Zscaler, Inc.

Welcome to the Z-scale of fourth quarter and fiscal year-end earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentations, there will be a question-and-answer session. To ask a question at that time, please press star-one-one on your touch-tone telephone. As a reminder, today's conference call is being recorded. I will now turn the conference over to your host, Mr. Bill Choi, Senior Vice President of Investor Relations and Strategic Finance. Sir, you may begin.

Good afternoon, everyone, and welcome to the Zscaler Fiscal Fourth Quarter and Full Year 2022 Earnings Conference Call. On the call with me today are Jay Chowdhury, Chairman and CEO, and Remo Canessa, CFO. 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 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 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. I would also like to inform you that we'll be attending the following upcoming events in September. Goldman Sachs Communicopia and Technology Conference on September 13th. Missoula Software Summit on September 28th. Now I'll turn the call over to Jay.

Thank you, Bill. I'm very pleased to share our strong Q4 results to end another outstanding year. In the quarter, we delivered 61% revenue growth and 57% billings growth as customers continue to embrace our Zero Trust Exchange platform to secure their digital transformation. We are delivering this strong growth while generating strong profitability. Our free cash flow margin was 24%, which was a record for Q4. While many public SaaS companies are happy to get to rule of 40, we surpassed the rule of 80 for the quarter and for the full year. These outstanding results reflect the strong underlying unit economics of our business that has high 90% growth retention rate and over 80% gross margins. This is possible because of our differentiated service and purpose-built multi-tenant cloud platform that scales efficiently. For the full year, our revenue grew 62% to $1.1 billion and billings grew 59% to $1.5 billion. We're seeing revenue growth across all products industry verticals, market segments, and geographies. Our platform is securing over 34 million users for over 6,700 customers, and we are making great progress towards our goal of protecting 200 million users. To reach our goal, we will continue to invest aggressively in growing our business and driving innovation. while focusing on operational efficiencies to drive the bottom line. Let me share with you some of my observations and how we plan to manage through the uncertain macro environment in fiscal 23. First, my conversations with hundreds of IT executives confirm that cybersecurity remains the number one IT priority and a top board level issue. Independent CIO surveys confirm zero trust security and SASE will continue to be a top priority. Zscaler's proxy-based cloud platform is the best solution for tackling sophisticated cybersecurity challenges. In addition, the rise of hybrid work and the need for secure digital transformation are driving the demand for Zscaler. We believe periods of macro uncertainty can accelerate adoption of disruptive technologies like ours, which offer better security and user experience while substantially reducing cost and IT complexity. As the pioneer and recognized leader in security service edge, we are well positioned to capture this ongoing market shift towards zero trust. second we address a 72 billion dollar market with significant new customer and upsell opportunities our superior architecture and proven experience delivering measurable outcomes at the cxo level elevate us above the competitive noise we drove 62 year-over-year growth in customers with greater than 1 million dollars in arr ending with over 320 of these customers, including over 20 customers exceeding $5 million in ARR. We have a blueprint for delivering great value, which drives strong upsell for us. Approximately 60% of our new business comes from existing customers, and our net retention rate has again exceeded 125% now for seven consecutive quarters. Happy customers buy more. And our net promoter score continues to exceed 70, which is more than two times the average NPS for SaaS companies. In addition, we expect our deep and wide platform together with our enviable customer base of large enterprises to continue to drive upsells As we have indicated before, we have a six times upsell opportunity with our existing customers just for our core ZIA and ZPA product pillars. Lastly, our concertative sales process plays a major role in our success and enables us to maintain a high level of engagement with our customers, especially at the C-level. As part of this process, we produced CFO-ready business cases with ROI and payback periods calculated in collaboration with our customers. In Q4, as we saw more deals getting scrutinized, we delivered more of these business value assessments, which helped us close many large multi-year, multi-product pillar deals. We believe our adaptive sales process makes us resilient to changing business environment and will continue to drive our business. Looking forward, I'm excited about fiscal 23 as we continue to win opportunities with new and existing customers. Increasingly, customers are buying ZIA, ZPA, and ZDX together to deliver a complete zero-trust solution for users. This accelerates our customers' transformation journey and makes us a critical partner for them. Let me discuss two such deals in Q4. In a new logo win, A Fortune 50 pharmaceutical company purchased ZIS, ZPA, and ZDX for all 145,000 employees. This deal started with a regional need to improve security without compromising user experience in China. With multiple data centers in China covering various regions with premium connectivity options, Zscaler has superior zero-trust access for multinationals out of China. Next, this customer engaged us for global M&A IT integration and hybrid work use cases. Impressed with these results, they accelerated the company-wide zero trust adoption with us. They disqualified the incumbent next-gen firewall vendor who had no referenceable customer at the required scale for its SASE cloud VPN product. This customer understands that a VPN, either as an appliance or hosted in the cloud under any name, is not zero trust and is the biggest security risk. This customer also purchased Zscaler for workloads for 10,000 workloads to enable multi-cloud app-to-app connectivity to support their M&A strategy. This was the three-year eight-figure deal for all four pillars of our platform, ZI, ZPA, ZDX, and Zscaler for workloads, or what we use to call cloud protection. We closed this deal with AWS Marketplace, which is becoming a larger channel for us. Next, one of our largest deals in the quarter came from a delighted Fortune 500 tech customer who deployed the entire Zscaler for users offering, including ZIA, ZPA, and ZDX. This provided fast and direct access for users working from anywhere to