Zscaler, Inc.

Good day, and thank you for standing by. Welcome to the Zscaler third quarter 2022 earnings conference call. At this time, all participants are in the listen-only mode. After the speaker's presentations, there will be a question and answer session. To ask a question during that session, you'll 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 Third 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 to our investor relations website. Unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis. You'll 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 objectives and outlook, our customer response to our products, and 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 June. Loop Software Conference on June 1st, Bank of America's Global Tech Conference on June 8th, Mizzou Virtual Cybersecurity Summit on June 13th, and we will also host an investor briefing focused on our latest innovations at the Zenith Live Conference on June 22nd. Now, I'll turn the call over to Jay.

Thank you, Bill. We are pleased to report another strong quarter. In Q3, we delivered 63% year-over-year revenue growth, 54% billings growth, and 15% free cash flow margins, all while investing for high growth. While most public SaaS companies are happy to get to Rule of 40, we again exceeded the Rule of 70 based on revenue growth, and free cash flow margins. With our increased guidance today, we expect to achieve the rule of 80 for the full year. We are not only delivering excellent growth, we are also delivering strong profitability. We are disciplined in making investments for innovation and go-to-market scale. With the breadth and depth of our ever-expanding Zero Trust platform, we can efficiently sell to our growing base of enterprise customers. We believe our clear focus on securing large enterprises makes us the partner of choice for our customers' Zero Trust security journey. While there are broader macro challenges and economic uncertainties, We have seen an increase in large multi-year commitments for multiple product pillars of Zscaler platform as periods of uncertainty can act as a catalyst for change. This coupled with growing cyber threats such as ransomware are driving IT leaders to transform security from castle and moat security to zero trust architecture. In this environment, customers cannot risk transformational and mission-critical projects with immature offerings from unproven vendors. As the pioneer and category leader in Security Service Edge, or SSE, with the widest and deepest offerings, Zscaler is the trusted partner for vendor consolidation, cost savings, increased user productivity, and better cyber protection. We are adding new global 2,000 customers at a record pace. In the last two quarters, we added close to 80 G2K customers. Now 40% of the Fortune 500 and 30% of global 2,000 companies trust Zscaler to secure their digital transformation. Approximately half of our global 2,000 customers have both ZIA and ZPA. And I am excited to report that ZPA has surpassed over $200 million in annualized revenue. In Q3, we had significant growth in new $1 million plus ACV deals across major geographies and customer verticals. We are seeing an acceleration in multi-year, multi-product pillar deals as enterprises are racing to transform their business. We provide a path for large strategic customers to ramp into larger and longer commitments for our entire transformational platform, not just for elements of it. This is driving a strong growth in bookings, with the total value of our committed future revenue reaching a key milestone. It has surpassed $2 billion. Now, let me highlight some customer deal wins during the quarter. As I mentioned before, I believe all customers will ultimately purchase ZIA, ZPA, and ZDX for all users. This quarter, we have seen ample evidence that customers are buying ZIA, ZPA, and ZDX together, providing zero-trust security for users with fast user experience. In a new logo win, a global 500 food services conglomerate headquartered in Europe purchased ZIAS, ZPA, and ZDX for all 100,000 users. Leveraging our globally distributed SSE platform, this customer is consolidating dozens of different vendors' point products across hundreds of locations in 45 countries. The customer was most excited about having a single zero-trust security policy framework for in-line inspections, across its business units in every location. Given the significant cost savings, up-level security, and improved user experience across the company, the CEO and CFO signed off on this non-budgeted four-year commitment. In addition, they started a paid pilot for our Zero Trust for Workloads offering for this sizable AWS footprint which we are very excited about. Next, in an upsell deal, a global 10 oil and gas customer headquartered in Europe, after deploying ZI and ZPA for 100,000 users, purchased ZDX for all 100,000 employees. ZDX is delivering immediate value by reducing the customer's time to troubleshoot performance issues by 50 to 80%. while consolidating 40 legacy performance point products. In addition, the customer upgraded to a newly introduced ZPA Transformation Bundle that includes browser isolation, application protection, and deception services. This is a four-year deal that increased the customer's annual spend by over 70%. This customer's journey with Zscaler is remarkable. I remember sitting with the chief architect in their office, finalizing the purchase of our ZIA professional bundle six years ago. Since then, their annual spend has increased over 14X to well over $10 million. Next, we look forward to working with them on Zero Trust for workloads. In an upsell win, a Fortune 500 bank in Asia that has deployed ZIA for over 50,000 users, purchased ZPA and ZDX for all 50,000 employees. This is another example of a large customer buying ZIA, ZPA, and ZDX for all users. While the immediate objective for this deal was to replace a legacy multi-vendor VPN infrastructure, ZPA was selected to implement zero trust access by establishing an application-level policy where users connect to specific applications, not to a network, hence achieving app segmentation without having to do legacy network segmentation. CPA did not just replace VPN. It's eliminating the need for the entire inbound DMZ, including DDoS protection, app delivery controllers, and firewalls, generating a payback on their Zscaler purchase within six months. Because of this substantial ROI, even in a tougher macro, Zscaler can help reduce cost while driving transformation. Our integration with Microsoft's E5 suites across ZIA and ZPA was also an important decision factor for them. This latest purchase more than doubled the customer's annual spend. ZIA, ZPA, and ZDX together form a complete solution to implement zero trust for users. Our next immediate big opportunity is zero trust for workloads powered by the same core ZIA and ZPA technology. Let me highlight a few exciting wins in this area. An existing Fortune 100 financial services customer with ZIA deployed for 60,000 users purchased zero trust for workloads to protect 50,000 workloads spanning across multiple data centers and public clouds. This eliminates the need for virtual firewalls and site-to-site VPNs. This multi-million dollar ACV deal is our largest workload deal to date and more than doubles the customer's annual spend. The customer now protects both users and workloads under a single policy framework, enhancing their cyber protection, providing visibility, and simplifying