Zscaler, Inc.

Good day, and thank you for standing by. Welcome to the Zscaler second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded, and if you require any assistance during the call, please press star 0. I would now like to hand the conference over to your speaker today, Mr. Bill Choi, Senior Vice President of Investor Relations and Strategic Finance. Mr. Choi, the floor is yours.

Good afternoon, everyone, and welcome to the Zscaler Fiscal Second Quarter 2022 Earnings Conference Call. On the call with me today are Jay Chowdhury, Chairman and CEO, and Remo Canessa, CFO. Hello. Please note that we have posted our earnings release and a supplemental financial schedule on our investor relations website. As was noted, all numbers we talk about today will be on an adjusted non-GAAP basis. You will find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release. I'd like to remind you that today's discussion will contain forward-looking statements, including, but not limited to, the company's anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow, dollar-based net retention rate, future hiring decisions, remaining performance obligations, income taxes, earnings per share, our market share, and market opportunity. These statements and other comments are not guarantees of future performance, but rather are subject to risk and uncertainty, some of which are beyond our control. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC as well as in today's earnings release. We will upload a copy of today's prepared remarks to the IR website when we move to the Q&A segment of the call. I would also like to inform you that we'll be attending the following upcoming events in March. Berenberg Thematic Software Conference on March 2nd, JMP Securities Technology Conference on March 7th, and Wolf Research Virtual Software Conference on March 23rd. Now I'll turn the call over to Jay.

