Zoom Communications, Inc.

Hello, everyone, and welcome to Zoom's second quarter fiscal year 2022 earnings release. I'd like to remind everyone that this call is being recorded. At this time, I'd like to 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 2022. 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 at investors.zoom.com. 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 GAAP to non-GAAP financial results. During this call, we will make forward-looking statements, including statements regarding our financial outlook for the third quarter and full fiscal year 2022. Zoom's expectations regarding financial and business trends, Zoom's growth strategy and business aspirations to drive evolution on multiple fronts as organizations and people reimagine work, communication, and collaboration, and Zoom being well-positioned to be successful as a platform. 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 our annual report on Form 10-K and quarterly reports on Form 10-Q. Zoom assumes no obligation to update any forward-looking statements we may make on today's webinar. In addition, as you all know, we announced our intent to acquire 5.9 in July. Clearly, we're excited about joining forces with 5.9. But please note that we will not be discussing or addressing questions regarding the pending transaction this time as we are in the process of regulatory review. And with that, let me turn the discussion over to Eric.

Thank you, Tom. And thank you all. And welcome to everyone joining us on today's webinar. I want to start by thanking our customers and partners for their trust and loyalty, which led to our continuous strong revenue growth alongside remarkable profitability and a free cash flow. We also want to thank our hardworking employees for their dedication to delivering happiness to our customers and partners. I have been humbled by the stories of the whole finance professionals have leveraged Zoom to reimagine the way they work. Specifically, I'd like to thank Charlie Munger of Berkshire Hathaway for his remarks about how Zoom has added so much convenience to his life. We are so delighted to count Charlie as a happy user. And I nominated myself to be Charlie's personal Zoom tech support if he ever needs it. In Q2, we also achieved several milestones, setting the foundation for us to thrive as a platform. In July, we launched Zoom apps, which brings over 50 apps right into the Zoom meeting experience. And this is just the beginning. The beauty of our platform is it allows our ecosystem of developers to add even more functionality by building apps where workflows are integrated with meeting interactions. This is a win-win because better integrations will boost our customer productivity and afford our developers exposure to our large user base. The Zoom Apps Fund, which has already invested in over a dozen startups in our Zoom Apps and SDK ecosystem, further aligns us with the developers, enabling them to focus more on innovation. We are also excited to have launched Zoom events in July. Zoom events is an easy yet a powerful solution to produce and host the company and the public events. It acts as a layer above our existing Zoom video webinars and Zoom meetings products. Zoomtopia will be virtual on Zoom events in only two weeks, and we hope to see all of you there. In Q2, we saw several large customers upsells. We were very happy to expand with a leading tech firm who increased their meetings licenses over six fold to 95,000. and with a global financial services customer who added over 63,000 Zoom phone licenses, making them our new largest customer. Both wins were displacement of legacy solutions that Zoom beat in terms of reliability, simplicity, and integration. And let me recognize a few very big wins for the quarter. I want to welcome NEC Corporation to the Zoom family. Based out of Japan, NEC is a leader in the integration of IT and network technologies behind their slogan, orchestrating a brighter world. In order to enhance the productivity, collaboration and happiness of their global workforce, NEC deployed approximately 110,000 Zoom meetings licensee. I also want to welcome CIGIT technology to the Zoom family. CIGIT is a global mass data storage infrastructure leader, innovating world-class precision engineered data storage and measurement solutions with a focus on sustainable partnerships. Seagate recently decided to modernize and integrate their global communications infrastructure with over 14,000 Zoom meetings licenses and over 17,000 Zoom phone licenses. Next is a Zoom phone upsell. In Q2 of last year, we welcomed ExxonMobil, which develops and applies next-generation technologies to help safely and responsibly meet the world's growing need for energy and chemical products to the Zoom family. They began as a Zoom video conferencing customer to enable their teams to collaborate globally. We are very grateful to have seen our partnership evolve over the past year and excited that ExxonMobil has recently decided to add a Zoom phone to further enhance the user experience for their global workforce, leveraging a communications platform that is very easy to deploy and manage. In addition to these great customer wins, we also closed another strategic channel partnership with Telkomsel, the largest cellular operator in Indonesia, which is the world's fourth largest country by population. Health Council understand and want to support their 170 million subscribers need for seamless and reliable virtual meetings to thrive in the digital workplace area. We will be leveraging the power of Zoom's developer platform and ISV positive program to deliver a fully integrated solution where there are CloudX offerings for the enterprise segment and Zoom native apps for the consumer segment. The collaboration between TelcomCell and Zoom will bring in communication to the next level by combining Zoom's strong capabilities and feature-rich platform with TelcomCell's best quality network and localized interface, together creating a powerful tool to improve customer productivity and collaboration. Thank you, ANC, Seagate, ExxonMobil, and Telecomcell. I love you all. Enterprise is one of the digital platforms that combine meetings, phone, events, office technology, and developer solutions in a way that is simple, reliable, and frictionless. This fundamental truth underpins our leadership position in video conferencing and will help to drive further growth in Zoom phone, and Zoom Rooms as we expand our platform and addressable market in the hybrid world. Today, we're very fortunate to be a leading global brand with over half a million customers having more than 10 employees. Our internal innovation engine is very strong and boosted by our growing Zoom apps developer ecosystem and acquisitions such as CACs. that will strengthen our position in AI transmission and translation. As organizations and people reimagine work, communications and collaboration, we are faced with a once-in-a-lifetime opportunity to drive this evolution in multiple forms. Thanks again to the hard work of our over 5,700 employees and the trust of our loyal customers. We are positioned very well to be successful as a platform embracing and enabling hybrid world. I'm very excited about the future. The journey has only begun. And with that, let me pass it over to Kelly. Thank you.

