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Zoom Video Communications, Inc. (NASDAQ:ZM) Morgan Stanley 2022 Technology, Media & Telecom Conference March 7, 2022 4:15 PM ET

Company Participants

Kelly Steckelberg - CFO

Conference Call Participants

Meta Marshall - Morgan Stanley

Meta Marshall

All right. Welcome, everybody. We have Zoom here. We have Kelly. I am delighted. We'll make an obligatory, this is not over Zoom call. But, welcome, everybody. I'm Meta Marshall. I cover the communications software space here at Morgan Stanley. We have Kelly Steckelberg, CFO of Zoom, who you all have seen many times over the years. And for any research disclosures, please check www.morganstanley.com/researchdisclosures or check with your sales representatives.

Question-and-Answer Session

Q - Meta Marshall

So Kelly, it's clearly been a roller coaster year for Zoom over the past couple of years. You went from being kind of the darling of the pandemic to now having to face kind of are you just a work-from-home winner? And how do you explain to investors what the drivers are for the company from here on out for the next few years?

Kelly Steckelberg

Yes, first of all, thank you so much for having us today. We're thrilled to be here and to see you all in person. So we are really in a very interesting transition point for the company. We're moving from being this killer meetings app to being a unified collaboration platform. And for those of you that had the opportunity to see the earnings call last week, Eric talked about 3 key pillars of that.

So first one, of course, is unified communications. And we can talk about all the products in there, but that is comprised of not only Zoom meetings, which you all hopefully know and love, but also Zoom Phone, which is our cloud PBX solution; Zoom Rooms, which is our conference room solution; Zoom Events, which is our hybrid events platform that maybe we can start to incorporate into events like this going forward. And then Zoom Contact Center, which we are thrilled to have announced GA 2 weeks ago. So really excited about how that's coming together in our unified communications platform.

The second pillar is hybrid work. As everybody is trying to figure out what does the future of work look like, how does that come together, Zoom is spending a lot of time listening to our customers and trying to solve their problems.

And then the third pillar is workflows. So how do we all get more done, especially over Zoom every day. And our goal is to become the operating system that underpins what you do every day. Eric talked about on the call, some of that is through integrations and partnerships. One of them he highlighted was a partnership with DocuSign. We also have our Zoom Apps, which integrate processes from companies like ServiceNow from Asana.

And then last but not least, if you think about really your workflows and your business processes that's where Contact Center is also going to come in. As people spend their day, if that's really what their job is, they're going to spend their day in Contact Center. So those are really the 3 pillars and how we're thinking about the future of this company and moving from being an app to a platform that you spend your day on all the time.

Meta Marshall

Got it. That certainly explains the expand part. How do we think about just that upmarket sale of -- you were still kind of very highly penetrated at a low dollar content at a lot of the Global 2000? How do we think about kind of that further move or standardization of market as a driver of growth?

Kelly Steckelberg

So when we look across the opportunity, what Meta is referring to is, less than 20% of the Global 2000 are spending more than $100,000 with Zoom today. And for that size of a customer, the opportunity is sizable, much more sizable than that. And so what we are focusing on is the future selling strategy for Zoom Phone, for Zoom Rooms, for Contact Center is to sell into our existing installed base. So if we have penetration with those customers, it's really thinking about how do we get them to spend more.

And one of the other measurements you can think about is when we looked, 2 quarters ago, at our internal penetration for Rooms and Phone on a deal basis, it was single digits for our meeting customers, which tells you there's a huge opportunity even with our existing installed base.

And then international. Remote work and video adoption, while 30% or more of the U.S. employees are going to work remotely, it's a little less than that internationally. So we really see tremendous opportunities to continue expansion from both video, voice and Contact Center internationally as well. And a big part of our investment in sales in FY '23 is going to be building out sales capacity internationally as well as building out our channel. That has been a really important part of our strategy for Zoom Phone in the U.S., and it's very nascent outside of the U.S. So that's a big part of our focus area of investment as well.

Meta Marshall

Got it. I mean in that conversation upmarket, is it really selling that full platform? Or is it getting the standardization conversation?

