Zoom Communications, Inc.

Hello, everyone, and welcome to Zoom's second quarter fiscal year 2021 earnings release. This call will be recorded. At this time, I'll hand it over to Tom McCallum, head of investor relations.

Thank you, Matt. Hello, everyone, and welcome to Zoom's earnings video webinar for the second quarter of fiscal 2021. Joining me today will be Zoom's founder and CEO, Eric Yuan, and Zoom CFO, Kelly Steckelberg. Our earnings press release was issued today after the market closed and may be downloaded from the investor relations page on the zoom.com website. Also on this page, you'll be able to find a copy of today's prepared remarks and a slide deck with financial highlights that along with our earnings release include a reconciliation of gap to non-gap financial results. During this call, we will make four looking statements about market size and growth strategy, Our estimated and projected costs, margins, revenue, expenditures, investments, growth rates, our future financial performance, and other future events or trends, including guidance for the third quarter 2021 and full fiscal year 2021. Our plans and objectives for future operations, growth, initiatives, strategies, and the impact to our business from the COVID-19 pandemic.

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These statements are only predictions that are based on what we believe today and actual results may differ materially. These forward-looking statements are subject to the risks and other factors that could affect our performance and financial results, which we discuss in detail in our filings with the SEC, including today's earnings press release and our latest 10Q. Zoom assumes no obligation to update any forward-looking statement we may make on today's webinar. And with that, let me turn the discussion over to Eric.

Hey, Tom, thank you. Hello, I hope you are all doing well. I want to thank our customers, investors, and the community for their support of Zoom. Their care, feedback, and trust of Zoom make a huge difference. And we grew our business from being a startup to a not-so-public company. to be a long-term sustainable company, we might be facing all kinds of challenges. But no matter how busy we are, no matter what challenges we are facing, we are always recharged when we think about our customers' support and become even more motivated to serve them better. With the pandemic persisting, we are very committed to work hard and are humbled by our role of enabling communications worldwide during this challenging time. As remote work trends have accelerated during the pandemic, organizations have moved beyond addressing immediate business continuity needs to actively redefining and embracing new approaches to support a future of working anywhere, learning anywhere, and connecting anywhere. And we continue to see meaningful adoption of Zoom's video-first unified communication platform across industries and geographies. So let me share with you just a few key metrics that reflect this. Revenue grew 300%. 55% year-over-year in Q2. Customers with more than 10 employees grew 458% year-over-year, as new customers chose Zoom to be their preferred communication and collaboration solution. And we had over 35,000 educators, school administrators, and IT professionals from around the world join our free virtual Zoom Summer Academy. The successful two-day Zoom event was our biggest educational event to date, bringing together social leadership in remote learning, practical training, and networking opportunities. And we remain committed to helping our education customers including the more than 100,000 K-12 schools who have signed up to use the platform for free during the pandemic. Moving on to a few recent business highlights, we've completed our 90-day plan on security and privacy. A comprehensive summary of accomplishments is available on our website. I'm very proud of our team's swift and transparent response, as well as the resulting improvements we made to our platform. Although the 90-day initiative is over, security and privacy matters will remain an important part of Zoom's strategy and DNA moving forward as we strive to maintain our customers' and other stakeholders trust. We also made two exciting hardware announcements in the quarter. First is the launch of Zoom Hardware as a Service, which offers customers a variety of subscription options for phone and Zoom hardware from leading hardware manufacturers. This offering makes Zoom Phone and Zoom Rooms more accessible by minimizing friction around hardware procurement. Second is Zoom for Home, our new innovative category of software experience and hardware device partnerships to support remote work use cases. We launched this program with our partner D10 in July, and this month we announced its expansion to Amazon. Facebook, and Google devices. We also achieved significant accomplishment for Zoom Phone. In mid-June, Zoom Phone was authorized under the FedRAMP program, enabling federal agencies to consolidate their costly Lexi telephoning systems onto our unified modern cloud solution. We expanded the availability of Zoom phone service to 25 additional countries and territories. Zoom now provides local telephone service and the domestic calling in more than 40 countries and territories. On a final note, we welcome our new CISO, Jason Li, former SVP of Security Operations at Salesforce. And our new general counsel, Jeff Chu, former EVP and general counsel at Palo Alto Networks. We are very excited to have them.

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Now, let's talk about some exciting wins in the quarter. Let me start with a couple of new customers that represent some of the largest companies in their industry. First, we are thrilled to welcome ExxonMobil, one of the largest publicly traded international energy companies to the Zoom family. ExxonMobil develops and applies next generation technologies to help safely and responsibly meet the world's growing needs for energy and chemical products. They recently used their skill and capabilities to ramp up production to make medical-grade masks, seals, and hand sanitizers. We are grateful that ExxonMobil chose Zoom as their unified communication platform. ExxonMobil wanted a solution that would enable them to collaborate reliably and securely with their teams, customers, and partners around the world. ExxonMobil employees are now using Zoom video communications across their global business. Second, Activision Blizzard, a member of the Fortune 500, has chosen Zoom to modernize and consolidate onto a single communication platform across their business units and gaming franchises. As a leading interactive entertainment company connecting and engaging the world through epic entertainment, Activision committed to a full enterprise layout of Zoom meeting and Zoom rooms to replace their mix of legacy video conferencing products. Our ability to expand with existing customers also helped drive our results this quarter. One of the highlights this quarter was the expansion with ServiceNow, who has been a Zoom customer since 2018, using Zoom meetings for its 11,000 global employees. Since the global pandemic, ServiceNow employees working from home have relied heavily on Zoom's easy-to-use interface to stay productive and connected with their customers. And the Zoom platform has become a core piece of ServiceNow's technology ecosystem. This past quarter, the company chose to replace its legacy hardware PBX system with Zoom phones across their organizations, further elevating their Teams work anywhere experience with seamless one-touch communication and collaboration.

