$ZS Zscaler Inc Q4 2023 Earnings Conference Call

Thank you, Bill. We had a strong close to our fiscal year. In Q4, we delivered 43% revenue growth and 38% billings growth with balanced growth across all verticals, customer segments, and geographies. For the full year, our revenue grew 48% to $1.6 billion and billings grew 37% to over $2 billion. In addition to achieving record billings in the quarter, we also set records across several other measures. We added the highest number of $1 million ARR customers, generated record new pipeline for a Q4, and attained record operating profit margin. I'm proud of our team's achievements and humbled by the trust our customers are placing in our platform. While the macro environment remains challenging, we are executing well. With cybersecurity as a high priority, IT executives are moving forward with zero trust initiatives, driving our business. As I mentioned before, we are partnering earlier with CxOs to create compelling CFO-ready business cases with clear ROI and payback periods. Our results demonstrate refining our high-touch sales process is helping get large deals across the finish line. We have a blueprint for delivering immediate value, which drives faster upsells, often within 12 months of initial purchase. We closed a record number of deals over $1 million ACV in Q4, driven by broad-based strength across our key industry verticals. In addition to our industry-leading top-line growth, we are generating record profitability. Due to our spending discipline, we achieved a record 19% operating margin as we more than doubled our operating income on a year-over-year basis. These outstanding results reflect the strong unit economics of our business with best-in-class 80% gross margins. Our innovation and customer obsession drove our net promoter score to exceed 80, which is more than two times the average for SaaS companies, and contributed to our high 90% gross retention rate. I am very pleased to announce that we doubled our annual recurring revenue from $1 billion to over $2 billion in seven quarters, reaching a milestone only a select handful of SaaS companies have achieved. We secure over 7,700 customers and protect over 41 million users. With every customer looking to adopt zero trust architecture in today's world of cloud, AI, and mobility, we believe we are in the early stages of capturing a large share of our $72 billion market opportunity. We have our sights set on achieving our next goal of $5 billion in ARR. We are on a mission to take zero trust everywhere—to users, workloads, and OT systems—and become the go-to platform for vendor consolidation, cost savings, increased business agility, and better cyber and data protection. To fully realize the business value enabled by our platform, customers are increasingly buying Zscaler for users, a complete zero trust solution for user protection, which includes ZIA, ZPA, ZDX, and data protection. In addition, we are gaining traction with workload protection powered by the same core ZIA and ZPA technology. These broader platform purchases drove 37% year-over-year growth in customers with greater than $1 million in ARR. We ended the quarter with nearly 450 such customers, including 43 customers exceeding $5 million. Let me highlight one deal where the customer purchased all product pillars. A large global system integrator partner headquartered in Asia became a customer and adopted our platform to enable their work-from-anywhere strategies. They purchased ZIA, ZDX, and advanced data protection for 300,000 users and ZPA for 270,000 users. They also purchased workload protection and deception technology to improve application security for their hybrid environment. This customer can now open new offices and offshore development centers much faster and more securely. They are also seeing a 50% reduction in the time to onboard employees. As a highly distributed organization with data everywhere, data protection was a major consideration for them and accounted for 20% of the deal value. Data protection is an important new pillar of growth for us, approaching a quarter billion dollars in ARR and growing 60% per year. We are increasingly replacing incumbent legacy DLP in the largest of enterprises, with data protection representing a 10-plus billion dollar opportunity for us. Due to targeted investments and rapid innovation, we believe our data protection solution is now the widest and the deepest in the market, and we are taking data protection beyond users to workloads and devices. Let me highlight a new logo win led by data protection. A large telecom operator purchased Zscaler for users for 80,000 employees. Data protection was a key driver for the win, as this customer became increasingly uncomfortable with gaps left by their firewall and VPN-based security, which struggles with data protection for TLS encrypted traffic that comprises over 85% of their internet traffic. With Zscaler, this customer is consolidating multiple point products and expects a payback on the purchase within nine months. Our emerging products, including ZDX and Zscaler for workloads, continue to see increased adoption and contributed 18% of our new business in fiscal 23. We expect emerging products' contribution to increase to over 20% in fiscal 24. I'd like to highlight two deals that were driven by our emerging products. In a seven-figure ACV upsell deal, a Fortune 50 insurance company purchased ZDX Advanced for all 170,000 users after realizing value from their initial ZIA deployment. With the Zscaler platform already in place, ZDX gets deployed quickly, reduces troubleshooting time, and improves field agent productivity. We directly impact the customer's revenue and their agents' ability to earn commissions. ZDX exemplifies the platform benefits of our zero trust exchange and expands our share of customer spending beyond security. In another seven-figure ACV upsell win, a Fortune 10 healthcare company purchased Zscaler for workloads just one quarter after making their initial purchase of Zscaler for users for all 150,000 employees. With workload protection, this customer is accelerating plans to move most of their on-prem workloads to the cloud as well as protect workload traffic from over 9,000 locations. Lastly, let me highlight our success in the federal vertical. 