Zoom Communications Inc (ZM) 2022 Q2 法說會逐字稿

Hello, everyone, and welcome to Zoom's Second Quarter Fiscal Year 2022 Earnings Release. I'd like to remind everyone that this call is being recorded.

At this time, I'd like to hand it over to 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 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'll be able to find a copy of today's prepared remarks and a slide deck with financial highlights that, along with our earnings release, include a reconciliation of GAAP to non-GAAP financial results.

During this call, we will make forward-looking statements, including statements regarding our financial outlook for the third quarter and full fiscal year 2022, Zoom's expectations regarding financial and business trends, Zoom's growth strategy and business aspirations to drive evolution on multiple fronts as organizations and people reimagine work, communication and collaboration and Zoom being well positioned to be successful as a platform.

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 discuss in detail in our filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. Zoom assumes no obligation to update any forward-looking statements we may make on today's webinar.

In addition, as you all know, we announced our intent to acquire Five9 in July. Clearly, we're excited about joining forces with Five9, but please note that we will not be discussing or addressing questions regarding the pending transaction this time as we are in the process of regulatory review.

And with that, let me turn the discussion over to Eric.

Thank you, Tom, and thank you all, and welcome to everyone joining us on today's webinar. I want to start by thanking our customers and partners for their trust and loyalty, which led to our continued strong revenue growth, alongside remarkable profitability and free cash flow. We also want to thank our hard-working employees for their dedication to delivering happiness to our customers and partners.

I have been humbled by the stories of how finance professionals have leveraged Zoom to reimagine the way they work. Specifically, I'd like to thank Charlie Munger of Berkshire Hathaway for his remarks about how Zoom has added so much convenience to his life. We are so delighted to count Charlie as a happy user, and I nominate myself to be Charlie's Zoom tech support if he ever needs it.

In Q2, we also achieved several milestones, setting the foundation for us to thrive as a platform. In July, we launched Zoom Apps, which brings over 50 apps right into the Zoom meeting experience, and this is just the beginning. The beauty of our platform is it allows our ecosystem of developers to add even more functionality by building apps where workflows are integrated with meeting interactions. This is a win-win because better integrations will boost our customers' productivity and afford our developers' exposure to our large user base The Zoom Apps Fund, which has already invested in over a dozen start-ups in our Zoom Apps and SDK ecosystem, further aligns us with developers, enabling them to focus more on innovation.

We are also excited to have launched Zoom Events in July. Zoom Events is an easy yet powerful solution to produce and host company and public events. It acts as a layer above our existing Zoom Video webinars and Zoom Meetings products. Zoomtopia will be virtual on Zoom Events in only 2 weeks, and we hope to see all of you there.

In Q2, we saw several large customers upsells. We were very happy to expand with a leading tech firm who increased their Meetings licenses over sixfold to 95,000 and with a global financial services customer who added over 63,000 Zoom Phone licenses, making them our new largest customer. Both wins were displacement of legacy solutions that Zoom beat in terms of reliability, simplicity and integration.

And let me recognize a few very big wins for the quarter. I want to welcome NEC Corporation to the Zoom family. Based out of Japan, NEC is a leader in the integration of IT and network technologies behind their slogan: Orchestrating a brighter world. In order to enhance the productivity, collaboration and happiness of their global workforce, NEC deployed approximately 110,000 Zoom Meetings licenses.

I also want to welcome Seagate Technology to the Zoom family. Seagate is a global mass data storage infrastructure leader, innovating world-class precision-engineered data storage and management solutions with a focus on sustainable partnerships. Seagate recently decided to modernize and integrate their global communications infrastructure with over 14,000 Zoom Meetings licenses and over 17,000 Zoom Phone licenses.

Next is a Zoom Phone upsell. In Q2 of last year, we welcome ExxonMobil, which develops and applies next-generation technologies to help safely and responsibly meet the world's growing need for energy and chemical products, to the Zoom family. They began as a Zoom video conferencing customer to enable their teams to collaborate globally. We are very grateful to have seen our partnership evolve over the past year and excited that ExxonMobil has recently decided to add Zoom Phone to further enhance the user experience for their global workforce, leveraging a communications platform that is very easy to deploy and manage.

In addition to these great customer wins, we also closed another strategic channel partnership with Telkomsel, the largest cellular operator in Indonesia, which is the world's fourth largest country by population. Telkomsel understands and want to support their 170 million subscribers' need for seamless and reliable virtual meetings to thrive in the digital workplace era.

They will be leveraging the power of Zoom's Developer Platform and ISV Partner Program to deliver a fully integrated solution via their CloudX offerings for the enterprise segment and Zoom native apps for the consumer segment. The collaboration between Telkomsel and Zoom will bring communication to the next level by combining Zoom's strong capabilities and feature-rich platform with Telkomsel's best quality network and a localized interface, together creating a powerful tool to improve customer productivity and collaboration.

Thank you, NEC, Seagate, ExxonMobil and Telkomsel. I love you all.

Enterprises want digital platforms that combine meetings, phone, event, office technology and developer solutions in a way that is simple, reliable and frictionless. This fundamental truth underpins our leadership position in video conferencing and will help to drive further growth in Zoom Phone and Zoom Rooms as we expand our platform and addressable market in the hybrid world.

