Zoom Communications, Inc. Q1 FY2021 Earnings Call

Hello everyone, and welcome to Zoom's First Quarter Fiscal Year 2021 Earnings Release. As a reminder, this call is being recorded. At this time, I would like to turn the floor over to Tom McCallum, Head of Investor Relations.

Thank you, Matt, and hello everyone. Welcome to Zoom's earnings video webinar for the first quarter of fiscal 2021. Joining me today will be Zoom's Founder and CEO, Eric Yuan; and Zoom's 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 GAAP to non-GAAP financial results. During this call we will make forward-looking statements about our market size and growth strategy, our estimated and projected costs, margins, revenue, expenditures, investments, and growth rates, our future financial performance and other future events or trends, including the guidance for the second fiscal quarter of 2021 and full fiscal year guidance for 2021, our plans and objectives for future operations, growth, initiatives, or strategies, and the impact to Zoom's business from the COVID-19 pandemic. 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 risks and other factors that could affect our performance and financial results and which we discuss in detail in our filings with the SEC, including today's earnings press release and our latest 10-Q. Zoom assumes no obligation to update any forward-looking statements we may make on today's webinar. And with that, let me turn it over to Eric. I think Eric’s mic. Here he goes.

That’s great. Thank you, Tom. First of all, thank you all for your time today. I still remember the first time when we had an earnings call last year, it was around less than 1,000 participants. Today, we have over 3,000 participants. Thank you all for your time. And I hope you are doing as well as is possible in this unique moment around the globe. To the frontline workers, we thank you for your courage and the tremendous sacrifices you are making to keep us healthy and our community running in this pandemic. Everyone at Zoom appreciates all your incredible work. COVID has brought pain for many, in particular, vulnerable communities. The black community in the United States has also recently experienced shocking and a senseless loss. To our communities and customers, especially those in the black community, Zoom is standing with you, not only today, but also into the future. Nearly 10 years ago, we created Zoom to build a better, simpler and more efficient video communications platform. Today, I am proud to see that our platform is serving a critical role beyond our original vision in enabling communication and collaboration for businesses, schools, consumers and in the global community to stay connected and operational during the COVID-19 pandemic. Navigating this process has been a humbling learning experience, giving us a newfound appreciation for what it means to be a video communications technology provider in times of need. Work-from-Home and social distance initiatives have meaningfully accelerated the adoption and traffic on the Zoom video communications platform. We have seen many use cases, not only from enterprises to maintain work productivity as part of the business continuity plans, but also from first-time consumer users for personal and social use to connect with friends and families, when physical gathering is not possible. Let me share some metrics that illustrate the demand we experienced in this past quarter. Customers with more than 10 employees grew 354% year-over-year, as we deployed millions of licenses for new customers in the quarter. One new banking customer deployed approximately 175,000 new Zoom enterprise licenses in the quarter. Usage by customers in the Global 2000 grew over 200% sequentially. We peaked at over 300 million daily meeting participants, free and paid, joining Zoom meetings in April 2020, up from 10 million in December 2019. Currently, we continue to see elevated levels of participants even as governments around the world have begun to ease stay-in-place restrictions. We had an approximately twentyfold increase in our metric of annualized meeting minutes run rate, which jumped from 100 billion at the end of January 2020 to over 2 trillion meeting minutes based on April 2020’s run rate. Scaling capacity to meet this incredible increase in traffic and use cases while providing uninterrupted, reliable and high-quality services to our customers have been a tremendous undertaking for our team. And we could not have done it without relying on our partners. When the pandemic crisis started, our own data centers could not scale fast enough to handle the unprecedented traffic. Fortunately, some of the top public cloud providers were there to help. Immediately during the crisis, our long-time partner AWS and its CEO Andy Jassy enabled us to meet this rapidly increasing demand. As our demand increased and we had limited visibility into the growth, AWS was able to respond quickly by provisioning the majority of the new servers we needed, so sometimes adding several thousands a day for several days in a row. In April, our customer Oracle also showed great support to help us. Not only did Larry Ellison record a great video to encourage our team to do the right things for the world, but also offered Oracle Cloud support. We also provisioned a number of servers in the Oracle Cloud as the demand for Zoom continued to increase. We are so grateful for their partnership and their responsiveness to provide capacity during this time. While the COVID-19 pandemic has expanded our market opportunities, it also brought us many challenges. Prior to the pandemic, Zoom was primarily built for and used by large enterprises and institutions. During the crisis, with good intentions, we opened our platform to unprecedented numbers of first-time users without fully considering the challenges it would bring to those who did not have full IT support, or established protocols for security and privacy like our enterprise customers. As a result, we have experienced negative press related to meeting disruption, security and privacy issues. Since these issues emerged, we have transparently and quickly addressed specific security and privacy issues, including: enacted a 90-day plan initiative on security and privacy with a weekly webinar for customers to ask me anything, acquired the Keybase team to add engineering expertise to build an end-to-end encrypted meeting mode, and released Zoom 5.0 with new security features and enhancements to give customers unparalleled control over their meetings and data. The new release also includes support for AES 256-bit GCM encryption and the ability to report platform misuse to Zoom’s Trust & Safety Team. During this period of unprecedented usage growth and negative PR, as the CEO of Zoom, I was also facing tremendous pressure. And I reached out to the high-tech community and received great support from fellow CEOs, and many of them are my mentors. I can’t thank them enough for their advice. I’m also deeply grateful to see the strong support from our valued enterprise customers, such as CEOs from Atlassian, Equinix, HubSpot, Okta, PagerDuty, Poly, SurveyMonkey and many others, both through public statements and video testimonials. With that, our users trust us to deliver the best and most secure video-first communications platform. I believe our results will continue to make us a stronger company for our customers and in the global community. Now let me discuss a few of our happy customers. We are thrilled to welcome Arm Technology to the Zoom family. Arm Technology is at the heart of a computing and data revolution that is transforming the way people live and businesses operate. In Q1, Arm chose to deploy approximately 8,000 Zoom Meeting licenses, 800 Zoom Rooms and 9,000 Zoom Phones to deliver a one-touch experience to their employees globally. We are also happy to welcome Baker McKenzie. One of Baker McKenzie’s distinguished strengths is their use of cutting-edge technologies to help clients overcome the challenges of competing in today's economic world. We feel privileged to be the video communications platform of choice for the number one law firm brand in the world. Thank you, Arm and Baker McKenzie. On a final note, we welcomed Lieutenant General H.R. McMaster to serve as an independent director on Zoom's Board of Directors, Velchamy Sankarlingam as President of Engineering and Product, and Damien Hooper-Campbell as Chief Diversity Officer. Bringing their expertise to Zoom will be instrumental as we navigate rapid growth, transformation and scale. I want to commend and thank our 2,854 employees for what we have accomplished together, and for working tirelessly over the past quarter to support millions of participants around the globe. With that, let me turn things over to Kelly. By the way, I forgot to mention, today is also our CFO Kelly's birthday. So happy birthday, Kelly.

