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

Good morning, everybody, and thank you for coming to the Barclays TMT Global Tech Conference. Happy to be here today. My name is Pete Newton. Obviously, I'm not Ryan MacWilliams. Ryan just gave birth -- his wife gave birth [indiscernible] if you see him [indiscernible] Bloomberg or something in [indiscernible] I don't know if you're having [indiscernible] With that, we're here with Zoom Video Communications and their CFO, [Kelly Steckelberg].

Before we begin and dive any questions, there's a lot in the recent news. I do have to say the first time [indiscernible] was about months ago at the Zoomtopia event and you know how I check in to these conferences go. You walk around, you get your badge, your name tags, [indiscernible] food, drink, things like that. I saw [Technical Difficulty] really good. So I walked over there [indiscernible]. So the first I'm not telling -- I didn't bring back into that. I'm sorry [indiscernible] with that, I'm glad you have a talk. [indiscernible] But would love to hear your thoughts regarding the space and the market speculation around the recent M&A rumors.

Yes. Yes. So [indiscernible] somebody asked me this morning while we were kindling our [indiscernible]. And I'm here to say we are not rekindling [indiscernible]. We're highly respected there an amazing company with high regard to them. But we are really focused on building a [Technical Difficulty] in our home. And there was [indiscernible] news this morning about our new pricing approach that we're putting in place which just highlights our commitment to building a true enterprise-grade contact center. So the product, this is also another thing because we are still focused on this, actually, [indiscernible] itself is now managing the contact center team. So we've done a slight reorg within the organization and pulled that in, and it's really exciting to see. And I think we just help continue the focused commitment to acceleration of this product. But it's doing well. We announced on our call that we're over 700 customers and there are some great features and functionality that already exists today and some that are coming, they're either in beta or we release later this year. And what we announced is kind of a pretty standard in the industry peer pricing in terms of how you relapse depending on your needs for the product in price and engineering.

Very helpful. Just kind of double-clicking on that. You mentioned the 700 customers, which we believe up from 550 or so [indiscernible]. How should we think about the makeup and composition of an ideal Zoom contact center customer.

So we have one that we talked a little bit about, I think, on the call or some of the responses, where an ideal customer is one that already is likely a meeting [indiscernible] because they're familiar with the product. And we [indiscernible] with our customers that recently in the last year, they doubled their [ phone call commitment ] they also doubled their contacts center commitment and then in addition to that, they deploy workforce management and quality management. So we're building components around the core desktop as well. And seeing a customer really like that go all in is really amazing.

That's helpful to picture. I do want to just touch on the M&A point before we put it to rest. How do you think about acquisitions with regards to entering new markets? Versus with regard to something within the existing Zoom Video Communication.

And so we obviously have a significant amount of cash sitting on our balance sheet, $6.5 billion to be specific. And we really see that as an opportunity. It gives us flexibility to be focused on areas of potential investment. And what we are focused on is driving top line growth. We can talk about this more. In terms of the overall financial profile, but we really have gone through some transition this year that are focused on reaccelerating growth for the company in the long term. And M&A is a way to do that, you want to maintain the flexibility. And we look at it in terms of areas that we currently compete. We see these [indiscernible] as potential opportunities. And it could be [indiscernible] historically is buying smaller tech and talent, tuck-ins that accelerate development there or it could be a larger or more transformative M&A opportunity that brings you other areas, not only product customer, but areas of [indiscernible]. But, Beyond that, we also look at things that could sit adjacent to where our platform exists today, so that could be productivity. It could be expanding our verticalization in health care and education, which are really important for us today, even sales could be another opportunity. You start to think about more department specialization as well. So that's to say that [indiscernible] and they look at all of these opportunities on a database. And we think about M&A, there's one of the things that we look through. First of it is like [Technical Difficulty] that's really about the technology. We're very proud of our modern architecture that we have today, right? The ease of use, the reliability, we never would want our customers to have to decide around that. We look at culture, as culture, we believe, is a good indicator of potential success of the integration with us. And then we also look at valuation. And valuation certainly has become sincere over the last year, but we are very thoughtful [indiscernible] company, and they really want to be careful about how we come in and where we've had challenges in the past has either been technology evaluation. But we will eventually find the right match.

