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

All right. Well, thanks for joining us, everyone. I'm Parker Lane, Software Analyst here at Stifel. And with me in this session is Tom McCallum, Head of IR at Zoom. Tom, thanks for joining us.

Thanks for having me.

Really appreciate it. Everyone knows Zoom, everyone uses Zoom in some capacity or has in the past. So we're going to talk a lot about Contact Center and Phone, but I want to start with the core meetings business, the video business. Is there still an opportunity for a company like Zoom in video, especially post pandemic? Or is most of the growth from the meeting solution largely had already?

It's a much more mature product because of the amount of adoption that happened. There's still opportunity to take share. I think we're kind of down to sort of a big 3. It's like ourselves, Microsoft and Cisco still has a pretty good installed base. And the last couple of quarters, we've seen some pretty good large deals come over because this goes up in that enterprise space. We won a big tech company last quarter. [indiscernible] that one is an international airline. So there's definitely some enterprise share shift that could take place. There's still a little bit out there of some of the smaller guys, but they're just not as relevant. So I'm not sure it's much of a needle mover. If the economy were to improve and there were more knowledge workers created, say, we had an IPO, wealthy IPO market and the people were hiring, that would be helpful for us, but we're not going to wait for that. So what we're really focused on is expanding beyond just the video conferencing product. It is very, very well known. It's giving us a great brand. We've got a lot of customers, but it has matured just because of the adoption from the pandemic.

Yes. You mentioned Microsoft, you mentioned Cisco, yourselves. When it comes to the video offering itself, like how do you maintain that category leadership out there in a world where Microsoft can bundle it with other things as well?

Yes. So Microsoft is kind of known for bundling, it's kind of known for really good distribution. I think for us, we try to out-innovate them, stay ahead of them. They are a fast follower, so you can't sort of sit on your laurels, you have to be out there doing things. For instance, we, in September, launched our AI product, our AI Companion. And it basically comes free with the Zoom paid subscription. So you can have AI generated summaries of things. You're going to use AI to generate chats. So -- and we've done other things like we've added more to our chat product, which also comes free with the Zoom video subscription. And so -- and then other products we're cross-selling within. So a lot of innovation is probably the biggest thing. We're also very focused on customer happiness, as we always have been going all the way back from our IPO. And so we do a lot of things to add innovations that our customers specifically want.

I feel like we've been talking about this going back to the pandemic, but the online business was a major headwind. It's become less of a headwind. It seems to be stabilizing in real time. Can you just talk about that dynamic a little bit? And when you look beyond the stabilization point, is there an opportunity for that to be a growth driver of the business itself?

Yes. So I would say -- and just everybody knows, we have 2 businesses. We have an enterprise business, which is really enterprise just sort of down to the SMB space. And then we have an online business, which is self-service, small, anyone from a sort of SMB to kind of a prosumer maybe even a few consumers. It's a very profitable business. It has really great cash flow. It's basically credit cards, you collect, you get the cash. So, it was about 20% of our business before the pandemic and has gotten to the majority of our business. As our enterprise business grows faster than the online business, it is shrinking. I think it will continue to do that as a percent of the total business. I don't know if it gets back to maybe get start to get closer to 30% this year, next year, and then maybe it gets back to the 20% level. This -- it has been stabilizing over the last bit. First, we got the churn to stabilize. It's historic lows. It's been kind of historical low the last few quarters. And we focused on free to pay, try to drive new customers. We did a lot of things to make the website easier to use, added different kinds of currencies, different payment methodologies, local languages. And then we've also done some price increases. We started raising prices a year ago March and in December, we raised prices on all the other SKUs for that. And some of those will continue on into the rest of this year as people renew. But largely, I think the pricing increases are kind of behind us, but it's helped us, and it's part of our forecast to get it stable. It's a very good business, like I said, because it's very profitable. I think to get at sort of that next phase, we need to have something else to sell in there broadly, and that could drive future growth. But I would say getting it to stable at this point would be a big win for us. And that's how we're forecasting it for the end of the year. It has been kind of in this range now, like $470 million, $480 million, and we can get it by the end of the year to stop being a headwind, that would be great.