Thank you, Eric. And hello, everyone. We had an eventful Q2 with several highlights. The first of which was the strength in the enterprise. We were able to grow the number of enterprise customers spending more than $1 million in ARR by 77% year over year. And the second highlight is the acceleration we have seen with Zoom Phone. We grew the number of customers spending more than $100,000 in ARR on Zoom Phone by 241% year over year. In August, We will reach, in fact, right before this call, we reached 2 million Zoom phone seats, only eight months after reaching our first million. We added eight Zoom phone customers with more than 10,000 seats in the first half of FY22, bringing us to a total of 26. And in Q2, we broke our record for the largest Zoom phone deal to date twice in the same day. It is important to note that as we've just lapped our first full quarter year over year compare since the start of the pandemic, we have seen customers return to more thoughtful, measured buying patterns. While revenue, profitability, and cash flow were strong in the second quarter and the first half, other metrics have begun to normalize, especially when compared to the unprecedented year over year comps. In Q2, total revenue grew 54% year over year to $1.02 billion, marking our first billion-dollar-plus quarter, only five quarters after reaching a billion-dollar annual run rate. The top-line result exceeded the high end of our guidance of $990 million. We saw strength in our direct and channel businesses, which grew at twice the rate of our online business. Zoom phone, Zoom rooms, and Asia-Pac growth also accelerated in the quarter. The year-over-year growth in revenue for the quarter was driven by a healthy mix between new and existing customers, where new customers accounted for approximately 74% of the incremental revenue, and existing customers accounted for 26% of the incremental revenue. Let's take a look at the key customer metrics for the quarter. We saw 131% year-over-year growth in the upmarket as we ended the quarter with 2,278 customers, generating more than $100,000 in trailing 12-months revenue. We exited the quarter with approximately 504,900 customers with more than 10 employees, up 36% year-over-year and representing 64% of revenue. In Q2, customers with 10 or fewer employees represented approximately 36% of revenue in line with Q2 of last year, but down from its high of 38% in Q3 of last year. As we discussed previously, this cohort, which comprises SMB and consumers who typically purchase online, is more volatile and we expect it to continue to decline as a percentage of revenue as customers adjust to the evolving environment. Our net dollar expansion rate for customers with more than 10 employees exceeded 130% for the 13th consecutive quarter as existing customers increased their spend with Zoom and upsells of Zoom Phone and Zoom Rooms picked up pace. Both domestic and international markets had strong growth during the quarter. Our America's revenue grew 50% year over year. Our combined APAC and EMEA revenue grew 62% year-over-year to be approximately 33% of revenue, up from 31% a year ago. In recent quarters, we have made significant investments in our international teams. In Asia Pacific, our direct sales team drove several strong wins in the enterprise segment. However, in EMEA, we saw some headwinds, which were predominantly driven by declines in the online segment. Now turning to profitability, which is strong from both GAAP and non-GAAP perspectives. I will focus on our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, charitable donation of common stock, acquisition-related expenses, net litigation expenses, and gains or losses on strategic investments. Non-GAAP gross margin in Q2 was 76.2% compared to 72.3% in Q2 of last year and 73.9% in Q1 of this year. The sequential improvement in gross margin is mainly due to new data center capacity coming online and lower usage during the summer months, particularly for schools. We now expect gross margin outlook to be higher than previously discussed at approximately 75% for the remainder of the fiscal year, even while we continue to support free K through 12 education. Research and development expense grew by 89% year over year to approximately $54 million. As a percentage of total revenue, R&D expense was approximately 5.3%, an increase from Q2 of last year, demonstrating our ongoing commitment to building out our engineering teams globally and maintaining best in class product and innovation. Sales and marketing expense grew by 72% year over year to $211 million. Sales and marketing expense was approximately 20.7% of total revenue, an increase from Q2 of last year, mainly due to investments and hiring to drive sustainable future growth. We plan to increase investment in global sales capacity, as well as digital marketing and events to drive additional leads for our sales teams across meetings, phone, rooms, and events. G&A expense in the quarter grew by 73% to $89 million as we continue to scale these functions and invest in systems, automation, and compliance to meet our new scale. G&A expense was approximately 8.7% of total revenue, a slight increase from Q2 of last year. Revenue upside in the quarter carried through to the bottom line with non-GAAP operating income of $425 million speeding our guidance. This translates to a 41.6% non-GAAP operating margin for Q2, steady with both Q2 last year and Q1 of this year. Non-GAAP diluted earnings per share in Q2 was $1.36 on approximately 306 million non-GAAP weighted average shares outstanding. This result is 21 cents above the high end of our guidance and 44 cents above Q2 of last year. Turning to the balance sheet, deferred revenue at the end of the period was $1.2 billion, up 59% year-over-year from $743 million. Looking at both our billed and unbilled contracts, our RPO totaled approximately $2.3 billion, up 66% year-over-year from $1.4 billion. we expect to recognize approximately 69% of the total RPO as revenue over the next 12 months, as compared to 72% in Q2 of last year, reflecting a shift back to longer-term plans. It is important to remember that because over 40% of our business is billed monthly and typically bought online, deferred revenue and RPO trends are not reliable predictors of future revenue growth. As I mentioned last quarter, the timing of our renewals has increasingly shifted to the beginning of the fiscal year, with Q1 now representing our largest renewal quarter. This shift in seasonality is a result of the significant growth we experienced in the first half of FY21. We expect this front-weighted seasonality will persist and potentially become even more pronounced given the scale of our base and practice of upselling coterminously with existing contracts. As such, we would expect total deferred revenue and RPO to be modestly down from Q2 to Q3. We ended the quarter with approximately $5.1 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. We had strong operating cash flow in the quarter of $468 million up from $401 million in Q2 of last year. Free cash flow was $455 million up from $373 million in Q2 of last year. The increase is primarily attributable to the top-line growth and discipline spending. Looking at the remainder of the fiscal year, we expect to increase our capital expenditures related to ongoing data center expansion to support our growth outlook. Now, turning to guidance. Please note that the ever-changing nature of the global pandemic continues to impact our segments and regions in different ways. Our outlook is based on our current assessment of the business environment. Specifically, our outlook assumes that our direct and channel business will continue to experience robust growth, while our online business will be a headwind in the coming quarters as smaller customers and consumers adjust to the evolving environment. For the third quarter of FY22, we expect revenue to be in the range of $1.015 to $1.02 billion. We expect non-GAAP operating income to be in the range of $340 to $345 million. Our outlook for non-GAAP earnings per share is $1.07 to $1.08 based on approximately 309 million shares outstanding. For the full year of FY22, we expect revenue to be in the range of $4.005 to $4.015 billion, which would represent approximately 51% year-over-year growth. We expect non-GAAP operating income to be in the range of approximately $1.5 to $1.51 billion, which would represent approximately 53% to 54% year-over-year growth. Our outlook for the non-GAAP earnings per share is $4.75 to $4.79, based on approximately 308 million shares outstanding. Before concluding, I'd like to welcome everyone to join us in two weeks at Zoomtopia, our two-day immersive experience that is packed with exciting product updates, guest speakers, and virtual networking opportunities. And on day one of Zoomtopia, please join us for our financial analyst briefing, where we will be providing you with greater detail on Zoom Phone, the platform, our channel partnerships, and much more. And as always, Zoom is grateful to be a driving force enabling connection and collaboration worldwide with our high quality, frictionless, and secure communications platform. Thank you to the entire Zoom team, our customers, our community, and our investors. If you have not yet enabled your video, please do so now for the interactive portion of this meeting. Matt, please queue up our first question.