Okay. That's very helpful color. Just broadly, just thinking about your cash position right now. And I know the past [indiscernible] share buyback is kind of on an annual basis. How should investors think about the timing of an M&A transaction as well as at what point would -- can Zoom potentially cause that strategy and look forward to [indiscernible] buyback?

We did -- we've done on buyback, okay. We did that in FY '23, and it was, I think, very swiftly executed to offset more than the dilution in that year. And we have a submission every quarter with our team and our Board. And again, it's about maintaining -- currently maintaining the flexibility if we were to see something that was really attractive to us in terms of M&A. Historically, we have been very reluctant to take on debt. And also given where the stock rate is today, I would rather use cash for an acquisition then issue stock in introduction [indiscernible]. So, it doesn't mean that we won't do another buyback at some point, and it's just a matter of evaluating the opportunities that we see in the market and balancing that with potentially returning cash.

I think we have kind of beat the M&A topic. We're are good to move on. So just looking at FY '25, how should investors be thinking about growth prospects moving forward the next...

Yes. So the growth drivers of the company for the future, certainly [indiscernible] continues to be a very important growth driver for us. As a reminder, we announced we've crossed over the 7 million seat mark. So really excited about the ongoing momentum there. It will be contact center for all the reasons that we've spoken about earlier. Certainly, AI plays a very important role in our overall growth strategy in terms of not only improving retention, but also being a really key comparative differentiator for us, especially, I guess, Microsoft is the fact that our AI companion income included or are paying customers at no additional cost. And our CTO recently did a blog that highlights how our AI companion continued to get Microsoft in terms of product responsiveness in terms of accuracy at a fraction of the cost and the fact that they're charging $30 a month and ours is included. I think it's a really important differentiator. And then the other opportunity areas for growth is really around international. International has really been a headwind for us for the last couple of years. That's a combination of FX rates, the economy we've seen, the impact [ in Russia ] starting to see those markets eventually return to stabilization would really be a help for us as well as we're investing in growing our sales teams and our [indiscernible] in those markets.

It sounds like growing contact center is key drivers. So just kind of touching on the contact center. You said [indiscernible] you're heading a division, a group. What's the strategy looking like for targeting customers? [indiscernible]

Yes. So first of all, it's really focused on adding new features and functionality that we need to get to that true enterprise level -- ability to compete at the enterprise level. And so, today the products need to integrate with voice, with video and with SMS. We need social, which is in data right now is Messenger and WhatsApp, things like e-mail integration as well, outbound dialing and then PCI compliance, the standards which you can take credit card [indiscernible]. And all of those are coming, I would say, within the next month. And so when we get to that level, then we'll really -- I think I can say so in the next year-ish we'll really be able to compete at those levels. The other thing that we are working on in establishing that's really important selling as well. And we have some of those in place, but some of them are still very nascent, especially when you look outside the U.S.

That definitely makes sense. I think from like an AI purchase perspective, within the contact center. What are customer conversations looking like for domain within for AI within the contact center?

So there's a couple of different components. There's the Zoom Virtual Agent, which is actually a stand-alone SKU that we sell that leverages AI to respond to customers without [indiscernible]. And that we've seen great successes we've deployed internally for [indiscernible] contact center. We've deployed it also early to handle some [indiscernible] questions, especially around taxes, et cetera and we've seen great success internally on the online contact center to handle and like 85% of the inbound calls. So that's really been successful. Yes. So there has been a lot of discussion around contact center in terms of like what AI want to do to the contact center and we honestly are agnostic when we talk to our customers about, "do you want to deploy a human agent to address this? Or do you want to use a virtual agent?" And we have a [indiscernible] we're really excited about the future there. And then as part of the announcement this morning, there's also a feature called AI Assist, which helps the agent prompt them and some of the [indiscernible] coming is like will elect obvious steps [indiscernible] not obvious. So what's the next recommended step stick with this customer based on the discussion that you're having right now. So this is where AI, I think, is going to really help not only organizations being more efficient by leveraging potentially on virtual agents, but also having agents themselves more efficient by prompting them potentially more [indiscernible] able to upsell depending on the conversation that they're having. So I think those are all the things that are coming with AI in general.

