All right. Let's get started. Before we get started, some disclosures. Important disclosures, please see the Morgan Stanley Research Disclosure website at www.morgansanley.com forward slash research disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. My name is Josh Baer, software analyst at Morgan Stanley, and we are thrilled to have Michelle Chang, CFO of Zoom here today. Thank you so much for joining us.
My total pleasure.
Maybe, Michelle, to set the stage, Zoom closed out the year, growing enterprise revenue 7% in Q4, now represents over 60% of the business. When you look at that improved growth trajectory, could you unpack what were the key changes that really bent that growth curve for you?
So maybe for those that don't follow Zoom as closely, you know we'd had growth that at an overall level was three percent and three percent and then we we finished last year at 4.4 so an inflection of 130 basis points and enterprise to your question is sort of the the headliner of that and there'd really be kind of four things that i would call out first is um product diversification we've moved a lot as a company from just being a medium company to to a much more portfolio so clearly and i'm sure we'll get into more conversations there. That's one of them. Second one is AI monetization. It's very clear that AI monetization is inflecting our growth rates. So that's tremendous to see. The third is an investment in our channel, right? With where we need to go from a product perspective, we have been investing very heavily in our channel of all flavors, not just incentives, but building out the maturity there. And the last one would be really just continuing to hone our execution from an enterprise perspective in our direct sales organization. And so clearly that's playing out as well.
Excellent. And we will dig into all of those.
Thinking about as you head into FY27, what are the key, the top operating priorities that sort of sustain that momentum that you've had over the last year yeah so look we have three priorities that we're about as a company and these three priorities they shape everything we do from where we put our dollars um because they are the things that will inflect our growth rate even more so maybe as a as a build on to your prior question the first one is that we have got to infuse ai in our core business so that means for us. Workplaces, which is where meetings is, as well as our phone. That's priority number one. Priority number two is, this is probably the most forward thinking of our three priorities. We've got to get new routes to AI monetization up and running, be they horizontal or vertical. And I'm sure we'll unpack each one of these as we go. And then the third one is, Zoom is really getting into a great moment with our contact center business, which is one of those product diversification that I mentioned. And we've just got to get behind scaling that because the market is in transformation and we have great momentum behind what we're doing.
Excellent. Before we dig into AI, I wanted to get your perspective on the demand environment. So when you're sitting with chief information officers, other CFOs, how is this collaboration and UCAS based? How are budgets being allocated? Is there a trend from best of breed to consolidation? And, you know, how does that impact where you're investing and playing in the market?
Yeah. Look, I think it's changing. If I thought maybe a year ago in some of the conversations, you know, it was a mix of best of breed, best of suite, if you will, to which I think Zoom has a great response to each. You know, In Best of Breed, we're clearly known for being excellent and chosen by customers at what we do. In Best of Sweep, we have not only a holistic platform, but also the ability to integrate with so many others. So one of the things I love about coming to Zoom is we embrace kind of the customer where they are on their journey. If they own Microsoft or Google, great, bring that in. And that becomes essential in the third category, which is really where I think the shift in conversation is, which is to what I would call pragmatic AI. Not flashy, everybody needs it AI, but show me pragmatic value from an AI perspective. So best of breed and best of sweet conversations, I think, are still there. Good CFOs always kind of grind on those things, but I think far more the conversations get down to AI, pragmatic value and how can i prove it out awesome well let's jump into ai uh obviously key debate on the the whole sector assessing the risks and opportunities around ai particularly around incumbent sass and so i want to just directly ask you how is zoom positioned specifically for ai yeah so this is this is a good one i think um to make sure people understand and Eric has a great way our CEO of talking about this so I'll kind of leverage