Thank you, Eric. And this is the best birthday present I could ever have. Hello everybody. Q1 was an exceptional and pivotal quarter for Zoom. We are grateful for the incredible increase in demand as millions of doctors and patients, teachers and students, businesses and consumers chose Zoom to deliver critical communication and connection in a time of need. It speaks greatly of their trust and the quality and ease-of-use of our technology platform. We are also proud of our efforts to support our customers, employees and the global community during the COVID-19 pandemic. In addition to opening up our platform to deliver free services to over 100,000 K-12 schools in 25 countries and millions of people around the world, especially those in areas highly impacted by the crisis, we have also donated $1.4 million to COVID-19 focused charities and funded another $1 million of stock to launch our charitable fund, Zoom Cares. The key long-term focus of Zoom Cares includes education, social equity and climate change. Internally, we provided a one-time bonus, equivalent to two weeks of pay, for all Zoom's non-commissioned employees to offset costs associated with any disruption caused by the crisis. Not only has the world changed since we last reported results in early March, but so as Zoom's market opportunities and growth trajectory. Let me start by reviewing our financial results for Q1, then discussing our outlook for Q2, and the full year of FY ‘21 that has been recalibrated to adjust for the new trends and scale of our business. Total revenue grew 169% year-over-year to $328 million in Q1. This topline result significantly exceeded the high-end of our guidance range of $201 million due to the increase in demand and strong sales execution in the quarter. For the quarter, the growth in revenue was primarily due to subscriptions provided to new customers, which accounted for approximately 71% of the increase, while subscriptions provided to existing customers accounted for approximately 29% 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 Q1. We continue to see expansion in the up-market as we ended Q1 at 769 customers with greater than $100,000 in trailing 12 months revenue, up 90% year-over-year. This is an increase of 128 customers over Q4, a record number of adds in a quarter. Further demonstrating the strength in the up-market was the addition of over 500 customers with greater than $100,000 in annual recurring revenue in Q1. This is a one-time metric that we are sharing to provide more insight to our Q1 results. For customers with more than 10 employees, we added over 183,000 in Q1, exiting with a total of approximately 265,000 customers in this segment. Year-over-year, we added over 206,000 new customers, growing 354%. While this is remarkable growth, our customer segment with 10 or fewer employees also expanded during the quarter as individuals adopted Zoom for many personal and social uses. As a result, we have experienced a mix shift of customer cohorts, where customers with 10 or fewer employees represented 30% of revenue in Q1, up significantly from 20% in Q4. In addition, the increase in customers with 10 or fewer employees also shifted our billing mix, as these customers generally pay monthly, rather than annually like most enterprise customers. Our net dollar expansion was over 130% for the eighth consecutive quarter, as existing customers continue to support and trust Zoom to be their video communications platform of choice. Both domestic and international markets had strong growth during the quarter. Americas grew at a rate of 150% year-over-year. However, our combined APAC and EMEA revenue grew even faster at 246% year-over-year and represented approximately 25% of revenue. International expansion is a key growth initiative for Zoom. Our global brand awareness has spread more quickly and we have expanded into more countries than we had originally planned for FY '21. Now turning to profitability, the increase in demand and execution drove net income profitability from both GAAP and non-GAAP perspectives. For my following comments, I will focus on our non-GAAP results, which exclude the charitable donation of common stock, stock-based compensation expense and related share-based equity taxes. Non-GAAP gross margin for the first quarter was 69.4% compared to 80.9% in Q1 last year and 84.2% last quarter. Although in early March, we originally guided lower based on an increase in usage of our platform, our gross margin was further impacted by the elevated demand, especially higher levels of free meeting minutes, including those from K-12 schools in March and April. Higher incremental cost also resulted from leveraging the public cloud providers, which was critical to our ability to meet the sudden exponential growth in usage, as the crisis spread and governments instituted stay-in-place policies around the world. Moving forward, as we build additional capacity in our own data centers, we expect to gain some efficiencies, bringing gross margin back to the mid-70s in the next several quarters ahead. R&D expense in Q1 was approximately $21 million, up 66% year-over-year. As a percentage of total revenue, R&D was 6%, which was lower than Q1 last year mainly due to the strong topline growth. In FY '21, we plan to continue investing in R&D to drive innovation and security functionality, including leveraging the expertise