And I think so 6 months ago, there was a big [indiscernible] from [indiscernible] there was a big concern on context on the company because you thought AI is just going to drive efficiencies to a point where we could automate and remove contact center agents, seat-based model, you can see there can be a clear headwind. So what have you seen with regard to AI potentially replacing agents?

I think that they will be able to really make agents more efficient is how I think about it. And they can take away the majority of the repetitive type transactions. So like what we've seen internally is password we've had, like I said, on the billing side, adding things like enabling the customers to input their tax ID without having to talk to an agent, right? So those are non-value actions that a virtual agent [ can remember ] AI can accelerate, where the agents then can get elevated up to is really the value add, whether it's solving a more difficult product [indiscernible] problems for the customer, potentially talking to them about an additional product that could be up-sold to, and that's where I think is going to start. The AI really drive more value into the context.

Making the Tier 1 interactions kind of automated. Tier 2 is much more value-add. I can see that. Moving over to the AI and the noncontact [indiscernible] AI companion which is, like you said, baked in the existing product offerings and pricing plan. We love this approach, by the way. Back then [indiscernible]

So customers love it. The feedback has been great so far. Eric was even telling you story about having dinner reasoning with the CIO and is so interesting. So we often see that our customers are leveraging [indiscernible] Microsoft. And we build our products to increase [indiscernible] really comfort perspective. This is the customer is leveraging the meeting and [indiscernible] by using Microsoft Teams for chat. And what I said to Eric, there was talking to them about a companion and we think it is at all the functionality that you get, especially as you start to use it across the platform, the CIO said, "You know what, that now is a compelling reason for me to really look at Zoom Chat because I can leverage the AI capabilities across the entire platform and by the way, I don't need an additional $3 a month to get that. And so I think this is where you're going to start to see the product really be -- Zoom AI companion be a differentiator for us and not only drive retention, but even potentially drive attraction to the platform. Because, it is as good as anything else they're probably better than may think because of our federated approach and the ability to really provide a great product at no additional cost to our paying customers.

It sounds like Zoom AI companion can almost help Zoom serve as a consolidator across all different point solutions.

Exactly. in general, we believe -- if we look at the -- I mean there's some poor products [indiscernible] we really even talk about. We have an amazing whiteboard product. We have a scheduling product that is [indiscernible] We have Zoom Clips, which is our asynchronous video product. So they're really -- and when you look at the total cost of ownership benefits that our customers get, whether you pick each of those products individually or you do them as a bundle under a Zoom One bundle, the opportunity to consolidate onto our platform, have an amazing experience from reliability, ease of use, amazing integration where all of these are cloud, the modern architecture product at a very competitive price, I think, is a really compelling [ proposition ].

I definitely agree. So it kind of sounds like there's ways to indirectly monetize Zoom AI companion. Have you thought about pumping down the line, are there ways to directly monetizing Zoom AI companion?

Yes. So there are SKUs to leverage AI that are monetized. As I mentioned, like Zoom virtual agent, for example. We have Revenue Accelerator, which is a sales analytics tool. We have things like prescription, which are all separate SKUs that are separately priced, but specifically to AI companion itself, there are a couple of avenues that potentially in the future could [indiscernible] monetization. Right now, SaaS products by definition are multi-tenant, right? AI and the data around AI -- it starts to play to an interesting [indiscernible], which as we've said very exclusively [indiscernible] to train our models. Some customers, so it comes to us and they want to leverage their data for their own model, right? And so what you could start to develop over time [indiscernible] tenant relationship with those customers, whereby you're building an environment that segment their data or segregate their data only for their benefit, and that could be potentially a premium offering that we could charge for. They're also today, the things that we're including in AI companion, which are like eating summary or catch me up, which allows you to join a meeting late and ask what did I miss? I stepped out of the meeting yesterday and while I was gone, somebody did something like this is what you missed. It was a really great summary on what happened during the meeting while I was gone. Like chat compose, email compose, we believe those are all people take and are going to be included. But there could be premium offerings to go over and above that at some point.

Well, I could really use that [indiscernible] give you a number of times I missed something I call and look from Ryan. Not just diving more into like the quarter performance and kind of questions around that. You've got at a recent [indiscernible] in business and business plus plans. Can you just go over the details on that?