Kelly Steckelberg

So it's both. I mean what we really see is now that companies are sort of past that panic-buying stage of the pandemic, they're going back to more normalized sales patterns, which includes proof of concept. It improves RFPs and land and expand, which is a very familiar selling approach for us. So previous to the pandemic, some of you may know, this was a very common way that Zoom sold, and we're going back so this is really standard. Often companies buy a few seats of meetings. They try it out, they do an RFP and they love it. And then they realize they want to continue to start to expand and grow from there. We see multiples of growth when they do that from up to 4x the original deployment when they start adding on more seats, when they add on Zoom Rooms and when they add on Zoom Phone.

Meta Marshall

Got it. I mean we're now basically 2 years at the anniversary. I think it was this conference where you guys had your first case of what was ahead over the next couple of years. So we have a lot of renewals that are kind of coming up right now. Just what type of behavior are you seeing? Is it really that -- like are they there yet in terms of thinking around the whole platform? Or is it really still, okay, I just need to think about getting my employees back to work, let's just kind of continue with the same thing.

Kelly Steckelberg

So we have seen amazing strength in our renewals over the last 2 years. We -- I've gotten very pointed questions about have we lost any big customers and we have not. And what we're seeing is that companies are moving from this phase of having everybody work remotely to hybrid. They're now trying to think about how do we keep our employees productive and be inclusive at the same time. And I think that's the real challenge, right? We all knew how to work together when we were all remote. We all knew how to work together before that we were all together. Now how do we bring everybody together in a way that still is equitable and inclusive.

And Zoom is a really important part of that strategy, not just the Meetings portion, but also the Rooms portion to ensure that when you're sitting in a conference room, for example, or if you're not the one that's in the conference room, either way, you're still having that amazing experience. And we have innovations like Smart Gallery, which is a combination of software and hardware that recreates the experience when you're used to seeing everybody's face on the screen, Smart Gallery can do that for those that are outside the room.

And then we also have something called Companion Mode, which gives those in the room the ability to participate and interact with the meeting in the same way you do when you're online. So think about the ability to chat or the ability to participate in polling. Like if you just walk into a conference room, you're not on your device, you're not participating in that way. And we've heard from many, many of our customers that Zoom Meetings gave a voice to people that didn't feel like they necessarily had a voice in the room before. And Chat, for example, is a really great way for them to speak up. So we're constantly listening to our customers and hearing the problems they're trying to solve and Smart Gallery and Companion Mode are in direct response to a couple of those things.

Meta Marshall

Got it. I mean just as you spoke to kind of the expanded unified communications platform, like is this annual renewal cycle a great chance to talk about Phone? Is it a chance to kind of talk about some of the rest of the portfolio?

Kelly Steckelberg

That's exactly right. So we don't, of course, wait necessarily till the annual renewal cycle, but it presents a great opportunity to talk to our customers about additional products or about their strategy and how they're thinking about it. So Phone has had experienced amazing momentum over the last year, and we're really excited about that, and we can talk more about that. But now it will also create an opportunity to talk to our customers about Contact Center as well.

Meta Marshall

Okay. Perfect. I think a characterization or something I hear from investors is who is left to have video? Didn't everybody who wanted video over the last couple of years get it? And so -- just how do you view that U.S. penetration here versus otherwise. There were obviously kind of questions on the over 10 customer count kind of on the last print.

Kelly Steckelberg

Yes. So we looked recently at an external report that said from a market share on meetings perspective, we have about 1/3, WebEx has about 1/3, Cisco has about 1/3 and Microsoft has a 1/3, and then the rest is sort of cats and dogs out there. And that means there's still a lot of opportunity for Zoom to continue to take market share. And I get this question a lot, yes, what are other people -- the reason that maybe customers or prospects, I should say, are using other services. Some companies are very thoughtful and measured about change. They aren't willing to discuss a change until the renewal window comes up. We love when those opportunities happen or when a CIO that's at a Zoom-enabled company makes a change that creates a window of opportunity for us. So our AEs are really focused on building relationships with those prospects in advance so that whenever that window presents itself.