and resources from top security firms. Also, we recently announced the addition of two Engineering Centers of Excellence where we expect to add up to 500 software engineers in the next few years. The new R&D centers in Greater Phoenix, Arizona and Pittsburgh, Pennsylvania will both be located near top engineering universities. Sales and Marketing expense for Q1 was $104 million. This reflects an increase of 69% or $42 million over last year with investments to drive future growth. As a percentage of total revenue, sales and marketing was 32%, a decrease from Q1 last year mainly due to strong topline growth. Overall, the increase in expense was attributable to record sales hiring and higher sales commissions due to strong execution, while we saw efficiencies in marketing. We are expanding our hiring plans for the rest of year to meet the opportunity presented in this new environment. G&A expense in Q1 was $49 million, up 196% on a year-over-year basis. It represented 15% of total revenue, up from Q1 last year, due to higher accruals for telco taxes from higher billings, a one-time license payment and external professional services. Non-GAAP operating income was $55 million, translating to a 16.6% non-GAAP operating margin for the first quarter. This compares to Q1 last year’s result of $8 million and 6.7% margin. Again, the higher revenue plus strong execution across all areas were the main drivers of this additional profit. Non-GAAP earnings per share in Q1 was $0.20 on approximately $295 million of non-GAAP weighted average shares outstanding and adjusting for undistributed earnings. This result is $0.10 higher than our guidance and $0.17 higher than Q1 of last year. Turning to the balance sheet. Deferred revenue at the end of the quarter was $552 million, up 270% year-over-year. Looking at both our billed and unbilled contracts, our RPO totaled approximately $1.1 billion, up 184% from $377 million year-over-year. The increase in RPO is consistent with the increase in demand and strong execution in the quarter. We expect to recognize approximately 72% or $772 million of the total RPO as revenue over the next 12 months, as compared to 64% or $240 million in Q1 of last year. We ended Q1 with approximately $1.1 billion in cash, cash equivalents and marketable securities, excluding restricted cash. In Q1, we had exceptional operating cash flow of $259 million, up from $22 million year-over-year. Free cash flow was $252 million, up from $15 million year-over-year. The increase is attributable to strong collections from topline growth, higher percentage of monthly contracts, as well as billings that started early in the quarter. Looking ahead, we expect to increase capital expenditures for additional data center infrastructure. And as a reminder, we will see the semi-annual cadence of net cash outflows from ESPP purchases to occur in Q2. Now turning to guidance, as I have mentioned earlier, the current environment has expanded Zoom’s market opportunities and outlook as the increase in demand propelled us to a higher growth trajectory than originally planned for this year. This requires us to recalibrate our original FY ‘21 plan for the new scale of our business. The COVID-19 pandemic added unprecedented new variables to our business model, where historical knowledge may no longer apply. Today, as we present our current best estimate of future quarters based on new assumptions of the dramatic shift in our business, we caution that the impact and extent of the crisis and its associated economic concerns remain largely unknown. Significant variations from our assumptions could cause us to modify our guidance. With that, we provide a higher outlook for FY ‘21 based on our view of the current business environment. For the second quarter, we expect revenue to be in the range of $495 million to $500 million. We expect non-GAAP operating income to be in the range of $130 million to $135 million. Our outlook for non-GAAP earnings per share is $0.44 to $0.46 based on approximately 299 million shares outstanding. For the full year of FY ‘21, we expect revenue to be in the range of $1.775 billion to $1.8 billion, which would be approximately 185% to 189% year-over-year growth. Let me now provide a bit more context on the assumptions behind our guidance. As I discussed earlier, we have a far higher portion of revenue attributable to new customers with 10 or fewer employees, who opted for monthly contracts. Historically, monthly subscribers have a higher churn rate compared to annual or multi-year subscribers. In addition, as governments start to ease shelter-in-place restrictions, we may see a moderation of demand for our services. Given our assumptions on higher churn rate as well as economic uncertainty, we are projecting Q3 and Q4 revenue to be relatively consistent with Q2. For the full year of FY ‘21, non-GAAP operating income is expected to be in the range of $355 million to $380 million. We expect to deliver non-GAAP earnings per share of $1.21 to $1.29 for the full year FY ‘21, based on approximately 300 million shares outstanding. In closing, we executed well in Q1 and are proud of how our team dedicated themselves to support our customers and global community. Thank you to the entire Zoom team. And everyone, please stay healthy and safe. With that, let's open it up for questions. 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.