Thank you, Bill. I'm pleased to share our strong results for fiscal Q2. We continue to see strong demand for our Zero Trust Exchange platform as our customers embrace the cloud. We delivered 63% year-over-year revenue growth and 59% billings growth, while also generating over 50% growth in operating profits and free cash flow. Public SaaS companies are happy to get to Rule of 40, while we have been exceeding the Rule of 70 for the last 12 months, validating our strong execution in pursuing our large market opportunity. Our continued investment in scaling our engineering and go-to-market machines is yielding the best revenue growth we have had in three years, even as we surpassed $1 billion in annualized revenue. We plan to keep on making substantial investments across the company to continue our rapid pace of innovation and growth. What we deliver with our platform is critical to our customers' highest priorities. This is reflected in our deal sizes, which are increasing due to our success with large enterprises who are buying more of our expanding platform. With a significant growth in the number of new logo and upsell customers for orders with over $1 million in annual value, we now have over 250 customers exceeding $1 million in ARR, an increase of 85% year-over-year. Business momentum for a zero-plus exchange is strong due to the market need for a modern security architecture in the world of cloud and mobility. Our flagship ZIA offering has been growing very well as we continue to expand our cyber and data protection services. ZPA has emerged as our second flagship offering, supporting millions of users and the majority of our global 2,000 customers. We are the clear market leader in zero trust application access with proven maturity and scalability. With CI and ZPA, we had demonstrated our success implementing zero trust for users. Our next immediate big opportunity is to bring zero trust to workloads in our ZCP pillar, powered by the same core ZIA and ZPA technology. In addition, our ZDX pillar is enabling a highly productive workforce, and it is seeing strong demand. In a single integrated cloud platform, our Zero Trust Exchange provides secure any-to-any connectivity for users, applications, workloads, and IoT and OT systems, regardless of their location. While many vendors claim to offer a platform because they bought a bunch of point products that are very hard to integrate, no one comes close to the capabilities of our cloud-native extensible platform. We will continue to invest in engineering Customer support, marketing, and sales to accelerate the growth of our new products while keeping the strong momentum on our flagship products. We believe we are in a sustained high demand environment. We have a large and expanding market opportunity powered by our customers' digital transformation journeys, which continue at a pace never seen before. According to IDG's recent State of the CIO report, the top CEO mandate for IT in 2022 is to upgrade cybersecurity to reduce business risk. Whether it is supporting remote work or enabling new digital customer and employee experiences, IT leaders must ensure that business operations are agile, resilient, and secure. Given the explosion in ransomware and high-profile data breaches, IT leaders are looking to phase out castle and mode security to adopt zero-trust architecture to unlock the full promise of digital transformation. It is clear from our growth and our large enterprise wins that architecture matters. Despite legacy vendors' marketing claims, True zero trust security can't be built on legacy network security architecture. As I have highlighted before, there are two reasons why enterprises are selecting Zscaler. One, we're the only proven cloud security provider with a proxy architecture that inspects TLS encrypted traffic at scale to deliver superior security. We connect users to applications. and not to the network, eliminating lateral threat movement. This is a core principle of zero-trust architecture that can't be achieved by next-gen firewalls or cloud VPNs. Let me discuss some of our Q2 deal wins that highlight the advantages of our zero-trust exchange. I will start with a big ZIA win. a Fortune 100 professional services customer initially purchased our ZIA Transformation Bundle plus CASB and DLP and ZDX for 125,000 employees working from anywhere. This quarter, they added 175,000 ZISCs to secure all 300,000 employees. With a cloud-first strategy, and mission-critical client-facing data at stake, they selected our proven scalable platform with a global footprint needed to support the business in over 150 countries. With 93% of their internet traffic encrypted, TLS inspection was a major requirement, and the customer only considered a proxy architecture. Next is a new logo customer that started with ZPA as part of a strategic initiative to transform their IT infrastructure. This global 50 manufacturer, headquartered in Europe, purchased ZPA for 200,000 users to implement Zero Trust Secure. ZPA will eliminate their attack surface, protecting thousands of private applications behind our Zero Trust Exchange. Hence, their apps can't be discovered, exploited, or DDoSed. We are replacing their firewall-based VPNs that allow lateral threat movement. A global systems integrator partner who is implementing the overall transformation project played a major role in driving the Zscaler win, an example of the channel leverage we are creating with our investments in our SI partners. As the shift to the cloud accelerates, customers are buying ZI and ZPA together, enabling a true transformation with direct and seamless access to SaaS and private applications, whether on-prem or in the public cloud. Let me highlight several such deals. In a new logo win, a Fortune 50 insurance customer signed a four-year commitment for ZI, ZPA, and ZDX to securely enable 65,000 employees working from anywhere. For comprehensive cyber and data protection, they purchased the high-end transformation bundle plus CASB, advanced DLP, and SSBM, or SAS Security Posture Management, which is like CSBM for SAS. Fast user experience and superior cybersecurity were the key factors for our wins. In another new customer win, a Fortune 500 FinTech company that had grown through acquisitions signed a nearly five-year commitment to up-level security and simplify IT. They purchased ZIA Transformation plus CASB and DLP as well as ZPA and ZDX for 60,000 employees. This consolidates seven different security point products and accelerates the closure of the 24 data centers. Moreover, ZPA also shortens new employee onboarding to a few days from two and a half months. It also eliminated the need many of the employees had for two laptops to access two separate networks. I'm also excited about our success selling security transformation in new countries. a global 500 manufacturer headquartered in Mexico, purchased ZIA and ZDX for over 18,000 users and CPA for 14,000 users. This is our first seven-figure annual deal in Latin America, a region where we recently started making investments. Next, M&A is an elegant use case for the Zscaler platform. In an upsell deal, Diversified industrial conglomerate with over 20 operating companies that previously purchased ZIA transformation bundle added ZPA for 16,000 users to accelerate M&A integration and reduce business risk without having to connect two corporate networks with legacy firewalls, which could have taken 14 months or more. R0 Trust Exchange provided secure access to applications across both companies in weeks, saving time and money. This customer purchased a high-end ZPA bundle with integrated browser isolation to enhance data protection. They also bought our deception technology to intercept bad actors who may have infiltrated the network. This latest purchase. more than doubled the annual spend with us. Next, let me highlight customers purchasing all four pillars of our platform. In a new logo win, a global 2,000 leader in technology products purchased ZIA transformation with DLP and Caspi, ZPA and ZDX for 11,000 employees, and ZCP workload posture for 6,000 workloads in multi-cloud environments. As they accelerated the digital transformation, the CIO's top priority was to eliminate the risk of legacy VPNs and lateral threat movement while ensuring the best user experience. They put ZDX to the test by asking us to troubleshoot poor Microsoft 365 experience of an executive traveling in Europe. ZDX mapped the entire network path over the internet in real time. isolating specific issues and allowing the customer to quickly resolve the issue and improve the user experience. This proof of value led to the quick ZDX purchase. I believe that over time, every ZIA and ZPA customer will embrace ZDX as workforce productivity is one of the highest priorities for a CIO. Lastly, I'm happy with our early success in expanding our routes to market via cloud marketplaces, first with AWS and now with Azure. Let me highlight two Azure marketplace deals. First, an existing global 200-format customer with headquarters in Europe purchased ZPA for all 87,000 employees, enabling zero-trust access to the private apps hosted in hybrid cloud environments. This purchase was done with just a couple of mouse clicks, and it doubled the annual spend with us. Second, a new Fortune 500 customer in the energy industry made a three-year, eight-figure commitment for ZIS, ZPA, and ZDX for all 23,000 employees. We will continue to invest in cloud marketplaces as a new channel to revenue. Enterprises trust Zscaler over cloud imitators and new entrants because we have a true zero trust architecture and have over 10 years of operational experience running the largest security cloud in the world. Our zero trust exchange processes over 210 billion transactions in line and prevents more than 7 billion security and policy violations per day, providing our customers an unmatched network effect for superior security. To flawlessly run the world's largest security cloud with five nines of availability requires more than security expertise. It requires networking expertise and the ability to control the traffic paths. As Zscaler was born as a cloud company and has been operating an inline cloud since 2008, we have gained this expertise over time. There's no compression algorithm for years of experience. This expertise will become even more important as we address hundreds of millions of workloads and billions of IoT devices. Let me share an example of our cloud operations differentiation. Microsoft extended direct fiber connectivity from the major data centers to ours because of the volume of traffic that flows between Zscaler and Microsoft. This direct connectivity enables us to deliver higher reliability and performance than the traditional internet exchange peering approach. This is a validation of our scale and the criticality of our services to our mutual customers. Another example of delivering great availability and high performance is our integrations with Microsoft and Zoom. With API-based integration for Teams and Zoom, We proactively identify and resolve performance issues for these latency-sensitive apps, without which user collaboration is disrupted and business productivity is lost. Our proven track record running the world's largest inline security cloud makes Zscaler the obvious and trusted partner of choice when enterprises need to securely access mission-critical applications. Let me also talk about our recognized market and innovation leadership. Zscaler pioneered the zero-trust architecture. And over time, our platform subsumed functionality of multiple point products into our secure web gateway foundation. As the market evolved, and customers migrated towards a platform approach such as Zscaler. Gartner expanded the scope of the secure web gateway MQ to include functionalities such as CASB, ZTNA, digital experience monitoring, and browser isolation, and renamed it SSE, or Security Service Edge. After 10 consecutive years of being named a leader in Gartner's M2 for secure web gateway, we were again named a market leader for SSE. Many of you are aware of SASE. So how are SASE and SSE related? SASE framework is the combination of SSE and WAN edge. has all the security capabilities built on Zero Trust architecture and is independent of the type of network. WAN Edge, which is generally SD-WAN, provides connectivity to an SSE cloud. Importantly, Zero Trust security is implemented in the SSE cloud, not in the WAN Edge. As the category leader in SSE, With the widest and deepest offerings, Zscaler is the go-to platform for vendor consolidation, cost savings, increased user productivity, and better cyber protection. As our market opportunities expand, we are promoting two strong leaders to continue scaling Zscaler. We're expanding Amit Sinha's role to president of the company. Amit will continue to lead our engineering and cloud operations teams while also assuming broad responsibilities for expansion of our platform into new areas. We are also promoting Dolly Reich to Chief Operating Officer. Dolly will continue to lead our global sales organization while also assuming broader responsibilities for interlocking among sales, marketing, business development, and transformation teams to further enhance the customer's lifecycle journey. In the new roles, Amit and Donny will be responsible for driving further growth, operational excellence, and collaboration across Zscaler as we continue the path towards our next milestone of $5 billion in ARR. To enable our customers' ever-growing digital transformation aspirations, and extend our market leadership. Our entire organization is focused on attracting and developing talent and creating a culture that awards innovation at all levels. We added approximately 1,000 employees globally in the last six months and have over 4,000 employees who are energized by our shared mission to create a hyper-connected digital world in which the exchange of information is always secure and seamless. In today's competitive hiding market, Zscaler is a destination for top talent. We are proud of our Glassdoor rating, which is among the highest in the industry. Zscaler has never been stronger, and I believe we have a large and growing opportunity in front of us. Now, I'd like to turn over the call to Remy for our financial results.