And then there are still customers out there that are using a hybrid of 3 or a mixture of products. And I think what we're seeing is organizations really realizing that's largely inefficient. Having -- especially in a hybrid work environment, having your employees on multiple platforms for different purposes is really not efficient for them. And it's difficult for the employees to navigate.

I spoke recently to someone who's buying for a professional services organization, and she was telling me that they had -- they were doing that, right? They were sort of parsing it out and you were using this service, you kept using that service. And when they finally just realized, okay, let's just open it up and let the employees choose, their deployment of Zoom went up 12x. And they were okay with that because they were okay with even paying where they had free because they realized the efficiency they've gained as well -- the ROI is immeasurable for their employees. And that just goes to not only employee satisfaction, but efficiency and productivity.

Meta Marshall

Got it. I mean another question that we also get is just the impact of these free alternatives, whether it be that it's included with Teams or Google or bundled in with Cisco, how do you see coexistence with these solutions? And where is the greatest value proposition when you're up against kind of what's viewed as a free alternative.

Kelly Steckelberg

So if we talk about the enterprise portion of our business, generally, there is a perception of free for some of our competitors, and yet they still are willing to pay because our product works so much better. And we knew if we just sort of talked directly about competition for a minute with Microsoft, we partner with them very closely. They are a great partner, and we expected them to be the most formidable competitor. We've expected this and seen this coming for a long time. And we really focus on delivering happiness to our customers. And if that means they want to use a portion of the Teams platform in conjunction with Zoom, we are okay with that. We have a very strong integration with them. You can 1 click launch a Zoom phone call or Zoom meeting from the Team's interface. You can start a Zoom meeting from a Microsoft-enabled conference room and that's great. For others, they really want -- they want better and they want zoom, and that's what we're there to provide.

Meta Marshall

Got it. You have enormous brand equity around video. I think everybody here knows that you're the Kleenex of video. Are you seeing this help as you move into other categories? I know a lot of your sales and marketing dollars are kind of spent to expand the platform. Where do you think the opportunities lie or what the attach rates could be in some of these other products you mentioned, like Events, Phone, Contact Center?

Kelly Steckelberg

Yes. So our brand awareness has really benefited us in 2 ways. So the first one, which is a little different, but it's around international. So historically, when we wanted to hire reps or go into a new market, we would spend dollars there to warm up the market, the region and then hire salespeople and now we're able to just hire salespeople wherever we see the opportunity. So that is really an important part of our growth strategy for FY '23.

And then additionally, it's exactly, as you say, it's a big part of our growth strategy is selling into our existing installed base. These customers that already know and love Zoom and have seen how we transform their meetings experience, it creates a lot of trust in Zoom, and they believe that we will do the same thing for them for their cloud PBX solution or now their Contact Center solution. So our brand equity and the trust we've built with our customers over time has really is an important part of the growth driver of the future of this company.

Meta Marshall

Got it. You mentioned it kind of in the workflow piece of kind of what are the growth drivers coming up. But just as you advance the platform, how does -- what is being built as far as the app platform or what you're seeing kind of requested from customers impact other areas that you guys plan on going into.

Kelly Steckelberg

So we spent a lot of time talking to our customers in general, 20% of any release is devoted to customer requests. And I think that's continued to evolve beyond even just future releases, but also new product development. And I mean Contact Center is a perfect example of that, right? It's really the third leg of the stool when you look at video, audio and now Contact Center, bringing that all together, and that's based on what we hear from our customers. They really want an integrated platform built on modern architecture, which is what Zoom has to offer. And that won't ever change. We -- you kind of alluded to the app.

So as a reminder, we have the Zoom Apps Fund, and we're investing in Zoom Apps and that's a big part of the workflow’s ecosystem. And we -- you use that as an opportunity to see what's important to our customers, what apps are gaining traction, and that helps inform not only, of course, our road map, but to potentially also our M&A strategy going forward.

Meta Marshall

Has there been anything that you kind of point to that has come out of the road map either in feature sets or something that was built kind of came out of the Apps.