Before our first question, actually, Eric has asked me to open the mic for him. Eric, I think you’re muted.

Yes, I am muted.

Okay. Our first question is from Alex Zukin with RBC.

Hey, Eric. Thanks for taking my question and thanks for everything you do. You just delivered one of, if not the greatest all time quarters in enterprise software history, I think you've been given an amazing opportunity with Zoom becoming not just a verb, but really the poster child for enabling remote work. But with that opportunity also comes a question, which is, where does Zoom go from here? How do we think about the percentage of your TAM that's been penetrated in the current environment? What are the most exciting incremental growth drivers? And do you have an update for us in terms of the long-term vision of your company, because it seems like the prior long-term vision were there? And I got a quick follow-up.

Alex, great questions. If we had time, I’d probably spend more time because I also want to get into what's the future. But anyway, I truly believe video is a new voice. Video is going to change everything about communication. The way for us to work, live and play is completely changed. From that perspective there's a huge opportunity, a lot of opportunities ahead of us. However, for now our top priority is to make sure we always keep our service up, because so many people are counting on Zoom to stay connected. Our top priority is to make sure we keep the service up, and to double down, triple down on privacy and security. And also down the road, we are going to figure out where we are going to double down on new growth areas. But for now, one thing we know for sure is the TAM is bigger than we thought before. It's a matter of how to capture that new TAM. There are many important and new opportunities; our team is going to work together, step by step. For now, number one is to focus on the current product and the user experience, and make sure during this pandemic crisis, hopefully it can end very soon, customers can leverage Zoom to stay connected.

Next question, please, Matt?

Our next question is from Sterling Auty with JP Morgan.

Thanks. Hi, guys. So Eric, maybe a technology question for you. You did your 90 day program and end-to-end encryption really became a big focal point of discussion around security and privacy. You made the acquisition. Can you update us on when you plan to deploy? And then the encryption, how will it be deployed? And is there actually an opportunity to monetize it perhaps as an upsell?

Yes, Sterling, that's a good question. Before I answer, I'd like to take a step back to share what the industry standard is today for conferencing: many vendors use AES 256-bit encryption, either GCM or CBC, that's a standard. The reason why if you enable end-to-end encryption, you cannot use your phone to dial in; you cannot support traditional, legacy, hardware-based H.323 and SIP devices. In addition, cloud recording is also not available or is limited with true end-to-end encryption. That's why most industry conferencing vendors do not support this feature today. However, we believe we need to support it. For customers who need the highest level of confidentiality, you should be able to enable a mode where Zoom does not have the session key. We do not want to charge customers for this feature. We intend to make it available at least to enterprise or business customers; we will likely not offer it to free users. We also want to work with law enforcement, such as the FBI and local authorities, in cases of misuse. We published a whitepaper about a week ago and received a lot of feedback; the team is working on execution now and we will announce a release date soon. For now, we are reviewing feedback and have confidence this will be a very good feature for our enterprise customers.

Thank you.

Great. Next question please, Matt?

The next question is from Nikolay Beliov with Bank of America Merrill Lynch.

Hi, can you guys hear me? Kelly, happy birthday, and look forward to chatting with you on Thursday at our conference. My question is I would like you guys to provide us with a little more context on the guidance. I was wondering what trends you saw in the business during the month of May. And what gives you confidence that those prosumers, increasing the mix from 20% to 30% are going to stay for the rest of the year? Just trying to get more color around the confidence in the guide.

Yes.

