Earnings Call
Zoom Communications, Inc. (ZM)
Earnings Call Transcript - ZM Q2 2021
Operator, Operator
Hello, everyone, and welcome to Zoom's Second Quarter Fiscal Year 2021 Earnings Release. This call will be recorded. At this time, I'll hand it over to Tom McCallum, Head of Investor Relations.
Tom McCallum, Head of Investor Relations
Thank you, Matt. Hello, everyone, and welcome to Zoom's earnings video webinar for the second quarter of fiscal 2021. Joining me today will be Zoom's Founder and CEO, Eric Yuan; and Zoom'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, includes a reconciliation of GAAP to non-GAAP financial results. During this call, we will make forward-looking statements about market size and growth strategy, our estimated and projected cost, margins, revenue, expenditures, investments, growth rates, our future financial performance, and other future events or trends, including guidance for the third quarter 2021 and full fiscal year 2021, our plans and objectives for future operations, growth initiative strategies and the impact to our 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 the risks and other factors that could affect our performance and financial results, which we discussed 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 statement we may make on today's webinar. And with that, let me turn the discussion over to Eric.
Eric Yuan, CEO
Hey, Tom, thank you. Hello. I hope you are all doing well. I want to thank our customers, investors, and community for their support of Zoom. Their care, feedback, and trust in Zoom make a huge difference, and we grew our business from being a startup to a publicly traded company to be a long-term sustainable company. We might be facing all kinds of challenges, but no matter how busy we are or what challenges we are facing, we are always recharged when we think about our customers' support and become even more motivated to serve them better. With the pandemic persisting, we are very committed to working hard and are humbled by our role of enabling communications worldwide during this challenging time. As remote work trends have accelerated during the pandemic, organizations have moved beyond addressing immediate business continuity needs to actively redefining and embracing new approaches to support a future of working anywhere, learning anywhere, and connecting anywhere. We continue to see meaningful adoption of Zoom's video-first unified communication platform across industries and geographies. Let me share with you just a few key metrics that reflect this. Revenue grew 355% year-over-year in Q2. Customers with more than 10 employees grew 458% year-over-year as new customers chose Zoom to be their preferred communication and collaboration solutions. We had over 35,000 educators, school administrators, and IT professionals from around the world join our free virtual Zoom Summer Academy. The successful two-day Zoom event was our biggest educational event to date, bringing together thought leadership in remote learning, practical training, and networking opportunities. We remain committed to helping our education customers, including the more than 100,000 K-12 schools who have signed up to use the platform for free during the pandemic. Moving on to a few recent business highlights. We completed our 90-day plan on security and privacy. A comprehensive summary of accomplishments is available on our website. I'm very proud of our team's swift and transparent response as well as the resulting improvements we made to our platform. Although the 90-day initiative is over, security and privacy matters will remain an important part of Zoom's strategy and DNA moving forward as we strive to maintain our customers' and other stakeholders' trust. We made two exciting hardware announcements in the quarter. The first is the launch of Zoom Hardware as a Service, which offers customers a variety of subscription opportunities for phone and meeting room hardware from leading hardware manufacturers. This offering makes Zoom Phone and Zoom Rooms more accessible by minimizing friction around hardware procurement. Second is Zoom for Home, our new innovative category of software experience and hardware device partnerships to support remote work use cases. We launched this program with our partner DTEN in July, and this month, we announced its expansion to Amazon, Facebook, and Google devices. We achieved significant accomplishments for Zoom Phone. In mid-June, Zoom Phone was authorized under the FedRAMP, enabling federal agencies to consolidate their costly legacy telephony systems onto our unified modern cloud solutions. This month, we expanded the availability of Zoom Phone service to 25 additional countries and territories. Zoom now provides local telephone service and domestic calling in more than 40 countries and territories. On a final note, we welcome our new CISO, Jason Lee, former SVP of Security Operations at Salesforce, and our new General Counsel, Jeff True, former EVP and General Counsel at Palo Alto Networks. We are very excited to have them. Now let's talk about some exciting wins in the quarter. Let me start with a couple of new customers that represent some of the largest companies in their industry. We are thrilled to welcome ExxonMobil, one of the largest publicly traded international energy companies, to the Zoom family. ExxonMobil develops and applies next-generation technologies to help safely and responsibly meet the world's growing needs for energy and chemical products. They recently used their scale and capabilities to ramp up production to make medical-grade masks, shields, and hand sanitizers. We are grateful that ExxonMobil chose Zoom as their unified communications platform. ExxonMobil wanted a solution that would enable them to collaborate reliably and securely with their teams, customers, and partners around the world. ExxonMobil employees are now using Zoom video communications across their global business. Second, Activision Blizzard, a member of the Fortune 500, has chosen Zoom to modernize and consolidate onto a single communication platform across their business units and gaming franchises. As a leading interactive entertainment company connecting and engaging the world through epic entertainment, Activision committed to a full enterprise rollout of Zoom Meeting and Zoom Rooms to increase their mix of legacy video conferencing products. Our ability to expand with existing customers also helped drive our results this quarter. One of the highlights this quarter was the expansion with ServiceNow, who has been a Zoom customer since 2018, using Zoom Meetings for its 11,000 global employees. Since the global pandemic, ServiceNow employees working from home have relied heavily on Zoom's easy-to-use interface to stay productive and connected with our customers. As the Zoom platform has become a core piece of ServiceNow's technology ecosystem, this past quarter, the company chose to replace its legacy hardware PBX system with Zoom Phone across their organization, further elevating their teams' work-anywhere experience with seamless, one-touch communication and collaboration. Thank you, ExxonMobil, Activision Blizzard, ServiceNow, and all our wonderful customers for trusting Zoom. I love you. All Zoom employees love you. Thank you. In summary, we continued to scale and expand our business to meet the needs of our customers and the global community. I'm very proud of our achievements and thank our more than 3,400 employees for another exceptional quarter. Let's remain focused on delivering happiness to our customers and community. With that, let me turn things over to Kelly.