12 of the 15 cabinet-level agencies are our customers, and we are starting to see larger awards from these agencies. Let me highlight one such agency-wide deal. We were awarded a multi-year contract from an agency with more than 100,000 users. The value of this contract will be realized over time based on deployment with the field units. Against this award, we received a mid-seven-figure ACV task order for ZIA and ZPA. This customer chose Zscaler over firewall vendors because our cloud-native architecture delivers better security and user experience, all while meeting FedRAMP requirements. We remain the only cloud security service to have two key products at the highest level of FedRAMP certification. These certifications and the executive order for zero trust security are driving a significant opportunity for us in the federal market. Next, let me discuss some key industry trends. Cybersecurity remains the number one IT priority, and having the right security architecture is fundamental to reducing cyber risk. According to our latest Zscaler Threat Labs VPN Risk Report, nearly half of enterprises reported they were targeted by cyber attackers who exploited a VPN vulnerability, and a third of enterprises fell victim to ransomware attacks within the past year. Growing cyber threats, including ransomware, are driving IT leaders to transform security from legacy network security to zero trust architecture. True zero trust security can't be built by spinning up a bunch of virtual firewalls and VPNs in a public cloud. Do you know any VPN vendor whose products have not been compromised? Our architectural differentiation gives us long-term advantage. As you may have seen, investors and regulators are increasing pressure on companies to improve cybersecurity. With the new SEC requirement to report a material security incident in four business days, there will be increased executive and board-level focus on cybersecurity. Zscaler's zero trust exchange platform delivers comprehensive security controls for visibility and fast reporting, each of which is now a must-have for meeting corporate governance requirements. In this environment, customers cannot risk transformational and mission-critical projects with immature offerings from unproven vendors. Both legacy vendors and newcomers in the security industry have tried to mimic our messaging. The reality is that no vendor comes close to providing the depth of functionality and level of performance at our scale. Good enough in cybersecurity is never good enough. Next, let me discuss AI, which is top of mind for customers and investors. Generative AI has tremendous potential to unlock insights, improve employee productivity, and solve complex problems. However, the risk of data loss and issues of data sovereignty are limiting the potential of this new technology. To address these concerns, we already delivered data protection capabilities that prevent the leakage of sensitive data through AI prompts and appropriation into public training models. For example, our browser isolation session would not let employees paste or type any sensitive information into gen AI prompts. This not only enables employees to use AI but also do so in a secure manner for enterprises. Our engineering teams have innovated rapidly on new AI-driven functionality that's available in our premium-priced bundles, such as auto-classification of unstructured data for advanced data protection and auto-segmentation of applications for zero trust access. Second, we will have new products based on AI that will provide significant upsell opportunities with our customers. We recently launched Risk 360, which enables executive teams and boards to better understand the risk posture of their organizations and provides unparalleled visibility with up-to-date security status and corrective actions they can implement in a timely fashion. Using AI, I believe we will be able to use our unique data set to also predict and prevent most of today's ransomware and other sophisticated attacks on our customers. AI-driven cyber insights and prevention has the potential to add tremendous customer value, and we believe we can monetize that opportunity. Zscaler has AI experts and data scientists and valuable anonymized private data to customize and train LLM models for the security domain. Based on our proxy architecture, our zero trust exchange acts like a private switchboard that captures all communication logs. We have the largest inline security cloud, inspecting over 320 billion transactions daily, with transactions doubling every 18 months. These logs provide more than 500 trillion signals per day that feed our AI models for better detection of user and application traffic anomalies, resulting in a positive network effect of superior threat protection for our customers. We have been investing in AI for quite a while, including our first AI acquisition in 2018, and we will continue to invest in fiscal 24 for rapid AI innovations, cloud enhancements, and go-to-market to take our AI solutions to the market. All investments will be made within the envelope of margin guidance that Remo will discuss. In closing, we are excited about the opportunities ahead. We have a track record of building and growing new innovations like ZDX, data protection, and zero trust for workloads, and we are now turning our attention to AI. We believe these new products will contribute increasingly to our future growth. Our business value message is resonating in this challenging macro environment, and more customers are adopting our broader platform to consolidate multiple point products. We believe customers trust Zscaler more than any other provider for securing the zero trust journey. We have grown our global team to nearly 6,000 employees with the mission to secure the hyper-connected world of cloud, AI, and mobility. I'm extremely proud of the strong growth and profitability we delivered in fiscal 23. I want to thank our employees and our partners for their tireless efforts and commitment to our customers' success. We will invest aggressively to delight our customers and capture the large opportunity ahead of us while continuing to deliver operational excellence. Now I'd like to turn over the call to Remo for our financial results.

