Zoom Communications, Inc. Q1 FY2022 Earnings Call

Hello, everyone and welcome to Zoom’s First Quarter Fiscal Year 2022 Earnings Release. I’d like to remind everyone that this call is being recorded. At this time, I would like to turn it over to Tom McCallum, Head of Investor Relations.

Thank you, Matt. Hello, everyone and welcome to Zoom’s earnings video webinar for the first quarter of fiscal 2022. 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 at investors.zoom.com. Also on this page, you will be able to find a copy of today’s prepared remarks and a slide deck with financial highlights that, along with our earnings press 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 second quarter and the full fiscal year of 2022, Zoom’s growth strategy, business aspirations to lead the evolution to hybrid work and the continued impact of the COVID-19 pandemic on our business. 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, which we discuss in detail in our filings with the SEC, including our Annual Report on Form 10-K as well as the current report on Form 8-K we filed with the SEC today. Zoom assumes no obligation to update any forward-looking statements that we may make on today’s webinar. And with that, let me turn it over to Eric.

Thank you, Tom and welcome everyone joining us on today’s webinar. I want to start by thanking our customers for their commitment to and trust in Zoom, which drove a strong start to our fiscal year with revenue growing 191% year-over-year as well as strong profitability and free cash flow. I also want to recognize our more than 5,000 employees. Their dedication to our customers’ happiness is an incredible advantage and creates a positive feedback loop that keeps our customers coming back and our employees eager to meet their diverse needs. Our ability to help our customers by increasing their productivity, promoting their employees’ happiness and connections to each other and reducing their travel-related carbon footprint gives our work great meaning and makes Zoom a great place to work. Our company culture is strong and we are more motivated than ever. Let me also thank all of you, our investors, for your trust and support. So we are very grateful to our employees, our customers, partners and our investors. Thank you. As parts of the world reopened, a few things are clear. First, many customers I talk to are looking to create hybrid solutions as they seek to cautiously reopen some offices; and second, each industry, company and individual varies in their optimal working model. Zoom is here to help each customer calibrate their future working model in their own way. Many companies are redesigning the workplace to enhance the hybrid work experience. So, to meet this need, we announced Zoom Rooms features such as Smart Gallery, which puts in-room and remote participants on equal footing, virtual receptionist, participant counting, and environmental sensors. We have begun to deliver on our platform strategy. In February, we launched our Video SDK. In April, we announced our $100 million Zoom Apps Fund to further build our app ecosystem. Zoom Apps is designed to enable users to bring their favorite apps directly into the Zoom experience in a way that inspires collaboration, boosts efficiency, creates healthier habits and generates much more fun. We will also launch Zoom Events, our events platform, which will be focused on our enterprise customers and support an array of virtual event use cases. In a recent study we conducted, 80% of U.S. respondents agreed that all interactions will continue to have a virtual element post-pandemic, and that figure was even higher in many of the other markets we are serving. The hybrid model is here to stay and Zoom Events will be an excellent solution for our customers who are looking to create and host their company events with a versatile and powerful solution. We are very happy to announce that we closed our largest deal ever in terms of ARR, with a leading global financial services firm that selected Zoom Meetings to deploy for over 90,000 hosts. That is only one of the large deals we closed this quarter. Let me recognize three more industry-leading companies that have increased their commitment to Zoom. First, I want to thank Kimberly-Clark, whose trusted brands are an indispensable part of life for people in more than 175 countries, for expanding the relationship with Zoom by adding approximately 25,000 Zoom Phone licenses. As an existing Zoom Meetings and Video Webinar customer, Kimberly-Clark saw the same reliability, value and innovation in Zoom Phone. I also wanted to recognize our partner, British Telecom, for advocating for Zoom in the decision-making process at Kimberly-Clark. Next, thank you, Target Corporation, which serves guests at more than 1,900 stores and online at Target.com with the mission to help families discover the joy of everyday life for their commitment to Zoom. We are very excited to help Target take their communications initiatives to the next level by expanding their Zoom platform solution while unifying their internal and external communications on our technology. As a longstanding Zoom Meetings customer, we truly appreciate their trust and faith in Zoom as a platform and partner. And finally, I want to thank Denso, Japan’s largest and the world’s second largest automotive parts company, and a leading company in the Toyota Group. They first joined the Zoom family last year, but last quarter, they decided to significantly expand their usage of Zoom Meetings and Zoom Video Webinars for internal and external communications. Zoom now connects 47,000 employees across offices, factories and homes. Denso said the introduction of Zoom has contributed greatly to our ability to create a work environment that drives faster decision-making. Kimberly-Clark, Target and Denso, thank you. Love you. We are off to a great start in fiscal 2022. I look forward to updating you on our hybrid workspace and a platform evolution throughout the year and at Zoomtopia, which will be held on September 13 and 14 in a virtual format. Before handing it over to Kelly, I want to share a quick update. As you know, demand for Zoom Phone has been amazing and I am very excited to announce our new device category, the Zoom Phone Appliance. I have invited Graeme to tell you more. Thank you.