Yes. So as a reminder, earlier this year for our online segment, the lower bundle is Pro, and we had a price increase for monthly pro users earlier this year with $1 on top of the $14.99 price. Biz and Biz Plus are the next 2 levels of bundles for our online. And in November, we announced a price increase there at $2 per month for Biz and Biz Plus for both monthly and annual customer. And then earlier this week, we announced a price increase for that to Pro, the annual version of Pro, which we didn't do last year. So basically, all of the online bundles have gotten price increase over the last 12 months now.

Is that pro annual price increase $1 as well. Monthly? Or is that...

I think it's the way it's probably 10$ in total because I think we give them 2 months for free. I think it's how the math actually works out.

Helpful. And then just on the Biz and Business Plus side, how large [indiscernible]

We don't disclose the actual number of our customer base. What we have about our online consumer base, the majority of them are on the Pro plan. So the majority of them have gone through it, but there's obviously still an opportunity and the price increase for Business Plus is $2. So it's a little bit higher. There's more value there. It's a little bit higher.

I understand this takes effect December 8, Friday. Is this baked into or factored into the 4Q guidance at all? Or how could we look for upside for FY '25?

So we did know this was coming obviously for times we did guidance there, but yes, we remember, some of those customers are monthly, so they'll get [indiscernible] some of them are annual. So the full effect of it very specifically in December to enable us to have the full impact in FY '25. That's really -- minimal impact in Q4 [indiscernible]

Good enough. And then just on a macro perspective, have you seen any changes in macro since the quarter end? Can you elaborate on how that -- how macro is currently impacting different parts of the business.

Yes. So in general, macro environment, we've been on for few quarters now. We certainly continue to see deal scrutiny, along at itself like old second quarters. We saw that in Q3. We expect to see it again in Q4. And then the other impact we've seen [indiscernible] right, I think [indiscernible] their own reductions through their employee base. And an example of this would be a customer that comes to us and says, I have had 100 employees. They had 100 meeting licenses. I laid off 20% of the employee base. So now I'll need 80%. Our team has done a really, really good job of saying, "great, let's look at your right sized, but let's talk about now moving on from meetings to Zoom One, which is a bundle. And we announced on the call that our Zoom One customers grew 330% in the paper. And that's really important because what it does is, first of all, it serves the customer. It preserves generally the spend because you're moving them to a higher base SKU or able to say now you're buying 80 at a higher dollar, so maybe a sustained dollar amount. And what it does over time, is, first of all, it's on a bundle, and you know that customers who want more than 1 product are more [indiscernible] and that's great. It also gets them better situated in terms of a higher dollar scheme. So that eventually improves and they start to grow again and now they're growing at a higher level SKU. So by looking at the data that the majority of the customer had renewal opportunity in FY '24. The majority of them hopefully have worked through this. However, and unfortunately, I don't think we're completely done with rightsizing. We are going to have customers that are going to renew in FY '25 that didn't have a renewal period in FY '24. And as you've seen over the headlines in the last few days, we've seen announcements from [ Twilio ]. Some of those are our customers. So we will obviously continue to work with them through these, but I feel like we have probably another year or so of this rightsizing transition period that we're working through, which is a transition phase which is a little bit difficult. But I think on the other side, coming out of it, we're better positioned as we're able to move them to these bundles, which really for the long run bring them a lot of beneficial total cost of ownership, but for us also [indiscernible] SKUs which we roll it for them to be on for all the reasons I mentioned [indiscernible]

So on the linearity perspective or those kind of optimizations and like contract renewal sizes getting a little smaller. Have you seen any improvement or trend in 3Q versus 2Q versus 1Q in FY '24?

What we did see this year, which was as a reminder, we did a pretty significant reorganization and restructuring of our own in Q1 of this year and sales teams, especially some of that lingered into Q2, partly due to international labor laws. They had some structural changes, a new leader. What we did see, which is very interesting is, historically, if you remember Q2 and Q4 have been our high end [ business ] quarter and we have reps that are round 6-month plans and then Q1 and Q3 are seasonally balanced. We actually saw bookings in Q3 equal to those of Q2, which was an interesting phenomenon. And I think it's a good -- I think it's a good example or a good indicator that we've kind of worked through that transition period. Q2 was probably a little bit impacted still by the reorganization. It's always a distraction when you go [indiscernible] like that. And it tells me that like Q3 is like, okay, we're kind of back and their focus in [indiscernible] what's coming in for.