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Thank you, ExxonMobil, Activision Blizzard, ServiceNow and all our wonderful customers for trusting you. I love you. All the employees love you. Thank you. In summary, we continue to scale and expand our business to meet the needs of our customers and the global community. I'm very proud of our achievements and I thank our more than 3,400 employees for another exceptional quarter. Let's remain focused on delivering happiness for the customers and the community. With that, let me turn things over to Kelly.

Thank you, Eric. And hello, everyone. Q2 was a remarkable quarter for Zoom as we continued to rapidly grow and invest in our business to meet the demands of our customers and community. Let me start by reviewing our financial results for Q2, then discuss our outlook for Q3 and the increased view of our full year FY21. Total revenue grew 355% year over year to $664 million in Q2. This top line result significantly exceeded the high end of our guidance range of $500 million as demand remained at heightened levels combined with lower than expected churn and exceptional sales execution. For the quarter, the year-over-year growth in revenue was primarily due to subscriptions provided to new customers, which accounted for approximately 81% of the increase, while subscriptions provided to existing customers accounted for approximately 19% of the increase. This demand was broad-based across industry verticals, geographies, and customer cohorts. Let's take a look at the key customer metrics for Q2. We continue to see expansion in the up market as we ended Q2 at 988 customers generating more than $100,000 in trailing 12 months revenue, up 112% year over year. This is an increase of 219 customers over Q1, the highest number of ads in a quarter. We exited the quarter with a total of approximately 370,000 customers with more than 10 employees. we added approximately 105,000 of these customers in Q2, the second highest number of ads in any quarter. Year over year, we added approximately 304,000 new customers with more than 10 employees for 458% growth. We have continued to benefit from significant growth in our customer segment with 10 or fewer employees as small businesses and individuals adopted and maintained their Zoom licenses for various uses during the pandemic. In Q2, customers with 10 or fewer employees represented 36% of revenue, up from 30% in Q1 and 20% in Q4 of last year. The increase in customers with 10 or fewer employees continues to shift our billing mix, as these customers generally pay monthly rather than annually, as do most enterprise customers. This shift is an important point for our outlook which I will discuss in just a moment. Our net dollar expansion for customers with more than 10 employees was over 130% for the ninth consecutive quarter, as existing customers continued to support and trust Zoom to be their video communications platform of choice. Both domestic and international markets had strong growth during the quarter. America's grew at a rate of 288% year over year. Our combined APAC and EMEA revenue accelerated to 629% year-over-year and represented approximately 31% of revenue. We will continue to invest in international expansion to capitalize on our brand awareness and the increased global opportunity. Now, turning to profitability. The increase in demand and strong execution drove net income profitability from both GAAP and non-GAAP perspective. I will focus on our non-GAAP results, which include stock-based compensation expense and associated payroll taxes, charitable donation of common stock, and acquisition-related expenses. Non-GAAP growth margin in the second quarter was 72.3% compared to 82.2% in Q2 last year and 69.4% last quarter. The incremental improvement from Q1 reflects our strategy to increase our co-located data setter capacity while leveraging the public cloud as needed. We expect growth margin for the rest of the year to be consistent with Q2. However, actual results may vary as growth margin is contingent upon the percentage of free users and the utilization of public cloud during the pandemic. R&D expense in Q2 was approximately $29 million, up 128% year over year. As a percentage of total revenue, R&D was approximately 4%, which was lower than Q2 last year, mainly due to the strong top line growth. In FY21, we will continue to invest in R&D to drive innovation across all aspects of our platform. We also plan to diversify our engineering talent as reflected by our expansion in the U.S. and India. Sales and marketing expense for Q2 was $123 million. This reflects an increase of 78% or $54 million over last year with investments to drive future growth. As a percentage of total revenue, sales and marketing was approximately 19%, a decrease from Q2 last year due mainly to strong top-line growth and marketing efficiencies from our increased global awareness. Overall, we plan to add sales capacity quickly over the next several quarters. The swift ramping of our sales organization to further capitalize on market opportunities is a priority. G&A expense in Q2 was $51 million, up 189% on a year-over-year basis due to higher accrual for telco taxes correlated to higher billing, professional services, and additional hiring to meet the functions of a public company of this scale. As a percentage of total revenue, G&A expenses approximately 8%, a decrease from Q2 last year as we gained leverage on our investments with a rapid growth in revenue. The substantial revenue upside in the quarter carried over to the bottom line with non-GAAP operating income of $277 million, far exceeding our guidance, translating to a 41.7 non-GAAP operating margin for the second quarter. This compares to Q2 last year's results of $21 million and 14.2% margin. The significant margin expansion year over year is due to the steep increase in revenue in Q2, which outpaced the rate of investment, even as we added over 500 employees in Q2, a 20% increase from last quarter and a 53% growth year over year. Non-GAAP earnings per share in Q2 was 92 cents on approximately 297 million of non-GAAP weighted average shares outstanding and adjusted for undistributed earnings. This result is 46 cents higher than the high end of our guidance and 84 cents higher than Q2 of last year. Turning to the balance sheet. Deferred revenue at the end of the quarter was $743 million, up 309% year over year. Looking at both our billed and unbilled contracts, our RPO totaled approximately $1.4 billion, up 209% from $458 million year over year. The increase in RPO is consistent with the strong demand and execution in the quarter. We expect to recognize approximately 72% or $1 billion of the total RPO as revenue over the next 12 months, as compared to 62% or $285 million in Q2 last year. This indicates a shift in our renewal seasonality, which was historically weighted towards Q2 and Q4, and has now shifted to Q1 due to the strength of last quarter's performance. As a reminder, we do not focus on calculated billings as a metric for our business. We have a diverse business that spans from enterprises to individuals. With the changing mix of our business, annual billing terms, and the growing level of monthly billing terms, such calculations have become less meaningful, especially now that we have a full quarter of monthly billings making up a bigger part of our revenue. We ended Q2 with approximately $1.5 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. Similar to Q1, we had exceptional...

