Zscaler, Inc.

Hello, and welcome to Zscaler Second Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during the session, you will need to press Star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press Star 1-1 again. I would now like to hand the conference over to Bill Choi, Senior Vice President, Investor Relations and Strategic Finance. Sir, you may begin.

Good afternoon, everyone, and welcome to the Zscaler second quarter fiscal year 2023 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 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 March. Morgan Stanley TMT Conference in San Francisco on March 6th. JMP Technology Conference in San Francisco on March 7th. Now, I'll turn the call over to Jay.

Thank you, Bill. We delivered a solid Q2 despite economic challenges that have impacted the broader tech industry. For the quarter, our revenue grew 52% year over year, and billings grew 34%. Billings were impacted by new customers being more deliberate about their large purchasing decisions at the start of the calendar year. These deals have not gone away, and we have closed a few already in February. On the other hand, we had strong growth in our expansion business with existing customers, increasing the deployments and adopting a broader platform. Once again, our donor-based net retention rate was over 125%. We continue to delight our customers by accelerating their path to better security, business agility, and cost elimination, helping them solve some of their highest priorities. This drove our Net Promoter Score, or NPS, to a new high. Our NPS now exceeds 80, which is more than two times the average for SaaS companies. And today, more enterprises than ever before recognize Zscaler as the best choice to secure their digital transformation. strengthening my confidence in our $72 billion serviceable market opportunity. Our disciplined approach to growth is reflected in our strong operating profit and free cash flow, both of which doubled on a year-over-year basis. Our operating margin expanded by approximately four percentage points, while our revenue also continued to grow at a very high rate. As the world's largest security cloud, we have outstanding unit economics with a stable high 90% growth retention rate and 80% growth margins. These best-in-class metrics are the result of our differentiated services, market leadership, and highly scalable multi-tenant cloud platform. Let me share with you some of my observations about the environment and how we plan to manage our business for the remainder of 2023. With macro concerns weighing on business leaders, more organizations are being cautious and measured about their spending. In January, we saw a higher scrutiny on budgets compared to December, resulting in additional delays in large deals. These deals haven't gone away, and customers are taking longer to make decisions and requiring additional approvals. In select instances where timing of budgets was a hurdle for new customers, we enable them to ramp into larger subscription commitments. These strategic deals lowered our first year billings, but will grow into a higher annual run rate level in the second year. We typically have some ramp deals each quarter, but in Q2, the impact of ramp deals on our billings was higher. These ramp deals position us to expand the customer relationship over time to create long-term value. As we enter the second half of fiscal 23, we are expecting customer cautiousness to continue. We have accounted for further lengthening of sales cycles and uncertain timing of large deals in our outlook. Even though our current pipeline has grown and has more mature deals, we are assuming a slight deterioration in close rates. While not immune to economic slowdowns, cybersecurity is relatively more resilient. In my conversation with hundreds of IT executives, cybersecurity remains their organization's number one IT priority. Two weeks ago, we hosted a CISO Summit with 80 CISOs from global 2000 companies. They talked about the business need to innovate, become agile, and gain competitive advantage with security as the enabling foundation. They talked about their plans to shift to zero trust security, to reduce attack surface and to adopt the direct to cloud architecture that Zscaler pioneered. Customers are excited by the new innovations being added to our platform and their engagement with us remains very strong. Given the large opportunity we see in front of us, we will keep on building and innovating while also increasing profitability. After significantly growing our teams in recent years, we took a fresh look at our organization and found opportunities to streamline operations and to align people, roles, and projects to our strategic priorities. As a result of that review, we initiated our targeted cost optimization plan to drive additional operational efficiency that best positions us to deliver profitable growth. Remo will cover this in more detail. As I mentioned before, I believe that periods of uncertainty can accelerate the adoption of disruptive technologies like ours. C-level leaders are telling me that technical debt of legacy network and security point products impedes progress and slows down business operations. By consolidating point products and embracing zero trust architecture with Zscaler, our customers are modernizing their security while reducing costs, giving them the competitive edge they need to succeed in today's rapidly evolving business environment. We have expanded our business value team to collaborate with customers to create CFO-ready business cases with clear ROI and payback periods that facilitate necessary deal approvals. In today's environment, Customers can't afford to risk their mission-critical projects with immature offerings from unproven vendors. We are starting to see deal wins from customers who initially purchased a single 10 Celsius solution from the incumbent firewall vendor that failed to deliver in the real world. These customers were misguided by the flawed message. keep on buying my boxes and use my so-called cloud service when your users are on the road or in a branch office. A single-tenant architecture, whether deployed as appliances or as virtual machines spun up in a public cloud, will not allow enterprises to fully realize the benefits of secure digital transformation. every customer we have one has lots of firewalls in the data centers but when it comes to zero trust security and digital transformation the choosing z scaler because of our multi-tenant cloud architecture that scales and delivers business agility Our Zero Trust Exchange is the largest inline security cloud in the world, processing over 280 billion transactions and preventing 9 billion security and policy violations per day. This massive amount of traffic provides us with more than 300 trillion signals per day to feed our machine learning and AI engines for better detection of user and application traffic anomalies, resulting in superior tech protection. Our AI ML capabilities are driving customer success at scale in the real world today. Let me share an example with you. In December, we helped a global 500 conglomerate experiencing a targeted cyber attack on one of its divisions. Our Threat Labs team worked closely with the customer to identify the root cause of the attack and act quickly to prevent any potential damage. Subsequently, this customer upgraded to our ZIA transformation bundle to prevent zero-day attacks and secure the entire ecosystem. This win highlights the value of our high-end