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

I'm Karl Keirstead. Thank you, Kelly and Charles and the Zoom team, for participating in our event. And I was just mentioning to Kelly, because Zoom's revenue mix is shifting a little bit more to the phone and contact center, the growth engines, at least our in-house expert broadly on that UCaaS space, Taylor McGinnis, I thought it would be great to have Taylor up. And Taylor and I will quiz Kelly on those growth vectors.

I can take it.

Yes, you can take it. Great. Kelly, thanks for joining. So when I was reflecting on how to conduct this fireside, I would typically -- because your print wasn't that long ago, just drill you a little bit on 3Q, but let's not do that this time. Let's like look forward into 2024, 2025 and talk about what can take Zoom from a, call it, low single-digit growth story to something bigger. So let's talk growth drivers instead of dissecting the 3Q. How does that sound?

Thank you. That's much more fun to talk about.

Yes, more fun, right? So you gave us, Kelly, a little bit of a hint where you mentioned at least as a baseline for thinking about next year. You obviously didn't give any guidances to look at the exit growth rate. So that's 1%-ish. So maybe you could just describe for a little bit what some of the key growth variables could be that could lift that 1%.

Yes. So I'm going to say it one more time. I'm not giving guidance. But in terms of the outlook and thinking about the future of Zoom, obviously, one of the really critical growth drivers is Zoom Phone. We announced that we crossed over the 7 million seat mark in Q3, so really excited to see the ongoing momentum there. But that continues to be a significant opportunity for us when you think about how many land lines or on-prem seats are still sitting out there. And that's an area that we're continuing to innovate around, invest in as well as think about our channel relationships, especially on an international basis. That's a really significant opportunity. And we disclosed a few quarters ago that we had crossed over the 10% of revenue mark, and we certainly aspire to have Zoom Phone comprise at least 25% of our revenue at some point in the future. So that's a really key driver. And then, of course, there's Contact Center, which is very, very early in its life cycle, but we announced on the call that we've grown to 700 customers there. And there's a couple of things that need to happen for that to start -- well, I would say, accelerate in terms of its overall contribution. Some of it is features and functionality. There's a few areas of functionality that we still need to really be able to compete for those big 10,000 Contact Center seat deals, but we'll get there. And then also, channel relationships and international expansion are going to be important as well. So just as a quick reminder, when we were primarily meeting this company, we were 95% direct-led, and that worked very well when we were selling Meetings. But as we've grown into these additional areas of Phone and Contact Center, customers and prospects look to third-party experts to help them with this. And so that's been an area of focus and investment for us, is continuing to grow those relationships as well as invest in our own internal processes and systems to enable those third parties. And then the other area of growth that's really important for us is international. If you saw our Q3 results, we grew in the U.S., but we declined a little bit in both EMEA and Asia Pac. And part of that is in response to we did a pretty significant sales reorg earlier this year, and it's just taken longer internationally to get sort of back into stabilization and growth mode. And then it's also, as I said, we have been investing in our channel relationships in the U.S. for a couple of years, but we're now really focused on driving that internationally as well.

So maybe let's take those in order. So let's start with Phone. Taylor, I'll ask one and then feel free to jump in. So Kelly, if you're going to take Phone from, call it, low double digits percent of revs to 25%, as you mentioned, what needs to happen organizationally to execute on that? It seems to me like especially, if a lot of that is going to land overseas, it's going to require some decent investment in sales and marketing. Maybe you could talk about that.

Yes. So there absolutely is an investment in sales and marketing, as I said, especially internationally. As we're doing FY '25 planning, we have a new leader in EMEA, we have a new leader in ANZ, who are both great and amazing. So really excited about that and continuing now to support them as they expand and build out their teams. And as I said, channel is going to be a really important part of that. And then we are really focused internally on working with our customers, especially our Meeting customers have been with us as well and having them move from a pure Meeting, deployment to a bundle. And we announced on the call that growth in our Zoom One bundle, so a bundle that includes Zoom Phone, that's the definition that we use for this metric; had grown 330% year-over-year. And that's really important for many reasons because it drives the growth of Phone. It exposes people to the broader communications and collaboration platform that we have, but it's also really important from retention because we know that customers that have more than one product are much more retentive. So overall, setting the stage to grow and retain these customers for the long run.