Today, we're very fortunate to be a leading global brand with over 0.5 million customers having more than 10 employees. Our internal innovation engine is very strong and bolstered by our growing Zoom Apps developer ecosystem and acquisitions, such as Kites, that will strengthen our position in AI transcription and translation.

As organizations and people reimagine work, communications and collaboration, we are faced with a once-in-a-lifetime opportunity to drive this evolution in multiple -- on multiple fronts. Thanks again to the hard work of our over 5,700 employees and the trust of our loyal customers, we are positioned very well to be successful as a platform embracing and enabling hybrid work. I'm very excited about the future. The journey has only begun.

And with that, let me pass it over to Kelly. Thank you.

Thank you, Eric, and hello, everyone. We had an eventful Q2 with several highlights. The first of which was the strength in the enterprise. We were able to grow the number of enterprise customers spending more than $1 million in ARR by 77% year-over-year. And the second highlight is acceleration we have seen with Zoom Phone. We grew the number of customers spending more than $100,000 in ARR on Zoom Phone by 241% year-over-year. In August, we will reach -- actually, right before this call, we reached 2 million Zoom Phone seats, only 8 months after reaching our first million. We added 8 Zoom Phone customers with more than 10,000 seats in the first half of FY '22, bringing us to a total of 26. And in Q2, we broke our record for the largest Zoom Phone deal to date twice in the same day.

It is important to note that as we just lapped our first full quarter year-over-year compare since the start of the pandemic, we have seen customers return to more thoughtful, measured buying patterns. While revenue, profitability and cash flow was strong in the second quarter and the first half, other metrics have begun to normalize, especially when compared to the unprecedented year-over-year comps.

In Q2, total revenue grew 54% year-over-year to $1.02 billion, marking our first $1 billion-plus quarter, only 5 quarters after reaching $1 billion annual run rate. The top line result exceeded the high end of our guidance of $990 million. We saw strength in our direct and channel businesses, which grew at twice the rate of our online business. Zoom Phone, Zoom Rooms and Asia Pac growth also accelerated in the quarter.

The year-over-year growth in revenue for the quarter was driven by a healthy mix between new and existing customers where customers account -- sorry, excuse me. New customers accounted for approximately 74% of the incremental revenue, and existing customers accounted for 26% of the incremental revenue.

Let's take a look at the key customer metrics for the quarter. We saw 131% year-over-year growth in the upmarket as we ended the quarter with 2,278 customers generating more than $100,000 in trailing 12 months revenue. We exited the quarter with approximately 504,900 customers with more than 10 employees, up 36% year-over-year and representing 64% of revenue.

In Q2, customers with 10 or fewer employees represented approximately 36% of revenue, in line with Q2 of last year but down from its high of 38% in Q3 of last year. As we discussed previously, this cohort, which comprises SMB and consumers who typically purchase online, is more volatile, and we expect it to continue to decline as a percentage of revenue as customers adjust to the evolving environment.

Our net dollar expansion rate for customers with more than 10 employees exceeded 130% for the 13th consecutive quarter as existing customers increased their spend with Zoom and upsells of Zoom Phone and Zoom Rooms picked up pace.

Both domestic and international markets had strong growth during the quarter. Our Americas revenue grew 50% year-over-year. Our combined APAC and EMEA revenue grew 62% year-over-year to be approximately 33% of revenue, up from 31% a year ago. In recent quarters, we have made significant investments in our international teams. In Asia Pacific, our direct sales team drove several strong wins in the enterprise segment. However, in EMEA, we saw some headwinds, which were predominantly driven by declines in the online segment.

Now turning to profitability, which was strong 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, net litigation expenses, and gains or losses on strategic investments.

Non-GAAP gross margin in Q2 was 76.2% compared to 72.3% in Q2 of last year and 73.9% in Q1 of this year. The sequential improvement in gross margin is mainly due to new data center capacity coming online and lower usage during the summer months, particularly with schools. We now expect gross margin outlook to be higher than previously discussed at approximately 75% for the remainder of the fiscal year even while we continue to support free K-12 education.

Research and development expense grew by 89% year-over-year to approximately $54 million. As a percentage of total revenue, R&D expense was approximately 5.3%, an increase from Q2 of last year, demonstrating our ongoing commitment to building out our engineering teams globally and maintaining best-in-class product and innovation.

Sales and marketing expense grew by 72% year-over-year to $211 million. Sales and marketing expense was approximately 20.7% of total revenue, an increase from Q2 of last year mainly due to investments and hiring to drive sustainable future growth. We plan to increase investment in global sales capacity as well as digital marketing and events to drive additional leads for our sales teams across Meetings, Phone, Rooms and Events.

G&A expense in the quarter grew by 73% to $89 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 8.7% of total revenue, a slight increase from Q2 of last year.

Revenue upside in the quarter carried through to the bottom line, with non-GAAP operating income of $425 million exceeding our guidance. This translates to a 41.6% non-GAAP operating margin for Q2, steady with both Q2 last year and Q1 of this year.