Thanks, Eric. Hi, everyone. I am Graeme Geddes. I am the Head of Zoom Phone and Zoom Rooms and I am excited to be joining the call today from, you guessed it, my Zoom Phone Appliance. Our new Zoom Phone Appliances allow our customers to take advantage of the powerful audio and video capabilities of Zoom and they are a great solution for touchdown spaces, huddle rooms and executive offices alike. We also can’t wait to see some of the vertical applications that our customers come up with for this new category as well. And while I am here, I have got some exciting news to share. I think I will use the whiteboarding feature of this device. So at the end of December, we announced reaching 1 million seats of Zoom Phone sold. Well, that momentum continues and I am excited to announce that we have now surpassed 1.5 million seats of Zoom Phone sold as of the end of September. It’s been absolutely amazing to see the growth continue to accelerate. Thank you for allowing me to join you today. And now, I will turn it over to Kelly.

Thank you, Graeme and thanks to you and your team for your hard work and for that amazing accomplishment. Hello, everybody. Our impressive growth story continued in Q1. As you can see, we continued to win awards and third-party recognition for our strong security focus, empowering company culture and lasting impact on society. Thank you to all of our amazing customers and employees who made these accolades possible. In Q1, the year-over-year growth of total revenue remained strong at 191%, reaching $956 million. The top line results exceeded the high end of our guidance of $905 million due to strong sales and marketing execution, led by our direct and channel businesses as well as lower than expected churn. Demand was widespread across products, industry verticals, geographies, new logos and customer cohorts. It’s also worth noting that our fiscal 2020 results have shifted our renewal seasonality, which is now more weighted towards the beginning of the year. To illustrate, we saw approximately 4x more deals up for renewal in Q1 of FY ’22 as compared to Q1 of last year. Our renewals, sales and online marketing teams really outperformed in their differing renewals and the success is a testament to their hard work and our product’s strong and lasting value proposition. 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 57% of the incremental revenue and existing customers accounted for 43% of the incremental revenue. This trend towards existing customers was expected considering the tremendous growth in our base last year. Let’s take a look at the key customer metrics for the quarter. We saw growth in the up-market as we ended the quarter with 1,999 customers generating more than $100,000 in trailing 12 months revenue. We exited the quarter with approximately 497,000 customers with more than 10 employees, adding approximately 30,000 customers during the quarter. In Q1, customers with more than 10 employees represented approximately 63% of revenue. We also continue to benefit from solid growth in our segment of customers with 10 or fewer employees. In Q1, customers with 10 or fewer employees represented approximately 37% of revenue, up from 30% in Q1 last year and stable quarter-over-quarter. Our net dollar expansion rate for customers with more than 10 employees exceeded 130% for the 12th consecutive quarter as customers acquired more Zoom Meetings, Rooms, Webinars and Phone products. For this customer subset, we expect the net dollar expansion rate to remain above 130% for the next few quarters. For customers with 10 or fewer employees, which are not included in this net dollar expansion metric, we expect that cohort to be lower than FY ’21 and more volatile as economies continue to reopen. Both domestic and international markets had strong growth during the quarter. Our Americas revenue grew 159% year-over-year. Our combined APAC and EMEA revenue grew 288% year-over-year to be approximately 34% of revenue, up from 25% a year ago. In recent quarters, we made significant investments in our international teams, which have already begun to pay dividends. The global opportunity remains large and we will continue to empower our team to capitalize on it. Now, turning to profitability. The increase in demand and strong execution drove net income profitability 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 and net litigation expenses. Non-GAAP gross margin in the first quarter was 73.9% compared to 69.4% in Q1 last year and 71.3% in Q4. The sequential improvement in gross margin is mainly due to optimization of public cloud resources. We expect gross margin to remain relatively stable in the low 70s as long as we continue to support free K-12 education. Research and development expense grew by 97% year-over-year to approximately $41 million. As a percentage of total revenue, R&D expense was approximately 4.3%, which is lower than in Q1 of last year, mainly due to the strong top line growth. However, on a quarter-over-quarter basis, expenses grew by 33%, demonstrating our commitment to building out our engineering teams globally and maintaining best-in-class product and innovation. Sales and marketing expense grew by 84% year-over-year to $191 million. This reflects an additional $87 million over last year primarily due to investments in hiring to drive future growth. Sales and marketing expense was approximately 20% of total revenue, a decrease from Q1 of last year, mainly due to strong top line growth. We plan to continue to invest in adding global sales capacity and brand and product