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

Thanks, everyone, for joining. This is Day 2 of the Wells Fargo TMT Summit here in Southern California. Pleased to have with us CFO of Zoom, Kelly Steckelberg, with us for the next session. Kelly, thanks for joining.

Of course, thank you for having us.

Making the ride from the airport through Long Beach.

Beautiful location.

Thank you.

So I mean, there are multiple areas of the business that I'd like to spend time on with the conversation. But maybe we can start with Zoomtopia. I spent time there in San Jose. I was at the analyst session. There were a number of different kind of product announcements and takeaways. So maybe you can just start with sort of capturing what the takeaways were from that event for investors. And then we can talk about some of the product offerings that you're using to kind of diversify beyond the meeting stream.

Sure. So of course, there was lots of discussion around AI at Zoomtopia. So Zoom AI Companion launched. It's been out now for probably about 3 months, and we're really excited about the momentum seeing there. We have over 200,000 accounts that have activated it. We've issued 3 million meeting summary, which is probably the most used aspect of our AI Companion. And just as a quick reminder, Zoom AI Companion comes included at no additional cost for our paying customers. So we think that's a real key differentiator and we can talk more about that later, I'm sure. Also, Zoom Docs, the announcement of Zoom Docs. So this is our first foray into really the area of productivity tools and think about this as the opportunity, the first time for a suite of these types of applications to be built natively with AI integration in it. So it really creates, I think, an interesting opportunity to rethink what even docs are, what -- whether you're talking about a word doc or like an Excel-type doc. Having that integrated from the very beginning and built from the ground up, I think is really exciting. And so that -- those were some of the key features. And then of course, Contact Center is a really important part of our growth strategy. So some exciting announcements around that too.

That's great. I'm going to go -- so we'll come back to this. I want to start sort of sequentially earliest in terms of time and touch on Zoom Phone. You continue to give good stats around seat adoption, the pace of that has been pretty rapid. Appreciating that it takes time to just build to significant stream relative to how big the core business is. But maybe you can just level set where Phone sits and if you're finding a sweet spot in terms of areas within the existing installed base types of customers that it's best suited for?

So we're really excited about Zoom Phone and our momentum. As you said, we crossed over the 7 million seat mark. We announced earlier this year that it had grown to be over 10% of revenue. So we are really -- now the product has matured to the level that we win across all aspects of the business. So we are typically taking share from some of the on-prem legacy providers, Cisco and Avaya. But we also win against the other cloud providers and really excited. We have some of our Fortune 10 customers using Zoom Phone. So that shows that it's really matured to the state that it can meet the needs of the most sophisticated users and we were recently granted a license to sell Zoom Phone in India, which was one of the really key milestones that prospective customers have been looking for because the ability to natively use this product -- we have a bring-your-own-carrier approach, which allows you to integrate. But natively using it really expands the benefits you can get with things like 4-digit dialing, just extension dialing and that's what a lot of organizations really want. They want their global team to feel as one through this product. And so we're really excited with the progress we're making there.

On the point on wins relative to other cloud players, are there points of differentiation you're finding? Obviously, there's probably a very strong brand association with the video product given we've all spent a lot of time within that experience. So how much does that help? And then are there other things that customers are providing feedback along where you're realizing those are key points of differentiation in UCaaS?

Well, I think there's 2 key differentiating -- 3 probably. The first is that it is the most modern cloud-based UCaaS offering out there. And it's the same can be said for our CCaaS offering as well. But if you think about -- it's been again, been natively built to integrate with Zoom Meetings. You get -- by having Zoom Meetings and Zoom Phone together, you get incremental benefits that you're not going to get by bringing 2 other providers together if it's one of those being Zoom and then integrating with somebody else because you have things like one-click ability to launch a Zoom phone call from a team chat message for example, or one-click launch from a phone call into a video meeting, like all of these things that natively come together and are seamless in the platform. And by the way, from a change management perspective, if you're transitioning your employees, say that you're a Meetings customer and you're adding Zoom Phone in, it's now just one more icon on the desktop. So it's very easy. You don't have to learn another platform. It's really, really easy for them to make that transition. And of course, we assist with porting phone numbers, et cetera. And then the third point of differentiation, I would say is total cost of ownership. So when you're competing against the legacy providers, of course, you -- on a price per month, it's much cheaper. And then when you look at the ability to get rid of all that on-prem hardware and people that manage it, it's a key savings. And then when you look at us compared to the other cloud providers, our list price is around half, depending on the calling plan that you get from us, but around half of that of the others.

