Zscaler, Inc. Q3 FY2024 Earnings Call

Hello, and thank you for standing by. Welcome to Zscaler Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I'd now like to turn the call over to Ashwin Kesireddy, Vice President of Investor Relations and Strategic Finance. Sir, you may begin.

Good afternoon, everyone, and welcome to the Zscaler third quarter fiscal year 2024 earnings conference call. On the call with me today are Jay Chaudhry, 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 also want to inform you that we'll be attending the Bank of America Global Technology Conference in San Francisco on June 5. Now, I'll turn the call over to Jay.

Thank you, Ashwin. We delivered an outstanding quarter with all metrics exceeding our guidance. And I'm very pleased to increase our full-year guidance based on our strong performance. Revenue in Q3 grew by 32% year-over-year, and billings grew by 30%. Our $1 million-plus ARR customers increased 31% year-over-year to 523, and we ended the quarter with over 50 customers with $5 million-plus in ARR. Our disciplined approach to growth is reflected in our operating profit, which nearly doubled year-over-year, and our operating margin reached a record 22%. I'm also pleased to report that we had our first quarter of GAAP profitability on a net income basis for Q3. Our strong performance was driven by continued demand for our Zero Trust Exchange platform, which we purpose-built to secure communication among users, workloads, and devices. We expect demand to remain strong as an increasing number of enterprises are planning to adopt our platform for better cyber and data protection. Zero Trust security remains our top initiative for IT teams as legacy castle-and-moat firewall-based security is ineffective in the new world of cloud and AI. Our Zero Trust Exchange, processing over 400 billion transactions and preventing billions of security and policy violations per day, provides superior security to our customers. For example, last calendar year, our platform prevented over two billion phishing attempts, up 60% year-over-year. The cyber and data protection capabilities of our platform are resonating with customers, and we are accelerating the expansion of our core platform with innovations across multiple pillars. We recently introduced the industry's first AI-powered Co-pilot for ZDX, our digital experience monitoring solution. This helps simplify and automate detection and resolution of performance issues. We added two significant products to our data protection pillar. One, Data Security Posture Management, or DSPM, to discover, classify, and protect sensitive data in public clouds; and two, GenAI App Security to provide deep visibility and granular controls for GenAI apps. We introduced Zero Trust Network Segmentation, which expands our platform to local area networks inside branches, campuses, and factories. We expanded our AI Cloud solutions by introducing Unified Vulnerability Management to enable customers to proactively identify critical vulnerabilities. We will continue our rapid platform expansion with organic innovations as well as strategic acquisitions. We recently acquired two early-stage innovators, Avalor and Airgap Networks. Avalor's Data Fabric ingests, normalizes, and unifies data across enterprise security and business systems to dynamically prioritize vulnerabilities based on holistic risk. This innovative Data Fabric will combine data from our 400 billion daily transactions with over 150 third-party data sources to add various contexts to provide better understanding of risk for timely mitigation. As a result, customers can get real-time actionable insights in operational efficiencies, improving their overall security posture. For securing customer branches, campuses, and factories, we continue to innovate our Zero Trust Branch solution. Released last year, this enables each branch office, campus, and factory to be treated like a Starbucks, meaning there is no lateral threat movement as the branches are not on the corporate network, and there is no need for firewalls as branches are no longer exposed to the internet. With the Airgap acquisition, we are taking branch security to the next level as we introduce the industry's first Zero Trust segmentation inside branches, campuses, and factories for servers and IoT and OT devices. This eliminates the need for legacy fiber-based segmentation for East-West traffic. We talked about our $72 billion market opportunity in the past. Our recent acquisitions and other innovations increase our market opportunity by several billion dollars as they extend our platform into new adjacent markets, including vulnerability management, security operations, and branch security. Moving on to our AI innovations, we are developing multiple AI-powered applications, including Risk360 Business Insights, Unified Vulnerability Management, and more. We are training our AI security models with the vast amounts of data generated by over 400 billion daily transactions on our platform to deliver superior threat detection. We are leveraging AI to automatically classify data and enforce policies for better data loss prevention. We have delivered GenAI App Security to enable secured use of AI apps by our customers. Our GenAI App Security delivers one, visibility into the AI services used by employees; two, policy control, allowing different user groups to access only approved AI services from the thousands of such services and three, enforcement of data protection policies to prevent sensitive data from leaking to public AI services. We will be showcasing these and other innovations that combine the power of Zero Trust with AI at our Zenith Live User Conference in June. Organizations are relying on Zscaler to continue to innovate as threat actors are evolving and posing new challenges by frequently exploiting firewall and VPN-based security architectures. Recently, hackers exploited a Zero-Day vulnerability of a leading Next-Gen firewall and a vulnerability of a leading VPN. Such exploits put organizations at risk as attackers can likely move on the flat networks created by legacy firewalls. These shortfalls in legacy security will continue to be exploited until enterprises embrace Zero Trust Architecture and phase out firewalls and VPNs. Zscaler's Zero Trust Architecture eliminates lateral tech movement, which dramatically improves the security posture of organizations. Our differentiated Zero Trust and proxy-based architecture is foundational to delivering superior security. Let me give you a few examples. After experiencing a catastrophic cyberattack last year, a large financial services new logo customer purchased our ZIA