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

All right. Let's get started. Before we get started, some disclosures. Important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. My name is Josh Baer, software analyst at Morgan Stanley. And we are thrilled to have Michelle Chang, CFO of Zoom here today. Thank you so much for joining us.

My total pleasure.

Awesome. Maybe Michelle to set the stage, Zoom closed out the year growing enterprise revenue, 7% in Q4, now represents over 60% of the business, when you look at that improved growth trajectory, could you unpack what were the key changes that really bent that growth curve for you?

Yes. So maybe for those that don't follow Zoom as closely, we've had growth that at an overall level was 3% and 3%, and then we finished last year at 4.4%. So an inflection of 130 basis points. And enterprise, to your question is sort of the headliner of that. And there'd really be kind of 4 things that I would call out. First is product diversification. We've moved a lot as a company from just being a median company to a much more portfolio. So clearly, and I'm sure we'll get into more conversations there. That's 1 of the Second one is AI monetization. It's very clear that AI monetization is inflecting our growth rates. So that's tremendous to see. The third is an investment in our channel. Right, with where we need to go from a product perspective. We have been investing very heavily in our channel of all flavors, not just incentives, but building out the maturity there. And the last one would be really just continuing to hone our execution from an enterprise perspective in our direct sales organization. And so clearly, that's playing out as well.

Excellent. And we will dig into all of those thinking about as you head into FY '27, I mean what are the key -- the top operating priorities that sort of can sustain that momentum that you've had over the last year?

So look, we have 3 priorities that we're about as a company. And these 3 priorities, they shape everything we do from where we put our dollars because they are the things that will inflect our growth rate even more. Maybe as a build on to your prior question. The first one is that we have got to infuse AI in our core business. So that means for us, workplaces, which is where meetings is as well as our phone. That's priority number one. Priority number two is this is probably the most forward thinking of our 3 priorities. We've got to get new routes to air monetization and up and running, be the horizontal or vertical. And I'm sure we'll unpack each one of these as we go. And then the third one is Zoom is really getting into a great moment with our contact center business, which is one of those product diversification that I mentioned. And we've just got to get behind scaling that because the market is in transformation, and we have great momentum behind what we're doing.

Excellent. Before we dig into AI, I wanted to get your perspective on the demand environment. So when you're sitting with chief information officers, other CFOs, how is this collaboration and UCaaS space, how are budgets being allocated? Is there a trend from best-of-breed to consolidation? And how does that impact where you're investing and playing in the market?

Yes. Look, I think it's changing. If I thought maybe a year ago in some of the conversations, it was a mix of best of breed, best of suite, if you will, and to which I think Zoom has a great response to each in best of breed. We're clearly known for being excellent and chosen by customers at what we do, invest of suites. We have not only a holistic platform but also the ability to integrate with so many others. So one of the things I love about coming to Zoom is we embrace kind of the customer where they are on their journey. If they own Microsoft or Google, great, bring that in, and that becomes essential in the third category, which is really where I think the shift in conversation is, which is to what I would call, pragmatic AI. Not flashy, everybody needs it to AI, but show me pragmatic value from an AI perspective. So that's a breed investor suite conversations, I think, are still there. Good CFOs always kind of grind on those things. But I think far more the conversations get down to AI pragmatic value and how can I prove it out.

Awesome. Well, let's jump into AI. Obviously, a key debate on the whole sector, assessing the risks and opportunities around AI, particularly around incumbent SaaS. And so I want to just directly ask you, how is Zoom positioned specifically for AI?