Okay. I wanted to spend a little bit of time similarly on Contact Center. Again, something you're providing more proof points around 700 customers, I think, was the most recent statistic. I think MLB some exciting use cases that you were able to showcase at Zoomtopia. And so how would you characterize where Zoom is CCaaS today? And is it still -- is there still sort of incubation needed to get to some of the larger Contact Centers? Or just kind of help level set where you currently are in that journey.

So Zoom Contact Center is taking a very similar path that Zoom Phone did, which means we very deliberately brought this product to market before it had all of the features and functionalities that we know are needed to win those true big like 10,000-seat Contact Center deals. But that doesn't mean that they aren't coming and so there's a few areas that we know we are working on. So today, the core desktop agent that we sell, the agent desktop, I should say, integrates with voice, with video and with SMS. There are 2 other channels that are really needed, which include e-mail, which is coming before the end of this calendar year and then it's social, which we are in beta with a few of those like Facebook and WhatsApp. So that -- those are all coming as well. And then there's another really important piece of functionality, which is called PCI compliance, which you may be familiar with. These are standards which you can safely take credit cards and this is really important for any contact center that is selling anything or renewing customers. And so that is on the road map within the next 6 months, and that's really, really important. But we're -- yes, we're really excited about the wins that we've seen. And we also have continued to build out the platform itself. We have built natively a workforce management tool, which is really important as well as a quality management tool. So this gives the customers the flexibility. Sometimes they engage with third parties. So we have the APIs, where they can leverage the product that they already have in them or if they're doing an all-in new implementation, they can leverage the natively built applications. We also have Zoom Virtual Agent, which is our offering now as virtual agents are coming more and more, I think, imperative to the future of how contact centers are going to operate, that we have an offering. So we're also -- there's a lot -- been a lot of discussion about how is AI going to disrupt contact center and we're really agnostic around that because we have offerings for both aspects of it.

As the CFO, when you think about sort of the trade-offs, the margin profiles of different segments that you're expanding into, relative to the strong core margins the business has, what are the trade-offs you're assessing? And then is it fair to think there's willingness to kind of -- you've laid out target models that are below where the current margin structure. So is it fair to think that you're willing to invest in these opportunities because of significance within mix that is going to come and over time, you could still see glide path for further expansion. And then I'm just wondering, as CFO, if there are advantages with scale of the existing video base that you feel are points of advantage versus other players that might be going after similar product set.

