Earnings Call Transcript - ZS Q3 2023

Operator, Operator

Thank you for standing by and welcome to the Zscaler Third Quarter Fiscal Year 2023 Earnings Conference Call. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. Bill Choi, Senior Vice President of Investor Relations and Strategic Finance.

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

Good afternoon everyone, and welcome to the Zscaler third quarter fiscal year 2023 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 a reconciliation of GAAP to the non-GAAP financial measures in our earnings release. I'd like to remind you that today's discussion will contain forward-looking statements, including but not limited to, the company's anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow dollar-based net retention rate, future hiring decisions, remaining performance obligations, income taxes, earnings per share, our objectives and outlook, our customer response to our products and our market opportunity. These statements and other comments are not guarantees of future performance, but rather are subject to risks and uncertainties, some of which are beyond our control. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC, as well as in today's earnings release. I would like to inform you that we'll be attending the following upcoming events in June. Bank of America Global Tech Conference in San Francisco on June 7, Cantor's Security and Infrastructure Conference on June 9, and we will also host an investor briefing focused on our latest innovations at our Zenith Live Conference on June 15. Now, I will turn the call over to Jay.

Jay Chaudhry, Chairman and CEO

Thank you, Bill. We delivered strong third quarter results with all financial metrics above the high-end of the guidance we provided last quarter. On a year-over-year basis, revenue grew by 46%, billings grew by 40%, and current billings grew by 44%. Our new business grew significantly across various industry verticals and we had approximately half of our revenue come from outside the U.S. We have a strong and loyal base of customers with gross retention rates in the high 90s. We have a disciplined approach to growth, and once again on operating income more than doubled on a year-over-year basis, with operating margins now exceeding 15%. While we continue to operate under tighter economic conditions, I believe the comprehensive functionality of our Zero Trust Exchange platform, our strong execution and our customer-first approach, will enable us to navigate this macro backdrop and deliver on our guidance. Our consultative sales process enables our account teams to adapt to the changing business environment and stay close to our customers, especially at the C-Level. We are partnering earlier with CXOs to jointly create compelling CFO-ready business cases that have clear ROI and payback periods. As our Q3 results demonstrate, this high-touch engagement is helping get deals across the finish line. Our go-to-market engine enables us to close many large multi-year, multi-product deals. We are providing increased guidance for the full year, which we believe balances our business optimism and macroeconomic uncertainties. A few quarters ago, we noted that customers were increasingly scrutinizing their projects and budgets, due to macro conditions. We are seeing this elevated level of scrutiny continue in Q3. Nevertheless, we see high-priority initiatives still moving forward. In my conversations with hundreds of IT executives, cybersecurity remains their number-one IT priority. Traditional network security based on firewalls and VPNs cannot handle the complexity of safeguarding enterprises in what has become a work-from-anywhere world. Given the explosion in ransomware and high-profile data breaches, IT leaders are looking to phase out castle-and-moat security, to adopt Zero Trust architecture. Moreover, C-level leaders from around the globe are telling me that the technical debt of the legacy network and security point products impedes progress and slows down business operations. Our business value message is resonating with customers. Our Zero Trust Exchange offers better security and user experience, while substantially reducing cost and IT complexity compared to legacy networking and security. By consolidating point products and embracing Zero Trust with Zscaler, our customers are modernizing their security and increasing productivity, which gives them the competitive edge they need to succeed in today's rapidly evolving business environment. We also partner with many tech leaders to deliver easy, jointly integrated solutions for customers, which increases our business value and creates go-to-market leverage for us. Our current marketing campaign called Beyond the Perimeter is a great example of the successful field collaboration with our tech partner CrowdStrike, that is increasing our pipeline. In today's environment, our strategy is to double down on customer success. From pre-sales to deployment and customer success management, we have built our organization to deliver measurable outcomes at the CXO level. We've made a number of investments in customer success services, technical account managers, partner services, and certification of partners, which together will help our customers move faster towards realizing business value. We