it here if you think about the interactions in the world there was there's always been human to human interactions and there was human to system and increasingly their system to system and look in an AI world all of those probably exist in some form or fashion but the thing that doesn't go away as that human connection. And probably what used to then be two or three steps just becomes kind of singular, gets more streamlined in nature. And so where Zoom, I think, is going and why I look at this and get really excited about our future in an AI world is really around something called system of action. You think about it, there's system of records, there's systems of engagement, and none of those quite fit in an AI world, right? What everyone is having to reinvent themselves, right, towards something that we talk about as a system of action. And that system of action is really about going from conversations that happen every day into tangible, real business value, pragmatic AI value, and action. And so Zoom, you might say, well, okay, I've heard those buzzwords or I've heard all that, like, why does Zoom sort of win in this? And it's really, I think, on a couple of dimensions. For Zoom, we think about the work that happens in this system of action as work that happens inside an organization and work that happens outside of an organization. And historically, the world has thought about those as very different, very siloed-off things, and yet in an AI world, I think they begin to blend. And in really good ways from a customer perspective. And so Zoom has a great mix of things inside the organization, outside the organization, that really get lit up. And I'm sure we'll talk about that as we get to things like phone and contact center. The other reasons that we're hearing great things about and great response from customers in AI is obviously things like quality and approach and open ecosystem and trust and all those. But look, it's that context that exists across that system of action. You think about all the unstructured data that we all have as we go from one meeting to the next and we can't remember who decided what or who said what or what action you took in that and just what a powerful advantage that is to Zoom in an AI world is the ability to take all those unstructured dialogues and take them from conversation to completion.
Perfect. Eric also uses the word AI-first company. You've got a federated approach. How does that approach show up in your cost structure today? And thinking about all of this AI usage as that scales, how do you protect Zoom's gross margins and operating margins?
So being a CFO, I'm not about just endless AI investments. They got to come with return on the monetization side that I'm sure we'll talk about. But look, they also have to be, you know, rationalized from a profitable perspective. Because in the end, it's all just business. It's not an investment for an investment's sake. So we spend a lot of time on the monetization side, but to your question, more uniquely on the cost. What Zoom does in its federated approach is say that we're going to use a combination of SLMs and LLMs, depending on kind of the volume. So we're going to take our more everyday common things and we're going to run them through an SLM and we're going to take more specialized stuff and run it through an LLM. And that really translates into two things from a Zoom perspective. One, the quality goes higher, and two, the cost goes down, right? and so one of the ways that we're able to still say in an AI world where usage is going up three times year over year we're going to hold to those long-term margins of 80 percent is because of this federated approach but look there's also things like AI cost pairs will naturally come down and we're going to keep working it on our core backbone of COGS and other things that we use to offset And then maybe I'll give you one more as a key piece to how we're able to continue to adhere to gross margins at the 80%, you know, best-in-class range. And that is our own product. Look, I'm sure we'll get into this more, but, you know, like any company, Zoom has a contact center. And like any company, I used to be a CFO of a contact center. Gosh, they are the worst businesses, man. The costs go up, and, you know, CSAT is always not what you would want it to be. And so, look, we leverage in our own company, our own contact center, virtual agent or agent-assisted, and we use that as really a means to get costs down as well.
Excellent. While we're on the topic of monetization, AI monetization, could you talk a little bit more about that framework for you? You have a base level of AI in paid SKUs, so no extra charge. You've got a custom AI companion, and then AI tiers in the contact center suite. So how are you thinking about the revenue opportunity for AI?
