Zscaler (ZS) Q1 2024 Earnings Call Transcript

Zscaler (ZS 1.28%)
Q1 2024 Earnings Call
Nov 27, 2023, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by and welcome to Zscaler's first-quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator instructions] As a reminder, today's call is being recorded.

I will now turn the conference over to your host, Mr. Bill Choi, senior vice president of investor relations and strategic finance. Please go ahead.

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

Good afternoon, everyone, and welcome to the Zscaler first quarter fiscal year 2024 earnings conference call. On the call with me today are Jay Chaudhry, chairman and CEO; and Remo Canessa, CFO. Please note that we have posted our earnings release and a supplemental financial schedule to our investor relations website. Unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis.

You will find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release. I'd like to remind you that today's discussion will contain forward-looking statements, including but not limited to the company's anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow, dollar-based net retention rate, future hiring decisions, remaining performance obligations, income taxes, earnings per share, our objectives and outlook, our customer response to our products, and our market share and market opportunity. These statements and other comments are not guarantees of future performance but rather are subject to risks and uncertainty, some of which are beyond our control. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future.

We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC, as well as in today's earnings release. I also want to inform you that we'll be attending the UBS Global Technology Conference tomorrow. Now, I'll turn the call over to Jay.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you, Bill. I am pleased to share our first-quarter results, which exceeded our guidance across all metrics. We delivered 40% revenue growth and 34% billings growth. Our operating profit and free cash flow more than doubled year-over-year, and free cash flow margin reached a record 45%.

We exceeded the Rule of 60 for the 13th consecutive quarter. At a significant scale of $2 billion-plus in ARR, we are delivering a unique combination of high growth and high profitability that only a few SaaS companies have accomplished. In Q1, we executed well in a challenging macro environment and what is typically a slower quarter for us. The elevated scrutiny of large deals remains mostly unchanged.

The increased frequency of high-profile breaches, coupled with impending SEC disclosure requirements, has propelled zero-trust security more into focus at the management and the board level. Against this backdrop, we achieved a Q1 record for number of new logo customers with over $1 million in ARR. We also achieved a record for new pipeline generation in a quarter. More customers are adopting our broader platform to consolidate multiple-point products, increasing our average deal size.

As a result, we are actively working on more large, multiyear, multi-pillar opportunities than ever before. To meet this demand and to further scale our business, we are adding two key go-to-market leaders, one in sales and one in marketing. I will provide details about these new executives after reviewing our Q1 performance. Let me highlight three factors that drove our strong Q1 performance.

First, large new logo wins were strong this quarter, with a Q1 record of 14 new logos contributing over $1 million ARR. We ended with 468 such customers, up 34% year over year. These wins spanned across many verticals, proving that every vertical needs Zscaler. Second, customers are buying the broader Zscaler platform with multiple product pillars.

I have said before, over time, I believe every one of our customers will buy ZIA, ZPA, and ZDX for every user to deliver secure, fast, and reliable access to any application, anywhere. This quarter, nearly half of our new logo customers purchased all three user pillars, ZIA, ZPA, and ZDX. In addition, strong platform upsells drove our 120% dollar-based net retention rate. Third, this was a record U.S.

federal quarter, with new business up over 90% year over year, including four deals that are greater than $1 million in ACV. We are starting to see larger awards as multiple U.S. federal agencies are standardizing on Zscaler to meet the president's executive order to adopt zero-trust security. We are extremely proud of having landed 12 of the 15 cabinet-level agencies as our customers, where we have plenty of opportunity to expand.

For example, at a cabinet-level agency, we expanded their ZIA and ZPA deployment from 25,000 users to 100,000 users while cross-selling ZDX for all 100,000 users. We also won a top defense integrator who purchased ZIA, ZPA, and ZDX for its employees. In parallel, they launched a go-to-market service to take Zscaler to their federal customers. As our SI partners are selling and deploying Zscaler for their customers, they are also adopting Zscaler to make their own businesses secure, agile, and competitive.

From my conversations with hundreds of IT executives, it is clear that cybersecurity is the No. 1 IT spending priority. Adopting zero-trust architecture and protecting their enterprise from gen AI risks are top priorities for CISOs in 2024. We have enhanced our data protection policies for AI/ML applications and tools to protect our customers' risk of data loss due to increasing use of gen AI.