marketing programs in order to capitalize on our growing leadership position and growth initiatives. G&A expense in the quarter grew by 51% to $73 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 7.7% of total revenue, a decrease from Q1 of last year. Revenue upside in the quarter carried through to the bottom line, with non-GAAP operating income of $401 million, exceeding our guidance. This translates to a 41.9% non-GAAP operating margin for Q1, a large improvement from 16.6% in Q1 last year and a slight improvement from 40.9% in Q4. Non-GAAP diluted earnings per share in Q1 was $1.32 on approximately 305 million non-GAAP weighted average shares outstanding. This result is $0.35 above the high end of our guidance and $1.12 above Q1 of last year. Turning to the balance sheet, deferred revenue at the end of the period was $1.1 billion, up 98% year-over-year from $552 million. Looking at both our billed and unbilled contracts, our RPO totaled approximately $2.1 billion, up 94% year-over-year from $1.1 billion. We expect to recognize approximately 72% of the total RPO as revenue over the next 12 months, consistent with the level of this metric last year. It’s important to remember that deferred revenue and RPO trends are not reliable predictors of future revenue growth due to the large percent of monthly billings in our customer base. In addition, the timing of our renewals has increasingly shifted to the beginning of the fiscal year, with Q1 now representing our largest renewal quarter. We expect sequential increases in deferred revenue and RPO in each of the remaining quarters to be lower as our available population of annual renewals is smaller. We ended the quarter with approximately $4.7 billion in cash, cash equivalents and marketable securities, excluding restricted cash. We had exceptional operating cash flow in the quarter of $533 million, up from $259 million in Q1 of last year. Free cash flow was $454 million, up from $252 million in Q1 of last year. The increase is primarily attributable to strong sales execution and collections. Looking at the rest of the fiscal year, we expect to increase our capital expenditures related to ongoing data center expansion to support our growth outlook. We also expect a legal settlement, which will be disclosed in our 10-Q to be a cash outflow in late FY ’22. Now, turning to guidance. We are pleased to raise our outlook for Q2 FY ’22 and the full fiscal year. Please note that the impact and extent of the global pandemic still remain largely unknown. Our outlook is based on our current assessment of the business environment as well as our own research and conversations with customers. For the second quarter of FY ’22, we expect revenue to be in the range of $985 million to $990 million. We expect non-GAAP operating income to be in the range of $355 million to $360 million. Our outlook for non-GAAP earnings per share is $1.14 to $1.15 based on approximately 311 million shares outstanding. For the full year of FY ’22, we expect revenue to be in the range of $3.975 billion to $3.99 billion, which would represent approximately 50% year-over-year growth. We expect non-GAAP operating income to be in the range of approximately $1.425 billion to $1.44 billion, which would represent approximately 45% to 46% year-over-year growth. Our outlook for the non-GAAP earnings per share is $4.56 to $4.61 based on approximately 311 million shares outstanding. Before concluding, I am happy to highlight that we recently launched our ESG website, which can be found on our Investor Relations and corporate website. We also recently published our Social Impact report, which can be found on our Zoom Cares website. Giving back to the community has always been a key tenet of what we do at Zoom. We look forward to updating our investors as we continue along our ESG journey. 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, the entire 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.

And our first question is from Ittai Kidron with Oppenheimer. Ittai, you are on mute.

Congratulations on the milestone today, you announced 1.5 million. I am trying to think in the past, I think you launched Phone in early 2019. So it took, I guess, a couple of years to get to 1 million and then five months to add another 0.5 million. Although at the beginning, you didn’t have the global availability you have now and plus you weren’t pushing as hard at least in the beginning from the sales standpoint. So help me think about what is the pace of addition, Kelly, or should we peg this to about 100,000 per month addition? Is that — sounds like the more recent kind of track record here? And maybe also you can talk about the success of Zoom United, your ability to kind of bundle Meetings, Phone and Chat together. How much of your renewal activity comes in United right now versus maybe a quarter or two ago? How successful are you in that effort?

So, we are really excited about the momentum of Zoom Phone and it was great to have Graeme as a guest star today on our call. And what I think you are seeing and what you are gathering, Ittai, is that there is definitely increased momentum happening there. So, it took us seven quarters to get to that 1 million seats level. And then, yes, that was in December. So, it’s taken us about five months to add an additional 500,000 seats to that number. So, it doesn’t happen equally in each of those months, as you can imagine, there are trends at the end of the quarter, but we absolutely are seeing an acceleration in the momentum there and we are very excited about it.