Yes. So this is a good one, I think, to make sure people understand. Eric has a great way, our CEO of talking about this, so I'll kind of leverage it here. If you think about the interactions in the world, there was -- there's always been human-to-human interactions. Then there was human to system and increasingly, their systems assistant. And look, in an AI world, all of those probably exist in some form or fashion, but the thing that doesn't go away is that human connection. And probably what used to then be 2 or 3 steps just becomes kind of singular gets more streamlined in nature. And so where Zoom we think is going and why I look at this and get really excited about our future in an AI world is really around something called system of action. If you think about it, there's system of records, there's systems of engagement. And none of those quite fit in an AI world, right? What everyone is having to reinvent themselves, right, towards something that we talk about as a system of action. And that system of action is really about going from conversations that happen every day into tangible real business value, pragmatic AI value and action. And so Zoom, you might say, well, okay, we have heard those buzzwords or I've heard all that, like why does Zoom sort of win in this, and it's really, I think, on a couple of dimensions. For Zoom, we think about the work that happens in the system of action as work that happens inside an organization and work that happens outside of mineral organization. And historically, the world has thought about those is very different, very siloed off things. And yet in an AI world, I think they begin to blend and in really good ways from a customer perspective, and so Zoom has a great mix of things inside the organization outside the organization that really get lit up, and I'm sure we'll talk about that as we get to things like phone and contact center. The other reasons that we're hearing great things about great response from customers in AI is obviously things like quality and approach an open ecosystem and trust and all those -- but look, it's that context that exists across that system of action. You think about all the unstructured data that we all have as we go from one meeting to the next, and we can't remember who decided what or who said what or what action you took in that and just what a powerful advantage that is to zoom in an AI world. Is the ability to take all those unstructured dialogues and take them from conversation to completion.

Perfect. Eric also uses the word AI-first company. You've got a federated approach. I mean how does that approach show up in your cost structure today? And thinking about all of this AI usage as that scales how do you protect Zoom's gross margins and operating margins?

Yes. So like in a CFO, I'm not about just endless AI investments. They got to -- they got to come with a return on the monetization side that I'm sure we'll talk about. But look, they also have to be rationalized from a profitable perspective. Because in the end, it's all just business. It's not an investment for an investment sake. So we spend a lot of time on the monetization side, but to your question more uniquely on the cost. What Zoom does in its federated approach is say that we're going to use a combination of SLM and LLMs. Depending on kind of the volumes, we're going to take a more every day common things, and we're going to run them through an SLM and we're going to take more specialized stuff and run it through an LLM. And that really translates into 2 things from a Zoom perspective. One, the quality goes higher; and two, the cost goes down, right? And so one of the ways that we're able to still say, in an AI world, where usage is going up 3x year-over-year, we're going to hold to those long-term margins of 80% is because of this federated approach. So look, there's also things like AI cost pairs will naturally come down. And we're going to keep working on our core backbone of COGS and other things that we use to offset. And then maybe I'll give you one more as a key piece to how we're able to continue to adhere to gross margins at the 80% best-in-class range. And that is our own product. Look, I'm sure we'll get into this more, but like any company, Zoom has a contact center. And like any company, I used to be a CFO of a contact center, they're the worst businesses now. The costs go up and CSAT is always not what we would want it to be. And so look, we leverage in our own company, our own contact center, virtual agent or agent assistant. And we use that is really a means to get costs down as well.

Excellent. Maybe while we're on the topic of monetization, AI monetization, could you talk a little bit more about that framework for you have a base level of AI in paid SKUs. So no extra charge. You've got a custom AI companion and then AI tiers in the contact center suite. So how are you thinking about the revenue opportunity for AI?

Yes. Let me break it down and give some categories to all the things you just talked about because I think it's helpful. And there's a visual that we did as part of Zoomtopia if anyone wants to go to our investor website. First, we started out on our AI journey and really taking at the time what was kind of an unusual decision to democratize AI. Meaning we put AI in for all paid SKUs into like Zoom meetings and workplace SKUs. And obviously, there's some degree of monetization there, churn reduction, bringing in new customer stickiness of the platform, okay? But then we moved into sort of the more explicitly monetized. And we tend to think about it in 2 buckets: horizontal and then vertical. On the horizontal front, if you think about the base of virality of usage that you get sort of in the workplace or from our phone SKU, that core priority that I talked about, you then have the ability behind a pay wall, if you will, to say we're going to monetize in scenarios where the customer is getting incremental value. More search, their own data, their ability to create their own agents, so high kind of high-value scenario. And then there's what we call vertical. So this one is a bit odd in his naming, but let me unpack what it means. Contact center, for example, is a huge area where you can get AI value. If you think about all those painful moments we've all had is customers where you call in and you're in an incessant loop or you're repeating yourself, or you can't even get to your answer, like the value that AI can bring to that is tremendous, and that is the largest place where Zoom is monetizing AI right now. But then if you think about that what we're doing, taking that conversation into action. We believe there's great other scenarios in vertical, which is ultimately, I think, where the value is easy as to prove to a customer where they will monetize. So we made a recent acquisition of BrightHire as well as we have like Zoom Revenue Accelerator, which is our AI SKU focused on our sales organization.