Excuse me.

Similar to Q1, we had exceptional operating cash flow in Q2 of $401 million, up from $31 million in Q2 last year. Free cash flow was $373 million, up from $17 million in Q2 last year. The increase is attributable to strong collections from the large increase in top line growth and higher percentage of monthly contracts throughout the quarter. For the second half of the fiscal year, we expect to increase capital expenditures for additional data center infrastructure. As a reminder, we will see the semiannual cadence of net cash inflows from ESPP purchases to occur in Q3. Now, turning to guidance. We are pleased to raise our outlook for FY21 for both revenue and non-GAAP profitability. Although we remain optimistic on Zoom's outlook, Please note that the impact and extent of the COVID-19 crisis and its associated economic concerns remain largely unknown. Our higher outlook for FY21 is based on our view of the current business environment. For the third quarter, we expect revenue in the range of $685 to $690 million. We expect non-GAAP operating income to be in the range of $225 to $230 million. Our outlook for non-gap earnings per share is 73 to 74 cents, based on approximately 300 million shares outstanding. Before giving you the full year outlook, let me provide some context on our assumptions. While better than expected churn was one of the drivers to our Q2 outperformance, we did experience a significantly higher level of overall churn in Q2 as compared to historical rates. As customers with 10 or fewer employees have increased to 36% of our revenue, we are assuming a higher rate of churn due to this mixed shift. From an expense perspective, we continue to focus on investing for growth, targeting investments that are appropriate for our market opportunity and the size of the business that we have become. Looking ahead, we expect operating margins to decrease from the peak in Q2 over the balance of this year as our hiring and spending catch up with a much greater scale of our business. It is prudent to expect margins to normalize to lower levels over the next several quarters. For the full year of FY21, we expect revenue to be in the range of $2.37 to $2.39 billion, which would be approximately $281 284% year-over-year growth. This implies that Q3 and Q4 revenue will be only modestly higher than Q2, indicating a decline in quarter-over-quarter growth. For the full year of FY21, non-GAAP operating income is expected to be in the range of $730 to $750 million. We expect to deliver non-GAAP earnings per share of $2.40 $2.47 for the full year FY21 based on approximately 300 million shares outstanding. In closing, we executed well in the first half of our fiscal year. With our commitment to delivering customer happiness, we believe we will grow to over $2 billion in total revenue this fiscal year, which would be a remarkable milestone considering our guidance was below $1 billion in revenue at the start of this fiscal year. We are proud of how our team continues to perform in support of our customers and global community. Thank you to the entire Zoom team. Before we move to our Q&A session, let me turn it back to Eric.

Thank you, Kelly. By the way, I want to invite you all to our virtual Zoomatopia event on October 14th and 15th. There are so many cool features, like a visual filter. We hope to see you all there. Now, let me hand it back to Tom. Tom?

Thank you, Eric. And with that, let's open it up for questions. If you have not enabled your video, please do so now for the interactive portion of this meeting. I will ask everyone to try to keep themselves to one question. And if we have time at the end, we'll do some follow-ups. But please try to keep it to one question. And Matt, please queue up the first question.

First question is from Alex Zukin with RBC.

Thank you. Thanks, Matt. And Eric, first, I want to say thank you from the analyst community. And as a parent, as a husband, you've made a substantive difference in all our lives. So I guess the question I get most frequently, Eric, is most people are now staring at their Zoom screen probably more than watching any kind of content globally. So outside of starting to show commercials in between your relevant Zoom calls, Talk about the biggest opportunity for continued bookings growth, whether it's Zoom phones, opening up the APIs, you know, monetizing consumers, filters that you just showed. But can you tell us, you know, the better you do this year, the harder it is for us to know and understand what's the durable growth rate? How do you comp this amazing, spectacular performance? So I'll stop there. I could go on for a bit.

Yeah, Alec, first of all, I should appreciate it for your continued support for many years. I think you are so right. It looks like there are so many opportunities here and there, all kinds of use cases. My kids are also using Zoom and telemedicine, telehealth. I think seriously, for now, our top priority is to help people stay connected and make sure our service is always up and quickly based on the customer feedback, add some features, and make sure when you have multiple meetings, you do not have a meeting to take, right? I think that's our top part. So we would like to maybe live for the future, you know, for how to further monetize. Again, that's not our top part. We've got to lay the foot on one thing, how to truly make a customer happy. So how do them stay connected, especially during this pandemic time?

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Perfect. And then maybe if I could squeeze one in for Kelly. Kelly, you talked about the differences in churn that you're experiencing from the new customer cohort that you onboarded through the pandemic. And we've talked previously about what your historical churn looked like for monthly customers. And we know, I think, a little bit about how it looked in guidance beforehand. Can you level set at a high level? What was the, you know, what did you experience with that cohort versus where it's been historically? And at a high level, what are you assuming in your guidance for that term, for that monthly cohort of new users?

So remember going all the way back to the S1, we talked about that the monthly customers turn on average about 4% per month. Their monthly rate is about 4%. And we did see an increase against that in Q2. And we have modeled at that same level going forward as we, with all the uncertainty with how long this pandemic will last and what other potential economic uncertainty there is, we've modeled at that same rate going forward.

Got it. Thank you. Our next question is from Mita Marshall with Morgan Stanley.

