Earnings Call Transcript - ZS Q3 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the Zscaler Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentations, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Bill Choi, Senior Vice President of Investor Relations and Strategic Finance. Mr. Choi, the floor is yours.

Bill Choi, Senior Vice President of Investor Relations and Strategic Finance

Good afternoon, everyone, and welcome to the Zscaler Fiscal Third Quarter 2022 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'll find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release. I'd like to remind you that today's discussion will contain forward-looking statements, including, but not limited to, the company's anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow, dollar-based net retention rate, future hiring decisions, remaining performance obligations, income taxes, earnings per share, our objectives and outlook, our customer response to our products and our market share and market opportunity. These statements and other comments are not guarantees of future performance, but rather are subject to risk and uncertainty, some of which are beyond our control. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC as well as in today's earnings release. We will upload a copy of today's prepared remarks to the IR website when we move to the Q&A segment of the call. I would also like to inform you that we'll be attending the following upcoming events in June: Loop's Software Conference on June 1; Bank of America's Global Tech Conference on June 8; Mizuho Virtual Cybersecurity Summit on June 13; and we will also host an investor briefing focused on our latest innovations at the Zenith Live Conference on June 22. Now I'll turn the call over to Jay.

Jay Chaudhry, Chairman and CEO

Thank you, Bill. We are pleased to report another strong quarter. In Q3, we delivered 63% year-over-year revenue growth, 54% billings growth and 15% free cash flow margins, all while investing for high growth. While most public SaaS companies are happy to achieve the Rule-of-40, we again exceeded the Rule-of-70 based on revenue growth and free cash flow margins. With our increased guidance today, we expect to achieve the Rule-of-80 for the full year. We are not only delivering excellent growth; we are also delivering strong profitability. We are disciplined in making investments for innovation and go-to-market scale. With the breadth and depth of our ever-expanding Zero Trust platform, we can efficiently sell to our growing base of enterprise customers. We believe our clear focus on securing large enterprises makes us the partner of choice for our customers' Zero Trust security journey. While there are broader macro challenges and economic uncertainties, we have seen an increase in large, multi-year commitments for multiple product pillars of the Zscaler platform, as periods of uncertainty can act as a catalyst for change. This, coupled with growing cyber threats such as ransomware, is driving IT leaders to transform security from traditional models to zero-trust architecture. In this environment, customers cannot risk transformational and mission-critical projects with immature offerings from unproven vendors. As the pioneer and category leader in Security Service Edge or SSE, with the widest and deepest offerings, Zscaler is the trusted partner for vendor consolidation, cost savings, increased user productivity, and better cyber protection. We are adding new Global 2000 customers at a record pace. In the last two quarters, we added close to 80 G2K customers. Now 40% of the Fortune 500 and 30% of Global 2000 companies trust Zscaler to secure their digital transformation. Approximately half of our Global 2000 customers have both ZIA and ZPA, and I am excited to report that ZPA has surpassed over $200 million in annualized revenue. In Q3, we had significant growth in new $1-million-plus ACV deals across major geographies and customer verticals. We are seeing an acceleration in multi-year, multi-product pillar deals as enterprises are racing to transform their business. We provide a path for large strategic customers to ramp into larger and longer commitments for our entire transformational platform, not just for elements of it. This is driving strong growth in bookings, with the total value of our committed future revenue reaching a key milestone. It has surpassed $2 billion. Now, let me highlight some customer deal wins during the quarter. As I mentioned before, I believe all customers will ultimately purchase ZIA, ZPA, and ZDX for all users. This quarter, we have seen ample evidence that customers are buying ZIA, ZPA, and ZDX together, providing Zero Trust security for users with fast user experience. In a new logo win, a global 500 food services conglomerate headquartered in Europe purchased ZIA, ZPA, and ZDX for all 100,000 users. Leveraging our globally distributed SSE platform, this customer is consolidating dozens of different vendor point products across hundreds of locations in 45 countries. The customer was most excited about having a single Zero Trust security policy framework for in-line inspection across its business units in every location. Given the significant cost savings, upgraded security, and