XP Inc.

Good afternoon, everyone. Welcome for joining us for our last keynote session of the day one of our DB Tech Conference. I'm Matt Nicknow, Communications Software Analyst here at Deutsche Bank. And we're very pleased to have Zoom's CFO, Kelly Steckelberg, joining us. Kelly, welcome.

Thank you, Matt. Thanks for having us today.

And for the purpose of everyone on the line, if you do have any questions, please feel free to type them out in the Q&A box you see at the bottom of your screen. I'll see them on my end and I'll try to weave them in to the discussion. So without further ado, why don't we jump into our fireside chat? Maybe just to start, Kelly, can you talk about your top priorities? What you're most focused on at Zoom right now as we head into the second half of the fiscal year?

Yeah, we are really focused on a couple of things. First of all, helping organizations think about the future of work and the future of communications. We've all experienced a dramatic shift in how we work and communicate over the last 18 months. And work is becoming not necessarily a place any longer, but a space in which anywhere that you can get things done. And we're really focused on ensuring that we support our customers in this transition. And part of that is Zoom is really evolving from being a meetings company, this killer meetings app, into a platform. And that platform includes, of course, our meetings product, but also Zoom Phone, which we've seen a lot of momentum over the last couple of quarters, which we can talk about later. Our chat product, which, again, especially as we're not in the same building, the same space together any longer, provides asynchronous communication. Also, Zoom Rooms, which is a really important part of the Work From Anywhere strategy, as we've all gotten used to this experience, right? Where we can clearly see each other on the screen, we might have our name as prompts, like it's really, this has been a great part of what's come out of this last 18 months and looking forward to helping customers and prospects with technology that recreate some of this experience, even when you have some people in a conference room and some people working in different locations. And then also we're very excited about Zoom events, which is our corporate events platform, which became generally available in June and will be the platform on which we're hosting Zoomtopia next week. If you can see from my background, Zoomtopia is next Monday and Tuesday. We hope we will see you all there to hear some of the amazing product announcements that Eric and Odette are going to talk about.

That's great. Yeah, no, we're definitely looking forward to it. And so as we sort of delve into my next question, I think you sort of alluded to it. As we look at global economies emerging from and businesses maybe planning for life post-pandemic, can you talk a little bit more about Zoom's strategy to strengthen that platform and really maintain its prominence for customers who've really come to view Zoom as a necessity over the last 18 months?

So we've absolutely seen that with our customers on a global basis. So what we saw, if you go back to kind of what's happened over the last 18 months, is we saw the significant growth in our meetings platform last year as people were trying to keep their employees safe, make sure they were productive. And then as they kind of moved through that buying cycle, we saw them thinking more strategically about, okay, great. Now, how do we keep everybody, you know, give them the flexibility they need, but keep them highly efficient? And that's where Zoom Phone comes in. We've seen significant momentum around Zoom Phone. It's currently available in 47 markets on a native basis, which allows some of the largest multinationals to have a native implementation with supporting all their employees around the globe. It's also really efficient and easy from a change manager perspective in terms of if you already are a Zoom meetings customer, it's just one more icon on your Zoom client. So it's really made an easy transition for customers as they've added this into their portfolio. And again, on a global basis, which is really important. And then Zoom Rooms, as I said, is going to be a significant portion of that as well. And the platform strategy has been extending as we've moved around the globe, too, as international has grown significantly over the last 18 months with the pandemic. Combination of what's happened is the elevation of the Zoom brand awareness, as well as the acceleration of video adoption and customers really looking for a platform that has the ease of use and the reliability that Zoom does.

Got it. And so maybe if I can follow up one question, something that came up last week on the earnings call was customers maybe being a little bit more deliberate, I think was the word that was used, with their purchasing decisions. I'm just wondering if you can talk a little bit about how that purchase decision is now, whether it's sales cycles, Potentially lengthening, whether it's customers maybe evaluating competitor solutions, but what's different when it comes to customer purchasing decisions today, maybe versus a fiscal one cue or two cue from a year ago?

