Zscaler, Inc. — Call Transcript 2019

Speaker 10: Good day everyone, welcome to the Zscaler's 4Q 2019 earnings conference call. Today's conference is being recorded, at this time, I would like to turn the conference over to Mr. Bill Choi, Vice President of Investor Relations. Please go ahead, sir.

Speaker 2: Good afternoon, and thank you for joining us to discuss Zscaler's financial results for the fourth quarter of fiscal 2019. With me on the call are Jay Chaudhry, Chairman and CEO, and Remo Canessa, CFO. By now, everyone should have access to our earnings announcement. This announcement may also be found on our website in the investor relations section. In addition, a supplemental financial schedule was posted to the investor relations section of our website earlier today. Let me remind you that we'll be making forward-looking statements during today's discussion, 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, income taxes, and earnings per share. 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. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. 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 that could impact our future operating results and financial condition, please see our filings with the Securities and Exchange Commission, as well as in today's earnings release. Unless otherwise noted, all numbers we talk about today, other than revenue, will be on an adjusted non-GAAP basis. Please refer to our earnings release on the investor relations portion of our website for a reconciliation of GAAP to the non-GAAP financial measures. For historical periods, the GAAP to the non-GAAP reconciliations can be found in the supplemental financial information referenced a few moments ago. I would also like to inform you that we will be hosting our Analyst Day next week on September 17th, in conjunction with our Zenith Live conference in Las Vegas. Zenith Live is our annual customer and partner cloud summit, featuring keynote presentations and topic-specific breakouts regarding the transformation to a cloud-first future. We will be webcasting both the Zenith Live keynotes and the Analyst Day program, which you can access on the event section of our IR website. Now, I'll turn the call over to Jay.