improved user experience across the company, the CEO and CFO signed off on this non-budgeted, 4-year commitment. In addition, they started a paid pilot for our Zero Trust for Workloads offering for their sizable AWS footprint, which we are very excited about. Next, in an upsell deal, a Global 10 oil and gas customer headquartered in Europe, after deploying ZIA and ZPA for 100,000 users, purchased ZDX for all 100,000 employees. ZDX is delivering immediate value by reducing the customer’s time to troubleshoot performance issues by 50% to 80%, while consolidating 40 legacy performance point products. In addition, the customer upgraded to our newly introduced ZPA Transformation bundle that includes browser isolation, application protection, and deception services. This is a 4-year deal that increased the customer’s annual spend by over 70%. This customer’s journey with Zscaler is remarkable: I remember sitting with the chief architect in their office, finalizing the purchase of our ZIA Professional bundle six years ago. Since then, their annual spend has increased over 14 times to well over $10 million. Next, we look forward to working with them on Zero Trust for Workloads. In an upsell win, a Fortune 500 Bank in Asia that has deployed ZIA for over 50,000 users purchased ZPA and ZDX for all 50,000 employees. This is another example of a large customer buying ZIA, ZPA, and ZDX for all users. While the immediate objective for this deal was to replace a legacy multi-vendor VPN infrastructure, ZPA was selected to implement zero-trust access by establishing an application-level policy, where users connect to specific applications, not to a network, hence achieving app segmentation without having to do legacy network segmentation. ZPA did not just replace VPN; it’s eliminating the need for the entire inbound DMZ including DDoS protection, app delivery controllers, and firewalls, generating a payback on their Zscaler purchase within 6 months. Because of this substantial ROI, even in a tougher macro, Zscaler can help reduce costs while driving transformation. Our integration with Microsoft’s E5 suite across ZIA and ZPA was also an important decision factor for them. This latest purchase more than doubled the customer’s annual spend. ZIA, ZPA, and ZDX together form a complete solution to implement Zero Trust for users. Our next immediate big opportunity is Zero Trust for workloads, powered by the same core ZIA and ZPA technology. Let me highlight a few exciting wins in this area: An existing Fortune 100 financial services customer with ZIA deployed for 60,000 users purchased Zero Trust for Workloads to protect 50,000 workloads spanning across multiple data centers and public clouds. This multi-million-dollar ACV deal is our largest workload deal to date and more than doubles the customer’s annual spend. The customer now protects both users and workloads under a single policy framework, enhancing their cyber protection, providing visibility, and simplifying operations. Lastly, let me discuss a new customer purchasing all four product pillars together. An elite research university purchased our comprehensive ZIA, ZPA, and ZDX offerings for 35,000 users and Zero Trust for Workloads for over 3,000 workloads for their multi-cloud environment. Their CIO’s top priority is to eliminate the risk of legacy VPNs and lateral threat movement as universities are increasingly becoming targets for ransomware and intellectual property theft. Also, a critical requirement for this win was our Zero Trust platform meeting the criteria of the Zero Trust framework as recommended by NIST. We closed this 3-year, 8-figure deal through the AWS marketplace. I’m very happy with our continued success in expanding our routes to market via cloud marketplaces. Next, I am excited to highlight the U.S. Federal government where we’re having considerable momentum. Driven in part by the President’s Executive Order, we are seeing increased interest in our Zero Trust Exchange across all levels of the government. We are excited to help our country dramatically improve our security posture while significantly reducing legacy IT costs. We have the highest level of FedRAMP certifications for ZIA and ZPA. In addition, ZPA is the only Zero Trust solution with DoD IL5 certification. There are only a select few cloud companies that have this level of certification, and there is no other cybersecurity company at this level. IL5 certification is an important differentiator for us. Let me highlight two new customer wins this quarter where this was an important factor: First, a defense contractor that purchased ZIA and ZPA in a 6-year seven-figure ACV deal. Second, a DoD unit also purchased ZPA for secure access to SAP instances in AWS Gov cloud. Two important considerations for our ongoing success in the Federal market are: First, ZPA is the only cloud security service with FedRAMP High authorization for Zero Trust Remote Access. We connect users to applications and not to the network, eliminating lateral threat movement, a core principle of zero trust architecture that can’t be achieved by next-gen firewalls or cloud VPNs. Second, ZIA’s proxy architecture, which inspects TLS-encrypted traffic at scale delivering superior security. Our proven track