Yes. And the channel strategy makes a lot of sense because historically, the incumbents relied heavily on the channel, right? So that's where all the land lines are sitting, it's with those partners. But I guess as you make that shift historically, that channel has been heavily incentivized, right? So how are you thinking about balancing, building out those relationships, digging deeper but also considering margins and profitability as well?

Yes, it's a really, really good point. And we have this debate internally all the time because part of it is absolutely, what you want to do is make sure that those channel partners are not selling against you. However, we also know that we have the most modern platform out there today and that there is a love and a brand awareness for Zoom that separates it from some of the competitors. And so the velocity of those sales cycles are quicker, and so we do incentivize those channel partners. We don't actually incentivize them at the same levels that some of our competitors do. And if you talk to channel partners, you will hear that. But we do it -- I mean it's a very thoughtful by design because we believe that they should be able to get through those sales cycles with a Zoom product more quickly than they're getting through a competitive product. And so finding that right balance is something that we always talk about and think about, especially as we go through these negotiations on a regular basis with the channel partners. And then it's balanced with also how are you incenting your internal teams to work with them. I think that's the interplay and we're constantly thinking about our own internal comp plans as well. In think that over time -- at the beginning, our sales reps were learning how to work with channel partners, and we had to incent them in a different way. And now, as they start to see them as more bringing incremental and not necessarily competition, you can start to normalize a little bit your comp plans internally as well. So we don't -- yes, it's an investment, I don't think it's going to have a significant impact on our margins over time.

Maybe just a quick follow-up in terms of the channel strategy that you guys are -- that you think is the best approach because you have master agents or system integrators, there's a lot of diversity in the UC space, so which do you -- which are you guys betting on, which you think is the best approach?

Well, the answer is it varies because it varies by country and it varies by market. And so we are learning ourselves what works best in each of these markets, and it's definitely not a one size fits all. And so we are building the relationships with the systems integrators, making sure that they're enabled and really understand our technology, how the collaboration platform comes together. But also, master agents from a distribution perspective are really important. So it is both, it's where we're investing.

And Kelly, on the switch maybe to the Contact Center side, tough question, but over what time frame should investors think about Zoom making those required product functionality improvements, such that your -- you have a seat at the table and are being considered for large deals? Are -- hard to put a time frame on it, but are we talking 6 months, 18 months, any sense?

Yes, it's definitely closer to 6 months than 18. So this is a quick reminder, the platform today, the Contact Center platform integrates natively with voice, with video and with SMS. There's a couple of areas that are really needed to jump into that true enterprise realm, which include integration with social and we're in beta with several of the social channels today, including Facebook and WhatsApp. There, we need integration with e-mail, which is coming next month. And then, we also need to be PCI compliant, which PCI compliance are the standards in which your contact center has enabled to take credit card information over the phone in a secure manner. And that's, of course, very important for anybody using a contact center for sales, and that's coming within the next 6 months. So I would say, within about 6 months, we should be at a stage where you have the majority. Now, there's always going to be added features and functionality that are coming. But as a reminder, in addition to the core Contact Center desktop that we have, we also have a workforce management tool that we've built, we have a quality management tool we built, and we also have Zoom Virtual Agent, which is a stand-alone SKU that is literally a virtual agent that can take lots of the queries as well. So it's starting to be a pretty complete Contact Center offering and within 6 months will be even more so.

Yes. And maybe just adding on to that, so I think historically, we've heard that it's more smaller and midsize customers that want that UC and CC integrated offering. I think the Enterprise space, it can be a little bit different. But I'm just curious what you're hearing from your customers because historically, you haven't had a single vendor that sold both. It's been a very disparate selling motion. So do you feel like that's changing at all? And what are you hearing from your larger accounts?

For sure. Our larger accounts are excited and anxious to see the features and functionality that I just mentioned become available because they're excited about having the opportunity to have a modernly built, natively integrated platform. It doesn't exist today. And we, by far, are going to have the most modern platform that they can start to seamlessly bring together their UC and their CC offering. And they know how well we've transformed their meetings experience in the past and expect us to do the same for phone and for contact centers. So they're just waiting because there are some gaps, but we are very well aware of what they are and are working as quickly as we can to fill them.