Thank you, Jay. As Jay mentioned, we are pleased with results for the second quarter of fiscal 2022. Revenue for the quarter was $256 million, up 11% sequentially and 63% year-over-year. On a year-over-year basis, revenue growth accelerated in the quarter, driven by strong business activity. ZPA product revenue was 17% of total revenue, From a geographic perspective, we had broad strength across our three major regions. Americas represented 51% of revenue, EMEA was 35%, and APJ was 14%. APJ continues to be our fastest growing region with revenue growth of 116%. Our total calculated billings grew 59% year-over-year to $368 million, with billings duration near the midpoint of our 10 to 14 months range. We were also pleased to report 61% year-over-year growth in short-term billings. Remaining performance obligations, or RPO, were $1.95 billion as of January 31st, growing 90% from one year ago. The current RPO is 50% of the total RPO. Our strong customer retention rate and our ability to upsell the broader platform have resulted in a high dollar-based net retention rate, which was again above 125%. We had 251 customers paying us more than $1 million annually, up 85% from 136 in the prior year. The continued strength of this metric speaks to the strategic role we play in our customers' digital transformation initiatives. We added over 560 customers in the past 12 months, paying us more than $100,000 annually, ending the quarter at 1,751 such customers. Turning to the rest of our Q2 financial performance, total gross margin of 80.4% was approximately flat quarter-by-quarter and down 90 basis points year-over-year. Our total operating expenses increased 13% sequentially and 62% year-over-year to $183 million. Operating expenses as a percentage of revenue of 72% were similar to a year ago, even as we made ongoing investments in smokescreen, and trust-owned businesses we acquired in the second half of last year and with a partial return of T&E. Operating margin was 9% and free cash flow margin was 12%. We continue to expect CapEx as percent of revenue to be in the high single digits for the full year. We ended the quarter with over $1.61 billion in cash, cash equivalents, and short-term investments. Now, moving on to guidance and modeling points. As a reminder, these numbers are all non-GAAP, which excludes stock-based compensation expenses and related payroll taxes, amortization of debt discount, and amortization of intangible assets. For the third quarter of fiscal 2022, we expect revenue in the range of $270 to $272 million, reflecting a year-over-year growth of 53 to 54%, gross margins of 79%. I would like to remind investors that a number of our emerging products, including ZDX, workload segmentation, and CSPM, will initially have lower gross margins within our core products because we are more focused on time to market and growth rather than optimizing them for gross margins. Operating profit in the range of $19 to $20 million. As noted before, we have more in-person events starting this quarter, including customer events, conferences, and our internal mid-year sales events. net loss and other income of $100,000, income taxes of $4 million, earnings per share of 10 to 11 cents, assuming 149 to 150 million fully diluted shares. For the full year fiscal 2022, we are increasing our revenue guidance to a range of $1.045 billion to $1.05 billion for year-over-year growth of 55 to 56%. Increasing calculated billings to a range of $1.365 billion to $1.37 billion for year-over-year growth of 46% to 47%. Increasing our operating profit to a range of $95 to $98 million. Increasing our earnings per share to a range of 54 to 56 cents, assuming approximately 149 to 150 million fully diluted shares. Please note that our share count guidance includes dilution from our convertible to ventures based on the existing treasury method of accounting. With a large market opportunity and customers increasingly adopting the broader platform, we're committed to investing aggressively in our company. We see a window of opportunity to extend our first mover advantages in this fast-growing market, which will have positive long-term impacts. We will balance growth and profitability based on how our business is growing and but we'll continue to prioritize growth, which we believe is in the best interest of our shareholders, employees, and customers. Operator, you may now open the call for questions.