Yes. So if we -- let's start with the gross margin first and talk about that. So this is a business that from the very beginning, we built a scalable infrastructure, and that has served us very, very well. If you go back to prepandemic, our gross margins were consistently in the 80% plus range. We saw this impact during the pandemic where it went down to 69% was the low, as we leveraged the public cloud. But I think we've done a really great job. Our DevOps team has done a lot of work to get that traffic back into our own colos and really leverage a more efficient way of supporting that traffic. We're going to always maintain some flexibility in the cloud because the providers -- the partners have been great with us, and it just gives us that ability to flex up and down as needed. But we're back into the sort of the 80% margin range. Now the puts and takes, as you look forward is Zoom Phone has a slightly marginally lower rate because of the transport cost on the end. So that -- we consider that obviously, you've seen as Zoom Phone has grown significantly, we've been able to really manage that, I think, very well this year. Contact Center, interesting enough, has a higher gross margin because of the price point of that product. So that could be upside potential over time. There, of course, is lots of discussion around AI and probably in every discussion you're having today. And our investment in compute does -- we've talked about on the call, have the impact to have a little bit of cause some contraction in our gross margins. However, the team is being very thoughtful about optimizing what's in our colos and seeing how we can create room for AI compute, which is an area we absolutely are going to invest in, but trying to do that as efficiently as possible. So that's a long way of saying like our gross margins are in a range that could move up or down probably a couple of hundred basis points, but not going to significantly change over time. I think we're doing a really good job of managing that. In terms of operating margins, as we came into this year and we saw that our growth -- we anticipated a year of transition and growth impact. We made a very deliberate choice at the beginning of the year to do a reduction in force. We took about 15% of our headcount, which is a difficult decision, but we -- as we saw the growth profile, we want to be very, very thoughtful about our operating margins. And we just announced operating margin in Q3 of 39%. So I think we've managed that very, very well and very thoughtfully. As we look forward, to the extent that we see opportunities to drive growth and reaccelerate growth, which is exactly what we're focused on, both organically and even potentially inorganically if we found the right target. But to do that, we have said we would potentially -- the areas that we would invest would be sales, building -- expanding our sales capacity, internationally, especially is an opportunity. We would invest potentially in channel programs, both externally and internally, meaning there are commissions that you have to pay that have some impact on margins as well as we are currently investing in our own systems and processes. We -- you have to go back in time and remember that before the pandemic, Zoom was a 95% direct-led organization. So we've had to evolve internally and build out systems and processes to support channel, which is a very important part of our growth strategy. And then, of course, there's investment in R&D, both in continuing to expand our platform itself as well as potentially investing more around AI.

So on the AI piece, I think the Companion product makes a lot of sense. And you did a good job kind of showcasing the value at Zoomtopia event there as well. Anything you can share on early feedback and then the strategy around not charging for it initially. Is that to kind of showcase the value, gain more confidence around the ROI and potentially evolve? Can you just talk about early adoption feedback and then how you're thinking about pricing strategy there, not just currently, but over time.

So we -- our approach to AI is we have what's called a federated approach, which means we are leveraging open AI as one of our key partners, but also Anthropic, Meta and Zoom's own large language model. And what this does, it allows us to create an experience for our customers. First of all, we're not dependent upon any one provider, which I think over the last 2 weeks, we've realized is a good strategy. I got asked that directly even on TV. And I think it's -- vendor diversification is always a good risk management strategy. But more than that, our CTO is a man named XD Huang who joined us recently from Microsoft. And he has taken a very thoughtful strategic approach to this, and I would really encourage you -- he recently -- last week, he wrote a blog about this which benchmarks our performance against -- what he's doing is he is using ChatGPT 3.5 as a proxy for what he believes Microsoft's performance would be, because he knows generally, that's what they're using. And what you see is by leveraging this federated approach and going to the, basically, the most cost-effective model first for an answer and then scoring that answer and then deciding is this a good enough answer? Or do we have to go to the next level? We are currently benchmarked against what we believe Microsoft's results to be at a fraction of the cost and a better performance in terms of latency and accuracy of results. And so that's really what -- first of all, that approach enables us to provide what we consider table stakes around some of these key features at no additional cost and provide a really high-quality solution. And so that's the benchmarking, right? You can go look at all the technical data. Feedback from customers is, it's been really great. Like meeting summary which -- before meeting summary, we had transcription, which was literally a word for word transcription of the meeting, and we would use that as a starting point, for example, for the transcription on our earnings calls. But it was a starting point, definitely. Like you had to go through and you had to proof it, you had to change it. Like it wasn't great. This is great. Meeting summary is great. Like it starts to understand context, it understands humor, it understands people's names, like it's really good. And so I would say like, we're going to get to a point where you're all going to come into a meeting like this, and you're going to want to start Zoom on your phone because you're going to want it to just take the meeting summary as your notes and not big notes anymore. That's what we're going to get to.

That's very cool. So tying that together with some of the things you're working on in productivity. I guess the first question is how is the Zoom Phone adoption curve, maybe not to size of revenue scale that that's gotten to. But in terms of customer adoption, is that a fair adoption curve for us to think about with some of the newer products? And then with productivity, how much does that tie into a bundling strategy? Because it seems like you have a very entrenched base of customers. It is very large, that is loyal to the brand, and it makes sense to try to kind of test in a few different ways. What else you can monetize from that base?