And with respect to the United plans, how much of your renewal activity comes in this type of bundle form?

So absolutely, our salespeople take the opportunity when there is a renewal to talk about cross-selling and up-selling. In terms of the specific packages themselves, we aren’t going to disclose the actual breakout of that, but a lot of what you saw disclosed in the revenue coming from new customers is the opportunity they saw to up-sell either Zoom Phone or Webinars or Rooms as people are thinking about going back into the office spaces again.

That’s great. Thanks, guys. Good luck.

Ittai, just quickly to add on to what Kelly said, when it comes to Zoom Phone growth, what’s fascinating is that it’s about our product innovation, reliability, security, availability, all the very good features. There are so many customers, no matter which solution they deployed before, either on-prem or other cloud-based home solutions, they all like Zoom solutions.

Our next question is from Dan Bartus with Bank of America.

Hey, guys.

Hi, Dan.

Great to see you. Thanks for taking the question. So Kelly, you had modeled heightened churn in the first half of this year related to renewals coming up. Based on what you are seeing, what’s the reality? Do upmarket renewals really mean heightened churn or is it showing more of an enhanced expansion opportunity versus what you expected? And maybe just continuing with the churn theme on the other side of the business, the 1 to 10 employee base, I am just curious, what’s the latest of what you are seeing in the second half of this year and any reason to be more optimistic than when you started this year? Thanks.

So, we were really pleased. And as I said, great thanks to all of our renewals and sales and online marketing teams for their great work done in Q1 as we had a better-than-expected result in terms of not only retaining customers, but also up-selling them during Q1, especially in that cohort of customers with greater than 10 employees. So that’s really exciting to see as we expect that momentum to continue as we carry through the year. We see significant renewals also coming up in Q2 as well. In terms of the customer segment with fewer than 10 employees, as we mentioned in the prepared remarks, we are still expecting that to be more volatile as that’s a segment that we have seen over the last 15 months has reacted more quickly to the openings and potential closings of markets around the globe.

Alright, great. Thanks guys.

Thank you, Dan.

Our next question is from Alex Zukin with Wolfe Research.

Hey, guys. Thanks for taking my question and congrats on another great report. I guess first for Kelly and then I have got a quick one for you, Eric. Kelly, the unending debate on the stock, I believe is that, what does growth look like in 2022? And I know that you are not going to guide there now and we understand the churn is an unknown factor. But can you help us better understand the trend that you do have control over today? Specifically, how much have you increased your quota-carrying capacity relative to pre-pandemic levels? What are you seeing on the productivity of the sales organization relative to pre-pandemic and what’s driving that productivity today?

So first of all, we continue to see tremendous opportunity. We were thrilled with the performance in the upmarket in Q1. As Eric just talked about, we had our largest deal to-date and we had some amazing customer wins. And so we are continuing to invest in our direct and our channel sales organizations, especially. And we have seen pretty consistent sales productivity. It’s going back to levels that are more reflective of pre-pandemic, but at an elevated level from there given the benefit we have of the global brand awareness, our expanded portfolio of products. And so we are really excited about the future, especially in that upmarket and international as well. As you heard, we are 34% of revenue internationally and then, of course, we look to Zoom Phone and the continuing momentum that we are seeing there.

And then, Eric, the return to office is on everyone’s mind. Looking at some recent articles, I think it’s on your mind as well. With that, it will be logical to think about Zoom Rooms as really starting to become a material growth driver in this new and developing hybrid world. Can you talk about what you are seeing from that product today? How do you think about the opportunity in terms of just the sheer number of conference rooms that are out there and what are your most forward-thinking clients doing today and how is that impacting the spend relative to that you are seeing?

Yes, Alex, that’s a great question. First of all, I want to say I am a fan of you, because you regularly update what’s going on in the SaaS market. Very well done, Alex. Thank you. I think when it comes to Zoom Rooms, that’s a huge opportunity, in particular, for every business when they are reopening their office, because the way to set up Zoom Rooms or the conference rooms are very different. They like, as I mentioned earlier, we have a Smart Gallery view, which puts Zoom participants and remote participants on equal footing. That kind of experience I did not see requested before. But in the future, more and more of that, a lot of innovation is on Zoom Rooms. I would say this is probably the third revenue driver in terms of usage and lots of new use cases. Also, what’s more important is that when it comes to the conference room or Zoom Room setup, customers like a consistent experience meaning when they are back at home, because the future is about hybrid work. When they are working from home, they also want to have a consistent experience. That’s another reason why a customer not only deploys the desktop Zoom Meetings or Webinar, but also they like the conference room experience as well. So that’s another driver for our customers to standardize on the Zoom platform for Meetings, for Webinar and for Phone, again, a lot of innovation in the pipeline for Zoom Rooms.