now have 400 customers with greater than $1 million in ARR, including over 35 customers exceeding $5 million in ARR. In Q3, our new logo business grew approximately 20% year-over-year. Our proven experience at scale makes us a partner of choice for customers pursuing their Zero Trust security journey. We have a blueprint for delivering greater value, which drives strong upsell. Approximately 60% of our new business came from existing customers, and our net retention rate has again exceeded 125%. Happy customers buy more and our Net Promoter Score of over 70 is a testament to our strong relationship with our customers. As we have indicated before, we have a 6x upsell opportunity with our existing customers for protecting their users. Our engineering team is innovating at a rapid pace and has expanded our comprehensive platform from securing users to securing workloads, as well as securing IoT and OT. As I mentioned before, customers are increasingly buying Zscaler for Users, which bundles ZIA, ZPA, and ZDX together. Let me highlight one SaaS platform deal in the quarter. In an exciting upsell win, a fast-growing global bank in APJ upgraded to Zscaler for Users bundle for 150,000 users after deploying ZIA last year. With this upgrade, this customer is significantly reducing the time to open new branches by 50% and eliminating the need for firewalls and MPLS network services. We are now a strategic partner to them as they continue to expand their footprint and transform into a cloud-centric organization. This customer said it is the first time they have seen a security vendor that understands the business needs and aligns its solution to address them. With this latest purchase, this customer's ARR surpassed $10 million. This is also an example of the geographic diversity of our business outside the U.S. Today, we serve eight of the ten largest financial services and diversified insurance companies in the world, outside of China. Over the past few quarters, I observed that analysts and investors often equate ZPA with VPN replacement. This is simply not true. ZPA replaces the entire inbound DMC and ZPA is often purchased for all employees. In fact, over half of our ZPA customers have purchased ZPA services for all employees, hence delivering Zero Trust whether they work in the office or at home. In Q3, ZPA was an area of strong growth and we saw large new logo deals that landed with ZPA. Let me highlight two such deals. A Fortune 100 logistics company made a four-year multi-million dollar ACV purchase of ZPA and ZDX for 100,000 users. ZPA provides Zero Trust application access architecture for their employees, partners, and suppliers as it consolidates multiple point products, including multiple VPNs, load balancers, VDIs, and dedicated private network services. As a result, ZPA is expected to generate a 300% ROI for this customer. In another ZPA landed deal, a global 300 tech manufacturing company made a three-year seven-figure ACV commitment for ZPA and ZDX for all 30,000 employees. Cybersecurity was their top priority as their IP in software development and manufacturing was being actively targeted by nation-state actors and hackers. Another aspect of our market not well understood by investors is that scale and performance are paramount considerations to customers in the real world. When you are providing inline inspection, you cannot have a trade-off between performance and security. Given our large opportunity and our success in the market, it is not surprising to see a number of vendors claiming that they have the same capabilities as we do; they built their products using something known as service function chaining in order to reduce their time-to-market. The reality is, service chaining for inline traffic inspection using microservices results in poor performance. They are effectively trying to scale lower performance. Our unique architecture, with our patented single-stand, multi-action technology enables us to deliver comprehensive security at high performance and scale. We secured over 40 million users from some of the largest global brands, and we surpassed $300 billion transactions daily. We are the largest inline security cloud, and no one comes close to us; customers cannot afford to risk the mission-critical operations with immature offerings from unproven vendors. Let me highlight a deal which showcases the scale of our platform. In a large SSE win, a global 30 healthcare insurance company purchased ZPA and ZDX for 450,000 users and ZIA for 430,000 users. Their incumbent CASB provider could not scale to even 5% of the employees when TLS inspection was turned on. At this customer, we are consolidating dozens of point products from a handful of vendors, including DLP, CASB, web proxies, firewalls, and VPNs. Our integration with Microsoft E5 suite across ZIA, ZPA, and ZDX was also an important decision factor for them. In addition, the customer will use Zscaler to rapidly integrate new acquisitions in weeks, rather than months, that are required by legacy network security architecture. Next, let me highlight a deal that was led by data protection. In our largest win in the transportation vertical, a global 50 company purchased the ZIA transformation bundle plus ZDX and advanced data protection suite for 165,000 users. Zscaler was chosen over