Non-GAAP diluted earnings per share in Q2 was $1.36 on approximately 306 million non-GAAP weighted average shares outstanding. This result is $0.21 above the high end of our guidance and $0.44 above Q2 of last year.

Turning to the balance sheet. Deferred revenue at the end of the period was $1.2 billion, up 59% year-over-year from $743 million. Looking at both our billed and unbilled contracts, our RPO totaled approximately $2.3 billion, up 66% year-over-year from $1.4 billion. We expect to recognize approximately 69% of the total RPO as revenue over the next 12 months as compared to 72% in Q2 of last year, reflecting a shift back to longer-term plans.

It is important to remember that because over 40% of our business is billed monthly and typically bought online, deferred revenue and RPO trends are not reliable predictors of future revenue growth. As I mentioned last quarter, the timing of our renewals has increasingly shifted to the beginning of the fiscal year, with Q1 now representing our largest renewal quarter.

This shift in seasonality is a result of the significant growth we experienced in the first half of FY '21. We expect this front-weighted seasonality will persist and potentially become even more pronounced given the scale of our base and practice of upselling coterminously with the existing contracts. As such, we would expect total deferred revenue and RPO to be modestly down from Q2 to Q3.

We ended the quarter with approximately $5.1 billion in cash, cash equivalents and marketable securities, excluding restricted cash. We had strong operating cash flow in the quarter of $468 million, up from $401 million in Q2 of last year. Free cash flow was $455 million, up from $373 million in Q2 of last year. The increase is primarily attributable to the top line growth and disciplined spending.

Looking at the remainder of the fiscal year, we expect to increase our capital expenditures related to ongoing data center expansion to support our growth outlook.

Now turning to guidance. Please note that the ever-changing nature of the global pandemic continues to impact our segments and regions in different ways. Our outlook is based on our current assessment of the business environment. Specifically, our outlook assumes that our direct and channel business will continue to experience robust growth, while our online business will be a headwind in the coming quarters as smaller customers and consumers adjust to the evolving environment.

For the third quarter of FY '22, we expect revenue to be in the range of $1.015 billion to $1.02 billion. We expect non-GAAP operating income to be in the range of $340 million to $345 million. Our outlook for non-GAAP earnings per share is $1.07 to $1.08 based on approximately 309 million shares outstanding.

For the full year of FY '22, we expect revenue to be in the range of $4.005 billion to $4.015 billion, which would represent approximately 51% year-over-year growth. We expect non-GAAP operating income to be in the range of approximately $1.5 billion to $1.51 billion, which would represent approximately 53% to 54% year-over-year growth. Our outlook for the non-GAAP earnings per share is $4.75 to $4.79 based on approximately 308 million shares outstanding.

Before concluding, I'd like to welcome everyone to join us in 2 weeks at Zoomtopia, our 2-day immersive experience that is packed with exciting product updates, guest speakers and virtual networking opportunities. And on day 1 of Zoomtopia, please join us for our financial analyst briefing where we will be providing you with greater detail on Zoom Phone, the platform, our channel partnerships and much more.

And 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 to the entire Zoom 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.

Our first question is from Ittai Kidron with Oppenheimer.

Great quarter again, guys. Kelly, I want to focus kind of on this transition. Clearly, you're doing extremely well with Phones. It's phenomenal, the growth that you're seeing over there. But can you give me a little bit more insight as to what is the growth in Meetings right here right now? My math suggests a very significant deceleration in your expansion rate; and I would suspect that, that's tied specifically to Meetings decelerating. Help me think about the contribution of growth of those 2 elements and perhaps how would that change over the next 12 months.

So I think in terms of the expansion rate -- you're talking about the implied expansion rate that you calculated?

Yes.

Yes. And I just want to remind you, first of all, that when you calculate that, it includes all of our customer base. And as we mentioned, we are seeing headwinds in the online segment of our business for sure. So that -- I would say that while we don't break out revenue, we see strength -- continued strength in the upmarket enterprise in both Meetings and Phone. And where you're seeing that challenge in the implied metric, it's really coming from the online segment of our business.

So should I interpret that, that to me that churn is now finally rising in that category? Is that the right way to think about this going forward? Now that the economy is slowly opening, some businesses, I guess, scaling back on the usage here.

Yes. So remember, the online business is primarily -- not exclusively but primarily small businesses and individuals. And I think what we've seen is while the future of Delta is still unknown, we do see individuals especially moving around the world and feeling comfortable. Like I think we were talking about most of us are probably socializing in person now, doing fewer things like Zoom happy hours. And that's where we're starting to see some of the challenges. So the net dollar expansion in the online segment is what's driving -- pulling that number down [if you look at it].

Our next question is from Steve Enders with KeyBanc.

I guess I just want to dig in a little bit more on kind of the trends you're seeing in the second half. It looks like you're now guiding down a little bit, at least a downtrend. I think before, we're talking about an uptrend. So just want to get a bit of sense for what's the biggest incremental change that you're seeing there in the outlook and what's changed in the past 3 months specifically.