Yes. That's great. I wanted to shift gears to your second act as a company, which was Zoom Phone. It's been a tremendous success story of scaling there. In 2024, where we sit at right now, is that becoming more of a hook into the platform versus the meeting side of things? Or is it more of a cross-sell notion still today with Zoom Phone?

Yes. We actually met with an investor earlier today, they were an all Microsoft Team shop, and they were saying that they were looking at -- they were looking at Microsoft and decided to go with Zoom instead, just some of the features functionality that Zoom's Phone had versus. So they're going to be running Zoom Phone next to Teams. So it definitely -- we're in a world, I think, where people are looking to move off the old PBX systems to more of a cloud PBX system. And it looks -- again, just like video conferences, it's sort of us and Microsoft are kind of the faster-growing companies in that space of size. Clearly, share is coming from Avaya, it's coming from Cisco, it's coming from Mitel and to some extent, the RingCentral's and the 8x8's of the world. People have kind of shifted over to us. So it is still a lead. It's a nice lead for contact center -- so you think about it when you're on a Zoom meeting, that audio on there is a voice over IP. It's basically the building block for Zoom Phone. We just had to extend out to the phone number. And once you have a phone system in somewhere at a company and they have a contact center, they like everybody to be on the same phone system a lot of time. So it becomes something where we can then bring in the contact center. So there's a lot of affinity between the contact center and Zoom Phone.

And is there a certain profile of customer that's most attractive to Zoom Phone? Or is it something that has broad appeal across your base?

It has broad appeal across the base. It's a little bit more challenging with the smaller customers. I said if we had -- you can provision it for small customers, but if there's any as you're provisioning it, if there's any people involved in it that can really eat into your profitability. So you really need something that's a little bit more lightweight and easy to deploy, not easier, but easy to deploy, be the way to think of it. We're focusing more and more on larger enterprise. We have -- last quarter, we won a large bank -- big bulge bracket bank for over 100,000 seats. And that brings us up to 5 customers with over 100,000 seats. So definitely doing really well with the large enterprises, but it can go down pretty easily all the way to smaller. Just when you start getting into that 1, 2, 5, 10 kind of range with those really small customers are, that's probably more of an opportunity for us than something we're executing strongly to today.

Got it. I wanted to move over to contact center because that's a really intriguing growth driver for this business and big opportunity. When you think about the push you guys made there, what's been the biggest surprise to the positive and to the negative of entering the contact center market? And can you just discuss the reason it made more sense to organically develop that versus acquire your way into that space?

Yes. I don't think there was any negative except our attempt to acquire Five9 2-years ago. Really great people, have a lot of respect for them. Unfortunately, the Arabs got a hold of the deal and demanded billions more than we were willing to pay. And so we decided to walk on that. Since then, we've built out our own product, I think we're on a really good pace kind of like we were with Zoom Phone to keep moving that up. We have 90 customers with over $100,000 in ARR. We have -- we're approaching 1,000 customers in general. So it's -- and it's moved from being basically in on-prem -- sorry, in-house IT or HR help desk to an externally facing one. I think our largest customer is well over -- well over $1 million ARR, and it has over like 3,000 seats. We'd like to see it get up to 5 or 10. So I don't know if there's a disappointment as much as -- this is our ambition over the next bid is to get to much, much bigger customers. But there hasn't really been anything I can think of is -- I think it's been just really great to see the level of innovation coming in the door outside of the fact that, like I said, we really wanted to make that acquisition 2 years ago, and it would have probably gotten us in a little bit faster, but we would have had 2 code bases to try to combine up because we really did want to build that next generation of contact center. As far as the market goes, it's really interesting because 2-years ago, I don't really -- people weren't -- everybody is talking AI, right? We all have AI, but generative AI really just came out of nowhere and in some senses, and really it's put us all back to day 1. And the nice thing about, I think where we are is because we have a new code base and it is modern, it's cloud, SaaS, that we're able to pull in more services very easily into our contact center. So -- but it does put us all back to day 1. And when it comes to, are people going to buy agents or they're going to buy bots? We have both. We have an AI intellectual -- intelligent bot that people can buy. We use it internally. It covers like 90% of our -- 90-plus percent of our queries coming in, which are hundreds of thousands a month. And -- but we also have an agent pricing as well. So agents will still be with us. They're just going to have to be more productive, I think, and you'll just have fewer in general.