Speaker 6: Thank you, Bill, thank you everyone for joining us on our call today. In Q4, we are pleased to announce that we delivered strong revenue and operating profit growth in the fourth quarter, with positive free cash flow. For the quarter, our revenue grew 53% and billings grew 32% year-over-year against a very difficult comparison. For the full year, our revenue grew 59% and billings grew 51%. I will start the call by commenting on our market opportunity. Next, I will discuss our sales execution, including the hiring of our new President, Go-to-Market and CRO, and conclude with some of our deal wins in the quarter. We are seeing a mega shift take place, where organizations are choosing multi-tenant cloud architecture to empower them to scale quickly as they move their applications and data to the cloud. Digital transformation and adoption of mobile and cloud fundamentally change network traffic patterns and break the traditional perimeter protection model, where organizations built a hub-and-spoke network and a moat of security appliances to secure the network. Built for a world without walls, Zscaler cloud acts as the business policy engine, which is now deployed across more than 150 data centers to deliver the full set of security and policy enforcement on a direct path to the application. Our mission is to provide fast, secure, and reliable access to information, no matter where it lives. Responding to customers need for better advice for a cloud-centric world where appliance-based perimeter security is less relevant, Gartner has recently published a groundbreaking research note titled "The Future of Network Security is in the Cloud." In this paper, they introduce the concept of a Secure Access Service Edge, pronounced SASE. SASE goes well beyond the disruption of MPLS with SD-WAN or hardware appliances with cloud or applying zero trust principles. As I interpret it, SASE has the following key points. Number one, demands that service edge providers offer compute power at the edge of a widely distributed network, distributed as close as possible to each endpoint. Number two, light branch with just a router and all security services in the cloud. Three, delivers inline encrypted traffic inspection at scale. Most importantly, Gartner recommends reducing complexity of network security by moving to ideally one vendor for secure web gateway, cloud access security broker or CASB, DNS, zero trust network access, and remote browser isolation capabilities. We agree with these key findings. I recommend that everyone read this report. It is available on our main website. Zscaler platform was designed from the start for the world that Gartner has spelled out. As the world moves towards the SASE model, traditional network security vendors are embracing Zscaler's vision of cloud-based security after rejecting it for years. They're trying to retrofit the legacy appliances into a cloud world and making more and more noise about what we believe are their fundamentally flawed hybrid security cloud offerings. Their message is, "Keep on buying my boxes, but use my so-called cloud service when your users are on the road or in a branch office." We believe their pieced together hybrid clouds can't scale, leave gaps in security, are expensive, deliver a poor user experience, and will not allow enterprises to fully realize the benefits of the cloud. Just like you can't create a Netflix service by stacking thousands of DVD players in the cloud, you can't offer an inline high-performance security cloud by spinning up a bunch of virtual machines in a public cloud. This is a defensive strategy of cloud imitators, which, in our view, does not serve the needs of the customer. To put it simply, architecture matters. Zscaler has four architectural advantages that firewalls can't just add on. Edge cloud for policy enforcement, multi-tenancy, proxy for SSL or TLS inspection, and Zero Trust Network Access. Zscaler's platform, deployed across more than 150 data centers, was built from the ground up and provides the advantages of elasticity, scale, deep content inspection, and user experience that is difficult to match. In addition, we have over 10 years of operational experience running our security cloud at scale. As I have said before, there really is no compression algorithm for experience. To keep on growing at a rapid pace as we seek to reach $1 billion in revenue, we need to build a sales machine to drive consistent sales execution, critical for a top-down transformational sale, which delivers even if the market environment gets tougher. We're not sure if the macroeconomic environment is having an impact, but we started to see some large deals taking longer to close. To help us deliver go-to-market scaling and execution, I'm very pleased to announce that Dali Rajic is joining Zscaler as our President, Go-to-Market and CRO. I have been deliberate about finding the right leader with a progressive mindset as this is an extremely important role. Dali shares my views on value-driven strategic selling, and I'm confident that he is the right leader to drive our sales execution. He brings a wealth of SaaS and cloud experience and a proven ability to scale global sales and channel in support of our long-term growth objectives. On the deal front, I'm excited that more customers are buying the ZIA and ZPA platforms together, which enables a true transformation with direct access to any service or application from anywhere on any device without backhauling traffic through the data center. ZIA for internet and SaaS, and ZPA for internal applications in your data center or in the cloud. As some of you know, ZPA is a newer platform that we started selling about two years ago and is now an important part of our business, already contributing 14% of our new business. We are seeing rapid growth with ZPA, with approximately half of the business coming from existing ZIA customers. Let me start by highlighting a new customer that bought ZIA and ZPA together. A global information services company spun off one of its business units, along with the legacy network and data center infrastructure. With an opportunity to start with a clean slate, they adopted a strategy to pursue a full transformation to the cloud with internet as the wide area network, cloud as the new data center, and Zscaler as the policy enforcement platform. The customer purchased the ZIA Business bundle plus Cloud Firewall and data loss prevention for all 25,000 employees and ZPA for 10,000 mobile users. Without building a new network with scores of new security gateways. The customer is leveraging Zscaler to provide secure, fast, and reliable access for all users from all locations on any device at a lower cost of ownership and with greater operational simplicity. A global system integrator partner who is implementing the overall transformation project played a key role in driving the Zscaler sale, an example of channel leverage we are creating with our investments in our SI partners. Let me give you an example of an existing ZIA customer adding ZPA. A Fortune 100 multinational oil and gas customer with headquarters in Europe that bought our ZIA Transformation bundle for 65,000 employees last year purchased ZPA for over 56,000 users. ZPA represents the next step in this customer's IT transformation journey towards a cloud-first strategy. After adopting local internet breakouts for 450 locations, the customer bought ZPA to replace its legacy VPN and do a lot more. ZPA will provide access to its applications in the data center and in the public cloud while increasing the level of security with a Zero Trust Network Access approach. ZPA creates a unified policy-based access across all environments, including the thousands of apps that they're moving to AWS and Azure. This large company also expects to benefit from ZPA to integrate potential acquisitions. This latest purchase increased the total customer spend with Zscaler by two-thirds. In our large ZIA deals, we continue to see Office 365 deployments and securing local internet breakouts as the primary driver. A Global 500 industrial company with headquarters in Europe purchased a Business bundle and Cloud Sandbox for 120,000 users as they required a scalable solution that can keep pace with over 50% growth in internet traffic per year. In addition to Office 365, SSL traffic inspection and Cloud Sandboxing were needed for better security for all locations across 60-plus countries and all users, whether at the headquarters or branch office or on the road. In another deal, a Fortune 100 consumer goods company that purchased Business bundles several years ago upgraded to Transformation bundle plus data loss prevention for all 100,000 employees. After deploying Office 365 last year, the customer was overwhelmed with the growth of traffic for OneDrive and SharePoint. With Zscaler, they will no longer have to backhaul Office 365 to four data centers. Instead, they're implementing SD-WAN for nearly 300 locations for local internet breakouts to deliver better user experience. To secure all local breakouts, the customer purchased Cloud Firewall, Cloud Sandbox, and DLP for all users to keep malware from coming in and sensitive information from leaking out, no matter where the user is. For customers who want network and security transformation, we believe we are the only cloud-native multi-tenant platform that meets their needs. The cloud security market is evolving rapidly, and we are adding significant functionality to our platform and creating more distance from the cloud imitators. You will hear more about our innovations at our Zenith Live Cloud Summit next week. Overall, the competitive environment remains favorable, and we have high win rates, coupled with a strong net dollar retention rate of 118%. In fact, our customer churn rate declined quarter-over-quarter and year-over-year. We ended fiscal 2019 with over 3,900 customers. Total Global 2000 customers increased to over 400 as of July 31, up from over 300 a year ago. We have over 100 of the Fortune 500 companies as our customers. We are strengthening our channel partnerships with large system integrators and global service providers who contribute over 50% of our revenue. We will continue to aggressively invest in our business to pursue our significant market opportunity. Now, I'd like to turn over the call to Remo to walk through our financial results.