Yes. So again, we continue to see strength in our upmarket. We're excited about what we're seeing in the enterprise, in Zoom Phone and international. We all saw growth accelerate in Q2. When we look out, though, what we have seen is a slowdown in the online segment of the business, which, again, even though the pandemic seems to be far from over, we are happy that people are feeling more comfortably out traveling, and that's really where we're seeing the slowdown. And we had -- if you back all the way up to when we gave guidance at the beginning of the year, we had expected that towards the end of the year, but it's just happened a little bit more quickly than we expected. And I mean, of course, we feel good that people are out moving around the world, but it's certainly creating some headwinds, as we said, in the online segment of our business.

Okay. Great. And is that creating any opportunities then as companies [go to think about] going back to the office for Zoom Rooms and incremental activity with that product?

Absolutely. So we saw Zoom Rooms start to accelerate again in Q2, which was very exciting, as our customers are planning and thinking about the attach rates more than doubled quarter-over-quarter from Q1 to Q2. So absolutely, companies are preparing and planning for welcoming their employees back to the office.

Our next question is from Taz Koujalgi with Guggenheim.

Can you guys hear me now?

Yes.

Sorry about that. I have a question on Zoom Phone. So if you look at the numbers reported tonight, you add about 500 million seats, I think, in the last 4 months. Prior to that, you're adding about 500 million seats -- [500,000] seats every quarter. It looks like a bit of a slowdown in the number of seats you're adding this quarter. Is that a fair comment?

It's almost exactly the same time frame because I think we had announced in December that we hit 1 million, and then we announced 1.5 on our call in April and then 2 million on this call. So it's almost exactly at the same pace.

Got it. And then just one follow-up. You said a weakness in the online segment. Is that coming from just increased churn? Or are you seeing a slowdown in the -- in new customer acquisition in that line item?

It's a little bit of both. So as we mentioned, we specifically saw some challenges in certain regions like EMEA where the world at least for a period of time was a little more open again and people are moving around, and that's where we see people taking advantage of being out in the world and being some slower top line bookings as well as accelerated churn.

Our next question is from Meta Marshall with Morgan Stanley.

Kelly, I just wanted to dig into your kind of commentary on more measured spending patterns that you're seeing and taking away from kind of the smaller business commentary that you've been giving and focusing that on enterprise. And so just trying to get a sense, does that mean normalizing the amount of seats that they're adding -- or that they're rationalizing kind of the seats that they've had, that they're rationalizing number of video solutions that they're having in-house? Just what does that kind of commentary around more measured patterns around the enterprise business means?

Yes. Thank you, Meta. We saw this start a little bit in Q1 and now continue into Q2 where I think it's not necessarily measured in terms of how much they're buying but more measured and thoughtful in how they are buying in that they want to take their time. They're doing more complete like proof of concepts, for example, versus if you think about a year ago, they were in this sort of stage of trying to keep the lights on almost and buying very quickly, and now they're taking the time to really be thoughtful. And it's just -- it's back to kind of the way they used to buy prepandemic, which is just a much more normal buying pattern. So I think that we're back to more normal, and the sort of poor quarters-ish we saw last year was really the blip, and now we're back to a more normal measured approach (inaudible).

And is part of that just because it's a coupled decision with Phone now or just anything having to do with that?

I think that, certainly, the Phone is a different buying cycle; but usually by the time they get to Phone, they already know Zoom. So it's not that, that is necessarily slowing us down. It's just that they're taking their time to think about these decisions that they're making.

Our next question is from Matthew VanVliet with BTIGA -- BTIG.

I guess on the continued success on Zoom Phone here, called out a number of very large deals. Curious on how often you're being brought in, where they're also contemplating a contact center upgrade. Where have you stood? Obviously, the partnership with Five9 has been in place for a while. But just more generally speaking, how often is upgrading to Zoom Phone a part of a broader modernization across that could potentially include contact center?

I actually don't know exactly off the top of my head the specifics around that. We -- obviously, having an integrated phone and contact center solution is really important to many companies, which is why we're excited about the deal that we're working on with Five9. And as you say, we've been partnering with them. We also have other partnerships in place as well. And so there's nothing different about that, that has changed. I'd have to go back and look. I don't know exactly what the typical cap rates are between those 2, though.

Eric, if you have -- do you have a perspective on that?

Sure. So Matt, if you look at our installed base, right, for now, I think we really wanted to migrate from on-prem PBX system for the cloud, right? That's where the huge opportunities comes from.

Also, since the pandemic, I think we do see some of the enterprise customers. They also started asking about, hey, what's your cloud contact center strategy because they started planning now, right? That's why we think this is kind of the new opportunity for us, not only for the brand new revenue stream for contact center, but also it might further grow our Phone business as well because like a year ago, right, where a few large [enterprise] customers, they really wanted to migrate their on-prem contact center solution. Now given the digital transformation for almost every enterprise customers, we do see more and more customers who are very interested. That's why timing-wise, it's perfect for us to double down on the [trial as the] contact center grows.

Great. And then following up quickly on the education front. As schools get back into session, whether or not they're going to be in person or not is sort of up to debate here. But I guess what's the, I guess, potential of monetizing more of that installed base? Is it still going to be a relatively free solution? Or how has that strategy evolved?