Yeah. So what we saw in Q1 and Q2 of last year was this really momentum of buying that was almost being done in a frantic way, really, by some customers as they were, depending on where they were in their cycle of business continuity planning, they might have needed to accelerate that to to get meetings in place to keep their employees connected when they found themselves suddenly in this instance where they needed to send everybody home to keep them safe. And now that we've moved past that cycle, what we see is customers taking the time now and going back to the way that they really bought sort of pre-pandemic, right? So a much more natural buying cycle, which sometimes includes different concepts, It includes user acceptance testing, potentially RFPs or competitive evaluations. And so that common earnings call was just to highlight that we're going back to a more normalized state, which is what we were used to before the pandemic, just not what we've experienced in sort of the last four to five quarters of last year and early into this year as well. But it's a normalized buying pattern that we're used to and that nothing that we aren't accustomed to, just to sort of highlight that it has shifted.

That's great. One of the biggest questions, I think, on investors' minds is Zoom's growth potential post-COVID. And, you know, we've seen, obviously, the company now scale to a $4 billion-plus business. You've laid out a TAM, I think, in the past of about $86 billion, which we'll discuss, obviously, in more detail, and I'm sure you'll talk about next week at the Analyst Day. Can you maybe from a high level, and I don't need specifics, but From a high level, can you help frame how investors should think about Zoom's forward growth potential beyond fiscal 22? Yeah. So...

We are in really early stages of the opportunity of growth for this company. So some of the stats that I can give you to highlight this include the penetration of the global 2K, which is one of the metrics that we look at on a quarterly basis. There is only 16% of the global 2K today that is spending more than $100,000 with us. And for a company that size, even $100,000 isn't that significant of a spend. But that tells you that there's 84% of the global 2K that have a tremendous opportunity for expansion with us. When you look at our attach rates... Even if you look at our existing install base and you look at our attach rates for phone and for rooms, and we are going to give these in detail next week, but you know, they're both of those products are nearly early stages of their cycle. So there's tremendous growth opportunity, even with our existing install base, even if we didn't add new logos. So that's what I think is really exciting when you look at there's an international opportunity for community expansion in new logos. There's an existing opportunity just within our own install base, so within our own customer base that we can continue to sell these new products into. And then when you think about things like Zoom events, Zoom apps, which we haven't even begun to monetize yet. And then some other new exciting announcements that you're going to hear about next week. Like there is just tremendous growth opportunity and we're in very early innings of this company's growth cycle.

Understood. Okay. And we'll be patiently waiting for those data points next week. I want to hit small business trends because that was really front and center, I think, last week. There's a lot to talk about with enterprise, and that's going to be a big chunk of our discussion. But maybe let's hit small business first. So higher churn, obviously, within that segment, small business, prosumer, online segment, we can call it either one. Certainly been top of mind, as I noted. So I want to maybe dig into what specifically you're seeing. both in terms of gross revenue growth and churn in this cohort, and maybe how we should think about your expectations for both gross revenue growth and churn in the second half of the year.

Yeah. So when we were coming into this fiscal year and we were giving guidance for the full year, we talked about our expectations for churn for this segment specifically. And we hearkened all the way back to the one time that we've talked about churn for the segment, which we said, you know, in the S-1 it was disclosed that it's 4% monthly for this segment at that period of time. And we said that we were modeling it in multiples of that. And, you know, that's due to this segment being the most reactionary to what's happening in the world. You know, approximately 40% of our total customer base is billed monthly. And as you can expect, there's a large overlap with this segment of our customer base. And they just are the most volatile, and that has been true all along. So we were absolutely expecting significant amounts of churn from this segment. What did happen, though, was it came a little bit earlier than we expected in the year. We expected that to be, you know, late in the back half of the year, and... Due to good things happening in the world, like vaccine distribution occurring more quickly than we expected, this is very difficult to predict that. We're seeing people moving around the world in different ways, right? People going on holiday, people going out to dinner and happy hour rather than doing those via Zoom. And that's what's led to the volatility that we're seeing in this segment of the customer base. Some of that may be summer seasonality, as this is a different business for us, and we can't really look at the seasonality trends of last summer. So we'll see now that everybody's back from holidays, back in school, but we felt that the appropriate way to think about that term for the rest of the year was to model it based on those rates that we saw, those heightened rates that we saw at the end of Q2.

Okay. And then maybe in terms of what's embedded in the outlook that you've given for fiscal 3Q, and I think what we can back into for fiscal 4Q, are you assuming that that churn worsens relative to the 2Q exit rates?