operations. Lastly, let me discuss a new customer purchasing all four product pillars together. An elite research university purchased our comprehensive ZIS, ZPA, and ZDX offerings for 35,000 users and zero transfer workloads for over 3,000 workloads for the multi-cloud environment. Their CIOs top priorities to eliminate the risk of legacy VPNs and lateral threat movement as universities are increasingly becoming a target for ransomware and intellectual property theft. Also, a critical requirement for this win was our zero trust platform meeting the criteria of zero trust framework as recommended by NIST. We closed this three-year, eight-figure deal through AWS Marketplace. I'm very happy with our continued success in expanding our routes to market via cloud marketplaces. Next, I am excited to highlight U.S. federal government, where we are having considerable momentum. Driven in part by the president's executive order, we are seeing increased interest in our zero-trust exchange across all levels of the government. We are excited to help our country dramatically improve our security posture while significantly reducing legacy IT costs. We have the highest level of FedRAMP certifications for ZI and ZPA. In addition, ZPA is the only zero-trust solution with DoD IL-5 certification. There are only a select few cloud companies that have this level of certification, and there's no other cybersecurity company at this level. IL-5 certification is an important differentiator for us. Let me highlight two new customer wins this quarter where this was an important factor. First, a defense contractor that purchased ZIA and ZPA in a six-year, seven-figure ACV deal. Second, a DoD unit also purchased ZPA for secure access to SAP instances in AWS GovCloud. Two important considerations for our ongoing success in the federal market are, first, ZPA is the only cloud security service with FedRAMP high authorization for zero trust remote access. We connect users to applications and not to the network, eliminating lateral threat movement, a core principle of zero trust architecture that can't be achieved by next-gen firewalls or cloud VPNs. Second, ZI is proxy architecture, which inspects TLS encrypted traffic at scale delivering superior security. Our proven track record running the world's largest inline security cloud makes Zscaler the obvious and trusted partner of choice for governments and enterprises. We now have 288 customers, exceeding $1 million in ARR, an increase of 77% year over year. We deliver a mission-critical service that requires unmatched reliability and availability for an inline cloud. There is no compression algorithm for over 10 years of operational experience running such a cloud. An example of a proven scale is that Zscaler processes over 240 billion transactions in line per day, which is more than 20 times the number of Google searches per day. Now, let me share a few observations about our high net retention rates, which has exceeded 125% for the last six quarters. We made a number of investments in customer success services technical account managers, partner services, and certification of partners, which together are driving a faster and greater adoption across our broad portfolio. We have a solid blueprint for accelerating value delivery, which is driving upsells. All of these investments result in happy customers demonstrated by our Net Promoter Score, or NPS, of more than 70, which is more than two times that of an average SaaS company. Next, let me now highlight a rapid pace of innovation. After having built the most comprehensive platform to provide zero trust for users, we are now expanding it for zero trust for workloads. Unlike scores of vendors who offer point products for cloud-native apps, Zscaler has developed a fully integrated CSPM, CIEM, and infrastructure as code scanning with a common backend and fully correlated actionable dashboard. Gartner calls its functionality CNAP, but we have moved beyond CNAP by integrating the threat and data awareness from CIA and ZPA. We will be highlighting it and other innovations at Zenith Live our annual cloud summit next month. We enhanced our AI ML engine for ZDX, our fastest growing new service, to leverage billions of telemetry points from millions of users to improve digital user experience. It cannot only automatically figure out what and where performance issues are, but can also provide information about the quality of voice, video, and screen sharing due to our integration with Microsoft Teams and Zoom. We have also integrated ZDX with ServiceNow, making customer and user support far more efficient. ZDX also got certified and became available on our federal cloud. Our ThreatLabs security research team is tracking over a dozen APT groups and getting better reconnaissance about the tools and behavioral patterns resulting in higher order threat intelligence. This specific threat intel coupled with our massive cloud effect from 240 billion transactions and 300 trillion signals per day enables Zscaler to deliver better threat protection than other vendors. Moving beyond users and workloads, we are now bringing Zero Trust to IoT and OT systems a large emerging opportunity. Today, Siemens and Zscaler announced the availability of an integrated all-in-one solution to accelerate secure access to OT systems. Our joint development with Siemens brings the benefits of Zscaler to factory and industrial control systems. We are thrilled to have Siemens, a long-standing customer, as a development and go-to market partner. In closing, in spite of uncertain macro conditions, we continue to see strong demand for our services. We are in a strong financial position and we will continue to aggressively invest in our business. We are focused on hiring and developing talent and creating a culture that rewards innovation at all levels. We have grown our global organization to approximately 4,500 employees who are energized by our shared mission to secure the hyper-connected world of cloud and mobility. We grew our total sales and marketing headcount by 54% year-over-year, and we remain focused on investing in our go-to market machine. In today's competitive hiring market, Zscaler is a destination for top talent. To drive continued growth in hiring, and to build on Zscaler's high-performing hybrid work culture. This month, we welcome Brandon Castle, Google's former global head of talent acquisition, as our new chief people officer. Brandon has proven experience in building highly motivated and productive teams at scale. With app transformation already mainstreamed, network and security transformation is also becoming mainstream, which we pioneered with our Zero Trust Exchange. We believe customers trust Zscaler more than any other provider for securing their cloud journey. Recent uncertainty in the macro environment is driving customers to accelerate their network and security transformation with our integrated platform resulting in a reduction in cost, complexity, and business risk. We are adding a record number of Global 2000 customers, now with 30% of Global 2000 and 40% of Fortune 500 customers trusting Zscaler. These demanding customers are making large multi-year commitments to our platform. We are not just growing rapidly at any cost, We are also profitable and delivering efficient growth. We will continue our disciplined investment in innovation and growth to capture the large and growing opportunity ahead of us. Now, I'd like to turn over the call to Remo for our financial results.

