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

I'm going to read some disclosures first to get started. For important disclosures, see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. We are pleased today to have Kelly Steckelberg, CFO of Zoom. For those of you who don't know me, I'm Meta Marshall. I cover the communications software space here at Morgan Stanley.

So before we dive into fiscal '24, I just kind of want to keep the conversation a little bit high level to start. Given customer satisfaction and the presence with Zoom in the market, Zoom to me, seems like a product that we should be using more during the day versus just when you have a Zoom meeting. So what are the opportunities do you see to kind of build out that throughout-the-day Zoom platform?

So first of all, thank you. We agree we should be using all Zoom all the time. And there is absolutely the opportunity for that. Eric really talks about it in terms of becoming the operating system where you spend your day. So yes, everybody knows Meetings and spends a lot of time there. But if you talk about sort of some key components of the platform, of course, there's Zoom Phone and there's Zoom Contact Center. But if you think about productivity, there are also some amazing products like Zoom Whiteboard. So some of you might be using other third party. But the value of having that integrated into where you're spending your day is really immeasurable, right? Because it starts to be -- you can come into this client and really spend your day there and be very efficient and productive. There's also Zoom Chat. We use this extensively internally at Zoom. We barely use e-mail. In fact, it's really reduced the amount of -- the volume of e-mail at Zoom. And for me, it's also my filing system. It's where everything comes to me like the prep for your questions today are all in my Zoom Chat. [indiscernible] And that is also what it does, of course, is to your point, it starts to increase the retention rate of the products because it's really where you spend your day. And then, of course, we announced in November the beta of e-mail and Calendar and it's along that same vein. We're not trying to replace enterprise e-mail and calendar solutions, but to bring them into this client. So again, it's all as efficient as possible, and it really reduces that sort of tax of clicking around to different applications. And over time, this is absolutely what we strive to be is where you spend your day.

Got it. Clearly, Phone has been a hit. I know you've added something like 1.5 million seats in just under a year becoming a market leader. Where are those seats coming from? Are they coming from legacy systems? Are they coming from other cloud vendors? Just as we think about kind of the opportunity for Phone, where are you seeing the most traction?

Yes. So we are thrilled with the momentum of Zoom Phone. On the Q4 call we announced we've crossed over the 5.5 million-seat mark. And that is coming -- depending on the size of the customer, for larger customers, it's absolutely coming from the legacy on-prem providers likely Cisco and Avaya. In the SMB or commercial space, there's some of that as well, but largely coming from other cloud-based providers. And so we continue -- we're still at very low penetration rates even internally when we look at our Meetings customer base, it's in like the 15-ish percent range, so lots and lots of opportunity there still.

Got it. I mean, people know about the success of Phone and the early success of Contact Center. But kind of to your point of there's a lot of kind of this land and expand still to do, where are we on giving either multiproduct-customer set or a penetration set like as the platform expands.

So for Zoom Phone, we have said that we will certainly disclose it when it hits that 10% of revenue, which it hasn't done yet, it's very, very close. So we'll obviously disclose that then. And then as we've done for other products, so with Phone, right, we said we would disclose milestone metrics, and that's what we've done. We've done seats. And we will do the same for Contact Center. As a reminder, Contact Center hasn't even had its birthday yet. So it's still early, early in its life cycle. We did announce on the call though we had our largest deal to date, which was a 2,000-seat deal, an international deal. So really excited. And also excited because that's just Phase 1 of this project. There's the opportunity for that to even grow. And we'll continue to come up with milestone metrics that make sense as those products progress.

Got it. Okay. I mean on Contact Center, you mentioned you're kind of at Phase 1 of what you hope to accomplish there, but it's becoming a populated landscape, even if just from like a press-release standpoint. So where can you differentiate and what further kind of milestones or investments are needed there?