Thank you. As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, please press the pound key. We also ask that you please limit yourself to one question at a time. Now stand by as we compile the Q&A roster. Our first question comes from Andrew Nowinski of Wells Fargo. Your line is open.

Great. Congrats on a nice quarter this afternoon, gentlemen. I'd like to start off with a question on the impact from the Russia-Ukraine conflict. So at the start of the COVID pandemic, you clearly saw some new momentum with ZPA as more employees were forced to work remotely. I'm wondering if the Russia-Ukraine conflict is had a similar effect creating any new demands for your solutions and whether it's from companies in the region or even outside of Ukraine that might be concerned with the ensuing cyber attacks that could be launched.

Andrew, it's a little bit early to tell the impact, but our customers are concerned. There's higher cyber threat sensitivity. I was talking to a CXO from Germany earlier today And he actually opened the call I had with him with this topic. And customers want to make sure they're secure. And one of the things we think is going to help us directly is ZPA, which can hide the attack surface. If you can't see something, you can attack it. And ZIA becomes more important for all the in-line protection. Our research team is seeing signals of increased reconnaissance activity that's increasing for the past few weeks. We have a 100-person research team, and we're making them available as a resource to our customers.

Got it. Thank you.

Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets. Your line is open.

Yeah, thank you. This is Matt Swanson on for Matt Hedberg. Jay, first of all, incredibly impressive to be able to find and hire 1,000 people over the last six months in this environment. But when you kind of think about one of every four Zscaler employees being new to the company, could you just talk about how you're managing that growth and also, you know, given the expanded breadth of the products and the more multi-pillar sales, how we should think about the ramp time for adding new sales headcount?

Well, thank you. Multi-part question. So first of all, let me start by saying that we are very pleased that we have been able to do good hiring in this top hiring environment because we are a top destination for top talent. So hiring is obviously the starting point. Two, I think we are doing a number of things that need to be done to make sure these people can be easily incorporated in the company. And in the past, we talked about a very strong enablement team, a number of boot camps for training we do, and buddy systems we align. So a number of things we're doing to make sure these people are becoming part of it. And the results we have shown over the past two years show that in this COVID environment, we have been able to do a good job in making them productive. What's the next part?

From a headcount perspective, we called out last quarter that we had an outstanding quarter for field quota ads. We had an equally great quarter also in Q2. So our plans are to really push growth. We see this as a huge market opportunity. We're going to continue to do that, and we're going to continue to hire across the company.

The only comment I'll add next to it is it's not just RSMs that matter for us. Our top-down strategic sales process requires solution architects. We have a transformation team of CIOs, CISOs, and CTOs. They all play an important role, and we're doing well across the board in hiring them. Thank you. Thank you.

Thank you. And next we have the line of Alex Henderson of Needham. Your line is open.

Great, thanks. And let me also extend my compliments to an outstanding quarter. You guys really, I guess, a very tough comp that really delivered superb results. I was hoping you could talk a little bit more in the terms of hiring around the capacity expansion within your sales organization to what extent you've delivered on the prior hiring, you know, say a year ago, getting to quota and where we are on the current hiring getting to, you know, when you think they'll get to quota and what your expectations are. For CY22, for staffing increases in sales capacity, is it reasonable to think that it could be another year the 50% capacity growth? Thanks.