And Kelly, just to keep going on the growth levers, you touched on the Zoom bundle. So that gets to a question broadly on like price and bundling. So how much room is there to go on Zoom One? And are you contemplating any other pricing bundling changes that we should think about as a potential growth driver next year and the year after?

So Zoom One is a really important growth driver, overall, when you think about the company as we want our customers and our prospects to move beyond just the core of Meetings, which is a really important aspect of the platform, but it's so much more than that. And it goes even beyond. We've talked a lot about Phone and Contact Center, but it goes way beyond that even. We have Whiteboard. We have Scheduler. We have Team Chat that is integrated in our Meetings platform for free. So it starts to -- you start to see we have Clips, which is asynchronous video communication. So the platform itself can really cover all of your synchronous and asynchronous communications needs. And as I mentioned earlier, it's really important from a retention perspective as well. When you think about starting to have all of us on one platform, the total cost of ownership, the ease of use, the reliability, all of that for your employees even, it's all in one, right? It's such an easy way, it reduces the toggle text. There's just so many advantages to it, that it's really important and it's important from a pricing, but it's really also really important from a retention perspective over time.

Okay. I'm intrigued by your comment about Clips. It sounds like a small product. But investors listening or in attendance know that Atlassian bought Loom. So that seemed to validate that space. But also, it seemed like a relatively high price tag when rivals like Zoom have that already as part of the suite. Any observations on that Loom deal, Kelly?

First of all, we have a high regard for Atlassian, so I want to be very thoughtful about that. But there are a lot of companies today that exist that -- I always say their features, they aren't stand-alone products. And you see them in our platform, and we've innovated and we've built them. And I think that what you're going to see over time is they're going to have to consolidate, which is obviously what Loom did. But there's many others still sitting out there today. And I think -- especially given the environment, you probably see them -- see more and more consolidation.

Okay. What about on the AI front? Most of the companies up here on stage when they're thinking about next 2-year growth drivers are talking about their AI suite. It seems like the leadership at Zoom you included are talking a little bit more about embedding a lot of the AI features in the suite rather than having some stand-alone SKU that we can all try to model out as this new revenue source. Maybe you could articulate whether AI can actually be a growth driver for you or not.

So we have both aspects in our platform, meaning we have some stand-alone products that are powered by AI. These are things like Zoom Virtual Agent. We have a translation SKU. We also have Revenue Accelerator. Those are all stand-alone SKUs that are monetized. But the core of our AI companion is included for all of our paying customers at no additional cost. And that includes things like meeting summary, which I keep saying there's going to come a day when you're going to want to go in a meeting and you say, "I'm going to turn Zoom on because that way, I don't have to take notes because this meeting summary is so good. This is what I'm going to file away, and these are going to be my meeting notes." And it really is getting to the point that it's that good. It's also a feature called Catch me up. So if you join a Zoom meeting a little bit late, you can just chat in there like, "Hey, what did I miss?" And it's going to give you like this really quick little meeting summary of what just happened or you can clarify. Like we test this in our staff meets all the time like, "What did Eric just say are the top 3 initiatives for this quarter?" And it just goes -- and it just types them up really quickly. And so that and along with things like chat compose, e-mail compose, we believe are just table stakes in terms of making our platform that much better. And that's why it's included for free.

There's 2 more growth drivers I want to hit on. One is Enterprise new logos. So I think there might be a perception that the core meetings and video conferencing space is like fully tapped out. Yet you're still adding. I think you added something like 1,600 new Enterprise logos. And I'm sure the majority, if not all of those, are core Meetings customers. So clearly, it's not at 100%. So maybe talk a little bit about where we are in the penetration. And who are those Enterprise logos you're adding? Who is not already using Zoom?

I used to work there. But I think it's phenomenal that Webex still has $1 billion in revenue today. So there's obviously opportunities to continue to take share from our old alma mater. And then what is also really interesting though in adding new logos is that both Phone and Contact Center are starting to attract logos from themselves. And that is also really exciting when you think about the future. I mean -- I think Contact Center, even in some ways, more than Phone, again, because there hasn't been real innovation in the contact center space in a very long time. And so that stands apart. And especially as we continue to move more upmarket in terms of our offering, I think you'll see more and more of that driven from there as well.