a CASB vendor because of our best-in-class capabilities in DLP, CASB, browser isolation, SSPM, and SaaS supply chain security. And of course, our proven cloud scale and resilience was a big factor. This deal started with data protection and quickly expanded to include web proxy, firewall, and sandbox, and to implement direct-to-cloud architecture at across their 6,500 locations. We see more customers buying our data protection along with ZIA and replacing their existing CASB point products. As these deals show, customers are embracing our expanded platform, including our two emerging product pillars ZDX for digital user experience and Zscaler for workloads. These emerging products are on track to meet our full-year target of high-teens percentage of new business. This quarter we had an upsell deal with a global 200 bank headquartered in APJ that purchased Zscaler for workloads for 70,000 workloads, in a multi-cloud environment. As an existing ZIA customer, it was easy and seamless for them to roll out workload protection which increased their annual spend with us by 35%. We are also starting to close larger deals with our federal government customers, as the Zero Trust deployments move beyond the initial land deals. A cabinet-level agency purchased ZIA and ZPA for 110,000 users to cover all of its sub-agencies. After a thorough evaluation, they are standardizing on Zscaler to consolidate multiple point products across the agency and to comply with the president's executive order, which mandates federal agencies to adapt Zero Trust principles. Our highly scalable and reliable platform and highest FedRAMP authorization for both ZIA and ZPA have been key differentiators in this win, having landed 12 of the 15 cabinet-level agencies, we have plenty of opportunity to expand further with these very large organizations. To take our customer-centric innovation to the next level, we welcome Syam Nair as our new CTO who will lead our R&D teams. Syam has extensive experience in leading and scaling engineering and product development teams that accelerated innovation cycles at Salesforce and Microsoft. He was the driving force in scaling the AI-powered customer engagement platform at Salesforce, which is critical to the next phase of our AI journey. Let me highlight a few examples of how we are leveraging AI/ML to deliver better cyber protection today. Our first acquisition in 2018 was an AI/ML company. We leveraged their technology together with Zscaler data to deliver far better detection for zero-day attacks. This resulted in reducing the number of files being sent to our sandboxing engine by 80%, reducing time to detection and improving user experience. ZDX, our digital experience service was launched three years ago; it was built from the ground-up to leverage AI/ML to not just show where performance is degraded, but what caused the issue. The data protection advancements we launched in October 2022, leveraged AI/ML to classify unstructured documents for policy enforcement. And after the launch of ChatGPT, Zscaler delivered policy-based access controls to ensure that customers can use AI applications safely. If employees submit sensitive data to ChatGPT-like applications, our DLP technology detects it and blocks it. While plenty of AI apps like ChatGPT, GPT-4, Bard, and Bedrock use public data, AI-powered cybersecurity for enterprises requires their own private data. Based on a proxy architecture, Zscaler Zero Trust Exchange is like a private switchboard for all communication for users, workloads, and devices, that captures all communication logs, a whopping 300 billion logs per day. These are not DNS logs that have little information beyond the domain, nor are these firewall logs that cannot often see SSL traffic. These are complete logs that have structured and unstructured data, including the full URL providing trillions of signals per day. Zscaler has AI experts and data scientists, and the most valuable anonymized private data to customize and effectively train LLM models for the security domain. Imagine a world where our customers will know they are about to be breached, before they are breached, so they can proactively prevent the attack. Using AI, I believe Zscaler has the opportunity to predict most of today's ransomware and other sophisticated attacks on our customers. We plan to launch a number of innovations, including many from AI/ML at Zenith Live, our Annual Cloud Summit in mid-June, in Las Vegas. I invite you to join us. In closing, we believe that we are still in the early stages of a significant market opportunity to disrupt 30 years of traditional network security and capture a large share of our $72 billion addressable market. Our Zero Trust Exchange is built on a unique architecture that securely connects users, devices, and applications using business policies regardless of their location. We believe our 10-plus year track record of running a massive inline cloud that has to be highly reliable and available makes Zscaler the go-to platform for vendor consolidation, cost savings, increased user productivity, and better cyber protection. We remain focused on creating shareholder value by driving customer-centric innovation, new business growth, and increased profitability. Now, I'd like to turn over the call to Remo for our financial results.