Yeah, I'll take it. So from a quota perspective, we are seeing people, you know, getting ramped quicker, but, you know, they're on full quota after one year, so that hasn't changed at all. Regarding, you know, sales capacity, you know, I don't want to give, you know, percentages out. What I'd like to say is that This is a huge market opportunity, and we see it. So we will continue to build sales capacity in our model. The one thing that we did call out in the last quarter or the quarter before, if we're growing over 30% on the top line revenue, you can expect less than 300 basis points operating margin expansion. Our view is that this is a huge market opportunity. And you're right, Alex. These results for a company at our scale are outstanding. They're absolutely outstanding. You've got billings growth at 59%. You've got short-term billings growth at 61%. And you look at a model that's got tremendous leverage in a market that's, in my opinion, huge. we're going to continue to really focus in on that top line and invest in our business. And, you know, we're very confident that we have the best product and a huge market opportunity.

Great. Thank you very much.

Thank you. Next, we have the line of Hamza Farawal of Morgan Stanley. Your line is open.

Hey, guys. Thanks for taking my question. Remo, if I could direct my question to you first. Jay mentioned a lot of great things about the demand environment, about some of the secular tailwinds that you guys are seeing, larger deal sizes. If I look at the billings growth, and 59% growth at this scale is obviously very impressive, it was a little bit below the usual seasonality and the 70% type billings growth that you guys were doing over the last four quarters. So I'm just curious, you know, when we think about billings at this scale, is there anything that we should be mindful of in terms of seasonality going forward or anything that was perhaps one-timey, you know, a year ago or last quarter when we think about billings growth in relation to revenue growth over the next four quarters?

Yeah, I mean, a lot of questions there. Let me try to answer with, so, you know, 59% billings growth, as you mentioned, is absolutely outstanding. If I take a look at Q2, if there's one area that didn't perform at the level that we thought it would, it was federal. Federal was low single digit of our new and upsell business. Now, why is that? It's just the budget constraints, basically. So, Our feeling is that federal will be a big portion or substantial portion of our business. We got the FedRAMP certification. Also, we built up a strong team with the relationships. But the call-out one thing in the quarter that I would say didn't come as we expected would be federal. It was low single digits. Regarding billings and revenues that go forward, Hard to say. You know, it all depends on our, you know, really top level, you know, growth. You know, like I mentioned before, you know, with Alex, it's a huge market opportunity, absolutely huge. We feel we're well positioned. You know, we're seeing, you know, the traction, you know, with our customers. I believe we had 251 customers greater than the million dollars ARR. which is growth rate 85% over the prior year. Our customers appeared in $100,000 ARR was like $1,750. So substantial growth also year over year, I think it's like 500 customers or something like that or 550. The market is there and we feel we have the solution. And again, from my perspective, the results that we put up were outstanding results. And again, the key thing for investors is that You know, we're going to continue to invest in top-line growth in the business. We see no reason to slow it down. We'll be, you know, cognizant and related to, you know, operating profitability. But you're all aware, you know, the SAS model with 80% gross margin, you know, getting to operating profitability, high operating profitability, it's not a difficult thing. You know, really trying to take advantage of this market is what we're after. Got it.

Really helpful. Thank you.

Thank you. And next we have Joel Fishpin, sorry, Fishpine, Truist. Your line is open.

Thank you, and congrats on the great execution. I guess this is for JN Remo. You've been pretty successful in terms of cross-selling a lot of the different products, and obviously deal sizes are going up pretty dramatically. I'd love to, you know, get your take on how ARPU Per Seed has been trending. And then the second part of that is, you know, how is it being able to sell into different parts of an organization since the products affect, you know, obviously different parts of an organization? That would be helpful as well. Thank you.

I can start. In my prepared remarks, I covered so many deals where ZIA, ZPA, ZDX worked together and a number of deals with all four product pillars of VARC. So we're actually very happy. The traction we're seeing, you're seeing over the past couple of years that ZI and ZP are common together, has become, fear me, a common thing. And now ZDX, for the last one year, has become more and more common. We're seeing lots and lots of customers buying ZDX because without this, you can't troubleshoot if something goes wrong somewhere. And ZCP is becoming an interesting seeding opportunity for us. because that's an early market for the workloads, and we are positioning ourselves well to grow it. So we feel very good about the cross sign. Remo can give further color to it.

Yeah, I mean, the ARPU is definitely increasing, and we'll be getting information on that on an annual basis. New versus upsell in the quarter was 45% new and 55% upsell. So, you know, it's a good quarter, you know, balance between new and upsell for us. Thank you.

Thank you. And next we have Gray Powell of BTIG. Your line is open.

Oh, great. Thanks for taking the question. And, yeah, congratulations on a strong quarter. So I know a lot of people are focused on, you know, billings as the primary metric. But if I'm doing my math correctly, it looks like current RPO grew about 80% this quarter, pretty close to 83% last quarter and well above your 63% revenue growth rate. So just curious, what do you think we should be looking at as the best leading indicator for future revenue growth? And should it converge to RPO trends over time?