Thank you, Jay. As Jay mentioned, we are pleased with results for the third quarter of fiscal 2022. Revenue for the quarter was $287 million, up 63% year-over-year and up 12% sequentially. On a year-over-year basis, revenue growth exceeded 60% for the third straight quarter, driven by strong customer demand for our Zero Trust platform. CTA product revenue was approximately 18% of total revenue, growing 87% year-over-year. From a geographic perspective, we had broad strength across our three major regions. Americas represented 52% of revenue, EMEA was 33%, and APJ was 15%. APJ continues to be our fastest growing region with revenue growth of 105% year over year. Our total calculated billings grew 54% year over year to $346 million. with billing duration comparable to a year ago and above the midpoint of our normal 10 to 14 months range. Our remaining performance obligations for RPO grew 83% from a year ago to $2.216 billion. The current RPO is 49%, 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 is again above 125%. We had 288 customers paying us more than $1 million annually, up 77% from 163 in the prior year. I'm very pleased with the pace at which we're adding these $1 million ARR customers. We increased by 37 customers in the quarter. The continued strength of this metric speaks to our large enterprise focus and the strategic role we play in our customers' digital transformation initiatives. We added 140 customers in the quarter, paying us more than $100,000 annually, ending the quarter at 1,891 such customers. Turning to the rest of our Q3 financial performance, total gross margin of 80.6% was approximately flat quarter-over-quarter in year-over-year. Our total operating expenses increased 11% sequentially and 70% year-over-year to $204 million. Operating expenses as a percentage of revenue was 71% compared to 68% in the year-ago quarter due to a partial return of T&E. Operating margin was 9% and free cash flow margin was 15%. We continue to expect data center CapEx to be around high single-digit percent of revenue for the full year. We ended the quarter with over $1.66 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 discounts, and amortization of intangible assets. We are once again increasing our guidance across all metrics. For the fourth quarter of fiscal 2022, we expect revenue in the range of $304 million to $306 million, reflecting a year-over-year growth of 54% to 55%. 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 than our core products because we're more focused on time to market and growth rather than optimizing them for gross margins. Operating profit in the range of $33 to $34 million. We have more in-person events this quarter, including customer events Zenith Live and RSA conferences. Net loss on other income of $500,000, income taxes of $3 million, earnings per share of 20 to 21 cents, assuming approximately 146 to 147 million fully diluted shares. For the full year fiscal 2022, we are increasing our revenue guidance to approximately $1.078 billion or year-over-year growth of 60 percent, increasing calculated billings to a range of $1.425 billion to $1.43 billion, or year-over-year growth of approximately 53 percent, increasing our operating profit to a range of $106 million to $108 million, increasing our earnings per share to a range of 64 to 65 cents, assuming approximately 147 to 148 million fully diluted shares. Free cash flow of $215 million, reflecting free cash flow margin of approximately 20% for the full year, with a revenue growth outlook of 60% and free cash flow margin of 20%, we expect to operate at the rule of 80 for the full year. With customers increasingly adopting the broader platform with longer-term commitments, we plan to invest in capturing our large market opportunity. We have confidence in the durability of our business model with very high contribution margins after the initial land and proven ability to retain and upsell to our enterprise customer base. We will balance growth and profitability based on how our business is growing, but we'll continue to prioritize growth, which we believe is 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 will need to press star one on your telephone. To withdraw your question, please press the pound key. Standby as we compile the Q&A roster. Our first question comes from Andrew Nowinski of Wells Fargo. Your line is open.