Kelly Steckelberg

Yes. I think the biggest thing is the integration that we've seen with some of these amazing names like Asana and ServiceNow, Box -- Dropbox. Those really making it efficient for people to get their work done every day within the Zoom platform is really what people are looking forward to.

Meta Marshall

Okay. When you went into Phone, a big message you guys kind of had around the IPO was we're not looking to replicate every legacy system. We're looking to kind of give you the features that you want, and that's going to address 95% of the use cases. You're moving into the Contact Center market now that clearly has some of the same dynamics. And so how do you view taking a new approach to this market? And can you be successful on it by that approach?

Kelly Steckelberg

So I think there's a couple of things to touch on there, which is, first of all, our Contact Center, which was previous called video engagement is video first, and that is a differentiator right there. It's also fully integrated with audio and voice and our Chat product. So having a fully integrated product that is built on modern architecture is also a really key differentiator. There are some great products out there. But Zoom will be the most modern Contact Center in cloud Contact Center, and that is really helpful when companies are thinking about what's their future strategy and how do they want to invest in a platform that is not only cloud-enabled but really modern, which means reliable, easy to use. All of those great things that you've come to know and love about Zoom are going to be reflected in the Contact Center as well.

Meta Marshall

Got it. As you're looking to expand into some of these categories, and we'll talk about Five9 maybe a little bit later, but just how do you weigh that build-versus-buy argument?

Kelly Steckelberg

So we have a very high bar for both talent and technology in our company. And that's how we always look at opportunities is how could any M&A augment either the talent or the technology. And we've done 3 small little acquisitions to date, which have been mostly on the talent side. I would expect that you'll see more of this going forward. We have a great team member, Sanjay Rao, who joined my team about 6 months ago from another bank, and he's really, really great, and he's focused on this every single day. And I think if you look at Contact Center, for example, that's a perfect opportunity where you could buy like a technology tuck-in that could accelerate our development.

If you look at sort of the components of what make a great Contact Center, it's really easy to see, okay, maybe you could get some of those components more quickly by acquiring them.

Meta Marshall

Got it. I mean you talked about kind of technology tuck-ins. I guess just post the Five9 process. Just how does it inform how you think about M&A going forward? How does it think about how you think about kind of growing the business going forward?

Kelly Steckelberg

So we -- largely looking forward, we'll focus more on the technology side. I mean the opportunity we had with Five9 would have been a great one because it brought more, it brought not only technology, but also an amazing team as well as some amazing customers that we were excited about. There aren't -- the other thing that was very unique in that situation, I would say, is there was a very strong cultural alignment between the companies, which is really, really important to us in any potential acquisition that we would look for. And I think that was a unique situation that's probably not likely to replicate itself anytime soon. So -- but we keep looking. I don't -- I mean we wouldn't rule it out. I just don't know that you're going to see another opportunity like that that's so well aligned.

Meta Marshall

Okay. Got it. You noted on earnings, you look to be price disruptive in the markets that you enter, whether it be Phone or Contact Center. One, there is a concern right now kind of in the marketplace about kind of what's happening with price points and do you feel like language like that kind of advances some of those concerns? And then two, you guys have been an incredibly profitable company, but how do you convince investors that you can still be profitable with that approach.

Kelly Steckelberg

So Zoom's approach from the very beginning has been to be price disruptive. If you look at our list price for Meetings and for Phone, they're about half the price of competitors' list. So that has not -- this is not something new to the company. And our discussion and our strategy internally is always we will win based on products, and we will not lose based on price. And we have a very highly efficient platform that allows us to do that with gross margins that we've guided you next year in the mid-70s. We peaked in the past at 80-ish and that's what we're -- our goal is to get back to that level as well.

We are focused today on taking market share and driving growth. And so while we'll always keep a balance in watching our margins there, if we have the opportunity to be disruptive in price and still do it and be profitable and generate cash flow, we're going to do it because we want to continue to take market share.