Remo Canessa, CFO

Thank you, Jay. Revenue in Q3 was $419 million, up 46% year-over-year and up 8% sequentially. ZPA product revenue was approximately 20% of total revenue, growing 66% year-over-year. From a geographic perspective, the Americas represented 54% of revenue, EMEA was 31%, and APJ was 15%. Our total calculated billings in Q3 grew 40% year-over-year to $482 million. Until we get more certainty around the macroenvironment, we believe looking at total billings on a sequential basis can be a relevant measure of our billings performance in the near term. On a sequential basis, billings declined 2% quarter-over-quarter, which is better than our normal seasonality. Our calculated current billings grew 44% year-over-year. Our remaining performance obligations or RPO grew 36% from a year ago to $3.023 billion; the current RPO is approximately 50% of the total RPO. Our dollar-based net retention rate was once again above 125%, while good for our business, our increased success 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. This is not a metric we try to optimize quarter-to-quarter, which could lead to variability on a quarterly basis. At the end of Q3, we had 400 customers with greater than $1 million in ARR, up 39% from a year ago. The continued strength of this metric speaks to the strategic role we play in our customers' digital transformation initiatives. We also ended the quarter with 2,432 customers with greater than $100,000 in ARR. Turning to the rest of our Q3 financial performance. Total gross margin of 80.2% compares to 80.4% in the prior quarter, and 80.6% in the year-ago quarter. Higher public-cloud usage for emerging products drove the year-over-year change in gross margins. Our total operating expenses increased 3% sequentially and 33% year-over-year to $272 million, primarily due to higher compensation expenses. Operating margin of 15.3% increased approximately 600 basis points year-over-year. Following our optimization efforts in Q2, we're seeing higher efficiency in supporting roles across the departments. Our free cash flow margin was 18%. We continue to expect our datacenter CapEx to be around the high-single-digit percentage of revenue for the full year. We ended the quarter with over $1.97 billion in cash, cash equivalents, and short-term investments. Next, let me share some observations about the macroenvironment and our framework for guidance. From our perspective, the global macroenvironment remains uncertain and customers continue to scrutinize large deals. We're seeing deals getting larger as customers are trying to consolidate more and accelerate their security transformation around our Zero Trust Exchange. Customers are expanding their commitments with us from a targeted use case to a much broader platform-centric approach. While good for our business, larger deals take longer to close as customers introduce more checks and reviews. In addition, in select instances, we enabled new strategic customers to ramp into larger subscription commitments. Typically, these ramp deals reduce our first-year billings, but will grow into a higher annual run-rate level in the second year. We are entering Q4 with a record pipeline and our customer engagements remain strong. However, predicting close rates in any 90-day period has become more challenging in this environment. Our guidance assumes that new business will take longer to close over the remainder of the fiscal year in view of the macro. As a result, we are assuming a slightly lower close rate in Q4 compared to Q3. We will continue to balance growth and profitability. In our outlook for Q4, we intend to deliver operating margin expansion of more than 400 basis points year-over-year. With that in mind, let me provide our guidance for Q4 and fiscal '23. As a reminder, these numbers are all non-GAAP. For the fourth quarter of fiscal 2023, we expect revenue in the range of $429 million to $431 million, reflecting a year-over-year growth of 35% to 36%. Gross margins of approximately 80%. I would like to remind investors that a number of our emerging products, including ZDX and Zscaler for workloads, will initially have lower gross margins than our core products. We are currently managing the emerging products for time-to-market and growth, not optimizing them for gross margins. In addition, we will continue to invest in our cloud infrastructure as we scale with the growing demand. Operating profit in the range of $69 million to $70 million, net other income of $13 million, income taxes of $6 million. Earnings per share of approximately $0.49, assuming $157 million fully diluted shares. Please note that starting in fiscal 2023, we adopted the new accounting standard, which requires the use of the if converted method for calculating EPS. To account for our convertible notes, you will need to add back $360,000 in quarterly interest expense. For the full year fiscal 2023, we expect revenue in the range of $1.591 billion to $1.593 billion, or year-over-year growth of approximately 46%. Calculated billings in the range of $1.974 billion to $1.978 billion, or year-over-year growth of 33% to 34%. Operating profit in the range of $224 million to $225 million. Our guidance reflects approximately 400 basis points of operating margin improvement compared to last year. Income taxes of $21 million, earnings per share in the range of $1.63 to $1.64 assuming approximately $156 million fully diluted share. As noted earlier, to account for convertible notes and EPS, you will need to add back $1.4 million in annual interest expense. We remain confident in our ability to capture our large market opportunity while increasing profitability. We will balance growth and profitability based on how our business is growing. The recurring nature of our business model gives us good visibility on top-line revenue and allows us to adapt quickly to changes in market conditions to deliver on our operating profit and margin goals. With a large market opportunity and customers increasingly adopting the broader platform, we'll continue to make disciplined investments to position us for long-term growth.

Operator, Operator

Our first question comes from the line of Brad Zelnick from Deutsche Bank. Your question please.

Brad Zelnick, Analyst

Excellent, thank you so much guys for taking the question and congrats on a strong Q3, especially in light of all the craziness going on in this world. Jay, I wanted to ask you about the U.S. federal opportunity, really seems like you've got a number of good things happening there, you're now in 12 to 15 cabinet-level agencies. Can you double-click on the opportunity and pipeline ahead? And maybe talk just more about your strategy in public sector more generally, not just Fed but SLED and maybe international government as well, thank you.

Jay Chaudhry, Chairman and CEO

Thank you, Brad. As we have been saying for the last several years, we made early investments in federal certification in FedRAMP, got some of the highest levels of certifications. In fact, they use the same certification; you get what's known as StateRAMP certification that states require. So we have a very strong presence in a number of states, at state-wide level, we've done well there. On the federal front, as we said we got early lands and got 12 to 15 agencies, but now they are beginning to do full rollout, and that's what we are beginning to see. It's being also helped by White House guidelines, Zero Trust implementation, and, of course, certifications are helping. We created a public sector vertical some time ago that covers U.S. Federal, as well as state part of it. So very happy to see the performance of both. We have a strong pipeline for the federal sector, sorry, for public sector for Q4 and we feel good about it. It was natural for us to expand beyond the U.S. And what we've done is looked at the West-friendly nations, NATO-friendly nations, who depend upon FedRAMP certifications for protecting their federal governments. We have a pretty good degree of engagement with those countries, and we expect to share more success with you next year and beyond.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Matt Hedberg from RBC. Your question please.

Matt Hedberg, Analyst

Great, thanks for taking my questions, guys, and congrats on the strong results. Jay, for you, you spent some time talking about generative AI, and the ability to monetize it with large datasets. I'm just curious how do you think about a couple of years from now? Are we going to be able to see that generative AI was actually a tailwind to growth and perhaps, could there be additional pricing perhaps consumption element that could support LLMs extended usage in the future?