Yeah, that's a great question. And if you take a look at our RPO growth year over year, it was about 90%, and CRPO growth was 79%. You know, we've always called out, you know, when the RPO growth rates and CRPO growth rates are going just triple digit, we brought back investors and said, billings is the best way to look at our businesses. You know, and when you take a look at RPO and CRPO, they're more sensitive to the timing of large deals, the timing of renewals, contract durations, and other specific terms. You know, it's for these reasons that, you know, we want, we feel that people should be looking at billing, you know, versus RPO or CRPO. Also, our, especially when we're in the range of 10 to 14 months. So, and also in the quarter, our durations was right in the middle of the range of 10 to 14 months. One thing I'd also call out that investors should probably look at is short-term billings growth. You know, our short-term billings growth was 61%. So, you know, I would look at everything as an investor, but from a Z-scaler perspective, it's really billings. And if we're in that range, 12 to 14 months, it kind of, you know, bounces. and then also short-term buildings growth. Those are the key metrics. That takes all the noise levels, all the things going on with RPO and CRPO out of the equation.

Understood. That's really helpful. Thank you very much.

Thank you. Our next question comes from the line of John Rookhaver of Beard. Your line is open.

Yeah, hey, guys. So you announced last quarter general availability of workload communication. So I'm just kind of curious to hear commentary on adoption trends, expectations around that ramp. How would you view long-term adoption over time? Will it be somewhat limited to larger organizations, similar to what you've commented on workload segmentation, or is it a bigger opportunity?

It's a very good question. Workload segmentation is only one piece of the offering. The core, the basic offering is what we call zero trust for workloads. Workloads are a mirror image of users. Like users, they talk to Internet. And like users talk to workloads, workloads also talk to other workloads. So we've taken our disruptive zero trust users, the CIS EPA, and applied to workloads. So today, what's done to really secure workloads in the cloud? It's largely VM versions of firewalls. There's a firewall before you go to the internet. There's a firewall before you go to another region, and so on and so forth. We believe we will disrupt the workloads-based security the same way we did it for users with GIS EPA. So it's a massive opportunity. I highlighted a number of deals where actually multiple products got bought together, including GCP. Some of these deals included a Fortune 500 semiconductor company, a Fortune 500 financial services company, a global financial logistics company. Now, I would say that customers do start small in the cloud workload area, and then they grow with us.

Helpful. Thanks, Jeff.

Thank you. Our next question comes from the line of Fatima Bulani of Citi. Your line is open.

Hey, good afternoon. Thank you for taking my questions. Remo, this question is for you on cash flow. We saw the relationship between operating margins and cash flow margins diverge pretty materially over the course of the pandemic, and we are starting to see that consolidate a little bit. So I'm curious if you can shed some light on how we should think about the free cash flow trajectory from here, particularly in the context of the multi-year commits and large deals that Jay alluded to in his prepared remarks and as you start to do a lot more enterprise and large deal and seven, eight-figure business.

Yeah, let me first say we'd like to be prudent with our projections. So, you know, keep that in mind. If you take a look at our free cash flow margins in Q1, it was like in the 35%, 36% range of revenue. In Q2, our free cash flow margins were 12% with operating profitability at 9%. You know, from my perspective, I just think it's just prudent to think about free cash flow being slightly higher, you know, three, four, five percentage points higher than operating profitability. It is going to fluctuate on a quarter-by-quarter basis. Our Q1s and Q3s are typically our highest quarter for free cash flow. The reason for that is that our Q2s and Q4s are our biggest billing quarters, so you're collecting the cash in Q1s and Q3s. As we get bigger, we bill typically annually. So, and that's when we talk about, you know, billing being a good metric between that 10 and 14 months, you know, that's what we talk about. You know, certainly we could increase free cash flow by doing multi-year billings, but that's not our model. What we try to do is get the multi-year commitment, you know, contracts, which we have seen increase, but, you know, for free cash flow or for cash flow or billings, we typically say it's, you know, one, you know, one year.

Very helpful. Thank you.

Thank you. Next, we have Tal Liani of Bank of America. Your line is open.

Hi. I want to ask about billing growth because the stock is going down on lower billing growth than buy-side expectations. So you grew billing around 71%, pretty stable the previous four quarters. In this quarter, it was much better than guidance, but it was lower than what we've seen the previous four quarters. So that's 59%. And then the guidance for the year is 46% more or less. So the question is, how should we think about billing growth? What can you say about this quarter? Why is it lower than previous four quarters? And then what's the explanation or what are the puts and takes for the following few quarters? Thanks.

Yeah, I mean, you know, great question. Well, four corgs in a row at this scale with 70% plus is outstanding. Is that sustainable? You know, it's very hard to sustain that when you get to the size that we are. Fifty-nine percent fillings growth is outstanding. If you take a look at some of our prior quarters, duration plays into that top-line billing growth. If you look at short-term billings growth, it was 61%. And so if you go back in prior quarters, you'll see that's a 61% short-term billings growth. That's a pretty good number, a very good number. Going forward, you've got our projections. We like being prudent with our projections. The key thing is that we see this as a huge market. And we're going to continue to invest, and we're going to keep on driving that top line numbers. Those numbers are for revenue and billings and short-term billings. And then because the value that you get from driving that top line number, the leverage you get is huge. Because in a SAS model with a contribution margin in that 60% range for years two and three, it doesn't take long to get to the operating profitability So building up your ARR is really, really important in getting that market share and being the dominant player. That's our focus.