record running the world’s largest inline security cloud makes Zscaler the obvious and trusted partner of choice for governments and enterprises. We now have 288 customers exceeding $1 million in ARR, an increase of 77% year-over-year. We deliver a mission-critical service that requires unmatched reliability and availability for an inline cloud. There is no compression algorithm for over 10 years of operational experience running such a cloud. An example of our proven scale is that Zscaler processes over 240 billion transactions inline per day, which is more than 20 times the number of Google searches per day. Now, let me share a few observations about our high net retention rates, which have exceeded 125% for the last 6 quarters. We made a number of investments in customer success services, technical account managers, partner services, and certification of partners, which together are driving a faster and greater adoption across our broad portfolio. We have a solid blueprint for accelerating value delivery, which is driving upsells. All of these investments result in happy customers, demonstrated by our Net Promoter Score or NPS of more than 70, which is more than 2 times that of an average SaaS company. Next, let me now highlight our rapid pace of innovation. After having built the most comprehensive platform to provide Zero Trust for Users, we are now expanding it for Zero Trust for Workloads. Unlike scores of vendors who offer point-products for cloud-native apps, Zscaler has developed a fully integrated CSPM, CIEM, and Infrastructure-as-Code Scanning with a common backend and fully correlated, actionable dashboard. Gartner calls this functionality CNAPP, but we have moved beyond CNAPP by integrating the threat and data awareness from ZIA and ZPA. We will be highlighting it and other innovations at Zenith Live, our annual cloud summit next month. We enhanced our AI/ML engine for ZDX, our fastest-growing new service, to leverage billions of telemetry points from millions of users to improve digital user experience. It can not only automatically identify what and where performance issues are, but can also provide information about the quality of voice, video, and screen sharing due to our integration with Microsoft Teams and Zoom. We have also integrated ZDX with ServiceNow, making customer end-user support far more efficient. ZDX also got certified and became available on our Federal cloud. Our ThreatLabZ security research team is tracking over a dozen APT groups and getting better reconnaissance about their tools and behavioral patterns, resulting in higher-order threat intelligence. This specific threat intel, coupled with our massive cloud effect from 240 billion transactions and 300 trillion signals per day, enables Zscaler to deliver better threat protection than other vendors. Moving beyond users and workloads, we are now bringing Zero Trust to IoT/OT systems, a large emerging opportunity. Today, Siemens and Zscaler announced the availability of an integrated all-in-one solution to accelerate secure access to OT systems. Our joint development with Siemens brings the benefits of Zscaler to factory and industrial control systems. We are thrilled to have Siemens, a long-standing customer, as a development and go-to-market partner. In closing, in spite of uncertain macro conditions, we continue to see strong demand for our services. We are in a strong financial position, and we will continue to aggressively invest in our business. We are focused on hiring and developing talent and creating a culture that rewards innovation at all levels. We have grown our global organization to approximately 4,500 employees who are energized by our shared mission to secure the hyper-connected world of cloud and mobility. We grew our total sales and marketing headcount by 54% year-over-year, and we remain focused on investing in our go-to-market machine. In today’s competitive hiring market, Zscaler is a destination for top talent. To drive continued growth in hiring and to build on Zscaler’s high-performing hybrid-work culture, this month, we welcomed Brendan Castle, Google’s former global head of talent acquisition, as our new Chief People Officer. Brendan has proven experience in building highly motivated and productive teams at scale. With app transformation already mainstream, network and security transformation is also becoming mainstream, which we pioneered with our Zero Trust Exchange. We believe customers trust Zscaler more than any other provider for securing their cloud journey. Recent uncertainty in the macro environment is driving customers to accelerate their network and security transformation with our integrated platform, resulting in reductions in cost, complexity, and business risk. We are adding a record number of Global 2000 customers, now with 30% of Global 2000 and 40% of Fortune 500 customers trusting Zscaler. These demanding customers are making large multi-year commitments to our platform. We are not just growing rapidly at any cost; we are also profitable and delivering efficient growth. We will continue our disciplined investment in innovation and growth to capture the large and growing opportunity ahead of us. Now I'd like to turn over the call to Remo for our financial results.