Yes. I think the real differentiator for Zoom Contact Center, it is the most modern cloud-based built -- natively built cloud-based contact center out there today. And the native integration that exists today between voice, video, and SMS is it really sets it up to have the opportunity to win deals like I just disclosed. There are a few things that are on the road map for the first half of this year that are also really important for those truly enterprise-grade wins, including integration with e-mail as well as some API integrations. So those of you that are familiar with Contact Center know well that when you look at a desktop agent, there are typically integrations with 4 to 5 external systems. That includes a CRM, of course, where all the customer data is. There's the knowledge base, which has the answers to all the questions that the customer rep is trying to answer. It's workforce management. And we today have integrations with about 3 customer -- with third-party systems, ServiceNow, Salesforce and Zendesk. So highly concentrated still on CRM, and we really need to build those out because obviously, enterprises don't want to do a wholesale implementation of all of those systems at one time if they're just focusing on the desktop agent. So that's rapidly coming in the first half of this year.

All right. We'll see how much [ echo ] there is here. How -- I think one of the most impressive answers that Eric had on the call was just all the ways that you guys have already used AI. And you guys are not new to turning to incorporate some of these things. But where can you continue to use AI as a differentiator? And how can you use your in-house tools to kind of give you a head start or to kind of continue that head start versus where will you utilize some of the third-party products that are coming out.

Yes. So as you say, AI is not new to Zoom. It is embedded in some of the core applications and benefits can get starting with Meetings. So with the Meetings product, for example, we have a transcription service, which if you record a meeting, then you can download a transcription. And that has continued to improve over time. And that's a really valuable tool that I use rather than if you don't want to take notes on a meeting. You just go back, refer back to the transcription. We also have something called smart recordings, which takes the meeting and breaks it up into chapters so that you can very quickly go back and if you haven't attended the meeting, for example, if you're watching a recording, go back and find the part that is most applicable to you, depending on what you need. That was built in conjunction with a partnership with ChatGPT. So it leverages both our own internal machine learning, but also ChatGPT. So we've already been partnering with OpenAI. And then if you jump to Contact Center, in Q4, we announced Zoom Virtual Agent, which is our conversational AI chatbot. And this was accelerated by our acquisition of Solvvy, which we completed last year. And we already have customers, for example, that are using this chatbot for use cases, simple use cases, especially like resetting your password without ever having to talk to an individual. So Contact Center is an area that lends itself very well to AI, and you should expect to see more there. But we also have a whole product, which I almost failed to mention, which is Zoom IQ for Sales, which leverages AI extensively as well. So this is our tool that sits on top of meetings and like we use it internally, for example, to go back and evaluate our sales team's calls and leveraging AI does things like how many times do they talk about Zoom Contact Center. Did they listen enough? Did they ask enough questions? Did they use a lot of filler words? And you should expect that there are going to be use cases for that beyond just sales. We've already had customers requesting can they use it in their Contact Center, it pairs very nicely for training of Contact Center agents. So I think you should expect there's going to continue to be AI application across all products in the platform.

Got it. Another question that we get kind of when we think about where the platform goes is just the apps ecosystem and where you're seeing traction there? Where it informs product road map? I mean, obviously, you just talked a lot about AI, but where are you seeing that kind of app ecosystem have the most traction?

So there's a lot of traction right now in the online segment of our business around apps. So Essential Apps is a bundle of the most requested apps that is now coming free in a first year of a subscriber's life on -- through the online segment. And there are 3 main areas we've seen this really start to emerge. There is around productivity, of course, makes sense. There's around team interactions, so fun things to do. And then there's also on the sales go-to-market side. And this really helps us, again, it's back to retention as customers find new ways to spend more time on the platform through these essential apps. It improves the retention and, of course, the value that our customers are getting from it.

Got it. So maybe just stepping into quarterly results from last week. You are seeing kind of an impact from macro. Where are you seeing the most sensitivity with customers? Is it certain verticals? Is it certain customer sizes? Is it certain -- just any kind of detail we can get on that?