Jay Chaudhry, Chairman and CEO

Yes, Matt, all of the above. First of all, AI is being used in some of the current products to do better threat detection, better data protection, and the like, that's number one. Number two, as AI/ML gets picked up, there will be bigger cyber risks. It's a race with the bad guy; they'll be able to do some of the more sophisticated attacks a lot more easily than they can do today. That means companies like Zscaler will need to step up to provide protection against such threats. And these are protection with clients, so to do good stuff with AI/ML, you need three things: good data scientists, you need large language models, and you need high-quality, large volumes of data. While many companies can hire data scientists and large language models are becoming open-source and will probably be available more easily, the data will become the new IP, the new barrier-to-entry. Zscaler with 300 billion logs per day and trillions of signals, we have probably the most precious private data. And that we anonymize and feed it to our large language model, to give us an advantage that I believe other competitors would not have. Now, these things, while being enhanced for functionality, I expect us to have new SKUs, new products that will give us plenty of upsell opportunity. So I expect AI/ML to expand our TAM.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Andrew Nowinski from Wells Fargo. Your question please.

Andrew Nowinski, Analyst

Thank you and congratulations on another impressive quarter. I have several questions, but I'll start with one regarding the ramp deals. You mentioned these at the beginning of the year, and it seems that currently we are facing the challenges associated with these deals, which means you're not really seeing any benefits yet. Could you explain when we might start to see a positive shift after the first year as customers transition to paying full price for their subscriptions? I'd appreciate your insights on the timing of this transition from headwind to tailwind for the ramp deals. Thank you.

Remo Canessa, CFO

Yes, I mean, it's a great question, Andy, I'll take it. You may take a look at the ramp deals in Q3 of last year and Q3 of this year, the percentage amounts are the same. So there's really no headwind or tailwind related to the ramp deals. Ramp deals started coming in a few years ago, and now it's basically pretty much the same on a year-over-year basis. I do expect ramp deals to go forward, you know as we go forward. If you take a look at basically the duration, the billings duration, our growth rate was 44% short-term; that basically was related to duration. The duration that we had in Q3 of last year was at the high end of our 10 to 14 month range and this year, the duration basically was slightly above the midpoint. So ramps did not create basically the positive impact to our short-term billings; it was really duration.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Joel Fishbein from Truist Securities. Your question please.

Joel Fishbein, Analyst

Hi, thank you for the question and congratulations on your strong margin performance and expense management. I have a question for Remo, which you've touched on a bit in the call, but I'd like to delve deeper into the methodology. I'm curious about how you're ensuring that you're not compromising growth while you continue to improve margins at this impressive rate. It seems like a balancing act, and while I know you have certain strategies in place, it appears to be quite challenging. I would appreciate further clarification on this.

Remo Canessa, CFO

Yes, from our perspective, the market size we discussed at our Analyst Day a few years ago is $72 billion. Our current revenue is approximately $1.5 billion, indicating significant potential for growth. We are still focused on top-line growth while balancing profitability, as demonstrated by the 600 basis points margin expansion in Q3 and 400 basis points for the full year. This aligns with the model we outlined. As top-line growth slows, we can achieve natural leverage. It's important for our investors to know that we are in a strong position to move forward, continue investing, and balance top-line growth with operating profitability. Regarding fiscal 2024, the current street consensus points to about 15.5% operating profitability, and I believe a target range of 15.5% to 16% is appropriate. This provides us with ample room to invest and capitalize on market opportunities.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Saket Kalia from Barclays. Your question please.

Saket Kalia, Analyst

Okay, hi guys, thanks for taking my question here. Jay, maybe this question is for you. First of all, the numbers speak for themselves. I wondered if you could just address the competitive backdrop a little bit, certainly, it doesn't appear in the numbers again, but I know that there were some noise out there with competitive quadrant stuff, wanted to see if you just had any views on that and more importantly whether you've seen that make its way into customer conversations at all?

Jay Chaudhry, Chairman and CEO

Thank you, Saket. So regarding the magic quadrant, I believe that customers are the real judge. And I'll give you three points why I believe they view Zscaler as the real leader. Number one, as you said they are rewarding us by spending on Zscaler, right? In fact, in Gartner's peer insight rating, which is a customer survey done by Gartner, Zscaler is the only MQ leader who is number one in eight Gartner's categories. So they've eight categories, we are number one in eight of them, that's wonderful. And also, we have expanded our vision far beyond just SSE for users, we do SSE for workloads, IoT, OT, B2B and all the like. There have been a number of conversations that I've had with customers; as you know, I talk to hundreds and hundreds of customers. I can tell you more than a dozen at least have asked me, hey, what is this MQ? How could this show up? I said, I don't know, you are the judge. So, is it impacting our performance? No. Is it impacting our engagement? No. I think we are focused on building, delivering, keeping our customers happy. Our NPS goal sits north of 80. So very happy with what we're doing and we'll keep on executing.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Sterling Auty from MoffettNathanson. Your question please.