Remo Canessa, CFO

Thank you, Jay. As Jay mentioned, we are pleased with the results for the third quarter of fiscal 2022. Revenue for the quarter was $287 million, up 63% year-over-year and up 12% sequentially. On a year-over-year basis, revenue growth exceeded 60% for the third straight quarter, driven by strong customer demand for our Zero Trust platform. ZPA product revenue was approximately 18% of total revenue, growing 87% year-over-year. From a geographic perspective, we had broad strength across our three major regions. The Americas represented 52% of revenue, EMEA was 33%, and APJ was 15%. APJ continues to be our fastest-growing region with revenue growth of 105% year-over-year. Our total calculated billings grew 54% year-over-year to $346 million, with billing duration comparable to a year ago and above the midpoint of our normal 10 to 14 months range. Our remaining performance obligations, or RPO, grew 83% from one year ago to $2.216 billion. The current RPO is 49% of the total RPO. Our strong customer retention rate and our ability to upsell the broader platform have resulted in a high dollar-based net retention rate, which was again above 125%. We had 288 customers paying us more than $1 million annually, up 77% from 163 in the prior year. I’m very pleased with the pace at which we are adding these $1 million ARR customers: we increased by 37 customers in the quarter. The continued strength in this metric speaks to our large enterprise focus and the strategic role we play in our customers’ digital transformation initiatives. We added 140 customers in the quarter paying us more than $100,000 annually, ending the quarter at 1,891 such customers. Turning to the rest of our Q3 financial performance, total gross margin of 80.6% was approximately flat quarter-over-quarter and year-over-year. Our total operating expenses increased 11% sequentially and 70% year-over-year to $204 million. Operating expenses as a percentage of revenue was 71% compared to 68% in the year-ago quarter, due to a partial return of T&E. Operating margin was 9% and free cash flow margin was 15%. We continue to expect data center CapEx to be around high-single-digit percent of revenue for the full year. We ended the quarter with over $1.66 billion in cash, cash equivalents, and short-term investments. Now, moving on to guidance and modeling points. As a reminder, these numbers are all non-GAAP, which excludes stock-based compensation expenses and related payroll taxes, amortization of debt discount, and amortization of intangible assets. We are once again increasing our guidance across all metrics. For the fourth quarter of fiscal 2022, we expect revenue in the range of $304 million to $306 million, reflecting a year-over-year growth of 54% to 55%; gross margins of 79%. I would like to remind investors that a number of our emerging products, including ZDX, Workload Segmentation, and CSPM, will initially have lower gross margins than our core products because we are more focused on time-to-market and growth rather than optimizing them for gross margins; operating profit in the range of $33 million to $34 million. We have more in-person events this quarter, including customer events, Zenith Live, and RSA conferences; net loss on other income of $500,000; income taxes of $3 million; earnings per share of $0.20 to $0.21, assuming approximately 146 million to 147 million fully diluted shares. For the full-year fiscal 2022, we are increasing our revenue guidance to approximately $1.078 billion or year-over-year growth of 60%, increasing calculated billings to a range of $1.425 billion to $1.430 billion or year-over-year growth of approximately 53%, increasing our operating profit to a range of $106 million to $108 million, increasing our earnings per share to a range of $0.64 to $0.65 assuming approximately 147 million to 148 million fully diluted shares; free cash flow of $215 million, reflecting free cash flow margin of approximately 20% for the full year. With a revenue growth outlook of 60% and free cash flow margin of 20%, we expect to operate at the Rule-of-80 for the full year. With customers increasingly adopting the broader platform with longer-term commitments, we plan to invest in capturing our large market opportunity. We have confidence in the durability of our business model, with very high contribution margins after the initial land and a proven ability to retain and upsell to our enterprise customer base. We will balance growth and profitability based on how our business is growing, but we will continue to prioritize growth, which we believe is in the best interest of our shareholders, employees, and customers.

Operator, Operator

Our first question comes from Andrew Nowinski of Wells Fargo.

Andrew Nowinski, Analyst

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

Remo Canessa, CFO

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

Jay Chaudhry, Chairman and CEO

Yes. Andrew, as you know, the President's executive order is to implement Zero Trust architecture, and it aligns well with what we have done. To be successful in federal, you need two things. One, you need the right architecture, Zero Trust, which we have. Two, unique FedRAMP certifications, and we have the highest FedRAMP certifications. Now there's a timing issue as well. The White House issued a memo setting a timeline for agencies to achieve Zero Trust architecture within 2 years. These plans are being submitted, and more budgets are becoming available. All of this is positive long-term development from our point of view. However, Fed opportunities always save time.