Our AI-powered threat protection uses a diffusion model to detect complex exploits and to catch sophisticated phishing attacks that evade traditional security controls. These AI-driven features are included in our advanced plus bundles, which are often priced 20% higher than advanced bundles. We now secure, on average, over 2 billion AI transactions every month for our customers. Next, let me discuss some of our Q1 deals which demonstrate our differentiation and business value.

We're starting to see some wins where customers are coming to us after initially purchasing a firewall-based, single-vendor SASE solution that failed to deliver in the real world. For those who are not familiar, firewall-based single-vendor SASE is the combination of SD-WAN and firewall and VPN deployed as VMs in the cloud. A leading software company made an architectural shift to our zero-trust exchange platform after trying to deploy a leading firewall vendor SASE solution across 50 office locations and multiple public cloud sites. It became clear to the customer that this solution expanded their attack surface to all locations and increased the risk of lateral threat movement.

They decided to move to our zero-trust security with the purchase of Zscaler for Users, our complete bundle for ZIA, ZPA, and ZDX, for all 25,000 employees. Our zero-trust exchange connects users directly to apps, eliminating attack surface and lateral threat movement. For unmanaged devices, the customer is deploying our browser isolation with ZPA to enable third parties to access their applications. Deals like this reinforce our conviction that firewall-based SASE solutions are not the future of security that some analysts advocate.

Customers are choosing Zscaler's purpose-built zero-trust platform. Let me highlight one new logo win where our superior security helped a customer after a breach. Despite extensive investments in firewalls and VPNs, a hospitality and gaming company experienced a crippling ransomware breach. To restore their operations, they purchased the entire Zscaler for Users bundle for 25,000 users.

With Zscaler, their apps are now hidden from threat actors behind our zero-trust exchange, and can't be discovered, exploited, or DDoS-ed. This customer also purchased our new Risk360 solution to understand their organizationwide risk and to get actionable information to reduce it. We have shared with you that data protection is one of the fastest-growing solutions for us. For our customers, after implementing cyber protection, adopting data protection is the natural second phase of their zero-trust journey.

For example, a Fortune 500 travel and hospitality services provider more than doubled their annual spend with us, with data protection being a critical component of the upsell. Their first purchase was ZIA for 22,000 users to inspect all traffic, including TLS-encrypted traffic, for cyber protection. As the next step, they are implementing real-time, in-line DLP for sensitive data. Our solution also enables this customer to enforce policies for secure use of AI applications.

These deals highlight the breadth and depth of our zero-trust security platform. We also help our customers achieve high ROI by eliminating tech debt and consolidating multiple-point products. For example, a Fortune 200 financial services group turned to Zscaler to consolidate data centers and safely adopt cloud with the necessary security controls for regulatory compliance. They purchased Zscaler for Users bundle for 10,000 employees and Workload Communications for 1,500 workloads.

By leveraging our cloud platform, they will eliminate half of their data centers, reduce their MPLS spend, and consolidate security and networking point products. We are eliminating several point products, including secure web gateways, firewalls, IPS appliances, VPNs, CASB, and DLP, from seven security vendors. This deal is expected to generate a remarkable 5x ROI for the customer. I'm also excited to share that ZDX, one of our emerging pillars, continues to gain significant customer adoption.

It is an important part of every deal conversation due to its unique ability to eliminate IT blind spots. ZDX significantly reduces helpdesk hours spent on ticket resolutions and manual correlation of metrics. Let me highlight a new logo deal where ZDX played a pivotal role. A top-ranked U.S.

hospital network purchased ZIA and ZDX Advanced Plus for 87,000 users and ZPA for 40,000 users. What initially began as a ZIA and ZPA project quickly evolved into a significant ZDX opportunity. The ZDX component alone is seven figures in ACV. Unlike their existing performance tools, ZDX provides comprehensive visibility and root cause analysis for users, devices, and applications.

This deal is a great example of the leverage we gain from working with system integrators, like Accenture, who was awarded this overall transformation project. We are also seeing strong customer interest in workload protection, our other emerging product pillar. Our zero-trust exchange is designed for any-to-any secure communication; it may be users to apps, workload to workload or IoT/OT devices. Thousands of enterprises already leverage Zscaler platform for secure user-to-app communication.

It is natural for them to extend our zero-trust platform to secure their workload communication. To radically simplify multi-cloud connectivity and automated deployment of workload protection at scale, we recently released significant enhancements to our Workload Communications offering, including granular workload segmentation using AWS user-defined tags, the first zero-trust security solution for workloads in the market. The only alternative is legacy virtual firewalls and real-time auto discovery of cloud resources. More than a third of our customers have made initial purchases for workload protection.