data protection and ZDX pillars for 25,000 users in a seven-figure ACV multi-year deal. This customer wanted Zero Trust Architecture and hence excluded their current firewall vendors from consideration. Our superior architecture and strong data protection capabilities were key to winning this deal as the customer said; Zscaler's CASB, EDM, and OCR technologies are amazing. Zscaler just works. In another example, an existing global manufacturing customer after learning about a major VPN vulnerability rolled out Zscaler to 100,000 devices in just three days. Subsequently, the customer increased the purchase of Zscaler for users, including ZIA, ZPA, ZDX, and Data Protection in a seven-figure ACV deal, increasing their ARR by over $5 million. This customer also made an initial purchase of Zero Trust for branch and our advanced privileged remote access solution, which speaks to customers' growing interest in our broader platform. Customers are also purchasing more of our platform to eliminate legacy tech debt and consolidate multiple point products while simplifying IT operations and improving user experience. Let me highlight two upsell deals that illustrate this. After making an initial purchase last year, a Global 100 Financial Services customer significantly expanded the purchase of Zscaler for users in a seven-figure ACV deal for over 64,000 users. Despite having years of relationship with the legacy firewall security vendor, they chose Zscaler. This customer is consolidating multiple point products, including Secure Web Gateway, VPN, and VDI. We work closely with one of our GSI partners on this large project. This deal is an example of us working with GSI partners to expand our market opportunity. In another upsell win, a large APJ-based financial services customer signed a seven-figure ACV multi-year deal for 10,000 users buying most of our platform services. In addition to expanding the purchase of Zscaler for users, they purchased our Zero Trust for workloads, Zero Trust for branch, and AI Cloud solutions. Our emerging products contributed nearly a third of the ACV value of the deal. I'm very pleased to share that we're seeing strong customer interest in our emerging products, which contributed nearly a quarter of our new and upsell business this quarter. Here are a few examples. In an eight-figure ACV deal, a Fortune 500 technology customer expanded the purchase of Zscaler for users and made their first purchase of Zero Trust for workloads and our AI Cloud solutions. With this purchase, the customer's total ARR increased over 5X to more than $10 million. This was also our largest workload protection deal to date, representing seven figures in ACV. I'm thrilled to see our recent innovations in workload protection receiving increased traction. We closed several deals for our AI Cloud solutions, including Risk360 and Business Insights, with customers across multiple verticals, including broadcasting, consulting, insurance, and many more. CISOs get inundated with lots of security alerts and signals that don't help them take specific actions based on risk. Customers are buying Risk360 as it provides them with the overall risk score of the organizations, the factors contributing to risk, and actionable recommendations to reduce risk. For Zero Trust branch, one of the largest retailers in Europe who initially adopted ZIA, ZDX, and Data Protection last year expanded the deployment in a seven-figure upsell deal to include the full suite of Zscaler for users and Zero Trust SD-WAN. Zero Trust SD-WAN, which will be deployed at the regional locations, contributed about a quarter of the ACV value of this deal. Next, in the federal vertical, we are proud to serve 12 of the 15 cabinet-level agencies, and we continue to pursue new and upsell business opportunities across the federal market to help them adopt Zero Trust architecture as mandated by the President's executive order. To give an example, in a seven-figure upsell win, an existing cabinet-level agency increased the purchase of ZIA and ZPA by over 50%, significantly increasing the ARR of this already $10 million plus customer. Next, let me give you an update on our progress in the Department of Defense, or DoD, segment. DoD has a requirement to implement Zero Trust with the technologies and solutions that work best for individual military services and departments. I'm thrilled to share that we signed a seven-figure ACV deal with the DoD branch this quarter. In this deal, the customer made an initial purchase of Zscaler for users to protect 50,000 users. With our proven Zero Trust architecture, this latest DoD deal demonstrates that we are well-positioned to capture the large cybersecurity opportunity at the DoD. Next, let me give you an update on our go-to-market organization, where we continue to make great progress. First, to capture the strong demand for our platform and to scale our business to $5 billion in ARR and beyond, we appointed Mike Rich as Chief Revenue Officer in Q2. Mike hired key leaders in Q3, and he now has his full management team in place. The quality and caliber of Mike's leadership team is exceptional. I'm very pleased with the progress of our sales hiring, particularly at the leadership level. With the right leaders in place, we are now focused on increasing the pace of hiring quota-carrying reps. Second, as I mentioned last quarter, we are evolving our sales motion from opportunity-centric to account-centric. The eight-figure ACV deal with the Fortune 500 technology company that I called out earlier is an example of the success of this new sales motion. We engage closely with this customer to recommend the best solution for now and the future. We look forward to working with them as they are fully embracing digital transformation and Zero Trust security. In conclusion, we are on a mission to take our platform everywhere so customers can benefit from better security, simplified IT operations, and improved user productivity. We are one of the few vendors that deliver tangible cost savings as we eliminate multiple legacy point products. The last three decades of the security industry have been centered around firewalls, which are no longer effective in today's cloud, mobile, and AI world. I believe the next three decades will be defined by Zero Trust architecture. We have the right platform and the right team to delight our customers and capture our large and growing market opportunity. I'm excited about the journey ahead and look forward to sharing how Zscaler is combining the power of Zero Trust with AI to power the future of secure digital transformation. Now, I'd like to turn over the call to Remo for our financial results.