Perfect. Thank you, guys. Appreciate the color.

Thank you, Alex.

Our next question is from Patrick Walravens with JMP Securities. He is joining through audio-only. Patrick, are you there? You can press star 6 to unmute yourself.

Hi, sorry, in the car. You don’t want to see that. Eric, I would love to hear what your — is there sort of like three strategic imperatives that you have for this year? I’d love to hear what you think they are?

Yes. So Patrick, drive safely. I want to share with you my personal priorities I shared with the company. For me, I think three top priorities as CEO: Number one is really make sure we focus on our company culture, to maintain the company culture and evolve it because we have so many new employees coming on board remotely. Number two is double down my time on the platform, the platform, the platform. It’s not only about video in the business, but also the overall platform. Last but not least, about some of the very big large and strategic deals, that’s more like my personal part. If you look at Zoom from a strategy perspective, first of all, I think how to make sure we support businesses reopening and reentering their offices. That’s very, very important. That’s why you see a lot of innovations around that angle, either the conference room or the Phone, or building the chat or meetings. That’s the first initiative. Number two is really about the international market expansion. There is a huge opportunity. From 25% to more than 30%, I think we do see a lot of opportunities from EMEA, APAC, Japan, a lot of opportunities, and we have to invest more. Last but not least is overall how to make sure our platform strategy works: how to double down on the platform driven by Zoom Events, Zoom Apps and our UC platform and also our HD capabilities. That essentially will set us up for future growth if we can invest more in our platform.

That’s super helpful. Thank you so much.

Thank you, Patrick.

Next, we have Sterling Auty with JPMorgan.

Yes, thanks. Hi, guys. Great to see you. I love the Zoom Pride logo. So first, just wanted to start out with, you added about $74 million in revenue quarter-over-quarter this quarter in about 30,000 customers. If I look at that same addition last quarter, it actually mathematically points to the average new customer being smaller this quarter than what we saw last quarter. Is that what you are seeing in the business or is there something else going on underneath those metrics?

I think that it actually depends on when in the quarter the renewals occur. Q1 has this very odd timing from last year, where the dramatic change in the business happened on March 15, so literally halfway through the quarter. So we don’t have the full benefit of all of those renewals yet in this quarter. You’re going to see it come into next quarter. Unfortunately, Q1 is always going to have that kind of funny phenomenon, because most people co-term with their original date, which was sometime after March 15 in last year.

Got it.

Also, Sterling, I would like to add a little bit more. If you look at Q1 or Q2 last fiscal year in terms of revenue growth, it was driven by a lot of online buyers like consumer SMB business. Starting this fiscal year, we do see it driven by large enterprise customers and Zoom Phone as well. We closed our largest ever deal. This is a very good sign. I think this is a future trend driven by our business customers.

That makes sense. And then maybe one quick follow-up, can you give us an update on your plans and where you are to monetize on Zoom Events?

Yes. Zoom has two parts. One is about corporate events. Another is consumer events. Our plan is to launch corporate events first. Essentially, we have so many webinar customers. They are looking for a lot of new innovations. They can’t run their annual user conferences entirely online without better tooling. That’s why we doubled down on an Events platform. We are going to focus on corporate events first. Later this year, we also want to address consumer events. If you have a Zoom Meeting host account, you can sell tickets and teach anything online. That’s the opportunity for the second half of this year.

Makes sense. Thank you.

Thank you, Sterling.

Our next question is from Meta Marshall with Morgan Stanley.

Great. Thanks. Kelly, you noted the gross margin pickup was largely due to gains and efficiency, but was there any contribution from students maybe returning to in-person and just less usage from students that’s worth calling out? And then second, you also noted that international is continuing to see traction from a lot of those channel investments you made at the time of the IPO. Just where are you on channel development in the U.S. versus international and how do you see that developing? Thanks.

In terms of the gross margin, it was really around continuing to optimize with our public cloud partners. As we have scaled up, we have had the opportunity to work with them on better pricing packages. And that’s really what that improvement is attributed to rather than seeing a dramatic shift yet in students going back to school. As we have talked about before, there is a pretty significant impact on gross margin due to the free K-12 program. What we expect is that benefit will come in over time. If all of a sudden schools were to go back in person, you would see a step function improvement in gross margin, but I expect that will more likely happen starting in the fall as more students are able to safely return. In terms of international expansion, specifically around the channel, we are focusing on our U.S. channel strategy first, especially around Zoom Phone and building out our master agent program and we are now working on building that out internationally. We are probably where we were in the U.S. a year ago or so—about a year behind in terms of our international channel strategy. There is opportunity ahead and our team is working on that now.