So in the guidance what we have considered, especially around those prosumers — the monthly users — we assume that churn will be elevated compared to historical norms. We have assumed multiples of what the historical churn rates have been. We have also taken a conservative approach given potential uncertainty around the economic environment. With that said, I want to make sure you understand that while we did see an increased growth of monthlies — about half of our sales in the quarter came from monthly subscribers — when you look at sales from our direct sales organization, the percentage of monthly subscribers was consistent with historical. So we didn't see an increase in monthly subscribers in the up-market; we saw the same percentage as we have historically. Those typically, when annual or multi-year, have a churn rate that is a fraction of monthly subscribers.

And Kelly, in this context, if I may ask a follow-up, billings grew 350% and CRPO grew around 220%. Why the discrepancy here? And what does it mean to revenues? And how revenues flow through from CRPO and billings?

So, thank you for the question about billings and RPO. As you know, we don't provide specific guidance around billings or RPO. Given the fact that growth has been exacerbated with the increase in monthly subscribers, those metrics are very difficult to interpret. They are less meaningful because of the high-rate of monthly billings and subscribers. They're just not good metrics for us in this environment.

Got it. Thank you.

Next question, please, Matt.

Our next question is from Alex Kurtz with KeyBanc.

Yes. Thanks. Zukin’s earlier question about growth opportunities, kind of a once in a lifetime opportunity to reimagine investments in new products, new sales coverage. And I mean, just look at your operating income this quarter next quarter, you couldn't have imagined that at the time of the IPO. So as the team and the Board look at the next 12 months, is there something that you guys are really laser-focused on that you could take all this extra cash flow and reinvest back into the business?

Yes, Alex, that's a great question. Even before this pandemic crisis, we offered not only video conferencing but also Zoom Phone. Voice and video together are key parts of one service, and that's a huge opportunity. The pandemic accelerated video adoption and brand recognition and introduced many new use cases, like online education and telemedicine. We would like to double down on those areas. In terms of specific opportunities, we will be working on that in the next several months. For now we need to ensure we continue helping people stay connected. Another thing we know for sure is the way we will work in the future will be different, and we need to focus on the whole new experience to ensure a consistent experience whether you're in the office or at home. Many innovations will come from that. I believe there are many opportunities, but we must be careful to choose where to double down and where to work with partners to develop applications or leverage opportunities on our platform.

Thanks. And then a quick question for Kelly. In the areas where they've been lifting the quarantine, the shelter-in-places, have you seen any kind of change in churn in those regions whether it's in the U.S., Europe or Asia?

It's really too early to tell, Alex. We've taken a conservative approach to modeling that, but it's too early to tell as most places even when they're starting to ease shelter-in-place, people are taking their time to go back to work.

Next question, please, Matt.

The next question is from Phil Winslow with Wells Fargo.

Thanks for taking my question. Two questions. First for Kelly, then one for Eric. Kelly, when you think about retention, that's something that's come up a lot on this call. What programs you have in place to make sure that all these users that you've added stick to the platform? I’m wondering if you can talk to us through the programs you’ve had in place. And then also Eric, would you think about Zoom Phone and particularly not just retention but also upsell Zoom Phone, a similar thing, what is going to be the messaging to customers? How do you think about the potential in a year from now, six months from now et cetera attaching a full unified communications suite to that video customer?

Yes. In terms of retention, for all of our customers, new and existing, we have a strong customer success team focused on ensuring training and usage adoption happen for all of our customers. We're also looking for opportunities with monthly subscribers to offer them incentives to upgrade to annual contracts and helping them evaluate options as well.

Philip, on the phone question: as I mentioned earlier, we believe voice and video will be key parts of one unified service. For example, a large global pharmaceutical company that was a heavy Zoom video customer deployed Zoom Phone in Q1 — an 18,000-license phone deal — because they liked a single consistent experience. There's a lot of opportunity. Many enterprise customers still have on-prem and PBX solutions; the pandemic has accelerated migration to cloud PBX. So we see a huge opportunity ahead of us.

Great. Thanks, guys. I do appreciate you enabling my kids to still go to school.

Thank you. By the way, I like your background — pretty nice.

Thank you. Branding, marketing.

Great. Next question please, Matt.

Our next question is from Pat Walravens with JMP.

Great. Thank you. And happy birthday, Kelly.

Thanks Pat.

So Eric, you started as an enterprise company, but now so many individuals are using Zoom to connect with their friends and their families and their classmates. When I go to say goodnight to my daughter at night, I get a lot of “Daddy, I'm talking to my friends, come back later.” So how is that changing your strategy going forward? What's your consumer strategy?

That's a great question. My kids also use Zoom for their online classes. I believe video is like a new voice: whether you're using a phone call or video call, the experience should be consistent across devices and contexts. Given that video conferencing is becoming mainstream, the boundary between prosumers/consumers and enterprise customers is less clear. We need to maintain a very consistent experience. Many features we build for enterprise customers can be used by prosumers and consumers, but we must ensure enterprise-level security features are available and can be enabled easily for consumers when appropriate. We are not pursuing a separate consumer strategy; our strategy is to offer one service that helps everyone stay connected, regardless of device or use case. That's a huge opportunity.

