Zoom Video Communications Inc (ZM) 2020 Q3 法說會逐字稿

Hello, everyone.

Welcome to Zoom's Third Quarter Fiscal Year 2020 Earnings Release.

I'd like to remind everyone that this conference is being recorded.

At this time, I'd like to floor over to Tom McCallum, Head of Investor Relations.

Thank you.

Matt.

Hello, everyone, and welcome to Zoom's earnings webinar for the third quarter of fiscal 2020.

Joining me today will be Zoom's Founder and CEO, Eric Yuan; and Zoom's CFO, Kelly Steckelberg, who's actually joining us remotely from Los Angeles, demonstrating another capability of using Zoom Video webinar for our earnings announcement.

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 press release, include a reconciliation of GAAP to non-GAAP financial results.

During the call, we may make forward-looking statements about our future financial performance and other future events or trends, including guidance.

These statements are only predictions that are based on what we believe today, and actual results may differ materially.

These forward-looking statements are subject to risks and other factors that can affect our performance and financial results and which we discuss in detail in our filings with the SEC, including today's press release and our latest 10-Q.

Zoom assumes no obligation to update any forward-looking statements we make on today's webinar.

And with that, let me turn it over to Eric.

Thank you, Tom.

Thank you.

And welcome and thank you all for joining us on today's Zoom Video webinar.

I am pleased to report that we had another strong quarter as evidenced by a combination of high revenue growth of 85% with increased profitability and free cash flow of $54.7 million.

We continue to have success with customers of all sizes, and one metric that has continued to impress is customers with more than $100,000 of trailing 12-month revenue.

This metric grew 97% from Q3 last year.

Our execution so far this year has put us in a position to finish the year strong, and we are raising our revenue and profitability outlook for the fourth quarter as well as full fiscal year.

As Kelly will discuss in a moment, our strong third quarter results were driven by 2 factors: first, our ability to attract new customers; and second, our commitment to customer happiness, which creates trust and enable us to significantly grow commitments with our existing customers.

Let me discuss some of the largest deals we closed this quarter with 2 happy customers.

Both expanded their footprint of our unified communications platform.

I'm excited that the US Postal Service is starting to deploy Zoom Meetings more broadly across the organization after an extensive proof of concept.

The USPS is our first major agency win since we received the FedRAMP approval in May.

They chose Zoom for our high quality video and audio.

Thank you, USPS.

I love you.

We are also grateful to have National Australia Bank as part of the Zoom family.

NAB is undertaking a large technology transformation and is looking to Zoom to support its enterprise telephone and video conferencing services in order to better connect its workforce of more than 30,000 employees.

NAB is Australia's largest business bank and one of our largest financial service customers in the region.

Since selecting Zoom in 2018 to help seamlessly connect its workforce across any device and internationally, they have continued to grow and adopt Zoom services throughout their business.

In Q3, the bank selected Zoom to support the telephony systems for a new Sydney-based major office building development.

Zoom Phone was selected to support a unified communications approach as the bank adopts a wireless working environment as well as delivering projected cost savings and enhanced features and functionality.

They will begin rolling out Zoom Softphones to over 6,500 users next year, focusing on tenants of the new building as well as continuing to expand their Zoom Rooms footprint.

We're excited to continue delivering improved experiences for the bank through a full end-to-end communications platform, which helps better connect their workforce.

Thank you, National Australia Bank.

Now let me discuss a couple of business highlights from Q3.

First, analyst firm Gartner named Zoom a Leader for the fourth consecutive time in their Magic Quadrant for Meeting Solutions.

We are grateful that Gartner has recognized Zoom for our completeness of vision and our ability to execute once again.

And second, we held our premier customer event, Zoomtopia, my favorite event of the year.

It is only our third Zoomtopia and we had record registrations of 2,600, up over 80% from last year.

During the event, customers like AB-InBev, Autodesk, Electronic Arts, Uber and Walmart shared their stories.

Many of these customers spoke to how frictionless Zoom experiences are, driving productivity and delivering happiness with internal and external stakeholders.

It's truly amazing and humbling to hear from so many happy customers from around the world.

Also at Zoomtopia, we were proud to announce expansions to our platform, including our new Zoom Rooms Appliance Program, expanded Zoom Phone service and capabilities and the growth of our App Marketplace.

Our customers tell us that Zoom just works.

And with these new innovations, we empower teams to do even more with video communications.

In closing, I'd like to thank the over 2,400 Zoom employees for their hard work and focus on our customers.

Their commitment to customer happiness and execution at scale will enable us to finish the year strong and position us for future growth.

With that, let me turn things over to Kelly.

She's on mute.

Hey, Matt.

She's on mute.

Got it.

I'm here.

Thank you, Eric, and welcome to everyone joining us.