applications in the data center or in the cloud. With dramatic improvements in user experience, employees were buzzing about the change. One employee slacked, and I could. Every morning, I log into my machine. I'm thankful for Zscaler. This customer doubled their seats to 120,000 users and extended the commitment for another three years. The journey with us started with a small M&A IT integration use case, which quickly expanded into a company-wide zero trust initiative. In less than two years, this customer's annual spend with Zscaler grew 13x to well over $10 million. Next, from a product perspective, we saw strong performance across all pillars of our platform. Our core pillars, ZIA and ZPA, have never been stronger, and we are excited about the rapid adoption of our emerging products, ZDX to manage digital user experience, and Zscaler for workloads to secure servers and workloads. Emerging products contributed 14% of our new business in fiscal 22, and we expect continued growth in fiscal 23. We continue to innovate rapidly and expand our platform. At our Zenith Live conference in June, we launched Posture Control for Public Clouds as a fully integrated solution that correlates vulnerabilities and risks across CSPM, CIEM, and infrastructure as code scanning. In addition, we integrated our recently acquired deception technology into our platform and saw great adoption by our customers. This is an example of a highly targeted early stage acquisition strategy, shortening our time to market for new innovations and expanding our market opportunity. Let me highlight three deals that are driven by our emerging products. We won a seven-figure ACB with a government agency in Australia for ZIA, ZPA, and ZDX, with ZDX accounted for approximately $1 million of the total ACB value. ZDX pinpoints and resolves performance issues in real time. by monitoring experience of every user, every network hub, and every application regardless of their location. The customer said ZDX is a must-have as it delivered immediate value by reducing troubleshooting time and improving employee productivity. In a seven-figure ACB upsell win, a Fortune 50 insurance company purchased ZPA Transformation Bundle for Zero Trust Access to implement user-to-app segmentation. This customer understands that if a user connects to the network with an on-prem or cloud VPN, that's not Zero Trust. With this latest purchase, they plan to replace the legacy network security, including VPN, network access control or NAC, network-based segmentation, and VDI infrastructure. They purchased Zscaler Deception to detect and intercept bad actors trying to infiltrate the network. Finally, a global 500 financial services customer in APJ purchased Zscaler for workloads for 36,000 workloads to complement the CI and CPS service for users. With many apps running in AWS and Azure, they wanted to implement a zero trust architecture to prevent lateral threat movement and eliminate backhauling workload traffic through the data center for inspection. We reduced cost and complexity by eliminating the need for virtual firewalls and site-to-site VPN networks while improving security and operational efficiency. Next, let me discuss the progress we're making in federal vertical. We now have FedRAMP high authorization for ZIA, which together with ZPA makes us the only cloud security service to have two products at the highest level of FedRAMP certification. In addition, ZPA is the only zero-trust solution with DoD IL-5 certification. These certifications are driving our federal business. In Q4, we added over 25 new federal customers, and over half of them purchased ZIA and ZPA together. We have landed 10 of the 15 cabinet-level agencies as customers with plenty of opportunities for upsell at these large organizations. I want to highlight one federal deal that I am particularly excited about. We were awarded a five-year, $46 million contract by a large cabinet agency with over 100,000 users. The value of this contract will be granted over time based on deployment. Against this award, we received an initial low seven-figure ACB task order for ZIA and ZPA. Next, let me comment on the increased leverage we are driving with our channel programs. We saw over 50% year-over-year growth in channel source deal registrations. Working closely with our cloud-centric VAR partners, we are building momentum down market in the enterprise and commercial segments, which is providing higher contribution to our new business. At RSA conference, you heard a key partner, Optip, talk about the plan to grow with us and further invest in Zscaler certifications for their consultants. I'm also excited about the opportunities we can unlock together with the global SIs that are building large zero trust and SASE transformation practices. Moving to cloud marketplaces. This channel is growing very well for us. We have made strategic investments in our collaboration with AWS and Azure, including deep technology integrations co-selling opportunities, and demand generation programs. In Q4, our new business through cloud marketplaces grew nearly 5x year over year. For example, we signed five greater than $1 million deals through the AWS marketplace, including two of our top five new and upsell deals of the quarter. Our strengthening Azure and AWS partnerships also give us access to their customers' sizable cloud budgets, which can streamline the deal close process. I want to highlight another important area for our customers, their ESG goals. Our highly efficient cloud eliminates the need for on-prem appliances, which significantly decreases IT waste, energy uses, and carbon emissions. We are also committed to our own ESG goals. Since achieving 100% renewable energy last year, we are proud to be carbon neutral for calendar 22, covering relevant scope one, two, and three categories including travel, customer use, public cloud use, and procurement. I'm excited to announce our goal to be net zero by 2025, joining our customers in a collective effort to transition to a low-carbon economy. In closing, even with uncertain macro conditions, We continue to see favorable demand for our zero trust exchange platform, which makes businesses more agile and competitive, simplifies IT, consolidates point products, and reduces cost. We believe customers trust Zscaler more than any other provider for securing their cloud journey. We have grown our global team to approximately 5000 employees who share a mission to secure the hyper connected world of cloud and mobility. I'm extremely proud of the strong growth and profitability we delivered in 2022. I want to thank our employees and our partners. for their tireless efforts and commitment to our customers' success. We will continue to invest aggressively to delight our customers and capture the large opportunity ahead of us while delivering operational excellence. Now, I'd like to turn over the call to Remo for our financial results.