So in terms of newer products following Zoom Phone, Contact Center is following a very similar path from a dollar perspective, not a percent of revenue because revenue is growing, remember. But if you look at where it is, it's about 6 quarters into its lifespan and you look at the traction it's gaining, it's following a very similar pattern. So the way that we're thinking about it is it should get to, say, $500 million-ish of revenue, if you will, in sort of the same time line as Zoom Phone did. Now remember, Zoom Phone was in its like fourth or fifth year before it was really visible in terms of the impact of the contribution to growth that it was having externally, which it took that long. So it's -- this is not an FY '25 or probably even an FY '26 phenomenon, but we'll see it and then it will start to become visible. Now other products on productivity like Zoom Docs, that's in such -- I mean that's not even in beta yet. So we have a way to go. But absolutely, the goal of Zoom is to be the platform where you spend your day to be a complete communications and collaboration platform. And so that extends beyond Meetings and Phone and Contact Center, right? And we have some really cool products that we -- I feel that we don't even talk about the meetings much like we have a really amazing Whiteboard product. We have a new product called Clips, which is an asynchronous video communication tool. These are all included in our platform. And you can see how this just continues to extend and be the place where you spend your day. And I think in addition to Zoom, the next place I probably spend the most time is in the Google suite, right, in terms of sheets and docs. And so that's, I think, the very -- that's why it is a very natural extension for us as well.

How much are you also contemplating the education and health care-specific breakouts on the website for more specific needs. And I think both of those make a lot of sense. How much do you think about either persona types or further verticalization as a strategy where maybe you can get deeper into some of the use cases that you're seeing as most prevalent?

Yes. Health care, especially is a really important area that we spend a lot of time focusing on and thinking about how do we get closer to some of the health care providers and we have a very strong APIs that we've built, that we work with. So I think that is a key area that we are focused on and we'll continue to invest in. And I think there's a lot of opportunity yet there for sure. Education has also obviously became very -- extremely important for us, especially during the pandemic and continues to be higher. And I think students, just like employees want flexibility and they want the ability to -- and they realize, right, they can get a quality education no matter where they are in the world. And so that's an area focuses for us as well. But I would put health care above education at this point.

Okay. We'll spend a little bit of time on the recent quarter's results as well. I think a key point of focus from investors has just been on kind of getting a sense of where things stabilize and then starting to think about swing factors that could tip more favorably in Zoom's direction and potentially kick the growth profile up a little bit. Obviously, something you spend a lot of time thinking about as well. The online business seems to be stabilizing as far as the churn rates continue to tick down, you raised price there. It doesn't seem like that was overly disruptive and probably helps protect growth there. So maybe just set the stage for where the online business currently sits and some of the lessons that you've learned in the past couple of years and kind of fine-tuning some of the strategy there.

So I agree. I mean we have a high standard when we say the online business stabilizing, we really want to see that quarter-over-quarter dollar amount being really even or going up, and it's close. I mean it's only -- the rate of decline is very small, it's a few million a quarter right now, but we're absolutely striving for flat to up. But you're right. So we announced our monthly churn of 3.0%, which is the lowest we've ever seen. And the platform -- we're not modeling it this way, but that, in theory, could even improve because the platform, this is comparing to where it was 4 years ago. The platform is so much better than it was then, right? There's been so many optimizations around the buy flow, about the products that are available there, the ease of use in terms of just buying itself, helping people as they decide they potentially want to cancel, taking them through a flow that ask them why and potentially offers them a discount. There's just been so many improvements just on the website itself. And then you mentioned the price increase. So we did a price increase earlier this year. Just a few weeks ago, that was on the Pro version of our product, which is the lowest bundle you could buy online. In early November, we announced we are also doing a price increase now on Biz and Biz Plus which are the next 2 levels, and that is both on the monthly and annual versions of those products. So that will go into effect in mid-December. So what that will do is give us the benefit of having a full -- that price increase available for the full FY '25, and that should be beneficial. And then as we continue to expand the products, there are certain products that avail themselves very well to selling online. Obviously, Meetings but also things that I mentioned like Scheduler, like Whiteboard, those are really great because those appeal to the individual consumer as well as small businesses. Contact Center, for example, is a product that's not going to ever lend itself well to being sold online. But this is more -- the extent we can expand the platform and the productivity suite that's available to them, that's really great. And then there are always ongoing initiatives that Wendy and our team are working on, to expand the overall market availability. So that's increasing the number of currencies in which we sell, increasing the product types that are available and then looking at ways to continue to improve the free-to-paid conversion. And that's improved over time due to things like limiting the amount of time you have on a free meeting, but where it's really going to come going forward is the differentiation between the free and the paid products themselves. For example, Zoom AI Companion is included in the paid version at no additional cost. Free users don't get access to that. There is a free trial they can use but only for a limited amount of time.

