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

Good afternoon. Welcome to the 25th Annual Needham Growth Conference. I'm Ryan Koontz. I cover the contact sector here at Needham on the sell side. We're joined today by Zoom, our everyday household name and CFO, Kelly Steckelberg. How are you doing Kelly?

Ryan, I'm great. And again, I'm going to apologize to everybody. I guess it was technical difficulty on my side and we're like so sorry about that. Everybody...

No, it's quite all right. We'll make the most of it. So let's start by just kind of recapping how we got here. You guys just finished a nice quarter and been putting up some continued nice Enterprise growth here through your last quarter. Can you kind of walk us through the trends in the enterprise revenue line?

Yes, of course. So we have been pleased with Enterprise renewals, which are, I think, top of mind for everybody right now, especially given this economic environment. And so I think what's driving that, of course, is every organization realizing that if they have people working outside of the office and giving -- supporting their employees and flexibility they need to continue with Zoom. And also, we are excited about the continued momentum of Zoom Phone. So that has been a really important aspect of our growth in Enterprise. And the renewal periods that are coming up again, early part of next year continue to create opportunities for more discussion around that. And then rooms and events as we're continuing to live in this hybrid world, organizations wanting to make sure they have the right technology in their conference rooms to be inclusive, having those hybrid events, which is what we use for Zoomtopia with Zoom Events. And I thought it was just so powerful to see how we were able to have tens of thousands of remote attendees joining in the room and being up on the screen, while there were thousands of employees, customers, prospects, partners, all in that convention area, and it was just an amazing experience. So all of that is what's contributing to the ongoing growth. And as you said, it was a little over 20% year-over-year growth for Q3. And...

Exactly. I do want to come back to those other product opportunities. And on the flip side, the Online business, continue to see some headwinds here with churn, kind of walk us through your latest view there. You saw a tremendous uptick during the pandemic and kind of feeling the effects of that post pandemic now I'm sure.

Yes. So just a quick reminder for everybody. Our Online business before the pandemic was about 20% of revenue, and it really serves as a funnel to our direct business as we saw momentum in certain aspects or customers that got turned over to our direct sales organization, and they will really let to grow it. And then it just increased the importance significantly during the pandemic as it was a very efficient channel for our customers to come to us and for them to self-serve quickly when we were having such an increase in demand. And now as we're looking forward, it is continuing to be a very important part of our business. So there's a couple of aspects. It certainly has been decreasing on a quarter basis. But I think -- and some of the headwinds you highlighted are international exposure, especially like economies in Europe have been a challenge. And then FX, and it is more internationally based. FX has been a headwind, and it's been more concentrated in Online segment of our business. However, some of the things that we're excited about, we have Wendy Bergh as the GM of that business is -- online churn was at 3.1% in Q3, and that's the best that we've seen since before the pandemic. And that, I think, is due to some of the incredible initiatives that Wendy and her team have undertaken continuing to improve the free-to-paid conversion that we're seeing. Also, the platform itself is improving. The cohorts are aging and all of that leading us to forecasting stability on a dollar basis in that business sometime next year.

That's great. You talked about the free business there as well. Is that still a pretty sizable component of cost for the company? And how do you look to monetize that? Obviously, it's a really key important element of your pipeline generation.

Yes. Yes. We love our free customer base. As you say, they're a really important part of the funnel and our sales cycle. It has -- the free usage as an overall percentage of usage has come down so to speak during the pandemic, and that's evident in the improvements in our gross margins, of course, that went all the way down to 69% during the pandemic, and were 79% last quarter. So we've said our long-term target is 80%. And so we're very, very closely approaching that. We were also, as a reminder, during the pandemic a significant growth of [ 3K ] through 12 usage that at its peak, had probably 500 basis points impact on our gross margin. And that's largely gone at this point, right? I mean it's very fortunate the students that have been able to return to their campuses and be with their friends again. And so while it was certainly -- we felt like the right thing to do at the time. I'm happy to see that to be able to go back to school.

Yes. So you just mentioned gross margins had a nice trajectory. So is free use returning to pre-pandemic levels yet? Or is there really just kind of a new normal with regards to the free user base?

Yes. There is absolutely a new normal. And Part of that is just the brand awareness, of course, as [indiscernible] Zoom has changed in terms of becoming a household name, which prepandemic, it wasn't. It was something that even I had to explain to people what it was at that point in time. And that's not the case to be longer. I get stopped in the grocery store when and where [indiscernible], which is [indiscernible]. So we definitely have a new normal. And I think also the rapid acceleration of the adoption of video communications. It was also clearly accelerated during the pandemic. And people realizing the convenience that this brings to their lives. And now that we're able to safely move around the world again, people picking and choosing, right, what they want to do in person and what they want to continue to leverage Zoom for because things like maybe driving their child across town to a tutoring session is not something that they're willing to do any longer because they understand they can have the same [indiscernible] or same benefit by doing that. [indiscernible] my nieces take piano lessons, sometimes they go in person, but sometimes they go do it via Zoom. And they're able to do it even like while we're on family trips as long as there's a piano available, they can have a lesson, and that's really, really powerful.