Our first question is from Itay Hidron with Oppenheimer.

Hey, guys. Thanks. Don't forget to unmute yourself. Great quarter again, guys. Kelly, I want to focus kind of on this transition. Clearly, you're doing extremely well with phones. It's phenomenal, the growth that you're seeing over there. uh but can you give me a little bit more insights as to what is the group growth in meetings right here right now my math suggests a very significant deceleration in your uh expansion rate and um i would suspect that that's time specifically to meetings decelerating help me think about the contribution of growth of those two elements and you know perhaps how would that change over the next 12 months so i think in terms of the

the expansion rate, you're talking about the implied expansion rate that you calculated. Yeah. And I just want to remind you, first of all, that when you calculate that it includes all of our customer base. And as we mentioned, we are seeing headwinds in the online segment of our business for sure. So that's that I would say that while we don't break out revenue, you know, we see strength, continued strength in the upmarket enterprise in both meetings and phone and where you're seeing that, challenge in the implied metric. It's really coming from the online segment of our business.

So should I interpret that to mean that churn is now finally rising in that category? Is that the right way to think about this going forward? Now that the economy is slowly opening, some businesses, I guess, scaling back on the usage here?

Yeah. So remember the online business is primarily, not exclusively, but primarily small businesses and individuals. And I think what we've seen is While the future of Delta is still unknown, we do see individuals especially moving around the world and feeling comfortable. Like I think we were talking about most of us are probably socializing in person now, doing fewer things like Zoom happy hours. And that's where we're starting to see some of the challenges. So the net dollar expansion in the online segment is what's driving pulling that number down a little bit.

Got it. Very good. Thanks.

Yep.

Our next question is from Steve Enders with KeyBank.

Okay, great. Thanks for taking my question here. I guess I just want to dig in a little bit more on kind of the trends you're seeing in the second half. It looks like you're now guiding down a little bit, at least a downtrend, or I think before we're talking about an uptrend. So just want to get a better sense for what's the biggest incremental change that you're seeing there in the outlook and what's changed in the past three months specifically.

Yeah. So again, we continue to see strength in our up market. We're excited about what we're seeing in the enterprise and phone international and international. We all saw growth accelerate. When we look out though, what we have seen is, um, a slowdown in the online segment of the business, which again, even though the pandemic seems to be far from over, we are happy that people are feeling more comfortable being out traveling. And that's really where we're seeing the slowdown. And, you know, we had to be back all the way up to when we gave guidance at the beginning of the year, we had expected that towards the end of the year, but it's just happened a little bit more quickly than we expected. And we, of course, we feel good that people are out moving around the world. But it's certainly creating some headwinds, as we said, in the online segment of our business.