Kelly Steckelberg, CFO
Thank you, Eric, and hello, everyone. Q2 was a remarkable quarter for Zoom as we continued to rapidly grow and invest in our business to meet the demands of our customers and communities. Let me start by reviewing our financial results for Q2, then discuss our outlook for Q3 and the increased view of our full-year FY'21. Total revenue grew 355% year-over-year to $664 million in Q2. This top line result significantly exceeded the high end of our guidance range of $500 million as demand remained at heightened levels, combined with lower-than-expected churn and exceptional sales execution. For the quarter, the year-over-year growth in revenue was primarily due to subscriptions provided to new customers, which accounted for approximately 81% of the increase, while subscriptions provided to existing customers accounted for approximately 19% of the increase. This demand was broad-based across industry verticals, geographies, and customer cohorts. Let's take a look at the key customer metrics for Q2. We continue to see expansion in the upmarket as we ended Q2 with 988 customers generating more than $100,000 in trailing 12 months revenue, up 112% year-over-year. This is an increase of 219 customers over Q1, the highest number of adds in a quarter. We exited the quarter with a total of approximately 370,000 customers with more than 10 employees. We added approximately 105,000 of these customers in Q2, the second highest number of adds in any quarter. Year-over-year, we added approximately 304,000 new customers with more than 10 employees for 458% growth. We have continued to benefit from significant growth in our customer segment with 10 or fewer employees, as small businesses and individuals adopted and maintained their Zoom licenses for various uses during the pandemic. In Q2, customers with 10 or fewer employees represented 36% of revenue, up from 30% in Q1 and 20% in Q4 of last year. The increase in customers with 10 or fewer employees continues to shift our billing mix as these customers generally pay monthly rather than annually, as do most enterprise customers. This shift is an important point for our outlook, which I will discuss in just a moment. Our net dollar expansion for customers with more than 10 employees was over 130% for the ninth consecutive quarter as existing customers 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 288% year-over-year. Our combined APAC and EMEA revenue accelerated to 629% year-over-year and represented approximately 31% of revenue. We will continue to invest in international expansion to capitalize on our brand awareness and the increased global opportunity. Now turning to profitability, the increase in demand and strong execution drove net income profitability from both GAAP and non-GAAP perspectives. I will focus on our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, charitable donation of common stock, and acquisition-related expenses. Non-GAAP gross margin in the second quarter was 72.3% compared to 82.2% in Q2 last year and 69.4% last quarter. The incremental improvement from Q1 reflects our strategy to increase our co-located data center capacity while leveraging the public cloud as needed. We expect gross margin for the rest of the year to be consistent with Q2. However, actual results may vary as gross margin is contingent upon the percentage of free users and the utilization of public cloud during the pandemic. R&D expense in Q2 was approximately $29 million, up 128% year-over-year. As a percentage of total revenue, R&D was approximately 4%, which was lower than Q2 last year, mainly due to the strong top line growth. In FY'21, we will continue to invest in R&D to drive innovation across all aspects of our platform. We also plan to diversify our engineering talent as reflected by our expansion in the U.S. and India. Sales and marketing expense for Q2 was $123 million. This reflects an increase of 78% or $54 million over last year with investments to drive future growth. As a percentage of total revenue, sales and marketing was approximately 19%, a decrease from Q2 last year, due mainly to strong top line growth and marketing efficiencies from our increased global awareness. Overall, we plan to add sales capacity quickly over the next several quarters. The swift ramping of our sales organization to further capitalize on market opportunities is a priority. G&A expense in Q2 was $51 million, up 189% on a year-over-year basis due to higher accruals for telco taxes correlated to higher billings, professional services, and additional hiring to meet the functions of a public company of this scale. As a percentage of total revenue, G&A expense was approximately 8%, a decrease from Q2 last year as we gained leverage on our investments with a rapid growth in revenue. The substantial revenue upside in the quarter carried over to the bottom line with non-GAAP operating income of $277 million, far exceeding our guidance, translating to a 41.7% non-GAAP operating margin for the second quarter. This compares to Q2 last year's result of $21 million and 14.2% margin. The significant margin expansion year-over-year is due to the steep increase in revenue in Q2, which outpaced the rate of investment even as we added over 500 employees in Q2, a 20% increase from last quarter and a 53% growth year-over-year. Non-GAAP earnings per share in Q2 was $0.92 on approximately 297 million of non-GAAP weighted average shares outstanding and adjusted for undistributed earnings. This result is $0.46 higher than the high end of our guidance and $0.84 higher than Q2 of last year. Turning to the balance sheet, deferred revenue at the end of the quarter was $743 million, up 309% year-over-year. Looking at both our billed and unbilled contracts, our RPO totaled approximately $1.4 billion, up 209% from $458 million year-over-year. The increase in RPO is consistent with the strong demand and execution in the quarter. We expect to recognize approximately 72% or $1 billion of the total RPO as revenue over the next 12 months as compared to 62% or $285 million in Q2 last year. This indicates a shift in our renewal seasonality, which was historically weighted towards Q2 and Q4 and has now shifted to Q1 due to the strength of last quarter's performance. As a reminder, we do not focus on calculated billings as a metric for our business. We have a diverse business that spans from enterprises to individuals. With the changing mix of our business, annual billing terms and the growing level of monthly billing terms, such calculations have become less meaningful, especially now that we have a full quarter of monthly billings making up a bigger part of our revenue. We ended Q2 with approximately $1.5 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. Similar to Q1, we had exceptional operating cash flow in Q2 of $401 million, up from $31 million in Q2 last year. Free cash flow was $373 million, up from $17 million in Q2 