So Matt, before I answer to that question, as you know, our company's value is care. The #1 thing is really about community, right? For -- to support the K-12 schools, I will say that's a no-brainer for us to support that at no cost, right? We feel very proud. We never thought about how to monetize our service for those K-12 schools, right? Now they all go back to school, right? With that, they have more benefits, resources right to think about how to monetize other installed base like free users.

Last year, we were extremely busy to have the world -- to have people stay connected. We even did not have bandwidth to think about how to monetize those free users, right, I mean how to embrace the consumer, right? We never thought about that before. Now it's right time, right? How to think about embracing the consumer strategy, how to monetize those free users is something very -- we are very excited. We do not want to monetize those K-12 schools. It's our responsibility to help them as always.

Our next question is from Pat Walravens with JMP Securities.

I mean I don't think there's ever been a company that has grown so fast and realistically pulled a lot of demand forward, right, because everyone needed to get their video conferencing solutions in place very quickly. And now as I look at 54% this quarter, Kelly, your guidance suggests 30%, 31% in Q3 and 15% in Q4. So all that is just a lead effort. Eric, what is your top 1 or 2 priorities in the next 12 months as you go from this hyper growth to a much more reasonable growth period? If you could just sort of contrast those for us, I think that would be really helpful.

Sure, sure. So I would say, Patrick, that's a great question. First of all, if you look at it prior to pandemic, look at our growth, always focused on in enterprise [customer], right? The first service will be the conferencing. We introduced the second revenue stream, Zoom Phone. Both of them are doing well. And how to introduce the third one or fourth one? How to double down on that? This is always our (inaudible), right?

We did not realize this is a pandemic crisis. Otherwise, several years ago, probably, we should have planned [the start of] services beforehand.

Now actually, now this is indeed our strategy, right, how to introduce more and more revenue stream, new services to support our enterprise customer. That's always top priority for us. Essentially, this is part of our overall platform strategy, right?

And inside of that, also there's a new opportunity ahead of us, as I mentioned earlier, right? We never realize there's so many consumers, right, and who are so loyal to our -- the platform, right? The usage is still pretty healthy. How to embrace the consumer strategy is also something on top of our minds as well, right? We never thought about it before. It's the right path, right? Those 2 things, enterprise platform and also consumer, those 2 things will drive our future growth.

Our next question is from Shebly Seyrafi with FBN Securities.

So looking at your implied guide for Q4, it seems like you're guiding it to decel to around 12% or so, plus or minus, from 30% or so in Q3 with a similar compare, I would argue. It seems like it'll actually be down potentially sequentially from Q3. So can you elaborate on why that might be the case? You talked about the online issues. How long do they last for example? And if we go to like 10% to 12% growth in Q4, should we accelerate afterward if we -- the compares get easier? How should we think about next year?

Yes. So in terms of what you're seeing in Q4, it is continued uncertainty around headwinds in the online segment, absolutely, that is driving that. And in terms of how that implies for next year, we're not ready to give FY '23 guidance today, unfortunately. So we'll be prepared to do that when we get on the Q4 earnings call. And of course, we'll have a lot more learnings at that point to share with you, but that's -- that is what is exactly what continues to drive that in Q4.

Okay. Is there any reason why the online issues would be bigger in EMEA than in the Americas and Asia?

Well, that -- that's like the pandemic question, right? Because it -- really, what we've seen is this varies depending by region and by segment, depending on where each of those countries or markets is in their pandemic life cycle. And we've seen it ebb and flow over the last 18 months by market. And so it's -- we -- that's the challenge, even I think, that all businesses are having right now. And thinking about the future with uncertainty -- so much uncertainty around the pandemic right now, it's just difficult to forecast exactly.

Yes. To add on to what Kelly said, look at our user base in EMEA. Seasonality also is a factor, right, in particular in the summertime. Not to mention the COVID situation and the user there might have a little bit longer vacation, right, is the seasonality for sure is a key factor, and that's another big difference compared to our user base here.

Our next question is from Ryan Koontz with Needham.

Great to hear the progress in the enterprise clicking along there, and it sounds like some real strength in APAC. Wondering if you could share with us any additional color on particular market verticals or applications you're seeing that are kind of key to penetrating and getting these big, large Global 2000 type wins.

Yes. Ryan, I would say, first of all, the top 2 markets is that education and health care is still pretty strong and also will bring us more opportunities when we expand into the international market like APAC. And also like those telco, Telkomsel, right, those kind of telco partnership will further help us, for us to penetrate into each of those APAC countries, right?

In terms of new opportunities, recently, we launched Zoom Apps and also like some of the partners, they build a new solution of our platform like [class] technologies, right? I think a lot of the new opportunities, right, we do not need to build by ourselves, right? And those third-party customers, they can leverage our either API or SDK or Zoom App to build all kinds of new solutions to focus on all those vertical markets or even the department as well, right? That's where the opportunity is coming from.

So you're seeing some opportunities to upsell into the CPaaS type applications in the enterprise?

Yes. Both, actually. Yes. Because those third-party partners, they build a very healthy business, also bringing Zoom to the installed base, and also by establishing their trust, right, we also can upsell in more stuff, right? Essentially, it's a very healthy channel not only for their own business doing very well, but also it's a great channel for us.