Let me start by first reviewing the financial results for Q3, and then I will discuss our outlook for Q4 and the full fiscal year.

Overall, we delivered another amazing quarter and demand for Zoom's unified communication platform remains strong across our major geographies and offerings.

Total revenue grew 85% year-over-year in the third quarter to $167 million.

This top line result exceeded the high end of our guidance range.

Key drivers of our revenue performance included both our acquisition of new customers and expansion of Zoom's footprint within existing customers.

Specifically, new customers accounted for approximately 61% of our year-over-year growth in subscription revenue, while the remaining 39% was due to additional purchases from existing customers.

Now let me share some of the key customer metrics for Q3.

Our two-pronged strategy of land and expand continue to drive growth.

First, we added 7,800 customers with more than 10 employees in the period and exited Q3 with over 74,100 customers, up 67% year-over-year.

Our continued expansion in the upmarket resulted in 546 customers with more than $100,000 in trailing 12-month revenue, up 97% year-over-year.

This is an increase of 80 customers and a record number of adds in a quarter.

Our ability to expand with existing customers was evident in our net dollar expansion rate that was over 130% for the sixth consecutive quarter.

Our net dollar expansion rate remains the top tier of our industry and reflects the high level of satisfaction and trust that customers have in Zoom.

This is further evidenced by our Net Promoter Score, which remained above 70 in Q3.

Eric discussed 2 examples of how this strategy contributed to our Q3 results, and let me give you a third one.

During the quarter, we had an expanded commitment from Quinnipiac University, a nationally ranked private university in Connecticut with over 10,000 students.

The university originally moved to Zoom Meetings based on the ease of use and reliability of the technology as well as a way to consolidate into one platform for their diverse community of users.

Looking to drive further adoption of an innovative communications platform, the university has also selected Zoom Phone to modernize their phone system.

The university has been a great partner and applauded Zoom's willingness to work with the university to enhance the feature sets of our technology on their journey toward a unified communications platform.

Next, as we discussed at our recent Analyst Day, international expansion is a key multiyear growth initiative for Zoom.

In Q3, our APAC and EMEA revenue combined grew 98% year-over-year and represented approximately 20% of revenue.

Revenue from the Americas was up 82% year-over-year and represented approximately 80% of revenue.

We see significant opportunity ahead for international expansion.

Now turning to profitability.

Our sales execution in Q3 also helped drive strong growth in our profitability and free cash flow.

We were net income profitable from both a GAAP and a non-GAAP perspective, but today, I will focus on our non-GAAP results, which exclude stock-based compensation expense and related share-based equity taxes.

Non-GAAP gross margin in the third quarter was 82.9% compared to 81.7% in Q3 last year and 82.2% last quarter.

For the full year, we expect non-GAAP gross margin to be at the top end of our long-term target of 80% to 82%.

R&D expense in Q3 was approximately $14 million, up 64% on a year-over-year basis.

As Eric discussed, we announced several expansions to our platform at Zoomtopia.

We continue to invest in innovating our platform with our highly efficient R&D model.

Given our hiring plans over the next several quarters, we expect R&D to return to the top end of the range at 10% to 12%, which is consistent with our long-term view.

Sales and marketing expense for Q3 was $82 million.

This reflects an increase of 58% or $30 million over last year with investments and initiatives to drive further growth.

As a percent of total revenue, sales and marketing was 49%, lower than Q3 last year but up from Q2 due to Zoomtopia.

We expect to generate a great return on investment in this area and we expect to increase hiring for our international upmarket growth initiatives in Q4 and into FY '21.

G&A expense in Q3 was $21 million and represented 12% of total revenue.

This compares to last quarter and last year, which both were 12% of total revenue.

Non-GAAP operating income was $21 million, translating to a 13% non-GAAP operating margin for the quarter.

This was an increase of approximately $19 million as compared to Q3 last year's result of $2 million.

The main driver of this result was the higher revenue, while spending was mostly in line with our expectations.

Non-GAAP earnings per share in Q3 was $0.09 on approximately 293 million of non-GAAP weighted average shares outstanding and adjusting for undistributed earnings.

This result is $0.06 higher than our guidance and $0.08 higher than Q3 of last year.

Turning to the balance sheet.

We ended Q3 with approximately $811 million in cash, cash equivalents and marketable securities, excluding restricted cash.

Deferred revenue at the end of the quarter was $202 million, up 89% year-over-year.

Looking at both our billed and unbilled contracts, our remaining performance obligations or RPO totaled approximately $517 million, up 102% from $256 million last year.

We expect to recognize approximately 64% or $330 million of the total RPO as revenue in the next 12 months as compared to 65% or $166 million in Q3 last year.

Current RPO was up 99% year-over-year, the same growth rate as Q2's current RPO.