Thank you, Jay. Our Q3 results exceeded our guidance on growth and profitability, even with ongoing customer scrutiny of large deals, changes in our sales organization, and higher than expected sales attrition in the quarter. Revenue is $553 million, up 32% year-over-year, and up 5% sequentially. From a geographic perspective, the Americas represented 54% of revenue, EMEA was 31%, and APJ was 15%. Our total calculated billings in Q3 grew 30% year-over-year and remained flat sequentially at $628 million. Our calculated current billings grew 29% year-over-year. Our Remaining Performance Obligations, or RPO, grew 27% from a year ago to $3.824 billion. Current RPO was approximately 51% of the total RPO. We ended Q3 with 523 customers with greater than $1 million in ARR and 2922 customers with over $100,000 in ARR. This continued strong growth of large customers speaks to the strategic role we play in our customers' digital transformation journeys. Our 12-month trailing dollar-based net retention rate was 116%. While good for our business, our increased success of selling bigger bundles, selling multiple pillars from the start, and faster upsells within a year can reduce our dollar-based net retention rate in the future. There could be variability in this metric on a quarterly basis due to the factors I just mentioned. Turning to the rest of our Q3 financial performance, total gross margin of 81.4% compares to 80.8% in the prior quarter and 80.2% in the year-ago quarter. On a year-over-year basis, gross margins benefited by approximately 60 basis points from a change in accounting attributed to the longer useful life of our cloud infrastructure. As mentioned on our previous earnings call, beginning in fiscal 2024, we extended the depreciable, useful life of our servers and network equipment and our cloud infrastructure for four to five years. Moving on, our total operating expenses increased 2% sequentially and 21% year-over-year to $328 million. We continued to generate significant leverage in our financial model, with operating margin reaching 22%, an increase of approximately 680 basis points year-over-year. Our free cash flow margin was 22%, including data center CapEx of approximately 6% of our revenue. We ended the quarter with over $2.2 billion in cash, cash equivalents, and short-term investments. Moving on to guidance for Q4 and full-year fiscal 2024, as a reminder, these numbers are all non-GAAP. For the fourth quarter, we expect revenue in the range of $565 million to $567 million, reflecting year-over-year growth of 24% to 25%. Gross margins at 80%, operating profit in the range of $107 million to $109 million, net other income of $17 million, income taxes of $11 million, earnings per share in the range of $0.69 to $0.70, assuming 165 million fully diluted shares. For the full-year fiscal 2024, we're increasing our guidance as follows: revenue in the range of $2.140 billion to $2.142 billion, reflecting year-over-year growth of approximately 32%, calculated billings in the range of $2.603 billion to $2.606 billion or year-over-year of approximately 28%, operating profit in the ranges of $422 million to $424 million, which reflects up to 490 basis points of operating margin improvement compared to last year, income taxes of approximately $32 million, earnings per share in the range of $2.99 to $3.01, assuming approximately 161 million fully diluted shares. We expect our free cash flow margin to be in the low-to-mid 20%. We will give specific fiscal '25 guidance on the next earnings call, but I'd like to mention that the increased spend on the data center CapEx, which we'd originally planned for fiscal '24 is now planned for fiscal '25. Q3 was a transitional quarter for our go-to-market team, and I believe we did an outstanding job navigating through it. Although our attrition was higher than we expected, as Jay mentioned, we had a strong quarter hiring, particularly at the sales leadership level. We're now focused on increasing the pace of hiring quota-carrying reps. We believe the combination of our existing sales team with these new hires will result in a much stronger go-to-market organization. That said, new hires will take time to ramp to full productivity, which we believe will result in a few points of headwind to our total billings growth in fiscal '25. With our customer obsession, expanding platform, and strengthening sales teams, we're well positioned to continue to gain share in a large and growing market for us. With that, Operator, you may now open the call for questions.