All right, great. Thanks and congratulations. Just wanted to get a sense of where you think you are kind of innings or percentage wise on working with organizations that may have kind of adopted you in a department or adopted you in part of, you know, having multiple services. of displacing those solutions or kind of having a more full organization discussion, as well as having a follow-up discussion, as well as tacking on phone or rooms or webinar-type services? And, you know, do you have the sales teams in place to start having those conversations on broader organization and deployments? Kelly, do you want to take it?

Sure. we continue to see growth in the period from both new customers as well as existing customers and tremendous opportunity with webinar especially as well as zoom phone we actually signed our largest zoom phone deal to date in q2 so exciting to see that continued momentum we also saw customers that were doubling one of them that quadrupled their existing deployment so we are still in early stages. And when we look at penetration, like we look at in the global 2000, like there's a small percentage that have a significant and have a significant spend with us. So there's tremendous opportunity still ahead meet us.

Sorry, you went back on mute.

Okay, just whether you have the kind of sales organization in place to kind of have that gather or gather conversation.

So we, as I said earlier, we are hiring very quickly to keep up with all of the demand that's potential. The team, thank you to our amazing Zoom team, which are really working around the clock to keep up with demand today and to support and serve our customers and the community. But we are hiring. Absolutely. This is one of the biggest priorities for the rest of this year.

Great. Thanks and congrats.

Our next question is from Nikolai Beliov with Bank of America.

Hi, thanks for taking my question. Just wanted to continue on the topic from the last question. Eric and Kelly, as the business grows at unprecedented rates, can you help us understand what's happening internally? Your customer support organization, your sales organization, your ERP system, HCM system, onboarding, you know, like a hyper growth scenario and maybe putting pressure on the systems and also culturally, what's happening inside your organization?

Yeah, that's a great question. So prior to the pandemic crisis, we maintain a steady growth and make sure our system, process, procedures, everything is doing well. And however, during this pandemic crisis, I think the business growth is just unprecedented. The good news, on the one hand, we had a very solid company culture. Nobody complained. We all worked very hard to look at are there any other holes in terms of procedure, process, and also we hired a lot of employees to double down on our support resources and customer success management team and to further help because there's so many new use cases, new customers. That's why we hired a lot of employees. On the other hand, we also wanted to leverage this opportunity. I could consume our business to the next level in terms of privacy, security, and internal process and systems. I think, again, you know, we are very committed, right? Every day we're working so hard, you know, what kind of new issues, like, you know, even the free user calls or online paid subscribers, you know, when they try to cancel the service, we would like to respond in a timely manner. I'm not saying we are perfect, but we are very committed. really double down on our execution, you know, to make sure it's going to be a lot of happening to all the users.

And Eric, which use cases, new use cases are most excited about and surprised you the most? That's it for me. Thank you.

If I talk about new use cases, probably I can speak for four or five minutes. I'll give you several. Like you see the problem next, using Zoom for the virtual property tour. Now during the last 10 weeks, they have closed over 50% of the newly launched properties in Singapore over Zoom. And also the CSK, the first law firm in Florida to have virtual trial by jury. And also like South Coast Community Services, which is largest and mental health service provider in California, also uses Zoom to offer mental health. Mental health is becoming a very big problem. A lot of new use cases like that. So every day I feel very, very excited to see so many new use cases. Not to mention, like we just announced, a partnership with the United States Tennis Association, right, all for the virtual experience. It's very cool.

Thanks so much.

Thank you.

Our next question is from Taz Kajalgi with Guggenheim. Yeah, we have you, Taz.

Hey, guys. I have a question for you, Eric. I think you mentioned that one of the customers that you signed this year was with ServiceNow, and they replaced the legacy PPA system with Zoom. Does that mean that you're offering video and phone functionality to ServiceNow? Have they replaced all their collaboration tools with one product, Zoom?

Yeah. So, you know, first of all, ServiceNow, you know, has been a customer since 2018. They deployed Zoom to replace other, you know, video conferencing, web conferencing services with Zoom video conferencing. Over the past several years, we already established a greater trust. We also announced our partnership. When they look at their entire UC strategy, they also, you know, deployed legacy, very costly, very complex on-prem TVX system. Why not consult into one system with a very consistent product front-end experience? same back in architecture. And in terms of total cost, much lower. User experience also much better. So that's why they decided to replace their legacy TVX system with one system standardized on Zoom's unified communication solution.

That's very helpful. Just one follow-up. Kelly, I think you mentioned that you signed the largest phone deal this quarter. Was that also an upsell to an existing video customer, or was that a new customer who signed up with Zoom Phone?

No, it was already a meeting customer as well, a video customer as well.

Thank you. Thank you.

Our next question is from Sterling Auti with JP Morgan.

Yeah, thanks. Hi, guys. So now that the 90-day feature freeze is complete, Eric, I'm kind of curious, where's the focus of R&D going forward? And you mentioned diversifying into India and the U.S., How are you structurally changing your R&D effort? Is that in relation to any type of geopolitical pressure?

Yeah, first of all, and we accomplished a lot over the past 90 days. But I can tell you that we take privacy and security extremely seriously. I'm not saying we are going to end that. I would say the journey just starts. We are going to double down on privacy and security. I mean, inside of that, you know, we also have a big R&D team. And our whole technology, our engineering leadership team here in San Jose, we also have an offshore team. You know, look at a lot of new use cases, not only for enterprise, but also, you know, the case, education, category of schools, and telemedicine, there's so many use cases. I think today's R&D team, I do not think that we can really handle that in terms of scalability. We have to find more talent in a timely manner. That's why we opened up two R&D offices in Phoenix and in Pittsburgh. And also, we would like this onshore-offshore R&D model. That's why India also opened up a big office. We hired our president of the product and the engineer of the time, a great leader. With that, we really want to hire engineers. and not only here but also other side also even including remote engineers right because there's so many you know features and a task you know that's why i want to invite you to join our zoom with obvia and which is our annual user conference we'd like to share with you a very good product roadmap thank you thank you the next question is from richard valera with needham

Thank you. Let me add my congratulations on another incredible quarter, team. So the question is on pipeline. Kelly, you were sort of on the record saying that you entered Q2 with a bigger pipeline than you had entering Q1. I'm wondering if you could give any similar color on how you entered Q3 from a pipeline perspective and if there's been any change in the composition of that pipeline in terms of product or geography.