Noncurrent RPO was up 108% year-over-year.

Our execution led to strong cash flow growth.

Operating cash flow was $62 million in Q3, up from $18 million or 240% year-over-year.

In Q3, free cash flow was $55 million, up from $10 million or 440% year-over-year growth.

As we discussed on last quarter's webinar, the benefit received over the last 2 quarters from the employee stock purchase plan will become a use of cash in Q4 when the first purchase will be made.

The quarter-over-quarter outflow in cash related to ESPP will be approximately $20 million in Q4.

Starting in FY '21, we expect the cadence of benefits from contributions to the ESPP to occur in Q1 and Q3 and net outflows from purchases to occur in Q2 and Q4.

Now turning to guidance.

We are pleased to be increasing our outlook for the full year based on our view of the current business environment, our ability to gain market share and the momentum we have achieved so far this year.

For the fourth quarter, we expect revenue to be in the range of $175 million to $176 million.

We expect non-GAAP operating income to be in the range of $17 million to $18 million.

Our outlook for non-GAAP earnings per share is $0.07 based on approximately 296 million shares outstanding.

For the full year of fiscal '20, we now expect revenue to be in the range of $609 million to $610 million, up from our prior guidance of $587 million to $590 million.

This would be approximately 85% year-over-year growth.

For the full year, non-GAAP operating income is expected to be in the range of $67 million to $68 million, an increase of approximately 50% from the top end of our prior guidance of $42 million to $45 million.

With this meaningful increase in profitability, we now expect to deliver non-GAAP earnings per share of $0.27 for the full year fiscal '20 based on approximately 293 million shares outstanding.

In closing, we are pleased with our progress this year and our unique ability to deliver high growth at scale, combined with profitability and free cash flow growth.

I would also like to thank the entire Zoom team for their hard work in Q3.

We are well positioned to end the year strong as we stay focused on delivering happiness to our customers every day.

With that, let's open it up for questions.

If you have not yet enabled your video, please do so now for the interactive portion of this meeting.

Matt, please queue up our first question.

Our first question is from Brad from Crédit Suisse.

Can you guys hear me?

Yes.

Thank you, Brad.

Fantastic.

It's great to see everybody, especially Eric and Tom on the beach, enjoying themselves after such great results.

You deserve it.

Fantastic.

Well, Eric, it's great to see the trend -- the traction that you're having with Zoom Phone, particularly the National Australia Bank deal that you highlighted.

How's the pipeline trended since the focus on Zoom Phone and Zoom Rooms at Zoomtopia?

And when should we start to see you sign more of these Phone and Rooms deals?

So first of all, I can tell you, we're very excited about the Zoom Phone opportunity.

And even at Zoomtopia, we shared our vision because we think video conferencing on a cloud with PBX, those 2 may be converged into one service as cloud-based video PBX.

Customers really like this story.

With that, we have one consistent front and experienced the same back-end architecture.

I think a lot of our customers -- I mean, existing customer, existing installed base, for us, have upsell opportunity that's huge.

And the feedback from our existing installed base is very, very positive, especially after the council -- the PUC.

Their feedback is, wow, that's amazing.

I think we have a high confidence about the future opportunities.

Okay, great.

And Kelly, just a follow-up, your operating and free cash flow profitability was very strong yet again.

How has the company been executing against its sales and marketing productivity goals?

And why not take some of the outperformance and invest it back into driving more customer adds?

Or would you be at a point of diminishing returns at that point?

We certainly are committed to investing as much as possible in terms of continuing to drive growth in the top line.

And we expect to see hiring to actually accelerate in Q4.

So you should see our head count numbers for the end of the year to finish really strong as well as Janine has seen a lot of progress in terms of efficiency in marketing.

So we continue to look for opportunistic ways to add but ensuring that we continue to produce a high ROI on any of our marketing spend.

Our next question is from Sterling from JPMorgan.

All right, great.

All right.

So actually, a question, start with Kelly.

The growth in current RPO especially outpaced what you saw in revenue.

Is that kind of telling us something in terms of what the linearity looked like in the quarter?

And what should we be thinking that tells us in terms of the growth contribution here into the fourth quarter?

Thank you, Sterling.

So you got it exactly right.

What we're seeing is a couple of things, is that a lot of our seasonality is -- for renewals is lining up to be July and January due to the nature of our 6-month quotas for our teams as well as, as we continue to move more and more upmarket, we're seeing a shift -- for those customers, the deals with those customers to shift more and more not only to the back end of the year, but also to the back end of the quarter, which is exactly what's driving that.

All right, great.

And then one follow-up question for you, Eric.

I think the big news in the quarter was the deal that RingCentral signed with Avaya.

Can you give us a sense of what you think of that partnership?