Okay, great. And is that creating any opportunities then as companies do you think about going back to the office for Zoom rooms and incremental activity with that product?

Absolutely. So we saw Zoom rooms start to accelerate again in Q2, which was very exciting as our customers are planning and thinking about the attach rates more than double quarter over quarter from Q1 to Q2. So absolute companies are preparing and planning for welcoming their employees back to the office.

Perfect. Thanks for taking my questions.

Yeah. Thank you, Steve.

Our next question is from Taz Kujaldi with Guggenheim. Hey, Taz, you're on mute.

Can you guys hear me now? Yes. Hi, Taz. Hi. I have a question on Zoom phones. So if you look at the numbers reported tonight, you added about 500 million seats, I think, in the last four months. Prior to that, you were adding about 500 million seats, 500K seats every quarter. It looks like a bit of a slowdown in the number of seats you're adding. this quarter? Is that a fair comment?

No, it's almost exactly the same timeframe because I think we had announced in December that we hit a million and then we announced 1.5 on our call in April and then, you know, one, 2 million on this call. So it's almost exactly at the same pace.

Got it. And then just one follow-up, you said weakness in the, uh, in the online segment, is that coming from just increased churn or are you seeing a slowdown in the new customer acquisition in that line item?

It's a little bit of both. So as we mentioned, we specifically saw some challenges in certain regions like EMEA, where the world, at least for a period of time, was a little more open again and people were moving around. And that's where we see people taking advantage of being out in the world and seeing some slower top line bookings as well as accelerated churn.

Thank you.

Our next question is from Mita Marshall with Morgan Stanley.

Great. Thanks. Kelly, just wanted to dig into your kind of commentary on more measured spending patterns that you're seeing. you know, taking away from kind of the smaller business commentary that you've been giving and focusing that on enterprise. And so just trying to get a sense, you know, does that mean, you know, normalizing the amount of seats that they're adding or, you know, that they're rationalizing kind of the seats that they've had, that they're rationalizing number of video solutions that they're having in-house? Just what does that kind of commentary around more measured patterns around the enterprise business means. Thanks.

Yeah. Thank you, Mita. We saw this start a little bit in Q1 and now continue into Q2 where I think it's not necessarily measured in terms of how much they're buying, but more measured and thoughtful in how they are buying in that they want to take their time. They're doing more complete like proof of concepts, for example, versus if you think about a year ago, they were in this sort of stage of trying to keep the lights on almost and buying very quickly. And now they're taking the time to really be thoughtful. And it's just, it's a, it's a, it's back to kind of the way they used to buy pre pandemic, which is just a much more normal buying pattern. So I think that we're back to more normal and you know, the sort of, Four quarters-ish we saw last year was really the blip, and now we're back to a more normal-measured approach that customers are taking.

And is part of that just because it's a coupled decision with phone now or just anything having to do with that?

I think that certainly the phone is a different buying cycle, but usually by the time they get to phone, they already know Zoom. So it's not that that is necessarily slowing it down. It's just that they're taking their time to think about these decisions that they're making.

Okay, great. Thanks.

Our next question is from Matthew Van Bleet with BTIG.

Yeah, hi, thanks for taking the question. I guess on the continued success on Zoom phone here, called out a number of very large deals. Curious on how often you're being brought in where they're also contemplating a contact center. Upgrade, you know, where have you stood? Obviously the partnership with Five9 has been in place for a while, but just more generally speaking, how often is upgrading to Zoom Phone a part of a broader modernization across that could potentially include contact center?

Hi, Matt. I actually don't know exactly off the top of my head the specifics around that. You know, we obviously having an integrated phone and contact center solution is really important to many companies, which is why, you know, we're excited about the deal that we're working on with Five9. And as you say, we've been partnering with them. We also, you know, have other partnerships in place as well. And so there's nothing different about that that has changed. I'd have to go back and look. I don't know exactly what the typical catch rates are between those two, though. Eric, if you have a perspective on that. Sure.

So, Matt, if you look at our installer base, right, for now, I think, you know, we really want to migrate from on-prem, you know, PDF system to the cloud, right? That's where the huge opportunities comes from. Also, you know, since the pandemic, I think we do see some of the enterprise customers they also started asking about, hey, what's your cloud, you know, contact center strategy? Because they started, you know, planning now, right? That's why we think this is kind of for the new opportunity for us, not only for the brand new revenue stream for contact center, but also it might have, you know, further, you know, grow our phone business as well. Because, you know, like one year ago, right, you know, where, you know, a few large universe customers, they really wanted to migrate their own plan, you know, contact center solution. Now, given the, you know, digital, you know, transformation for almost every enterprise customers, we do see more and more customers that are very interested. That's why it's timing wise, it's perfect for us to double down on the cloud business contact center tools.

Great. And then following up quickly on the education front, you know, as schools get back into session, you know, whether or not they're going to be in person or not is sort of up to debate here. But I guess what's the, what's the, I guess, potential of monetizing more of that install base. Is it still going to be a relatively free solution or how has that strategy evolved? Thanks.