Operator, Operator

Our next question comes from Alex Henderson of Needham.

Alex Henderson, Analyst

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

Jay Chaudhry, Chairman and CEO

Thank you, Alex. Firstly, regarding the implementation of Zero Trust, some people mistakenly create a basic VPN replacement and label it as Zero Trust. What we have developed with Zscaler Private Access is a comprehensive platform that replaces the entire inbound DMZ. There’s no need for anything between Zscaler and the workload or application in operation. Additionally, we’ve expanded our capabilities to include browser isolation, application protection, internal deception, and EIM-based policy for segmentation. This strength is a key reason we're securing significant ZPA deals. As for attacks, an attacker must first locate you. With our Zero Trust architecture, your applications are concealed behind Zscaler, making it impossible for them to detect you. Furthermore, addressing the threat of attacks requires a robust proxy architecture that terminates connections, inspects packets, decrypts them, and mitigates risks. We have developed a highly scalable architecture that far exceeds anything available today. Our unique approach, coupled with over a decade of experience managing an extensive inline cloud, sets us apart from competitors. On that note, many of our competitors emerging from the CDN, DDoS, or DNS sectors tend to focus on servers. We, however, prioritize users from the outset. It requires considerable time and experience to cultivate the extensive functionality we offer with ZIA, ZPA, and related features, which I believe will make it challenging for others to catch up to us. We continue to innovate at a rapid pace.

Operator, Operator

Next, we have Hamza Fodderwala of Morgan Stanley.

Hamza Fodderwala, Analyst

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

Remo Canessa, CFO

There are a lot of questions, but let me see if I can go through and just kind of give you my view, and maybe Jay can add on that also. Currently, we're at the Rule-of-80. That's what we're projecting for this year. And the way we define the Rule-of-80 is our revenue growth along with our free cash flow margin. Our free cash flow margin this year is projected to be 20%. It was 20% last year. So we're in a unique position to take advantage of this market opportunity because we've got significant cash flow coming into the company as well as being in the early stages of this market. So we're going to continue to make investments as we go forward. Those investments will span across the board throughout the organization, and our goal is to get to a $5 billion ARR company. So we're building the infrastructure in place to achieve that. Related to employees and incentives with the stock options and cash incentives, the cash incentives that we discussed on the last call are in response to the frothy environment; last quarter, many start-ups and companies saw substantial packages. We adjusted our merit to ensure our employees are at market levels. So from a cash compensation perspective, we're well-positioned. Regarding stock, all companies have seen decreasing stock prices. What we're doing is evaluating that. No decisions have been made yet regarding what we plan to do about stock. However, what I can say is that our stock-based compensation as we move forward will decrease as a percentage of revenue. When you reach a certain scale as a company, stock-based compensation tends to decline. We'll follow the same path as large companies, and you will see our stock base decreasing over time. Regarding the pace of hiring, we're witnessing all the trends that you're observing related to the global macro environment. However, from our perspective, we are essential to our customers. As Jay noted, our deal sizes are increasing. Our strategic nature and our engagement with our customers are intensifying. So our plan is to continue our pace of hiring, and should we find opportunities to increase that rate, we will do so. Now regarding insight about operating profitability and growth. We are mindful of operating profitability as a priority, as Jay and I are cautious with the bottom line. So we recognize the vast market opportunity and feel we're the leader in that segment. We will keep investing prudently, as we believe it serves the best interests of our shareholders and our employees.

Jay Chaudhry, Chairman and CEO

If I may add two quick comments to what Remo said, with very high gross margins and unit economics, it becomes easier for us to invest in businesses. Secondly, the hiring environment has actually improved. We are hearing about high-flying companies that raised funding and achieved multibillion-dollar valuations last year; they are starting to lay off or freeze hiring, and companies focusing on growth at any cost are now beginning to slow down. So we will continue to accelerate our plans since our customers want to leverage Zscaler to enhance their transformation and competitiveness.

Operator, Operator

Next, we have Matt Hedberg of RBC Capital Markets.

