It has strengthened over time. And at the beginning of the year, we had very good renewals. We build the customer. We collected cash, convert it to dollars, and it's been rolling off ever since. When we get to Q1, you will see more FX impact on the enterprise side because of those renewals. The online portion will probably go the other direction. Because the online, there's a lot of monthly deals. So they're always getting sort of mark-to-market as they go along throughout the year, whereas because of the annual nature of the enterprise business, you won't see a lot of the FX impact until the first quarter. And again, we will report out both as reported, clearly, and constant currency, you guys can take a look at which one. But you'll see, I think, a larger hit to the -- onto the enterprise versus online. So it might be even some reversal a little bit.

Perfect. I just follow up interesting for investors. When it comes to the chat and e-mail capabilities that you guys announced, I mean, you've kind of been linking of that for a little while, at least on the Calendar side. From like the e-mail side, I guess, what kind of vision there? Is this just like Zoom is a one-stop shop for an SMB? Or like what should investors take away from the announcement?

Yes, we've done a lot of questions from investors on this. So I just want to clarify sort of the enterprise space, we're not trying to compete with Google and Microsoft. They own mail and calendar for the most part. And what we're doing is we're building a single pane of glass. So when you go in, you can -- not only have your Zoom Meetings and your Zoom Chat, but you also can see your e-mails and your calendar and you can work all in there. So you don't have to keep going back and forth. Even myself today, I have to go back and forth to Google to do certain things. And then go back into the app. So this would just make it much, much more convenient. So it's a little bit more about stickiness. So we're building that integration. And for the SMB space, it is a little bit more defensive. That group is a little bit more open to having a client from somewhere else than just Microsoft or Google. And we want to make sure that we're providing that client for them. So it's really -- on the client side, it's really more of an SMB play, so.

Perfect. And just over the last 2 years, obviously, you've seen really strong growth, also strong headcount growth. As we enter next year, like how do you think about maybe like changing how you dial that headcount growth?

Yes. So you're going to see significantly less headcount adds next year, probably a fraction of this year. And just everybody knows, if you look at our long-term model, we're kind of getting very close to the ranges we put out there. So we kind of have done a lot of the catch-up hiring that we needed to do during the pandemic, specifically around the R&D side as well as our operations side. You see it less in the operations because the operation. The gross margins are going up. So it doesn't look like we're hiring a lot of people, but we actually have hired a lot of people on the operations side. And what they're doing is they're taking workloads from the public cloud, which is more expensive, and they're helping us get them on the our own private cloud, which is cheaper. And so that part of the business, we continue to hire in as well. As we head forward, I said you'll see very little hiring. And you also need to keep in mind that we did a lot of hiring this year. And so there is a run rate coming out of the fourth quarter, but that's where you should start with. So even if you kind of model in less hiring, just make sure you also look at the fourth quarter run rate because you will have next year a full set of FTEs for those people full-time equivalents. Because some people you hired in Q1, there's now -- they've been around for the whole year, but some people hired in Q4, and they've only been around for 1 quarter.

And then just to wrap things up here, as your business shifts more enterprise, right, which health, that's where you want to go, you want to move upmarket. It does put some pressure on margin just given the difference between like the consumer margin and then the enterprise margin, at least in the near term. How do you think about like ways to make the enterprise margin a little better? Or are you trying to streamline anything there?

Yes. So when we gave the long-term guidance, the major assumption in there, believe it or not, is product mix because we do have our online business is more profitable because there's very little sales and there's some digital marketing in there. There's no event marketing, things like that. So we made some assumptions based on our view of the profitability of those 2 sides of the business and how both of them would grow, that's why we have a range of 28% to 32%. So depending on how that mix goes, that will kind of dictate over at the high end or the low end at any given time. And then underneath that, there is an assumption about making things more productive, specifically sales, marketing as well and even G&A. But there is a productivity assumption underneath all of that as well that got us into that range, so.

I'm really glad you made it here. Not the easiest trip, but that's what 2023 means for Zoom and especially in contact center. So thank you so much.

Thank you, everybody. Appreciate the time.