And is that something that would be interested to Zoom?

Is there a partnership similar to that, that we might look for you to sign in the future?

So first of all, I think, Vlad, he already shared their view about the partnership as I am.

And I'm not going to repeat what he said before.

But from our perspective, I think, first of all, RingCentral is still our customer, partner and reseller, right?

We still maintain a good partnership.

And also, this market is very big.

And when we look at the cloud PBX system, I think it's different than any other vendors because we should -- we need video and voice as one system.

That's why we're focused on our existing installed base for upsell.

Essentially, customer -- whoever wants to deploy the traditional phone solution, I think they still might go with other vendors, that's okay.

However, for those customers that would like to look at -- we do first unified communication experience.

I think that's our opportunity.

I think occasionally we might have a little bit of overlap, but overall, the market opportunity is huge and I think it's still a good partnership.

And Avaya and RingCentral, I think, one is on-prem legacy vendor, another one is a cloud PBX, and probably it's good for both of them.

And we really focus on our existing installed base and deliver our converged solution to our installed base.

Our next question comes from Kash from Bank of America Merrill Lynch.

Yes.

Am I audible now?

Yes, Kash.

Excellent.

Okay.

I wanted to just ask you a little bit about the upmarket traction.

You talked about the HSBC win last quarter.

This time, it's the USPS.

When you look at the pipeline coming up for next fiscal year, what kind of enterprise deals are you seeing in the pipeline?

And do you feel like you need to add more salespeople that come from the enterprise background where you might need to invest a little bit more upfront, but the payoff can be certainly huge?

And what does that mean for retention rates ultimately for the business model?

And congratulations.

Yes.

And Kash, that's a wonderful question.

So if you look at our growth potential, international and also enterprise, we already hired a lot of enterprise reps over the past 12 to 18 months.

Also, want to focus on the quality rather than just quantity.

And from a leads perspective, it's very healthy.

Like HSBC, like USPS and also government, public sector as well and especially for a lot of enterprise customers, they would like to go through the PUC to make sure of the solution they are going to deploy for the next several years.

That's why architecture plays a very important role.

That's why we are winning, especially when customer, they are going to go through the PUC.

They want their employee involved to test the solution rather than just one person, 2 person make a decision to upgrade from the other legacy solutions to the new cloud solution.

And inside of that, I think our pipeline is pretty healthy, and we really are doubling down our enterprise expansion.

Great.

And Kelly, if I could follow-up with you on the free cash flow side, there are certain other items in accrued.

I cannot believe I'm actually asking you a cash flow or a balance sheet question, but it's a certainly big number that boosted the free cash flow.

I think it was prepaid and accrued liabilities or something that looked a little big and contributed to the jump in otherwise what would have been still a great free cash flow quarter.

Just curious what that onetime item seem to be.

In the -- let me just pull up the balance sheet.

It was -- yes, we can follow up offline if needed, but it was a fairly large item that stood up in the cash flow stream.

When we have our call back later, Kash, let's talk about it then.

Wonderful.

It's accrued expense and other liabilities, a big jump there.

Well, we can talk about it later.

Okay.

Our next question is from Meta Marshall from Morgan Stanley.

Great.

Just wanted to ask if -- I know that Zoom Voice has kind of initially been targeted at customers as kind of an add-on once they are already on board, but if you're seeing more interest upfront from customers wanting video and voice at the same time.

And then maybe just as a follow-up question for Kelly.

Just a little bit more rationale for the gross margin outperformance and just some of the factors there.

Eric, do you want to take the question about the...

Yes.

Go ahead.

Yes.

Okay.

So in terms of the gross margin, Meta, what we saw is obviously outperformance on the top line without additional expansion needs in this quarter in the data center as well as we saw outperformance -- or sorry, improvements in both our third-party audio costs as well as our professional services margins.

What you will expect is in Q4, remember, as a reminder, because we run our own servers in these colocated facilities, whenever we add servers, it was kind of a step function in the expense, so that's why we're guiding for that to be in line, but you'll see a slight tick in terms of Q4 for -- from a gross margin perspective as we're going to make some further investments in servers.

And then, Eric, do you want to talk about the strategy about continuing to focus on Zoom Phone for existing customers?

Yes, for sure.

Because over the past several years, a lot of our existing installed base, they told us they are still using a traditional legacy PBX solution.

They would like to move to one unified solution.

That's why it's still our top priority to focus on our existing installed base because those customers already understand video conferencing or we already build a trust relationship.

I think that's low-hanging fruit, that's our top priority.

And inside of that, for sure, down the road, we are going to open up the Zoom Phone service to the greenfield as well, and that's the next growth opportunity for us in FY '21 and the future as well.

Our next question is from Tom from Stifel.

Eric, I was hoping you could talk a little bit more about the international opportunity.