Let me break it down and give some categories to all the things you just talked about because I think it's helpful. And there's a visual that we did as part of ZoomTopia if anyone wants to go to our ambassador website. First, we started out on our AI journey and really taking, at the time, what was kind of an unusual decision to democratize AI, meaning we put AI in for all paid SKUs into, like, Zoom meetings and workplace SKUs. And obviously, there's some degree of monetization there, churn reduction, bringing in new customers, sticking us a platform, okay? But then we moved into sort of the more explicitly monetized, and we tend to think about it in two buckets, horizontal and then vertical on the horizontal front if you think about the base of virality of usage that you get sort of in the workplace or from our phone SKU that core priority that I talked about you then have the ability behind a paywall if you will to say we're going to monetize in scenarios where the customer is getting incremental value more search their own data, their ability to create their own agents, you know, so high, kind of high-value scenarios. And then there's what we call vertical. So this one's a bit odd in its naming, but let me unpack what it means. Contact center, for example, you know, is a huge area where you can get AI value. If you think about all those painful moments we've all had as customers where you call in and you're in an incessant loop, or you're repeating yourself, or you, you know, can't even get to your answer, like, the value that AI can bring to that is tremendous, and that is the largest place where Zoom is monetizing AI right now. But then, if you think about that, what we're doing, taking that conversation into action, we believe there's great other scenarios in vertical, which is ultimately, I think, where the value is easiest to prove to a customer, whereas Zoom will also monetize. So we made a recent acquisition, a bright hire, as well as we have like Zoom Revenue Accelerator, which is our AI SKU focused on our sales organization.
Okay, that's great. I want to ask one on Anthropic. You have a minority stake. After this past quarter, we learned there's a strategic investment portion of the balance sheet, and correct me if I'm wrong, the current amount, $1.6 billion in that line, reflects the current valuation. I want to make sure that I'm framing that right, but then I'm also wondering, beyond the economic relationship, is there a broader partnership that you can speak to?
We have this Zoom Ventures Fund, and it's about investing in things that are going to be helpful to our product roadmap, just key strategic partnerships. So many companies have them, and so do we. So you're exactly right. The total base of that is 1.6, of which the most significant portion is Anthropic. And so if it's helpful to investors to sort of reverse engineer the math, what we talked about in earnings was we had a gain of $532 million pre-tax, and that was predominantly off of a minority stake in Anthropic. But look, to your more meta question, we think about the federated approach that we took. Look, it's deeply based on Anthropic. You know, GLAAD runs throughout our product set. We are on their customer advisory board. We look at roadmaps together with them, as we do many other AI companies. But I would say we have a great relationship with Anthropic, and it's been a great investment for us outside of that. And look forward to it. And it's deeply part of our federated.
Okay. Excellent. Let's dig into some of these. Product areas, so maybe first starting with contact center where you have some very rapid growth Recently, you know zoom CX in Gartner Magic Quadrant at a high level like how would you characterize the demand environment today in that space and How are you scaling up market or what needs to happen to you move more up market in in the coming years?
Yeah, I mean, maybe I got into it earlier, so I'll reference it, which is just for any one of us that is called in to a company to try and get a problem resolved, it's painful. Even with all the tech that exists and legacy players to date, and you think about the 17 million agents out there, $200 billion worth of spend, and what is a really poor experience for most companies with the most important people in their business. And so, look, that's, to me, the broad opportunity. That's how we think about it. But I think that's also how the opportunity is today, right? So I think a lot of our customers come in and are like, oh, my gosh, how can AI and how can technology help me improve, get my cost down, or how can they get my CSAT up? But I think that's only a piece of where the story is going. And so I think increasingly what you'll see, and I think you see this a little bit in ZVA, and I'll break down our product here for a minute and explain what it is, where it actually becomes a really proactive, positive tool to be able to interact with your customers, to get better insights of them, to help delight them in other ways. And so all of a sudden, technology and AI enables you to take what was a very cost-intensive, problematic thing into potentially a very positive revenue-driving thing. So we get excited when we hear our customers' early thinking and stories in this regard. And we have two products, if helpful. I mentioned them earlier. One, we have a contact center traditional product in that, an AI SKU that is assisting the agent with AI and resolving the customer's issue. That's Zoom contact center. Then we have Zoom virtual assistant, which is no agent in the picture, just an AI bot, if you will, talking alongside you and solving the customer's issue.
That's great. I think you laid out the opportunity really well to disrupt this market, but why specifically does Zoom win when you think about either Contact Center with AI Assist or ZVA? Is it total cost of ownership? Is it integration with the broader Zoom platform? Like what's driving those wins?