Right, so Brad, this MQ is not slowing us down at all. SASE is a broad generic term. When Gartner started it a few years ago, it was an integration of SD-WAN and SSE, the gateway products. We have done integration with every SD-WAN vendor that matters out there. But that MQ that got started this time was for single-vendor SASE with SD-WAN often in it. You know, we have often said that SD-WAN is the opposite of zero trust. We do offer zero trust SASE, what we don't offer is the SD-WAN. So we're not on that MQ. We are about changing the world, not really propagating the old world, and we are very successful in doing so.

So when we started ZIA, ZPA, we started for users. A user can securely communicate with applications. It's natural to extend ZIA for workloads, ZPA for workloads, because workloads need to talk to each other in zero trust fashion. So our customers understand it and appreciate it. It's a great upsell opportunity for us to expand our POV as well as customer spend with us. So we are seeing good success. The deal size is still smaller because the number of workloads in various stages, various customers, but we literally have no competition when it comes to this area because we are the only provider that's actually offering zero trust communication among workloads or workloads through internet. We are upbeat about it for fiscal 24 as well.

Thank you. So SSE is widely understood and accepted. It's essentially the combination of CASB, SWG, and ZTNA we've built. But the term for SSE is large and it's getting larger than the market appreciates today. You know, from Microsoft, it was natural to be in the market for identity and endpoint security as they have traditionally owned Active Directory and Windows operating system. But inline security is a totally new area for them. This area of SSE that we pioneered has a very high bar: high performance, great security, no slowing down, and supporting a range of destinations. In fact, it's like being the switchboard. We have to connect to applications that are on Microsoft and AWS and GCP and a thousand SaaS applications out there. So customers like the positioning of a provider like Zscaler that's not tied to applications itself. Zscaler has earned trust of large enterprises. It'll take time for any new entrant. Yes, Microsoft's entry is further validation, but we don't believe it will impact us because of our positioning in the large enterprise market. And there may be some impact on the lower end of the market.

Thank you. On the high end of the market where we do extremely well, we really haven't seen a change. If there's any change, I would say our position has further solidified. And I wouldn't say it has gotten so much easier on the higher end of the market. When it comes to the firewall market, you know, we are replacing firewalls in the branches when Zscaler gets deployed with zero trust architecture. There's no room for any firewall in the branch office. Now, there are still firewalls in the data center and the like because we don't play inside the data center for east-west traffic and the like. But as customers are doing local breakout or traffic from every location, the amount of traffic going through the data center is slowing down, which is bound to impact the sales and demand for firewalls out there. So we do believe that the shift we have been talking about to truly zero trust away from traditional firewalls and VPN is happening and it will continue.

Yeah, so data protection becomes a natural thing for us when traffic starts flowing through Zscaler. So literally, it's hard to have any other data protection vendor when Zscaler is actually sitting in the traffic path. So what are some of the pieces of success here? First of all, DLP, data loss prevention, which essentially is done on the traffic that's inline. We are replacing the number one vendor we are replacing there is Symantec. Symantec Blue Coat boxes, they know the DLP is the secondary piece. The third big area I'll be replacing is some of the CASB vendors. CASB early on got sold as a point product, as a module. For us, it's a feature. So any customer who has a pure-play CASB deployed essentially gets kind of replaced by our data protection platform. So those are two big areas. But in addition, now we are seeing some of the newer areas coming up. For example, our endpoint DLP, which we recently launched, is getting tremendous traction out there. The email DLP module we added is wonderful as well through acquisition of Canonic. We have added, but that's the SASE ecosystem. Now, slight change, the data protection. So all this have made Zscaler the most comprehensive platform and it's sitting in the traffic line. That's why we kind of called it out because the growth is great, over 60% year over year, and we are close to $400 million in ARR.

Yeah, let me add. The bigger the platform we sell, the more likely you need to provide ramp because there are more pieces to be done. Number two, there's some of the tighter macro environments, the bigger deals scrutiny, but I have picked up in the past year or so as compared to two years ago. We factor that in as a part of doing business and it's not a bad thing. We just have to manage it right.

And also if I may add, we have a record pipeline and we're seeing pretty good momentum on our business. We were in Vegas doing our sales kickoff a couple of weeks ago. The energy and excitement in the room could be felt. Actually, it was very good because our sales team have a lot of confidence. We talked about the record pipeline, the record deals out there. We talked about the new momentum the channel is adding to us. So we feel very good about our fiscal '24 business.