Great. Thanks, guys.

Our next question is from James Fish with Piper Sandler.

Hey, Kelly and Eric. Thanks for taking the questions and Kelly, actually happy early birthday tomorrow.

Happy early birthday to you too, James.

Thank you. Eric, you guys noted a win with Kimberly-Clark for Zoom Phone, yet one of your competitors really cites BT as one of their key partners. Are you penetrating those tech incumbents that could open up their installed bases more? I am specifically talking like an Avaya, for example, more than you were last year as well as what are you hearing with carriers about partnership opportunities?

I think, first of all, as Kelly mentioned, not only driven by our direct business team, when it comes to Zoom Phone, many of our customers already have strong relationships with carriers or partners or master agents and we are doubling down on those relationships. This has become very important to our Zoom Phone growth. Every time we work together with channel partners or carriers—take British Telecom for example—when they evaluate our service with potential prospects, after they experience Zoom, they appreciate the roadmap, the usability and integration with video meetings, webinars and the reliability and security. Compared with other cloud-based phone solutions, they really like our roadmap and our innovation. That’s why we are winning. British Telecom advocated for Zoom at Kimberly-Clark, which led to a large deployment. We see more deals like that as customers test our solutions. We have high confidence Zoom Phone is much more innovative than other solutions for many customers.

That’s helpful. If I can sneak in one more, obviously, some exciting announcements with Zoom Phone Appliance and other things the last few quarters. How do you think about chat functionality outside of the video experience as well as the broader customer experience and collaboration markets longer term?

When it comes to Zoom Chat, we have been building chat for many years. Some customers already standardize on Zoom Meetings, Zoom Phone and Zoom Chat. Our approach is to focus on the end user and the customer experience. Some customers prefer to standardize on a single vendor; others use different chat tools. We prioritize integration between chat, meetings and phone to provide consistent experience. We take an open-minded approach—no matter which chat solution they are using, we want to ensure a great integration experience.

Thanks.

Thank you. Next question is from Siti Panigrahi with Mizuho.

Hey, Eric and Kelly, good to see you. Thanks for taking my question. I want to dig into that 1,999 customers generating more than $100,000. So this was a big renewal quarter for you guys. I just wanted to understand what sort of changes you have done to drive such success there. And what have you learned so that it can apply into Q2? And then a little bit of color on what sort of growth in terms of users or cross-selling products you saw in that segment?

So, it was really a combination of both user expansion and cross-sell. As mentioned in the prepared remarks, we saw expansion in terms of users, some transition from active hosts to enterprise licenses as well as additional products being deployed. What we did to drive success was ensure our upmarket reps were aligned with the goal of renewing as many customers as possible this quarter. We had a special bonus program in place for them to help focus on renewals, and it really worked. That program is also in place for Q2. We’re looking forward to a strong renewals performance in Q2 as well.

Okay. And then quick follow-up: It’s impressive to see that 90,000-plus host customer. When you think of your addressable market and many enterprises are reopening, how many such large customers could you potentially close?

Well, when we look at the opportunity, it’s huge. For example, within the Global 2000 or Fortune 100, there is still relatively low penetration of customers paying us more than $100,000. In the Global 2000, we’re still under about 15% penetration for customers paying more than $100,000 annually. That represents a large opportunity ahead and our sales team is focused on those opportunities with regular check-ins. The potential is still massive.

Thank you.

Our next question is from Will Power with Baird.

Great. Thanks for taking the question. Eric, earlier you spoke to some of the areas of strategic focus for you and the team this year, particularly turning Zoom into a broader platform. As you look out over the next 3 years, putting Zoom Phone aside and Zoom Rooms, as you look at the SDK/API opportunity, Zoom Events, what gets you most excited in terms of the bigger growth opportunity? And within that, what are you thinking about contact center? We hear UCaaS providers talk about contact center. Where does that fit into the equation?

Will, that’s a wonderful question. There are many exciting areas, but the top priority for the next several years is Zoom Apps. Zoom is becoming a people-centric interface and many interactions need more context. Zoom Apps allow bringing applications into the Zoom experience—this is our marketplace strategy, together with the Video SDK and other integrations. That’s the most exciting opportunity. For contact center, this is part of our UC platform. That’s why Zoomtopia in September will have relevant announcements—stay tuned. We integrate well with partners like Five9, Twilio and others today. Contact center is a big market and an important part of our platform vision.

Looking forward to that. Thanks.