Yes. So we're certainly seeing headwinds internationally. While our largest deal in general and our largest [ Contact Center ] both came internationally, we see opportunities, currency rates continue to be a challenge for us. And then EMEA, in general, is certainly having challenges. I would say in the Enterprise segment, it was -- the theme from Q4 was pretty consistent with the theme we saw in Q3, which is elongated sales cycles, more deal scrutiny and linearity that is back-end loaded in the quarter. And we -- as we were doing FY '24 outlook, we don't expect significant change in that as I think there's still concern. My peers when I talk to them, I think we're all thinking about the same things, which in some aspects, though, really sets up Zoom well, which we can talk about, which is platform consolidation, right? There's lots of -- I think everybody is looking for how do you be as efficient as possible. And so that's looking to your existing vendors, where is there room for a platform consolidation. Are there opportunities to reduce costs, which again Zoom Phone and Zoom Contact Center, especially are very well positioned from a price perspective. But with all that said, we don't expect a significant change from the themes that we saw in Q4 through FY '24.

Got it. I mean I think as we head into this fiscal Q1 quarter, which is obviously a lot of the COVID, annual renewals. We're just trying to get a sense of is that macro sensitivity really elongation of sales cycles. Is there a seat rationalization? You guys have a large number of high-tech customers who have obviously gone through some rationalization. Just like how are you parsing that out as you look at year?

Yes. So there's a couple of things about Q1. First of all, as a quick reminder, it has 3 fewer days than any other quarter. There's 89 versus 92 days, which when you're on a daily rev rec, starts to have an impact. Also, from a currency exposure, if you think back to last year, the dollar really started accelerating towards the back half of this fiscal quarter. So there are renewals that were not impacted last year. And if you just think about it on a year-over-year comparable basis, the currencies -- the major currencies that we do business in are down 5% to 10% year-over-year. So there is impact there. And then in terms of retention, both in the enterprise -- we've seen retention rates actually in the online segment improve over the last year. They were at 3.1% in Q3 and 3.4% in Q4. So we expect them to stay in that range, which is all the way back to the levels they were pre-pandemic. And then on the enterprise side, it's inconsistent that we've seen. We certainly have seen customers that are impacted by their own reductions. And so we've seen reduction in some seat count. We have not seen -- but the ability to maintain them, so we're not seeing logo churn, which is great because that still gives us the opportunity, of course, to work with them. But also, as I was saying before, try to bring them greater value by upselling potentially Zoom Phone and/or Contact Center, which is likely more -- going to have a better total cost of ownership than what they're using today.

Got it. The online business has been a business that we're waiting to see some stabilization. You've clearly been able to, as you just spoke to, get the churn levels to pre-pandemic levels. But where are we in just kind of some of the initiatives to improve new adds?

So we are currently forecasting that we're going to see dollar stabilization in the online segment of the business from Q2 to Q3. And as you say, we now know how the base behaves as we've seen the stabilization of churn rates and retention rates, we know how to model that. And then thinking about, okay, but how do you continue to add to the top of the funnel, our GM Wendy spent a lot of time thinking about new initiatives. She ran a lot of those in FY '23 and there's a lot on the road map for FY '24. And if you think about it, what it really comes down to fundamentally is expanding the market that's available, and she's done this through many ways. We've really expanded the number of currencies in which we sell on a global basis. We have expanded the type of -- payment type that we take. We've also really looked at pricing and packaging. So historically, the way we have done this is we've taken $14.99, convert it to a local currency, and that was the price in market. but that doesn't really work well, especially in cost-sensitive locations. So now we have localized pricing and packaging in many markets that we're testing or have been implemented. And it's great because we've seen a step-up in the revenue there, even though you're reducing the price in most of these markets overall due to the take rate. It's an improved retention -- I mean it's an improved revenue rate for the market. And then the other thing we've been focusing on is selling additional products online. That is -- it's mostly Meetings today, but Zoom Phone is available. And one of the things that we realized with Zoom Phone was not only did we need to make sure we could sell it, but also onboard those customers as most of these customers don't have an IT organization. So we spent a lot of time, especially on the last 6 months, improving that onboarding. And this is really important because we know the customers with more than 1 product are much more retentive. So this starts to create opportunities to maybe even improve that retention rate further. And that -- so all of those combined are the things that we're working on.

I mean you noted that, obviously, currency is a headwind now, but international is still kind of pointed to as one of the greatest growth opportunities, particularly just for net new adds. And so just you've noted kind of some trialing, like where can we gauge the success of some of these international efforts?