It's obviously a huge opportunity, and it's still pretty small relative to the overall size of your business.

On that topic, how ready is the market to really expand kind of wall-to-wall on Zoom as you look at the international prospects?

And then can you talk a little bit more about go-to-market?

How easy is it to hire sales reps?

How do you want to build those territories out?

Just an update on what you're seeing in Europe and APAC.

Yes, sure.

Absolutely.

So if you look at it revenue-wise, a rise of 20%, but the growth rate is much higher, 97% last quarter.

And we are already doubling -- we're already doubling down our expansion in Amsterdam, and -- which is our headquarter for the EMEA.

We hire a lot of people over there.

I think if you look at opportunities, especially for the video conferencing, I think the market is ready.

We just need to hire more people, have enough leads.

And however, if you look at the phone service, for sure, we are going to add more and more international coverage.

And I think that's another opportunity.

But probably we are going to play a different game.

Here, we focus on the video for us and obviously phone.

For international, video and voice at the same time.

I think probably we'll see accelerated growth for customers to deploy both video and voice at the same time, not only for the EMEA but also APAC as well, like in Japan, Australia, I think the 2 greater countries where we see the huge opportunity.

Our next question is from Ryan from Stephens.

So Eric, can you briefly mention about any updates to improving the global service coverage for Zoom Phone?

And have you seen the enterprises waiting to expand Zoom Phone licenses until in-country service coverage becomes available?

That's a good question.

Actually, we are in the process to support more and more countries because we shared our road map about which country we are going to support with customers transparently.

We really like that.

We are going to support U.S., Canada, Australia, New Zealand and Ireland.

And those countries, end of this calendar year, early January, we are going to support a bunch of other countries, specifically in Europe.

And also in Q1 next year, we're going to support a lot of countries in APAC.

I think we are going to roll out the services on more and more countries, I think, in the next several months.

And the customer, they are not going to say, hey, I want to win for this country or that country as not -- as we show their road map.

I think on the customers, they feel very confident.

And many UCaaS providers struggle to achieve local service coverage in China and India.

Is this something to be possible for Zoom over the next few years?

Not in the next few years.

It's the next several months, actually.

We are making very, very good progress.

I think that multinational customers whose office is probably in China, we already can support, to like support the China local network.

India was also making good progress and so soon we should support both India and China.

Well, if we wait for several years, we are going to have problems.

So we feel very comfortable to support both India and China very soon.

Our next question is from Alex from RBC.

Can you hear me?

Yes.

Go right ahead, Alex.

Perfect.

So maybe first one for Kelly.

If I look -- this is kind of going on Sterling's question.

If I look at the current RPO growth and the current RPO bookings growth, they're both sequentially and year-over-year much stronger than billings growth rate.

So I'm just curious, were there any kind of onetime impact.

I saw the long-term deferred fell off a little bit more this quarter.

So are there any impacts that's causing that disparity?

And which one of those is a much -- is a better metric for your forward revenue?

Yes.

So as a quick reminder, unlike many other SaaS companies, unfortunately, neither RPO or billings is a great metric for us as we still have a large percentage of our customer base that both bill and contract on a monthly basis.

So this makes it very difficult to use a metric that's comparative to other SaaS businesses.

What you're seeing is that because of this high -- there's a lot of month-to-month, I mean, because we don't incent either our customers or our sales reps to move to annual because we still have such a high retention rate that is -- but we are seeing slowly as we continue to move upmarket, some of those customers move more and more to annual.

But again, it's just really not a great metric for us, unfortunately.

Okay, understood.

And then maybe just on the topic of your new -- your recently -- maybe not so recent anymore, Ryan Azus.

Maybe Eric, what are the changes that you're seeing kind of him makes to go-to-market organization?

Are you kind of there with your hiring plans as you look into the fourth quarter and exit the year from a sales rep perspective?

And maybe what are just kind of 2 or 3 most important priorities?

Yes, sure.

So yes, we hired Ryan several months ago because we know Ryan well, and he's a good friend, and we really -- we feel very excited to work together again.

In terms of series of changes actually, he's working on -- first of all, in more enterprise, international, the Zoom Phone expansion.

And for us, next year probably, we also want to leverage our in-channel program more, right?

Looking at the discipline, it's by and large primarily driven by our direct sales force.

As we expand our base to international for the phone, I think, especially for the -- looking at phone base, probably in the hardware as well.

I think that, to support a much better channel program, certainly can help us.

And Ryan and his team, they're working on that.

The next question is from Zane from Bernstein.

Congrats on a great quarter.

So I wanted to dig into kind of the expansion profile of the large customers maybe.

I know you guys talked about the net expansion rate of being over 130% for 6 consecutive quarters.