Speaker 11: Thank you, Jay. Revenue for the quarter was $86.1 million, up 9% sequentially and 53% year-over-year. For the year-ago comparison, recall that Q4 2018 revenue was aided by $1.4 million in non-recurring revenue from a large public sector customer deploying our platform as a private cloud. From a geographic perspective for the quarter, Americas represented 51% of revenue, EMEA was 41%, and APJ was 8%. For the full year, revenue was $303 million, up 59%. ZPA remains the fastest-growing new product in our history. ZPA contributed 14% of our new and upsell business in fiscal 2019, up from 10% in the prior year. Turning to calculated billings, which we define as the change in deferred revenue for the quarter, plus total revenue recognized in that quarter. Billings grew 32% year-over-year to $126 million. As a reminder, our contract terms are typically one to three years, and we primarily invoice our customers one year in advance. Excluding upfront greater than one-year billings in both periods, billings would have grown over 50%. Remaining performance obligations or RPO was $554 million on July 31st, up 39% from $398 million one year ago. As a reminder, the large public sector deal added $26 million to RPO a year ago. Based on our ending July 31st annual recurring revenue for ZIA, approximately 43% is from our high-end Transformation bundle, which includes our next-generation firewall and sandbox, up from approximately 35% last year. Our strong customer retention and ability to upsell have resulted in consistently high dollar-based net retention rate, which was 118% for the quarter ended July 31st. This compares to 117% a year ago and 118% last quarter. Our increased success selling bigger deals up front, which start with Transformation bundle and faster upsells within a year, while good for our business, can reduce our net retention rate, which is calculated on a year-over-year ARR basis. Considering these factors, we feel 118% is outstanding and it will vary quarter-to-quarter. Total gross margin was 81%, down 1% sequentially and up 1% year-over-year. We feel that 80% continues to be a good target range in the near to medium term, as it is important to continue to invest in our platform to drive top-line revenue growth. Turning to operating expenses. Our total operating expenses increased 6% sequentially and increased 31% year-over-year to $62.2 million. Decreased as a percent of revenue to 72%. The sequential increase in operating expenses is primarily due to increased sales and marketing spend and R&D. We increased our headcount in Q4 by over 130 employees and end of the year with over 1,480 employees. Sales and marketing increased 6% sequentially and 33% year-over-year to $41 million. The increase is due to higher compensation expenses and marketing programs. R&D was up 7% sequentially and up 28% year-over-year to $13.2 million, as we continue to invest to enhance product functionality and to innovate on new products. G&A increased 3% sequentially and increased 26% year-over-year to $8 million. The year-over-year growth in G&A includes investments in building our teams and other expenses related to becoming a publicly traded company. These expenses exclude $3 million in litigation related expenses. Our fourth quarter operating margin was a positive 9%, which compares to a negative 4% in the same quarter last year. Net income in the quarter was $9.1 million, or non-GAAP earnings per share of $0.07. We ended the quarter with $365 million in cash equivalents, and short-term investments. Free cash flow was positive $7.6 million in the quarter, compared to a positive $11.9 million for the same quarter a year-ago. Our ESPP program decreased our free cash flow by approximately $4 million in the quarter, whereas in the year-ago quarter, it had a positive $3 million impact. The ESPP program does not impact our overall cash balance. Moving on to guidance. As a reminder, these numbers are all non-GAAP, which exclude stock-based compensation expenses, amortization of intangible assets, certain litigation-related expenses, and any associated tax effects. For the first quarter, we expect revenue in the range of $89 million to $90 million, reflecting a year-over-year growth of 41%-42%. Operating loss in the range of negative $1 million to break even. Please note, Q1 will include $6 million in expenses for three major marketing events, including Zenith Live Americas, Zenith Live Europe, and our sales kickoff. Income taxes of $700,000 and earnings per share in the range of $0-$0.01, assuming 139 million common shares outstanding. For the full year fiscal 2020, we expect revenue in the range of $395 million-$405 million, or year-over-year growth of 30%-34%. Calculated billings in the range of $490 million-$500 million, or a year-over-year growth of 26%-28%. Operating profit in the range of $13 million-$18 million. Income taxes of $2.8 million. Earnings per share in the range of $0.12-$0.15, assuming approximately 140 million common shares outstanding. Our guidance reflects plans to invest aggressively in our business to pursue our significant market opportunity. With our CRO on board, we expect to step up our sales and marketing investments in the coming quarters. In addition, we'll increase investments in our technology platform and cloud infrastructure. As you model billings, I want to remind you that historically, Q2 and Q4 have been our strongest billing quarters, with sequential declines in Q1 and Q3 quarters respectively. Over the last three to five years, first-half billings have represented on average 43%-44% of full-year billings. In fiscal 2020, we expect our first half mix to be in the 42%-43% range. The reason for this is primarily related to our new CRO getting familiar with our business and fully ramping. Also, please keep in mind that we had a large upfront billing of $11 million in Q2 of 2019 from a large public sector customer deploying our platform as a private cloud, which will pose a tough year-over-year comparison in Q2. Excluding this deal, our billings guidance for the full year implies 29%-32% growth. In terms of free cash flow, please note that we'll have additional spend for tenant improvements related to our headquarters move in January, as well as ongoing cash outlays for lease payments on our existing San Jose buildings and litigation expenses related to the ongoing Symantec lawsuit. With our headquarters move, we expect a modest budget of $4 million-$5 million for tenant improvements. Including these cash payments, we expect our free cash flow margins in fiscal 2020 to be 1 or 2 points lower compared to our operating profit margins. Longer term, we would expect free cash flow margins to be higher than our non-GAAP operating margins. I'd like to hand it back over to Jay.