Sure. That sounds like [indiscernible]. Take a look at the puts and takes of the deferred revenue guide for next quarter, like down 6% to 8% year-over-year. Could you just explain what's happening there just because from an optical perspective, [indiscernible] stronger book this quarter? And think that moving more towards enterprise deals [indiscernible] tech center as well. So in the commentary [indiscernible].

Yes. So it's a really interesting phenomenon that's happening, which is if you look at the total RPO, it's up year-over-year, which indicates as we're going through these -- kind of rightsizing discussions with our customers, we are able to get them to commit to longer-term [ contract ]. That's showing up in RPO. However, customers are taking advantage of the higher interest rate environment and are reluctant to give us their cash upfront, right? They want to do is they're willing to commit to a longer-term contract, and they typically get a discount in response to that, but they prefer to pay on [indiscernible] so if they're paying annually for, now they want to pay monthly, that allows them to preserve. I mean I can tell you they can earn 5% in the market, we don't give them a 5% discount to pay upfront. So they're making that right off with [indiscernible] but that's why you're seeing RPO extend, also the revenue coming down.

Okay. That's helpful. Really shifting a little bit over the Zoom Phone. You called out 7 million users, which is just wrapping it up, I would say. We're very impressed with this number. What are you seeing in Zoom Phone? Is that performance above or below expectation? And what's next for Phone?

Yes. So we are really pleased with Zoom Phone and the momentum that we're seeing there. What's next is focused on international expansion, building out the organization as well as channel relationships there. That's a really important area for us. Some of you may remember, we were mainly a direct-led organization where we had this meeting, we were 95% direct. And so we're continuing to focus on building that out. We recently got our license to sell Zoom Phone in India, which is a huge [indiscernible]. It's a very then consuming an elaborate process to achieve that. So we're really excited there. And that really is kind of the last, I would say, check box, for our large multinational phase. They want to be able to natively communicate -- use the native [indiscernible] to communicate with employees in India with what you get and we have the ability to sell there directly.

I think Zoom Phone [indiscernible] has been very impressive. So I think [indiscernible] down there. Just on the SBC side, I think it's an important piece of the Zoom story to touch on. Commentary regarding the supplemental grant program or what that should look like in FY '25.

Yes. Thank you for the opportunity to talk about that. So as a reminder, we had a supplemental grant program that we sunset in February of this year. So we're working through kind of the last phase of any of those brands. And if you look at FY '24, approximately 1/3 of our stock-based comp is directly tied to grant a supplemental program. And those brands [indiscernible] tied to the underlying vesting of those brands. So that's the cost. So those -- whatever the grant was given, there were 2 or 3 years left of vesting from that grant. That's how the design of the program. So it's simplest way to think about this is 1/3 of the stock-based comp in FY '24, we bill for just 3 years from now. It will not be -- it will come down in step by step by step. And then that date is kind of what's left in terms of -- based on the size of our organization today that you should expect with a recurring stock based -- normalized stock comp level.

Okay. So then 1/3 is on a dollar basis, it's not a percent of sales. And I think just moving forward before our time runs up, just loving to dive into the operating margin profile of online versus enterprise. Is it reasonable to think that online business margin could be double enterprise business margin or the [indiscernible]

I think the easiest way to think about it is the online business model margins have no sales expenses, but very minimal. What I should say. There's a small team that supports them. They do allocate marketing because they benefit for it, even though most of our marketing is targeted to the enterprise, there is obviously a benefit [indiscernible] into online, but the majority of it, you can almost completely take out the sales?

Very helpful. And before we wrap up, we will probably give you the floor, you think that investors should mind heading into 4Q or FY '25 [indiscernible] perspective.

I think we're really excited about the future. We think we are very well positioned with not only the extensive nature of our platform, ongoing expansion of contact center, AI companion, I think, is really going to be a key differentiator. And then, of course, as the economy itself eventually starts to improve, which we're not giving up '25 guidance, but we are not prompting on that for FY '25, but over [indiscernible] as it does, we'll be very well.

Thanks so much, everyone, for coming. And thanks, Kelly, for being here.

Thank you.