Workload Communication often starts with small land deals, and we expect to rapidly expand to secure their growing number of workloads. Zscaler pioneered zero trust and SASE, both delivered via our cloud-native platform. We have established ourselves as the premier provider for user protection and are now making progress expanding into workload protection and IoT/OT protection. We continue to push the boundaries of what our platform can achieve, extending it for B2B and 5G use cases.

As we are like a switchboard for all communications, we collect full transaction logs and trillions of signals daily. We are utilizing those signals and logs to deliver AI-powered insights and automation for our customers. Let me discuss a few of the high-value products in our AI cloud family. We recently launched Risk360, which is the industry's first holistic, AI-powered risk quantification and mitigation solution.

It delivers up-to-date risk posture and recommends corrective actions to mitigate risk in a timely fashion. We have already closed 10-plus Risk360 deals, and are in active evaluations with over 100 enterprises. For these deals, we are getting six-figure ACV on average, and we expect to grow this value over time. Risk360 provides critical insights to CISOs when reporting on cybersecurity risk, strategy, and governance, particularly in light of new SEC regulations.

Another exciting new product, Breach Predictor, currently under development, uses predictive and generative AI models to anticipate potential breach scenarios and eliminate those risks before they materialize. Early feedback from customers who have previewed Breach Predictor indicates the enormous potential value this solution can deliver. We are working with our technology partners to bring this world-class innovation to thousands of customers to proactively protect against potential breaches. While we have achieved tremendous success for user protection solutions, our platform's potential in other categories is just beginning.

Our relentless innovations have paved the way for an ever-growing stream of opportunities. As our platform continues to scale and expand, our go-to-market efforts are continuing to evolve and scale as well. To enable that next stage of go-to-market scaling, I'm excited to share the appointments of two exceptional leaders, Mike Rich as CRO and president of global sales, and Joyce Kim as CMO. They bring a wealth of experience in driving revenue and pipeline growth.

Mike joins from ServiceNow, where, as the president for Americas, he established an efficient and scalable process to drive deeper engagements with large enterprises and to scale their business to over $8 billion in revenue, an experience that is critical to the next phase of our growth journey. Joyce's previous experiences include CMO roles at Twilio, Genesys, and Arm, with expertise in building high-performance marketing teams and driving impactful marketing strategies and campaigns. With Mike assuming leadership of our sales organization, Dali, in his capacity as the COO, can focus on scaling our business operations. Dali has been instrumental in establishing the go-to-market process, which has helped Zscaler achieve a milestone of $2 billion in ARR.

With our expanded portfolio of products and experienced CRO and CMO on board, we will further scale our value-led sales process for larger platform deals, which will sustain our high growth. I'm thrilled to have strong go-to-market leaders who we believe will drive world-class execution to scale our business beyond $5 billion in ARR. Now, I'd like to turn over the call to Remo for our financial results.

Remo Canessa -- Chief Financial Officer

Thank you, Jay. Our Q1 results exceeded our guidance on growth and profitability even with ongoing customer scrutiny of large deals. Revenue was $497 million, up 40% year over year and up 9% sequentially. From a geographic perspective, Americas represented 53% of revenue, EMEA was 32%, and APJ was 15%.

As Jay highlighted, from a new business perspective, federal had its best new ACV quarter ever, growing over 90% year over year. Our new ACV outside of the Fed also grew year over year. Our total calculated billings in Q1 grew 34% year over year to $457 million. On a sequential basis, total billings declined 37% quarter over quarter with a difficult comparison to Q4, which had a $20 million upfront billing on a multiyear deal.

As a reminder, our contract terms are typically one to three years, and we primarily invoice our customers one year in advance. Our calculated current billings grew 33% year over year and a seasonal decline of 32% quarter over quarter. Our remaining performance obligations, or RPO, grew 30% from a year ago to $3.49 billion. The current RPO is approximately 51% of the total RPO.

We ended Q1 with 468 customers with greater than $1 million in ARR, adding 19 such customers in the quarter. Fourteen of the 19 $1 million ARR customer adds were new logos, which was a record for Q1. The continued strength of this large customer metric speaks to the strategic role we play in our customers' digital transformation initiatives. We also ended the quarter with 2,708 customers with greater than $100,000 in ARR.