Okay. That's great. I want to ask one on Anthropic. You have a minority stake. The most -- after this past quarter, we learned there's a strategic investment portion of the balance sheet and correct me if I'm wrong, the current amount, $1.6 billion in that line reflects the current valuation. I want to make sure that I'm framing that right. But then I'm also wondering, beyond the economic relationship, is there like a broader partnership that you can speak to?

So we have a Zoom ventures fun and it's about investing in things that are going to be helpful to our product road map, just key strategic partnerships, so many companies have them and so do we. So you're exactly right. The total base of that is $1.6 billion, of which the most significant portion is anthropic. And so if it's helpful to investors to sort of reverse engineering math, what we talked about in earnings was we had a gain of $532 million pretax, and that was predominantly off of a minority stake in Anthropic. But look, to your more meta question, we think about the federated approach that we took look at deeply based on anthropic. Quad runs throughout our product set. We are on their customer advisory board. We look at road maps together with them as we do many other AI companies. But I would say we have a great relationship with Anthropic and it's been a great investment for us outside of land and look forward to an deeply part of our [ Federated. ]

Okay. Excellent. Let's dig into some of these product areas. So maybe first, starting with contact center, where you have some very rapid growth recently, Zoom CX and Gartner Magic Quadrant. At a high level, like how would you characterize the demand environment today in that space? And how are you scaling up market or what needs to happen to move more upmarket in the coming years?

Yes. I mean maybe I got into it earlier, so I'll just -- I'll reference to it, which is just for any one of us that is called into a company to try and get a problem resolved, it's painful. Even with all the tech that exist in legacy players to date. And you think about the 17 million agents out there, $200 billion worth of spend. And what is really poor experience from most companies with the most important people in their business. And so look, that's to me the broad opportunity, and that's how we think about it. But I think that's also how the opportunity is today, right? So I think a lot of our customers come in and are like, oh my gosh, how can AI and how can technology help me improve get my cost down or how can they get my CSAT up? But I think that's only a piece of where the story is going. And so I think increasingly, what you'll see, and I think you see this a little bit in VVA, and I'll break down our products here for a minute and explain what it is, where it actually becomes really proactive, positive tool to be able to interact with your customers to get better insights of them to help to light them in other ways. And so all of a sudden, technology and AI enables you to take what was a very cost-intensive problematic thing into potentially a very positive revenue driving things. So we get excited when we hear our customers' early thinking and stories in this regard. And we have 2 products is helpful. I mentioned them earlier. One, we have a contact center traditional product in non and AI SKU that is assisting the agent with AI and resolving the customer's issue. That's Zoom Contact Center. And we have Zoom Virtual Assistant, which is no agent in the picture, just an AI bot, if you will, talking alongside you and solving the customers.

That's great. I think you laid out the opportunity really well to disrupt this market. But why specifically does Zoom when you think about either contact center with AI assist or ZVA? Is it total cost of ownership? Is it integration with the broader Zoom platform? Like what's driving those ways?