Thank you, Jay. We're pleased with the results for the fourth quarter and full year. Revenue for the quarter was $318 million, up 61% year over year, and up 11% sequentially. VPA product revenue was approximately 19% of total revenue, growing 80% year over year. From a geographic perspective, we had broad strength across our three major regions. America's represented 52% of revenue, EMEA was 33% and APJ was 15%. APJ continues to be our fastest growing region with revenue growth of 88% year over year. For the full year, revenue was $1.09 billion, up 62% year over year. This is an acceleration from the 56% growth we delivered in fiscal 2021. Our total calculated billings in Q4 grew 57% year over year to $520 million, with billing duration comparable to a year ago and slightly above the midpoint of our normal 10 to 14 months range. We saw strong growth in our top five verticals, finance, manufacturing, healthcare, technology, and services. Our remaining performance obligation, or RPO, grew 68% from one year ago to $2.607 billion. The current RPO is 49% of the total RPO. As a point of clarification, the total contract value of the five-year $46 million award from a US federal government agency that Jay mentioned is not included in our RPO. RPO for this contract will be recognized as the individual task orders are received. which are 12 months in term length, as is typical for our federal customers. Moving on to our product pillars, for the full year, emerging products, which include ZDX and Zscaler for Workloads, or what we used to call cloud protection, met our targets and contributed 14% to our total new business. Including our new CNAP and deception offering is the Zscaler for Workloads pillar, We expect emerging products to contribute high teen percentage of our total new business in fiscal 2023. ZPA was 27% of our total new business in fiscal 2022 and grew as a mix between the two core ZIA and ZPA pillars. We have a large opportunity in all our pillars and we will continue to innovate and expand our portfolio to strengthen our leadership position in the zero trust security market. Our strong customer retention rate and our ability to upsell the broader platform have resulted in a high dollar base net retention rate, which is again above 125% for the last seven quarters. We have a strong base of large enterprise customers, which provides us with a significant opportunity to upsell our broader platform. We had 327 customers paying us more than a million dollars annually, up 62% from 202 in the prior year. The continued strength of this metric speaks to our large enterprise focus and strategic role we play in our customers' digital transformation initiatives. We added 198 customers in the quarter, paying us more than $100,000 annually and in the year at 2,089 such customers. Expanding our field engagement with small enterprises with 2,000 to 6,000 employees and the increased investments in our Summit Partner Program are contributing to our overall customer growth. Turning to the rest of our Q4 financial performance, total gross margin of 81.6% was up nearly one percentage point quarter over quarter and year over year. Our total operating expenses increased 8% sequentially and 60% year over year to $221 million. Operating margin was 12% and free cash flow margin was 24%. We continue to expect data center CapEx to be around the high single digit percent of revenue for the full year. We know the quarter with over $1.73 billion in cash, cash equivalents, and short-term investments. Before providing our guidance, I would like to share a few thoughts about the framework for our business outlook in the current environment. Zscaler is operating from a position of strength. We are entering this fiscal year with a record pipeline and a large set of customer opportunities. We have confidence in the durability of our business model with very high contribution margins after the initial lamb and proven ability to retain and upsell to our enterprise customer base. With customers increasingly adopting the broader platform with long-term commitments, we plan to continue to invest in capturing our large market opportunity. As Jay mentioned, there was more deal scrutiny at the end of Q4 which resulted in business being more backend loaded. We think it's prudent to expect this higher level of review and scrutiny by our customers to continue given the uncertain macroeconomic outlook. While demand for the Zscaler platform remains very strong, if the business environment changes, our business model allows us to adapt quickly and to deliver on our operating profit and margin goals. In fiscal 23, in our guidance, we intend to deliver operating margin expansion of approximately 150 basis points. 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 and amortization of intangible assets. For the first quarter of fiscal 2023, we expect revenue in the range of $339 million to $341 million, reflecting a year-over-year growth of 47% to 48%. Gross margins of approximately 80%. I would like to remind investors that the number of our merchant products 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 $37 to $38 million, net other income of $5 million, income taxes of $2.5 million, earnings per share of approximately 26 cents, assuming 155 million fully diluted shares. Please note that starting in fiscal 2023, we adopted the new accounting standard, which requires the use of if converted method for calculating EPS. To account for our convertible notes, You will need to add back $360,000 in quarterly interest expense and include 7.63 million shares to the fully diluted share count. For the full year fiscal 2023, we expect revenue in the range of $1.49 billion to $1.5 billion, or year-over-year growth of approximately 37%. Calculated billings in the range of $1.92 billion to $1.94 billion or year-over-year growth of 30 to 31%. While we don't normally guide to quarterly billings, I want to remind you that we will have a difficult year-over-year comparison in Q1. In the year-ago quarter, we had a one-off deal and multi-year invoices in Q1. In the year-ago quarter, we had a one-off deal and multi-year invoices that resulted in billing duration at the high end of our normal 10 to 14 months range. With that in mind, we expect Q1 23 billings to grow approximately 30% year over year. We also expect our first half mix to be approximately 42% to 43% of our full year billings guide, which is higher than the first half mix in the last few years. Operating profit in the range of $173 to $176 million. Income taxes of $14 million. Earnings per share in the range of $1.16 to $1.18. assuming approximately 157 million fully diluted shares. As noted earlier, to account for convertible notes in EPS, you will need to add back $1.44 million in annual interest expense and include 7.63 million shares to the fully diluted share count. Let me conclude with comments on our investment framework. We'll balance growth and profitability based on how our business is growing. If we continue to have high growth, we'll prioritize investing in the business. As we have discussed, if we're growing revenue faster than 30%, you can expect less than 300 basis points of margin expansion in the year. We remain confident of reaching 20 to 22% operating margins in the long term. With a huge market opportunity and customers increasingly adopting the broader platform, we're committed to investing aggressively in our company while balancing this with our operating profit goals. However, if we see a deteriorating global economic environment, we have the flexibility to place a higher priority on operating profitability. Operator, you may now open the call for questions.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star 1-1 on your touchtone telephone. Again, to ask a question, please press star 1-1. We do ask that you please limit yourself to one question to allow everyone to get a question in. Thank you. Our first question comes from Andrew Nowinski of Wells Fargo. Your line is open.