last year. The increase is attributable to strong collections from the large increase in top line growth and higher percentage of monthly contracts throughout the quarter. For the second half of the fiscal year, we expect to increase capital expenditures for additional data center infrastructure. As a reminder, we will see the semi-annual cadence of net cash inflows from ESPP purchases to occur in Q3. Now turning to guidance, we are pleased to raise our outlook for FY'21 for both revenue and non-GAAP profitability. Although we remain optimistic on Zoom's outlook, please note that the impact and extent of the COVID-19 crisis and its associated economic concerns remain largely unknown. Our higher outlook for FY'21 is based on our view of the current business environment. For the third quarter, we expect revenue in the range of $685 million to $690 million. We expect non-GAAP operating income to be in the range of $225 million to $230 million. Our outlook for non-GAAP earnings per share is $0.73 to $0.74 based on approximately 300 million shares outstanding. Before giving you the full-year outlook, let me provide some context on our assumptions. While better-than-expected churn was one of the drivers of our Q2 outperformance, we did experience a significantly higher level of overall churn in Q2 as compared to historical rates. As customers with 10 or fewer employees have increased to 36% of our revenue, we are assuming a higher rate of churn due to this mix shift. From an expense perspective, we continue to focus on investing for growth, targeting investments that are appropriate for our market opportunity and the size of the business that we have become. Looking ahead, we expect operating margins to decrease from the peak in Q2 over the balance of this year as our hiring and spending catch up with the much greater scale of our business. It is prudent to expect margins to normalize to lower levels over the next several quarters. For the full-year of FY'21, we expect revenue to be in the range of $2.37 billion to $2.39 billion, which will be approximately 281% to 284% year-over-year growth. This implies that Q3 and Q4 revenue will be only modestly higher than Q2, indicating a decline in quarter-over-quarter growth. For the full-year of FY'21, non-GAAP operating income is expected to be in the range of $730 million to $750 million. We expect to deliver non-GAAP earnings per share of $2.40 to $2.47 for the full-year FY'21 based on approximately 300 million shares outstanding. In closing, we executed well in the first half of our fiscal year. With our commitment to delivering customer happiness, we believe we will grow to over $2 billion in total revenue this fiscal year, which will be a remarkable milestone considering our guidance was below $1 billion in revenue at the start of this fiscal year. We are proud of how our team continued to perform in support of our customers and global community. Thank you to the entire Zoom team. Before we move to our Q&A session, let me turn it back to Eric.
Eric Yuan, CEO
Hey, thank you, Kelly. By the way, I wanted to invite you all to our virtual Zoomtopia event on October 14 and 15 with too many cool features like video filters. We hope to see you all there at Zoomtopia. Now let me turn it back to Tom. Tom?
Tom McCallum, Head of Investor Relations
Thank you, Eric. Now, let's open the floor for questions. If you haven't turned on your video yet, please do so now for the interactive part of this meeting. Matt, please get the first question ready.
Operator, Operator
First question is from Alex Zukin with RBC.
Alex Zukin, Analyst
Thank you, Matt and Eric. First, I want to express gratitude on behalf of the analyst community and as a parent and husband. You've made a significant impact on our lives. The question I hear most often from people is about their increased screen time on Zoom compared to other content consumption globally. Outside of introducing commercials during relevant Zoom calls, could you discuss the greatest opportunity for continued growth in bookings? This could include Zoom Phones, opening up the APIs, or monetizing the consumer filters you recently showcased. Additionally, it becomes challenging for us to determine the sustainable growth rate following such impressive performance this year. I'll stop there for now, but I could elaborate further.
Eric Yuan, CEO
Yes. Alex, first of all, I surely appreciate your continued support for many years. I think you're fully right. It looks like there are so many opportunities here and there, all kinds of use cases, right, my kids also use Zoom for telemedicine and telehealth. I think it's clearer to define now our top priority is to help people stay connected and make sure our service is always up. Quickly, based on the customer feedback, add some features, and make sure when you have multiple meetings, you do not experience meeting fatigue, right? That is our top priority. So we would like you to maybe leave for the future for how to further monetize that. Again, that's not our top priority. We must laser-focus on one thing: how to truly make a customer happy rather than stay negative, especially during this pandemic time.
Alex Zukin, Analyst
Perfect, and then maybe if I could squeeze one in for Kelly; Kelly, you talked about the differences in churn that you're experiencing from the new customer cohort that you onboarded through the pandemic, and we've talked previously about what your historical churn looked like for monthly customers, and we know, I think, a little bit about how it looked in guidance before. Can you level set at a high level, what did you experience with that cohort versus where it's been historically, and at a high-level, what are you assuming in your guidance for that churn, for that monthly cohort of new users?
Kelly Steckelberg, CFO
So, remember going all the way back to the S-1, we talked about how the monthly customers churn on average about 4% per month. We did see an increase against that in Q2, and we have modeled at that same level going forward with all the uncertainty concerning how long this pandemic will last and what other potential economic uncertainty there is. We've modeled at that same rate going forward.
Operator, Operator
Our next question is from Meta Marshall with Morgan Stanley.
Meta Marshall, Analyst
All right, great. Thanks and congratulations. Just wanted to get a sense of where you think you are kind of innings or percentage-wise on working with organizations that may have kind of adopted you in a department or adopted you in part of having multiple services, of displacing those solutions or kind of having a more full organization discussion as well as having a follow-up discussion as well of attaching on phone or rooms or webinar type services, and do you have the sales teams in place to just start having those conversations on broader organization and deployments?
Eric Yuan, CEO
Kelly, do you want to take it?