I'm going to come back to those because I think they're secondary. What I think we're seeing is the market transformation that I talked about and why Zoom is winning is unlike a lot of the legacy players, the names that all of us know, they've got tech debt from a legacy base that they're trying to move forward versus Zoom sort of starting with a fresh position. And so I think that's what's driving us to be the fastest entrant to Magic Quadrant, right? And I think it really reflects itself in our revenue. If you look at our top 10 deals, 10 out of 10 are AI. And if you look at the high double-digit revenue growth, even growing or inflecting in Q4, it is exactly that that's driving it. So first sort of reason of why we win is clearly AI. Then I would say there's a bunch of things that I would group into what you talked about, like Zoom is trusted, it's secure, we have a fast pace of innovation, We have an open ecosystem and integration philosophy, all the sort of traditional Zoom ethos-y stuff that have us displacing large names that you all would think of. So of our top ten largest deals, seven out of ten are displacements. And then there may be a third kind of category that I would call out that we see as a pattern in our wins, and that is this concept of, remember earlier I talked about a system of action where there's work that sort of happens inside an organization and work that happens outside of an organization and just how much those worlds are being blurred and AI is taking conversations to completion. Where we see a lot of wins are people that come in with phones or meetings in their base, and then they have contact center for communications outside the organization. But it turns out customers really just want to solve problems. they don't tend to think about them as necessarily having to be two sets of products. And so this concept we call is sort of better together, where you can have technology that seamlessly goes out and solves the customer's problem, comes back and resolves it, and seamlessly goes back out again. And so we win all of that, a long-winded way of saying we win a lot with phone and contact center together.
Great answer. Sure. Maybe to follow up, on phone, that has a nice mid-teens type of growth rate. Where are we in the maturity of that product? Is it more about upselling contact center into the Zoom phone base, or are you still landing with Zoom phone?
You know, I think if you'd asked me that question last year this time, I would have said, well, the mental model we have is relative to the Zoom base, How penetrated are we? And I think two years ago we gave the stat of 19% penetrated. And I would have felt good about that, right? Like there's progress and then there's opportunity on the upside. And it's still true, but then you look at the AI value that our customers are turning on in phone and that combination of contact center where we actually now see a lot of new customers coming in in contact center and then wanting that single platform that I talked about and it pulling customers in reverse. All of that, a way of saying that mid-teens growth, that 10 million seats, we still see runway ahead.
Excellent. One of the four sort of buckets of driving growth that you mentioned was the channel. I'm hoping we could expand on that a little bit. What is the channel's contribution to your enterprise growth?
So if you think about those three priorities that I talked about, okay, it's about maintaining and growing the meeting space and the phone. You know, the channel is essential to phone, right? It's just how customers want to interact with it, right? So essential to that piece. Then you go to new scenarios of AI, depending on how you define channel, also important there. But then you go to the scaling or customer experience or contact center, and channel is just essential for that. So, you know, if you look at, and that's why we've been building out this channel ecosystem to go with it. It's not going to be enough just to have Zoom sellers directly selling at it. We've got to invest in a broad channel ecosystem because it's integral to the businesses that we're entering. And it also gives us, frankly, great routes to market. So we now have built out a notable channel ecosystem where companies are betting their business on us. One of the stats we check is how many of them are new customers to Zoom and are they able to upsell us on that. And we're really pleased so far with the progress that we had. Said another way, it's a majority of our both phone and contact center deal. Go ahead.
I want to make sure we get into some numbers, given that you're CFO and I'm an analyst. And then we can come back to some other questions if we have time. So growth versus margins. If growth can continue accelerating, call it high single digits, even low double digits, I mean, what does that mean for operating margins and profitability? Right now your operating margins that you're running out are trending well ahead of the, I think, 33% to 36% prior long-term models. So how should we think about growth versus margins?