If I can ask Kelly a quick question. And thank you, Eric. I know sometimes when you are replacing a competitor and they have an existing contract, you sign up the customer, but then you let them have however many months are left on the competitors' contract for free? When you do that, how do you account for that? Does that count as one of your new customers? And does that have any impact on billings or RPO?

So we do count them as a new customer. Under ASC 606, the revenue gets amortized over the full period including the free periods.

Okay. And so that would go into billings to them?

Yes. We bill them upfront and defer revenue over the contract period; it depends on what their period is, but yes, it's part of billings.

Thank you very much.

Next question, please, Matt.

Our next question is from Meta Marshall with Morgan Stanley.

Great, thanks. I just wanted to ask a question on, as you go forward with hiring salespeople. With the influx in new customers, do you change from looking for more gatherers versus hunters? And just as you look to layer on Zoom Phone, is the channel strategy still as important or as an overlay sales team more important going forward? Thanks.

So on the one hand, we already doubled down on sales hiring starting late last year and made very good progress in Q1. We are hiring not only hunters — account executives and quota-carrying reps — but also roles like SDRs. For Phone, it's different: historically our video business was driven by direct sales, but Phone requires a different go-to-market. We are shifting focus to embrace our partner programs, like master agents, which helped us a lot in Q1. We'll do more with partner deals and channel sales for the phone business. The team is working hard on that.

Got it. Thanks, and congratulations.

Thank you.

Thank you. Matt, next question, please.

Our next question is from Heather Bellini with Goldman Sachs. Heather, can you unmute?

Great. Sorry about that. Look, I just wanted to say first of all, thank you for the company and with your steering acting the way it did over the last few months, which has been just such a trying time for so many. But not only obviously did you enable all of us to stay in touch and working, but just being able to still connect with family and friends. So thank you, I think on behalf of everybody. My question has to do with your view — and you've been asked a little bit about the Zoom Phone cross-sell opportunity here. And I know you've touched on it a little bit already. But I'm interested in a little bit about your vision on how you can expand your offerings given how much broader your customer base is now. So the two parts are: what are you seeing in terms of uptake of Zoom Phone? Is there anything you could share with us about penetration rates or the seat count that you're at now, or maybe just how you might have seen adoption inflect in the quarter? So anything around that just so we can see how that's starting to take off given how many more new customers you've added? But also when you look at this evolving collaboration market, what's next for you all? Because you have phone, you obviously have video. Should we expect a chat service at some point just so we could close the loop on the entire messaging experience? So any thoughts you have there? Thank you so much.

Thank you, Heather. Maybe Kelly can address the phone uptake and I will address the broader product direction.

So the primary demand and focus of our new customers and expanding customers in Q1 was really ensuring business continuity. They were focusing mostly on the video communication platform. But as our focus for Zoom Phone is to step-sell into our existing installed base, it now creates a huge opportunity for more sales in Q2 and the rest of this year. So we're really looking forward to that team having an expanding customer base to sell to.

To answer your second question: if you look at the video collaboration business, the TAM is bigger. Adding Phone together is also a huge market. We also have an online business component which used to be a small portion of our net MRR growth, but the popularity of video conferencing has broadened use cases, including online learning and classes, and creates more opportunity to monetize with online subscriptions and services. We will not pursue an advertising model, and we will never sell customer data. In terms of other services like chat, we already have chat functionality, and we integrate with Slack and Microsoft Teams and with providers like Dropbox and Box. Our approach is open and flexible: integrate and interoperate with best-of-breed providers, and focus on our core DNA of video and voice for enterprise and prosumer customers.

Matt, next question please.

Next question is from Walter Pritchard with Citi.

Hi thanks. A question for Kelly, I'm wondering if you could help us understand on the churn side, obviously unprecedented demand for those under 10 employee monthly type customers. Any order of magnitude you can put around the sort of churn versus what it's been historically that you're thinking about in the forecast? And then I had one follow-up.

All I will say is that we're taking a very conservative approach, assuming that historical norms don't necessarily apply to this new cohort, both from the magnitude as well as the potential around economic uncertainty. The way we're forecasting it is using multiples of the historic churn rates.

And then maybe as you get into — the obviously next quarter is going to be just sort of more of what you have this quarter in terms of a full quarter of all the business. But as you think about then the quarters beyond that, how do you think about just a sustainable level of new customer adds? I mean, do you feel like what's happened here has pulled forward multiple years of demand? Or do you think it has opened up awareness so much to what you do that you could actually see higher levels of new customer adds as we get past this big bump up that we've seen with COVID?

We certainly have seen a lot of pipeline creation in Q1 and early Q2, which is positive. Remember that our selling strategy around Zoom Phone and Zoom Rooms is to land in customers and expand into them. This quarter's new customers create a whole new pool of potential buyers for those future products.