A lot of interesting data points, I guess, but I'll start with the big Fed deal. It doesn't sound like it contributed maybe any revenue in Q4, given that it's not an RPO yet, but wanted to clarify that. And I'd imagine a deal that size was likely competitive. So just wondering if you could discuss, you know, which vendors you beat in that deal. And then finally, given the upcoming fiscal year end with the Fed, how does the remaining pipeline in the Fed look this quarter, given the strong results you just put up? Thanks.

I'll take the first part, Andy. You're absolutely right. There's not much revenue in the quarter for that large deal. But your call-out also that's not in the RPO is a great call-out also, which is what we've been talking about with RPO growth. It's better for Zscaler to look at billings growth because that entire $46 million, or almost all that $46 million, is not in RPO. Now I'll turn it over to Jay.

Good. The deals, the nature, the competitiveness, you can imagine that almost all federal deals need to go through a very competitive process. And all the obvious names you would expect for all competing, all legacy vendors, network security, firewalls, and the like, they all competed for it. But it was the architecture that won at the end of the day. We are excited about it, but as you know, some of these federal deals take time. we do have 10 of the 15 Cabinet-level agencies that are customers. And there's a lot of opportunity for us in the federal market.

That's great. Thank you so much.

Thank you. Our next question comes from Brad Zelnick of Deutsche Bank. Your line is open.

Guys, on a fantastic end and unbelievable execution against a tough environment, which leads to my question. Jay, I think it's well understood that security and connectivity are essential non-discretionary budget items for customers, but two related questions. One, it would seem in tougher times it's more difficult to land new logo customers, and I'm curious if that's true for Zscaler and how you mitigate that. And just related, is there any shift that you're seeing in terms of where the budget is coming from for customers to fund their network and IT transformation initiatives? Thanks.