I think Eric said on the last earnings call that Zoom Contact Center is ready for prime time. When he talks about it being ready for prime time, what does that mean to you?

Yes. So there were some features and functionality we needed to add into it over the last sort of 6 months. If you go back to last summer, we were like fully omnichannel, but we didn't have all of the major social players. We didn't have all of the major e-mail players, all that. So all of those things are now in the product. We've also added things like our ability to take credit cards, which is a key thing for contact center. They can upsell, so they can bring in a payment through a credit card. So those things are now in there. We also launched multiple tiers that include quality management, workflow management. And we're seeing those things starting to get some pickup in the last 2 quarters. Really, that was a great surprise. I mean it's still small, but the fact that our ASP is actually going up for a contact center because people like these higher-level SKUs. And it basically doubles the SKU. The SKUs are higher. They could go from like $70 to like $150.

Got it. Zoom AI Companion, this is a newer part of the story. You referenced it earlier. What do you guys view that as? Is that a driver of revenue growth? Is it a customer success story going forward? And maybe you could just touch on what exactly AI Companion does for customers?

Yes. And let me just take a quick step back and talk a little bit about Zoom's approach to AI. So we are taking what's called a federated approach. So we're not beholding to one AI company. We work with OpenAI, we work with Anthropic. We work with LLaMa-2. We also build our own large language models. And we have a gateway that's able to figure out what the best answer is at the best price. And it's a really kind of unique model. We also are not using people's data, your data to train our models. We're either using internal data. So Cole, who's here with me today, just joined the IR team. If he and I are on a Zoom meeting, I can let Zoom use that data. But if I'm talking to Parker here, since he's external, it won't use that data. So we're very much keeping an eye on people's privacy and data and not using it to train our model. So we do that or we buy public data. So overall, I think we have a really unique AI strategy. And then when you look at AI Companion, 2 things we wanted to do. One is we wanted to drive the adoption of AI and when you look at AI Companion, this kind of the table stakes level of services, things like AI-generated summaries. And if you think back years ago, we used to pay for transcripts, we don't pay for transcripts anymore, it just comes with it, right? And so eventually, I think that would have commoditized as well. And so by giving people AI Companion as part of their paid subscription, we're enabling them to deploy it, to use it, to get used to understand how AI works, how they can use it in their everyday life. And then eventually, we'll come back with a next gen of AI products that might be more consultative or more customizable to who you are and upsell you on that. So our goal is to drive AI adoption. But at the same time, hopefully, we'll see some additional retention increase. People -- what we found is if people buy and use more than one product, the retention goes up significantly. But it's -- you've got to get people to use it. They can't just deploy it. They have to actually get in and start using those products. So I think AI is one of those things. If you haven't used Zoom AI summary, it's really great. I mean you don't have to take notes anymore.

That's good. When you look at the legacy players that you -- when you look at the legacy players that you compete with, they have their own issues from a technical standpoint. How would you assess their ability to deliver some of those AI features that you're talking about in a way that Zoom is?

Yes. Look, again, I think we have an advantage because our code base is so new and it's modern. And you look at some of our folks that we compete against and their code base is 20 or 25 years old, it's a lot tougher for them to do it. They can add things on to it, but it's not going to have that same level of integration that you could have with a more modern code base. So -- and Zoom's already been known kind of as being an innovator, and we really pride ourselves on adding things really quickly. Our Zoom contact center has gone from product launch to prime time, as you said, in 2 years. That's amazing. I think if you talk to some of the other folks in the contact center space, how long it took them to build out a full-fledged contact center with omnichannel and workflow management, some of them don't even have workflow management, they rely on third parties.

So when you look at the Contact Center opportunity and the Phone opportunity, how would you say you guys are doing in the channel itself. It's usually a pretty critical component when it comes to the communications space. Are you very far along in the development of that channel? Is there still room to grow that over time? And how important is that to driving business in the enterprise?