I think we do disclose the percentage of revenue from the international markets. So you're -- you'll see as it's directly having impact. But I think it is -- in the online segment of the business is more impacted by international currency rates and the success there. So as you see the split of revenue as well as the retention rates, those are all going to be indicators of the success that we're having.

Got it. You made some changes last year to improve free-to-pay conversion. And you noted a lot of usage is still this kind of free usage. Are there ways -- or is there still a lot of runway there?

Yes. So the big change we made last year was applying the 40-minute limit to even one-on-one meetings. And that had a step-function impact on conversion. We are testing other things now though, like forced breaks between meetings because we know there are still individuals that are having one-to-one meetings and just having them back to back to back to back back. And so what we want is to, of course, have everyone get value from the platform. But if you're driving -- if you're running a business on the platform, then we want you to be a subscriber, and that's what that would indicate. And so trying things like forced break and you're going to continue to see more of a divergence between the difference between the free and the paid platform. So really bringing more value to our paid customers and hoping that those free customers see the incentive to upgrade.

Got it. You've made some tough decisions around staffing earlier this year. Where are those kind of -- maybe on the earnings call, you kind of talked about them being more broad kind of across the organization. But where should we think of more directly those savings being focused and areas where you've maybe reallocated some of those savings?

Yes. So it was a very difficult decision as these always are because you're impacting people's lives. However, we are focused on investing for top line growth. And that means, again, always prioritizing around innovation, so R&D as well as our go-to-market teams. And in addition to the reduction, we are also doing a restructuring in the go-to-market teams and a couple of -- and what it's really -- what we're really focused on getting to is allocating resources towards the higher end of our market, so the enterprise and majors teams and helping our commercial and SMB teams be as efficient as possible as we see there's still significant opportunities in the globe around these upmarket customers. And so we have taken our Zoom Phone overlay team, which -- these are the Zoom Phone experts that have been there for the last 4 years, supporting our AEs. They are now carrying full quotas. So as of March 1, they've dropped into the sales org and are carrying full quotas. So this -- what this does is it immediately gives us more sales capacity from seasoned sellers at Zoom, which we're excited about. And then we're looking at the SMB aspect of our business. And historically, we have encouraged customers with 10 or fewer customers to self-serve online. We're now going to move that up to customers with 50 employees as the platform has improved and sometimes customers would prefer to self-serve. They don't necessarily want to talk to a sales rep. And what that does, again, is it makes us more efficient in that segment of the business and allows us to allocate more resources upmarket. And then I would say outside of go-to-market across the business, we are always focused on being as efficient as possible in both COGS and G&A functions and reinvesting where we can in other aspects of the business. And what the reduction does is it got our margin structure more in line with what we wanted to be for the long term, but also giving us a little bit of room to reinvest as we see opportunities.

Got it. I mean you just noted that SMB is kind of an area where you're making some adjustments to kind of the self-service limits. Just do you -- as you think about the year, do you think about just less new adds here? Do you think about more churn here as like a way to model that impact?

I think what we -- I mean there's still a lot of opportunity in SMB. This doesn't indicate that this is a less strategic area for us, just an opportunity that doesn't necessarily have to be touched with an account rep in the same way that -- I mean what's interesting about SMB, right, this is the heart and soul of where Zoom started. And yet I don't think we have evolved over time in a way that keeps up with honestly supporting the best -- the needs of our customer in the best and most efficient way possible.

Got it. Cash flow has been difficult to model personally. And part of that is you're moving to a full taxpayer. Part of that is some of the SEC changes or just exercised rate changes. Just other than the top line, what are some of the unknowns that form kind of this $250 million range on the $1 billion to $1.25 billion guide?

Yes. So FY '23, we know was particularly difficult as we transitioned to being a full taxpayer and then there was unknown around Section 174, which didn't get repealed as we were predicting that it would. As we look towards FY '24 and beyond, what we're aspiring to get to is a more normalized relationship between operating margins and free cash flow. So what we had if we go all the way back to the pre pandemic, 3 or 4 years ago, and that's what we're aspiring to get to. While we think there's still some transitions this year, that's why we gave probably a wider range than you would have expected. But really hoping that we can -- as we're modeling for you and giving you color that you start to see a more normalized relationship.