Sterling Auty, Analyst

Yes, thanks. Hi, guys. Jay, you talked about the success and kind of the go-to-market function and customer success teams. Wondering if you could just highlight for us or remind us the timing of when you did your big hires? Where you are in the capacity of your sales force and what the hiring might look like going forward to extend the durability of the growth that you're seeing currently.

Jay Chaudhry, Chairman and CEO

Yes. We aim to build a comprehensive go-to-market team and continue hiring at the right pace, including teams that support the launch of new products. We have scaled back some hiring as we observed the market decline over the last few quarters. Remo, would you like to add more details?

Remo Canessa, CFO

Yes, from a capacity perspective, we're in good shape. When we reduced our workforce at the end of Q2, we emphasized that we would continue to prioritize hiring for quota-carrying positions and R&D, and that's still the case. We are currently in a hiring mode and will keep hiring. It's important to note that this is a significant market opportunity for us. We are committed to investing in hiring and R&D across the company. What we did in Q2 was aimed at positioning ourselves better to make the right hires moving forward, and that’s what we are focused on.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of John DiFucci from Guggenheim Securities. Your question please.

John DiFucci, Analyst

Thank you. This quarter was indeed a strong one, as noted by others and as you mentioned in the pre-announcement. The numbers show very clean results, which is encouraging, yet it seems unusual given the current environment. You have mentioned that the challenging conditions persist. I'm trying to understand what changed for your team this quarter compared to the previous two quarters, which were more difficult in terms of new ACV signings. This quarter's performance stands out as particularly strong. Did larger deals contribute to this, or is it more about your team improving execution? What exactly changed?

Jay Chaudhry, Chairman and CEO

So this quarter was strong across all areas. Americas and APJ were particularly strong on a year-over-year basis. Last quarter we said some of the large new logo deals in the Americas were taking longer to close. We also said those deals were not lost, but just delayed. And we did close a good number of those deals. From a vertical perspective, it was very well-diversified. Strong verticals for federal, for financial services, healthcare, and transportation. Our large and major segment did well; we highlighted a number of $100,000-plus user deals. So the fundamentals of our business are very strong; customers are not going to delay cyber as a priority, it is a priority. Cost-saving is a big priority as well and we do well in both areas. Cyber, as well as our cost-savings. I can tell you when it comes to cyber, companies we're probably the only company that delivers significant ROI because we are actually eliminating a bunch of point products. So it is fitting well; it's a tougher market, there's more scrutiny, but our foundation is strong, our pipeline is strong. Remo?

Remo Canessa, CFO

Yes, I'd like to go with what Jay mentioned. The pipeline is mature, execution is strong across the board; the Americas performed well, APJ was strong, and the federal sector was strong. The key takeaway is really good execution from our sales organization globally. Regarding large deals, we used to define mega deals as those over $10 million when we first went public, but we've now raised that threshold to deals over $20 million. There were no deals exceeding $20 million this quarter, but we did secure one deal worth $10 million.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Roger Boyd from UBS. Your question please.

Roger Boyd, Analyst

Great, thanks for taking the question. And again, congrats on the very strong results. As you think about fiscal 4Q in fiscal '24, it sounds like you're broadly being pretty conservative around close rates, but Jay, you talked a little bit about some of the efforts you've made internally to get in front of budget scrutiny with some of these CFO ready business cases. I guess I'm wondering, relative to a few quarters ago, are you feeling incrementally better about controlling your own destiny, your ability to influence sales cycles, and just curious how material these internal efforts have been in practice? Thanks.

Jay Chaudhry, Chairman and CEO

Yes, so this tougher market has made it us a lot more sophisticated than we were before. For example, for new logos, what have we done? We are now doing early engagement; our sales team is getting good at engaging at C-level early on in the cycle. Number two, we had to refine our business value case, CFO-ready case studies a lot more. No longer are annual numbers good enough; now they want to go into quarterly levels to see when the ROI can be done. Our engagement of cloud market-based have gotten much better because we are leveraging the annual commit that's only spent annual spend that's already committed to the hyper scalers; now we had to do ramp deals more frequently, which is kind of to meet their timing of budgets and the like. For upsell, we had done a number of things in the past few quarters; we are ensuring that customers are realizing the value more and more. Our customer success teams, our TAMs, are doing a great job. And then the product specialists team we put in place for emerging products, that's working well. It's working very closely with our field sales team. So having a great, highly differentiated platform which we built on Zero Trust as a key platform, we are not a firewall company that's trying to pivot to Zero Trust, we're not a CASB company that's building. This is our core business and nonstop from day one, and our sales execution is good and we'll keep on improving it.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Mike Walkley from Canaccord Genuity. Your question please.

Mike Walkley, Analyst

All right, thanks. Remo, you talked a little bit about future lumpiness in dollar-based net retention. I guess given some large deals that you'll grandfather in. But can you share with us kind of that mix, you expect to maybe fiscal 2024 of new logo sales versus upsell, is it still around 60%, 40% ratio given that 6x times upsell opportunity?