Next question is from Matthew Niknam with Deutsche.

Hey, guys. Thanks so much for taking the question. First, just on Zoom Phone — congrats on the success — can you give more color in terms of where you’re seeing some of the accelerating growth both in terms of customer cohorts and upmarket versus small business? And then talk about some of the geographic mix where you’re adding subs? And then just to go back to churn, particularly for the less-than-10 employee base, Kelly, can you talk about how that trended in the quarter relative to expectations and what’s embedded in your forecast for the second half of the year? Thanks.

In terms of Zoom Phone, we continue to see success across all segments. We’re excited about expansion into the upmarket: we currently have 21 customers with more than 10,000 seats of Zoom Phone, which shows momentum in enterprise. International was the fastest-growing geographic segment for Zoom Phone last quarter, so we’re seeing widespread momentum globally. Regarding the one-to-10 employee cohort, it has been the most volatile cohort. It grew significantly over the past year from about 20% of revenue to the mid-30s currently, and it’s more volatile because most of these customers buy on monthly plans which gives them flexibility. We modeled accelerated churn in that segment coming into the year and that is how we’re continuing to think about it for the rest of the year.

To add, when you look at Phone deployment today, many customers already had on-prem or other cloud solutions. Our growth is coming from replacing those with Zoom Phone—both on-prem replacements and migrations from other cloud solutions. Our solution’s modern interface, integration with video, and unified experience make it attractive. We see growth coming from nearly everywhere, but it’s only been two years since launch, so we’ll be able to share more details over time.

Got it. Thank you both for the color and congrats.

Thank you.

Our next question is from Karl Keirstead with UBS.

Thanks everybody. Kelly, congrats. $533 million in operating cash flow is great. I think investors extrapolate the gap between operating margins and operating cash flow margins. Given you raised full year operating margin guidance, is there anything happening in Q2 or Q4 that you would encourage us to keep in mind as we adjust cash flow estimates?

Thanks for asking, Karl. First, Q1 was our largest renewals quarter and due to heavy renewals last year, Q1 had the largest billings. That leads to exceptional fluctuations in that quarter. As we go through the year you should see the relationship between free cash flow and operating margin return to more normal pre-pandemic patterns. One exceptional consideration is that we do have eSBC purchases in Q2 and Q4, so there will be associated cash outflows when those purchases occur.

Okay. And then, Kelly, regarding the renewal front-loading and seasonality, is there anything else that distorts or changes seasonality and other metrics we should keep in mind?

The main impact is on billings and collections due to the renewals timing, which affects cash flow fluctuations. Beyond that, think about the concentration of renewals at the beginning of the fiscal year.

Next question is from Shebly Seyrafi with FBN Securities.

As kids go back to school, what kind of gross margin uplift are you thinking about is possible in the second half of the year? For example, you just hit 74%, are you thinking about a couple of points of uplift in the second half? And following that, you have a long-term target of 80% for gross margin. Talk about your expected timetable to get there.

In our guidance we have not modeled any benefit from return-to-school as we continue to support schools as long as needed. If schools were to all return to in-person quickly, you could see a couple points of improvement in gross margin, but more likely it will be measured over time, starting in the fall. Regarding the long-term 80% target, we haven’t set a specific timeline as the duration of free K-12 service needs remains uncertain.

Our next question is from Tyler Radke with Citi.

Hey, thanks a lot for taking the question. I loved the demo. I’m glad we didn’t have to write our questions using that white board in the webinar. So Kelly, I wanted to ask: strong revenue growth this quarter, but magnitude of upside relative to your guidance was smaller than we’ve seen the last four quarters. You called out better-than-expected churn, and customer adds look good. Was there anything unusual that held back more robust revenue upside relative to your guide? Or is this the new normal given you’re starting to lapse tough comps?

We’ve talked about this previously: we’re starting to lap tougher comps and we’re approaching almost $4 billion in revenue this year, becoming a very large company. We’re pleased with guidance of 50% year-over-year growth, but you should expect more normalized growth rates at this scale relative to earlier pandemic-driven expansions.

Great. Thank you.

Our next question is from Matt Stotler with William Blair.

Hi, guys. Good to see you, and thanks for taking the question. Given the conference going on, I’m sure this has been asked already. Zoom Events platform was great to see. Double-click on how meaningful the opportunity could be. Obviously, it makes sense and many companies have been hosting events on Zoom. But as you think about the broad opportunity with Zoom Events, any numbers or qualitative color would be helpful. Thank you.

