ZM Analyst Questions From Q3FY21 Call

[sjo]

Analyst Questions From Q3 Earnings Call
11/30/2020 4:30 CT

Eric Yuan, CEO made prepared remarks via recording as he had a personal situation that did not allow him to be live on the call.

Kelly Steckelberg, CFO took all the questions in Eric Yuan’s absence.

Questions:
Question from Phil Winslow Wells Fargo: Regarding the customer segment w/ less than 10 employees and Zoom phone. Answer from CFO: Seeing consistent performance from small business to enterprise. Zoom is seeing the largest progress in this segment ever.

Question: How do you transfer from monthly to annual progress. Answer: This continues to be a significant part of the focus of the marketing team.

Question from William Blair re: Linearity in the quarterly deals: Answer: It was more front end loaded than Zoom typically sees. CFO expects to see in Q4 is fulfillment through direct sales force and will start to be more back end loaded.

Question re: ZM Phone as a natural extension. Where do you see this going? Answer: Call Center focus is part of their strategy. Focusing on this.

Question from Sterling Autee of JP Morgan RE: Customers w/ less than 10 employees. Answer: CFO said that churn was better across ALL segments of the business and not just the businesses with under 10 employees. More of the sales will come from direct sales force from Zoom in the future.

Question: Is there a monetization strategy with regard to “On Zoom.” Answer: CFO said there is not yet a monetization strategy that has been established. Focusing on launching the product and getting this right first. Will announce monetization strategy next year, but do not expect to see significant revenue from “On Zoom” next year.

Question: What % of revenue came from greater than 100,000 customers. Answer: 18% coming from this group.

Question: How do you feel re: Being staffed to focus on global 2K expansion around the world?
Answer: Zoom is able to hire into markets and seeing significant demand for Zoom outside the US.
Question: How does M&A impact this?: Answer: Zoom will look for opportunities here to bring in the best staff and technology.

Question re: Team-based collaboration in chat. How do you see this playing out and how will you be able to compete here? Answer: Customers are asking for it and company plans to expand this.
Question: How much is +100,000 expanding w/ Zoom phone? Answer: Not calling it out and may disclose it in the future.

Question re: Sales productivity in Q3. Answer: Continued to see strong sales productivity and are starting to come down to more normalized rates of pre-Covid sales productivity.

Question from BTIG Analyst re: International vs. Domestic expansion: Answer: Focusing on international expansion. Putting teams into local/foreign markets has been successful.

Question RE: 75% usage growth, how much of it is K-12. Answer: A large % of the growth was from education. Education continues to be a significant revenue source and was the 2nd fastest vertical growth in Q3.
Question: What drove improvement in revenue? Answer: It was diversified across all geographical and verticals markets. Land and expand continues to be a strong part of their sales strategy.

Question from City Group: Of the customers that churned, are there correlation or trends? Answer: Largest churn is in companies with less than 10 companies, but even that was better than they anticipated.

Question from Zane Crane from Bernstein: What is named price vs. active hosts pricing? Answer: Allows companies to begin to use Zoom and then grow into it.
Question re: How do you go from 1 month or a qtr or a year commitment. Answer: Active market use is most prevalent with up markets, have access to Zoom’s service and then measure their high water mark and negotiate a deal based on determining a fair and appropriate price.

Question: Any major outliers or things impacting growth in different geographies: Answer: Some regions are impacted by larger deals and there is not an outlier or wonkiness that stands out in any specific geographies. Strong global demand for Zoom.

Question re: The way Zoom measures the effectiveness of partners. Answer: It is based on the % of revenue that comes through or is touched by the channel.

Question from Richard of Needham RE: Operating margins-expenses, R&D is catching up with this. How is trajectory of this impacting guidance into the future? Answer: Zoom wants to continue to invest in R&D as a priority as 3% of revenue now and eventually to 8-10% of revenue. Then expanding investments in marketing and will likely see operating margin coming down as a result.

Question: Are there any major enhancements to functionalities you see w/ Zoom Phone that you plan to expand/improve? Answer: No, nothing major –very well set in this regard and now in 44 companies and going well.