Matthew Hedberg, Analyst

Congrats. Jay, what really stood out to me was the success in large deals and multiproduct sales. I think it is especially impressive given the partner momentum in some of these large deals. Can you talk about the importance of hyperscalers? I believe you called out an 8-figure deal. Is there more that you can do to drive even faster partner contribution? Because it really does feel like that flywheel is really kicking in well.

Jay Chaudhry, Chairman and CEO

Yes. The partner momentum comes from two sides. One is partners like Microsoft, who have helped us even without fulfillment through the marketplace. That momentum has been leveraged for the past several years. Now it has extended over to AWS quite a bit. So that's one area. The second area is being able to deliver orders through cloud marketplaces. It represents one more channel for our revenue. Our business through both AWS and Azure has been steadily growing, and these current views are seen as part of a cloud transformation solution. So when it's focal through a marketplace channel, it often comes out of annual cloud spend that's already committed by the customer with a hyperscaler. So that facilitates easier transactions in many ways. In Q3, we had one of our largest deals through the AWS marketplace. If you recall, we executed a very large deal last quarter through Azure Marketplace, and we are training AWS and Microsoft sales teams. I believe there's a good opportunity to create more leverage. You’ve seen our momentum in larger deals over the last two quarters—we've added nearly 80 Global 2000 companies to our portfolio, which is remarkable, and we don't anticipate any slowdown.

Operator, Operator

Next, we have Patrick Colville of Deutsche Bank.

Patrick Colville, Analyst

Thank you so much for having me on and echoing everyone else's congratulations on a very impressive set of numbers. My question is on the billings guide, which to me was probably the standout metric of the quarter. It seems to be above where many investors were expecting, which is very healthy. Can you just discuss what you see in the pipelines for fiscal fourth quarter and the health that underscores your confidence in providing that strong billings guidance for the fiscal year?

Remo Canessa, CFO

Yes. I'll start, and Jay, if you'd like to add anything. We have a strong pipeline. As we talked about, we're becoming more strategic. Our deal sizes are getting larger. We review our pipeline with our sales organization, and based on our projections, we provided a strong guide, Patrick, which is basically up 6%. The key thing is that with the changes in the world regarding applications moving to the cloud and users becoming more mobile alongside workloads existing in both cloud and on-premises, the Zscaler platform addresses this market effectively. Additionally, the efficiency we create for customers yields a very attractive ROI, which stands out. We are seeing large customers adopt more of the platform as Jay has mentioned, and we are experiencing growth in that area. So our guidance reflects our assessment of the pipeline and our understanding of customer engagement.

Jay Chaudhry, Chairman and CEO

Yes. So I concur with Remo's statement. Our projections consider both the pipeline and customer engagements. At a qualitative level, as I engage with numerous CIOs and CSOs, there is a sense of uncertainty out there, and they are beginning to evaluate how to reduce costs and complexities through consolidation. We become increasingly important in this regard, as customers strive for transformation. We help them achieve this. Additionally, cybersecurity remains a significant concern. Consequently, when these factors converge, customers are eager to learn what all security and networking products they can replace with ours. Now we are able to discuss a more extensive set of products needing replacement, which leads to a larger portion of the platform being purchased. It is intriguing to observe that, certainly among some high-flying private startup companies, there is a shift toward discussions about reduced hiring, indicating that the unnecessary noise in the market is expected to dissipate. We remain optimistic about our business.

Operator, Operator

Next, we have Joel Fishbein of Truist.

Joel Fishbein, Analyst

I'll echo the congratulations on the great execution this quarter. Jay, I just want to ask about workload segmentation. It sounds like you're very excited about it and have some good uptake. I’m interested in go-to-market strategies around workload segmentation and IoT as well as OT. It doesn’t seem like they naturally align as they have different buying centers within organizations compared to ZIA, ZPA, and ZDX. I would love to hear your plans for targeting those specific areas and increasing deal sizes.