Jay Chaudhry, Chairman and CEO

Yes, I mean net retention rate is something we don't write to or look at. Our mix this year, we're expecting 40% to 60% new versus upsell. We look at, really if we look at new and upsell as those are the drivers in total, and we've talked about before is, we believe the best measure for Zscaler is really billings at 125% is outstanding.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Joshua Tilton from Wolfe Research. Your question please.

Unidentified Analyst, Analyst

Hi guys, this is Patrick on for Josh. First off, just wanted to congratulate you on the great results in what's been a tough environment. Clearly the mix checks in the quarter were not exactly correct. So, I was wondering, what do you think is sort of driving that disconnect between the strong numbers put up in the quarter and then the general feedback from the channel we've heard recently?

Jay Chaudhry, Chairman and CEO

I believe there isn't anything new here. We've consistently stated that we are not a conventional security company that sells boxes through value-added resellers. Our approach is focused on transformation; it's a high-tech sale that involves close collaboration with our customers, often large ones. That defines our business model. Channel checks can often be misleading, which is my perspective. When you're engaging at the transformational C-level and similar areas, it operates differently. So, I would suggest a more nuanced approach to channel checks. Our business remains robust, our customer interactions are strong, and our differentiation is significant. While our competitors may attempt to create confusion in the market, it's our responsibility to educate and communicate the truth. The best outcomes we achieve occur when customers utilize our technology and share successes like being able to activate 20,000 users in just 7 days with outstanding results. Contrastingly, I have only encountered a few instances where competitors' solutions struggle as they work to expand their networks from office to cloud with outdated architectures. Despite the surrounding noise and miscommunication, our engagement, distinctiveness, market execution, innovation, and advancements in AI and machine learning give us a unique edge through improved data handling and better mechanisms for structured and unstructured data. We will outperform any existing vendors. Regarding unstructured data, each vendor has logs which are essentially structured data detailing origins and destinations. The most insightful information for generative AI comes from URLs, which can be extensive. This is where you can discern what’s happening. Most firewalls lack that URL detail, typically focusing only on domain-level information. As we progress in this area, I believe we'll enhance our lead and expand our total addressable market and growth ambitions.

Operator, Operator

Got it, thank you.

Jay Chaudhry, Chairman and CEO

Thank you.

Operator, Operator

One moment for our next question. And our next question comes from the line of Adam Borg from Stifel. Your question please.

Adam Borg, Analyst

Thank you for taking my question. Jay, you mentioned in your remarks about the growing interest in Zscaler for Users. I would like to understand the proportion of new customers who are adopting Zscaler for Users right from the beginning and how that fits into the overall distribution of Zscaler for Users among our current customer base. Thank you.

Jay Chaudhry, Chairman and CEO

Yes, so thank you. Zscaler for Users, this bundle was created a little over a year ago. And we have seen very, very good growth of this combined bundle. And we have some customers who will go with ZIA, ZPA; we actually have some customers, it's interesting, but large customers who actually started the ZPA and ZDX at the same time. But overall the bigger bundle to eliminate a bunch of point products is the trend we are seeing and as I had said even two or three years ago, it's a matter of time. When every customer buys ZIA, ZPS, ZDX for every employee and that trend is happening more and more. And as we said before, if we do so on current customers, their spend with us could go to 5x or 6x kind of stuff, and I think we are tracking well and we are tracking well for two reasons: one, customers who are seeing value, they're realizing the value format. Number two, we're actually able to remove a bunch of point products and show ROI and that actually gives them more incentive to buy more from us, Remo.

Remo Canessa, CFO

Yes. And customers that have bought ZIA, ZPA and ZDX, it's more than 25% of our total customers. So it's definitely getting traction.

Operator, Operator

Awesome, thanks again. One moment for our next question. And our next question comes from the line of Shrenik Kothari from Baird. Your question please.

Shrenik Kothari, Analyst

Hi, thank you for taking my question and congrats on the strong execution despite the macro. So, for Jay and Reno, feel free to chime in, you mentioned on a sequential basis. You saw a better than normal seasonality and then of course you guys touched upon factors starting to close larger deals with federal; you of course are seeing benefit from kind of strategic customers ramping into larger commitments. And then of course the execution, the high-touch engagement is helping to get to finish line, international. Can you help us unpack some of these drivers in terms of kind of maybe relative impact on this better than normal seasonality, and then I have a quick follow-up.

Jay Chaudhry, Chairman and CEO

Yes, I think. Everything you mentioned is 100% correct. You know, I'm a traditional and I'll go back to what I feel, I think it's better execution on our sales organization. Yes, I mean, all the factors are aligned, but we are still in a tougher environment with a lot more scrutiny and it's doing better execution. But if you've got a good product offering that is highly differentiated and there is a need for it, because customers do want to save money and better cybersecurity, that's really what's positioned us well.