Got it. last question that I get constantly is you have a very healthy balance sheet. You generate a lot of cash. You've completed a share repurchase or exercised your full share repurchase. Just how do you think about capital structure, particularly when you seem to indicate that tuck-ins is kind of an M&A strategy you would most likely pursue.

So this is a discussion that we have with our Board every single quarter, about what is the optimal strategy we should be using to deploy the healthy balance sheet that we have. And again, back to everything aligning this year, to how do we accelerate the growth rate that I don't think anybody is happy with what we've guided to, but how do we accelerate that? And certainly, M&A is an opportunity for that. Why we have historically done tuck-ins is because we have a very high bar. It starts with technology. It includes culture and then it includes valuation. And we haven't found anything. We tried. We tried before and then the valuation component just got beyond what we thought made sense. So thinking about longer term, the valuations certainly have become more attractive over the last 6 months. And we just want to maintain the flexibility in case we see either a tuck-in or potentially something larger that is attractive and aligns across all 3 of those lenses. So that's where we're sitting today.

Got it. And I know the answer to this will be short. But any -- obviously, you terminated your President last week. Just any commentary there as well as just any plans to replace?

Yes. So it is a personal matter that I can't really comment on other than to say, as I just said, as we look forward to FY '24, nobody was happy the growth, and we decided to make some changes and Eric really wanting to be closer to the go-to-market teams. And so all those directs, including our CRO; our CMO; Wendy, who's the GM of the online will be reporting directly to Eric. And I think that gives him a great opportunity dig in. Again, your CEO should always be your #1 salesperson in the company, and this gives Eric the opportunity to see that and really help us inform any potential investments for FY '24.

Got it. With that, I'll open it up to the audience to see if there's any questions.

Kelly, stock comp 3 years ago used to be roughly $275 million. This year, it was over $1.2 billion. Can you just give us a sense of where that's going and when you expect to be GAAP EPS profitable again?

Yes. So stock comp really became elevated over the last year due to the supplemental grant program that we had in place. Some of you are probably very familiar with this. And I can provide more questions -- more color on it afterwards. But we sunset that program effective February 1. And so you shouldn't see the same additions to stock-based comp going forward. The underlying grants that were associated with that, though, do vest over 2 to 3 years. So you're going to continue to see it at the same level for the next couple of years. And then in Q4, as a result of the sunsetting of that program, there was a $200 million acceleration of expense into Q4. It did not have dilutive impacts because those -- they were like promises for grants that were just never given but you do see it in the stock-based comp. So it's going to take a few years, but what -- you should start to see is stock-based comp coming down as those underlying grants are vesting and then you shouldn't see the same additions this year as we're hiring many fewer employees, and we aren't giving those supplemental grants any longer.

Kelly. Good to see you again. Good to see that Eric is backed, very focused on the go-to-market. But what you haven't addressed today, I feel is like the core Zoom product. When you think about your components of growth over 20 -- calendar '23 and calendar '24, you've got Contact Center, you've got Zoom Rooms all of them doing really well, but the core Zoom business, in a world of consolidation, you do have very big competitors competing there. How are you going to focus on growth from a core Zoom perspective?

Yes, it's a really good point. I mean Zoom Meetings certainly is core to everything that we do. And it's still -- I mean, the biggest deal that we had in Q4 was a brand-new logo to the company, which includes a significant portion of Meetings. And so especially internationally, we continue to see an opportunity there. And I think it's back to the discussion we're having earlier about how do you keep evolving the meetings experience. And Eric's goal has always been to be -- to make a Zoom meeting better than an in-person meeting. And I think AI played a huge function in that. If you think about the leave behinds in terms of the summary, the action items, the rescheduling of the next meeting. And so those are all the things that we're continuing to work on.

Great. Kelly, thank you so much for being here with us today and...

Thank you. Great to see everyone.