Great, thank you. Congrats on another amazing quarter. I wanted to ask about your federal demand. Jay, I think you said you saw you're seeing considerable momentum in the U.S. federal this quarter, which seems to be an uptick from Q2, where I think it was maybe one of the underperforming sectors. So just wondering if you could comment on maybe what changed and what caused that uptick in demand this quarter ahead of their, you know, the usual budget flush trend. in calendar Q3?

You know, Andrew, I'll start it. You know, last quarter in Q2, our federal was low, single-digit, new and upsell, and in Q3, you know, it was mid-single-digit, so definitely an uptick. Also, on a go-forward basis, you know, we do see federal as being an important contributor to Zscaler. We feel that we're well-positioned in the federal market. I'll let Jay speak more to that.

Yeah, Andrew, as you know, the president's executive order is to implement zero trust architecture, and it's well aligned. It actually aligns with what we have done. To be successful in federal, you need two things. One, you need the right architecture, zero trust, which we have. Two, you need FedRAMP certifications, and we have the highest FedRAMP certifications. And now there's a timing issue as well. White House issued a memo setting a timeline for agencies to achieve zero-trust architecture within two years. These plans are being submitted, and more budgets are becoming available. All of this is positive long-term development from our point of view. However, fair opportunities always take time.

That's great. Thanks, guys. Keep up the good work.

Thank you. Thank you. Our next question comes from Alex Henderson of Needham. Your line is open.

Great. Thank you very much. I've been listening to a lot of people trying to get into this zero trust market. One of the things that really strikes me as highly differentiated is, one, the policy implementation mechanics are so radically different in what you're doing versus the traditional perimeter defense. And then second is the sharp increase in attacks that we're seeing in terms of encrypted traffic. Received a report today talking about over a 300% increase in encrypted attacks over the last year. Can you talk to the relevance of those two data points or those two concepts relative to your platform and how you solve that better than say, alternative vendors. And in that context, can you just address CloudFlare's comments that they're getting more aggressive in this space? Thanks.

Yes. Thank you, Alex. So first of all, zero trust implementation. People sometimes build a little VPN replacement they call a zero trust. What we build with Zscaler Private Access It's a platform that replaces the entire inbound DMC. Literally, you need nothing between Zscaler and the workload and application running. And in fact, on top of that, we further expanded to add browser isolation, app protection, integrated deception, and EIMF-based policy that can help you do segmentation. It's because of that you're winning ZPA deals big time. So that's one part. The second part was attacks. So first of all, for someone to attack, they need to find you. With our zero trust architecture, your applications hide behind these because they can't even find you. And the next part of attacks is, and this is encrypted attacks, for that you need a proper proxy architecture that actually terminate connection, look at the packets and everything, decrypt them, find them, and take care of them. For that, we have built a very, very highly scalable architecture that sets us apart, that scales like nothing else out there. So it's a combination of these things with 10 plus years of experience running a massive inline cloud is what sets us apart from others. Now, regarding some of the competitors coming from CDN market or DDoS or DNS market, those guys generally have been focused on servers We started focusing on users to start with. It takes a lot of time and experience to build the richness and breadth of functionality we have built with ZI and ZP and associated functionality. I think it will take a long, long time for someone to try to catch us, and we are sitting. We are innovating at a very fast pace.

Thank you very much. Thank you.

Thank you. Next, we have Hasma Fadawalla of Morgan Stanley. Your line is open.