Yes. I'm going to come back to this because I think they're secondary. What I think we're seeing is the market transformation that I talked about. And why Zoom is winning is unlike a lot of the legacy players, the names that all of us know, they've got that from a legacy basis, they're trying to move forward versus in sort of starting with a fresh position. And so I think that's what's driving us to be the faster center into Magic Quadrant, right? And I think it really reflects itself in our revenue. If you look at our top 10 deals, 10 out of 10 are AI. And so -- and if you look at that high double-digit revenue growth even growing or inflecting in Q4, it is exactly that's driving it. So first sort of reason of why we win is clearly AI and I would say there's a bunch of things that I would group into what you talked about, like Zoom is trusted, it's secure. We have a fast pace of innovation. We have an open ecosystem and integration philosophy. All the sort of traditional Zoom [indiscernible] that have us displacing large names that you all would think of. So our top 10 largest deals, 7 out of 10 are displacement. And then there may be a third kind of category that I would call out that we see as a pattern in our wins. And that is this concept of -- remember earlier, I talked about a system of action, where there's work that sort of happens inside an organization, work that happens outside of an organization. And just how much those worlds are being blurred and AI is taking conversations to completion. Where we see a lot of wins are people that come in with phones or meetings in their base and then they have contact center for communications outside the organization. But it turns out, customers really just want to solve problems. They don't tend to think about them as necessarily having to be 2 sets of products. And so this concept we call is sort of better together where you can have technology that seamlessly goes out and solve the customer from them, comes back and resolve it and seamlessly goes back out again. And so we win all of that a long-winded way of saying we went a lot with phone and contact center together.

Great answer. Maybe to follow up on phone, that has a nice mid-teens type of growth rate. Like how -- where are we in the maturity of that product? Is it more about upselling contact center into the Zoom phone base? Or are you still landing with Zoom Phone?

I think if you ask me that question last year this time, I would have said, well, the mental model we have is relative to the Zoom base, how penetrated are we? And I think -- 2 years ago, we gave the stat of 19% penetrated. And I would have felt good about that, right? Like there's progress and then there's opportunity on the upside. And it's still true -- but then you look at the AI value that our customers are turning on in phone and that combination of contact center where we actually now see a lot of new customers coming in, in contact center and then wanting that single platform that I talked about, and they're pulling customers in the bars. So all of that a way of saying that mid-teens growth, that 10 million seats, we still see runway ahead.

Excellent. One of the 4 sort of buckets of driving growth that you mentioned was the channel, hoping we could expand on that a little bit. What is the channel's contribution to your enterprise growth?

Yes. So if you think about those 3 priorities that I talked about, about -- okay, it's about maintaining and growing the median space and the phone the channel is essential to film, right? It's just how customers want to interact with it, right? So essential to that piece. Then you go to new scenarios of AI depending on how you define channel also important there. But then you go to the scaling our customer experience or contact center and channel is just central for that. So if you look at -- and that's why we've been building out this channel ecosystem to go with it. It's not going to be enough just to have the Zoom sellers directly selling on it. We've got to invest in a broad channel ecosystem because it's integral to the businesses that we're entering. And it also great gives us, frankly, great routes to market. So we now have built out a notable channel ecosystem where companies are betting their business on us. They're one of the stats we check is how many of them are new customers to zoom. And are they able to upsell is on that? And we're really pleased so far with the progress that we had. Said another way, it's a majority of our both phone and content.

Excellent. Go ahead. I want to make sure we get into some numbers, given that you're CFO, and I'm an analyst, and then we can come back to some other questions if we have time. So growth versus margins if growth can continue accelerating call it, high single digits, even low double digits. I mean what does that mean for operating margins and profitability. Right now, your operating margins that you're running out are trending well ahead of, I think, 33% to 36%. Prior long-term model. So how should we think about growth versus margins?

Yes. Great question. And the way I traditionally answered this by saying like my focus as CFO was on growth rate inflection. First and foremost, that's what I am about, and we're really pleased with the results that we have. Right? We're not -- maybe where investors always want more, and that's good, we'll keep going. But look, our first focus is on growth. And you don't get the right to do that and I'll hold profitability in our Zoom Co.. And so we just guided to '27. We guided to 40.5% operating margin. And so look, to your point, dramatically better than sort of our long-term guidance had been more in the 33% to 36%. And really, what I would say is I've been -- will, at some point, update the long-range guidance. So we're not going to tap into margins in that ZIP code until we see notably more growth inflection. That's just important to me as the CFO. And so the guidance that I've given investors even before this last earnings was you can expect to see something more like '27 until it is very clear to everyone why we would take margins into that kind of Zoom Co.