The last growth driver I can think of is M&A. That's always a lever that you can pull. You've got an incredible balance sheet and cash flow profile that some of us are sort of waiting for you to put to work. So I know you get this question a lot, but I can't help but ask when you think about the potential for transformative M&A, what are the guardrails that Zoom uses to decide what's an attractive asset?

So we think about this every day, and we have -- certainly have the discussion with our Board every quarter around capital allocation. And we do have over $6 billion of cash on our balance sheet, and we are preserving that for the flexibility that gives us when we think about M&A opportunity. And we look for M&A opportunities through 3 lens. So the first one is the technology and what would that bring to our customers. We are very, very proud of our platform, of ease of use and the reliability that you get and people have come to expect from Zoom, and we would never want our customers to have to compromise that through an acquisition. The second is culture. We take great pride in our culture at Zoom and also view that as a key indicator of the potential success of an integration. If you're trying to bring two divergent cultures together, that can be very, very difficult. And we would obviously want to go into something with as much success insurance as possible. And then last but not least, of course, is valuation. And we're a very thoughtful, very frugal company by nature. And so trying to find an organization that meets all of those without lowering the bar has been challenging. We've obviously gotten very, very close in the past. Unfortunately, with the previous Five9 transaction, we were just going to have to put too much cash in it at the end, and we just didn't feel like that was the right decision for shareholders at the time. And I think looking back, given where the market cap is today, that was the right decision. But it was unfortunate that we weren't able to do that. And we continue to look for opportunities to leverage -- the trade-off is always what could we do to drive top line growth versus potentially leveraging that cash to return to shareholders. And we would rather, at this point, be using our cash for acquisition than issuing stock, given where the stock price is today. And that's why we're really maintaining the flexibility that we have.

Can I ask you a couple about the quarter while I've got you?

Sure. Yes.

The online or downmarket part of Zoom, as you guided to, decel-ed sequentially a little bit more. Part of that is just going to be waiting out when macro stabilizes and improves, but there are some levers that you can pull to try to accelerate that. So what are the one or two ways that maybe you've got a little bit of control that you're pressing on to try to stabilize that Online segment?

So there's 2 really important components of the Online business in terms of getting to stabilization and then, ultimately, the goal is to get it back to growth. First is the retention rate. So we now announce the churn rate on a quarterly basis. And the rate of 3% per month that we announced in Q3 is the lowest that we've ever seen. And that's great, right? That means we've made a lot of progress. . And as we continue to see this differentiation between free and paid, including AI companion being included for Online customers that are paying, we expect that to continue to contribute to that retention rate stabilization and potentially improvement over time. So that's a really important component. And then there's the platform growth or the Online growth itself. And there's a couple of things that we're working on there. First of all, it's the free-to-pay conversion. We have a lot of free customers still. So how do you incent them to convert? Historically, there was really no differentiation between the free and paid product other than the time limit in which you could use it, that is now changing and has been changing over time. There's more and more value in the paid product itself to really compel people to upgrade. We actually are -- we just announced, are in the process of implementing a price increase, so as a reminder, we did one earlier this year for Pro, which is the lowest offering Online. We announced in November that we will be increasing the price now for the Business and Business Plus packages, increasing it by $2 per user per month. We saw a really good response to the price increase earlier that we did last year. And the learnings from that were that we saw lower churn than we expected. So that implies people see a lot of value in the platform and are willing to pay for it, so going forward now with that price increase as well as continuing to expand and open the top of the funnel, meaning adding -- the Online segment is much more international than the direct business because it doesn't -- you don't need a salesperson, right? It's just whoever accesses the web. And so the way you can even expand that opportunity is by increasing the payment types in which you offer, the currencies in which you sell and that -- those are the initiatives that we continue to drive and continue to expand.

And then, Kelly, on the Enterprise side, you had signaled 3 months ago that even the Enterprise segment could see some sequential decel, yet it came up a little bit better than that. It was actually relatively stable. Now I'm sure your aspirations are to have it a whole lot better than stable, but that was an upside surprise. Was there any part of the Enterprise business that might have contributed to that at least slight outperformance? .