Meta Marshall

Be profitable to kind of targets or --

Kelly Steckelberg

We always look at the balance between growth and margins. And our guidance for FY '23 was in the low 30s, which is certainly down from where we were last year in the 40s. But I just want to remind everybody that we had such rapid acceleration of our top line over the last 2 years, we literally as a company could not keep up with the investment in terms of hiring and investing. And one of the areas I would really point to is R&D. Our long-term target for R&D spend as a percentage of revenue is 10% to 12%. We were under 7% last year, and we were under 4% the year before that. So that is an area that for me is really indicative of where we need to accelerate our investment. And that's really important for the long-term growth.

You heard Eric, on the call, if you heard he said he wants to accelerate the great pace at which we're producing new products. And the only way you can do that is by continuing to invest in R&D. And then the other important area of investment is sales and marketing and especially -- we already talked about the sales capacity and our international channel.

Meta Marshall

Got it. A lot of the investors in this room have had their kids have Zoom school for the past couple of years, are now moving more towards in person. Clearly that, that was an area where you guys gave a great service and subsidized that for the past couple of years. Are you seeing any way to have that be monetizable going forward kind of that K-12 opportunity?

Kelly Steckelberg

So we were very proud that we could provide K-12 for free around the globe, and we've done that for over 125,000 organizations over the last 2 years. However, we have seen amazing school districts be paying customers during this time as well, including in the U.S., New York and LA, which are the 2 largest school districts. So we are monetizing certain districts for sure. And as organizations and schools look forward, I think they're all trying to figure out how do they also keep video as a component of their curriculum or their PTA or their parent-teacher conferences. And so we absolutely continue to see monetization and growth in the EDU space, and expect that to continue.

Meta Marshall

Got it. Maybe another area where you guys’ kind of rolled out over the past year was the video or kind of ad-subsidized videos services, and this is beta. Is there any learnings that you've kind of had from just early days here? Could this be a revenue stream at some point? Just any update there?

Kelly Steckelberg

Yes. So we're still in really early stages of testing advertising. And the reason that we decided to do this because they get a lot of questions like how does this fit in with delivering happiness to your customers. And we're being very, very thoughtful about how we are testing it outside of the U.S. And we have seen a tremendous growth in our free user base over the last 2 years. And in certain markets that are very price sensitive. And so we want to test this theory that we continue to provide an amazing product for customers around the globe, but do it in a way that also creates monetization opportunities for Zoom. And again, we're testing and learning. What I will say, that's been really great so far. It's still very early and very new, but we are able to find this balance where it's not disruptive to the user experience, which is what I think is the most important to us.

Now over time, I mean, for FY '23, it will be -- have minimal contribution to revenue. But I think over time, it has an opportunity to contribute a lot more.

Meta Marshall

Okay. Got it. That's very helpful. We've circled around this a couple of times. I've just -- the investments that you're needing to make either catch up or just continuing to expand for growth. And just what kind of internal benchmarks are you using for either sales or marketing efficiency? Like what are you targeting in terms of how to make some of those kind of investments now that you can make normal course investments?

Kelly Steckelberg

Yes. So we have a long-term model margin profile that -- we owe all of you an update. We didn't update it at our last Investor Day because of the potential impending acquisition. So we will be updating our long-term model at our Analyst Day in November. And then we'll talk more explicitly about that. I know there's been a lot of questions. But I guess I would just go back to the discussion we're having a few minutes ago, which is we always look to balance growth and margins. We have been highly profitable and cash generative, and that is an important part of our strategy going forward as well.

Meta Marshall

Got it. Another question we got from investors was you kind of gave more detail breaking down that above 10 cohort and basically breaking it into a finer definition of enterprise. Why do you think that this is a valuable distinction? And just are there different churn rates or attach rates of ancillary products going forward?

Kelly Steckelberg

Yes. When we went public 3 years ago, we came up with this metric of customers with greater than 10 employees. And we use that as a proxy to differentiate between our direct business, touched by our direct business or enterprise business and then the customers with fewer than 10 employees as a proxy for our online segment. And what's happened over the last 2 years as the online channel has really grown, it was a pre-pandemic, when you look at the way we break it now in the new metrics, it was about 25% of our revenue and it peaked all the way at 56% of our revenue last year and was 50% of our revenue, greater than -- sorry, 56% last year, 50% in Q4. And so that just highlighted that how our business has changed, and we wanted to be more explicit with investors because the previous metric wasn't that helpful in terms of modeling the business.