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

Great, thanks for taking my questions, guys. Congrats on the quarter, really nice to see the results in, obviously, a difficult selling environment. I guess, Jay, I think one of the questions that we often get from investors is around security consolidation. And I think you gave a lot of great anecdotal evidence around the success of newer products and the traction you're seeing there. Could you expand upon that and just talk a little bit more about the role of Zscaler in broader consolidation, because it certainly feels like customers want to do more with less, and just how strategic is Zscaler in that initiative?

Of course, Matt, thank you. Customers do want consolidation and simplification of lots of point products, but they want to do it along the best of deep platforms. They don't believe in a single vendor offering the entire, what I may call, God security platform. Our customers are moving a bunch of front point products, the whole DMZ, demilitarized zone goes away. So, we are playing a big role in consolidation, we're taking out lots of firewalls, VPNs, and that's how lots of savings come. That's why we're able to justify the sale of our platform by taking out a lot of products. Now, customers do want two or three tiers of security. That's why often it's Zscaler for inline by a media vendor and identity vendor. But the notion of selling ELA bundled everything doesn't go well. More and more CIOs and CFOs are scrutinizing expenses with us being involved. So, consolidation is happening; we are playing a big role, but it's focused, selected consolidation, not a point blank give-me-everything type of stuff.

Thank you. Our next question comes from the line of Saket Kalia with Barclays. Your line is open.

Okay, great. Hey, guys, thanks for taking my question here, and echo my congrats on the quarter. Jay, maybe I'll make my question for you. I think we all know your views on firewall-based solutions. But I'm curious how you're faring competitively against the smaller competitors here that are maybe more purpose-built solutions. And do you feel like the market's view here on pricing is changing at all as we see more of those purpose-built competitors enter the market? So, the results certainly would indicate so, but just want to hear your view on that part of the competitive landscape.

So, thanks, Saket. So, yes, small vendors, as you know, we play in the large enterprise market. We don't really see some of these small vendors that are so-called purpose-built. A lot of those purpose-built vendors come from taking firewall as a service into a network together, and all that type of stuff. Part of the challenge I have with the idea of those solutions is that it facilitates lateral-type movement. So, where we are headed, we think services like SD-WAN have to go away, and it will be replaced with Zero Trust. That's the new market segment we are pioneering. So, we will keep on driving innovations. Sometimes investors think that these markets are static. They often ask the question, "Aren't these guys going to catch up with us?" Of course, they're trying to catch up and do what we did four years ago, but we've moved forward another two years ahead. In the cybersecurity space, it's a race, and we keep on innovating at a faster pace. And I don't think smaller vendors or legacy vendors will be able to catch up with us.

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

Great, thank you very much, and it's great to see you guys executing against a tough environment here. But I was taken aback by the commentary around the higher attrition in your sales organization even as you're bringing in a lot of additional new sales people and leadership. So, can you talk a little bit about the mechanics of why that is occurring? Is that a reflection of change on policy? Is it a change in skill sets that the firm thinks it needs? What has caused that attrition, and should we be sanguine when we're hearing that you're seeing accelerating people departing the firm?