So, Matt, you know, before I answer to that question, you know, as you know, our company's value is care. The number one thing is really about the community, right? To support a K-12 school, I would say that's no brainer for us to support that at no cost, right? We feel very proud. We never thought about how to monetize, you know, our services. for those K-12 schools, right? Now, we all go back to school, right? With that, we have more benefits, you know, resources, right, to think about how to monetize other, you know, installer-based. I give you an example, like free users. You know, last year, we were extremely busy to help the world, to help the people stay connected. We even did not have a bandwidth to think about how to monetize those free users. I mean, how to embrace the consumer, right? We never thought about that before. Now it's right time, right? How to think about embracing the consumer strategy, how to monetize those free users. It's something very, you know, we are very excited. We do not want to monetize those K-12 schools. You know, it's our responsibility to help them, as always. Thank you. Thank you, Mike.

Our next question is from Pat Walravens with JMP Securities.

Great. Thank you. Hi, guys. I mean, I don't think there's ever been a company that has grown so fast and, you know, realistically pulled a lot of demand forward, right? Because everyone needed to get their video conferencing solutions in place very quickly. And now as I look at, you know, 54% this quarter, Kelly, your guidance suggests 30%, 31% in Q3 and 15% in Q4. So all that is just a lead up for Eric. What is your... top one or two priorities in the next 12 months as you go from this hyper growth to a much more reasonable growth period? If you could just sort of contrast those for us, I think that would be really helpful.

Sure, sure. So I would say, Patrick, that's a great question. First of all, you look at it, you know, prior to the pandemic, you know, look at our growth always, you know, focus on enterprise costs, right? the first you know service video conferencing we introduced a second revenue stream zoom phone both of them are doing well and how to introduce the third one a fourth one how to you know double down on that there's always our top word right i know if We did not realize this is a pandemic crisis. Otherwise, several years ago, probably we should have planned third or fourth services beforehand. Now, actually, this is indeed our strategy, right? You know, how to introduce more and more revenue stream, new services to support our enterprise customers. That's always a priority for us. Essentially, this is part of our overall platform strategy, right? Having said that, also, there's a new opportunity ahead of us. You know, as I mentioned earlier, We never realized there's so many consumers who are so loyal to our platform. The usage is still pretty healthy. How to embrace the consumer strategy is also something on top of our minds as well. We never thought about that before. It's right high. Those two things, enterprise platform and also consumer, those two things will drive our future growth. That's great. Thank you. Thank you, Patrick.

Our next question is from Shevly Seyrafi with FBN Securities.

Yes, thank you very much. So I'm looking at your implied guide for Q4. It seems like you're guiding it to decel to around 12% or so, plus or minus from 30% or so in Q3 with a similar compare, I would argue. And it seems like it'll actually be down potentially sequentially from Q3. So... Can you elaborate on why that might be the case? You talked about the online issues. How long do they last, for example? And if we go to like 10% to 12% growth in Q4, should we accelerate afterwards after the compares get easier? How should we think about next year?

Yeah. In terms of what you're seeing in Q4, it is continued uncertainty around headwinds in the online segment. Absolutely, it's driving that. And in terms of how well that implies for next year, we're not ready to give FY23 guidance today, unfortunately. So we'll be prepared to do that when we get on the Q4 earnings call and of course we'll have a lot more learnings at that point to to share with you but that's that is what exactly what continues to drive that into war okay is there any reason why the online issues would be bigger in amia than in the americas in asia well that that's like the the pandemic question right because it really what we've seen is this varies depending by region and by segment, depending on where each of those countries or markets is in their pandemic life cycle. And we've seen it ebb and flow over the last 18 months by market. And so that's the challenge, even I think that all businesses are having right now and thinking about the future with uncertainty, so much uncertainty around the pandemic right now. It's just difficult to forecast exactly.

Yeah, to add on to what Kelly said, look at, you know, our user base in email. You know, seasonality also is a factor, right? In particular in the summertime, in order to mention that the COVID situation and the user there might have a little bit longer vacation, right? Seasonality for sure is the key factor, and that's not a big difference compared to our user base here.

Okay, thank you.

Thank you.

Our next question is from Ryan Kutz with Needham.

Hi, thanks for the question. Great to hear the progress in the enterprise clicking along there and sounds like some real strength in APAC. What if you'd share with us any additional color on particular market verticals or applications you're seeing that are kind of key to penetrating and getting these big, you know, large global 2000 type wins?

Yeah, I would say, first of all, the top two market is education and healthcare is still pretty strong. And also we're bringing us more opportunities when we expand it into the international market like APAC. And also like those telco, you know, telecom cell, right? Those kind of a telco partnership will further help us for us to penetrate into each of those APEC countries, right? In terms of new opportunities, you know, recently we launched, you know, Zoom Ash. And also, you know, like, you know, some of the partners, we built a new solution upon our platform, like a class technologies, right? I think a lot of new opportunities, right? We do not need to build by ourselves, right? And, you know, those third-party customers, they can, leverage our, you know, either API or SDK or Zoom app to build all kinds of, you know, the new solutions, you know, to, you know, focus on all those vertical markets or even the department as well, right? That's where the opportunities, you know, are coming from.

So you're seeing some opportunities to upsell into the CPaaS type applications in the enterprise?

Yeah, both, actually. Yeah, because, you know, those third-party partners, they build a very healthy business, also bringing the Zoom, you know, to the installer base, and also by establishing the charts, right, we also can upsell in more stuff, right? Essentially, it's a very healthy channel, not only for their own business doing very well, but also it's a great channel for us. Helpful. Thanks, Eric. Thank you, Ryan.