Remo Canessa, CFO

I mean, just to follow-on, customers recognize the ROI; it is significant, the ability to simplify your network is significant also. Architecture, related to inline cloud, multi-tenant architecture, not only for users but workloads and IoT, OT and B2B. You know that that's the vision, basically Zscaler. The pioneer with all this Zscaler, so the leader. If you take a look at our penetration into the Fortune 500 which is 40% in Global 2000, 30%. I mean CIOs, CISOs, they talk to each other. We do I mean customer advisory board meetings, Jay, we do one like on average, like one a week, I believe I mean companies typically do this once a year, we do it once a week. And so what is the strength, it's all things I mentioned and your comments; it's pretty much across-the-board, all those things. One point I'll make, which hasn't come across so far in this discussion. What we do being the switchboard is probably the most critical, mission-critical business service, and it must work and so customers basically want to go with a proven vendor who knows how to operate and run and manage such a massive cloud. It is becoming a differentiator when a new vendor comes and says, I got the cloud too, and then the customers are saying, what's your track-record, what's your experience, that's helping us. One of other areas that's helping us with some of the new private companies and all, customers aren't going to vary off trying to go with someone who may be losing a lot of cash and who may not be around tomorrow, and that's helping us as well, because customers are looking at vendors who will be around and will be the leaders in this area.

Operator, Operator

Thank you. One moment for our next question. And our next question comes from the line of Peter Levine from Evercore. Your question please.

Peter Levine, Analyst

Great, thanks guys for squeezing me in. We've seen one of your competitors come out this quarter with a very specific campaign kind of targeting you guys or somewhat kind of right reverse engineering your tax? So, Jay, is there any validity behind kind of what they're building, you explain to us the complexity, the lift and shift customers overnight. And if you you've been seeing any attrition on that front and then just one quick one, Remo yes, thanks for the color on the fiscal 2024 margins, but to the extent you can any color or high-level discussions you can share with us now on how you're thinking about the growth outlook and to what extent macro playing into that thought process, thank you guys.

Jay Chaudhry, Chairman and CEO

So every vendor has a core competence and they do very well in that competency. A firewall company will be a great firewall company, the company will be a great CASB company, and someone who does CDN and DNS should be a good CDN DNS company. You can try to pivot for that competency, you build and create over years and years. It's very hard. If I came and told you that in one year, I'm going to build the best firewall, while it would be hard for me to say that because I can say it may make statements like that, but when companies try to pivot, it takes a while, and especially pivoting to do something that's inline, multi-tenancy, figuring out all the cyber threats without slowing things down it's hard; it's an architectural change. We believe the intellectual property, the IP needed to do so is very hard. That's number one. Number two, the amount of passive one has to handle to really deliver the service, your gross margins are likely to be selling in the 50s and 60s and not like 80% where we sit at. It's because we purpose-built stuff. So it is not unnatural for us to see the competition trying to comments, maybe I can get into this space I have many times described Zscaler, being inline business almost like an ERP application, thousands of SaaS applications on view at that point products that can be built. How many ERP vendors do you see out there doing SaaS? Very few; it's hard sitting inline as far we think that gives us a big, big barrier-to-entry for others to compete, and we are not offsetting. We are expanding our platform at a larger pace. So do I kind of tried to focus too much on some of the competitive campaigns that cannot find to spread lies? I don't be focus on innovation; we focus on our customers and we are doing well and top-line growth. We'll talk about that on the next call for year-end.

Operator, Operator

Thank you guys. One moment for our next question. And our next question our final question for today comes from the line of Joseph Gallo from Jefferies. Your question please.

Joseph Gallo, Analyst

Hi, guys, really appreciate the question and great job on the billings performance in a tough environment. I appreciate the commentary regarding the year-over-year mix of ramp deals in F3Q, is F4Q the same expected year-over-year mix based on the pipe you guys are seeing today? And then just any other color or commentary on how to think about F4Q billings, which appears seasonally conservative. I know you mentioned lower close rates, but is there anything else timing renewals or anything else we should think about, thanks guys.

Remo Canessa, CFO

Yes, ramps. I would consider the same, quarter-over-quarter, just remember it is a tough compare last year; our billings growth was approximately, basically I think it was close to 60% billings growth.

Jay Chaudhry, Chairman and CEO

In Q4, also, we had a strong Q3, so basically a tough compare.

Operator, Operator

Thank you.

Remo Canessa, CFO

All right.

Operator, Operator

This does conclude the question-and-answer session. I'd now like to hand the program back to CEO, Jay Chaudhry for any further remarks.

Jay Chaudhry, Chairman and CEO

Thank you for your interest in Zscaler, I hope to see you at Zenith Live in Vegas in a couple of weeks. I would also like to thank our shareholders, our customers, and our partners. Talk to you next quarter, great, thank you.

Operator, Operator

Thank you ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.