But on an individual customer level, looking over a long-term time horizon, what can we kind of expect that growth in participants using Zoom or growth in host using Zoom to look like?

Because I looked at the Walmart example where they switched from WebEx to Zoom, it looks like within about a 1-year period of making that transition, there were 50% more people participating in video conferences.

What does that look like over a 2- or 3- or 4-year time frame?

So first of all, if you look at the typical large enterprise customers, very likely, they started from a small footprint, right?

They grow video conferencing, and because it just works, we see in the next several quarters, after we deploy the video conferencing, we've seen more and more host license.

At the same time, we're going to upsell the Zoom Phone as well.

And ultimately, the goal is to do a deal like HSBC, the entire workforce that can standardize on Zoom platform.

That's why today, when you look at Fortune 100 companies, if you look at all those companies, so many companies, they are our customer, however, not for the entire company, right?

That's why huge opportunity to upsell both video conference license as well as phone license.

That's our growth strategy for enterprise, not like where, hey, you got to deploy Zoom across the entire organization.

We like to get a small footprint and grow our business over there.

That's our growth strategy for large enterprise customers.

That makes sense.

And is there an example you're going to point to where a customer has continued growing 40%, 50% annually for multiple years?

What can we kind of expect that increase in the TAM to look like due to higher quality and effective service?

I think that NAB is one of the good examples recently, right?

They started with video conferencing, end up more in video license and also deployed the Zoom Phone as well.

This is a good example.

More Zoom Rooms, too.

Yes.

More -- yes, you're right.

More Zoom Rooms as well, yes.

Yes.

I reference our parent company, NAB, all the time.

So I was hoping for more examples there, but yes, we've loved it.

So it's been great.

Our next question is from Alex from KeyBanc.

Can you hear me now?

Yes, we can.

Is that better?

Great.

Sorry about that.

So Eric, when you think about your top 50 phone deals in the pipeline, looking into Q4 and into the first half of next year, how dependent are those top deals on the international regulatory approval that you talked about at Zoomtopia?

And then I have a question for Kelly.

I think if you look at our pipeline at the top, the Zoom Phone customers, I think it's still like primarily driven by the multinational companies which are headquartered here in the U.S. or Canada.

However, as they deploy Zoom Phone for the entire organization, they probably, this start of -- normally, they have multiple traditional legacy, the PBX systems, right?

They probably started replacing a lot of them.

That's why as long as we share with our road map our international coverage, they feel very confident because we already support multiple countries over the very short period of time.

And I think for the customer like NAB is one example, in APAC, we do see a lot of opportunity impact -- in APAC.

They want to deploy video and a phone at the same time.

When you look at the top deals, still like our existing installed base because, look, most of our big enterprise customers are based in the U.S. So I think that's the opportunity.

So the initial big phone deployments, they'll start in the U.S. then go into international markets as you guys get approval?

Yes, that's right.

Step by step, yes.

Okay.

And then Kelly, just assumptions on the Zoom Phone impact on gross margin.

It doesn't seem like it's helping much yet.

But as we look into Q4 and the first part of next year, how should we be thinking about that?

Yes.

So when we modeled Zoom Phone on a stand-alone basis, it does have a gross margin that's 3 to 4 whole points lower than the Zoom Meetings.

As you said, right now, given the overall contribution, it's not having any impact on the gross margin.

And what we're really focused on is continuously improving those gross margins so that by the time it does become a more material part of our results that ideally we'll have improved the gross margin so that it's very close equal.

But we're right in the middle of doing the FY '21 planning right now, and so we'll be giving further outlook on that in the Q4 call.

Yes.

So Alex, yes, sorry, just to add on to what Kelly said, if you look at the gross margin, because we did not build the Zoom Phone system from the ground-up because we share most of the back-end architecture when we build a video conferencing system.

That's why we share the same server, same back-end.

I think from a cost perspective, we can really leverage the existing infrastructure.

Our next question is from Bhavan from William Blair.

Can you hear me okay?

Yes, we can.

I guess I had a -- first, a fairly broader sort of strategic question here for Eric.

So we all know collaboration is converging.

And obviously, video, voice, text, e-mail, that whole idea of this convergence of how you communicate internally with customers, the real-time nature of channels, you're partnered with some of these players.

As you think about 10 years from now, not next quarter, not next year, but 10 years from now, where do you think you are in that collaboration space?

It can't just be voice and video.

So how do you think about that picture long term?

That's a good question.

Anyway, so if you look out to 10 years, I think, first of all, we look at it based on IDC estimates.

We look at it by 2021, the unified cloud communication market are already $43 billion, right?

That's a huge market.

I think for us especially, we've started from video conferencing, we do the new voice.

Next several years, I think 3 or 4, 5 years, that's still our top priority because we have to be the #1, market leader on many fronts, right?