Kelly Steckelberg, CFO
Sure. We continue to see growth in the period from both new customers as well as existing customers and tremendous opportunity with webinar, especially as well as Zoom Phone. We actually signed our largest Zoom Phone deal to date in Q2. So it's exciting to see that continued momentum. We also saw customers that were doubling; one of them quadrupled their existing deployment. We are still in the early stages, and when we look at penetration, like we look at it in the Global 2000, a small percentage that have a significant spend with us, so there is tremendous opportunity still ahead, Meta. Meta, I'm sorry, you went back on mute.
Meta Marshall, Analyst
Oh, sorry. Just whether you have the kind of sales organization in place to kind of gather or gather conversation?
Kelly Steckelberg, CFO
As I said earlier, we are hiring very quickly to keep up with all of the demand that's potential. The team, thank you to our amazing Zoom team, is really working around the clock to keep up with the demand today and to support and serve our customers and the community, but we are hiring; absolutely. This is one of the biggest priorities for the rest of this year.
Operator, Operator
Our next question is from Nikolay Beliov with Bank of America.
Nikolay Beliov, Analyst
Hi, thanks for taking my question. Just wanted to continue on the topic from the last question, Eric and Kelly, as the business grows at unprecedented rates, can you help us understand what's happening internally, your customer support organization, your sales organization, your ERP system, HCM system, onboarding like hyper growth scenarios, so many people and maybe putting pressure on the systems, and also culturally, what's happening inside the organization?
Eric Yuan, CEO
Yes. That's a great question. Prior to the pandemic crisis, we maintained steady growth and made sure our internal systems, processes, and procedures were doing well. However, due to this pandemic crisis, the business growth is just unprecedented. The good news, on the one hand, is we had a very solid company culture. Nobody complained. We all worked very hard. We looked at other holes in terms of procedure and process, and also we hired a lot of employees, doubling down on our support resources and customer success management team to further help because there are so many new use cases and new customers. That's why we hired a lot of employees. On the other hand, we also wanted to leverage opportunities that could transform our business to the next level. In terms of privacy, security, and internal processes and systems, we are very committed, right? Every day, we work very hard on what kind of new issues arise, like even the free calls or online paid subscribers, when they try to come for service. We would like to respond in a timely manner. I am not saying we are perfect, but we are very committed to really double down on our execution to ensure that everything is happening for all users.
Nikolay Beliov, Analyst
And Eric, which use cases, new use cases are you most excited about and surprised you the most? That's it for me.
Eric Yuan, CEO
My golly, if I talk about new use cases, I could probably speak for four or five minutes. I'll give you several. For example, PropNex uses Zoom for their virtual property tour. During the last 10 weeks, they closed over 50% of the newly launched properties in Singapore over Zoom. Also, the CSK, the first law firm in Florida to have a virtual trial by jury, and also, like South Coast Community Services, which is the largest mental health service provider in California, also uses Zoom to offer mental health services. Mental health is becoming a very big problem. A lot of new use cases like that. Every day, I feel very excited to see so many new use cases, not to mention, like we just announced the partnership with the United States Tennis Association to offer a virtual experience that is very cool.
Operator, Operator
Our next question is from Taz Koujalgi with Guggenheim.
Taz Koujalgi, Analyst
Hey, guys, can you hear me? Can you guys hear me?
Tom McCallum, Head of Investor Relations
Yes, we hear you, Taz.
Taz Koujalgi, Analyst
A question for you, Eric, I think you mentioned that one of the customers that you signed this year was with ServiceNow and they replaced the legacy PBX system with Zoom. Does that mean that you're offering video and phone to ServiceNow that they base all their collaboration tools with one product, Zoom?
Eric Yuan, CEO
Yes. You know, first of all, ServiceNow has been a customer since 2018. They deployed Zoom to replace other video conferencing and web conferencing services with Zoom video conferencing. Over the past several years, we already established a great trust. We also announced the partnership. When they looked at their entire usage rate, they also deployed a legacy, very costly, complex on-prem PBX system. Why not consolidate into one system with a very consistent product front-end experience, same backend architecture, and in terms of total costs, much lower and a user experience that is much better? That's why they decided to replace their legacy PBX system in favor of a single standardized solution with Zoom's unified communication solution.
Taz Koujalgi, Analyst
That's very helpful. Just one follow-up, Kelly, I think you mentioned that you signed your largest phone deal this quarter. Was that also an upsell to an existing video customer, or was that a new customer who signed up with Zoom Phone?
Kelly Steckelberg, CFO
No, it was already a meetings customer, a video customer as well.
Eric Yuan, CEO
Thank you.
Operator, Operator
Our next question is from Sterling Auty with JPMorgan.
Sterling Auty, Analyst
Yes, thanks. Hi, guys. Now that the 90-day feature freeze is complete, Eric, I'm kind of curious where the focus of R&D is going forward. You mentioned diversifying into India and the U.S. How are you structurally changing your R&D effort? And is that in relation to any type of geopolitical pressure?
Eric Yuan, CEO
Yes. First of all, we accomplished a lot over the past 90 days, and I can tell you that we take privacy and security extremely seriously. I'm not saying we are going to give any of that up; I would say the journey just starts. We are going to double down on privacy and security, and inside that, we also have a big R&D team and our core technology engineered leadership team here in San Jose. We also have an offshore team that looks at a lot of new use cases not only for enterprises but also for kids' education, K-12 schools, and telemedicine. There are so many use cases. I think this R&D team, I do not think that we can really handle that in terms of scalability. We have to find more talent in a timely manner, and that's why we opened up two R&D offices in Phoenix and in Pittsburgh. We would like this onshore/offshore R&D model. That's why India has also opened up a big office. We hired our President of Product and Engineering for China, a great leader. With that, we really want to hire engineers both here and at the other sites, including remote engineers, because there are so many features and tasks. That's why I want to invite you to join our Zoomtopia, which is our annual user conference. We'd like to service you with a very good product roadmap.
Sterling Auty, Analyst
Thank you.
Operator, Operator
The next question is from Richard Valera with Needham.