Thank you, Walter. Next question, please Matt.

Next question is from Zane Chrane with Bernstein.

Thank you, guys. Eric, Tom, Kelly and everybody at the Zoom team, I just want to say thank you for your corporate leadership and the role of corporate citizenship that we all needed during this time, especially the things that you guys have done in the educational space. I'm wondering, how do you think about balancing the data security and privacy concerns versus ease of use? It seems like that's always a balancing act where if you lean too far one way or the other, you're going to upset one type of customer, and that becomes even more complex now that you're heavily moving into the consumer space. How do you balance that from a technological and user interface perspective? And then I have one follow-up.

That's a great question. Our service was built for enterprise customers with many security features, and enterprise IT teams normally enable or disable settings via an onboarding process. During the pandemic, we had many first-time users and as CEO I should have done a better job anticipating that we would also need to play an IT role for those users. That was a mistake and a lesson learned. For enterprise customers, security features should be enabled and available; for prosumers it's different. When there's a conflict between privacy/security and usability, privacy and security are more important. For example, adding an extra click or two may reduce ease of use, but if it protects privacy, we will do it. At the same time, we are hiring security researchers and engineers to improve security while minimizing impact to ease of use. It's an ongoing effort and we are committed to being both secure and usable.

Very helpful. And just a quick follow-up to what Heather was asking. She mentioned chat; I've been thinking, is there opportunity for embedding more cloud-based storage or file sharing to enable more real-time collaboration and file editing while on a Zoom call? Is that something you guys have considered? Or, I know you have a partnership with Dropbox. Is there something that would maybe make sense to build out yourself or even acquire some capability along those lines?

Yes. We already announced partnerships with Dropbox and Box, and we support Google Drive and OneDrive as well, allowing seamless file sharing from those cloud providers within the meeting interface. We focus on the customer experience and on integrating and interoperating with best-of-breed providers. Our core remains video and voice, and we will continue to integrate useful collaboration features through partnerships and integrations.

Thanks Zane. Next question, please, Matt.

Our next question is from Bhavan Suri with William Blair.

Hey guys, thanks for taking my question. I just have one: it's really around competition. In the last few months, given your success and given COVID, we've seen BlueJeans being acquired, and other moves like RingCentral announced their own video solution. I'd love to understand — none of these actually imply anything immediately material in the competitive environment — but how do you think about navigating through this and differentiating? Obviously, the scale you have is a differentiator. But how do you think about the competitive technology differentiation in the space?

Look at the competitive landscape: the pandemic hasn't changed our focus — we remain laser-focused on video and also on voice with Phone. The market opportunity is larger now. Competition is good for consumers; it drives innovation. If we keep focusing on delivering quality, reliability, and innovation, and listening to customers' use cases, we can continue to compete effectively. Video and voice that work 24/7 at scale with strong features is not easy, so best-of-breed providers will continue to have an advantage if they keep innovating and executing.

Next question, please?

Our next question is from Ryan MacWilliams with Stephens.

Thanks for taking the questions. I attended a Zoom wedding last month and it went great. And my own wedding in September might be over Zoom. So I just want to say thank you for providing a backup plan there. Really a standout quarter and congrats on the execution. For Kelly, for the second quarter, would you expect new recurring revenue added in the second quarter to be above the recurring revenue added in the fourth quarter of last year? I just have one follow-up.

New recurring revenue in Q2 to be greater than Q4, yes, based on the outlook, I think it will increase relative to Q4.

Perfect. And then Eric, on addressing Bhavan's last question, you mentioned in your comments that enterprise communications continue to be a fragmented market with low overall cloud penetration rate. But with both competitors and customers now trending towards one platform for cloud video and voice, over the next few years, do you see this market consolidating around maybe one to two competitors for enterprise applications?

It's too early to tell. I believe best-of-breed service providers will survive and thrive. Customers want services that just work anywhere, anytime, on any device. It's not easy to provide that reliability and continuous innovation. If we keep listening to customers and innovating to meet use cases, even with many competitors, we can continue to serve many customers. The market is huge and there's room for multiple successful vendors.

Great. Thank you, Ryan. Can we have the next question please, Matt?

Our next question is from James Fish with Piper.

Hey, thanks for the question. Kelly, happy birthday. I’d agree that June 2 is the best day of the year in my humblest of opinions. You guys talked about churn in the second-half of the year. I think if you look at some verticals like education or some consumer additions that you guys had in the quarter as potentially not sustainable in terms of that 300 million users. How should we think about that 300 million user number in terms of all added in education for example?

I want to clarify that the 300 million number is daily participants, both free and paid. That was the peak we saw in April. It has come down a little in May on average, but we still continue to see a high level of usage from both free and paid users. Over the long term, we expect usage to grow beyond that 300 million number.