Excellent. Your net retention rate has been very stable around 98%. What needs to happen to drive that above 100%? And what is the takeaway as far as the path from here?

So look, it's the same things that I talked about. It's continuing to diversify our product. Its growth in enterprise. We stabilized our online business and grew for the first time since FY '22. It's about taking that into mid-growth is single-digit range. It's about continuing to focus on enterprise and the product diversification and those are going to be the building blocks that frankly get us to revenue growth. I mean we look at net dollar expansion, but it's not where we run the company. We run the company to grow because there are limitations to the metric. And so from that standpoint, we feel great that we saw 130 bps of revenue acceleration in these conditions and out of the gate guided to an acceleration minus the piece that I talked.

Excellent. Let's move to free cash flow, which I think was $1.9 billion last fiscal year, which was close to a 40% margin. This year's guidance, FY '27 looks for 1.7 to 1.74. So can you help bridge the gap as far as the year-over-year?

Yes. So first, what I would say is we've used a consistent forecast methodology. So we'll let investors kind of factor in that element based on our history. But there's 3 areas that I talked about that are taking the cash flow down. And so we wanted to give as much clarity as we could to investors in that. First and most material is last year, in FY '26, we had a low CapEx share. We just -- we -- there are certain cycles of refresh post pandemic when we refresh our database. This is not AI CapEx. This is like just core infrastructure CapEx, low comparable, more normalized comparable. That's about $75 million. But look, again, in a world where we're holding best-in-class operating margins, I feel good about that kind of trade-off. It's more a cash flow dynamic. Second thing is we obviously have large cash balances close to $8 billion interest rates coming down sort of an interest rate phenomenon as things come due. And that's about $50 million. And then the third piece is we made a decision to move from less stock-based comp to more cash-based comp accretive to GAAP margin, but has some headwinds in terms of cash flow. We're now through all of that. all of this in terms of what I think may be the intuitive question from investors is like, what does this mean? This is manic going down on a permanent state. It means that it's a bit more of a comparable and temporal thing, such that cash flow should continue to grow more like what they have post this year.

Okay. Great. I'm going to ask one more, and then we'll pull the audience. So on M&A, you have a very healthy balance sheet. I think $8 billion in cash. How should we think about buybacks versus small M&A versus something more transformational, what's the takeaway on M&A and maybe more broadly, capital allocation.

Yes. Let me start capital allocation, and I'll round this out at M&A at the end. Look, just as I said, growth was going to be my #1 priority with that comes, you have to be excellent at capital allocation. I think this company has made a lot of progress in capital allocation. Meaning if I just take internal capital allocation, I think there's a lot that we've done to say -- these are our priorities. These are the building blocks for long-term revenue growth. And accordingly, we will invest in them, and we will reduce other things to drive it. More internal, but look at that's important step. That's what's underlying the conviction to a revenue growth acceleration. The second thing, we've become more buyback in nature. For a while. We hadn't done those when I first came in, I added $1 billion to it. And last quarter, added another $1 billion such that we've announced $3.7 billion of buyback and executed against $2.7 billion. The other thing I want to make sure because there was so much -- there's so much in the February earnings that people really got investors kept saying, well, give me the frame, tell me how to think about buybacks, how can I model it in going forward. And so what we gave guidance is that in FY and beyond, we will do buybacks as a means to keep with offset dilution at a minimum. And then to your M&A question, look, in these conditions, it's great to have a strong balance sheet, and it's also an advantage in being able to look at things, the right thing. I said on the other side of many of our M&A, but broadly, how we think about what we would look at, it's 1 of those 3 priorities. We're going to be thoughtful and disciplined, of course, -- it's going to be for growth accretion. It will not slow down the company in its growth rate. And so what we've said then is, okay, well, that sounds like a little bit of words. What does that mean in terms of the size, which is often what investors want to know and what we've said is that will translate more into small to medium and in nature.