Richard Valera, Analyst
Thank you. Let me add my congratulations on another incredible quarter, team. So, the question is on pipeline. Kelly, you were sort of on record saying that you entered Q2 with a bigger pipeline than you had entering Q1. I'm wondering if you could give any similar color on how you entered Q3 from a pipeline perspective and if there's been any change in the composition of that pipeline in terms of product or geography.
Kelly Steckelberg, CFO
Certainly, coming into the quarter, our pipeline is still strong, and we're continuing to see demand, but based on our guidance, you can see that the demand for the year was front-end loaded, and we saw that in the performance in Q1, the benefit of which we saw in Q2, and that's why the guidance is highlighting that we expect revenue for the back half of the year to be effectively consistent with Q2.
Richard Valera, Analyst
Got it. Just in terms of the contribution of phone in the pipeline, has that changed much? Any color at all on how you're thinking about the magnitude of phone in the balance of the year?
Kelly Steckelberg, CFO
No, it's performing as we expected, and as I said, we're really excited to see our largest deal to date and ongoing upsell. So, we still see strong demand for Zoom Phone, and we see a lot of potential there for the future.
Operator, Operator
Our next question is from Tom Roderick with Stifel.
Tom Roderick, Analyst
Great, thank you guys, great job on another outstanding quarter. Eric, this is going to kind of go in conjunction with the question on Zoom Phone and kind of was thinking about it as a unified communications platform, not just a communications tool for video. I'd love to hear about some of the strategic conversations you're having in the context of digital transformation and what else these customers want you to do, and if you can elaborate in conjunction with how your customers are thinking about your next game plan in security, that would be great.
Eric Yuan, CEO
Yes, that's a great question. The pandemic crisis accelerated every enterprise and business customer's digital transformation because you want to support employees no matter where they are. The traditional on-prem systems really do not apply anymore. That's why you look at all the cloud and software service companies doing very well. With respect to Zoom Phone, I think, overall, that's a part of our video conferencing offering. We truly believe video is the new voice. There's no reason for any business to deploy two separate systems, totally different experiences. Hindsight of that, when customers who still deploy on-prem legacy PBX systems migrate to the cloud, they want to understand who has the better architecture. They want to consolidate into one system. That's the reason why we're positioned very well. Some SMB customers already deployed perhaps some other cloud with PBX systems; they also want to consolidate into one system to further solidify their experience. Overall, we do not even think there are two separate markets. It is just one thing. Video conferencing and cloud-based PBX converge into one service. So that's our story when we talk with customers, and they really like that.
Tom Roderick, Analyst
And Kelly, a quick one for you in terms of the conversation around security, but as you've agreed to enable end-to-end security for not just paying customers but for all customers, which is a recent pronouncement, I think, what does that do to the cost structure? Is that meaningful? Will we have notice that? Can you just talk about that a little bit?
Kelly Steckelberg, CFO
Yes. No, you won't see a meaningful impact. We certainly have been investing in both our security team. We're thrilled to have Jason Lee have joined us, and you'll continue to see some ongoing investments there, but it doesn't really have a meaningful impact on the margins.
Tom Roderick, Analyst
Got it, thank you. Great job, appreciate it.
Kelly Steckelberg, CFO
Thank you.
Operator, Operator
Our next question is from Heather Bellini with Goldman Sachs, who is joining us by phone.
Heather Bellini, Analyst
Great, yes. Yes, great, thank you so much, and congratulations, and I think as Alex started out by saying, Eric and team, just thank you for keeping everybody connected. We're so appreciative that school started today on Zoom. So my kids were app users today. For the question I had, was really just a little bit on Zoom Phone, and I know, Kelly, you've just answered a handful of questions, but Eric or Kelly, I'm just wondering if you could share with us how fast do you think you can see these kind of legacy phone systems. Like how fast do you think this work-from-home benefit can drive displacement of legacy PBXs, which we've all been waiting for, for quite a long time, and I know this is only sold to new customers, but you have so many of those — or to existing customers, but you have so many of those at this point, and is there any kind of typical competition sphere that you're seeing as you're talking to customers and they're making the migration? Thank you so much.
Eric Yuan, CEO
Yes. Heather, that's a very great question. I think prior to this pandemic crisis, if you look at the enterprise, a very high percentage of customers were still deployed with traditional on-prem legacy costly PBX systems. However, I think this pandemic crisis was sort of a wake-up call. You got to think about how to embrace digital transformation. Having cited that, cloud-based PBX is one of the things we've got to look into. Another, top priority compared to video conferencing, but for sure, it’s a lot of enterprise customers looking at that script. At the same time, they have a lot of other systems, not only for PBX but also a lot of other systems. They also look at the cloud-based solution. I think this crisis just accelerated that migration from traditional PBXs to cloud-based systems, and Zoom is very well positioned. With customers, they do not want to migrate to the cloud and also want to look at the new user experience, like a Zoom solution because this is the one existing. I think in the next 12 to 18 months, I would say you will see a little bit higher acceleration for enterprise customers to migrate to unified collaboration and communication solutions as Zoom. In terms of competition, right, still the traditional legacy systems and some other cloud-based PBXs, but again, Zoom is much better positioned because we have one unified solution. Thank you, Heather.
Heather Bellini, Analyst
Thank you, again.
Operator, Operator
Our next question is from Will Power with Robert W. Baird.
Will Power, Analyst
Great, thank you. I want to ask a question on the rest of world strength. You saw a surge in activity there. Usage revenue obviously grew significantly as a percentage of the total. I wonder if you could speak to how broad-based that was. Were there any particular regions or countries that stood out? I know you talked a bit about India, and how do we think that progressing from here? Do you expect that to continue to grow as a percent of revenue? And what might that mean for the margin impact of the business, if any?