Speaker 6: Thank you, Remo. In summary, designed as a cloud-native, multi-tenant architecture, we believe we are in the early innings of a significant market opportunity to enable cloud transformation. Just like Salesforce and Workday developed cloud-native multi-tenant platforms to disrupt large legacy software vendors, Zscaler has a similar opportunity to disrupt network security. With multiple tailwinds such as Office 365, SaaS adoption, SD-WAN, and app migration to public clouds, we believe the market is coming to us. With the addition of Dali Rajic, we are building a sales organization that can deliver world-class execution. We look forward to seeing you at our Zenith Live Cloud Summit and our Analyst Day in Las Vegas, where we will showcase some of our upcoming new products. We thank you for your interest in Zscaler and look forward to reporting on our progress in the future. Operator, you may now open the call for questions.

Speaker 10: Thank you. Ladies and gentlemen, to ask a question, please signal by pressing 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, press 1 to ask a question, and we'll take our first question from Brad Zelnick with Credit Suisse. Please go ahead.

Speaker 3: Great. Thank you so much. Can you guys hear me?

Speaker 6: Yes.

Speaker 3: Hello? Excellent. Congrats on a fantastic year, and it's great to see your sustained growth above 50% if we make the proper adjustments. Jay, I wanted to ask you about your comment about large deals taking longer to close. What are the proof points that suggest to you that this may be due to macro deterioration versus perhaps execution issues? What gives you the confidence this isn't a change in the competitive dynamic for what you're selling?

Speaker 6: Yes. We deal with a large number of deals. Our pipeline has been growing. The comment we made was that some of the larger deals took longer. Talking about macro versus competition, I can tell you that if we analyze our top 50 deals, which we did, we rarely see any competitive, real competition from firewall guys or any other guys. Our competitive rate remains very strong. On the macro level, we haven't seen any significant things to really say that macro is playing a role in it. We do believe that as the large number of reps are being hired, they all need to go through a bit more sophisticated sales methodology, sales framework and the like, so we can keep on scaling the successful execution we have been doing so far. Not worried about any competitive pressures. No clear indications on the macro, though that kind of remains to be seen as everyone does talk about them. We are excited that we have a new CRO who can help us further scale the kind of work we've done before to the next level.

Speaker 3: Congrats on the hire. Just to follow up on this topic with Remo, if we look at long-term deferreds, it would seem there as well that duration might be shrinking a bit from what it had been last quarter. Is this due to the same dynamics that Jay is discussing, or are there other factors to consider as well? What's baked into your guidance for the full year? Is it more of what you're seeing exiting fiscal 2019, or is it assuming what you saw on average throughout the entire year? Thank you.

Speaker 11: Yeah. Thank you, Brad. My guidance basically is what we've seen through the entire year, based on duration. If you take a look at the total deferred revenue, it grew 53%. Short-term deferred revenue grew 57%. What we have in long-term deferred revenue, we've got that public sector deal which transfers over from long-term to short-term. I wouldn't think anything different related from a duration perspective in my guidance for fiscal 2020.

Speaker 3: Great. Thanks so much. We'll see you next week.

Speaker 11: Thank you.

Speaker 6: Thank you.

Speaker 10: We'll take our next question from Alex Henderson with Needham & Company. Please go ahead.

Speaker 12: Hi. Thanks. This is Roger Boyd on for Alex. Wondering another way, can you say what portion of RPO you expect to recognize over the next 12 months?

Speaker 11: The CRPO, it's about 45%. I'm sorry. The CRPO is $305 million. That'll be over the next 12 months.

Speaker 12: Got it. Then, on sales execution, I was wondering if you could just provide some detail on what you offer in terms of channel enablement and what you do for your partners in the way of training education to help them smooth out their deployments.