Jay Chaudhry, Chairman and CEO

Very good question. In Q2, we discussed how a number of our large customers are beginning to buy Workloads, our Zero Trust for Workloads, but at a small scale. This last quarter, we've started to see them purchasing some large orders in this area, which is promising. Regarding buyers and the products, Cloud Protection products can be categorized into two broad buckets. One, what Gartner now refers to as CNAPP, which encompasses CSPM and CI-type offerings; this represents API-based security and is a newer focus for everyone. We have a great offering in this space, which we've revamped, and will be launching at Zenith Live next month. Concurrent with that is Zero Trust for Workloads, which utilizes ZIA and ZPA technology designed for workloads, as these flows need to access the Internet through the ZIA engine and communicate with each other through the ZPA engine. This is introducing Zero Trust to workloads. Combining the in-line aspects and API components sets us apart from other vendors. Regarding purchasing centers, if we were selling at a lower level, the buying process would differ significantly. Irrespective of who is acquiring the product, when it pertains to security, the CSO is inherently involved. Our strong relations with CSOs aid us in selling Zero Trust, Workload, and Cloud Protection. Our engagement with Heads of Networking is also strengthening because previously, you had to extend your data center to the cloud using dedicated links. We are also building more rapport with the DevOps side of the business. While our relationships with CSOs are robust, and are facilitating our growth, we are not establishing an overlay team. Instead, we are hiring product specialists to work closely with our broad sales team. Did that help?

Operator, Operator

Next, we have Fatima Boolani of Citi.

Fatima Boolani, Analyst

Remo, this question is for you. In Jay's script, there were many anecdotes highlighting multi-land transactions and the 8-figure deal momentum alongside the $1 million customer momentum. I wanted to ask, from a booking standpoint, you noted that you’re seeing bigger multi-year commitments from customers. We aren’t yet seeing that reflected in billings in terms of invoicing duration. I'm curious if you could share observations about your backlog? Are there any duration impacts that we should be considering more critically?

Remo Canessa, CFO

Yes. That's a great question. When examining our RPO and CRPO growth on a year-over-year basis, those are committed deals. Our RPO growth was 83% and our CRPO growth was 75%. Concerning duration, it was comparable on a year-over-year basis. There are no headwinds here; we expect duration to fall within the normal 10 to 14 months range. Thus, the key insight from billings is that it reflects calculated billings, which is derived from deferred revenue. We consistently monitor RPO and CRPO growth rates, with RPO at 83% and CRPO at 75% year-over-year. However, while these metrics are impressive, we believe billings remain the best measure for Zscaler, given the typical duration of 10 to 14 months. The actual commitments made by customers to Zscaler are quite noteworthy.

Jay Chaudhry, Chairman and CEO

And Remo, if I may add, this was an outstanding quarter with numerous customers undertaking multi-product pillar deals for multiple years, which is very encouraging.

Operator, Operator

Next question comes from Ben Bollin of Cleveland Research.

Benjamin Bollin, Analyst

Good afternoon, I wanted to revisit the topic of cloud marketplaces. Remo, can you quantify how much of the business is being transacted over cloud marketplaces today, or how that has evolved? Additionally, I would like to understand any margin implications of that business compared to other sales channels.

Remo Canessa, CFO

Yes. I mean, there isn’t currently much business going through cloud marketplaces. However, we view that as an essential channel for our future growth. Regarding margins, we anticipate healthy margins through the marketplace. Jay, do you want to add on this?

Jay Chaudhry, Chairman and CEO

Yes, one aspect to consider is that our business through cloud marketplaces has been consistently growing. However, I don’t think the fulfillment channel itself drives our operations. I personally care about partners who assist in strategic sales to customers. For instance, having a Microsoft accounting executive sit down with a CIO to discuss a large deal is incredibly valuable. Moreover, engaging the cloud hyperscaler sales teams is becoming increasingly important because they are compensated for business that comes through the channel marketplaces. Therefore, we are focusing on training the AWS and Microsoft sales teams, which benefits both sides.

Operator, Operator

And next, we have Tal Liani of Bank of America.

Tal Liani, Analyst

I have two questions. One, in general, I'm trying to understand the impact of an economic slowdown on your business. This is a philosophical question; it’s something many investors are asking, and I’d like to hear your thoughts on the topic. Secondly, as we focus on cash flow and margins, I note that your operating margin in the last four quarters declined from 13% to 8.7% in the previous quarter and slightly recovered this quarter, concurrently with revenue growth of about 50%. However, we’re not witnessing significant margin leverage. If I look forward over the next two to three years, can you speak about margin leverage and what needs to happen for you to see serious margin upside?