So, certainly, coming into the quarter, our pipeline is still strong, and we're continuing to see demand, but based on our guidance, you can see that the demand for the year was front-end loaded, and we saw that, you know, the performance in Q1, the benefit of which we saw in Q2, and that's why the guidance is highlighting that we expect revenue for the back half of the year to be effectively consistent with Q2.

Just in terms of the contribution of phone in the pipeline, has that changed much, any color at all on how you're thinking about the magnitude of phone in the balance of the year?

No, it's performing as we expected. And as I said, we were really excited to see our largest deal to date and ongoing upsell. So really still can see strong demand for Zoom's phone. We see a lot of potential there for the future.

Got it. Thank you.

Our next question is from Tom Roderick with Stifel.

Great. Thank you. Thank you, guys. Great job on another outstanding quarter. Eric, this is going to kind of go in conjunction with the question on Zoom phone and thinking about the unified communications platform, not just a communications tool for video. I'd love to hear about some of the strategic conversations you're having in the context of digital transformation and what else these customers want you to do. And if you could comment in there in conjunction with how your customers are thinking about your next plan and that would be great. Thanks.

Yeah, that's a great question. So I would say this dynamic crisis, you know, completely accelerated every enterprise, every business customer's digital transformation. but you want to support employees no matter where they are, right? But the traditional on-prem system really is not forgettable anymore, right? That's why you look at all the clubs, just corporate service companies doing very well. With respect to Zoom phone, I think overall that's a part of our video conferencing offering. We truly believe video is a new voice, the new reason for any business to deploy two separate systems. totally different experience i'm excited i'm excited that when customers who still deployed on-prem legacy pbx system when they migrate to cloud they want to understand who has the better architecture they want to consolidate into 160. that's reason why you know we positioned wherever and some other smb customers already deployed maybe some other cloud with the pbx system they also want to consult it into one system to further simplify their experience. So overall, we even do not think that's a separate market. It's just one thing. Video conferencing and cloud-based PVX are converged into one service. So that's our story when we talk with customers. The customers really like that.

And Kelly, a quick one for you in terms of the conversation around security, but as you agreed to enable end-to-end security for not just paying customers, but for all customers, which was a recent pronouncement, I think. What does that do to the cost structure? Is that meaningful? Will we even notice that? Can you just talk about that a little bit?

Yeah, no, you won't see a meaningful impact. We certainly have been investing in both our security team. We're thrilled to have Jason Lee have joined us. And you'll continue to keep ongoing investments there, but it will have a meaningful impact on the margins. Got it.

Thank you. Great job. Appreciate it.

Thank you.

And our next question is from Heather Bellini with Goldman Sachs. She's joined in by phone. And Heather, press star nine to unmute. Star six.

Great. Yes. Yeah, great. Thank you. Thank you so much. And congratulations. And I think as Alex started out by saying, Eric and team, just thank you for keeping everybody connected. We're so appreciative. And school started today on Zoom. So my kids were apt users today. For the question I had was really just a little bit on Zoom phone. And I know, Kelly, you've just answered a handful of questions. But Eric or Kelly, I'm just wondering if you can share with us How fast do you think you can see these, you know, kind of legacy phone systems? Like, how fast do you think this work from home benefit can drive displacement of legacy PBXs, which we've all been waiting for for quite a long time? And I know this is only sold to new customers, but you have so many of those or to existing customers, but you have so many of those at this point. And is there any, you know, kind of typical competition sphere that you're seeing as you're talking to customers and they're making the migration? Thank you so much.

Yeah, Heather, that's a great question. So I think prior to this pandemic crisis, you look at enterprise, a very high percentage of customers, they still deployed with the traditional on-prem, legacy, costly PVX systems. However, I think, you know, this dynamic crisis, I think it's sort of like a wake-up call. We've got to think about how to, and focus on, embrace digital transformation. I've decided that in the cloud with TVX, for sure, it's one of the things we've got to look into that. I'm not thinking that the top part, you know, as compared to the video conferencing, but for sure it's on a lot of enterprise customers' radar screens. And at the same time, I think they have a lot of other systems, not only for PBX, but also a lot of other systems. They also look at a cloud-based solution. I think this crisis just accelerated that migration from a traditional PBX to the cloud-based system. And also, Zoom is in a very low position because customers, they do not want to, oh, I migrated to the cloud. And they also want to look at a new user experience, like a Zoom solution, because this is the one system. I think that, you know, next to 12 to 18 months, I would say you will see a little bit of higher, you know, acceleration rate for individual customers to migrate to unified collaboration and communication solution at Zoom. Thank you very much. Hector Vazquez- yeah typically in terms of a competition my student traditional legacy and 50 and some other you know cloud is the pbx but it's again zoom much better position, because we have one unified. Hector Vazquez- Thank you.

Hector Vazquez- Thanks again.

Our next question is from willpower with Robert w very.