Yes. What we saw -- as a reminder, we had this reorganization at the beginning of the year, and that took a little bit of time for everybody to get sort of reoriented again as change like that often does. And so what we saw was momentum at the back half of Q3. I mean it was very back-end loaded as we've seen customers have returned to their buying motions of waiting to the last parts of the quarter to leverage what they can from a discount perspective. But what we saw was some momentum at the back half of the quarter, which is not typical for a Q3. So we have reps that are on 6-month quota. So typically, historically, Q2 and Q4 have been our larger bookings periods. And what we saw in Q3 was actually almost even with Q2, which is not the normal cycle that we see. Usually, we see Q2 up, Q3 down, Q4 up, like that's been sort of what we've seen in the last few years. So that was a nice momentum.

And you would attribute that more to better execution, given the reorg, as opposed to a signal that the environment is improving, is that correct?

I don't know the environment is really improving that much yet because on the other hand, the thing that we're working through with our customers is many of them have gone through their own retractions in employee count this year. And so we're helping them reallocate that spend. This is why we spent a lot of time with other customers this year who were potentially wanting to reduce the number of Meeting licenses they have but take that spend and preserve it by moving them to a bundle. And what that does is it's all really good for the long term because now what you've done is you've moved them from a single product to a multiproduct, which is greater retention. You've moved them from a lower-dollar SKU to a higher-dollar SKU. And over time, as the economy improves that they're starting from a different point, in which they can grow, and then we'll grow as well.

But evidently, there must be enough of those that are contracting their own headcount, and that's probably, Kelly, contributing to the NRR number, the trailing 12 months for Enterprise. So you had mentioned in this last quarter that it was 105%. You signaled that it wouldn't be shocking if it kind of dipped down a little bit more towards 100%. Any sense for how long it might take for that number to stabilize, Kelly?

Well, it's a trailing 12-month metric. So until we start to see kind of that reacceleration in Enterprise, you're going to continue to see that it drift a little bit more. Again, I think the good news is the preservation of spend, the move into the bundle, the Zoom One, and also the growth in the RPO shows you that there -- customers are committing to longer-term contracts. So those are all really positive signs in the metrics. But I guess -- and the other thing that I would say is we know that the majority of our customers have had a renewal event during this year. So we believe that we have moved through most of that down selling or rightsizing as it's been happening during this year as most of the customers have had the opportunity if they needed to do so that they've gotten it accomplished.

Taylor, unless you had another one, I was going to close with a question on margins. Did you have anything else? .

Yes. I have one more. Just on generative AI, I'd love to hear your thoughts on how that could potentially change the UC landscape. Like when you hear Microsoft talk, they talk about how important Copilot Teams is to Copilot adoption. So I guess when you think about how that might change the competitive landscape or how you guys are approaching like the evolvement of your own UC offering, maybe you could just provide a little bit more color there.

Yes. I mean we really believe also that what it's going to -- what AI is going to or AI companion is going to enable on the platform, it's going to make everybody much more productive, it's going to really reduce competitive task -- I mean, repetitive tasks, also freeing up your time. If you don't have to go to a meeting, just the ability to come back and quickly skim through a summary to save all of us from having to take notes in meetings, like it's really going to be compelling over time.

Yes. I'll close with a margin question. So Kelly, your -- one of the standout metrics from your 3Q print was those crazy EBIT margins you put up of 39%. That's like almost best-in-class in software. And it's also way above what you mentioned your long-term target was, which is, I think, 28% to 32%. So why not throttle back on that, Kelly, because we've just spent the last 30 minutes intentionally running through all the pretty cool growth drivers, so why not lean into those and sacrifice margins?

And we will. We -- as we've had this period of lower growth rates, we have intentionally been very, very thoughtful about our margins and wanting to ensure that investors know, we are being very thoughtful about that. However, where there is an opportunity to invest, whether it's in innovation, R&D, AI, go-to-market, branding, awareness, any of those components as we're thinking about FY '25 to reaccelerate top line growth, we will. And so the idea would be when you start to see top line acceleration and that could come at the expense of some margin contraction. But we want to be very thoughtful. We won't do one without the other necessarily.

My opinion, probably the better trade-off for the stock, Kelly?

Yes.

Thanks, everybody, for listening in. Thank you, Kelly, and Charles, for coming to the event.

Thanks for having us. Great to see everybody.