No, we've assumed that it kind of sustains at that same level.

Okay. Okay. Makes sense. I guess one of the more recent developments has been the Delta variant. And even this morning, I mean, I was reading headline after headline of airlines coming into the lower end of their outlooks because of Delta and, you know, impacted some of the bookings they've seen. Are there any notable, I guess I don't want to call them tailwinds, but benefits to the business maybe from the spread of the Delta variant that you've seen or that you'd call out?

No, you know, what's interesting about Delta is we're seeing it, I think, more impact our upmarket and larger customers in terms of them delaying their office reopenings. But we've not seen it as much in terms of... potential growth, if you will, in that in that smaller segment is I think, is individuals that varies, you know, around the globe, of course, not the same, but as individuals, I think are in their personal lives are moving around the world a little bit more freely.

Makes sense. And then maybe just to sort of put this all together, when we think about that sub-10 employee cohort, longer term, what's Zoom's strategy for serving this customer set? And then maybe with some of the higher churn and free options that are out there, is this a segment of the market you think is still worth pursuing and investing in?

Oh, absolutely. So first of all, we love all of our customers. And even as a reminder, like, let's just fast forward to what I think is going to happen, which is that this segment of the customer base is going to stabilize in terms of a dollar amount likely. And these are so still be a very important contributor to our top line in terms of revenue, as well as our bottom line is they're very profitable customers as they mostly self-serve. So they will contribute to both revenue and profit. Now, if they stabilize in terms of dollars, then, of course, they won't be contributing to the overall growth rate. In fact, they could have the impact of, you know, kind of dampening down the overall company growth rate that will be largely driven mostly by continued growth in the up market. But. First of all, even if someone chooses that they don't want to pay for Zoom, if they don't have a need for it immediately, they can always revert to our free product, which is still available to them, right? It's just limited in the 40-minute capacity. And that's what most of them do. We make it very easy for our customers to come and go. on our online platform as we want them to use the product when it suits them and when they need it in their life. And then come back when they're ready. And remember, even free users always have the opportunity to expose somebody new to the power of Zoom or to find an opportunity somewhere in the future that they want to upgrade for a period of time. So we absolutely love all of those customers and will continue to support them. You know, we... have been and continue to run campaigns for retention in this segment. The best way to retain these customers is to promote usage. So we're always helping them ensure that they learn about the product, they understand the features and functionality that are available to them. And then, of course, we offer campaigns for things like discounts if they want to commit to a multi-year agreement or an annual agreement, as well as potentially to buy another product like Z-Phone. So we continue to value them, and we certainly want to keep our arms close around them and do everything we can to retain them.

And as we just think about just one follow up there, as we think about what percentage of revenue can come from this cohort over time, I know it was 20 percent pre-pandemic. We sort of ballooned, I think, to 38 percent at the peak. Do you have any sort of longer term assumptions in terms of where that can go?

You know, longer term, I think that it will gradually decrease. Like, I don't expect it to necessarily increase, but I think it will gradually decrease over time. Where it settles, I don't know, but I think that it's just going to gradually decrease. What we expect is it's going to, once you get through some of these subscription churn curves, right, what you end up with is this long tail of retentive customers, which is what we will get to. And then, as I say, they will be a nice contributor to our top line.

Okay. Let's pivot to enterprise and upmarket. I know it's a huge, huge focus for the company. So I'm wondering, can you talk about Zoom's plans to enhance its wallet share among the 505,000 customers in this cohort with more than 10 employees? And so when I look at some of the stats that were put up last week when you reported earnings, I think a little over 2,000, they're generating over 100K in trailing 12-month revenue. It's only about 156 customers that are north of a million. So by most measures, the potential is significant. So how do you think about the opportunity to improve your share? And then maybe where do you see the most low-hanging fruit?

Yeah, so I think some of it is what we've already spoken about a little bit, right? Probably the lowest-hanging fruit is with that existing install base that already know and love and trust Zoom is to continue to sell more products. So, you know... Zoom phone is a perfect example of that as with very low penetration rate. Zoom rooms as they're thinking about it. And then, of course, you know, once we everybody gets the opportunity to experience Zoom events next week to sell there as well. You know, we also are always. always innovating and thinking about other opportunities to monetize our install base. Again, some of them are going to become visible to you next week, and then some of them we're going to continue to work on. So this idea of a platform, right, is not done, right? We're not done. And there's a continued opportunity to keep expanding and extending there. And, you know, we're not going to talk about the pending acquisition, but obviously call center and the potential for that is a really important part of the extension of our platform as well.