Hey, guys. Thanks for taking my question. Just one question for Remo. I'm wondering if you can give us a little bit more color on how you're thinking about the margin trajectory going forward. It seems like you want to continue hiring against the market opportunity that you're seeing. Zscaler has obviously been more of a destination for talent in the last couple of years, and particularly the incentive structure around the stock. A lot of employees have done well. How are you thinking about that incentive structure between cash and stock going forward, given that we're probably going to be in a more difficult equity market in general, and just the pace of hiring relative to what you've done in the last couple of years? Those are a lot of questions.

Yeah.

Yeah. Let me see if I can go through and just kind of give you my view, and maybe Jay can tell us that also. Currently, where's the rule of 80? That's what we're projecting for this year. And the way we define the rule of 80 is our revenue growth and also free cash flow margin. Our free cash flow margin this year we're projecting to be 20%. It was 20% last year. So we're in a unique position, you know, to really, you know, take advantage of this market opportunity because we've got significant, you know, cash flow coming into the company, as well as we're in the early stages, you know, of this market. So we're going to continue to make investments as we go forward. Those investments are going to be across the board, you know, throughout the organization. And we're going to, you know, our goal is to get to a $5 billion ARR company. So we're building the infrastructure in place to do that. It related to, you know, employees and incentives, you know, with stock options and, you know, just cash incentives. You know, the cash incentives that we talked about on the last call, you know, related to, you know, with the frothy environment, you know, last quarter with a lot of startup companies and PE companies or PE-backed companies giving really big packages. So we adjusted our merit to reflect to get our employees at market level. So from a cash compensation perspective, we're in pretty good shape. Regarding stock, all companies basically have decreased stock prices, and what we're doing is we're taking a look at that. No decisions made at this point regarding what we're going to do from a stock perspective. But what I can say is our stock-based compensation, as we go forward, will decrease as a percentage of revenue. What happens is that when you get to a certain scale as a company, a very large company, their stock-based compensation goes down. We'll follow the same path as the large companies. You'll see your stock-based coming down over a period of time. Regarding the pace of hiring, again, we're seeing all the things that you're seeing related to the global macro environment. we're not seeing it. You know, from our perspective, you know, we are, you know, strategic for our customers. You know, as Jay talked about, you know, our deal sizes are getting large. You know, our strategic nature and our engagement with our customers is increasing. So our plan is to continue the pace of hiring, and if we can increase the pace of hiring, we will. Now, regarding, you know, color related to operating profitability and also growth. We'll put growth as number one. Now, we are mindful, Jay and I are mindful of operating profitability, and we're old school, quite frankly. We look at the bottom line. But what we see, we see a huge market opportunity, huge. We feel we're the leader in that market. We will continue to invest, and we'll do it on a prudent basis that we feel is the best interest of our shareholders and our employees.

If I may add two quick comments to what Remo said, with very high gross margins and unit economics, it becomes easier for us to invest in businesses. Secondly, the hiring environment is actually getting easier. We are hearing of high-flying companies that raised funding and multi-billion dollar valuations last year. They're starting to lay off people or freeze hiring. And companies that are spending to grow at any cost are now starting to slow down. So we'll keep on accelerating our plan because our customers want to leverage Zscaler to accelerate their transformation because they want to be competitive in HR.

Very helpful, gentlemen. Thank you for that.

Thank you. Thank you. And next we have Matt Hedberg of RBC Capital Markets. Your line is open.

Great. Thanks for taking my questions, guys. Congrats. Jay, what really stood out to me was the success in large deals and multi-product sales. I think especially impressive given the partner momentum in some of these large deals. Can you talk about the importance of hyperscalers? I believe you called out one in an eight-figure deal. Is there even more that you guys can do to drive even faster partner contributions? Because it really does feel like that flywheel is really kicking in well.

Yes. So the partner momentum comes from two sides. One is partners like Microsoft who have been helping us even without fulfilling through marketplace. That momentum has been leveraged for the last several years. Now it has extended over AWS quite a bit. So that's one area. The second area is being able to deliver orders through cloud marketplace. It is one more channel for us to revenue. Our business through both AWS and Azure has been steadily growing. And Zscaler is viewed as a part of a cloud transformation solution. So when it's fulfilled through a marketplace channel, it often comes out of an annual cloud spend that's already committed by the customer with the hyperscaler. So that makes it actually easier in many ways. In Q3, we did one of our largest deals through AWS Marketplace. And if you recall, we did a very large deal last quarter through Azure Marketplace. And we are training AWS and Microsoft sales teams. And I think there's a good opportunity to create more leverage. And these are generally larger deals. So you're seeing our momentum in larger deals. In the last two quarters, we have added almost 80 global 2,000 companies to our portfolio. I mean, that's pretty remarkable, and we don't see any slowdown. Super excited. Thanks, guys.