Yes. So just in general, if you go back to like the early days of Zoom and Zoom meetings, it was so easy to deploy. It was so simple. Anybody could do it. You just downloaded off the Internet and you're up and running. And the same thing you had at the enterprise experience as well. There wasn't a lot of value add for a systems integrator or a VAR. And so most of our channel partners early on were hardware partners like Logitech or we have ISVs as partners. Since then, we have been building out our channel, started with Phone. We hired Ryan Azus, who came over from RingCentral. He was the Head of Sales. He became our CRO, and he had built out their channel for them on the master agent and then eventually the telco. So we've been building out that piece. And if you look at Zoom Phone, close to 1/3 of their transactions, their sales are coming from the channel now, which is pretty impressive. When you get to the contact center, we've been working with the channel and you get more sort of systems integrators. So you think about it, any company today, and there might be some greenfield out there, but most companies of any size have some kind of contact center. And the larger you get, there's probably more homegrown software integrations that are built in. And so they're going to need a systems integrator kind of help them move from their legacy, mostly probably on-prem to more of a cloud-based one. And so we're building out that part of our channel. It's still early. We've got some really good relationships. If we found a 10,000-seat deal. I'm sure we could bring in one of the partners. Eventually though, what you like to see them do is what they call build out a practice so that they have people who are -- they know Zoom really well. They've been trained on Zoom. They can basically eat, live and breathe Zoom contact center. That's what you eventually like to get to. So I think as we scale the business, that's when you'll start to see them have a higher level of interest.

So the platform is undoubtedly evolve from the post or pre-pandemic times, you're a much bigger company today, you've got a lot more to offer customers -- how is the go-to-market around these different products evolve in response to the platform expansion?

Yes. I mean it's been interesting because channel is definitely something that we just talked about that has expanded and gotten more sophisticated, I would say. The regular go-to-market, we split off the online business. We brought in Wendy Bergh, who's professional Internet person, Internet site person, and she really took something that had been kind of shared between marketing and sales and really put like a GM focus on it. So that part of the business really -- she's been out building relationships, you can buy Zoom through credit cards and through the Walmarts of the world and you can go to the Apple store. So she's been really, really building it out from a go-to market as well as a lot of other features and functionality. Our sales organization, we were kind of a one product organization, especially going into the pandemic, and we really have had to switch people over to a multi-product group. And we've done that by with Zoom Phone, starting with Zoom Phone, we brought in an overlay sales team. And so for first few years, they were not quota-carrying, anybody who had a Zoom Phone deal that needed help, they would help them because it is a different nomenclature from the Meetings product. If you talk to Phone deals, it's just completely different the way they talk, not only do they do a different channel than most people, but they also have a different nomenclature. So that was really helpful. Last year, we took those folks, and we moved them from non-quota-carrying to quota carrying, took a few quarters for them to kind of get themselves back up to speed, build out their own leads and then start moving those through the funnel. But so we've kind of shifted that. We are now bringing in or have started bringing in people on the contact center side who are contact center experts to help the contact center folks. Because you -- because there, you're not only talking to IT, but now you're talking to the CXO, the Chief Experience Officer. And so you need to be able to speak that nomenclature as well. So we've kind of taken the same model and kind of repeated it. Workvivo has a lot of their own sort of experts because they're talking a lot to HR folks. And it was an acquisition. We've purposely kind of left them alone and helping them build out their own business, but anybody at Zoom and the sales organization can bring in a Workvivo deal, but we also have very specific Workvivo folks as well.

Got it. I want to see if anyone in the audience here has any questions before I continue.

Want to get an update on your international business. It seems like it's a little bit better performing last quarter [indiscernible].

Yes. So Europe was kind of flat the last couple of quarters, which is -- it had been down. Some of that being FX, some of that being the macro. And so that does seem to be stabilizing a little bit. In general, international was hit a little bit harder when we did our sales reorg last year. Part of it was just the fact that you need to go through in some countries, a labor board before you can tell people they're laid off. So we announced the layoffs. People know somebody's being laid off in the room. They just don't know who it is, it's me, is it you? And it takes -- it took a couple of quarters to get all that put in place. And then we hired new leadership as well, and it's taken them -- So I think it's starting to come back of all the sort of things. I think the international will be the latter one that comes back into play for us. Not Asia, but APAC has been hit with a little bit of currency impact in Japan specifically. Japan is one of our largest countries outside the U.S. and the yen has weakened a bit. I think we're pretty close to flattish if we don't have the FX impact. But hopefully, that has the same kind of trajectory as the leadership -- the new leadership gets up to speed. We've gone from a global model with a global head of sales for international to more of a regional one where we put Head of APAC and a Head of EMEA in place as well as one in North America or the Americas.