Our next question is from C.D. Panagrahi with Mizuho.

Hey, guys. Thanks for taking my question. I just wanted to dig into the enterprise segment. Q1, Q2, those are two big renewal quarters. Now that's behind now. So what sort of changes you are doing on your go-to-market strategy, mainly increasing quota, getting sales safe, or any changes that you are doing for this normalized environment? And phone used to be one of the big cross-sell opportunity for you. And how should we think about the phone as you get into a more normalized renewal environment?

So we are absolutely continuing to invest in our sales capacity. We are focused on certain regions, especially where we see lots of opportunity like Asia Pac. We recently hired a new leader there and are really excited about the progress we're already seeing with his leadership. And then we are continuing to invest in marketing. So as we've moved post-pandemic era a little bit in terms of, not post-pandemic, but sort of what we saw from last year with the lift in brand awareness, we're continuing now to think about how do we invest more in marketing? specific product marketing around Zoom phone, around Zoom rooms, as well as digital marketing campaigns. So helping to drive additional leads for all of our teams on a global basis. And then also the channel continues to be a really important aspect of our go-to-market. So the channel was responsible for approximately 27% of our Zoom phone sales in Q2. We added six additional master agent partners during Q2. So really excited about continuing to invest in the channel on a global basis.

Thanks, Kelly. Thanks.

Our next question is from Alex Zukin with Wolf Research.

Hey guys, thanks for taking the question. So I think I'm going to, I'll probably touch on a topic that's been mentioned here before, because I think a lot of people that are investing in the company at this point, they really are investing in the non-online story of the company, right? The enterprise story, the large business. There's a lot of metrics. There's a lot of kind of pollution and noise in these metrics. How do we think about the growth of the important part of the business for investors, meaning the over 10 employee customer base, either from an incremental bookings perspective, from an incremental revenue perspective? And when does the headwind or anchor on the business from the pandemic, from the once in a generation SMB buying pattern, when does that trough, And so when do we see a normalized kind of normalized growth rate for the company?

Yeah, so thank you, Alex. First of all, we agree with you that you really, we want everyone focused on the long-term potential of the upmarket. As a reminder, in Q2, that segment of the business grew at twice the rate of the online business. So that gives you some indication of how those two segments are diverging a little bit. As we look forward, I guess the best way to help you think about it is you want to look at like the net dollar, the implied net dollar expansion rate that we were talking about earlier. Right. You can think about what's happening there is the net dollar expansion rate for the online segment is under one. Right. That gives you some idea of what's happening again, how to think about those two different segments of our business. In terms of where is there a trough, I think that it's back to kind of trying to predict a pandemic, which is a difficult thing for obviously anybody in the world to do right now. And as much as we're excited about, you know, vaccines being more widely distributed, unfortunately, as we see Delta continuing to grow in certain parts of the world, we have even in the last few weeks, like seeing certain pockets of strength. So I think that that's going to depend on really what we continue to see in terms of the spread of the variants around the world.

And I guess maybe for Eric, you mentioned the, seasonality, the vacations in Europe. Is there a way to kind of get a sense for the Delta, pardon the pun, about just EMEA SMB versus U.S. SMB, just so we can get some sense of that magnitude change?

I think overall, I think our market is doing well, you know, especially, you know, look at the North American business, right? You know, in India, I think it's a mess market. Online, SMB, I think, you know, I think it did not do well in the last quarter. You know, seasonality, COVID situation, for sure, you know, made things a little bit worse because of the longer vacation or so on and so forth. Here, look at our North American market, I think the upsell phone and also the Zoom rooms, because every company, I think they started going back to the office, the new opportunities are coming and also doing very well. That's why I say even if a little bit of China on SMB buy-in a lot, we did not see the big problem. And because offset by the hybrid work opportunities, right? I think if you look at APAC, we did not see that at all in the last quarter. It's still doing very well. I think overall, as you mentioned earlier, we've got to go back to our enterprise play. Because last year, I think the online business used to be just a marketing channel. But however, not only a marketing channel, but also contribute a lot to our revenue from a percentage perspective. Now, given that percentage is going down for online, you know, online is very healthy for our patients, right? With that, we can focus on our core enterprise customer, And plus, you know, given that we become a household name, it will bring a new opportunity to monetize. Used to be the monetization for online, no end user, just the online subscription. I would say that may not be the sustainable strategy, right, for the online users' monetization. You've got to have other ways, right, to monetize the online, you know, the installer base. That's why we are very excited about the future.

Thank you, guys.

Thank you, Alex.

Our next question is from James Fish with Piper Sandler.

Hey guys, thanks for the question. On the win with Seagate as an example here, how often are you seeing it that phone is leading to a greater number of seats at existing customers? Or really, how can we think about that potential uplift within just your install base today of selling phone with meetings that creates a greater number of seats at current accounts, not just meeting seats, but overall employees that you can actually sell phone into? Is it a two times opportunity that we just don't have as many meeting seats because you can have more You can have less hosts than you do employees.