Got it. Thank you.

Thank you. Our next question comes from Mike Walkley of Kenacord Equity. Your line is open.

Hey, guys. Good afternoon. It's Daniel on for Mike. Thanks for taking my question. So over the... Over recent periods, you've been working on really improving your sales motion within the enterprise segment. Could you give us some color on how this part of your business trended this quarter? And I guess if you're recognizing some additional wins given the investments you've made so far. I will start.

Enterprise segment, which we define as 2,000 to 6,000 employees per company, is progressing very well. And we continue to make significant investments and growing the team. Moving to small enterprises is a natural step for us. It's an attractive market, and it's also a market where channels can play a bigger role, and Summit Channel Program has been helping us quite a bit. So we plan to continue to invest and grow this area. Remo, do you want to add anything to it?

Yeah, I mean, in the quarter, all segments grew well, but given our strength in large deals during the quarter, the larger enterprise did better.

Okay, great. Thank you so much for the caller.

Thank you. Our next question comes from Patrick Caldwell of Deutsche Bank. Your line is open.

Hey, thank you so much for taking my question. Can I just double-click on the point you made earlier in the call around federal? You called out that federal, was only no single digit of new and upsell. Can you just give us a framework to just compare what that was like last quarter or last year so we can get a frame of reference? And can I also just ask, were there any deals that were pushed out or that have subsequently closed after January 31st that we should be aware of?

I'll answer the first part, and Jay can answer the part about the deals. But, you know, typically federal has been mid-single digit, you know, sometimes even high single digits. And I don't recall, Patrick, what it was last year, you know, but, you know, you can think of federal being mid-single digit, you know, an average contribution of our quarterly new and upsell business. And this quarter it was low single digits.

And in terms of Pipeline and deals and all, it is growing. Pipeline is growing. We are well engaged. We are seeing more momentum coming from some of the new memos and initiatives being put in place. We got the architecture. We got the federal certifications. I think one thing remains a little bit unpredictable is some of the federal budgets and the timings.

Thank you so much.

Thank you.

Thank you. Our next question comes from Keith Bachman of Bank of Montreal. Your line is open.

Hi. Thank you. Just clarification on the question, Remo. You mentioned duration, and if you look at short-term billing, you grew at 61 percent. There's a little bit of a degradation called seven points from the previous quarter, but the compare was six points higher, so your short-term billings have been pretty steady. um if i look at the the the january through july quarters of last year you grew 70 plus percent but can you just remind me how much that was enhanced by duration so we can normalize for the compare and then if i'm allowed to sneak one in i just wanted to see if you could just talk about nrr trends as you see going through the year does that does it stay steady or do you think as you're rolling out you know new products like zcp that that those trends actually may improve to facilitate growth thanks very much

No problem. I'll just call out one quarter that I'm aware of, which is Q3 of last year. Q3 of last year, in that 10 to 14-month range, it was close to that 14-month range in Q3. So that's the duration impact, Q3 of last year, which I can recall. Regarding NRR, new products, the comment that we made last quarter is that if it's over 125%, You know, we're not going to give out specifically, you know, what the NRR is. It was over 125% in the quarter. But our new products are doing well. I mean, our new products are doing well as well as, you know, VPA. And those are, you know, pretty big contributors related to that NRR. If I may add, we expect NRR to do well.

But having said that, you know, it's one of those things you see, the bigger bundles we sell up front, the lower the NRR. Or if we do the first deal today and in two quarters we do the second upsell deal, that doesn't really get picked up in NRR. So happy with NRR, but in the past we kind of said that we don't really try to focus too much on NRR. That's why we're giving you 125% of higher ads as a good indicator.

Great. Thanks, Jay.

Thank you. And next we have Brian Essex of Goldman Sachs. Your line is open.

Hi, good afternoon, and thank you for taking the question, and congrats on the results. You know, I guess, Jay, maybe if you could address this one. I know when Dolly came on board, you know, focus of his was increasing deal velocity and also hiring. Well, now you've got – you're kind of getting larger deals. You have a more mature sales force, so there's some puts and takes there. Maybe any commentary you can provide on sales cycles and now that you're larger, growing over large numbers with bigger deals, but now with a more mature sales force, how you're managing that dynamic and what those sales cycles look like. Thank you.

Yeah, so it's a good question. So first of all, it is the sales force with all the processes and enablement we put in place. has helped us grow exceptionally well over the past two and a half, three years since we put this new motion in place. That's number one. Number two, I think at that time, we were merely focused on the higher end of the market, largely major in LEs. Now we expanded further down to enterprise as well, which is doing quite well. As you would expect, the sell cycle is lower toward the lower end of the market. It remains fairly high on the high end of the market. It is a transformation sale. It involves CIO, CISO, CTO, multiple parties. But as we go in, we engage, we end up winning big. And not only that, we start, wherever we're going in these accounts, we are so sticky that we keep on upselling and growing. So I'm very confident, very comfortable. Obviously, as numbers are growing bigger, we need to keep on doing the same thing. The market is there. product portfolio is there. We have no comparative pressure. And it really needs to keep on executing. I think we're doing a good job and we'll keep on driving. And we have good margins at the gross margin level to keep on investing.