Let's dig into phone and events, and then I want to bounce to international. But why don't we start with phone? You recently surpassed 2 million seats in terms of Zoom phone, doubled the base, I think, since January. So very, very strong growth. Can you talk a little bit about the opportunity you see in phone, how significant Zoom phone could become for the broader Zoom platform over time?

Yeah. So, you know, the Tamper phone itself is in excess of $30 billion or something. I don't remember exactly what it is off the top of my head, but there's, you know, over 400 million phone, you know, on-prem phone seats out there that are available today. So that tells you, you know, how... Early we are in this cycle for Zoom Phone. While we're thrilled to have crossed over that 2 million phone line, there's tremendous, tremendous opportunity ahead that we're very, very excited about. And international is a really important aspect of this. Again, the international availability. And then also another aspect of the strategy for Zoom phone, which is a little bit different than how we approach meetings, is the channel. You know, the phone buyer is typically they are accustomed to buying through the channel. This is a different approach than we took with meetings. But we, you know, Ryan Azis, our CRO, and Laura P, our head of channel, have both done an amazing job in building out our channel program. 27% of our Q2 deals, phone deals were touched by a channel partner. So, you know, given that we didn't even have a channel program really speak of 18 months ago, I think that's tremendous progress there. And it's that program still today is largely USA. So the opportunity and the focus now is on expanding that internationally, and it starts to act as an accelerant to really get into different customers or different prospects than those that are already sitting in our existing install base and reach that phone buyer and potentially start there. And then from there, back into having them become a Zoom meeting customer as well. So really, really excited about that opportunity.

And when we think about the sales motion for phone, I mean, how does that compare to meetings? Are customers maybe making the purchases jointly? Does phone migration away from on-prem PVX take a little bit longer? Maybe help us think about the comparison between the two.

Yeah, so sometimes they're all together. That decision is being made together. But again, our strategy for selling Zoom phones is selling into our existing install base. So often it's a separate selling cycle. It is a little more technical and complex product to sell. So the way we approach it is we have a team of Zoom phone ninjas that are an overlay team that we have hired. They're experts in their field. We've hired them. And they're really, their role is to go in, you know, hand in hand with the account executives and to sell Zoom phones. And then we have a really great professional services as well as customer success team that helps support the customer with that transition in terms of porting over numbers and the implementation of that, which again, it can take a little bit longer than do meetings. Especially when it's an existing Zoom meetings customer, that selling cycle is a lot easier because, again, they already know and they already trust Zoom. They're familiar with us as a vendor. So it accelerates that. But we have a whole specialty team that's built around supporting that sales cycle and implementation process.

And when we think about the competitive landscape, I mean, the stats I've seen are of that 400 mil base, I think it's, you know, whatever, it's 15, 20 mil that have moved to the cloud. So there's a lot of runway for growth. I'm just wondering, can you talk about why customers choose Zoom? relative to the competition. Part of it may be they're an existing meetings customer. Part of it is the simplicity of the platform. But I want to maybe dig into whether this is, is it a rising tide lifts all boats for cloud-based telephony coming out of a pandemic? Or is there maybe something unique to the Zoom phone product that a peer or multiple peers of yours may not have?

Yeah. So there's definitely, you know, momentum right now of moving from on-prem to the cloud. But even when we compete against other cloud PBX providers, we win based on usability, reliability, as well as total cost of ownership. So we are very competitively priced when you look at our list price compared to other cloud providers. And then, of course, there's opportunities depending on deal size, the willingness to commit to the multi-year agreements or pay up front that customers can avail themselves of further discounts. And when you put all of that together, what we hear from our customers is they see great value in a very modern technology that meets the needs of the most sophisticated buyers. Just as a reminder, one of the deals that we talked about on the call was, you know, our biggest Zoom phone deal to date of 63,000 seats. And it's a financial services firm. And it actually that deal pushed them into being our largest customer now. And so that shows that the product itself has really evolved to meeting the needs and has the functionality to meet the needs of the most sophisticated buyers.