Great question. And the way I traditionally answer this by saying, like, my focus as a CFO is on growth rate inflection. First and foremost, that's what I am about, and we're really pleased with the results that we have, right? We're not, maybe we're investors, always want more, and that's good, we'll keep going. But look, our first focus is on growth, and you don't get the right to do that and not hold profitability in our zip code. And so we just guided to 27. We guided to 40.5% operating margin. And so, look, to your point, dramatically better than sort of our long-term guidance had been more in the 33 to the 36. And really what I would say is I've been, we'll at some point update the long-range guidance, but we're not going to tap into margins in that zip code until we see notably more growth inflection. That's just important to me as a CFO. And so the guidance that I've given investors even before this last earnings was you can expect to see something more like 27 until it is very clear to everyone why we would take margins into that kind of zip code.
Excellent. Your net retention rate has been very stable around 98%. What needs to happen to drive that above 100%? And what is the takeaway as far as the path from here?
So, look, it's the same things that I talked about. It's continuing to diversify our product. It's growth and enterprise. We stabilized our online business and grew for the first time since FY22. It's about taking that into mid-growth-ish, single-digit range. It's about continuing to focus on enterprise and the product diversification and AI. And those are going to be the building blocks that, frankly, get us to revenue growth. I mean, we look at net dollar expansion, but it's not what we run the company to. We run the company to grow through inflection because there are limitations to the metric. And so from that standpoint, you know, we feel great that we saw 130 bps of revenue acceleration in these conditions and out-of-the-gate guided to an acceleration minus the piece that I talked about.
Let's move to free cash flow, which I think was $1.9 billion last fiscal year, which was close to a 40% margin. This year's guidance, FY27, looks for a $1.7 to $1.74. So can you help bridge the gap as far as the year-over-year?
So first, what I would say is we've used a consistent forecast methodology, So we'll let investors kind of factor in that element based on our history. But there's three areas that I talked about that are taking the cash flow down. And so we wanted to give as much clarity as we could to investors in that. First and most material is last year at FY26, we had a low CapEx here. We just, there's certain cycles of refresh post-pandemic when we refresh our database. This is not AI CapEx. this is like just core infrastructure capex low comparable more nominalized comparable that's about 75 but look again in in a world where we're holding best in class operating margins i feel good about that kind of trade-off it's more a cash flow dynamic second thing is we obviously have large cash balances close to eight billion interest rates coming down sort of an interest rate phenomenon as things come due. That's about $50 million. And then the third piece is we made a decision to move from less stock-based comp to more cash-based comp, accretive to gap margins, but has some headwinds in terms of cash flow. We're now through all of that. All of this in terms of what I think may be the intuitive question from investors, like, what does this mean? Does this mean it's going down on a permanent state? It means that It's a bit more of a comparable and temporal thing such that cash flows should continue to grow more like what they have post this year.
Okay, great. I'm going to ask one more, and then we'll pull the audience. So on M&A, you have a very healthy balance sheet, I think $8 billion in cash. How should we think about buybacks versus small M&A versus something more transformational? What's the takeaway on M&A and maybe more broadly capital allocation?
Yeah, let me start capital allocation, and I'll round us out at M&A at the end. Look, just as I said, growth is going to be my number one priority. With that comes you have to be excellent at capital allocation. I think this company has made a lot of progress in capital allocation, meaning if I just take internal capital allocation, I think there's a lot that we've done to say these are our priorities. These are the building blocks for long-term revenue growth, and accordingly we will invest in them and we will reduce other things to drive it. more internal, but look, that's important stuff. That's what's underlying the conviction to a revenue growth acceleration. The second thing, we've become more buyback in nature. For a while, we hadn't done those. When I first came in, I added a billion to it, and last quarter, I added another billion, such that we've announced $3.7 billion of buyback and executed against $2.7 billion. The other thing I want to make sure, because there was so much in the February earnings that people really got, is investors kept saying, well, give me the frame. Tell me how to think about buybacks. How can I model it in going forward? And so what we gave guidance is that in FY27 and beyond, we will do buybacks as a means to keep an offset dilution at a minimum. So, and then to your M&A question, look, in these conditions, it's great to have a strong balance sheet, and it's also an advantage in being able to look at things, the right Like, I've been on the other side of many a poor M&A, but broadly how we think about what we would look at, it's one of those three priorities. We're going to be thoughtful and disciplined, of course. It's going to be for growth accretion. it will not slow down the company in its growth rate and so what we've said then is okay well that sounds like a lot of words what does that mean in terms of the size which is often what investors want to know and what we've said is that will translate more to small to medium in nature great any questions see one the mic is on its way a quick follow up just on when you mentioned the right things I mean in broader software everyone's wondering about you have maybe the old legacy version of SaaS software and then the transformations or transitions everyone's kind of going to.