Yes, if I may, it's all coming out of 100% only. That's the most important point. When the overall growth is pretty strong, for the new products, even if it grows 70-80% a year, it has to work very hard to even take away one or two percent from that total new ACV. That's pretty significant. So that growth of these new products is much faster than the growth of the overall new ACV, but they are fairly small and they're growing into good business. We called out data protection as it became a significant part of the business. And I think here too you're seeing a combination of workload protection and ZDX. Both are growing at a much faster rate. So I think we are actually happy with the growth rate. But the point I was trying to make is they are trying to steal away market share from the rest of the overall portfolio, which has a much bigger base. That's why the math looks small, but it is pretty impressive.

Let me start to give you a big picture and Remo, you can add your color to it. So our guidance is starting with first of all a record pipeline and the momentum we have in the business. And we have plenty of product to sell. We have a growing market opportunity and many business drivers. We have a lot of new customers who are really buying zero trust for better security. Lots of market that's not covered. We are still in about 30% of the Global 2000 market. And we're seeing public sector coming strong, federal market coming strong, and that's really further pushed by some of the mandates that are happening out there. And you saw in some of the deals we announced, customers are increasingly buying more of these kind of platform, leading to bigger deals. CASB, our flagship products are still doing strong. We have factored in good growth for data protection, which complements it. Actually, it needs to go on every Zscaler customer. Emerging products are contributing nicely and they are contributing. So when you look at all this, that's what we took into factor to give you our guidance.

So multimodal DLP is still in development. It starts shipping, but there's a bunch of engagement with customers and interest is high because there's nothing like this out there in the market. You don't see it. Zscaler always likes to pioneer new things that no one has done out there. Risk 360, on the other hand, is actually shipping. We have taken a bunch of orders. This product has more interest up front than any of the other products I can think of because our engagement with CISOs are strong. When a CISO looks at Risk 360 and says, 'Wow, I have actually a single point to really tell me the holistic view of my business and actually where my risk factors are and what tangible, prioritized actions I could take to improve my risk.' So this is significant velocity going on. Very, very good feedback and the product is growing very rapidly in terms of functionality as well.

The other governor also had is since Zscaler can actually reduce cost while reducing business risk, there's added attraction. We're able to engage with customers and close deals even when the macro is tight. We also felt very good about the record number of $1 million deals in Q4. So I see strengths across all major areas, major verticals, regions, and that's why we feel good about it.

So let's start with data. There are lots of companies and lots of data. What's exciting about Zscaler is we are designed as a switchboard for all communication between different parties. A firewall is not a switchboard. Firewall is a door, it's a gate. It says you are inside, you're outside. That's number one. Number two, firewall logs are often what's known as short logs. It's still a small number of firewall transactions, whether they are on-prem or in the cloud, as we are SSL decrypted. If the transactions aren't decrypted, your logs aren't of much use at all. Or if you take DNS logs, they're not very useful at all. It says which domain are you going to. We have full logs after decryption about all information including the full URL. The URL has a lot of useful information that we have. For any reconnaissance before a breach happens, reconnaissance, exploits, it could be trying to exploit software vulnerabilities, it could be trying to phish employees. All of that traffic goes to us and we collect those logs and that's why we can actually do some of the things like being able to predict potential breach and the like. So that's one big part on the log side of it. The second question, how do we monetize AI-driven products? Don't think of these as having only AI-driven products separately charged. It is going to influence all of our product lines. Today, some of our premium bundles include AI-powered products. So we are actually monetizing it as a part of the premium bundles and they are actually fairly highly priced as compared to other bundles. Products like Risk 360, leveraging AI/ML big time, is a charged SKU. Some of the new products we're building, they will have upsells, they'll have their own SKU. So we think there's plenty of opportunities to charge because customers are seeing values from the products we're building.

Yeah. As you know, traditionally channel has played a limited role for us. We have been working on it. We are seeing more and more progress being made. Just to clarify, we do take all these through channel with some exceptions, but customers insist on us. So that's one part. We are seeing year after year, or in the past several quarters, channel providing more leverage to us. That means doing more work for us. We recently hired our channel chief called Sudhakar. He comes from extensive experience and strong relationships in the channel. And he's done a lot of work in three areas of channels: system integrators, VARs, and service providers. In the system integration space, we have actually most of the large SIs, they have selected and deployed Zscaler for their own transformation and zero trust architecture. So they are embedding our solution into the SI advisory services, which is very good because then it becomes a lot better. We also, so we're counting on more leverage from broad channel. Even the VAR channel itself, they're going through some focused training program, enabling program, which will help them do more transformation with us. In fact, we had nearly 200 channel partners come to our sales kickoff and join hands and conduct sessions with our sales teams. We think that's bringing our teams a lot more closer to work together, common account planning and the like. So we're pleased with the progress and we think we're moving in the right direction.

Well, thank you all for your interest in Zscaler. I'm looking forward to seeing you at some of the investor conferences. Thank you again.