Matt, the reason we built Zoom Events is customer feedback. Many customers already hosted Zoom Webinars and wanted better end-to-end tooling for planning, pre- and post-event engagement, and ticketing. Zoom Events is a natural migration for webinar customers and a new revenue opportunity for corporate events and prosumer/consumer events later this year. We integrate with payment providers and ticketing to enable hosts to monetize events. It’s both an experience and revenue expansion opportunity.

Thank you.

Next question is from Matt VanVliet with BTIG.

Hi, everyone. Thanks for taking the question. Thinking about the channel, how much of an opportunity is that for the video-only side versus primarily Zoom Phone driving most of the channel business?

Early on we sold a lot of meetings through direct, and we’ve continued to expand channel relationships across both Meetings and Phone. It depends on the customer—some buy through channel, others directly. A larger percentage of our Zoom Phone business comes through the channel, reflecting historical buying patterns, but we want to meet customers where they prefer to buy.

Okay. Thank you.

Thank you, Matt.

Our next question is from Taz Koujalgi with Guggenheim.

Hi, guys. Thanks for taking my question. On Zoom Phone, you’ve been selling through channel partners and direct as well. I had a question about the impact on margins when you sell through the channel versus selling directly because I’ve heard there is a lot of margin given to channel partners. So can you talk about the headwinds to margins for Zoom Phone when sold directly versus through a channel partner?

We have a channel program that we think is attractive and competitive. While there is some impact to margin when a channel partner is involved, we view that as a worthwhile trade-off to grow market share quickly. Overall, we believe the approach is sustainable long-term and supports top-line growth.

And one housekeeping question: Did you disclose the number of Zoom Phone customers this quarter? I think last quarter it was 11,000. Can you comment?

We did not disclose the number of Zoom Phone customers this quarter. We disclose on milestone bases and the next milestone where we are likely to disclose it will be at Analyst Day at Zoomtopia in September.

Thanks, guys.

Thank you.

Our next question is from Jonathan Kees with Summit Insights Group.

Great. Hey, thanks for taking my question and congrats on the quarter. I wanted to double-click on Phones and that you’re winning more and more business. Is that becoming a bigger part of wins versus replacing legacy on-prem phones? Are you seeing wins against other cloud providers? Any details on bake-offs between you and other phone providers would be great.

Sure. Two years in, since launch, the growth and adoption shows the product works. Many enterprise customers are rapidly moving from on-prem solutions to cloud. We are seeing wins both from replacing on-prem systems and replacing other cloud-based phone providers. Customers choose us because of trust, modern interface, integration with video, and unified experiences. We are competing successfully against other cloud providers, and we see customers switching to Zoom Phone for these reasons. Over time we’ll share more detailed metrics.

Thank you, Eric.

Our next caller is on the line — we are unable to hear your line.

I know I said my question was asked. Thank you. Congratulations.

And we have our next question from Rishi Jaluria with RBC.

Hey, Eric, Kelly and Tom, thanks so much for taking my questions. Nice to see continued momentum. I wanted to ask a philosophical question about hybrid work. It’s consensus that work will be hybrid, but definitions vary. What does hybrid work mean when you think about it and is there a particular model you think Zoom favors?

Rishi, to answer your question: hybrid work is about flexibility. Different businesses will define hybrid differently—two days in the office, three days, alternating weeks. The core is giving employees flexibility. Surveys show many employees, especially younger generations, want flexibility and companies that provide it will retain talent. Zoom’s role is to enable whatever model a company chooses by providing consistent, high-quality experiences across home and office.

Thank you.

We have time for one more question. That last question is from Tom Roderick with Stifel.

Hi, Eric, Kelly. Good to see you. Thinking back a year ago, you spent a lot of time on security improvements. It’s telling that we haven’t uttered the word security on this call much, but threats aren’t going away. Can you give an update on how you stay ahead on security? What’s next?

Great question. Zoom was originally built for enterprise customers, but the pandemic brought rapid consumer and K-12 usage. We take security seriously. We have increased our security and privacy resources significantly—nearly 200 people focused on those areas—and we continue to add resources. We ran the 90-day security initiative and we still run monthly security webinars and share transparently with customers. Security and privacy are now part of our core DNA: processes, features and road map. We’ve added features and controls, and we continue to innovate in areas like Zoom Apps security and app permissions. Many security companies and events standardize on Zoom, which also reinforces our focus and credibility. We will continue to double down on security to support future growth.

Great update. Thank you, Eric.

By the way, Tom, we recently looked at RSA Security Conference—they are using Zoom as well. We have many security companies who standardize on the Zoom platform, which underscores how seriously we take security.

And that was the last question we have time for today. Thank you, everyone, and thank you for joining us.

Thank you all. I really appreciate it. Thank you.

Bye, everybody. Thank you.