Speaker 6: Two questions here. One is, what are we doing to enable our partners? The second question is about deployment. From what we have said all along, that our sale is not a typical security appliance type of sales where you train hundreds of our channel and they go and sell to technical people. We are fundamental to enabling cloud transformations. Sales is driven top-down at the C-level, CIO, CTO, CISO. Our best channel partners are system integrators and service providers, though we end up doing a fair amount of heavy lifting. The heavy lifting is natural because when you're driving a new transformational sale, when you're disrupting the old world, you have to drive high touch. As I indicated in one of the wins I highlighted, our SI partners are doing a great job. Regarding deployment, actually Zscaler is relatively easier to deploy. We do train our channel partners. We also have our own sales deployment teams that work with channel partners. Our deployments happen pretty well, fairly fast, and customers overall are very happy, as you can see from our net retention rate, and also our churn rate, which has been pretty low.

Speaker 12: Great. Thank you very much.

Speaker 6: Thank you.

Speaker 10: Moving next, we'll go to Tal Liani with Bank of America. Please go ahead.

Speaker 14: Hi, guys. I have two questions. Number one is a more high-level question for Jay. Last week there was an analyst day of one of the competitors that said that in the long run, proxies are not the right solution, and the right solution is to offer the same services from the network, and this was a firewall company. The stock went down on this. I'm wondering if you can address this issue directly. The second thing is there anything you plan on doing outside of what you discussed, is there anything you plan on doing to address the slower sales growth because of the environment that you noted? Thanks. Thank you.

Speaker 6: Yeah. First of all, about proxy. I think if you asked any expert out there what security inspection technology gives you better capability to inspect and block threats, I think 99% of smart people agree it's a proxy technology. I think a statement like that made by competition truly making zero sense. In fact, a lot of you work for large banks. All right? You care about security. If you look at the top 10 large banks in the world and how many of them have next-gen firewall, lots of them. How many of them replaced a proxy technology for outbound traffic? I believe you'll find it zero. In fact, I know of a very large bank that has spent tens of millions of dollars on a next-gen firewall and deployed them all over, and this bank is still depending upon a proxy technology to inspect its traffic for threats. Two, if you look at any vendor who's doing any meaningful thing, even sitting in front of servers, like Akamai's of the world, they all have proxy-based technology because without proxy, you have little or no control. Lastly, firewall, which is a pass-through device, was a good thing before the SSL world, when traffic was not encrypted. Today, in most of the cases, 90%+ of the cases, it's SSL traffic, TLS traffic. Firewalls were never designed to inspect SSL. Proxy technology is needed for SSL. If you really don't inspect the traffic, it is like a luggage passing through an airport inspection check post without inspecting. That's not a good thing. I think these statements are meaningless. They mislead customers. They give them false sense of security and do a disservice to the security industry.

Speaker 11: From a growth perspective, things that we've done. We've been up without a CRO for about a year and a half. That was deliberate on our part, Jay's part, to make sure we found the right person. We did not want to jump the gun and hire the wrong person. We feel that we have the absolute right person to run our sales organization. We made several hires over the last four to six months. VP of Federal, a VP of the East, a new VP, General Manager of EMEA, the CRO, and a VP of Sales Enablement. We see this as a large market opportunity, and we're going to increase our sales and marketing efforts in fiscal 2020. Having the right person on board gives us confidence to invest more into our sales and marketing organization to maximize this market opportunity.

Speaker 6: Yeah. If I may add, as we compete out there, we almost win every deal. Very little situations where we don't win. Very comfortable with our differentiator technology, very comfortable with our sales process refined. We just need to make sure we can keep on scaling it as we set our targets for bigger and bigger numbers.

Speaker 14: Given the comments you just mentioned, does it mean it is going to take you longer to get to your margin targets? Does it change the trajectory of margin improvement?

Speaker 11: No. From our perspective, what we've said all along, that we get to our operating model of a 20%-22% operating profitability once we're at $800 million-$1 billion. There's no change in that. The one change related to the guidance is that we brought down the first half down to 42%-43%, versus historically, where we've been 43%-44% of our total billings. The reason for that is that, with Dali coming on board, he's going to take some time to get ramped up to understand the landscape. We want to give him some room related to our billing guidance.

Speaker 14: Thank you.

Speaker 10: Our next question will come from Andrew Nowinski with Piper Jaffray. Please go ahead.

Speaker 1: All right, thanks. Congrats on the ninth quarter. Maybe if you could just start with, I know in the past you've talked about Office 365 as a significant tailwind for Zscaler. I'm just wondering if you can give us any parameters on how we should think about that in terms of what's left as we head into fiscal 2020, if you could also just rank order your top growth drivers impacting your fiscal 2020 guidance. Thanks.