Our 12 months trailing dollar-based net retention rate was 120%. Turning to the rest of our Q1 financial performance. Total gross margin of 80.7% compares to 80.7% in the prior quarter and 81.4% in the year-ago quarter. Higher public cloud usage for our emerging products drove the year-over-year change in gross margin, partially offset by approximately 60 basis points of benefit from a change in accounting attributed to the longer useful life of our cloud infrastructure.

As mentioned last quarter, as a result of advances in technology and efficiencies in how we operate our server and network equipment, starting this quarter, we extended the depreciable useful life for these assets in our cloud infrastructure from four to five years. Moving on our total operating expenses increased 11% sequentially and 26% year-over-year to $311 million. We continue to generate significant leverage in our financial model, with operating margin reaching 18%, an increase of approximately 620 basis points year over year. Our free cash flow margin was 45%, including data center capex of approximately 6% of revenue.

Free cash flow benefited from strong collections from Q4 billings, including the $20 million upfront billings I mentioned. We ended the quarter with over $2.3 billion in cash, cash equivalents, and short-term investments. Next, let me share some observations about the macro environment and our framework for guidance for the rest of the fiscal year. While the global macro environment remains challenging and customers continue to scrutinize large deals, from our perspective, customer sentiment seems to be stabilizing.

Our customer engagements remain strong, and we have a large and growing pipeline. However, we want to be prudent in our assumptions given the sales leadership change. In our outlook for fiscal '24, we are balancing our business optimism and continued sales execution with ongoing macroeconomic uncertainties. With that in mind, let me provide our guidance for Q2 and full year fiscal 2024.

As a reminder, these numbers are all non-GAAP. For the second quarter: We expect revenue in the range of $505 million to $507 million, reflecting a year-over-year growth of 30% to 31%; gross margins of 80%, including the change in accounting for useful life of server equipment. I would also like to remind investors that a number of our emerging products, including newer products like 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; operating profit in the range of $84 million to $86 million; net other income of $15 million; income taxes of $8 million; earnings per share in the range of $0.57 to $0.58, assuming 160 million fully diluted shares.

For the full year fiscal 2024, we are updating our guidance as follows: increased revenue in the range of $2.09 billion to $2.10 billion or year-over-year growth of 29% to 30%; calculated billings in the range of $2.52 billion to $2.56 billion, or year-over-year growth of 24% to 26%; we still expect our first half mix to be approximately 42% of our full-year billings guide; increased operating profit in the range of $360 million to $365 million, which reflects up to 250 basis points of operating margin improvement compared to last year; income taxes of $35 million; increased earnings per share in the range of $2.45 to $2.48, assuming approximately 161 million fully diluted shares. We expect our free cash flow margin to be up year over year and in the low 20% range. We continue to expect our data center capex to be high single-digit percentage of revenue for the full year, reflecting a 3 to 4 percentage points of headwind to free cash flow margins. We expect the timing of capex spend to be more toward the second half of the year, as we invest in upgrades to our cloud and AI infrastructure.

Our guidance reflects our plans to invest aggressively in our business to pursue our significant market opportunity. With our new CRO and CMO coming on board, we expect to step up our sales and marketing investments in the coming quarters. In addition, we will increase investments in our technology platform and cloud infrastructure. With a large market opportunity and customers increasingly adopting the broader platform, we plan to invest aggressively to position us for long-term growth while increasing profitability.

Operator, you may now open the call for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] One moment for our first question. Our first question comes from the line of Brad Zelnick at Deutsche Bank. Your line is open.

Brad Zelnick -- Deutsche Bank -- Analyst

Great, thanks so much, and congrats on a strong start to the year and nice to see the leverage in these results. You know, Jay, your distinction in SaaS has always been clear and is perhaps no more obvious than right now at a time when traditional network security providers are having a tough time selling more and more boxes. And it seems they're paying you a nice compliment as they all double down their focus on the cloud and SASE. So, as this all plays out competitively and you're increasingly subject to the law of large numbers, how should we think about your ability to sustain high growth and specifically the rate at which you can scale your emerging product portfolio? Thanks.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Brad, very good question. It is flattering to see all kind of vendors becoming SASE vendors overnight. But the challenge for them would be it's a different architecture, it's not an incremental change and feature you can add on to it. That's what we spent a dozen-plus years building a true zero-trust architecture, which is our advantage.