Thanks, Brad. It is true that it takes more time and effort to land new logos, especially when your current customers are very happy and delighted. That's why our business is coming from both sides, expansion and new logos. And what are we trying to do to get new logos in current markets? I'll tell you one very exciting thing, which is very unusual. A big source of new logos for us is when CXOs who frequently move from company A to company B, they often call us. I mean, I can tell you I've personally seen probably well over a few hundred tests. The CXOs went, they called us, and once they do the discussion, the conversation goes a lot faster. In addition, we are doing a lot of demand gen programs. A lot of demand gen programs are doing the alpha channel partners and the like are largely focused on new logos because we want to do both new logos as well as upsell. Both are important for us. Second part of your question is where the budget is coming from to fund. Yes, we are driving transformation, but the nature of our transformation has been changed. First of all, before COVID, network transformation used to be a big problem. COVID killed all of that discussion and said internet is the corporate network. So network transformation evangelism has gone away. It's mainstreamed that you should be able to go and work for many people. Now, where is the budget coming from? Number one thing CIOs and CFOs are asking now is, please help me eliminate a lot of point products. Help me save money. So cost reduction by elimination is a big thing, and especially a platform provider like ZSkiller, which can eliminate lots of products. We actually end up showing good ROI and, in the process, getting a bigger budget sale. That's one part. The second part is I highlighted in my previous remarks that marketplace vendors are helping us. Some of these large deals are actually coming out of the hyperscaler budgets because their revenues already commit for them. And it is true that customers are asking for better business value quantification, and that's what we're doing with a very mature business value process. That's why it's seen us do very well in spite of increased growth.

Fantastic. Thank you so much and congrats again, guys. Thank you.

Thank you.

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

I think back at your, you know, Zenith Live event, you talked about conditions such that, yes, there may be some stretching of duration, but that in turn is resulting in a higher adoption rate, mainly because you're able to help them lower costs and lower the amount of employees they need to run their operations, as well as eliminating the point products. So as the conditions have tightened further over the last month and a half, Have you seen an increased win rate and some larger deal sizes as a result of that ability to help companies significantly diminish their staffing and cost requirements?

We have actually many, many customers who have publicly stated in our conferences that the number of resources needed to run or operate Zscaler service. It's much lower. Often it's kind of specified as a fifth of what it takes to run appliance companies, firewall companies, and the like. So that's part of the operational cost that you talk about. There are four pieces of cost that customer looks at from reduction from Zscaler. Operational is obviously one part of it. Cost savings from elimination of point products. is an important area. You won't believe how many security products are sitting at any large enterprises. And one CISO called it appliance fatigue. Third area is improved business productivity, which is linked to user experience. It is interesting as users are working from everywhere, accessing very critical information out in the cloud. Users are very, how should I say, intolerant of any slowness and slow experience. And fourth thing is risk reduction. It's hard to quantify risk, but our customers are looking and saying, what's the cost of breach? What's the cost of downtime and the like? So we have always had a good business value assessment process. It has sharpened. And also when we work with C-level and the C-level becomes sponsor of the process, it helps us show them savings and it helps us get our deal done.

The question, just to be clear, was has there been a change in that environment that has then amplified the benefit of those four factors?

Yes. I think that probably the direct answer would be there is more and more need to do a strong assessment, quantification, and commitment to delivering those results. Absolutely, yes.

Okay, brilliant, Corda. Thanks for the answer.

Thank you. Our next question comes from Joel Fishbein of Truist. Your line is open.

Great question, and congrats on the great execution. Remo, just one question, two parts. Great outperformance on the gross margin side of the business. Want to understand what the drivers of leverage going forward will be. I know you gave us a little bit of color into FY23. And then also, you know, $1.7 billion in cash. What's the best use of cash at this point in the evolution?

Yeah, I mean, good questions. So the outperformance in gross margin in Q4, we did 81.6%. Basically, it's the efficiency that we've created with our software optimization. It's just overall lower cost, bandwidth cost, co-low cost depreciation, as well as the outperformance on the top line. Those are the primary reasons. Key thing to recognize with our gross margin, we have the ability to come out with applications faster by putting basically applications in public cloud. We will continue to do that. Again, from our perspective, you know, we are going to deliver the best product as quickly as we can to our customers. And our gross margin, we expect, you know, in fiscal 23 and also the midterm is 80%. From a long-term perspective, we expect gross margins between 78% and 82%. So as long as we're within that bound, you know, it just gives tremendous flexibility from a modeling perspective for Zscaler because we have such high gross margins with high growth to invest in the business. From a perspective of the $1.7 billion in cash, really no plans for that. It'll be used for strategic purposes. We clearly don't need it for working capital as our free cash flow last year was significant. And also from a free cash flow perspective in fiscal 23, I'd expect free cash flow margin to be 20% or above. So really just for strategic purposes is best cash flow.

Thank you.

Thank you.

Thank you. Our next question comes from John Davucci of Guggenheim. Your line is open.