Speaker 6: Office 365 has been a big driver because Office 365 almost requires that you do local breakout, and that's because the amount of traffic generated by Office 365 is far, far bigger than all other SaaS applications combined. That's point number one. Point number two, today, about 20% of the largest global 2,000 companies are Zscaler customers. That means about 80% aren't. Most of the customers have bought Office 365, but the deployment is lagging behind. Zscaler comes in to help do local breakouts, deployment can happen cost-effectively with better response time. We see a significant opportunity for Office 365 ahead of us. We are not linked to the sale of Office 365. We are needed for the deployment of Office 365. The second big driver for us is SD-WAN. SD-WAN technology is evolving. Actually, SD-WAN is also driven by a big part because of Office 365 and local breakout type of requirements. If you look at all the SD-WAN deployments are happening in large enterprises, Zscaler is often the choice to secure those SD-WANs. That's a big opportunity as well. Among drivers, I would say Office 365 and SD-WAN are our top two drivers, along with ability to provide security, especially with the SSL traffic happening out there at a much larger scale than it used to be.

Speaker 1: That's great. Thanks, Jay.

Speaker 10: Our next question will come from Saket Kalia with Barclays. Please go ahead.

Speaker 13: Hey, guys. Thanks for taking my questions, and apologies for the background noise. Maybe for you, Jay, we were talking about competition from the firewall players. I guess the major change that's happened in the last 90 days has been one of the major appliance vendors, of course, changing hands. I'm curious, and of course, I'm talking about Broadcom Symantec. I'm curious, how have your conversations with customers changed, if at all, since that's been announced?

Speaker 6: Yeah. First of all, the large enterprises we are dealing with, if there's one solution that's deployed besides Zscaler for outbound traffic, it is Symantec Blue Coat. On the lower end, you start seeing other proxies from different other vendors. Our success in the large enterprises has been by displacing those proxy appliances. As I went out and met customers, which I often do, where the customers in the past felt that, yes, they need to change, but they'll make a change over time, there is more urgency because of uncertainty in the space. We do believe that we'll be the beneficiary of this change.

Speaker 13: Got it. That makes sense. For my follow-up for you, Remo, as we think about the billings guide for next year, how have you sort of thought about the big deal environment? It sounds like here in Q4, maybe some large deals took a little bit longer to close. What have you assumed about large deals in your fiscal 2020 guide?

Speaker 11: Yeah. I would say they're going to get back to similar levels as they were in fiscal 2019. I mean, there's a lot of things that go into the guidance. I mean, it's the new CRO on board, trajectory of hiring, and so forth. I'd say it's going to be pretty similar.

Speaker 13: Very helpful. Thanks, guys.

Speaker 10: We'll go next to Dan Ives with Wedbush Securities. Please go ahead.

Speaker 4: Yeah, thanks. Can you talk about maybe some of the hiring plans in fiscal 2020 and maybe how that would be even U.S. versus international?

Speaker 11: Yeah. The total hires that we had in fiscal 2019, we had net hires about 430 employees. My expectation is that we'll hire and are planning for hiring more people than that. The concentration of the hiring is going to be in sales and marketing, number one, R&D, number two, cloud operations support, number three, and then basically everything else. When I take a look at geographically, if you take a look at the distribution we have at Zscaler, about a third of the employees are here in our headquarters in San Jose, a third are in India, and a third, the rest of the world. India's been ticking up a little bit over the last few quarters. We've got two offices, one in Chandigarh and one in Bangalore. My expectation is the percentages will probably be pretty similar, maybe a little bit more in India, versus the rest of the world, but pretty similar percentages based on what we have currently.

Speaker 4: Got it. If I think about seven-figure deals, there's large deals in the pipeline. Do you think most of those deals right now, it's only Zscaler in those deals in terms of them being non-competitive? Maybe just talk about that. I know there are questions that are asked before about competitive and dynamics. Maybe just talk about, is there any change there? Just from a high level, talk about what you're seeing in sales cycles. Thanks.

Speaker 6: As you would expect, a large enterprise, when they go and make a change, they do look for multiple providers as a standard process, as a standard practice. What's exciting that I find in this company that I've never seen before is when a large enterprise goes to RFP with five service providers for the network transformation and Zscaler, local breakout being part of it, we quite often get bid by all five providers, which is very exciting, and sometimes it may be four. Most of the time, the other one or two providers end up being typical proxy vendors you would expect, because that's what large enterprises expect. We win those deals hands down. We do very well. That's why we aren't worried about the competition. There's a lot of noise we hear about the firewall guys, okay? It makes no sense. In fact, last week, as someone alluded to, they talked about displacing Zscaler in 2 deals, and I wasn't sure what they were talking about. I know every Zscaler customer with over 1 million users, and they're all very happy and doing very well. Regarding displacement at a Fortune 50 retail customer they alluded to, I personally know every Zscaler's Fortune 100 Zscaler customer, and we did not lose any. People, I think when they get desperate, they look for leading information. I've analyzed top 50 deals, and we rarely see this firewall vendor in them. We do expect to see further misleading claims in the future from legacy firewall vendors who are trying to tout this cloud security wins. When legacy secure web gateway vendors were trying to compete with Zscaler, we saw the same behavior. They tried to upgrade the security appliances, they gave away the cloud, and they would falsely claim it as a cloud security win and displacement of Zscaler. Our technology, our differentiation stays strong, our sales methodology stays strong. We just need to make sure we can scale our sales execution well as our numbers keep on getting bigger and bigger.