Robert W. Great Thank you. I want to ask a question on the rest of world strength. You saw a surge in activity there. Usage revenue obviously grew significantly as a percentage of the total. I wonder if you could speak to how broad-based that was. Were there any particular regions or countries that stood out? I know you've talked a bit about India. And how do we think that progressing from here? Do you expect that to continue to grow as a percent of revenue? And what might that mean for the margin impact of the business, if any?

real cowboys customize and save with liberty mutual hey tex can someone else get a turn yeah so you look at our free user or paid online subscriptions right it's it's coming almost everywhere however you look at the number of uh visitors you know to our website you know the public countries like for sure know and us office number one and india number two japan number three canada uc number four number five I think, you know, it's users almost from, you know, every country, right? They try to use Zoom because it's very easy. It's free. And if 40 minutes is not enough, we would like to pay. And some SMB customers, they also try our webinar series. And also the enterprise customer might try the home service. I think organic growth because of the brand awareness, I think really helped us. So for now, we just say, no matter where the user is coming from, we would like to take a step back and see what we can do differently. to serve them better. We have a local data center, like we just announced, a data center in Singapore. And also we doubled down on India presence. And we are going to have a team to capture the growth from international expansion. Kelly, sorry, feel free to chime in.

No, that's OK. I was just going to say that the strengthen the growth outside the world was really consistent between EMEA and APAC, so we're very pleased with that. And overall, the market, the pricing is adjusted for the market, so you shouldn't see significant impact on the long-term margins based on the structure that we have in place for our pricing today.

Thank you.

Our next question is from Rishi Jaluria with DA Davidson.

Hey, everyone. Thank you so much for taking my question, and I'll echo a truly outstanding quarter, I think, beyond what any of us could have imagined. I wanted to follow up a little bit on the earlier question, which is some of the moves in China, right? I mean, stop free trials, recently stopped direct sales there, you know, at the same time expanding R&D efforts in India and in the U.S. as well. Just what's kind of the impetus for this move? Is this a signal of kind of distancing a little bit away from China, maybe in response to geopolitical pressure? And then, you know, for Kelly, what sort of impact would this have from a model perspective, both on the top line and margins? Thank you.

Yes. So we don't have any current plans to move our engineering talent out of China. We are focusing on diversifying it by adding talent in the U.S. and India. That's really the goal. And our leadership team is currently based in San Jose. So there's no change in that overall structure. You know, for the long term, if there were something were to change, there would be no immediate impact on our service or our ability to provide services to our customers. Sorry, in the short term, in the immediate term, over the long term, there could be a potential impact on the margins as we would, you know, need to replace those talents somewhere else potentially.

It's just that I don't quite decide the revenue wise is very small, no impact. Previously, you look at almost every country, we have online subscription, we have a direct sales of our channel. In China, overall revenue is very small. The online subscription, you need to have a special license. We already solved that before. So we would like to simplify our go-to-market, you know, because actually the support and a lot of resources, why not simplify that? Just to leverage our third-party partners with a wide-limiting, you know, solution. I think that's where sustainable is good from our side.

Wonderful. Thank you, Kelly and Eric.

Thank you.

Our next question is from Phil Winslow with Wells Fargo.

Hey, thanks for taking my question and congrats on another just phenomenal quarter. I wanted to talk about converting monthly users to annual users. Kelly, that was one of the things you talked about off the last call. I wonder if you can give us an update on just sort of what you saw from the call that Q1 cohort during Q2 in terms of your ability to convert those and how should we think about any sort of the promotions, sort of the issue of changing on board. Thanks.

Yeah, of course. So our marketing team is really focused on this running campaigns and reaching out to these customers to provide them the opportunity to convert from monthly to annual. And we were happy with the success that we saw in Q2 and are continuing to focus on this. And we've also made some changes to our online buy flow to make this easier for the customers as well to self-serve and upgrade if they are so inclined. So we expect to see this continue to be a focus for us as we move through Q3. Got it.

Thanks.

Our next question is from Shevely Serafi with FBN Securities.

Yes, thank you very much. Question is for Kelly. You're guiding revenue to be up around 3% sequentially, but if I assume that your customer count is at least flattish Q2Q. Your average customer count is going to be up around 16% Q2Q, which implies that your ARPU is implicitly going to be down 13% Q2Q. And so my question is, I've never seen a double digit decline in your ARPU before. What would drive that?

Well, as we're sitting here right now, looking forward, I think it's more around the uncertainty around churn and what's going to happen with the overall economy. That's really the uncertainty there and why we're guiding flat for Q3 and Q4 revenue will be flat modestly up from Q2. And we've had a significant increase in our mass market customers where there just remains limited visibility in terms of the long-term contribution for those customers. I don't think that we necessarily expect that dramatic increase in ARPU that you're pointing out. It's more around the uncertainty in turn and what does that mean for the top line growth.

Okay. Thank you.

Our next question is from Brad Zelnick with Credit Suisse.

Great. Thank you so much. And I echo my congratulations and gratitude all around. And it's nice to see everybody. My question is for Eric. Eric, from a product perspective, How might Zoom in the future be able to go deeper into the context in which communications is happening? I'm thinking about human behavior or human intent, for example, to help make the experience even more valuable.

Yeah, that's a great question. That's why please join our Zoom-topia. I think, first of all, you are so right. Zoom is not only a communication tool. How can it go deep? Because our mission is to develop a better service, a better online video conferencing service even better than face-to-face meeting. How to leverage AI functionality, like not only have you the meeting transcription, but also how to analyze that in a timely manner. Let's say if you change the topic, I give you a quick reminder, hey, please slow down. So it could be some face detection or something like that, all of the AI features. And plus, look at it in the long run, language translation, real time. and also you know how to you know shake hands remotely a lot of cool features like that and in the past you know you look at the you know the new vlog video and the perspective right how to edit some of the the fun features like the video filter and how to make the 3d video level ar i think a lot of technologies right not to mention 5g and in the future i think that you look at the future a lot of those cool technologies and truly make the video conferencing experience much better.