So, Alex, with the departure of our COO, we saw higher attrition in Q3 than expected. But we expect it to stabilize in Q4. It's a combination of factors, including skill set. But I'm very pleased with how well the transition has progressed. With the hiring of key leaders in Q3, Mike now has a full management team. As you know, we have a great brand; we are a destination for top talent. With the right leaders, we have accelerated our pace of hiring quota-carrying reps in Q4. Our high-caliber leaders are attracting and hiring seasoned reps, and they will play a key role in taking us from $2 billion to $5 billion.

Yes, it's a great question, Alex. The attrition is both voluntary and involuntary. As Jay mentioned, with Mike Rich coming onboard, he's hired his entire leadership in his first quarter here; our focus now is going to be increasing the pace of hiring for quota-carrying sales reps. In the first month of this quarter, we hired the same amount of reps as we did in all of Q3. The leadership is going to drive the makeup of the sales and go-to-market organization. I feel very good about the direction we are going, I think it’s outstanding.

And if I may add, I think I'm very pleased with the transition; it's a part of the plan to bring Mike onboard to get to account-based selling.

Thank you. Please stand by for our next question. Our next question comes from the line of Brad Zelnick with Deutsche Bank. Your line is open.

Great. Thank you guys so much for taking the question, and congrats especially on all the emerging product success that you're having. Jay, I wanted to follow up on Saket's question, because I think some investors are concerned about intensifying competition in your market, not just amongst specialized players, but some of the bigger ones as well. And I know Zscaler has always distinguished itself first and foremost on its architectural advantage. But what can you share with us to help appreciate the durability of that advantage? And maybe for Remo, what quantitative metrics can you share whether it's win rates, pricing trends, sales cycle times, or anything else that can help us gauge the competitive environment? Thank you.

Okay. So, starting with architecture matters; it's like going from a traditional car to an electric car. Most of the large vendors are trying to build upon what they have, and we don't believe they'll ever get there. The market functionality is not static; it's moving and evolving. You recall when we went public six years ago, our platform was relatively small. Look at how the market has expanded; there’s a big market for workloads. We saw a number of deals we talked about where workload is gaining traction. Then there are trillions of IoT OT devices. We are the right platform; we're expanding in that area. The rapid pace of innovation is another factor that will keep us ahead in the long run. You've seen how well we have innovated and how quickly we will continue to do so. More importantly, I'm extremely proud of our Net Promoter Score — happy customers buy more. In fact, I counted the CXOs from Fortune 1000 companies who have bought Zscaler for more than once, and the number was 285. All these factors give me confidence in our position.

From a win rate basis, they continue to be very high; no change in win rates. Pricing trends are remaining constant. The strategic nature of our platform and what we provide for our customers is key. Our sales cycles for large deals continue to be nine to twelve months, moving more towards the twelve-month mark, with no change there either.

Regarding pricing pressure, there is some, but we are focused on value selling. We can show customers that we can save them significant amounts which leads to good pricing for us. Market scrutiny exists, but my team is doing a good job showing value by eliminating multiple point products.

Thank you. Please stand by for our next question. Our next question comes from the line of Roger Boyd with UBS. Your line is open.

Great. Thanks for taking the questions. Remo, I know you're not guiding to fiscal '25, but you did suggest that the attrition you're seeing in the third quarter would have a few points impact on growth next year. I don't think we'll comment on that, but wondering alternatively if you can just talk about your growth versus profitability framework. In the past, you've talked about biasing towards margin expansion under a certain level of growth, but the messaging right now sounds like you feel pretty confident about rehiring with the new sales leadership.

Yes, I think Zscaler is perfectly positioned with our platform in its early stages in this emerging market, where we're expanding our product base. From our view, we will still continue to invest in top-line growth. You saw in Q3, our operating profitability was 22%. When we went public, we set our operating profitability target at 20% to 22%. I am not concerned about operating profitability; the model will increase profitability naturally as business slows down. The focus remains on top-line growth, and I foresee a slight increase in our operating profitability in FY25.

Additionally, we will keep investing to drive innovation and develop disruptive technologies. And we will also continue investing in our go-to-market strategy.

Thank you. Please stand by for our next question. Our next question comes from the line of Param Singh with Oppenheimer & Co. Your line is open.