My question is sort of a high level question. It goes back to Brad's a little bit. And it's on the macro environment, which which no one really escapes. And it's good to hear you acknowledge it, even though you really don't see it in your financial results. Your new ACV per hour calculations accelerated against the more difficult comp and your guidance implies some confidence in future, right? So, but you kind of talked about how you think about the macro softness and why it's not affecting your business right now. But I think this is probably for Remo. how did you think about it or how is it implied in your annual guidance if at all like in any this softness or whether it can get worse other than i mean you did mention businesses being more back and loaded and that was sort of assumed but but you've closed it anyway it's just back and loaded is there is there any any other color you can give us no i i mean i think it's a great question i think it's one of the key questions and you know thank you for asking it um you know we did see higher deal scrutiny uh in q4 so that that played into our guidance and that higher deal scrutiny you know related mostly to you know large multi-year multi you know product pillar type deals you know as you mentioned john you know not a significant impact you know on our business um and you know for from our perspective when we took a look at you know our guidance You know, many customers, you know, have not put their budgets in place for calendar 23. That will happen, you know, in a few months, you know, or a couple quarters. So that does create a level of uncertainty in the second half of our fiscal 23. So we took a look at all those factors in consideration, you know, when we did our guidance, and that is the reason that we guided for, you know, a higher contribution rate in the first half of our billings, between 42% and 43%. And that compares to last year, which was 41.5%. So, you know, a lot of thought went into, you know, the guidance. You know, we feel it's prudent. And also, you know, again, you know, we're recognizing that the second half of our fiscal year, you know, we don't have as good a visibility. And that's why, you know, we have better visibility in the first half.

And if I may add two things, Tom. If I may add two things I've done to make sure we do a good job. One is we are working more closely with our customers to identify what needs to go on, what needs to change from savings point of view. We are a lot more focused on helping customers save money because CIO is asking us, what can you do to save money? I have a lot of legacy debt products. Please help. So our sales process is focused more on that than it used to be before. That's one point. And the second, we alluded to it, but the business value assessment needs to be much sharper now than it used to be.

Okay. Thank you very much, guys. That makes a ton of sense. Thank you. Great.

Thank you.

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

quarter just to touch on the cloud marketplaces. It seems for a couple of quarters now you've highlighted the momentum with AWS and Azure, but 5X growth really stuck up this quarter. Any sense for how big of a channel that is for Zscaler today and how big that could get given it seems like a win-win for customers, VARs and ISCs like yourself. Thanks.

Yeah, I'll, I'll start then I'll have, you know, Jay, you know, still relatively early. It's still relatively a small part of our business, but the cloud marketplace is increasing, and we do see it as a very important and strategic basically channel for us. So with that, I'll turn it over to Jay.

Yeah. It becomes a new channel of revenue for us. Let me put it this way. Probably in the past three years, it has gone from nothing to pretty significant, and that's why From a small base, the numbers are looking big, but those big providers are now working with us and co-selling to generate net view pipeline for us. That's good. The other part that's helping us, it's kind of interesting, is some of these budgets are committed for hyperscalers on annual basis. And our solutions qualify to be come out of those budgets. That becomes one more justification with a little bit easier budget approval becomes one more area for us. We are dedicating resources.

We are making investment in this channel to become bigger. Great, Connor. Thank you.

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

Thank you very much, and congratulations on the strong results. Kay, I just wanted to get your thoughts. Just given the economic uncertainty and increased deal scrutiny, You know, given Zscaler's value proposition, you know, why wouldn't this year be a year you even accelerate share gains in the market? Or alternatively, are you just seeing customers, given the uncertainty, just tighten budgets and sticking with what they currently have?

I mean, that's what I tell Remo. Come on, let's be more aggressive.

You know, it's a great question. You know, we'll have to wait and see. I mean, you've got our guidance. When we give guidance, we'd like to be prudent. However, you know, when, you know, again, from my perspective, and you take a look at, you know, Zscaler, it was purpose-built for this world. You know, the highest level security, proxy-based, going down the SSL traffic. You know, as Jay talked about, lower complexity. You know, the number of security professionals in the world, you know, there's a major need for it, and that's going to get worse than lower costs. You know, again, you know, we like to do our guidance. We like to be prudent, you know, and we'll see how things, you know, play through. But I don't see any other, well, I shouldn't say, we are well positioned. Let's just say that we're in a position as a company.

That's what I'll say. I mean, hard times obviously require a lot of extra effort to make things happen. I would say with all the great things that are positioning as well, I expect us to do far better than most of the vendors out there.

Makes sense. Thank you.

Thank you. Our next question comes from Hasma Fadawala of Morgan Stanley. Your line is open.

Thank you for taking my question. Jay, we've obviously had a lot of change over the last couple of years in terms of the nature of work and IT, but to me it seems like security architectures still haven't fully caught up to that, and there's still a lot of technical debt. I'm curious, when Zscaler does come in and do some of these transformational deals, is there more pressure for CIOs and CISOs to want to replace existing solutions? And who are you or what technologies are you seeing yourself replace more often these days as we are entering into a more hybrid world going forward?