Remo Canessa, CFO

I'll start with that. We absolutely do have leverage in the model. In a SaaS model with 80% gross margins and the scale we are reaching, we do anticipate that leverage can improve. What we've discussed indicates that with this large market opportunity, it would be unwise for us to prioritize top-line operating profitability at this moment. It’s essential to note that our free cash flow margin was around 20% last year, and we anticipate it will remain at 20% this year. When you have a free cash flow margin like that as a company while making investments at this scale, there is no better use of our cash and resources than investing back into the business—executing and driving top-line growth. That said, we’re conscientious and will focus on operating profitability if necessary; however, our current position allows us to focus on growth. From an economic slowdown standpoint, security remains a vital concern, and organizations are under increasing threat. Consequently, companies that face downturns must seek cost reductions. Our ROI is exceptionally strong, enabling significant benefits, which is appealing even during economic challenges.

Jay Chaudhry, Chairman and CEO

Yes, I want to add two brief points. Firstly, the uncertainty in the current climate aids us since we can help customers with cost and complexity reductions. Furthermore, our leading products have achieved significant scale and generate strong margins. We are choosing to reinvest that to bolster the growth of new products. Our previous introductions, like ZPA and ZDX, have proven successful, and we maintain high hopes for Workload Protection as well. Thus, we are optimistic regarding our potential for further growth.

Operator, Operator

Next, we have Roger Boyd of UBS Securities.

Roger Boyd, Analyst

Congrats on the results. Just a brief question on SD-WAN. Historically, you've had some success tied to adoption there. I understand Zscaler is agnostic to how customers ultimately onboard to the Zero Trust Exchange. However, with some of the SD-WAN vendors facing disruption in market share and potential change of ownership, how do you perceive these changes as potential opportunities or risks?

Jay Chaudhry, Chairman and CEO

Yes. Prior to COVID, Zscaler typically started its engagements with network transformation. When COVID transpired, SD-WAN became less critical as most workforces shifted remote, resulting in customers rolling out Zscaler through a lightweight agent. Presently, many of our clients implement our solutions alongside or independent of SD-WAN. Consequently, we remain neutral regarding SD-WAN vendors. Our sales processes are no longer initiated by SD-WAN. If a customer chooses to deploy SD-WAN, we usually become their preferred option, so we don’t anticipate any changes in the SD-WAN marketplace affecting us.

Operator, Operator

Our next question comes from Joshua Tilton of Wolfe Research.

Joshua Tilton, Analyst

I don't believe you mentioned it in the prepared remarks, but can you discuss any business impact you've observed, either positive or negative, from the Russia-Ukraine crisis?

Jay Chaudhry, Chairman and CEO

Yes. The Russia-Ukraine situation was notably pressing a quarter ago. I decided years ago not to conduct business in Russia, which means we have no revenue exposure there or in Ukraine. However, cybersecurity constitutes a global threat, not confined to any region. Our threat research team is tracking an uptick in cyber threats, instilling increased concern among CIOs and CSOs, and consequently driving the adoption of Zero Trust architecture. This heightened concern is strengthening engagement with customers, particularly in Europe, where organizations are more anxious. Hence, we've seen several large deals emerge in Europe this quarter, including a few I previously highlighted. Overall, we do not perceive any negative ramifications from this conflict; instead, we are dedicated to working with our customers to foster transformation as they strive for increased agility and competence while combating cybersecurity threats.

Operator, Operator

The next question shall come from Rob Owens of Piper Sandler.

Rob Owens, Analyst

I wonder if you could elaborate on the Siemens partnership a little more. Jay, what do you view as the opportunity in OT from your perspective?

Jay Chaudhry, Chairman and CEO

OT plants and factories have historically been slow to adapt. However, the recent uptick in critical infrastructure attacks has escalated the urgency for change. Companies like Siemens are major providers of OT systems—they view this as an opportunity to transition from traditional fiber and VPN-based security towards Zero Trust-based security. This shift negates the necessity for remote VPNs while enabling secure IT-OT integration. Over the past year, Siemens has collaborated with us on joint solutions, and our technology is now deployed on their hardened OT systems. The combined Siemens-Zscaler solution is available to our customer base, and I believe this presents a significant opportunity for us as industries increasingly embrace Zero Trust for IoT applications in the future.

Operator, Operator

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

Jay Chaudhry, Chairman and CEO

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

Operator, Operator

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