And the 10 years are -- you're right, so there are 2 trends.

One trend is the best-of-breed service.

Like today, we are still seeing that's a trend.

Best-of-breed service providers will do very well, like via voice -- Zoom and like Slack and Okta I think will do very well.

Another trend is the customer, they might want to deploy one unified solution from one company, but I do not see that model sustainable.

Because quite often, when you have a problem from -- for web service, you're stuck.

That's why I think in the future, as we focus on video and voice, we might spend more time on technology side, AI or real-time language translation.

I shake hands with you, you can feel that as well.

And for us, more integration with other service providers are the best-of-breed service.

I think together -- I think we can grow the business together.

I do not see any single vendor try and grow their business by adding all those point solutions by themselves.

I do not think that's sustainable.

Plus, customers, they do not like that either.

Yes, fair enough.

And then on the Zoom App Marketplace, you said that, that could obviously be a place to highlight opportunities you may not necessarily have thought of in terms of how to expand the offering and things like that.

Just an update on the traction in the marketplace, what type of early opportunities you've been able to identify there?

Would love to get some color on how that's trending and how it's going vis-à-vis new use cases.

Atlassian, Jira Service Desk came from Jira's Marketplace.

Would love to see how you think about that.

Yes.

So as of last month, we had over 150 applications built up from our platform, like some [that are gone] and other -- the Chorus, right, they focus on the sales analytics, right, and build integration upon our platform.

We see a lot of new applications like from health care as well, online education.

And I think next several quarters, we probably will see some accelerated growth for our marketplace.

To get to the first 100 applications, really hard.

But now we are -- already have 150.

I think we'll be able to see more and more vertical applications built upon our platform.

And -- yes.

Sorry, I forgot to mention one thing, at Zoomtopia, our existing investors like Sequoia, Emergence Capital and -- they all established a fund, right, try to help us to kind invest into those third-party companies to build service upon our platform.

Well, I'm hoping they're thinking of a nice exit too, aren't they?

Anyway, thank you for answering my questions, and congratulations.

Our next question is from Will from Baird.

Great.

Yes.

So just a question -- 2 questions here.

So first on the Quinnipiac win, which looked like a nice additional win for phone, I think you referenced in the prepared remarks you needed to enhance some of the features.

Maybe just provide a little more color as to what you need to do there?

What are some of the other key pieces of feedback that you're getting from phone customers in terms of needed enhancements?

And when do you expect to kind of be full throttle, I guess, Eric, on the phone feature set front?

Yes.

So first of all, after the customer tested our phone service, I can tell you, they all like our service.

But only 2 things.

I think probably if we have a look through today, we'll have a conservative growth, but we are going to get there very soon.

Ryan -- we already mentioned and briefly touched on that, just the international coverage, and it's just more like it will take some time.

There's no technology challenge, right?

Just you need to go through sometimes local regulation like India and China and also more tests, right?

That's one area.

Another area just like in some of the features and I assume most of the time, we do not use those features.

But for customers who signed a contract, we're still going to make sure adding those features.

I'll give you 2 examples, like SMS.

I think it's not that critical.

But unfortunately, some customers say we probably still need that.

We are going to support that very soon.

Like another feature probably, never used that feature, called a park, right?

And some of the customers still want to have that feature regardless they use it or not, right?

All of those, I think, ton of features, we are going to add very soon.

It's not very hard.

It's just going to take some time.

Okay.

Yes, I guess, the other question kind of along those lines, probably more than just feature.

At Zoomtopia, you talked about some additional contact center partnerships.

Maybe update us as to how that's going.

And as you start to you have more Zoom Phone wins, how often is contact center coming up in conversation?

How important is that to have alongside you?

Yes, yes.

So our strategy is -- we also shared at Zoomtopia as well, we would like to partner with other cloud-based, contact center solutions like Five9.

It's a good example, right?

Rowan, who really understand the collaboration market, we have a wonderful partnership, and quite often, customer share their innovation about the full, contact center, we -- bringing our team and also Five9 team as well.

And having said that, we also -- because we have open platform, also integrate with other contract center solutions as well because some of the customers, they already deploy other cloud business solutions, like inContact, right, or maybe Talkdesk or maybe Twilio solution.

That's why we also needed to integrate as well.

Our next question is from Vinod from Oppenheimer.

I wanted to touch on your FedRAMP opportunity.

I believe you said that USPS was your first agency win.

How is your pipeline looking there?

And when do you think that could really become meaningful for you guys?

Yes.

For us to win big in the public sector, 2 things.

One thing is, for sure, we need to have a FedRAMP approval, right?

Obviously, this was done early this year, in May.

Another thing is make sure our back-end side, we have a special -- the infrastructure, and we call it the Zoom Government Cloud, right?