Let's talk about Zoom events. So obviously recent launch, we'll get to see it in action next Monday. Can you talk about the opportunity here in terms of incremental addressable market and really the ability for Zoom's platform to host these types of larger scale events?

Yeah. So this has really been an interesting shift that's also occurred over the last 18 months. Like us, many companies were running to convert their previously in-person corporate events to a virtual platform. And what we realized over the last 18 months is they're There were lots of sort of disparate pieces of it that you could piece together to bring together an experience, but there wasn't a holistic platform, which is what Zoom Events provides. you know i i think that i can't remember with the tam association if i think it's around five billion or something maybe specifically for events but i think that's probably greatly understated for this transition that we're seeing as people are going through this experience and even though again we all long for the day that we can come back together for these events having a virtual component to it i think is always going to be how these events are hosted because the reach that you see I mean, when you look at how Zootopia grew, it grew like 10 times from our in-person event to our virtual event last year. And that's an amazing reach. And we've heard story after story about how much more efficient, how lead generation has improved these virtual events because the reach is just so much more significant. And so that's what we're looking forward to is supporting organizations, not only in their virtual events, but in the future, right? Helping them build a hybrid approach to this.

Got it. Yeah, I think a lot of what you mentioned is pretty relatable to our conferences here. Now, I don't think it's unique to DV. I think we've seen it street wide as well. Let's let's pivot to international because the Americas still do make up. I think it's about two thirds of your revenues. But we've seen it being an APAC growing at a little bit of a faster rate. How do you think about the international opportunity relative to the Americas? And how should investors think about the investments needed to scale up that international business over the next year?

Yeah. So we absolutely believe that international should be 50% of our revenue in the future. And The acceleration of video adoption that we've seen over the last 18 months, as well as the know acceleration of our global brand awareness has really provided that opportunity to to do to accomplish that we what we need to do which is what we are doing is continue to add sales capacity around the globe so historically the way we would have done that if we would have gone in first we would have done brand awareness we would have seeded the market and then start to hire sales people so we're not putting them into a you know a cold location if you will And we don't have to do that any longer, meaning we can now add sales reps into markets as quickly as we see demand and as we feel appropriate for the organization to be able to adopt them and ready them. And that's what we're doing. And that's I think really exciting to see the, like Latin America, for example, we have a whole team built out there that we probably wouldn't have been there for another couple of years, but we've seen the acceleration of adoption there and the growth in demand that it really made sense to accelerate those plans. So that's what we've seen, and we're looking forward to continued performance there. They've done an amazing job over the last 18 months and expect them to continue to grow at a more aggressive rate even than we are in the US.

Is there anything structurally different for those international regions relative to the Americas?

Not really. I mean, the only thing is in certain markets for Zoom phone, there might be a little different regulatory environment, but we have an amazing team that, you know, is working experts in this field that are working on that was, you know, led to some of the timing of international availability. It's all about making sure that you have the right licenses in place to be able to sell. But that's really that's really the only difference. The acceptance and adoption of video communications, which, you know, pre-pandemic, if you will, the U.S. was years ahead of other markets around the globe. And that gap has really closed over the last eight years.

Got it. So you touched on my next question somewhat around investing for growth, the next stages of growth, but it's really a question around profitability. As you sort of look to ramp up OpEx post-pandemic to further scale out the business, where do you see Zoom investing most actively? I mean, I assume channel sales and marketing, these are all things that you referenced, but I guess what I'm getting at is how should investors think about this OpEx ramp and really the path for operating margins from here?