Great. Any way to quantify what sales cycles are and how they've trended?

I would say we haven't come and said they're reduced by X percent, but I would say 100%. It's a range of, we have always said the lower, smaller deals were three to six months, and bigger were from six to 12 months. It's getting bigger. Probably there's a movement towards the lower side of it. But, you know, deals come in many shapes and sizes. So they're all over. But we are, we have a very rapidly growing pipeline. And our close rates are pretty good as well. So I feel very bullish and comfortable.

Very helpful. Thank you.

Thank you. Next question comes from Roger Boyd of UBS. Your line is open.

Hi. Thanks for taking my questions. I wonder if you could talk about, first of all, really strong performance out of the 1.9 plus era cohort. I wonder if you could talk about what you're seeing in that smaller enterprise cohort in terms of competition, and then also what the recognition of Gartner on their new Secure Service Edge Magic Quadrant means as you go to market with that smaller 6,000 to 2,000 cohort? Right.

So good question. So first of all, the MQ is not just the lower market. MQ is across the board probably more relevant for larger markets to some degree because larger companies tend to be Gartner customers. But I would say, frankly, I was surprised to see that the two CASB vendors listed in the leaders quadrant, because we don't see them in the real world out there. So if I were to quibble with the criteria that Gartner used, I believe it was overweight on CASB, which is much easier to build. It's out of bands. And it was underweight on secure web gateways. which is foundation of Zero Trust, and much harder to build because it is in line. In our customer base, we are replacing lots of CaspiPoint products that have been sold over the years. And you look at our platform. It has expanded significantly, ZI, ZP, ZD, GCP, and all. Now, second question related to smaller enterprises. We do see more vendors in low-end of the enterprise than we saw when we see on the high-end. High-end are very savvy. They rule out actually some of the vendors who don't have the right architecture, and they also look for operational excellence. Yesterday, I had a call with a CIO of a large financial services company. He wanted to start the discussion by saying this. I see so many vendors that keep on coming and talking about all kinds of features and functionalities, And when I talk to their operational experience running the cloud, they don't have much to talk about. Well, they don't because they haven't really done it before. So operational experience is becoming more and more important as some of these you have seen issues with AWS to Azure AD and some of those stuff out there. But on the lower end, we do see firewall vendors, Cisco's on the wall, some of the other a new entrance, but once we engage and we win almost every time, typically in the past we had less presence in enterprise, but now we are actually engaged and putting more resources in the lower end of the market and winning. It's a growth area for us.

Very helpful. Thanks, Jay.

Thank you. And next we have Joshua Tilton of Wolf Research. Your line is open.

Hey, guys. Thanks for squeezing me in. I kind of just wanted to follow up on the previous competition question, but just a little bit more broadly. Could you possibly kind of just comment on, you know, how have your number of at-bats been trending and how would you characterize your overall win rates across the entire market relative to maybe previous quarters?

Oh, sorry. The first part was how are numbers trending?

How are the number of your at-bats trending? Are you getting more opportunities, less opportunities? You know, how's that been trending over the last couple months and previous quarters?

Yeah. So, first of all, driven by transformation deals, there aren't too many cases where we do have active back-offs. You know, in the security space, people are used to back-offs and all. We do less of that because Typically, we go in, we help drive transformation, working with the CIO and going down from there. And in cases we do have backups, we almost always win to the degree. We don't really track how many wins we expect us to engage and win. The main reason if we don't win a deal is because we couldn't really get the thing closed in the quarter. It moved down to the next quarter and the like. So probably different. Deal getting delayed is part of the reason. It's not generally that competitive pressure is kind of hurting our business. As we grow more and more platforms and the market is shifting fast, it's no longer the days of 90s and early 2000 when it's the same place. I mean, look at it two years ago, three years ago, or when we did IPO. ZIA, small piece, was the thing. Now ZIA, transformation bundle became the big thing. Now ZIA, ZPA together, so every user could work from wherever. Then we moved the game to have digital experience being part of the requirements and no workload and whatnot. So we think on the competitive side, we are good. We just need to make sure we keep on hiring and training people to do this top-down strategic sales.

Thank you. That was very helpful.

Thank you.

Thank you. And that concludes the Q&A portion of the call. I will hand the conference back over to Jay Chowdhury for final comments.

Thank you, everybody, for joining us and your continued interest in ZSK. I also want to thank our customers, partners, and employees for helping us deliver a strong course. We look forward to seeing you at upcoming investor events or to updating you next quarter on our continued progress. Thank you again.

This concludes today's conference call. This concludes today's conference call. Thank you for participating. You may now disconnect. Have a pleasant day.