And over the past several months, very good progress.

USPS is first customer.

I mean a big customer provision for the Zoom Government Cloud.

Because our infrastructure is also very ready and downloaded for every feature, not only do this for enterprise commercial cloud, but also, by default, we also support the government cloud.

We would say, you see, look at the pipeline is pretty strong.

I think we are -- finally, I think we're ready now.

Okay, great.

And just one question on the expansion rate.

I believe, I calculate it to be about 133% this quarter versus about 137% last quarter.

How should we think about expansion rate trends going forward given your ability to upsell Phones and upsell Rooms into some of your larger customers?

Kelly -- yes, you take.

Okay.

Here I am.

Thanks, Vinod.

So really, it's -- as a reminder, as we're continuing to move more and more upmarket, we see a great opportunity for the expansion rate to stay strong and/or continue to improve.

It might vary quarter-to-quarter, which is why what we give is that 130 because it can vary depending on timing of deals, and we can't really manage that.

We don't manage it.

And so I don't want there to be noise around this number as it moves up and down a few points quarter-to-quarter.

But we feel really great about a really strong retention rate.

Matt, do we have any more questions?

That was actually our last question from our analysts today.

I did see Pat Walravens out there.

Did he drop off, unfortunately?

No.

I do see him, but I don't see his audio connected.

So I can't actually have him talk and ask the question yet.

Okay.

Next time.

Next time.

Sorry, Pat.

We'll get you on there next time.

No.

Pat's -- I see Pat.

He's just on a different number, up above.

Do you see?

Oh, does it end in 111?

I see him on an audio right above his -- okay.

We can grab him in the after-calls.

Yes.

Sorry about that, Pat.

Hold on.

Let's try one more time, if he's connected to audio now.

Pat, are you on?

There.

Yes.

Yes.

I'm on.

Forgive me for the background noise.

What you can't see from the virtual background is me boarding my flight.

Eric, what's going to be the hardest part for you to scale -- in terms of keeping customers happy as you scale, what's the hardest part?

I think to keep an existing customer happy is really important and really hard because they'll request more and more features, and we try to do -- we also try to grow our business -- we have new customers.

But for now, our top priority is to focus on existing customers and make sure they are very happy.

This is pretty hard.

Okay.

And then another thing that seemed really important at the Zoomtopia was the appliances.

Can you tell us why everyone was so excited about that?

So we listen to our customers' customer, they would like to -- not for every customer.

We have a lot of customers that already deployed our existing Zoom Rooms based on the Mac or Windows, really like that experience.

But for some of the customers, they may not have enough IT resources.

They would like to have a simplified deployment model, where they get an appliance, [take on] the power and hook up the network, everything should work.

They wanted to gather their service from web vendors, from Zoom, right?

That's why we partnered with those, Poly and Neat and Logitech and DTEN and other, Crestron.

And essentially, we offer the appliance to customer to simplify the deployment.

Some of the customers really like that model.

Hey, Matt, I think I see Ryan Koontz raised his hand.

I don't know if you can reach out to him.

Certainly.

Ryan, let me go ahead and just unmute your mic.

Great.

If you can drill down a little on Zoom Rooms a little bit, please?

And where do you expect early adoption there?

How important is that for enterprise penetration?

And how is that going to roll out to sales in terms of sales and partner enablement?

If you could talk about that, please?

Yes, sure.

So Zoom Rooms is, I would say, very important, very strategic to our growth because customer, for surely, enjoy using Zoom for laptop, desktop, mobile.

Quite often, they have important meetings, they might be tired in the conf room.

But today, lots of enterprise customers very like to be -- will deploy old legacy, traditional video conferencing solutions, very hard to maintain.

That's why customers -- on the one hand, we do support those traditional hardware devices very well, we can incorporate very well.

On the other hand, those enterprise customers, they like a cloud-based solution, meaning just a video [interport] and all the software [sourcing] should be connected back to the cloud.

We see almost every enterprise customer, they are very interested.

They do not want to maintain a very complex video infrastructure.

And because of that, we just touch on that, Zoom Rooms Appliance Program, try to simplify that experience.

We offer the appliance to customer, very easy to deploy.

Plus the customer also want to have simplified the -- in voice as well, like Hardware as a Service.

Overall, I think customer really likes Zoom Rooms.

We want to make sure to simplify the deployment, simplify the building as well.

That's our focus in the next several quarters.

Anyone else?

Should have been our last question from our analysts today, actually.

Yes.

All right.

Do you want to end the call?

In closing, first of all, thank you for your time.

I really appreciate, and thank you all the Zoom employees.

Thank you for your hard work, and see you next quarter.

Thank you.

Thank you, everybody.

Bye.

Bye.

Thank you.

Cheers.