Questions re: Gross margins and free offering to public for Thanksgiving, etc.
Answer: Gross margins continue to allow us to support the communities and not prepared to give a change in the outlook, but CFO expects current situation to be duplicated into at least the next few quarters.

Question re: Zoom phone seats. Answer: Not disclosing the number of seats, but did have the largest growth number of Zoom Phone in history during Q3.

Question re: Guidance. How does Zoom grow going forward? High level, how would you calibrate growth for next year? Answer: Remote working trends have certainly accelerated, and yet remote working is certainly here to stay. Many companies will likely continue to offer remote work as an option for their employees.

Question re: Assumption for Q4 and as we go into a vaccine era, what’s going to give you the confidence with the churn post-pandemic? Answer: Overall assumptions have not changed, and they’re being prudent and conservative.

Question: Expand on Lumen Technologies from Century Link and how do you frame that up? Answer: This will be an area that will help Zoom drive growth next year.

Question from Stiefel analyst: With R&D down a bit, structurally, how much more do you need to throw at Zoom Phone. Answer: Decrease in R&D cost was due to previous consulting agreement for security during 1st & 2nd quarter of this year.

Regarding talent acquisition, Zoom is focused on hiring the best talent wherever they are and allowing them to grow the company with the top talent no matter where in the world they are living/residing.

?? How has performance been for all customers and not just paying customers? It’s available for any customers w/ more than 200 customers

Question from Oppenheimer analyst: Churn assumptions going into 4th quarter? Answer: CFO said they’re modeling churn in same way as when coming into Q3.

Question re: Size of federal as a vertical. Answer: Federal/Government was the strongest vertical this quarter. Education was the 2nd strongest vertical this quarter.

Question re: gross margin that was pressured in Q3. Was free usage or public cloud a bigger factor? Answer: Both are having the same impact.

Question re: The new 2nd wave of Covid. Answer: Not seeing an inflection point like they saw in the first wave.

Question from Ryan McWilliams, Analyst with Elliot: Zoom Rooms –Are enterprises updating their offices with new Zoom rooms to create an inclusive workforce for people who work in the office with those who work remotely? Answer: CFO said that Zoom’s Smart Gallery is a new product that will enable companies to help to facilitate that interaction.

sjo

[GDavenport]

++++++++++++++++++++++++++++++++++
Question from Zane Crane from Bernstein: What is named price vs. active hosts pricing? Answer: Allows companies to begin to use Zoom and then grow into it.
Question re: How do you go from 1 month or a qtr or a year commitment. Answer: Active market use is most prevalent with up markets, have access to Zoom’s service and then measure their high water mark and negotiate a deal based on determining a fair and appropriate price.
++++++++++++++++++++++++++++++++++

This Q&A was a very interesting part of the call. The response was quite a bit more bullish than this, and the implications here are that there will be a significant reset (higher) in revenue through seats sold when these contracts reset.

As a result, the % deferred revenue is not counted on the books and is not forecasted (it’s not necessarily known until the last month of the contract term), but it is owed. This will be a surprise upside for power users.

[sjo]

Great catch, and good information G Davenport.

Here’s the actual transcript of the verbatim Q&A and prepared remarks. SA posted this a few hours after my earlier post of the Q&A notes that I typed as quickly as I was able during the live Q&A.

Operator

Our next question is from Zane Chrane with Bernstein.

Zane Chrane

Hi, Kelly, thanks for taking the time. I was wondering if you could explain to us what portion of business customers are on the active host pricing model versus a named host pricing model? And why do you make that distinction? What does it mean for you in terms of strategy, adoption, overall growth? And then I have a quick follow up.

Kelly Steckelberg

Sure, hi, Zane. So in terms of the approach, and why we have active hosts versus named hosts is because it allows customers that aren’t sure exactly what their uses are going to be, to come in and buy Zoom at a level that feels comfortable to them, and then grow into that. So it’s a very effective mechanism for maybe somebody that’s newly adopting video communications, or expanding and extending it to a part of their organization that may not have used it before. And it’s a great way for them to have the opportunity to assess what that level of usage is going to be.