That's why we became the market leader. We pioneered this market. We evangelized to the fact that this is what's needed for better cybersecurity and ransomware protection and cost reduction. The way I look at, to sustain high growth is the following: one, is there a market demand came out? The market is growing and expanding at a much faster pace than I even thought.

Two, do you have the right platform with the right architecture, the right functionality? You've seen us build this platform on a true zero-trust architecture and expanded over the years. Think of what we had at the time of IPO versus what we have today. And the third area is go-to-market execution. We've done a great job starting with IPO crossing $2 billion in ARR, and now we got our sights set on crossing 5 billion.

And we have been growing and adapting go to market also along with the platform. That's why I'm very excited about bringing two key leaders, Mike as CRO and Joyce , as CMO, who can help us take us to the next level. Great market execution, great platform, I think is set. I'm very excited about the opportunity in front of us.

Brad Zelnick -- Deutsche Bank -- Analyst

Thanks. Appreciate it.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Saket Kalia of Barclays. Your line is open.

Saket Kalia -- Barclays -- Analyst

OK, great. Hey, guys, thanks for taking my question here. Jay, maybe for you, just building off of that last question on -- on some of the slowness that we've seen with -- with the traditional network security guys and the challenges with appliance set, [Inaudible] maybe do you feel like customers are more willing now to replace their appliance firewalls, at least at the branch, with -- with SASE architecture like what Zscaler provides so well?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

You know, I said many times, firewalls won't go away, but they will become like mainframes. We have been replacing firewalls at the branches for the last several years. Now, that trend is accelerated. In fact, one of the new things is done to help accelerate the demise of firewalls and branches is our Branch Connector technology, which now we have packaged to make it available.

So, you can become a Starbucks-like office in a matter of minutes rather than trying to wait for a long long time. So, we're seeing that campus environment becoming just like that. The only place where firewalls have been playing a significant role for a while is the data center, the east-west traffic, and the like. You know, the traffic is going away from the data center and that demand has to go away.

So, the big thing for someone to do it right had to really offer a Starbucks-like branch is zero-trust architecture. Market has made progress with traditional SD-WAN. We think traditional SD-WAN is a transitory technology and what we have brought to the market with Branch Connector actually is the next big phase to make it simple. Very excited with the opportunity to make the world free of firewalls.

Saket Kalia -- Barclays -- Analyst

Makes sense. Thanks, guys.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Alex Henderson of Needham and Company. Your line is open.

Alex Henderson -- Needham and Company -- Analyst

Oh, I'm torn on what to ask, but I think I'll go with the question around the channels. So, you guys have been doing a lot of work on expanding your VAR channels, expanding reach into federal, expanding reach into MSPs, expanding into the cloud arena as much as possible. Can you give us some sense of how you think the -- the mix of your sales leads will be driven by those different channel opportunities as we move through the current fiscal year, please?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Sure, Alex, you rightfully said we don't have a simple straight VAR channel that, traditionally, firewall and network security vendors had. We have VARs who play a role; we have system integrators; and we're service providers. And then, there are separate set of SIs for federal business as well. Let's look at each of these areas. VATs were slow to adopt these curve, but now as the market has moved, more and more of them are embracing us.

And our leader, Karl, has launched a number of programs where we're seeing very good progress but new source pipeline coming from our channel. The area we see probably a very rapidly growing opportunity is global systems integrators, actually maybe coming from ServiceNow, where a lot of partnerships with global SIs have played a big role. I expect that area to accelerate. And then, this next level of fulfillment versus transformation.

We like partners who work with us and work with partners -- sorry, our customers to do transformation. And we have been selective. You aren't going to find us with 5,000 or 10,000 channel partners. Our partners are hundreds, and we are doing targeted programs.

We're working with some of the very large SIs and very large deals to do transformation. I mentioned one of these deals in my prepared remarks, and I mentioned another SI who actually brought these internal along with actually launching the service to go out there. Remo, you want to add any more color?

Remo Canessa -- Chief Financial Officer

No, I think that's good, Jay.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

OK. Thank you, Alex.

Alex Henderson -- Needham and Company -- Analyst

No -- no comment on internal sales, which is obviously a piece of it?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Comment on internal sales.