Very helpful. And then so just to kind of dovetail into the enterprise segment. I know it's a lagging indicator, but the expansion rate gets a lot of attention. And so if there's a way for you to kind of help us kind of split the difference between seats as a driver of expansion and then just cross-sell of additional products, how you're thinking about the overall trajectory? And then just from a seat perspective, what you've seen, right? It's been a sort of a macro environment where a lot of companies have unfortunately gone through headcount reductions and other exercises. And so a lot of rationalization has gone into decisions. It seems like we're a year through those now. So maybe that helps create a level base for whatever happens next. But I'll let you kind of characterize the expansion rates and just where the enterprise segment fits and what we should be thinking about as swing factors into next year.

Yes. So as you indicated, the way that we calculate it, it's a 12-month trailing metric. So we unfortunately do expect it to come down a little bit more before it starts to stabilize and reaccelerate as our enterprise growth rate has come down a little bit. And as you said, there are a few contributing factors to that. So this year, we have seen, as you've seen -- as you mentioned, a lot of our customers rightsizing their underlying meetings. And the good news is that our team has done an amazing job of, first of all, logo preservation. So preserving those organizations as customers. But then talking to them about, okay, we understand you need fewer meeting licenses, but let's also take this opportunity to talk about converting you from a meeting SKU to a bundle. So preserving the dollar spend while reducing the seat count by moving them up to a higher level SKU. And one metric we gave on the call that portrays this is our customers that are on a Zoom One bundle grew 330% year-over-year. And the reason that is so important is because we know that customers that have more than one product are much more retentive as well as the fact that, that is a higher dollar SKU. So to the extent eventually the economy starts to improve and customers start to hire again, now they're going to be adding seats in this higher level SKU and that's really helpful over time. Again, we are not -- as we think about FY '25, we are not assuming the economy gets better. But what we're doing is -- as painful as this kind of restructuring is that we're going through, we're getting ourselves better positioned for the future. The other thing that's happening is customers are committing to longer-term duration of contracts. And you see that through the growth in our overall RPO, especially the long-term RPO that at current, as a percentage came down 1 percentage point, which indicates this duration extension. So all of that has gotten us, I would say, better positioned. Now when we look forward to FY '25, we know that the majority of our customers had a renewal event sometime in FY '24, not all of them, but the majority of them. So we hope that a lot of this is behind us. So as you said, we've sort of seen the economy start to get better and it feels like -- or I shouldn't say it's getting better, the economy stabilized in terms of at least reductions that people are doing. We don't know that all of those yet have worked through our customer base. And there's likely to be some of that still in FY '25, hopefully, to a lesser degree than we saw in FY '24, given the majority of our customers had a renewal opportunity, but I anticipate there's going to be some of that still coming through next year.

The last sort of major topic I want to cover is just the capital allocation strategy. You sit in a very sort of interesting seat where I think investors have a lot of opinions around different things that you could do. The business is super efficient, right? So it throws off a lot of cash which is nice and not something we always see in software. You're sitting on $6.5 billion in cash currently. So I guess the first question is just in terms of -- you've mentioned in the past, growth is the core point of focus, and that could be organic or that could be inorganic. The things you contemplate from an inorganic perspective, what is the hurdle for the type of company? Are there certain adjacencies that you most often think about? Or just how would you characterize that portion of the equation for investors?