Our next question is from Siti Panigrahi with Mizuho.

Just wanted to dig into the enterprise segment. Q1, Q2, those are 2 big renewal quarters -- now that's behind now. So what sort of changes you are doing on your go-to-market strategy, mainly increasing quota-carrying sales rep or any changes that you're doing for this normalized environment? And Phone used to be one of the big cross-sell opportunity for you. And how should we think about the Phone as you get into more normalized renewal environment?

So we are absolutely continuing to invest in our sales capacity. We are focused on certain regions, especially where we see lots of opportunity like Asia Pac. We recently hired a new leader there and are really excited about the progress we're already seeing with his leadership.

And then we are continuing to invest in marketing. So as we've move post-pandemic era a little bit in terms of -- not post-pandemic, but sort of what we saw from last year with the lift in brand awareness, we're continuing now to think about how do we invest more in specific product marketing around Zoom Phone, around Zoom Rooms as well as digital marketing campaigns, so helping to continue to drive additional leads for all of our teams on a global basis.

And then also the channel continues to be a really important aspect of our go to market. So the channel was responsible for approximately 27% of our Zoom Phone sales in Q2. We added 6 additional master agent partners during Q2. So really excited about continuing to invest in the channel on a global basis.

Our next question is from Alex Zukin with Wolfe Research.

So I think I'm going to -- I'll probably touch on a topic that's been mentioned here before because I think a lot of people that are investing in the company at this point, they really are investing in the non-online story of the company, right, the enterprise story, the large business. There's a lot of metrics. There's a lot of kind of pollution and noise in these metrics. How do we think about the growth of the important part of the business for investors, meaning the over 10 employee customer base, either from an incremental bookings perspective, from an incremental revenue perspective? And when does the headwind or anchor on the business from the pandemic, from the once-in-a-generation SMB buying pattern, when does that trough? And so when do we see a normalized -- kind of normalized growth rate for the company?

Yes. So thank you, Alex. First of all, we agree with you that, really, we want everyone focused on the long-term potential of the upmarket. As a reminder, in Q2, that segment of the business grew at twice the rate of the online business. So that gives you some indication of how those 2 segments are diverging a little bit.

And then as we look forward, I guess the best way to help you think about it is you want to look at like the net dollar -- the implied net dollar expansion rate that we were talking about earlier, right? You can think about what's happening there is the net dollar expansion rate for the online segment is under 1, right? That gives you some idea of what's happening, again, how to think about those 2 different segments of our business.

In terms of where is -- is there a trough, I think that it's back to kind of trying to predict a pandemic, which is a difficult thing for, obviously, anybody in the world to do right now. And as much as we're excited about vaccines being more widely distributed, unfortunately, as we see Delta continuing to grow in certain parts of the world, we have even in the last few weeks, like seen certain pockets of strength. So I think that that's going to depend on really what we continue to see in terms of the spread of the variant around the world.

Got it. And I guess maybe for Eric. You mentioned the seasonality, the vacations in Europe. Is there a way to kind of get a sense for the Delta part about just EMEA, SMB versus U.S., SMB, just so we can get some sense of that magnitude change?

I think, overall, I think our upmarket are doing well, especially if you look at the North America business, right? In EMEA, I think a mass market. Online SMB, I think it not too well in the last quarter. Seasonality, COVID situation, for sure made things a little bit worse because the longer vacation and so on and so forth.

Here, look at our North America market, I think the upsell Phone and also the Zoom Rooms because every company, I think they started going back to office, the new opportunities are coming, are also doing very well. That's why I say even if [a little bit of challenge] on SMB, by and large, we did not see the big [problem] and because offset by the hybrid work opportunities, right?

I think if you look at APAC, APAC, we did not see that at all, right, in the last quarter. It's still doing very well. I think overall, as we mentioned earlier, we got to go back to our enterprise, right? Because last year, I think as the online business used to be just a marketing channel, right, but however, not only a marketing channel but also contributed a lot to our revenue from a percentage perspective.

Now given that percentage is going to go down for online, online, that's a very healthy part of it, right? With that, we can focus on our core enterprise customer. And plus, given that we become a household name, it will bring a new opportunity to monetize. It used to be the monetization for online, [no one user], just online subscription. I wouldn't say that it may not be the sustainable strategy, right, to -- for the online users monetization. We've got to have other ways, right, to monetize those online -- the installed base. That's why we are very excited about the future.

Our next question is from James Fish with Piper Sandler.

On the win with Seagate, as an example here, how often are you seeing if that Phone is leading to a greater number of seats at existing customers? Or really, how can we think about that potential uplift within just your installed base today of selling Phone with Meetings that creates a greater number of seats at current accounts, not just Meetings seats but overall employees that you can actually sell Phone into? Is it a 2x opportunity that we just don't have as many Meetings seats because you can have more -- you can have less host than you do employees?

James, that's a great observation. I think you are so right. I think 1 year ago, we really did not see that, right? Normally, we buy more Meeting licenses and then probably a little bit upsell for Phone and also for the existing installed base, we upsell Phone. For the brand-new customers, because the customer look at one platform for both video and voice, right, we understand video and voice are converging into one platform, plus our Phone business is very mature now, right, every quarter doing very well. Customer like it is ready. It's not like, oh, this is something brand new. They do not want to take any risk. It's very mature. Plus, the integrated experience, both video and voice are doing very well.