Thank you so much.

Thank you. Please join us at the Zoom talk.

I wouldn't miss it.

Thank you.

Our next question is from Ryan Coons with Rosenblatt Securities.

Hi, great. Thanks for the question. With regards to the sales and marketing investment, it came in a little light there. And obviously, I'm really strong customer pull for the product. How do you think about your go-to-market motion and how you might change your sales strategy relative to your prolific success to date? And are you looking at reseller channels or other technology platform partners to take you to market in the enterprise? Thank you.

So the decline in sales and marketing was partly due to just the strong top-line performance as well as efficiencies that we're seeing in marketing. When we expect the, as a percentage of revenue sales and marketing to increase through the back half of the year, as we're really focused on continuing to hire globally. We also, we did, if you remember, we announced the master agent program for zoom phone in, in Q2 and are really excited about that program and expect it to go contribute, continue to contribute more significantly as we move through the year. And on the meeting side, continuing our mostly direct model, which has been very successful for us today.

Just briefly to add on to what Kelly said, you look at the marketing efficiency. You look at our marketplace. We already have more than 700 third-party applications. That's another way for us to promote our brand awareness. More and more integrations certainly can help our marketing efficiency.

Got it, thank you.

Thank you.

Our next question is from Bhavan Suri with William Blair.

Hey, thanks for taking my questions and congrats. I guess I wanna touch on something a little more probably high level and strategic. I've obviously asked you in the past about the convergence and where does Slack and collaboration fit in. So let's turn this a little bit differently. You're gonna host Zoomtopia and this whole event planning space is a huge market. And it feels like it'd be an obvious fit for you. And you have partners there, But, you know, the natural extension of this into events and meetings seems to make a lot of sense. How do you think about that market? And then do you think about sort of maybe using the stock as a way to buy? But you could also build. I mean, Kelly's got it to R&D coming up. You've got a lot of points between 40 and 30 to spend R&D and not all that's going to go to support the existing platform. So just some sense in the event space, how you think about it. Is that a build versus buy decision or a partner decision? Thank you.

First of all, I think you have a good question. So your other divisions right on. Looks like you have some great ideas. Actually, maybe after the call, I'd like to connect you with our product managers. I think you are so welcome. Thank you. Look at our Zoom copy, not only do we have a webinar, but also we need to look at an entire online event management experience. Not only just the real-time part, the pre-event and the planning and marketing and promotion and marketing content and materials. Every event, a lot of, I think, the content. I think having decided that, I think we believe this service has a strategic value. to help us further expand our webinar reach. Having said that, I think in terms of should we do that everything by ourselves, or be a partner, maybe, you know, acquire somebody, I think it's worthy to tell. But strategy-wise, you're so right. That has got to be our focus, our priority. It's low-hanging fruit, right?

Thank you.

Thank you.

Our next question is from Walter Pritchard with Citi.

Hi, thanks. I'm curious this quarter, just as it related to the really strong new customer ads and the revenue that came from that channels, how many, are you seeing an uptick in customers that are coming in through sort of displacements that had maybe not a older generation solution, but had tried something in the last three to six months and weren't happy with it and switched over?

I don't think that we saw as much of that. I mean, it's definitely... customers have been using something. I think that what has happened over the last four to five months is people have realized that the solution they had in place just wasn't up to the strength of what it needed to be in this pandemic. And so we've continued to see amazing brands move over from some of the competitors as they're really looking for something to ensure that they can keep their employees really effectively while keeping them safe as well. And then of course, You know, we're super excited about some of the school districts that we've seen sign up. You know, we have the top two school districts in the U.S. as our customers today. So that really highlights the scalability of the platform and then wanting to ensure that they have a really reliable solution as they went back to school.

Then what do you think you would give phone customer counts? Any horizon on that?

That's one of the things we're considering, Walter, that we'll talk about. We said that for Zoom Phone, we'll give milestone updates. We'll look at it at Zoomtopia and see if that makes sense. The last update we gave was actually at the anniversary date of Zoom Phone, so we might wait until then.

Okay. Thank you.

Thank you.

Our next question is from Matthew Van Fleet with BTIG.

Hi, guys. Thanks for taking the question. Great quarter there. You talked a little bit about channel partners, still remains a fairly low portion of your overall sales, but curious what the uptake is in total partners registering as part of the program. Is it something that you're proactively doing or is just the demand for the product sort of pulling them in? And then on sort of a related note from an international market perspective, do you feel like you can hire aggressively enough from a sales headcount internationally? Or do you need to look at partnerships in specific markets that could be smaller growth areas, but growth areas nonetheless?

So from the hiring side, we definitely believe we can hire everything that we need internationally. We've really invested in our talent acquisition team and are doing that on a broad base around the globe to ensure that we are able to hire as quickly as possible. As you know, there's a little bit of a longer lead time. or notice periods internationally, but we're hiring as quickly as we can. And then in terms of the uptick, you know, kind of partners in the channel, we don't give out those specifics, but we are continuously looking at our channel programs to ensure that they are not only competitive, but driving the results that we want. So it's something we evaluate on a constant basis.

Great. Thank you.

Our next question is from Quinton Gabrielli with Piper Sandler.

Hey, guys. Thanks for taking my question, and congrats on a great quarter. Really just one quick question from our end. Obviously, you guys saw some really strong enterprise traction for Q2. Just wondering if we could get some idea of the percentage of revenues from enterprise customers compared to the 23% we saw in the last quarter.