Speaker 4: Thanks.

Speaker 10: Our next question will come from Joshua Tilton with Berenberg Capital Markets. Please go ahead.

Speaker 15: Hi, this is Francois for Joshua. We were trying to understand the focuses on the winning the market. Could you possibly speak to how you're seeing pricing develop? Has it been improving? How have average deal sizes been trending? Any commentary around that would be helpful. One more follow-up on macro in EMEA. Have you seen any signs of slowdowns in that region due to these macro fears? That's it. Thank you.

Speaker 11: I'll try to answer a few of them. Average deal size is based on ARR for customers with greater than 3,000 users, has gone up every quarter, and it did go up in Q4. Related to any pricing pressure, our discounting quarter-to-quarter, Q3 to Q4, year-over-year for new and upsell business is lower. No, we're not seeing the pricing pressure. Related to EMEA, I'll let Jay talk more about that.

Speaker 6: Yeah. EMEA, there's a fair amount of talk on Brexit. You can hardly see the newspaper without the news about it. We do wonder about it, but we haven't seen tangible effect on the business. Talking about some of the uncertainty out there, can I put my pulse on the big effect? I'm watching carefully. I'm not sure I can put it on. Probably we have some more work to do to hiring and scaling the business. We brought in a new leader in EMEA last quarter. He's doing a great job ramping up the sales teams and really scaling it to where we need to go. I want to remind you guys that we are unusually large in EMEA or internationally. At our stage of the company, 50% of the business comes from international and about 40% of it come from EMEA, I'd say. A very important market for us. We'll remain focused on investing there to keep that kind of market share.

Speaker 15: Thank you.

Speaker 10: Our next question will come from Gray Powell with Deutsche Bank. Please go ahead.

Speaker 5: Great. Thanks for working me in. I greatly appreciate it. One, if I look at the guidance and I look at revenue growth in absolute dollar terms, in fiscal 2019, you added a little over $110 million in new revenue, just a total revenue basis. The guide for fiscal 2020 implies that you add a little bit less than $100 million. Is there any reason that the absolute dollar growth should go down, particularly given the sales and marketing investments that you made?

Speaker 6: We like to be prudent with our guidance, and our guidance, we feel, is prudent.

Speaker 5: Okay. Fair enough. Good answer. Maybe just one on the product side then. What kind of improvements have you made on the Cloud Firewall functionality? How do you feel about your potential to displace branch office firewalls?

Speaker 6: Potential to replace branch office firewalls. We have done tons and tons of them. First of all, if someone is talking about firewall, cloud firewalls, these collecting functionality, they may be getting mixed up with the data center firewall. Many times I talk to customers, this is what they say. They say, "Firewall guys are here. They're telling me that you should have the same policy in your branch firewall and as it is in your data center." I say, "Okay, tell me more. How many rules do you have in your data center firewall?" They say, "6,000." In fact, they say, "I bought two products to manage those firewall rules." I say, "Of course, your data center is complex over time, evolved, netting and everything." I said, "What are you trying to protect in your branch office?" The answer is employees. What's the difference between when you sit in a branch office or you sit in an airport or in a coffee shop? They say nothing. I said, "Are you really putting a firewall with 6,000 rules at your home or every branch office? That's silly." Firewalls in a branch office for outbound traffic are very straightforward. In fact, most of the cases, they aren't even needed. They're needed because somebody feels like they should have it. The reason they're not needed is when you don't have anything coming from outside in, you have no listening port, your attack surface becomes zero. That's when you have the best security, and that's really what should be done. Our firewall is very rich. We never lose any situation. We never have a case where someone said, "Your branch firewall is not rich enough." No. Our focus is not really creating lots of rules in branch firewall. Our focus really working on zero trust network type of approach that Gartner talks about, a SASE kind of approach, where you don't even bring people on the network. In summary, we're trying to do things a new way where you don't control the network. You don't worry with network security. You securely connect a user to an application, and you're simply a switchboard in the middle of it. Very comfortable with technology and the lead we are increasing. Next week, you're going to see some significant, big, new areas of expansion that we'll be announcing at Zenith Live.

Speaker 5: That's great. Thank you very much.

Speaker 6: Thank you.

Speaker 10: Our next question will come from Nick Yako with Cowen and Company. Please go ahead.

Speaker 9: Thanks, guys. Jay, you mentioned seeing more customers adopt both ZIA and ZPA out of the gate, which is great. I guess I'm just wondering if that's having an outsized impact on the sales cycles.