Eric Yuan, CEO
Yes. So, if you look at…
Kelly Steckelberg, CFO
Go ahead, Eric.
Eric Yuan, CEO
Yes. If you look at our free users or paid online subscriptions, it's coming almost everywhere. However, if you look at the number of visitors to our website, the top countries include, for sure, the U.S. obviously number one; and India, number two; Japan, number three; Canada, U.K., number four and number five. I think users are almost from every country. They are trying to use Zoom because it's very easy and free. If 40 minutes are not enough, they would like to pay, and some SMB customers are also trying our webinar service, and also, enterprise customers might try the phone service. I think organic growth because of the brand awareness is really helping us. So for now, we just say, no matter where the users come from, we would like to take a step back to see how we can do differently to serve them better, including having a local data center, like we just announced a data center in Singapore. We are also doubling down on our India presence, and we are going to have a team to capture the growth from international expansions. Kelly, sorry, feel free to chime in.
Kelly Steckelberg, CFO
No, that's okay. I was just going to say that the strength in the growth outside the world was really consistent between EMEA and APAC. We're very pleased with that, and overall, the market pricing is adjusted for the market, so you shouldn't see significant impact on the long-term margins based on the structure that we have in place for our pricing today.
Operator, Operator
Our next question is from Rishi Jaluria with D.A. Davidson.
Rishi Jaluria, Analyst
Hey, everyone. Thank you so much for taking my question, and I'll echo a truly outstanding quarter I think beyond what any of us could have imagined. I wanted to follow up a little bit on an earlier question, which is some of the moves in China, right? I mean stopped free trials, recently stopped direct sales there, at the same time, expanding R&D efforts in India and in the U.S. as well. Just what's kind of the impetus for this move? Is this a signal of kind of distancing a little bit away from China, maybe in response to geopolitical pressure? And then for Kelly, what sort of impact would this have from a model perspective, both on the top line and margins? Thank you.
Kelly Steckelberg, CFO
Yes. We don't have any current plans to move our engineering talent out of China. We are focusing on diversifying it by adding talent in the U.S. and India. That's really the goal and our leadership team is currently based in San Jose, so there's no change in that overall structure. For the long term, if something changed, there would be no immediate impact on our service or our ability to provide services to our customers in the short term and medium term. Over the long term, there could be a potential impact on the margins as we would need to replace those talents somewhere else potentially.
Eric Yuan, CEO
Yes, just to add on to what Kelly said, revenue-wise it is very small, no impact. Previously, if you look at almost every country, we have online subscription. We have a direct sales model out of China, but in China, the overall revenue is small. The online subscription needs to have a special license. We already sold that before. So we would like to simplify our go-to-market strategy because actually the support and sales associate a lot of resources; why not simplify that just to leverage our third-party partners with a white labeling solution? That is very sustainable and is good from our side.
Rishi Jaluria, Analyst
Wonderful. Thank you, Kelly and Eric.
Operator, Operator
Our next question is from Phil Winslow with Wells Fargo.
Phil Winslow, Analyst
Hey, thanks guys for taking my question, and congratulations on another phenomenal quarter. I wanted to talk about converting monthly users to annual users; Kelly, that was one of the things you talked about on the last call. I wonder if you can give us an update on sort of what you saw from the, call it, the Q1 cohort during Q2 in terms of your ability to convert those, and how should we think about any sort of the promotions, initiatives changing going forward? Thanks.
Kelly Steckelberg, CFO
Yes, of course. Our marketing team is really focused on this, running campaigns and reaching out to these customers to provide them the opportunity to convert from monthly to annual, and we were happy with the success we saw in Q2 and are continuing to focus on this. We've also made some changes to our online buy flow to make it easier for the customers as well to self-serve and upgrade if they're so inclined. We expect to see this to continue to be a focus for us as we move through Q3.
Operator, Operator
Our next question is from Shebly Seyrafi with FBN Securities.
Shebly Seyrafi, Analyst
Yes, thank you very much. A question for Kelly, you're guiding revenue to be up around 3% sequentially, but if I assume that your customer count is at least flattish Q-to-Q, your average customer count is going to be up around 16% Q-to-Q, which implies that your ARPU is implicitly guided to be down 13% Q-to-Q. What would drive that?
Kelly Steckelberg, CFO
Well, as we're sitting here right now, looking forward, I think it's more around the uncertainty around churn and what's going to happen with the overall economy. That is really the uncertainty there and why we're guiding flat for Q3 to Q4 revenue will be flat, modestly up from Q2, and we've had a significant increase in our mass market customers, where there just remains limited visibility in terms of the long-term contribution for those customers. I don't think that we expect that dramatic increase in ARPU; it is more around the uncertainty in churn and what does that mean for the top line growth.
Shebly Seyrafi, Analyst
Okay, thank you.
Operator, Operator
Our next question is from Brad Zelnick with Credit Suisse.
Brad Zelnick, Analyst
Great. Thank you so much, and I echo my congratulations and gratitude all around, and it's nice to see everybody. My question is for Eric. Eric, from a product perspective, how might Zoom in the future be able to go deeper into the context in which communications is happening? I'm thinking about human behavior or human intent, for example, to help make the experience even more valuable.
Eric Yuan, CEO
Yes. That's a great question. That's why please join our Zoomtopia. First of all, you're absolutely right; Zoom is not only a communications tool; we want to go deep because our mission is to develop a better service, a better online video conferencing service, even better than face-to-face meeting. We need to leverage AI functionality, like not only having the meeting transcription, but also how to analyze that in a timely manner. Let's say, if you change a topic, giving you a quick reminder to, hey, please slow down, right? So, based on face detection or something like that, all those AI features. For us, looking at it in the long run, right, language translation in real-time, and also how to shake hands remotely, a lot of cool features like that, and in the past, if you look at the inflow of video and perspective, we want to how to add some of the fun features like video filters and how to create 3D video, leveraging AR. There are many technologies, not to mention 5G, and in the future, if you look at the future, many of those good technologies can truly make the video conferencing experience much better.