In terms of what percentage comes from that, that’s not something that we disclose. It’s really a mix, depending on the customer segments, and how those customers want to buy.

Zane Chrane

That’s helpful. And as far as the customers that are on the active host pricing model, how long is the lag? Or how should we think about the relationship between revenue and usage? Is it a one month lag between monetization versus usage? Is it a quarter? Is it a year? How should we think about that in general?

Kelly Steckelberg

Yeah, so the active host model is most prevalent in our up market customers. And the typical structure – of course, again, we’re focused on delivering happiness to our customers. So these are all things that are negotiable. The typical structure of a deal would be, they would have access to a certain – a set number of licenses. They would pay for some fraction of that for the first year. And then after a year, we would look at where their high watermark was of usage for those hosts. And that would be their true up then for the next year.

Zane Chrane

So should we interpret that as meaning customers that have not hit that one year anniversary? Those may be in Q1 or Q2, that have expanded significantly in the last year, we should still see improved monetization of those in Q2, Q3 next year maybe?

Kelly Steckelberg

There’s absolutely the potential in that scenario, that yes, there’s a step up for those customers if they’ve expanded through where we started them in their minimum commitments at the beginning of their contract. Yes.

Zane Chrane

Super helpful. Thank you very much and congrats again.

Kelly Steckelberg

Thanks Zane.

Zoom Video Communications, Inc. (ZM) CEO Eric Yuan on Q3 2021 Results - Earnings Call Transcript
https://seekingalpha.com/article/4392186-zoom-video-communic…

sjo

[GDavenport]

To be clear, I believe this will be a small % over rider for the next 15 months as the adoption curve matures. It will reflect in the %growth numbers as a differential in that time. After which, the comps will catch up and growth will be less impacted by deferred revenue differences.

All major new products would be impacted by this mindset. (It’s quite common within the software sales business to “pilot” new features and additions).

The only reason why this is of note is because of the dislocation in their revenue comps from past quarters. If they were closer to the traditional S-curve and not as impacted from the COVID events, these numbers would naturally blend.

I hope they speak about this in a more quantifiable basis in their communications going forward.

[nilvest]

SJO and GDavenport make good points…

So the simplistic summary in my mind is:

Customer land and expand journey with Zoom looks something like this

Step 1: “named license” customers… i.e. in trial mode, though their usage may be high, they are still in the first leg due to pandemic, their commercial arrangement (and revenue) may still be nascent

Step 2. “Active license” - first year discount - where they have good usage and understanding of what is regular cost but charged less to get first year…

Step 2a / 3a. Add HW, Zoom rooms

Step 3. Full price - regular - for video / meetings…

Step 4. Add Zoom Phone

ofcourse its not this linear with every customer but certainly possible that a large portion of revenue growth this year, specially for those new customers gained through pandemic, was still in somewhere before step 3… which means just going through step 3 and step 4 will continue drive high growth next year… it will not be in 100s % but it does not have to be much below 100%, at-least for another year…

One thing that supports this theory is large number of $100K+ customers last quarter… I am sure a lot of those did not show up just in quarter… but their revenue ramped through last quarter to get them into $100K+ club… and it is still a “small” number and small % of Zoom revenue… this says long runway for growth still ahead.

[clydejaz]

The company I work for is on Step 4 - we seem to be early adopters of new technology - we started with Okta 2 years ago, Docusign 1.5 yrs ago and Zoom over a year ago pre-Covid - because Teams and Skype video were horrible.

We recently rolled out Zoom Phone for all employees worldwide - about 1500 people. It was seamless and we now have more features that ever before and I’m told it is cheaper.

Most people getting rid of physical phone HW and just using the computer or phone app. Some are keeping their physical desk phones and I’m told Zoom Phone is compatible with the hardware we had in place.

The switch allows us to drop Skype altogether. Previously we still used Skype for messaging and phone. Most IT departments want to minimize the number of applications they support so are always looking to dump legacy products.

My speculation is that many companies whether small, medium, or large will adopt Zoom Phone in the near future just like we did. That is one area of growth for ZM.

I no longer hold ZM stock but love the product.