James, that's a great observation. I think you are so right. I think one year ago, we really did not see that. Normally, we buy more meeting licenses and then probably a little bit of upsell for phone and also for the existing installer base, the upsell phone. For the brand new customers, because the customer look at one platform. for both video and voice right we understand video and voice are conversion into one platform plus you know our phone business is very mature now right every quarter being very well customer like it is traded it's not like oh this is something brand new they do not want to take any risk it's very mature plus the integrated experience both video and voice are doing very well essentially you know from now on i would say probably i do not know but i guess probably more and more customers they are not going to view uh i need to deploy a video first and then deploy a phone you know very likely on the event they will deploy both given the dynamics of each business you know sometimes probably they want to deploy more functions than the meeting licenses thanks thank you james next question is from will power with baird great thanks for taking the question i guess um

You know, tech question probably for you, Kelly, as we think about that, you know, the 10 plus employee cohort, you know, kind of your upmarket segment. How do we think about one, customer growth from here? And two, as we think about that net expansion, you've been, you know, above 130%. What's the sustainability of that, right? Because you've got a number of growth drivers and you've got the law of large numbers kind of working against you. How do we think about the outlook on that front?

Yeah. In terms of net dollar expansion, we expect it to stay above 30, certainly for Q3. And then in terms of Q4, we expect it to be at least in that range. It's a quarter out. We don't know exactly, but we're predicting it to be right in that same range still for Q4. And then in terms of the customer growth, I think that what you're going to continue to see is ongoing growth driven by large deals. So the customer count may slow, but that you're going to continue to see growth driven by these big deals as we see opportunities to continue to cross sell with Zoom phone. As you heard, right, we beat our two largest deals record in the same day this quarter. So really seeing opportunities there. And then as people are planning to go back to the office, also opportunities for Zoom rooms. And then think about Zoom events. So you're going to start to see opportunities for larger and larger, bigger customer wins. And I think the other thing to note, you know, we talked about the quarter, but just want to make sure everybody understands, like, you know, we had a deal this quarter that now became our new largest, sorry, our new largest customer. So not our new customer, an existing customer, but now with their upsell, right, they became the largest customer. So we're continuing to see these really significant large wins. And that I expect to continue. Thank you.

Our next question is from Matthew Necum with Deutsche Bank.

Hey, thanks for taking the question. You talked a little bit about some more measured behavior from customers in terms of buying patterns. I'm just wondering, can you talk a little bit about the competitive backdrop, whether you've seen peers maybe getting more aggressive, especially as larger enterprise customers really take their time to reevaluate the future of work post-COVID. Thanks.

Eric, you want to talk about some kind of news?

Sure, sure. I think, Matt, you look at the trend, right, the future work, hybrid work, for sure, that will be the mainstream, right? And however, and because of embracing hybrid work, a lot of employees, right, you know, still didn't, you know, work from home or maybe work in the remote locations. And not like prior to pandemic crisis, quite often, and you might deploy a solution, this is good enough, right? And give employees now to support hybrid work, the best service will do very well. Because you look at employee, they do not have IT support sitting next to them, right? And plus, you really worry about productivity if you do not give the best of tools. That's why in a good enough solution, we not do well. You know, every business would like to deploy the best business service. But always give the employees a much better tools to improve their productivity, to help employees because to support hybrid work is not that straightforward. And I give an example like a conference solution. We introduced the Somatic Gallery feature. Otherwise, customers, they do not dare to have a meeting. Some are sitting in the conference room, some will join remotely. That experience is not as good as the webinar or meeting. That's why I think the hybrid work certainly will help Zoom. Even sometimes our competitors might have elevated the price. I think the good news is the customers really want to have very reliable, frictionless platform, very easy to use. I think that's the reason why I think Zoom is positioned much better than any of our competitors. Thanks, Eric. Thank you, Mike.

Our next question is from Boyoung Kim with Citi.

Hi, I'm Tyler Radke. Earlier in the Q&A, you shared some progress around the major master agent program and also had cited some really large international phone deals. So I wanted to hear about what you're seeing in terms of the productivity of the channel partners and international markets relative to what you're seeing internationally. from channel partners in the US. And to what extent is that impacted by the decent stage of the master agent program in international markets, as well as the nascent state of the broader market in cloud based phone? Thanks.

So I think we're seeing strength in our channel partners globally. So, but as you say, it's a much newer program and a much smaller internationally. So excited to really, this is one of the main focuses for our channel team, which is expanding outside of the U.S. It's focused for the rest of the year. In terms of productivity, I don't think that it really varies. I mean, we were really excited about the TelcomSell deal, which is one of our largest channel partner deals, ISV deals to date. So that's really exciting, but we've had significant wins in the U.S. as well. So not seeing dramatic differences in productivity on a global basis at this point.

Great. Our next question is going to be from Matt Stotler with William Blair.

Hey, guys. Thank you for taking the question. I think just one for me. Obviously, as you guys have spoken to so far, the enterprise opportunity here is really kind of what's really exciting and compelling going forward. But given the commentary around finding other ways to monetize the base, whether that's consumer or otherwise, I would love to maybe get an update or whatever color you can provide on the level of freemium usage that you're seeing today, right? And outside of the seasonality with education, just, you know, the level of freemium usage on the platform, how that's changed over the past four or five quarters, thoughts on the back half there, and then, you know, any commentary on what conversion you've seen there or you expect you could see if you decided to really try and monetize that.