Remo Canessa -- Chief Financial Officer

Oh, so yeah, so we've increased our capacity in the quarter, you know, for -- for sales reps. Our plan is to, you know, increase capacity through the year. The one comment I'd make on Q1 is that, you know, we were -- we did hit our expectations internally, but we expect to hit, you know, basically our sales targets for the year. The current sales capacity that we have supports our guidance.

And, you know, as Jay mentioned, you know, with the new leadership, you know, with Mike on board, you know, we'll be looking to accelerate our hiring as we go through fiscal '24.

Alex Henderson -- Needham and Company -- Analyst

Great. Thank you so much.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah.

Operator

Thank you. One moment, please. Our next question comes from the line of Joel Fishbein of Truist. Your line is open.

Joel Fishbein -- Truist Securities -- Analyst

Thanks and thanks for taking my questions. Great execution here. Jay, one for you and then I'll jump back in queue. On the -- on these new advanced plus bundles, obviously very exciting.

Just can you share with -- you said AI is included -- some of the AI are included in that. Can you talk about adoption rates and whether or not you're getting any pushback on -- on -- on pricing as it relates to some of those bundles?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yes. So, we have had advanced bundles that include a bunch of functionality of ZIA or ZPA type of stuff. Now, we have added functionality where some of the data protection can be done with ZIA advanced techniques. Some of the cyberthreat protection can be done using that.

So, we created these bundles, we call them advanced plus. So, we're getting very good traction, and these advanced plus bundles are about 20% or so higher than the non-plus bundles. So, this is a good area. In fact, this is a good way for us to reach our customers as they're looking at buying these bundles with additional functionality.

It's helping them; it's helping us. Now, in addition, we are also creating some stand-alone SKUs. We talked about Risk360, a very popular recently introduced product, where I talked about having closed 10-plus deals in a pretty significant manner where the average ACV is sitting in six figures. And then, you'll see some more SKUs coming down the road as we really made AI cloud as one of the big focus areas.

And the reason we're making focus is because we have better logs, better data to train AI/ML. models. The starting point of good AI/ML is the data that we have better than anybody else.

Joel Fishbein -- Truist Securities -- Analyst

Great. Thank you.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Rob Owens of Piper Sandler. Your line is open.

Rob Owens -- Piper Sandler -- Analyst

Great, thanks for taking my question. Maybe building a little bit on Joel's question, you mentioned in your prepared remarks with an example around data protection as kind of one of the faster-growing solutions and how it doubled spend in existing customer. Just curious the potential for that and what you're seeing relative to typical uplift when you're able to attach that solution. Thanks.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

You know, when Zscaler customers started working with us several years ago, the No. 1 focus for them was cyber protection so they don't get compromised. Data protection was slower in adoptions. Data protection also takes a little bit work.

There's more considerations and customization needed. And -- and in large enterprises where our large customers have been, they have used Symantec 1, 2 as one of the primary data protection products. Over the past five, six years ago, we have expanded our data protection platform significantly, not just in line but as the actually endpoint DLP cloud data protection. All those things, including EDM/IDM technologies are there.

So, with all that technology, we are in a great position to replace some of those complicated data protection products out there. And this is natural. If we are sitting in traffic path, if we are doing SSL inspection, it's natural for the customers to use our cloud because the traffic is coming to a cloud from all kinds of locations. That's really driving our growth.

That's why we talked about this data protection. ARR is approaching a quarter of $1 billion, and it grew 60% year over year for us. And we see a lot of growth for quite a long time in this area. Did I answer your question?

Rob Owens -- Piper Sandler -- Analyst

Yes, thanks.

Operator

Thank you.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Just one comment I'll make is we have more complete platform for data protection. And customers want one set of policies whether they want to secure data at rest or data at motion. That's why it's -- it's picking up quite fast.

Operator

Thank you. One moment, please. Our next question comes from the line of Joseph Gallo of Jefferies. Your line is open.

Joe Gallo -- Jefferies -- Analyst

Hey, guys, I appreciate the question. Remo, I appreciate the rationale on the full-year billings guide, but just on methodology, is there any change there? I mean you saw a strong 1Q driven by fed strength. Why not pass along some of that beat? Is that solely due to the market -- or the go-to-market change conservatism, or is there anything else you're seeing there with large customer calendar '24 budgets? And there may be just a simplistically ask, is fiscal '24 billings more or less conservative now than it was 90 days ago?

Remo Canessa -- Chief Financial Officer

Wow, great -- great questions. So, I mean the -- the guide that we gave is solely related to basically the go-to market with our new sales leadership on board. We feel it's prudent to do that. When you take a look at close rates for Q2 this year versus last year, we're being a little more conservative with our close rates this Q2.