So we constantly look at opportunities for inorganic growth acceleration. We look both in spaces that we're already in as there are certainly -- if you look at UCaaS for a minute, it's a relatively crowded space. And there's certainly -- I think over time, there's going to be consolidation. It's just a matter of who's going to do the consolidating and kind of when. I think the same is with UCaaS, which is -- I'm sorry, with CCaaS, which is interesting as it's becoming even more crowded, right? Obviously, you have the 3 big leaders today, but also with us joining [ Trulioo ] and its product with [ Rings ] product, I think that starts to create some interesting discussions as well. But the way that we think about potentially any M&A is we first think about it from our customers perspective, so what is that -- what would be their technology? What do -- what would be their experience. And because we are -- we're very proud of the ease of use and the reliability that customers get from our platform today, and we would never want them to sacrifice that. So always thinking about what would be the road map if we were to bring in another third-party product. Second, we look at the culture. And we believe that culture is a really good indicator of the potential successful integration as not every M&A transaction is a success, and we would always want to ensure that we were striving for the highest possible success rate. And then third, of course, the valuation. And while valuations have become more attractive, I would say, over the last year or so, there's always this trade-off. There's some amazing companies out there we would love to have. But when you look at it from a valuation perspective, like is it going to move the needle of our growth. And at $4.5 billion of revenue, it's got to be something fairly sizable to really move that needle. What we've done to date very effectively are smaller tech and talent tuck-ins and so we continue to consider those. I mean we do those. I think we've gotten that muscle built now, and we know how to do that very, very well, and we're proud of what we've accomplished to date, but also would consider something bigger. And that's why the $6.5 billion really gives us that flexibility. I -- we've been very reluctant as a company to take on debt in the past as we haven't needed to, and we would prefer to maintain the cleanliness of our balance sheet that we have today. And also, frankly, I would rather use cash for an acquisition to date to the extent that I can, avoid issuing stock at these levels, right? So I think the trade-off then is, okay, we're not doing M&A, are we doing a buyback, which we've done one successfully in FY '23. We were able to offset more than the dilution in that period of time. And we consistently have this discussion with our Board about when is the time to reconsider that and yes, we will continue to do so.

Is it -- I mean, is it a part of that discussion then because valuations are in a more favorable environment than they've been and preserving that flexibility becomes more important? Because I think investors like the offset dilution just some kind of baseline to think about.

Yes, of course. So we executed $1 billion of buyback, which I understand why investors appreciate that. And yet when you look at some of the transformational deals that we could consider, it could, in theory, take all of our cash. And so that's why we're sort of straddling this flexibility maintenance because it's really important. We want to make sure that something comes to light that works that we're able to execute on.

Okay. That's super helpful. Just a couple of minutes left. So I'll leave to you for closing thoughts. We've touched on a lot. I think there are a lot of reasons for optimism around just some of the new product areas that you're focused on. But as you're thinking about planning for next year, sort of the key takeaways that you'd like investors to focus in on, what you think will be the bigger needle levers for Zoom and what you'd expect us to be talking about for next year and into the future?

First of all, I'm super excited about our platform. I mean, we have an amazing technical team between our Chief Development Officer, Mu Han, who came from Microsoft with Smita Hashim, who is our Chief Product Officer, who came from Microsoft. We have an amazing team that is innovating at a pace that I think is unheard of. And I feel badly sometimes because there are so many products we never even talk about, like Zoom Events, which is an amazing product. And so the expansion of the portfolio is really significant. And as I look forward to FY '25, the growth drivers are going to be the ones we've talked about. It's going to be Zoom Phone. It's going to be Zoom Contact Center. And then on the go-to-market side, we're really looking towards stabilization and growth internationally. International has really been a headwind for us this year. Part of that's the economy, part of that's local execution, part of it was FX rates. But we have great -- we have some new leaders in place, very excited about that, getting them set up to really lead their teams and invest there as well as building out our channel. I think all of that starts to come to fruition where you can see accelerated growth rates in the future.

Okay. Super helpful. Kelly, thanks for joining us.

Yes, thanks for having us today.

Appreciate you taking the time.

Thank you, everybody.