Anything else? No? Charge ahead. Margins. So Zoom has pretty robust margins multiple times in your public company life. You've talked about maybe investing more in R&D, you're investing more in sales and marketing. Can you walk through the puts and takes of your margin structure today, the AI investments, what impact they're having there? And if growth was to get back to the double digits, would margins be sacrificed in order to achieve that?

Yes. So A couple of things. Just going back to the guidance we gave just a couple of weeks ago on our earnings call. One thing that you should expect is you're actually going to see our gross margins dip a little bit this particular quarter. And what we're doing is we're enhancing our backbone, and we're going to have to run redundancy for the quarter. And once that redundancy and the backbones -- when the backbones in place, redundancy goes away and margins will rebound pretty nicely. So as you're modeling, just look at Q2, it's not anything to do with pricing or anything like that, it's completely to do with the operations of the backbone of the company and which you'll get is an enhanced service, which is really cool. We are still looking at like our long-term target there of like 80%. So we should be sort of headed back that way as soon as Q2 is done. We are hiring, and you might have seen we've hired a number of people from Microsoft on the AI side in the last 6 to 12 months. We're going to continue to hire. They're leaders. They have decades of experience and now we're hiring people to work with them. So you will see R&D go up -- continue to go up a bit. Our long-term target is between 10% and 12%. I wouldn't be surprised if we're kind of closer to the 12% this year as we build that out. We are investing in some sales capacity, around the channel, around contact center, but we're also being more focused on marketing investments. So they sort of offset each other a bit. And then there's always opportunity in G&A. I mean, we're pretty efficient G&A company. But -- and so last quarter, our non-GAAP gross margins were -- I mean, operating margins were up 40%. So I think that puts us into the top of the class for SaaS companies of some size and smaller. So as far as like sacrificing margin for growth, we are -- and I'm sure you have an inorganic question about M&A, but we are looking broadly. We have been for a while, just seeing if there's something out there that makes sense, it would be really hard to find anybody who's got 40% operating margins or even close to it. So it's not so much to sacrifice, but if you think about it, there are some things we could do to help companies too, if we bought something. I looked at Five9 and their gross margins are okay, but we could have helped them out on the gross margin side, just running through our data centers because we're just so efficient at doing it. So there could be something in the short run, I would think. But in longer run, we'll probably look for ways to get back to -- so it's not impacting the business. There is a mix in there. If theoretically, if the enterprise were to take off, you have more sales expense. It's probably the only thing that would -- I wouldn't call that a stack [indiscernible] It's just the math of it all, right? There's just -- there's more selling expense on the enterprise side than there is on the online side.

Got it. Yes. You kind of took us there, but let's move to the balance sheet. You guys sit on a mountain of cash. You talked about wanting to potentially buy something. You're out there looking for the right fit. Also been some share repurchases. I mean what is the capital allocation strategy?

So in Q4, we put in a $1.5 billion share repurchase program. It's our second. We had $1 billion a couple of years before. And we did -- we were active in Q1. We're going to be active in Q2. There was some pushback from some people that we didn't buy enough shares. You always want to buy it at the low as you all like to. It had nothing to do with that. It was just -- it just takes a while to get these programs up and running. And so I think you'll continue to see us active in the share repurchase program. But yes, we are looking at acquisitions. We have been for a while. We're being really thoughtful. I would say, I apologize for creating uncertainty for you all because you all want to know what we're doing, but we're really trying to be thoughtful. I think we do have a bias for build versus buy. And -- but if there's something out there that is modern technology that fit in well with our culture, we don't want to disrupt the company. And then at the right value, we would do it. So we are continuing to look, but nothing has come out. I mean most of the stuff we've done has either been sort of pre-revenue companies like Workvivo or acqui-hires. So I think those are still very fair game. I mean if we signed a company that had a bunch of engineers in the AI space, that we buy it, if we -- I think that's something where we'd like to invest more in.

Yes. That's probably a good place to stop considering time. So please join me in thanking Tom and Zoom.