Any questions see one. The mic is on its way.

A quick follow-up just on when you mentioned the right things. I mean, in broader software, everyone is wondering about you have maybe the old legacy version of SaaS software and then the transformations or transitions everyone's kind of going to -- like when we think about M&A, do we need businesses that already are maybe already on the transition side? Or are we willing to even look at a business that is maybe a bit more regular and we can actually make it go through that transition ourselves?

In terms of what we're looking at for M&A, I look like we're limiting it per se, but I would say probably more vers pragmatically to the AI side, meaning people that have already found acceleration, talent for a whole host of reasons, I would say a beer is more towards the [indiscernible]

And a quick clarification just on the free cash flow and like more to the temporal nature. And like how should we be thinking about the OBBA cash impact to that this year at all?

Tax.

On free cash flow yes, just the OBBA cash .

Yes. So what we said in the tax is that it will be a tailwind to cash taxes, but a headwind, slight headwind to the effective tax rate, such that really no different than what we've said to investors, but we did give clarity that the ETR will be somewhere in the 22% to 23%. Thank you. right I'll hop back into my list. We talked through a lot of the really attractive growth rate products driving that enterprise acceleration. I do want to ask one on online, just given it is still a meaningful part of the business. You've talked about how online is a fundamentally different business today than it was during the pandemic. Could you expand on that? And really, how should we think about the growth profile in assessing the overall composition and mix of the company? So first, maybe I'll just take advantage of our little time here to get and make sure everyone is sort of aware. So our online business is sub-40% just shy of like 40% of an revenue. it went through, as you can imagine, some kind of turbulent times post pandemic, where we went from like an 8% decline to last year, 25% flat to the first time we grew which is a good moment in the year we just finished, and now we're guiding to slight growth. To your comment, what I look at when I say it's fundamentally a different business is over 75% of our customers in our online business have been with us for over 18 months. The rest think of them as more monthly and cyclical in nature. So it shows that you've got a sticky user base. And I think -- to your question of like what are the building blocks of growth? Obviously, it starts with the foundation that loves the product that's in there using it all the time, that's been with you for a while. So it starts with that stable base. Look, in terms of growth, I would say -- I'd bucket it into 2 pieces that are ultimately going to drive growth for the online business. The first is by adding more value or product to the customer. It seems intuitive. But I think all too often, people talk about it as a price increase. Zoom has done 2 rounds of price increase here when really what it is, is us able to realize the price increase with really no impact to churn because we built out a platform with Zoom, you can get not only meetings, but chat and calendar and whiteboard and all these things that you enable a tremendous value for our customer and vendor consolidation. Think of these as small businesses, solar printers. So that's a huge win for them without having to stitch together all the tech, et cetera, right? And we added AI value. So the combination of those are really allowing us to both retain that base, build off that stable base and be able to grow it. But look, we're not kind of stopping there. We're working to add new incremental product value. We acquired a company called Bona. I think of this as like project management, customer relationship management, really at the solopreneur, which tends to be a big part of Zoom's business. and something that maybe we hadn't focused in on a lot. And look, we're continually kind of working on adding that product value. I'll give you an AI fund one, which is -- we talked about AI monetization is putting AI value in our core online SKUs, but we also just announced think of like a granola compete and personal assistance that comes with you to all your Zoom meetings, and it takes notes for you. And so it just shows kind of how we're beginning to get more back into product value for the online customer so that's bucket number one. And by far, the most important. The second is just there's more that we can do in working on our PLG motions, our buy flows, our customer journey, and so look, that's more on the execution element but something that we're focused on.

Perfect. Michelle, we are over time. Really appreciate the conversation. Thanks for coming. Thank you.

Thank you for having me. Thank you.