It's a very good question. So if you think about our big product portfolio at ZI and ZPA, we are essentially replacing all branch kind of devices or any of the firewall proxies and the like out there. It's the first wave of replacement out there. Number two, the ZPA, we are beginning to replace. Obviously, the VPN was the starting point, but think of the entire inbound DMV that many customers have to deploy. That's the second part. So branch firewalls, branch proxies, all this stuff is number one. Cloud workloads, with the announcement of the new solutions, we're done with ZSkiller for workloads, where zero trust is being brought to the cloud. And this is a relatively new product in the past eight or nine months. We have now quite a few customers who have no firewalls in the cloud. So typically, they buy a bunch of virtual firewalls in the cloud. We see, we think our customers will be firewall-free in the cloud. The third part is data center. That's the slowest moving part. The data center, DMZ, all these boxes are very complicated, and we actually don't like to go and fight in that area because that area is kind of pretty clumsy and cluttered, and data centers are shrinking over time. I would rather put my focus on where the puck is headed rather than the puck is So that's where we see a number of customers buying firewalls or data centers and the like, because there's also a little bit of demand coming from the COVID side of it. But all the branches replace almost everything out there. Public cloud, early stage, but very promising signs.

And data center will leave it alone for a while. Did I answer your question? That's helpful. Thank you.

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

Thank you for taking my question, and I'll echo my congratulations on the quarter. You guys obviously gave operating margin guidance for next year. Are there any guardrails you can provide us on how we should think about maybe the delta between the operating margin and the free cash flow margin for the full year?

Yeah, I mean, when you take a look at the last two years, our free cash flow has been above 20%. When you take a look at, you know, our guidance that we gave for fiscal 23, you know, it's the same, you know, basically, you know, it should follow what it's done the last two years being over 20%. The value that Zscaler has are very efficient, you know, company. You take a look at our cloud. know typically our cloud you know capital expenditure or expenses are you know high single digit in any one quarter which is relatively low our high gross margins you know just our you know overall operating profitability the key thing also with the arc free cash flow is that you know we typically bill annually so you know our our billing range is between 10 and 14 months so You know, we're just in a really good position, very efficient model. And again, looking at the last two years, you know, I wouldn't expect anything different from a pre-cash flow marsh perspective. And I would expect things to be similar, higher than 20%.

Thank you very much.

Thank you. Our next question comes from Greg Mazgiewicz of Mizuho Group. Your line is open.

And congrats on ZIA's FedRAMP authorization. You know, given that you're clearly already seeing a lot of momentum in your federal business, Jay, maybe you could expand on what having dual FedRAMP high authority will add to Zscaler incrementally. And then for Remo, it's interesting to me that your headcount growth actually accelerated in fiscal 22 to 58%, especially since you grew a robust mid-50s in the prior year. You know, given the macro uncertainty, how are you thinking about hiring growth over the next six to 12 months? Thank you.

I will start. We have good results in Q4. We are expecting good and healthy results for federal business in Q1. But we do know that federal business takes time. It has taken us years to get these very high-level certifications coming. Probably more painful than any other certification I've seen, but they're good ones. So they are positioning us well. But all these certifications still, they start us with smaller deals. and there's a lot of opportunity to expand. For example, 10 of the 15 cabinet-level agencies we talked about, mostly they've started small. There's plenty of opportunity for us to expand. So we are investing these sources. Our pipeline is growing, and we have high expectations from our practices.

From a headcount perspective, you know, Greg, you're absolutely right. It was a, you know, a great year for us. You know, it hit account expansion fiscal 22. What we talked about, you know, we are excited about the opportunity. We feel it's in the best interest, you know, for everyone to continue to prioritize growth but being mindful of operating profitability. We plan to continue to still prioritize growth going forward, but because of the leverage in our model, we're able to deliver…we're planning to deliver uh 150 basis points basically you know margin expansion the reason for that that we're able to to do that is that you know the sas model with rattleable revenue with the arr balance you've got pretty good visibility you know coming in you know to the year when you couple that with uh pie gross margins you know at 80 plus it just makes it a very you know attractive model you know for us to really you know manage our business right now where we're at you know we feel we have the right product at the right time which addresses a significant need for our customers we plan to invest you know across the board in the company we're going to be investing go to market r d in our cloud to really help customers navigate through this difficult time where they can lower their costs increase their security and basically decrease their complexity So from my perspective, we will continue to prioritize growth and we will continue to hire. So that is our plan for fiscal 23.

Anyway, if I may add just a comment on hiring. We did well last year. We are best to be hiring this year. We have become the top destination for top talent. I mean, in R&D and in sales, we're probably the best organization put together. You know, six, nine months ago, some of these startups that are funded like nothing else there, they're all trying to hire people. They're all laying people off. And we are investing heavily in it. And by the way, we hired Brandon Castle, our new chief people officer. He comes from Google with a deep expertise in scaling talent acquisition and development. So very, very excited and bullish about the business opportunity.

Very helpful. Thank you both.

Thank you. Our next question comes from . Your line is open. Good afternoon, guys.

Congrats on the ongoing strong performance and guidance. Question for either Remo or Jay. So, clearly, Jay, as you've indicated, you're showing great ROI for your customers. I want to actually focus on your ARPU trends. Maybe can you provide us with some color on recent ARPU trends? Are they on par with recent quarters? Have they been moving up in recent months? Have you instituted any pricing increase over the course of the past few months? Thanks for that.