Yes, hi. Thank you. I want to understand your Q4 guidance a little bit. If I just go back the last couple of years, your year-to-year growth rate doesn't change much from Q3 to Q4, but there's a significant deceleration in your Q4 guide this time. So, I want to understand, is that something that I'm missing outside of a little bit of conservatism for higher sales attrition that maybe people are not thinking about right now?

Thank you for the question. We like being prudent. Q3 was a very strong quarter for us, beating consensus on a top-line basis by 8%. The fourth quarter of fiscal '23 included a large $20 million deal, making it a tough compare entering '24. Additionally, yes, the attrition did play a role in the guidance.

Thank you. Please stand by for our next question. Our next question comes from the line of Eric Heath with KeyBanc. Your line is open.

Thanks for taking my question, again, just really strong results in acceleration. I would be curious to hear some of your perspective more on the macro environment and just hear what customers' willingness to do transformational projects like SASE at the moment, especially when they seem to be hitting pause in other areas.

Yes, the macro remains tough. Scrutiny remains high. But the two things that are helping us: one, CIOs, CISOs, and boards remain very worried about cyber with all the ransomware attacks. If you play a critical role in minimizing cyber threats, as we do with Zero Trust architecture to minimize lateral movement, we get attention and engagement with C-level executives. Secondly, when you can show the CXO that your initiative will save them millions, you get more attention. We have a strong business value assessment team engaging early with C-level executives to show those benefits. There are few cyber companies that can show tangible savings like we do, often taking out firewalls and VPNs for savings. Our high-caliber seasoned salespeople who can engage with C-level institutions are a part of our expansion and growth.

Thank you. Please stand by for our next question. Our next question comes from the line of Joseph Gallo with Jefferies. Your line is open.

Hey guys, thanks for the question and really nice results, especially amidst a broader tough software market. Jay, how should we think about the sustainability of these growth numbers? And as you look out over the next 12 to 18 months, what are the biggest upside drivers to the top line model? Is it the Salesforce ramping or the new products? And congrats on that quarter of new business coming from emerging; how should we think about that next year?

The biggest upside, you mentioned Salesforce, which makes a big difference. This initiative is a big opportunity for us. Additionally, emerging products are valuable but generally take time to scale; the more sizeable contributions are from product point of view from ZIA, and ZDX. Data protection portfolio has grown significantly, and once we are in line for traffic inspection, we are best positioned for data protection. Zero Trust segmentation with the Airgap acquisition is a big new market we are entering, and we plan to drive expansion there significantly. With great product offerings and a robust go-to-market team, we have an excellence trajectory.

Thank you. Please stand by for our next question. Our next question comes from the line of Fatima Boolani with Citi. Your line is open.

Good afternoon. Thanks for taking my question. Jay and Remo, I wanted to reconcile the strength in the execution this quarter against the commentary around the higher-than-expected sales capacity attrition. I'm wondering if you can map back to anything internally that helped drive that outperformance on sales execution in spite of sales capacity departures. Also, how are your verticalization efforts yielding relative to expectations?

To start, verticalization is a journey; it’s on track. Companies initially focused on services should gradually pivot towards vertical markets. We've initiated our vertical journey first in federal, followed by health care, with significant initiatives planned for expansion in the coming quarters. It is progressing well, and Mike Rich, with his prior experience, continues to lead it effectively. Regarding strong execution despite attrition, Zscaler is not just a point product; teamwork plays a critical role. We require seasoned CXOs, architects, and engagement with top talent. The impact of departing sales representatives is limited, and we've continued to perform well as depicted in our results.

The execution seen in the quarter was a result of the entire sales organization working well together, not just the new hires. We observed the execution being driven by robust relationships and engagements at the executive level. It is a strategic sale and more than just a general box sale, and that is vital to making transformational changes.

To add, our customers view us as a strategic partner, which contributes to our high retention rate.

Thank you. Please stand by for our next question. Our next question comes from the line of Shrenik Kothari with Baird. Your line is open.

Yes. Thanks for taking my question. Congrats on the great quarter. So, Jay, you highlighted data protection in the Q&A. As AI workloads grow and digital and cloud adoption continues across industries, how do you see new verticals and new use cases impacting your TAM and driving growth in the next year?