Really is, that's cool. So stepping now below the gross margin line on OpEx, you've been playing catch up a little bit over the years with the explosive growth you saw and you're just about there, your target levels on the OpEx line?

Yes. Yes. So we had the benefit of really expanding margins during the pandemic, which we all enjoyed for a period of time. However, it clearly was not sustainable. And as you say, we've been playing catch-up in important areas of investment, including R&D and sales and marketing. We've taken us a few years, but we're very close now. R&D, we said our long-term target as a percentage of revenue is 10% to 12%. And in Q3, we're right around that 10% number. So getting really close to that sweet spot, which is great. And then sales and marketing is where we have a little bit of room still for expansion and really thinking thoughtfully about that expansion outside of the U.S., international, also international channel expansion is a priority for us. So that's kind of where we are. But as you say, we're getting very close to where we want to be in terms of approaching our long-term margins, and we'll continue to be thoughtful about how they're prioritizing spending going forward.

You've also got some new products that you brought to market. And I'm sure those are areas of investment on both R&D and sales and marketing, and maybe we can walk through your thoughts there as far as some of those different product lines. I think Phones relatively mature, but I'm guessing that you still have a lot of attach rate to chase after for the big installed base.

Yes. Yes. So Phone, we're thrilled with the momentum of Phone. And as you say, as a product now, right, it's certainly, I think, reaching maturity in terms of the development. We will continuously add each of the functionality, but it's available natively in over 45 international markets, which is great. That was a really, really big focus for us. But in terms of attach rate, you're right. When we looked at the attach rate of Zoom Phone deals to our meetings customers in Q2, it was under 15%, which tells you there's a huge runway to go. And that's just internally with our existing customers. And then, of course, when you look around, you know that there are many, many legacy phone installation sitting out there from Cisco and Avaya. And those are the situations where we do really, really well as we have a tremendous improvement in terms of terms of total cost of ownership for those prospects because, first of all, we have the opportunity to get rid of that legacy expensive hardware that's sitting somewhere in their offices. They can redeploy somebody who's managing that hardware. And then when you look at the seat price, we are typically about half the cost of another provider at least. And so there are savings to be had there as well. And then another big theme, I mean, all my [indiscernible] are thinking about is simplification of vendor, strategy and rationalization of costs and we're able to help them with both of those. So we continue to see a lot of opportunity there. And then Rooms, I would say, a similar state in terms of product maturity. It's been around for a long time and yet we continue to innovate, especially with the change in the way that we're all working today, things like smart gallery and companion mode for your computer when you walk into room are really cool features that we've added. And then on the other side of some of the newer products, of course, we have contact center, which is really, really new. It's an exciting momentum, early stages there. And then, of course, Zoom IQ for Sales, which is also very, very early in the life cycle.

I want to walk through those a little bit. So on the Rooms side, you have hardware partners you bring to market -- you go to market with them? And I imagine you're typically displacing a legacy system in a lot of these cases.

Yes, that's exactly right. So I think one of the amazing things as a reminder about Zoom Rooms is the ease of use of setting up a route link that whole dynamic exchange where in the past, you would have to spend hundreds of thousands of dollars to set up a conference room and then a reminder that you had to have another room on the other side that was an investment of hundreds of thousands of dollars. And today, you can set up -- I'm sitting in the Zoom Room today, which has like 2 big screens, which, I don't know, probably their LG screens, their TVs, right? They're just LG TVs and then attached to -- I think this is a neat bar. And so for a few thousand dollars, you can -- and then there's a controller here on the desk. A few thousand dollars, you could have a really slick set up in a room, and it connects to any device anywhere. People could be joining from phone, from a laptop, whatever. And so that is a very powerful -- we do not resell hardware. We have partnerships so that we would meet with Poly, with Logitech, with some amazing partners that we work very closely with, and our sales reps refer to them. Some of them come depending on the products with the software embedded. So it's a real easy startup, but it's a really nice synergy that works really, really well.

That's great. And what kind of commentary do you have on kind of the return to office? I mean it's a controversial topic. I hear some cities are back to 75%. I know I walked around San Francisco. It's still like it goes down, downtown. What kind of anecdotal thoughts do you have about return to office and demand for Rooms upgrades?