Essentially, from now on, I would say probably -- I do not know, but I guess probably, more and more customers, they are now going to view -- are going to deploy video for us, and they did deploy it soon. Very likely on demand, they will deploy both. Given the dynamics of each business, sometimes probably they want to deploy more Phone seats than the Meeting license.

Next question is from Will Power with Baird.

I guess question probably for you, Kelly. As we think about that, the 10-plus employee cohort, kind of your upmarket segment, how do we think about, one, customer growth from here? And two, as you think about that net expansion [rate], you've been above 130%, what's the sustainability of that, right? Because you've got a number of growth drivers. You've got the law of large numbers kind of working against you. How do we think about the outlook on that front?

Yes. In terms of net dollar expansion, we expect it to stay above 30 certainly for Q3. And then in terms of Q4, we expect it to be in -- at least in that range, not -- it's a quarter out. We don't know exactly, but we're predicting to be right in that same range still for Q4.

And then in terms of the customer growth, I think that what you're going to continue to see is ongoing growth driven by large deals. So the customer count may slow, but you're going to continue to see growth driven by these big deals as we see opportunities to continue to cross sell with Zoom Phone. As you heard, right, we beat our 2 largest deals record in the same day this quarter, so really seeing opportunities there. And then as people are planning to go back to the office, also opportunities for Zoom Rooms, and then think about Zoom Events. So you're going to start to see opportunities from larger and larger, bigger customer wins.

And I think the other thing to note, we talk about the quarter, but I just want to make sure we understand, like we had a deal this quarter that now became our new largest customer. So not our new customer, an existing customer. But now with their upsell, right, they became the largest customer. So we're continuing to see these really significant large wins, and that I expect to continue.

Our next question is from Matthew Niknam with Deutsche Bank.

You talked a little bit about some more measured behavior from customers in terms of buying patterns. I'm just wondering, can you talk a little bit about the competitive backdrop, whether you've seen peers maybe getting more aggressive, especially as larger enterprise customers really take their time to reevaluate the future of work post COVID?

Eric, do you want to talk about competitors?

Sure, sure. So I think, Matt, if you look at the trend, right, the future work, hybrid work, for sure, that would be the mainstream, right? And however -- and because of embracing hybrid work, a lot of employees, right, still they're in work from home or maybe work in the remote locations. And not like -- and prior to pandemic crisis, right, quite often, and you might deploy solution, this is good enough, right? And given employees now to support hybrid work, the best breed of service will do very well, right?

Because you look at employees, they do not have IT support sitting next to them, right? And plus, you really worry about the productivity if you do not give the best tools. That's why, a good enough solution will not do well. Every businesses, they would like to deploy the best video service to always give the employees much better tools, right, to improve their productivity, to help employees because to support a hybrid work, it's not that straightforward right?

And I'll give an example like a conference solution. We introduced the Smart Gallery feature. Otherwise, customers, they do not dare to have a meeting, right? Some are sitting in the conference room. Some will join remotely. That experience is not as good as the webinar or meeting, right? That's why I think the hybrid work certainly will help Zoom, right? Even some of, sometimes, our competitors, they might have [added to] the price. I think the good news is the customers really want to have very reliable, frictionless platform, very easy to use. I think that's the reason why I think Zoom is positioned much better than any of our competitors.

Our next question is from [Bo-Hyun Kim] with Citi.

For Tyler Radke. Earlier in the Q&A, you showed some progress around the major master agent program and also had cited some really large international Phone deals. So I wanted to hear about what you're seeing in terms of the productivity of the channel partners and international markets relative to what you're seeing from channel partners in the U.S. and to what extent is that impacted by the nascent state of the master agent program in international markets as well as the nascent state of the broader market and cloud-based phone.

So I think we're seeing strength in our channel partners globally. So -- but as you say, it's a much newer program and much smaller internationally, so excited to really -- this is one of the focuses for our channel team, which is expanding outside of the U.S. It's focused for the rest of the year.

In terms of productivity, I don't think that it really varies. I mean we were really excited about the Telkomsel deal, which is one of our largest channel partner deals, ISV deals to date. So that's really exciting, but we've had significant wins in the U.S. as well. So not seeing dramatic differences in productivity on a global basis at this point.

Our next question is going to be from Matt Stotler with William Blair.

I think just one for me. Obviously, as you guys have spoken to so far, the enterprise opportunity here is really kind of the -- what's really exciting and compelling going forward. But given the commentary around finding other ways to monetize the base, whether that's consumer or otherwise, I would love to maybe get an update or whatever color you can provide on the level of freemium usage that you're seeing today, right? And outside of the seasonality with education, just the level of freemium users on the platform has changed over the past 4, 5 quarters, thoughts on the back half there. And then any commentary on what conversion you've seen there? Or do you expect you could see if you decided to really try and monetize that?

Yes.

Yes, go ahead, Kelly. Go ahead.