From a market -- overall market perspective, you know, the macro still remains challenging, but, you know, we feel that, you know, things -- that there's more of an acceptance to zero trust. There's more of an understanding of our platform. So, we feel good. Regarding, you know, guidance whether it's more conservative now or not, you know, I'd like to just say, you know, we like being prudent.

And again, it's all related to go-to market with our new CRO. And I don't want to comment any further than that.

Joe Gallo -- Jefferies -- Analyst

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Gabriela Borges of Goldman Sachs. Your line is open.

Gabriela Borges -- Goldman Sachs -- Analyst

Good afternoon. Thank you. Remo, I wanted to ask you about some of the idiosyncratic drivers in your federal business. And more specifically, as we think about all the momentum that you're seeing now, how should we think about the durability of growth in the federal vertical? Meaning, is this like a three- to five-year product cycle where we'll see a ramp and then we should be cognizant of a slowdown? Is it an 18-month to 36-month product cycle? How do we think about some of the visibility you have in federal and how it's going to impact your growth over the medium term? Thanks.

Remo Canessa -- Chief Financial Officer

That's another great question, Gabriela. I'll start and then maybe Jay can come in also. We've invested significantly in federal. This is not an overnight basically what's occurring.

This is occurring over the last five, six years of significant investments, both from a platform technology as well as, you know, people within the federal organization that works for us. We're in 12 of the 15 agencies -- cabinet agencies. As Jay talked about, you know, in the script, our growth rate in federal in Q1 was 90% year over year. I feel that we are very well positioned in federal as what we've talked about.

We've got an incredibly strong federal team, and I feel that, you know, going forward, federal should be a good driver, potentially significant driver, you know, for Zscaler. And we're doing well in federal. I'll turn it over, Jay.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah, so this -- this is how I think about it. First of all, number of users in the federal government, DoD, non-DoD. Yes, we do have 12 to 15 cabinet agencies, but they are in various stages. There's a big big upsell opportunities there itself.

Then DoD, we are just scratching the surface out there. So, if you look at from a number of users point of view, it's a massive market in front of us because we count the number of users. Then there are workloads for federal. There's a whole range of IoT/OT devices in federal business that need to be taken care of, so massive stuff.

But then on top of that, it's a platform. Our platform has expanded, its -- keeps on expanding. So, I think this is a significant growth opportunity for a long long time. And then, DoD takes us to the next level -- sorry, federal takes to other federal-friendly countries out there.

They all want to follow. The NATO-friendly countries want to adopt what U.S. has done here; that's an opportunity for us. The state governments are getting very very worried about adopting zero trust; that's another big opportunity for us.

So, very bullish. We've done some big investments, and that's why we have some of the best certifications for these kind of platform than any other company out there.

Gabriela Borges -- Goldman Sachs -- Analyst

Thank you for the color and congrats on the quarter.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Jonathan Ruykhaver of Cantor Fitzgerald. Your line is open.

Jonathan Ruykhaver -- Cantor Fitzgerald -- Analyst

Yeah, thank you. So -- so, Jay, we are seeing this convergence between cloud workload protection platforms, CSPMs, CIM, and a lot of other acronyms that are being thrown into this CNAPP kind of bucket. And we're also seeing a number of next-gen vendors that seem to have more of a, you know, product-led growth, sales motion, you know, aimed at the developer, which, you know, contrasts with -- with your approach which is more a high touch aimed at the C level. So, you know, as a product, it fits between build and runtime environments.

And you know, you could argue maybe that portfolio is shifting either -- even further left. How do you balance those dynamics when you look to go to market with your CNAPP offering?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

It's a very good question. So, all those four-letter acronyms you gave us, OK, we try to track them. And there have been 100-plus vendors in that space over the past two years. Though, about a year ago, I used to see a new vendor show up every other day.

For the last year or so, it has slowed down, and actually they're shrinking. But this -- adjacent right next to it that is cloud workload communication. Cloud workload communication is about workloads, software, and internet workloads talking to each other. That's where our core strength comes in with zero-trust architecture.

We are the only vendor I know of out there. We have workloads talk to each other through zero-trust architecture without being on the network. [Inaudible] Then we look at the CNAPP as an extension. To me, CNAPP is almost like has been in many ways during you make API calls, reading logs, you're reading configurations to figure out the risk and whatnot.