By the way James, those 300 million meeting participants is not unique participants — if someone joins multiple times in a day, they are counted multiple times, for both free and paid users.

Totally understand. And then just a quick follow-up, it's the eighth quarter in a row plus 130% net dollar retention. But could we get more color there as to how much stronger this quarter was from an upsell rate compared to the past few quarters?

We've committed to providing the metric of being greater than 130% because it does bounce around for each period, and we don't want you to read too much into small period-to-period changes. That's the guidance we're providing today.

Got it. Thanks and congrats again.

Matt, next question, please?

Our next question is from Ittai Kidron with Oppenheimer.

Hello, great quarter and happy birthday, Kelly. Fantastic. I had a couple of questions. First on the Global 2000, you talked about how it grew 200% quarter-over-quarter. Those are generally very sophisticated organizations with a lot of IT dollars and they move very quickly. My question is, as penetration increases with meetings at that point, where do you need to be given how fast they usually move? And then the second question related to phones: considering the environment, is it helpful in accelerating phone adoption or perhaps the other way around given many organizations already have established phone systems and people are using their cell phones from home?

We don't disclose specific penetration metrics for the Global 2000, but good news is penetration is not as high as you might think. So we still have lots of opportunity to grow in that segment even with the strong quarter-over-quarter growth. Regarding Phone, given our land-and-expand strategy and the significant increase in new customers this quarter, there's a lot of opportunity to sell Phone into our installed base. Phone remains the last major area of IT moving to the cloud, and as customers come to trust the ease of use and reliability of Zoom, Phone becomes a natural next step. We don't believe COVID should be an inhibitor to that.

To add: if Phone is just a separate service, many users might not adopt it because they have cell phones. But if Phone is part of the same unified video service, offering the same consistent experience, adoption increases. Our architecture and product vision treat Phone and Video as the same service, which presents a different and large opportunity.

Very good. Good luck guys.

Thank you.

Thanks, Ittai. Matt, next question, please.

The next question comes from Will Power with Baird.

Great. Thanks for taking the question. I wondered if we could drill down a bit into the education segment, either in terms of revenue, or paid users. Something to give us some context. And how you're thinking about education in the second-half of the year as we get back to school? Obviously, still a lot of uncertainties around that. And I guess the other part to that is, are there any learnings from some of these countries where they've gone back to school in terms of usage, whether South Korea or elsewhere?

We don't break out revenue by vertical, but I can tell you education was the fastest-growing vertical on a quarter-over-quarter basis. We saw very strong demand there. Looking forward, many universities and schools have announced plans to host classes remotely in the fall, so we expect demand to remain strong even as some shelter-in-place restrictions ease.

We offer free services to more than 100,000 K-12 schools globally. After the summer, we will work with schools on how they use Zoom for classes. For now, the immediate priority was to support K-12 and higher education during the crisis, and we will continue to work with them on their plans going forward.

Great. Thank you. Hey, Matt, we have time for probably one more question, please.

Well, our final question then will be from Tom Roderick with Stifel.

Here we go. We'll get the mute off. Hi everybody. Thanks for taking my question, I appreciate it. So, a lot of the questions have been asked about the topline, but you had to scale up massively in a way that 90 days ago, we couldn't possibly have expected this. You started to see a little bit of this in China and perhaps Europe at the time of the last call. So you had some awareness, but Kelly, even at that time, you were talking about gross margins in the 80% range. Can you just talk a little bit more about what you did? And how you managed to scale that business up so quickly? And then would love to hear just about the elasticity of that going forward to the extent that some of the monthly users do churn. Do you have the ability, and this may actually interact with the Oracle partnership that was announced late April, to scale up and scale down quickly? We'd love to just hear a bit more about that ability to scale up and scale down and how quickly you can do that?

First of all, huge thanks and credit to the entire Zoom employee base. Many people worked extended hours and weekends to support customers and increased demand. Also thanks to our partners who helped us scale up when it was difficult to forecast capacity needs. In terms of gross margin and scaling, we added public cloud capacity, which increased costs in the short term, and over time we'll add more capacity in colocation facilities to moderate gross margin impact. In other areas we scaled up with third-party resources to help us quickly, and over time we'll backfill those with direct employees which is more cost-effective. That combination helped us meet the unprecedented increase in demand.

Tom, during this crisis our top priority was corporate social responsibility: to help people stay connected even if it increased costs in the short term. We will return to focusing on gross margins as the crisis subsides.

Thank you, all. It's been a unique 90 days, so looking forward for next 90. I appreciate it.

Thank you, Tom.

Eric, do you have any final closing remarks before we turn off the webinar?

Yes. I want to say just, thank you all, thank you every Zoom employee, thank you all the users, customers, thank you for your trust. Thank you for our shareholders. We will do all we can to truly deliver happiness to you. We will not let you down. Thank you for the support and I truly appreciate it.