Yes. So it's really interesting, Ryan, I think that a lot of organizations are still determining what's the right balance because we've all enjoyed the flexibility that we've had over the last couple of years. I -- myself -- I have been to San Jose today at our headquarters, but I moved to Texas. First, I moved to L.A. and then I moved to Texas during the pandemic. So I really appreciate the opportunity to be closer to family and have some flexibility. But it varies by organization and we are working very closely with our customers, listening to them and thinking about how do we help ensure that the technology is a productivity enhancer that -- I think inclusivity has become even more important in this environment. You want everyone no matter where they're working to feel included and that's where some of the inventions I mentioned earlier, like Smart Gallery, which slices up the screen is very effective. Companion mode, which allows you to walk into a room like this because we all realized during the pandemic is how powerful it is to be in a room like this and to see everybody, but also be able to do things like chat in the meeting. And so to do that, you typically need another device, right? You want your phone or you want a laptop for that. So you can pair a device with a room, which is really cool because you walk in and your life already senses where you are and you just click join from a room and it pairs it like a state where the video is off, the voice is off so it's not disruptive to you or to anybody else in the room. And those are very simple things, but just make it seamless. And that's what we're really focusing on. We want work and the interactions and communications to be seamless no matter where your employees are.

That's impressive. There's a lot of redesign that has to go on around the workplace. And I'm sure the thinking of management teams and everything are just grappling with this, and you guys are right in the forefront. So congratulations on that.

Thank you.

So -- you talked about contact center. And can you kind of walk us through your strategy there, the types of markets and opportunities you're going after? It's -- I've had some experience in covering the space, and it's a tough space. The Enterprise barriers to entry are pretty darn high.

Yes. Yes. So we're excited about entering the contact center space. I agree with you. What I would say is really compelling about Zoom Contact Center, it's modern, it is natively built and integrated with, obviously, Zoom Meetings with Zoom Chat, with Zoom Phone, and it's built on the same infrastructure that everybody has come to rely on for all those other products. So inherently, the design principles that we've always had, if it just works in reliability are included in the building out of contact center. And in a way, similar to Zoom Phone, we had a huge start because the data centers are already in place. The infrastructure is already there, et cetera. So -- but with that said, of course, there is work to be done, and we recognize that. So the product today, it integrates with obviously voice, video, chat and SMS and we are working very closely on integration with e-mail, which will be coming in the kind of the first half of calendar '23. And then the other really important aspect is third-party integrations. As most client desktops -- desktop agents, their client rather, have integrations with somewhere between 4 and 5 other third-party systems. If you think about they need access to the CRM system, which is going to bring in all of that customer data and make it really easy for them to interact with that customer because it has their history. It brings in the knowledge base, which has all the answers to the FAQs or the product questions that they're going to need to address. So...

Ticket tracking, all that sort of stuff.

Exactly. That's exactly right. And so we have a few of those integrations built, but we don't have all of them yet. So these are some of the, I would call, the like table stakes that we need to accomplish in order to be considered for some of those bigger Enterprise wins, and that's exactly what we aspire to. In the meantime, though, while the product has been available, we've been really excited to see some really great names that as prospects and as customers that have come in and the larger customers are using that internally or say their internal IT help desk and some of the smaller companies using it for their external call centers. So excited about that momentum. And it's going to take time just like new [indiscernible] expected to go in a gradual way. So we're going to listen to our customers. We'll continue to add features and functionality. We're building out a go-to-market team. We're doing -- taking the same -- similar approach with an overlay team of experts that are here to work [indiscernible] with our AEs. And, yes, we're just excited about the potential there.

It's a tougher sale.

Yes, for sure. It's more -- absolutely, it's a more technical sale. The great news is some of our Zoom Phone experts have experience in this space as well, so we can leverage them. And we've hired a leader for the space, and we'll continue adding the expertise that we need.

Nice. And how many you mentioned was Sales IQ, I don't know all the [indiscernible] about it, but can you give me the 30-second picture on that?

Yes. Of course. So Zoom IQ for Sales. So this is using AI to assess and provide analytics on the experience of a meeting. You can do it after, the fact -- during the meeting as well. So we've been using it internally, for example, at Zoom for sales training. It's really helpful for managers to go back and assess and you can do simple things like how many times did they mention Zoom Contact Center in that call, you could do more complex things by analyzing who's doing the majority of the talking. You can get prompting in the meeting like, you haven't asked a question in a while. You've been talking a lot and helping people just sort of moderate that. And sales is the first case study as this is already a relatively defined space. There are incumbents in this space. And so I think it's a use case that people easily understand. We've already had a request from our customers to expand it to contact center, for example, so that you could use 4 training agents. I would say we can all use...

Are these customers calling in, right?