Brad Zelnick, Analyst
Thank you so much.
Eric Yuan, CEO
Thank you. Please join us at Zoomtopia. Thank you.
Operator, Operator
Our next question is from Ryan Koontz with Rosenblatt Securities.
Ryan Koontz, Analyst
Hi, great, thanks for the question. With regards to the sales and marketing investment, it came in a little light there, and obviously, you have a really strong customer pull for the product. How are you thinking about your go-to-market motion? How might you change your sales strategy relative to your prolific success to date, and are you looking at reseller channels or other technology platform partners to take you to market into the enterprise? Thank you.
Kelly Steckelberg, CFO
So the decline in sales and marketing was partly due to just the strong top line performance as well as efficiencies that we're seeing in marketing. We expect that as a percentage of revenue, sales and marketing will increase through the back half of the year as we're really focused on continuing to hire globally. We did — if you remember, we announced the master agent program for Zoom Phone in Q2 and are really excited about that program and expect it to go — continue to contribute more significantly as we move through the year. On the meeting side, we’ll continue our mostly direct model, which has been very successful for us to date.
Eric Yuan, CEO
Just to briefly add on to what Kelly said, if you look at the marketing efficiency, we already have more than 700 third-party applications. That's another way for us to promote our brand awareness, right? More and more integrations can certainly help our marketing efficiency.
Ryan Koontz, Analyst
Okay, thank you.
Operator, Operator
Our next question is from Bhavan Suri with William Blair.
Bhavan Suri, Analyst
Great, thanks for taking my questions, and congrats. I guess I want to touch on something a little more probably high level and strategic. Obviously, I've asked you in the past about the convergence and where does Slack and collaboration fit in. So, let's turn this a little bit differently. You're going to host Zoomtopia, and this whole event planning space is a huge market, and it feels like it would be an obvious fit for you, and you have partners there, but the natural extension of this into events and meeting seems to make a lot of sense. How do you think about that market? Do you think about sort of maybe using the stock as a way to buy, but you could also build? I mean Kelly has got it to R&D coming up. You've got a lot of points between 40 and 30 to spend on R&D, and not all of it is going to go to support the existing platform. So just some sense on the event space and how you think about it. Is that a build versus buy decision or a partner decision? Thank you.
Eric Yuan, CEO
First of all, I think you have a great question. So you have our vision right. It looks like you have some great ideas. Actually, maybe after the call, I'd like to connect you with our product managers. You're absolutely right. If you look at our Zoomtopia, we don't just have a webinar, but we need to look at our entire online event management experience. It's not only about the real-time part but planning and marketing and promotion, marketing content and materials for every event. A lot of content, I think having cited that we believe this service has strategic value to help further expand our webinar reach. Having cited that, I think in terms of doing everything by ourselves or bringing in a partner, maybe acquiring somebody, I think it's too early to tell, but strategy-wise, you're absolutely right. That's got to be our focus, our priority. It’s low-hanging fruit.
Bhavan Suri, Analyst
Thank you.
Operator, Operator
Our next question is from Walter Pritchard with Citi.
Walter Pritchard, Analyst
Hi, thanks. I'm curious this quarter just as it related to the really strong new customer adds and the revenue that came from that channel. Are you seeing an uptick in customers that are coming in through sort of displacements that had maybe not an older-generation solution but had tried something in the last three to six months and weren't happy with it and have switched over?
Eric Yuan, CEO
Kelly, do you want to take it?
Kelly Steckelberg, CFO
I don't think we saw as much of that. Customers have been using something, but I think what has happened over the last 4 to 5 months is people have realized that the solution they had in place just wasn't up to what it needed to be during this pandemic. We've continued to see amazing brands move over from some competitors as they really look for something to ensure that they can keep their employees really effectively while keeping them safe. We are super excited about some of the school districts that we've seen sign up. We have the top two school districts in the U.S. as our customers today. That highlights the scalability of the platform and wanting to ensure that they have a really reliable solution as they went back to school.
Walter Pritchard, Analyst
And then when do you think you can give phone customer count, any horizon on that?
Kelly Steckelberg, CFO
That's one of the things we're considering, Walter, that we'll talk about. We've said that for Zoom Phone, we'll give milestone updates. We'll look at it at Zoomtopia and see if that makes sense. The last update we gave was actually at the anniversary date of Zoom Phone, so we might wait until then.
Walter Pritchard, Analyst
Okay, thank you.
Kelly Steckelberg, CFO
Thank you.
Operator, Operator
Our next question is from Matthew VanVliet with BTIG.
Matthew VanVliet, Analyst
Hey, guys. Thanks for taking the question, great quarter there. You talked a little bit about channel partners still remaining a fairly low portion of your overall sales, but I am curious about the uptake in total partners registering as part of the program. Is it something that you're proactively doing? Or is it just the demand for the product pulling them in? And then on a related note from an international market perspective, do you feel like you can hire aggressively enough from a sales head count internationally? Or do you need to look at partnerships in specific markets that could be smaller growth areas, but growth areas nonetheless?
Kelly Steckelberg, CFO
From the hiring side, we definitely believe we can hire everything that we need internationally. We've really invested in our talent acquisition team and are doing that on a broad base around the globe to ensure that we are able to hire as quickly as possible. As you know, there is a bit of a longer lead time for notice periods internationally, but we're hiring as quickly as we can. In terms of the uptick in the channel, we don't give out those specifics, but we're continuously looking at our channel programs to ensure that they are not only competitive but driving the results that we want. It’s something we evaluate on a constant basis.
Matthew VanVliet, Analyst
Okay, thank you.