Thank you. Thank you.

Thank you. Next, we have Patrick Colville of Deutsche Bank. Your line is open.

Thank you so much for having me on, and I echo everyone else's congratulations on a very impressive set of numbers. My question is on the billings guide, which to me was probably the standout metric of the quarter. I think above probably where many investors were expecting, so very healthy there. Can you just talk to, you know, what you guys are seeing in the pipes for fiscal fourth quarter and, you know, the health that, I guess, you know, underlined the confidence to give that strong billings guidance for the fiscal year? Thank you.

Yeah, I'll start it. You know, Jay, if you'd like to contribute anything. Sure. We have a strong pipeline. As we talked about, we're becoming more strategic. Our deal sizes are getting bigger. We review our pipeline with our sales organization. And based on our projections, we did give a strong guide, Patrick, which is basically up 6%, basically guide up. The key thing is that with the world that's changed, with, you know, it's been this way for a while with applications in the cloud and users are mobile and workloads, you know, both in the cloud and on-prem and, you know, other locations. Platform that Zscaler created really addresses this market head-on. Also, you know, the efficiency that we create, you know, for customers at a very attractive ROI, it's really what stands out. And so, We're seeing, you know, with large customers, you know, adopting more of the platform, as Jay has talked about, we're seeing that. So, you know, it's just basically review the pipeline and review what we feel we're comfortable to guide to.

Yes, so I think what Remo said, our projections always take into account our pipeline, our customer engagements, but at a qualitative level. As I talk to lots and lots of CIOs and CISOs, I mean, there is a sense of uncertainty out there. And they're beginning to think about, how do I do my cost and complexity reduction, my consolidation? And that's where we start becoming pretty important. And for that, customers are driving transformation. We help them with it. On top of that, cyber is a big issue. So when you bring all these things together, we become more important for them, and they start that discussion with, Jay, what all security products and networking products can I replace with you? And now we are able to actually talk about a bigger set of products that need to be removed, which actually leads to a bigger part of the platform to be bought. Now, on top of that, It's interesting to see suddenly on the high-flying private startup companies, which would talk about all kinds of hiring, how many employees, all this stuff is getting tempered down. That means the unnecessary noise in the market is expected to slow down. And it's fascinating to see people calling us from those startups already. So we are bullish about the business.

Excellent stuff. Thank you so much.

Thank you. Up next, we have Joel Fishbein of Truist. Your line is open.

Thank you, and I'll echo the congrats on the great execution this quarter. Jay, I just want to ask about workload segmentation. It sounds like you're very – I know it's early days. You're very excited about it and have some good uptake. I'm really interested in, you know, go-to-market around workload segmentation and actually IoT and OT segments. It doesn't seem like, you know, they're natural, you know, they have different buying centers inside of organizations than ZIA and ZPA and ZDX. Love to hear how you're going to plan to go to market there and, you know, increase deal sizes around, you know, those specific areas.

Very good question. You know, in Q2, we talked about how a number of our large customers are beginning to buy workloads. our zero trust of workloads, but at a small scale. This last quarter, we start to see them actually buying some very large orders in this area. So that's very encouraging. Now, in terms of the buyer and the products, the cloud protection products can be put in two broad buckets. One, what Gartner now calls CNAP, is a collection of CSPM, CI type of stuff. It's API-based security. It's a new area for everyone. It's simpler to build, and we have a very good offering in that space. We have revamped our CNAP offering, which we'll be launching at CNAP Live next month. And parallel with that is Zero Trust Workload, which is taking ZI and CPA technology and making it available for workloads because workloads need to talk to internet that goes through ZI engine They need to talk to each other, which goes to ZPA engine. This is bringing zero trust to workloads. Bringing the two together, inline piece of it and API piece of it, sets us apart from any other vendor in the market out there. Regarding buying centers, if you really look at it, if we were selling at a lower level, buying will be very different. No matter who buys the product, when it comes to security part, CISO is definitely involved. So our good relationships, CISO, are helping us with zero trust for workload and cloud protection. Our relationship with head of networking are helping us because in the old world, you are extending your data center to cloud with all these dedicated links out there. The area we are developing and building more relationship is the DevOps side of it. But since CISO relations are strong, it is helping us. We are not creating an overlay team, but we do have product specialists. You need overlay teams when you're selling point products at a low level. When we have been selling platform at a high level, I don't need overlay teams. I do need product specialists, which we are hiring who work with our broad sales team. Get a help.

Very much. Thank you so much.

Thank you. And next we have Fatima Boulani of Citi. Your line is open.