Yeah, I'll take that. ARPU has been increasing on a year-over-year basis. Our ARPU has increased 20%. Related to price increases, we typically do it on an annual basis, and really it's related to additional applications and bundling. And with that, prices do go up, but they go up probably in the mid-single-digit type range. Nothing really significant, but it relates to additional applications and bundling, but that's typically done on an annual basis.

Yeah, we haven't done anything just like some of the hardware vendors you saw recently. They talk about here's a deadline of price. You kind of give the order before that. We have no deadline. So none of that, any of the pricing type of stuff got pulled into our business in future.

Thank you, guys.

Thank you. Our next question comes from Keith Backman of BMO. Your line is open.

And the question is, how are you thinking about mix in particular? And what I mean by that is, I think, Jay, you said about 60% of your new biz is from existing customers. Do you see that changing as perhaps new logos get more challenging? And or do you see a different composition associated with the solution sets? meaning VPN replacements has been a really strong business for the last couple of years. Is there any saturation there? Just any comments on how we should be thinking about mix? And finally, within the guidance, I also wanted to ask, Remo, you mentioned visibility is lower in the second half of the year, which I think is completely understandable. But did you take a, you know, a heavier cut, so to speak, or a more careful, more prudent approach, shall we say, versus what you're seeing in the current macro environment as you thought about the second half of that guidance?

I'll start, Raymond. By the way, regarding a mix, I think the 60% I said is upsell and 40% is new. It's not the other way around.

So with that, we are... Yeah, yeah, exactly.

No. Historically, we've grown our enterprise businesses very well the large enterprise to come from there as our business is getting bigger our customer base is getting bigger so upsell is getting bigger because the platform is bigger more customers to sell to the bigger platform to sell to is naturally increasing our upsell percentage of the total business we're doing and we'll see both upsell and new large customers when it comes to lower end of the market that's relatively newer for us. We are largely focused on getting new logos in that market. Our demand gen and channel programs are helping us to get more logos there. And our channel partners are helping us with logos there. So I think you'll see a combination. But, Remo, you probably can give a little bit more guidance, but I expect our upsell to go higher over time because our customer base is growing.

Absolutely, Jay. I think the upsell will go, you know, above, you know, the 60%, which it was this past year. You know, just for the reasons, you know, Jay mentioned, we've got 6,700 customers. And when you take a look at, we've talked about a 6X opportunity to sell just the IACPA at our last analyst day. That does not include workloads. So, you know, another part of our business. So, significant opportunity to upsell, you know, to customers. Related to, you know, consideration related to the second half, yes, that's why we gave the first half contribution, you know, of our total billing, you know, being at the midpoint 42.5% versus 41.5%, which we had last year. So, again, what we're saying of our total guide of the 30%, 31% billings growth year over year, we expect to see 42% of that in the first half this year versus 41.5% last year. That's how we took it into account.

Okay. All right. Many thanks.

Thank you. Our next question comes from Phil Winslow of Credit Suisse. Your line is open.

You're asking another great quarter. I mean, obviously the sales productivity metrics that we can follow from the outside looking in remain super strong. I wonder if you could give us just more color on sort of what you're seeing there. particularly in terms of the time to ramp new reps, their productivity metrics. And as you think about just the forward guidance, obviously you talked about continuing to lean in on the go-to-market in terms of headcount. But when you think about what's implied in terms of guidance, what sort of productivity levels relative to what we have been seeing are baked in there? Thanks.

Yeah, I mean, great question. So time to ramp is faster. I mean, there's no doubt. And that's basically the market is more mature now. as well as our sales operation, our sales enablement group. We have an absolutely outstanding sales enablement group, which gets our, you know, sales reps basically trained very quickly. In addition to that, you know, the channel. You know, as Jay talked about, the contribution the channels have, the marketplace, you know, the cloud marketplace also. All those things basically are helping, you know, for these sales reps to ramp up. faster related to you know what's embedded in the guidance for fiscal 23 for sales rep productivity we're expecting sales rep sales rep productivity these flattish to down the reason for that is basically again we talked about we're still going to prioritize growth over operating profitability but even with you know flattish to down sales productivity we can still bring in about 150 basis points of operating market expansion year over year, which is what our guidance is. Again, the model we have with the high gross margin and the high top line growth gives us the flexibility to what we feel we can do to make the right decisions to really capture this market.

And if I may add, I think I understand the importance of operating profit, especially in today's market. We'll definitely be mindful of that.

RenoCentral balanced growth and profitability.

Got it. Excellent. Thanks for the color and keep up the great work. Thank you.

Thank you. This does conclude our conference. I'd like to turn the call back over to Dave Padre for any closing remarks.

Thank you for your continued interest in these two. I hope to see many of you at the upcoming Southside events. Goodbye. Thank you.

Thank you.

Goodbye. Ladies and gentlemen, that concludes today's conference. Thank you all for participating. You may now disconnect. Have a great day.