Yeah. So, you know, we've had really high operating margins for the last four quarters, and that's due to the extreme ramp we've seen and acceleration we've seen in revenue, and frankly, the inability for us to keep up with that ramp from a hiring and an investment perspective. We are very focused on this. We are very focused on investing in R&D, especially, where It came in in Q2 at 5.3% of revenue. Our long-term target for that investment level is 10% to 12%. So hiring as quickly as we can around the globe. And then we are also heavily, heavily investing in sales and marketing. So continuing to add quota-carrying heads to build our sales capacity. And over the last 15 months-ish, we largely turned off our marketing and advertising spend as the level of demand allowed us to do so. But now looking forward, you should expect to see us investing again in targeted product marketing around certain aspects of the platform to ensure that everyone, you know, as they have this amazing awareness of Zoom meetings, that they have a similar awareness of Zoom phones, Zoom rooms, et cetera. So those are the really the areas that we're focused on in terms of continued added spending. When you look at GNA, it's really kind of right where we want it to be from a percentage of revenue perspective. So the focus there is on keeping it as efficient as possible as it is today. Maybe, you know, potentially driving more, but really it's kind of in that sweet spot already. And then our gross margins. So gross margins. You know, we don't specifically guide, but we said on the call, we expect to be in the range of 75%. Our long-term target there is 80. But our gross margins are going to continue to be weighed down a bit as long as we continue to provide our service for free to K-12 schools around the globe, which we do. And we will continue to do as long as there's a demand for that. So until that changes, you should expect that to be weighted down. Some of it is also due to the percentage of our traffic that's still in the public cloud. And we've talked about we have this multi-year strategy of moving some of that traffic, not all of it. We're always going to have hybrid approach, but getting the majority of it out of the cloud and into our own servers that are in co-located facilities. And we're sort of partway down the path on that strategy, but we're not there yet. So what you should expect is that operating margins are going to continue to decline, you know, on a sequential basis until we get sort of our long-term target, which we've said is, you know, 25%-ish plus, and that'll happen gradually over the, you know, the next several quarters.

Just to follow up on the migration of some of the traffic out of the public cloud into your own colos, I mean, what inning would you say you're in in terms of that exercise?

Yeah, probably three, three to four, somewhere in that range. Like we opened our data, our San Jose data center last quarter, which was great. And that's part of what, you know, you saw the improvement in the growth margins. But we have a couple others data centers in the pipeline that we're planning on doing and then continuing to add capacity in our existing data centers as well.

Got it. Okay. A question on capital allocation. So now, obviously, the business, we talked about this ramp in operating margins. The business is generating pretty healthy free cash flow. I think you've done a little under $2 billion over the last 12 months. You're also sitting on about $5 billion worth in cash and investments. How do you prioritize capital allocation uses of cash? And maybe within that also, you know, you've obviously announced a larger acquisition, but I'm wondering how you view potential incremental top gains or M&A.

Yeah. So we've, in addition to the big one, we've announced a couple small ones that we've done to date. And we continue to look for opportunities to either add to our amazing talent pool or to augment our technology. And We have a core dev team that looks at hundreds of companies every quarter and just continuously watching for the right opportunity. We also announced this year the Zoom Apps Fund, where we set aside $100 million to invest in interesting companies that are innovating on the Zoom platform. And I also see that as an opportunity to see what is happening in the ecosystem, in the app development. Is there anything really amazing there that we should look at that presents itself as an opportunity as well? So we like having the flexibility that our cash currently gives us and are continuing to look for the right opportunities to leverage it.

Great. And then just last question in the interest of time, we've got Zoomtopia coming up next week. It's about three days away, but I'll ask it anyways. Any initial insights you can share in terms of what investors can expect at Zoomtopia next week?

Yes. So first of all, if any of you have gone in the past, you can expect that Eric is always our keynote. He's always amazing and entertaining and has some really exciting announcements. So you don't want to miss that. And then, of course, at Analyst Day, we have had the great opportunity to spend time with many of you since earnings over the last seven or eight days. hear what your questions are. And what I love about Analyst Day is it gives us an opportunity to spend a little more time with you in a little more detailed, deeper way to delve into some of the trends, some of the metrics. And for those of you that haven't been in the past, we do take the opportunity to disclose one-time metrics that we give once a year at Zoomtopia. So it's a great way to get a deeper insight into the business. And then at our session specifically, we will also have Odette Gall doing some demos and speaking about the new product announcements. We will have Laura Pia, our head of channels, joining with a couple of channel partners, and then we'll have Q&A with Eric. So it gives you a great opportunity to be kind of in close and personal with Eric, which is always, I think, a great opportunity.

That's awesome. We're very much looking forward to it. I think we'll have to end it there just because we're out of time. Kelly, thank you so much for joining us and hoping we could do this in person next year. Thank you.

That was great. Thank you.