Good afternoon. Thank you for taking my questions. Remo, this one's for you. You know, in Jay's script, a lot of anecdotes around the multi-land transactions in the eight-figure deal, momentum in the million-dollar customer momentum, So what I wanted to ask you was just from a booking standpoint, I think you've called out that you are seeing bigger multi-year commitments from some of your customers. So we're certainly not seeing that impact on billings in terms of your invoicing duration. But I'm curious if you can comment or share any sort of observations on your backlog and if there's any duration impact in there that we should be thinking about more critically. Thank you.

Yeah, that's a great question. You know, if you take a look at our RPO and CRPO growth, you know, on a year-over-year basis, those are committed. Those are committed deals. Our RPO growth was 83%, and our CRPO growth was 75%. You know, related to duration, you know, the duration was comparable on a year-over-year basis. There was no headwinds. We expect, you know, duration to be in that 10- to 14-month range. So, I mean, the key things from billings, Billings is calculated billings, which is calculated off of deferred revenue. So that's what we actually bill. But we look at the RPO and CRPO growth rates. You know, RPO is 83% and CRPO is 75%, you know, growth rate, you know, on a year-over-year basis. Now, having said that, you know, even though those metrics are outstanding, we still feel that, you know, billings is the best measure, you know, for Z-scale it. Because we found that duration period from 10 to 14 months. So I hope that answers your question. I believe that answers your question. But the actual commitment that customers are making to Zscaler is quite impressive.

Fatima, if I may add one thing, this is an outstanding quarter from lots of customers doing multi-product dealer deals for multi-years. which is very exciting.

Very clear. Thank you, gentlemen.

Thank you. Next question comes from Bill Bolin of Cleveland Research. Your line is open.

Good afternoon, everyone. Thank you for taking the question. I wanted to go back to the topic around cloud marketplaces. Rima, can you quantify how much of the business is being transacted over cloud marketplaces today or how that has evolved? And then I'm also interested in any ways we should think about the margin implications of that business versus other sales channels. Thanks.

Yeah, I mean, not much business currently going through cloud new marketplace. There is business going through, but we see that as a very important channel for us. And related to margin, we expect good margins through cloud marketplaces. Jay, do you want to? Yeah.

But one thing, though, business through cloud marketplaces has been steadily growing over time. So that is very good. See, for us, I don't think the driver is what's the fulfillment channel for us. I personally care about partners who actually help me with strategic sales to the customers. When Microsoft's account exec and Zscaler account execs are able to sit together with the CIO and talk through a large deal, it is extremely useful. But it does help to get the cloud hyperscalers sales team more engaged because they actually do compensate it for the business that flows through the cloud marketplace. So we actually are... putting more focus on training AWS and Microsoft sales team, so which helps them and helps us.

Thank you.

Thank you. And next we have Tal Liani of Bank of America. Your line is open.

Hi, guys. I have two questions. One, in general, I get this question a lot from investors. I'm trying to understand economic slowdown. What's the impact on your business? It's a little bit of a philosophical question, but it's a question we're being asked a lot, and I would like to hear your view on this topic. And second, we are at times of focus on cash flow and margins, and I look at your operating margin. In the last four quarters, It went down from 13% to 8.7% the previous quarter. This quarter slightly recovered. And at the same time, your revenues went up by 50%, give or take. So we don't see much leverage on the margin. And the question is, if I fast forward two to three years, if I think about margin leverage and what needs to happen for you to have serious margin upside. Can you talk about the pros and cons of your operating margin? Thanks.

I'll start with that. We actually do have leverage in the model. In a SAS model with 80% gross margin, growing at the scale that we're growing, we actually have leverage. What we talked about is that with this large market opportunity, it would be a disservice to our shareholders and our employees if we tried to drive top-line operating profitability at this stage. Having said that, when you take a look at our free cash flow margin, last year it was around 20% or over 20%. And we're projecting free cash flow margin this year at 20%. So when you have that kind of, you know, free cash flow margin, at the scale that we are, making the investments that we're making, in the position that we are as a company, in this very large market, there's no better use of our cash or our resources than investing in the business and really executing and trying to drive our top line growth. Having said that, we will be mindful. We will be mindful. If we wanted to drive operating profitability, it doesn't take much. But with our free cash flow margin where it is, we're very, very comfortable. Now, from an economic slowdown perspective, security is important. Companies basically are not going to – the attacks are going to keep coming, and they're probably going to increase. Also, companies going through this downturn have to find areas to save money. We are efficient. Our ROI is absolutely outstanding. It is significant ROI with the highest level security down to the deepest level. So from an economic slowdown perspective, we are not seeing it currently. Now, can that change? It can. But right now, based on our pipeline, based on what we're seeing, and what we talked about, we're going to continue to hire at pace. Jay and I, as I mentioned before, have a lot of experience. We've seen the three downturns, three or four downturns, actually, in our lifetime, our careers. Zscaler is different, and we feel we're in a great position. We will take things into account, all things, and driving operating profitability at this stage. We will increase operating profitability as we go. but we're going to be also trying to drive that top line growth. Jay? Two quick comments.