Yeah. Go ahead. You go ahead. So we still see free users, you know, as a large, they've really grown over the last 18 months and they're about 30% of our minutes usage today as compared to like 10% pre-pandemic. So that gives you an idea of the number of, we don't talk about the number of users, but that at least gives you a relative understanding of how they've grown over time. And Like we always say, as Eric mentioned about our core value of care, we really care about all those free users, especially to keep people connected during these more difficult times. And there's always a hope that they continue to convert or that they have the opportunity to continue to expose more new users to the power of Zoom.

Got it. Thank you.

Our next question is from Haim Siegel with Eleazar Advisors.

Hi, Kelly and Eric, how are you? I had a couple of questions if you have time, but since obviously the focus is on enterprise, I just wanted to know how fast the sales force is growing and when efficiency for that sales force starts to kick in. I guess that's one and also just related to that on operating expenses. So I'm not sure how long you expect a flatter sequential growth, but on the operating expense, it seems like maybe it'll start to grow faster than revenues. And I'm just wondering, you know, with relation to focusing on getting the enterprise business going, you know, how fast expenses will grow versus revenues.

Yeah. As we've been saying for the last several quarters, there are areas that we were not able to hire and invest in as quickly as revenue grew last year. And so what we've been doing on the last couple of quarters is focusing on re-accelerating the investment, especially in the areas of R&D, as well as quota carrying heads. And we are absolutely continuing to do that. We still are underinvested in R&D at a little over 5% of revenue. And the long-term target is 8% to 10%. So we're continuing to hire as quickly as we can. And then similarly, in terms of quota carrying heads, we're being very thoughtful about the segments and the regions in which we're hiring. But remember, like stepping back for a minute, there is a huge TAM and a huge opportunity out there. And we want to continue to add quota carrying heads and sales capacity into our system to take advantage of that. So as long as we continue to see opportunity for growth, we will continue investing in quota carrying heads. We are also... As I mentioned earlier, accelerating our spend in marketing as we were able to pull back a little bit on that last year, but we think now is the right time to continue reinvesting there. And then, you know, the two areas that we always look to be as efficient as we can are GNA and COGS. And, you know, GNA is kind of right in the range of where we would want it to be for the long term. Over time, we do expect COGS to decrease as we continue to move more and more of our services out of the public cloud into the data center, our own data centers. I mean, we're always going to have a hybrid approach there. But also, eventually, at some point, right, when K through 12 schools are more free to go back to campuses, we do expect to see improvement in our gross margins. But we will absolutely continue to support those students and schools as long as we think it's needed.

Is there a general timing of efficiency where you expect that to kick in for the enterprise, for the salespeople in the enterprise? I know you've been growing it, and I know it takes time. I'm just wondering if there's a timing where a big tranche is going to start really performing for you.

No, I mean, well, this is what I would say is we are continuing to hire quota carrying heads quickly and we'll continue to do so. So that means there's a constant state of having ramping reps in the system. And since we have no plans to stop hiring quota carrying heads in the near future, that I can't say when all of a sudden they're going to necessarily be more efficient.

Thank you very much.

Our next question is from Rishi Jaluria with RBC.

All right. Hey, Eric, Kelly, Tom, thanks so much for taking my questions. Good to see you all. I wanted to just ask about Zoom events. So, you know, I know initially when you've talked about the product, it was kind of pitched as a little bit of a monetization vector for the prosumer segment, right? Helping, you know, fitness instructors, yoga instructors run classes online. But clearly it seems like there's much grander ambitions, right? The fact that you're going to run Zoomtopia on that, I think tells us there's maybe a bigger enterprise opportunity You know, and even as companies are looking at doing in-person conferences, again, they want to have a strong virtual and hybrid component to it. So can you maybe talk a little bit about what you see as a longer term vision with Zoom event, especially enterprise? And maybe let's go on that. Thanks.

Yeah, Rishi, that's a great question. So remember last year, last October, right? At Zoomopia, we introduced the Zoom events. You know, we started from on Zoom at that time. And, you know, we thought about how to have those, you know, and the people, you know, working from home still can get a training, right? Like fitness, you know, online classes, all those classes. That's, you know, the reason why we started building the Zoom events. However, again, we always listen to our customers, in particular, our enterprise customers, right? And they all told us, hey, there's even more opportunities around the corporate events. The corporate and public is not Zoom-topia. They all told us, hey, we badly needed that. We badly needed that. We already have a webinar platform. They want us to extend that, how to expand it into a bigger annual user conference like Zoom Topia. That's why we sort of pivoted our strategy and doubled down our corporate word on Zoom, which is rebranded as Zoom Events. We do see a huge opportunity. And inside of that, the consumer world is not called Zoom events anymore. This is more like our own Zoom website. We still are going to aggregate all those consumer-driven events. you know, online fitness class and so on and so forth. But for now, you know, if you look at the short-term opportunities, Zoom events will do well because many of our existing customers told us we need a platform like that because the trust already built, right? They do not want to go to any other platform. They are very patient with the wait. That's the reason why we shifted our strategy a little bit since last Zoom popular. All right. Wonderful. Thank you. Thank you.

Okay, well, thank you to all of our analysts. That's all the time for questions that we have for today. That's all, Tom.

Great. Thank you, everybody. And we hope to speak to you more in the rest of the quarter and see you at Zoomtopia. Anything else, Eric?

Yeah, thank you all for your time today. Hope you all will join next month's Zoomtopia, September 13th and 14th. I really appreciate it for your great support, as always. Thank you.

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