Operator, Operator
Our next question is from Quinton Gabrielli with Piper Sandler.
Quinton Gabrielli, Analyst
Hey, guys. Thanks for taking my question, and congrats on a great quarter. Really just one quick question from our end, obviously, you guys saw some really strong enterprise traction for Q2. Just wondering if we could get some idea of the percentage of revenues from enterprise customers compared to the 23% we saw in the last quarter. Thanks.
Kelly Steckelberg, CFO
We are sharing that the revenue — we don't call out specifically customers, but that the revenue from effectively customers with fewer than 10 was 20% in Q2, which is consistent with previous quarters in that same range.
Quinton Gabrielli, Analyst
Got it, all right, thank you.
Operator, Operator
Our next question is from Ittai Kidron with Oppenheimer. Ittai? Okay, we'll come back. Our next question is from Alex Kurtz with KeyBanc.
Alex Kurtz, Analyst
Yes, thanks for taking the question. Actually, someone at Zoom did a good job because we just switched our school district from Google meeting over to Zoom for the start of the fall semester. So someone deserves a raise. So, Kelly, as you think about OpEx trending into next fiscal year, I know you’re not going to talk explicitly to it yet, but a lot of churn to assume, especially in that Q1 of next year, and you have a lot of investments that you're making as far as R&D and sales and marketing. So as we're working through our models and looking into OpEx levels from Q4 to Q1, how should we be framing that?
Kelly Steckelberg, CFO
Yes. You should expect the operating margins to decrease incrementally each quarter going forward as we are continuing to invest in R&D and invest more in our sales and marketing teams as well, getting towards that longer-term margin that we've talked about historically. We're going to talk in more detail around this at Analyst Day, but the last time we updated you on this, we still said that our long-term margins are around 20%. So I think you should assume we're getting more in that range, nearer to that than the 41.7%.
Alex Kurtz, Analyst
Okay.
Eric Yuan, CEO
Alex, by the way, if your kid's school district has any questions or any feedback to Zoom, please let them know you know Zoom's CEO and can be there.
Alex Kurtz, Analyst
I will send them right to you, Eric.
Eric Yuan, CEO
Thank you, Alex.
Operator, Operator
Our next question is from Ryan MacWilliams with Stephens.
Ryan MacWilliams, Analyst
Thanks, guys for the question. So, for Zoom Phone, the unbelievable rate of achieving global service coverage; so congrats on the expansion there; Kelly, when you mentioned doubling or tripling Zoom Phone seats and various deployments, is that a part of this expanding global service coverage, and have you seen more enterprises trialing Zoom Phone as a result of this additional coverage? Thanks.
Kelly Steckelberg, CFO
Certainly, international expansion, I think we've said historically that was the biggest opportunity for us, and I think a perfect example of that is the two largest Zoom Phone deals in Q2 were outside the U.S. That really shows the strength and what the international coverage is bringing to Zoom Phone, and sorry, what was the other one — oh, enterprise customers trialing Zoom. Yes, absolutely. There are some amazing names that we can't talk about yet, but we're excited about the traction that we're seeing in the enterprise customer base as well.
Ryan MacWilliams, Analyst
Best of luck. Thanks, guys.
Operator, Operator
Our next question is from Pat Walravens with JMP Securities.
Pat Walravens, Analyst
Oh, great, thank you. If she comes in on time, I'm going to give you some real feedback from one of your customers. Here she is.
Unidentified Analyst, Student
Hello.
Pat Walravens, Analyst
Okay. What do you like best about Zoom?
Unidentified Analyst, Student
The breakout rooms. I thought they were really convenient because my teacher — we have a lot of students in our cohort, our group, and it's really hard for all of us to talk at once. So she put us in six breakout rooms, and I have four or five students with me, and it's really nice to talk to them to work with them, check answers instead of having 40 kids, like a huge group, and you can never get to talk. That's why I love breakout rooms so much, and I think it's really convenient.
Pat Walravens, Analyst
Thank you, Gigi.
Kelly Steckelberg, CFO
Great, thanks for the feedback, Gigi.
Pat Walravens, Analyst
So, my question is, Eric, when everyone's working from home, how do you make where you work an attractive place to work?
Eric Yuan, CEO
Well, first of all, your daughter Gigi's comments made my day today. I would like to talk to her. So speaking of the workplace, I think for now, for the foreseeable future, we all need to work from home, but we've got to think about the long-term planning. Meaning, after the pandemic crisis is over, what the new workplace would look like. We talk with many customers and partners. We believe in terms of working from home; this trend will stay. I'm not saying all of us will keep working from home. It's very likely that it's a hybrid model, meaning twice a week or three days a week, you can send all employees back home and some other times, we all keep working in the office, and also you can further consolidate a lot of the small offices. You do not need to have offices everywhere anymore. You can also hire talent almost everywhere, and for us, even for the workplace today, if you look at a lot of companies, it is a very big open space. I think that may not work anymore in the future. Good news, we do have targets for the next 10, maybe 12 months, to optimize what the future workplace looks like, but again, no matter what, I think tools like this continue to help.
Pat Walravens, Analyst
Okay, thank you.
Eric Yuan, CEO
Thank you.
Tom McCallum, Head of Investor Relations
Great, and I think we'll turn it over to Eric for any final comments. Eric?
Eric Yuan, CEO
Is Ittai still available? It looks like he has a question, right? No?
Operator, Operator
No, I don't think Ittai is going to be asking a question today.
Eric Yuan, CEO
Yes. So, thank you all for joining us today, and we're truly appreciative of your time. It has been a memorable first-half for our investors and analysts. We appreciate your continued support for Zoom. Thank you all. See you next quarter. Thank you.
Kelly Steckelberg, CFO
Bye. Thank you.
Eric Yuan, CEO
Thank you.
Tom McCallum, Head of Investor Relations
Thank you, everybody.