First of all, I do believe this uncertainty is helping us because we are going to help customers with cost reduction and complexity reduction. And on the other side, you know, our flagship ZIS EPA products, they have reached significant scale and are generating good margins. But we are reinvesting that drive the growth of new products. We have proven that when we brought ZPA on, we made it successful. We've seen we brought ZDX on, we're making it successful. It's growing even faster than ZPA did. And we have high expectations from workload protection as well. So I think with such a large platform, we expect that we'll keep on growing fairly efficiently.

Got it. Thank you.

Thank you. Our next question comes from Roger Boyd of USB Securities. Your line is open.

Hey, thanks. Thanks for the question and congrats on the results. Just a quick question on SD-WAN. Historically, you've had some success tied to adoption there. I know Zscaler is agnostic to how customers ultimately onboard to the Zero Trust Exchange, but With some of the SD-WAN vendors facing some disruption, share losses, and potential change of ownership, how do you think about those changes in terms of potential opportunities or risks?

Yeah, you know, before COVID came in, these guys used to start with, hmm, let's do network transformation. When COVID started two and a half years ago, SD-WAN went out the door. There was nobody working the branch offices. And customers start to roll out Zscaler by downloading a lightweight agent, and here it goes. So with that, the role of any network or SD-WAN became really insignificant. Today, most of our customers roll it out on laptop, mobile, with a lightweight agent. They can work from home. They can work from office with SD-WAN, without SD-WAN. So we'll stay neutral to supporting SD-WAN vendors our sales processes are no longer led by SD-WAN. If a customer says, I'm rolling on SD-WAN, we are generally the preferred choice, and that's how we see it. So we don't really see any changes in the SD-WAN marketplace impacting us.

Got it. Thank you. Thank you. Our next question comes from Joshua Tilton of Wolf Research. Your line is open.

Hey, guys. Thanks for taking my question here. I don't believe you mentioned it in the prepared remarks, but can you talk about any impact to the business you're seeing, either positive or negative, from the Russia-Ukraine crisis?

Yeah, Russia-Ukraine, it was a bigger thing a quarter ago. You know, I decided years ago not to sell in Russia. Hence, we do not have any revenue exposure in Russia or Ukraine. But cybersecurity is a global threat. It's not a regional threat. Our threat research team is tracking heightened cyber threat environments, which is making every CIO and CISO more nervous in this area. So this is driving the adoption of zero-trust architecture, and it is increasing our engagement with customers, more so in Europe. Actually, European customers are more worried about it, while Americans are too. So we have some very large deals in Europe this quarter, including a couple of them I highlighted. We don't really see any negative impact of this conflict, and we remain engaged with our customers to drive the transformation. They want to become agile, competitive. We play a role there. And then cyber on top of that. So don't see any negative impact.

Thank you very much.

Thank you. The next question shall come from Rob Owens of Piper Sandler. Your line is open.

Great. Thanks for taking my question. I wonder if you guys could drill into the Siemens partnership a little bit. And I guess, Jay, more broadly, what you see as the opportunity in OT from where you sit? Thanks. Thanks.

You know, OT plants and factories have been slow in changing. Typically, plants take their own time, but all these critical infrastructure attacks and some of that have made it a priority. Vendors like Siemens are big providers of OT systems out there. They see this as an opportunity for really providing, or should I say, taking firewall and VPN-based security of OT systems to zero trust-based security, where you no longer connect these OT networks and IT networks, where you no longer need remote VPN to access these systems. So Siemens has worked with us over the last year or so. They essentially chose us as a partner. We did joint development where we made our technology available on their hardened OT systems, and this combined solution of Siemens and ours is now available to our customers out there. I think it's a good opportunity for us. I think it's a matter of time, but all IoT OT systems will embrace zero trust, and we are positioned well for that opportunity.

All right, thanks.

Thank you. And this concludes today's Q&A session. I shall turn the conference back over to your CEO, Jay Chowdhury, for closing remarks.

Thank you. I want to thank you all for your continued interest in Zscaler. I also want to thank Zscaler employees, customers, and partners for delivering a strong portal. We look forward to seeing many of you at Zenith Live, our annual cloud summit. Thank you. Thank you.

This concludes today's conference call. Goodbye. Thank you all for participating. You may disconnect and have a pleasant day.