Notes from ZS Investor Innovations Briefing

Good afternoon, Everyone –

This post is on ZS’s Investor Innovations Briefing, which was held yesterday. I was hoping for a juicy confirmation it is business as usual or a raise in guidance. But we didn’t get anything quite that direct. We also didn’t get a discussion on competition with NET, although some other competitors were brought up. I put my thoughts in brackets below the statements in quotes. I’ve shortened questions or answers wherever you see ellipses.

“Alex Henderson [stock analyst]
So Alex Henderson again, over at Needham. I can’t let Remo get away without having some questions here. So clearly, conditions continue to be changing pretty rapidly. Europe under a lot of duress. We’ve seen the interest rates rise. Any change in any of the key parameters like pipeline or rapidity to close deals or deal sizes or alternatively, are you seeing benefit from that as a result of your ability to improve user access, user experience and productivity and all of other transformation benefits …

Remo Canessa [ZS CFO]
A lot of questions there. I know – the global economic situation is clear for everybody. It’s impacted the commercial and consumer side of businesses. Not so much large enterprises but if it continues, I do see an impact, from my perspective. It just makes sense for all the reasons you mentioned Alex, related to interest rate hikes …

Jay Chaudhry [ZA CEO]
Remo, can I just add one more point to what Remo said, I know we keep talking about value and outcome based. It’s enough fancy words. We create CFO-ready business cases. We consolidate cost across multiple dimensions. This has been our focus. So this is going to continue being our focus. So as far as I’m concerned and to Remo’s point, I think what we do and how we do it, whether or not the market is good or not so good, there’s a quantifiable outcome that we drive. And I don’t see that changing yet.”

[BTL Thoughts: Statements from the CFO give me flashbacks of the NET Jefferies conference. Sounds like ZS will not be immune if a recession hits. ZS’s CEO tried to clean it up by saying ZS is a solution people want and that is not changing “yet” (i.e., a recession would hurt ZS.]

“Brad Zelnick [stock analyst]
Remo, it’s Brad. Just a follow-up to Alex’s questions. Can you remind us the extent to which the newer products are expected to impact the P&L embedded in your guidance, if at all? Obviously, you have expense associated with a lot of the investments that have been made and the go-to-market investments, I imagine, are made as well specialized to some of the newer offerings. But what are your expectations in terms of when they should really start to generate revenue impact for top line?

Remo Canessa [ZS CFO]
Yes. I mean they’re doing well currently. And we talked about that for ZDX and ZCP, we’ve been low teens of new and upsell business and that’s what we’re tracking to for this year. Going forward, we do expect emerging products to contribute. And as we go forward, they’re going to contribute significantly. From a profitability perspective, the gross margins for the products, similar to the gross margins that we have. The advantage that Zscaler has is the – and I made the comment before, we have a lot of levers that we can pull. And what I meant by that is that when you’re in a ratable model with 80% gross margin, with that ARR gives you a lot of runway basically to change your business. That’s one. And two is basically our contribution margin. So first year contribution margin is negative, then years two and three and thereafter it’s 60%. Those are the levers that you can pull. And from that, how do you influence it? You can influence it by head count, right?
So, the comment that we’ve made is that we’re going to continue to aggressively invest in the business for growth and nothing has changed on that.”

[BTL Thoughts: Sounds like ZS has cash to invest in future products and will continue to do so b/c their future products will help out the business. But I admit to not understanding a lot of what he is saying.]

Angie Song [stock analyst]
Angie Song from Morgan Stanley again. So we have a question on federal. Could you give us an update on the pipeline there? And what do you – what are the typical deal sizes that you’re seeing today versus a few years ago or maybe a few quarters ago?

Remo Canessa [ZS CFO]
We’ve invested significantly in federal over the last several years. Our certifications for ZIA and ZPA that we’ve talked about. ZPA is FedRAMP high. And ZIA is basically FedRAMP high-ready. We see the federal market being a big market for us. It was mid-single digit of our new and upsell last quarter. I don’t want to give exact percentages but we’re well positioned in federal to move forward.

[BTL Thoughts: This is a big nothing-burger. “Well positioned … to move forward” tells me there isn’t going to be a big jump in Fed spending in the next few quarters. Man, the FED moves slowly, feels like we’ve been waiting for this spend to hit for ages.].

“Ashish Bhandari [stock analyst]
Ashish Bhandari with Ashler Capital. Just had one other quick follow-up to the competitive landscape. And specifically, it sounds like you’re really entering into the CNAPP space. But CrowdStrike also has capabilities that they offer as part of their Falcon platform. And of course, you have a strong partnership with CrowdStrike. Curious how you view kind of the differentiation between your two platforms for that – those specific capabilities? And then, I just had a question for Remo or Dali just – we’re hearing a lot about headcount reductions or slowdown in hiring, specifically in tech but – and with the recession looming, you can kind of anticipate that moving to other sectors as well. Curious how you think about kind of the ZIA/ZPA expansion motion? And how you’re kind of preparing for maybe what’s looming, maybe not today but a year or 18 months …

Remo Canessa [ZS CFO]
We’re not looking to slow down at all at this point. Again, we’ll monitor the business conditions as we go forward. And as I talked about, if a recession does come and hits basically large enterprises, we’ll adjust to it. Now having said that, the comment I made about the levers that we have in the business which is basically the ratable 80% gross margin. And you have a large ARR balance, you’re going to get significant revenue from that in the following years. So that gives us a good runway. And in addition with that, the contribution margin. So if the business were to slow down, the contribution margins in year two and three are over 60%. But right now, we are not looking to slow down. We see this as a huge market opportunity. We think we’re well positioned. We’re going to go after it. We’re not saying we won’t. But at this point here, there’s no thoughts about slowing down.

Jay Chaudhry [ZS CEO]
So we aren’t slowing down any investments.”

[BTL Thoughts: This is the best stuff, in my opinion, that we got from the conference. Sounds like they don’t currently foresee a slowdown. They also seem to say without saying that they will be able to weather a recession based on current strength of the business and future obligations that are locked in.]

“Angie Song [stock analyst]
Angie Song from Morgan Stanley again. So as you mentioned – this is a question for Remo. You mentioned that you aren’t really seeing a macro slowdown but you’re really mindful of the recession risk. So as you’re thinking about the fiscal year '23 guidance a couple of months from now, is recession a scenario that you’re considering reflecting on the outlook?
Remo Canessa [ZS CFO]
Not at this time. We’re not looking at that. Yes. I mean, well, as I mentioned, as we go forward, if we see things, we can adjust. But right now, we’re not putting that into our planning process.”

[BTL Thoughts: This sounds like ZS is not likely to guide down based on the macro yet. I’m thinking they will have a solid upcoming quarter but are being cautious about predicting beyond that in case macro things get worse.]

Hang in there everybody.



Long ZS