Thanks.

are sharing that the revenue, we don't call out specifically customers, but we, I'm sorry, enterprise customers, but that the revenue from effectively customers with fewer than 10 was 20% in Q2, which is consistent with previous quarters in that same range.

Got it. Thank you.

Our next question is from Itay Kidron with Oppenheimer. Okay, we'll come back. Our next question is from Alex Kurtz with KeyBank.

Yeah, thanks for taking the question. Actually, someone at Zoom did a good job because we just switched our school district from Google meeting over to Zoom for the start of the fall semester, so someone deserves a raise. Yeah, thanks. So Kelly, as you think about OpEx trending into next fiscal year, I know you don't are going to talk explicitly to it yet, but there's a lot of churn to assume, especially in that Q1 of next year. And you have a lot of investments that you're making as far as R&D and sales and marketing. So as we're working through our models and looking into OpEx levels from Q4 to Q1, you know, how should we be, what's the framework for that?

Yeah, so you should expect the operating margins to decrease incrementally each quarter going forward as we are continuing to, as you said, invest in R&D and invest more in our sales and marketing teams as well. And, you know, getting towards that longer-term margin that we've talked about historically, we're going to talk in more detail around this at Analyst Day, but The last time we updated you on this, we still said that our long-term margins were around 20%. So I think you should assume we're getting more in that range, nearer to that than to 41.7%. OK.

Alex, by the way, if your kids' school district has any questions or any feedback to Zoom, please let them know. You know Zoom will see you well and can be there. I'll send them right to you, Eric. Thank you, Alex.

Our next question is from Ryan McWilliams with Stevens. Thanks, guys, for the question.

So for Zoom Phone, pretty unbelievable rate of achieving global service coverage. So congrats on the expansion there. Kelly, when you mentioned doubling or tripling the Zoom Phone seat and various deployments, is that a part of this expanding global service coverage? And have you seen more enterprises trialing Zoom Phone as a result of this additional coverage?

So certainly international expansion, like we said, historically, that was the biggest opportunity for us. And I think a perfect example of that is the two largest Zoom phone deals in Q2 were outside the U.S. So that really shows the strength and what the international coverage is bringing to Zoom phone. And sorry, what was the other one? Oh, enterprise customers trialing Zoom. Yes, absolutely. There are some amazing names that we can't talk about yet, but we're excited about the traction that we're seeing in the enterprise customer base as well.

Best is yet to come. Thanks, guys.

Our next question is from Pat Walravins with JMP Securities. Oh, great.

Thank you. If she comes in on time, I'm going to give you some real feedback from one of your customers. Oh, here she is.

Hello.

Okay, Gigi, so Gigi's school also just switched from Google to Zoom. And Gigi, what is it that you like best about Zoom?

The breakout rooms. I thought they were really convenient because my teacher, we have a lot of students in our cohort, our group, and it's really hard for all of us to talk at once. So she puts us in six breakout rooms, and I have four or five students with me, and it's really nice to talk to them. work with them check answers instead of having 40 kids in like one huge group and you can never get to talk that's why i love breakout rooms so much thank you great thanks for the feedback so the uh my question is um so eric when everyone's working from home how do you make where you work an attractive place to work

So first of all, your daughter gave us a comment, made my day today. I would like you to drop it.

Okay, I'm glad.

Yeah. So speaking of workplace, I think for now, I think for the foreseeable future, we all need to work from home. But we've got to think about long-term planning. So meaning after the pandemic crisis is over, what's the new working place look like? You know, we've talked with many partners, we believe most of the working from home, this trend will stay. But I'm not saying all of us will keep working from home. It's very, very likely it's a hybrid, meaning twice a week or three days a week, you can send all employees back home. And some other time, we all keep working in the office. And also, you can further consolidate a lot of the small offices. You do not need to have offices everywhere anymore. You also can hire talent almost everywhere. And the price, even for the workplace, you know, today, look at a lot of companies, the very big open space, I think that may not work anymore in the future. Goodness, we do have a car, you know, for next, you know, 10, maybe 12 months, you know, we can optimize what the future workplace look like. But again, you know, no matter what, you know, I think the truth like this, and still can help.

Thank you. We have time for one more question, and the last question is from Jonathan Keys with Summit Insights Group.

Great. Guys, it's not me. I add my congratulations to the quarter, and thank you for getting me in here. So I guess I have my one question as well as, if I can, a clarification. The clarification first. Maybe it's more for Kelly. Kelly, you had said last quarter you were modeling the assumption that – your sales teams would start being more a moderate or more normalized level of business activity. I noticed that wasn't in the guidance in the commentary this quarter. Is that still the case then, that carrier from last quarter? That's a clarification. My real question is, can you tell me about the discounting or the pricing that you have for the enterprise RFPs? Are you seeing a lot of that? Are you seeing a good amount of that? Thanks.

So in terms of our sales rep productivity, you know, as you can imagine, it was an extreme high level in Q1 and also extremely elevated in Q2. As we looked forward to Q3 and Q4, we have modeled it certainly to be lower than that, but still higher than what we saw last year. So it's kind of somewhere in between what we saw for the first half of this year, but where it was exiting FY20. In terms of enterprise discounting, you know, we don't disclose specifics around that, but we haven't really seen a significant change in the buying patterns of our enterprise customers.

Great. Keep up the good work. Thanks.

Okay, that wraps up our Q&A.

Great. And I think we'll turn it over to Eric for any final comments, Eric.

Is the ePatch still available? It looks like He still has questions, right? No?

No, I don't think Yitai is going to be asking a question today.

Yeah, so thank you all for joining us today. And we truly appreciate it for your time. It has been a memorable first half to our investors and analysts. We appreciate your continued support for Zoom. Thank you all. See you next quarter. Thank you.

Bye. Thank you.

Thank you. Thank you, everybody.