product bundles and the benefits that our Threat Labs research brings to our customers. I'm delighted to share that an increasing number of customers are purchasing our comprehensive platform capabilities, which not only accelerates their business value realization, but also establishes us as a critical partner for their success. As I mentioned before, We are increasingly buying Zscaler for users, our complete platform for user protection, which includes ZIA, ZPA, and ZDX bundled together. In addition, we are gaining traction with workload protection powered by the same core ZIA and ZPA technology. Thanks to new and existing customers purchasing these expanded bundles, we drove a 51% year-over-year growth in the number of customers with greater than $1 million in ARR, ending with nearly 380 of these customers. And over 30 of these customers have ARR greater than $5 million. Let me highlight three deals this quarter where the customers purchase all four product pillars. In a new logo win, our top 10 global IT software and services company purchased Zscaler for Users bundle for 400,000 users including our advanced data protection suite and our Zero Trust for workloads for 3,000 workloads. This customer pursued a Zero Trust strategy due to their business growth resulting in a complex application and network environment. and heightened risk from data sprawl. They selected Zscaler as the only scalable zero trust platform that reduces their attack surface and protects their sensitive data while bringing agility to their business. With our integrated platform, they will simplify their security operations by consolidating dozens of point products, including firewalls, VPNs, VDIs, DLP, and CASB. By purchasing all four product pillars, the customer is making a platform bet on Zscaler to secure their users, workloads, and devices, regardless of their location. Next, in an exciting upsell win, a major auto manufacturer upgraded to Zscaler for users bundle for 35,000 users and purchased Zero Trust for workloads for 8,000 workloads. This platform purchase was driven by the customer's strategy to digitally transform their business operations, including management of the vast supply chain. In fact, we are helping them accelerate time to market for new EVs. Before purchasing ZPA, this customer experienced significant delays in commissioning new vehicles as third parties did not have fast, and secure remote access for collaboration. By using ZPA and CDX, they can now provision secure access to new third parties within a few days compared to over a month it used to take with legacy remote access technology. In addition, Zscaler for users significantly reduces the risk of ransomware that the firewalls and VPNs allow. Finally, a global 500 pharmaceutical company upgraded from ZIA for 45,000 users to Zscaler for users bundle for 85,000 users and purchased Zero Trust for workloads for 2,000 workloads. They purchased all four product pillars to pursue a cloud-first strategy with Zero Trust security for all users and workloads. With this upsell, the annual spend of this existing million-dollar customer increased by 6x with additional opportunity for workload protection as the public cloud usage grows. Earlier, I mentioned that in some instances, we enable new customers to ramp to larger commitments. in one such new logo win we are excited to partner with an innovative retail leader that's using facial recognition technology and cashless checkouts to redefine their future store experience this is a significant win for us as retail was a smaller vertical for us historically where we are now enabling new digital transformation possibilities This retail company committed to an eight-figure total contract value for a multi-phase ramp to secure over 90,000 ZIA users, 20,000 ZPA users, and 400 petabytes per month of data from the 20,000 retail store operations. This customer had bought a firewall-based SASE solution, which failed to scale as well as expanded their attack surface. Leveraging our highly scalable and reliable Zero Trust Exchange platform, they will use ZIA to create direct internet access for employee tablets and terminals while using ZPA to secure private access for store managers. Additionally, zero trust for workloads will secure all traffic from cameras and terminals in the retail stores to the cloud. Workload protection accounts for approximately 40% of the total deal value. As these deals show, customers are embracing our expanded platform, including our two emerging product pillars. ZDX for digital user experience management and Zscaler for workloads for securing servers and workloads. These emerging products are on track to meet or exceed our full year target of contributing high team percentage of our new business. Our Zero Trust for Workloads solution is roughly doubling year over year. In addition, our new CNAP solution is generating significant customer interest. You may recall at ZNF Live in June, we launched our CNAP solution called Zscaler Posture Control, which is an integrated solution that correlates vulnerabilities and risks across CSPM, CIEM, and infrastructure as code scanning. This quarter, we had a Posture Control upsell win with a global 1,000 engineering company for half a million dollar ACV to secure 5,000 workloads. Posture Control provided visibility across multi-cloud assets, remediated compliance violations, and revealed previously undetected high-risk vulnerabilities. We are proud that our pasture control solution was recently recognized by research from G2 in the leader quadrant based on independent peer reviews. We are bringing more innovations to our customers than ever before. In our latest major cloud software release, we brought over 150 new features to market, including product innovations such as AI-powered phishing detection and dynamic risk-based access policy. We continue to drive both internal innovation and highly targeted acquisitions to expand our leadership in the SASE and Zero Trust security markets. As announced a few weeks ago, we acquired Canonic Security, an innovative startup in SaaS supply chain security, which protects customer data in SaaS applications. For example, Google Suite could be sharing data with 30 other third-party connected SaaS apps that are posing significant risk of data breaches and data loss. Together with our inline DLP, browser isolation, out-of-band CASB, and SSPM for SaaS posture management, Zscaler now provides unprecedented visibility and most comprehensive data protection for SaaS applications and customer data. As we look ahead to the next few years, we are committed to driving broader adoption of our Zero Trust platform for users, workloads, and IoT to maximize the value of our customers' secure digital transformation efforts. CIOs are telling me that they're using this challenging environment to drive change. ROI and cost organizations are becoming bigger priorities as they're being asked to do more with less. With our superior architecture and proven experience, we deliver measurable outcomes at the CXO level that are aligned with our customers' top priorities. Our business value proposition is resonating. and more customers are consolidating multiple point products with our broader platform, which increases our wallet share with them. We believe that we are still in the early stages of a significant market opportunity to enable secure digital transformation, and we are on track to achieve our $5 billion ARR goal. Now, I'd like to turn over the call to Remo for our financial results.