Like when we think about M&A and M&A, do we need businesses that are maybe already on the transition side, or are we willing to even look at a business that is maybe a bit more regular and we can actually make it go through that transition ourselves?
In terms of what we're looking at for M&A, I don't think we're limiting it per se, but I would say it probably more veers pragmatically to the AI side, meaning, you know, people that have already found acceleration, talent, you know, for a whole host of reasons, I would say it bears more towards the AI front.
And a quick clarification just on the free cash flow end, like more to the temporal nature end of things. Like, how should we be thinking about the OBBA cash impacts to that this year at all?
The tax?
On free cash flow, yeah, just the OBBA cash impact.
Yeah, so what we said on the tax is that it'll be a tailwind to cash taxes, but a headwind, slight headwind to the effective tax rate such that really no different than what we've said to investors, but we did give clarity that the ETR will be somewhere in the 22 to 23%. Thank you.
I'll hop back into my list. We talked through a lot of the really attractive growth rate products driving that enterprise acceleration. I do want to ask one on online, just given it is still a meaningful part of the business um you've talked about how online has is a fundamentally different um business today than it was during the pandemic could you expand on that and really how should we think about the growth profile uh in assessing the overall composition and mix of the company um so first maybe i'll just take advantage of our little time here to get make sure everyone's sort of aware so our online business is sub 40% just shy of like 40% of Zoom's revenue it went through as you can imagine some kind of turbulent times post pandemic where we
went from like an eight percent decline to last year 25 flat to the first time we grew which is a good moment in the year we just finished and now we're guiding to slight growth to your comment what I look at when I say it's fundamentally a different business is over 75% of our customers in our online business have been with us for over 18 months. The rest think of them as more monthly and cyclical in nature. So it shows that you've got a sticky user base. And I think to your questions of like, what are the building blocks of growth? Obviously, it sort of starts with the foundation that loves the product, that's in there using it all the time, that's been with you for a while, so it starts with that stable base. Look, in terms of growth, I would say I'd bucket it into two pieces that are ultimately going to drive growth for the online business. The first is by adding more value or product to the customer. It seems intuitive, but I think all too often people talk about it is a price increase. Zoom has done two rounds of price increase here. When really what it is, is us able to realize the price increase with really no impact to churn because we built out a platform. With Zoom, you can get not only meetings, but chat and calendar and whiteboard and all of these things that enables tremendous value for our customer and vendor consolidation. Think of these as small businesses, solopreneurs so that's a huge win for them without having to stitch together all the tech etc right and we added ai value so the combination of those um are really allowing us to both retain that base that build off that stable base and be able to grow it but look we're not kind of stopping there um we're working to to add new incremental product value we acquired a company called bonsai. I think of this as like project management, customer relationship management, really if that's solopreneur, which tends to be a big part of Zoom's business. And something that maybe we haven't focused in on a lot. And look, we're continually kind of working on adding that product value. I'll give you an AI fun one, which is we talked about AI monetization as putting AI value in our core online skills, but we also just announced, think of like like a granola compete and personal assistant that comes with you to all your Zoom meetings and it takes notes for you. And so it just shows kind of how we're beginning to get more back into product value for the online customer. So that's bucket number one and by far the most important. The second is just there's more that we can do in working on our PLG motions, our buy flows, our customer journey. and so look, that's more on the execution element but something that we're focused on.
Perfect. Michelle, we are over time. Really appreciate the conversation.
Thanks for coming. Thank you. Thank you for having me.