So we still see free users as a large -- they've really grown over the last 18 months, and they're about 30% of our minutes usage today as compared to like 10% pre-pandemic. So that gives you an idea of the number of -- we don't talk about the number of users, but that at least gives you a relative understanding of how they've grown over time.

And like we always say, as Eric mentioned about our care value of care -- our core value of care, we really care about all those free users, especially to keep people connected during these more difficult times. And there's always a hope that they continue to convert or that they have the opportunity to continue to expose more new users to the power of Zoom.

Our next question is from Chaim Siegel with Elazar Advisors.

I had a couple of questions if you have time. But since, obviously, the focus is on enterprise, I just wanted to know how fast the sales force is growing and when efficiency for that sales force starts to kick in. I guess that's one. And also just related to that, on operating expenses, so I'm not sure how long you expect flattish sequential growth. But on the operating expense, it seems like maybe it'll start to grow faster than revenues. And I'm just wondering, with relation to focusing on getting the enterprise business going, how fast expenses will grow versus revenues.

Yes. So as we've been saying for the last several quarters, there are areas that we were not able to hire and invest in as quickly as revenue grew last year. And so what we've been doing in the last couple of quarters is focusing on reaccelerating the investment, especially in the areas of R&D as well as quota-carrying heads, and we are absolutely continuing to do that. We still are under invested in R&D at a little over 5% of revenue, and the long-term target is 8% to 10%. So we're continuing to hire as quickly as we can.

And then similarly, in terms of quota-carrying heads, we're being very thoughtful about the segments and the regions in which we're hiring -- remember, like stepping back for a minute, there is a huge TAM and a huge opportunity out there. And we want to continue to add quota-carrying heads and sales capacity into our system to take advantage of that. So as long as we continue to see opportunity for growth, we will continue investing in quota-carrying heads. We are also, as I mentioned earlier, accelerating our spend in marketing as we were able to pull back a little bit on that last year, but we think now is the right time to continue reinvesting there.

And then the 2 areas that we always look to be as efficient as we can are our G&A and COGS. And G&A is kind of right in the range of where we would want it to be for the long term. Over time, we do expect COGS to decrease as we continue to move more and more of our services out of the public cloud into the data center -- our own data centers. I mean we're always going to have a hybrid approach there, but also eventually at some point, right, when K-12 schools are more free to go back to campuses, we do expect to see improvement in our gross margin. But we will absolutely continue to support those students and schools as long as we think it's needed.

Is there a general timing of efficiency where you expect that to kick in for the enterprise for salespeople in the enterprise? I know you've been growing it, and I know it takes time. I was just wondering if there's like a timing where the tranche is going to start really performing for you.

No. I mean -- well, what I just want to say is we are continuing to hire quota-carrying heads quickly, and we'll continue to do so. So that means there's a constant state of having ramping reps in the system. And since we have no plans to stop hiring quota-carrying heads in the near future that I can't say when all of a sudden they're going to necessarily be more efficient.

Our next question is from Rishi Jaluria with RBC.

I wanted to just ask about Zoom Events. So I know initially, when you've talked about the product, it was kind of pitched as a little bit of a monetization factor for the prosumer segment, right, helping fitness instructors, yoga instructors around classes online. But clearly, it seems like there's much grander ambitions, right? The fact that you're going to run Zoomtopia on that, I think, tells us there's maybe a bigger enterprise opportunity. And even as companies are looking at doing in-person conferences again, they want to have a strong virtual and hybrid component to it. So can you maybe talk a little bit about what you see as a longer-term vision with Zoom Event, especially enterprise? And maybe let's go on that.

Yes. Rishi, that's a great question. So remember last year -- last October, right, at Zoomtopia, we introduced Zoom Events. We started from OnZoom at that time and we thought about how to help those -- and the people working from a home still can get a training, right, like fitness online classes, join all those classes, right? That's the reason why we started building the Zoom Events.

However, again, we have -- we always listen to our customers, in particular, our Events customers, right? And they all told us, hey, there's more opportunities around the corporate events, the corporate and public like Zoomtopia. They all told us, hey, we badly needed that. We badly needed that. We already have a revenue platform. They want to ask to extend that, right, how to expand into bigger, the -- and use a conference like Zoomtopia. That's why we sort of pivoted out strategy, right, and doubled down our corporate -- the [word] of OnZoom, which is rebranded as Zoom Events, right? We do see a future opportunity.

Inside of that, the consumer work is not called Zoom Events anymore. This is more like OnZoom website. We're still working to aggregate all those consumer-driven events, right, like online fitness class and so on and so forth. But for now, if you look at the short-term opportunities, Zoom Events will do well because many of our existing customer told us, we need a platform like that because trust is already built, right? They do not want to go to any other platform. They are very patient to wait. That's the reason why we shifted our strategy a little bit since last Zoomtopia.

Okay. Well, thank you to all of our analysts. That's all the time for questions that we have for today. Tom -- bring you back on, Tom.

Great. Thank you, everybody, and we hope to speak to you more on the rest of the quarter and see you at Zoomtopia. Anything else, Eric?

Yes. Thank you all for your time today. Hope you all will join next month at Zoomtopia, September 13 and 14. I really appreciate for your support as always. Thank you.

Bye, everybody. Thank you.

Thank you.