Yes. The new use cases and products are definitely increasing our TAM. In fact, if you look at data protection, it used to be only DLP inline; now it includes data at rest, endpoint data, data at public cloud and SaaS security, and vendor supply chain data loss. Expanding into areas like DSPM broadens our TAM significantly. AI increases our TAM too, embedding it into all products. Additionally, Zero Trust at the branch is an area we are entering that will also expand our TAM. Over the next few years, we anticipate significant growth, adding somewhere in the $10 billion to $20 billion on top of the previously talked about $72 billion TAM.

Thank you. Please stand by for our next question. Our next question comes from the line of Gray Powell with BTIG. Your line is open.

Great. Thanks for taking the question. Anecdotally, we've heard that larger GSIs, such as Accenture, are fans of Mike Rich. How can he enhance those relationships and drive more growth?

That's a good point. We stated last quarter that Mike's key initiatives are transitioning from opportunity-centric to account-centric, augmenting GSI partnerships, and vertical expansions. All three areas are progressing well. GSIs recognize the value we bring. We’ve been working together on various deals, but Jay's sometimes impatient and insists we can do more. Bringing in higher caliber leaders from GSIs will accelerate growth in this area.

Thank you. Please stand by for our next question. Our next question comes from the line of Joshua Tilton with Wolfe Research. Your line is open.

Hey, this is Patrick on for Josh. Recently, several firewall and VPN-based vulnerabilities were disclosed by some of your competitors. Can you talk about the impact those have had on demand, if any? And anything specific to highlight in the federal space?

Yes. It's true that vulnerabilities from leading VPN vendors and firewall suppliers have increased demand for our products. We're seeing a significant number of engagements arising from VPN vulnerabilities that the federal government has focused on. Although I can't provide a precise number, it is meaningful. Customers are realizing that whether it's an on-prem VPN or cloud service, they still face similar risks. We are replacing many of these, starting with ZPA, then many moves towards Zero Trust segmentation. Our federal business has been growing well; we're pleased with our progress, and guidance from CISA is playing a significant role.

Thank you. Please stand by for our next question. Our next question comes from the line of Gregg Moskowitz with Mizuho. Your line is open.

Okay, thank you for taking the questions. Jay, workload protection has performed well, but historically the deal sizes have been limited. Given your recent successes, do you think we may be at an inflection point for workload protection, or does the pipeline still indicate a longer timeline? And a quick clarification for Remo, you mentioned operating profitability going up slightly in fiscal '25. Does that apply to Op margins as well?

Regarding workload protection, while it is strategic for us, and we're seeing good growth, the deal sizes remain limited for now. It’s about getting bigger traction; however, the market potential is promising. As for margins, yes, I've referred to operating profit margin percentages.

I want to emphasize, we are pioneers in Zero Trust Communication and Workload, and have the potential for expansive growth. The deal sizes in technological companies are increasing; traditional companies are slower due to production workloads.

Thank you. Please stand by for our next question. Our next question comes from the line of Tal Liani with Bank of America. Your line is open.

Hi, guys. My question is on NRR. You discussed upsells and new products and their expansion, but your NRR has declined from 120% to 117% to 116% in the last three quarters. How can that decline be reconciled with your commentary on expanding products? Conversely, the contribution of new customers has now risen to 50% of your growth this quarter. Can you elaborate on this development and the profile of new customers you're attracting?

Yes, the NRR at 116% remains strong. Several integrative factors influence NRR. We're working to sell the user platform, leveraging various additions such as ZIA, ZPA, and ZDX. Additionally, when customers buy within the year, it doesn’t capture their NRR. Our existing speed and value propositions are key indicators.

A 116% NRR is impressive from our perspective.

As addressed earlier, quicker selling often correlates to lower NRR metrics, while larger bundles often lead to lower retention.

Thank you. Due to the interest of time, our final question comes from the line of Adam Borg with Stifel. Your line is open, Adam.

Awesome. Adam Borg with Stifel, thanks for taking the question. Maybe for Jay on the Advanced Plus Bundle, I know this is a newer offering that you discussed a few quarters back, and it has a healthy pricing uplift given some of the new AKI capabilities. Could you talk more about how that Advanced Plus Bundle is resonating and what percent of the installed base you think it addresses over time?

Overall, our customers are buying bigger bundles. That’s why our ARR is rising, because the bigger bundles can take out more products. I can't provide quantifiable figures, but overall, the trend of our customers towards larger bundles indicates a positive direction. We are no longer just selling user packages; we’re offering comprehensive platforms and integrated services. Well, thank you for your interest in Zscaler. We look forward to seeing you at some upcoming conferences. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.