And so now we're talking about enterprise and the definition of enterprise is customers that are touched by our direct business, a channel partner or an ISV partner. Now we've chosen the name enterprise, but there are customers of all sizes in there. And then the other portion of our business is online. And so those are customers that are coming through our online channel. And typically, they're buying 50 or fewer licenses through that channel. It might vary a little bit, but that's generally how to think about that. And we just -- that's how we think about the business internally. So since that's how we're thinking about it internally, of course, we want investors to have the opportunity to have that visibility as well. And that's why we decided now was the right time to make that change.

Meta Marshall

I mean do you feel like that -- I guess I'm trying to get a sense of -- are you seeing kind of adoption of Phone, Rooms, kind of some of these things through the direct channel or it's really something that we should only kind of expect upmarket?

Kelly Steckelberg

Yes. So you kind of touched -- mentioned earlier about like lives and retention rates. So the direct business is as you can imagine, much larger customers, they have much longer, they tend to buy annually or multiyear contracts. The retention rates are much, much higher. And they have a longer or larger lifetime value as they continuously expand their deployments over time is typically what we see.

Now the online portion of our business, while many of them buy monthly, we make by design, we make it very flexible for our customers to come and go, easy to buy or to pause their subscription if that serves them well. And a big part of investment that we're looking at for FY '23 is continuing to invest and optimize around this channel specifically. So working on localized pricing and packaging, additional payment currencies, additional payment types, ability to bundle in additional products. So we do sell Zoom Phone online and continuing to think about how do you optimize for price -- like pricing and packaging through this channel. And that will not only help stabilize it but also drive growth back into that channel again over time.

Meta Marshall

Got it. Are there any questions from the audience?

Kelly Steckelberg

All right. Good. Because I have more questions.

Meta Marshall

So clearly, Zoom Phone, 550,000 seats added last quarter. What is the most successful sales motion? What -- just are you kind of seeing in this market that's allowing you to kind of pick up the adds that you're having in this?

Kelly Steckelberg

Yes. So we're thrilled with the momentum of Zoom Phone. As you said 550,000, that's a record for us, and it's really a record in the industry. Nobody has ever done that. That many adds in a quarter. And I think it's a combination of the product, really getting to a great state of maturity, not only from features and functionality but also international availability. And it's also this momentum that's happening. The pandemic has really accelerated the movement from on-prem to the cloud for both Phone and Contact Center, actually. And so just having this amazing product at the right time, and especially as CIOs are now starting to think about what is the future of work, conference rooms and phones are front and center in that. So it's kind of a culmination of all of that coming together at the right time.

And again, our strategies we're selling into our existing installed base for customers that know and love and trust Zoom and expect us to deliver the same thing we've done for their meetings, experience with their Phone.

Meta Marshall

And maybe last question for me. Just -- this question does come up sometimes, but just what role does Zoom play as we head towards more of a Metaverse world?

Kelly Steckelberg

So Eric loves to talk about this. It's how do you bring together the experience of the meeting, but maybe in meta like having avatars or having a way you can participate in a different way. And like we're dipping our toe in through -- even we do have avatars, those of you who are on the most recent version of Zoom, you can go and find them. You can play around with them. They're really fun to see. And if you think about it, it's a way to participate in a meeting, but maybe give you a little break. If you want to be there, but not necessarily be on video, it's another way to do that. And so I think you're going to continue to see more of that over time.

Meta Marshall

Got it. And then just Russia-Ukraine impact, anything that we should expect there?

Kelly Steckelberg

So we feel very fortunate that while our hearts go out to everyone there, we don't have any employees that are directly impacted in either of those 2 regions. And we have a de minimis amount of business there.

Meta Marshall

Okay. Well, Kelly, thanks for getting us through the last couple of years. And I'm delighted that we could be here in person again. Thank you so much.

Kelly Steckelberg

Thank you so much for having us.

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