Speaker 6: Yes, the bigger the products that you buy, typically longer the sales cycle. Or if you talk in general, the bigger your deal, the longer the sales cycle. I think our mix is not really, I won't say that all, most of the deals are becoming combined ZIA, ZPA. The transformation sale in general is complex. It's top-down. You end up securing the support of not just head of networking, head of security, head of architecture. We have a large number of people who can do it well, but we need to grow that type of sales team along with some of the architects and all, to really make sure we are effectively selling it. The most exciting thing I found about Dali, he had some of the same top-down selling mindset with value creation and with very good sales methodologies. I think we'll be doing a great job in scaling it to make sure our numbers keep on growing.

Speaker 9: Great. Thank you. As a follow-up, as you continue to expand the platform and really address more components of the security stack over time, how do you weigh layering in that new functionality into that Transformation bundle versus pricing this new functionality as a separate product or component like you've done with ZPA? Thank you.

Speaker 6: Yeah. I think those are the things you take to the market, you look at adoption rate, you look at how the market willing to pay, and then you change your bundles over time. You have seen us change some of the bundles over the past couple of years, I think there'll be some more changes over time. I think you'll see some large platforms being announced that are significant beyond the traditional typical security we are talking about. I think you'll be pleased with the evolution, rather significant addition of the technology we are doing to further create distance between the cloud imitators and us.

Speaker 10: We'll take our next question from Keith Weiss with Morgan Stanley. Please go ahead.

Speaker 6: Keith, are you there?

Speaker 10: Caller, please check.

Speaker 8: Sorry about that. I was on mute. Thank you for taking the question. I was just asking, as we're going into the next fiscal year, you have a new CRO who needs time to kind of ramp up. You also have a much broader product portfolio. You're selling a much bigger vision into your customer. How should we think about the kind of degree of change we should expect in the sales force, kind of as we enter the year versus prior years? Is there significant kind of restructuring that we should expect sort of from the get-go, or is that going to come later in the year once Dali has time to kind of ramp up and come up with a game plan?

Speaker 6: Yeah. Dali and I have been discussing it for quite a while. We don't really expect significant change in the sales teams. We do expect a significant change in the sales methodology, sales framework to be able to deliver the message consistently. Those are the kind of refinement we need to do, which need to be consistently gotten across. We overall have a good sales team. We need to make sure our enablement, our training, our metrics to exactly know what needs to be done is where the focus is. I mean, we all know that when you go to a certain stage, say zero to $200 million, $300 million, $400 million, you have one set of stuff. As you go to the next big phase to a billion-dollar kind of targets, you make a lot of these things in place. Those are the type of things for the next level we are honing on and refining and scaling.

Speaker 10: Sorry.

Speaker 6: All those factors are built into Remo's forecast for 2020.

Speaker 11: Yeah. Ebony, we'll take one last question, please.

Speaker 10: Certainly. We'll go next to Keith Bachman with BMO. Please go ahead.

Speaker 7: Hi. Thank you. It's a good segue from the past question. Jay, I wanted to just push back a little bit. You've mentioned that you still have 80% of the largest enterprise you have to penetrate, and this is an evangelical sale. It requires, in many cases, an architectural change. I'm just wondering why you wouldn't need to lean on a much more significant sales force in order to keep revenue growth rates and frankly, penetration rates on new logos growing and less dependency on the SI community, who I think is more about fulfillment given the model that you have. I'm just wondering why sales and market expense wouldn't need to keep growing at a pretty high rate given those attributes. I'm just going to sneak in just one clarification. You told us what the CRPO was, $305 million, but I just wanted to see, could you just clarify what the growth rate of that was as well? That's it for me. Thank you.

Speaker 11: I'll answer the growth rate. That's 45% year-over-year.

Speaker 6: Regarding the first part of the question, I think if you looked at what I said early on, too, I said, yes, channel partners do help, but we do tons of heavy lifting. Transformation sales are actually high-touch sales. We are investing significantly in our sales and marketing. In fact, if you look at our 2020 plan, we haven't brought down sales and marketing as a percentage of revenue, which typically we would year-over-year. That's keeping in mind that we need to keep on putting some more gas on it. If I left another message impression, then I didn't do a good job. We actually are driving sales with our own sales organizations, and channel is helping us. Channel is facilitating us. We are getting channel leverage. What all of you should know, when transformation happens, channel can only do so much. When technology become more mature and commoditized, channel plays a much bigger role. We are investing, but prudently, right? There's only so much you can invest. In terms of number of salespeople, sales and marketing, total headcount we're adding this year or last year is pretty significant. Fully aligned with the message you said. If I said any otherwise, it wasn't clear.

Speaker 10: This does conclude today's question and answer session. I'll now turn the call back over to Jay Chaudhry for any additional closing remarks.

Speaker 6: We thank you for joining us for this call, and we look forward to seeing a number of you at our ZenithLive conference as well as on Analyst Day. Otherwise, we'll talk to you next quarter. Thank you.

Speaker 11: Thank you.

Speaker 10: Once again, this concludes today's call. Thank you for your participation. You may now disconnect.