And that is toward shifting more to the left. We believe that combination of cloud workload protection along with CNAPP puts us in a better position. Regarding product-led growth, I think there's an interesting opportunity for some of the companies. Obviously, we don't come from that side.

I haven't seen very many security companies have grown to hundreds of millions of dollars doing product-led growth. But we're watching and monitoring the space, but we'll be going from where our strength is. Our large customers love these. Kind of our users, now they are embracing these careful workloads for communication, and that allows us to extend it to CNAPP space as well.

That's how we look at it.

Jonathan Ruykhaver -- Cantor Fitzgerald -- Analyst

Yeah, that's helpful. Thank you.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah.

Operator

Thank you. One moment, please. Our next question comes from the line of Patrick Colville of Deutsche Bank. Your line is open.

Patrick Colville -- Deutsche Bank -- Analyst

Hey, there. Thank you for taking my question. I mean really set -- really impressive set of results guys. So, congrats on starting the new fiscal year as you have with -- you know, guys showing very impressive momentum.

I guess I wanted to touch on the leadership change. You know, these two new executive-level hires, how has Dali's role changed? Is he still at the firm, or has he moved on? And if so, you know, what -- how -- how can we expect his position to change going forward?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Dali has an active role as the COO of the company. He has played a phenomenal role in Zscaler's growth. You've seen over the past four years, we built a great go-to-market machine that has helped us grow past $2 billion in ARR. So, Mike's goal is to take us from here to $5 billion and beyond.

This frees up Dali to focus more in his capacity as a COO to really help scale our business operations capabilities. Now, what do you mean by that? A, as we are growing at a rapid pace, we have many things to improve on scaling side up in the operational side, streamlining our post-sale customer engagements, ranging from support to TAM to deployment to success, how do you bring them together to make it more productive and better streamline for better value realization of the customers. Second example lead to cash, process, systems, productivity improvement, streamlining. If we do a better job in these areas, as a company, we'll become a lot more productive.

And all these experience across the company will help us achieve some of those key things that are needed.

Patrick Colville -- Deutsche Bank -- Analyst

Thank you so much.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of John DiFucci of Guggenheim Securities. Your line is open.

John DiFucci -- Guggenheim Partners -- Analyst

Thank you. Jay and Remo both spoke about the challenging macro backdrop. And I think, Remo, if -- correct me if I'm wrong, but I think you said that you did not hit your internal targets for -- for 1Q. I guess, what do you think the reasons for that were? I mean you have new go-to-market people, and you explained that with the guide with Joe's question.

And sometimes, that means the previous people were an issue. But, you know, your COO was really good at it, to say the least. I know -- I know Remo said customer sentiment is stabilizing, but I'm not quite sure how that sort of fits in. Has the macro gotten a little worse, or is there something else that I'm not thinking about?

Remo Canessa -- Chief Financial Officer

Yeah, the macro has not gotten worse. And the comment, John, was related to quota-carrying reps. So, we didn't hit our internal, you know, projections for internal reps. We do expect to catch up.

We talked about, you know, before on earlier calls, we're in a huge market opportunity. We're going to invest significantly in -- in our company. You can see in the second half, we're going to, you know, increase our sales and marketing spend based on our guidance. That's related to just, overall, you know, we've got a new CMO on board with Mike on board.

That's that -- that was the gist of the comment. It's related basically purely to, you know, quota-carrying reps. We did increase capacity but not to the levels we wanted. And for my -- my perspective, you know, John, it's really execution on our part.

We need to execute better on that.

John DiFucci -- Guggenheim Partners -- Analyst

Got it. Thank you, Remo.

Operator

Thank you. One moment, please. Our next question comes from the line of Tal Liani of Bank of America. Your line is open.

Tal Liani, please make sure your phone -- please make sure your phone is unmute.

Tal Liani -- Bank of America Merrill Lynch -- Analyst

I'm on -- I'm sorry. I pressed on the mute button. So, you can hear me now?

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yes.

Tal Liani -- Bank of America Merrill Lynch -- Analyst

Oh, perfect. OK. RPO growth was slower. Also, the billing guidance was a tad below.

Although you -- you hit the quarter, you're above the quarter expectations. So, I wanted to ask about the discount level contract duration. Was there any change in the pricing environment or contract duration this quarter that is driving the lower RPOs? And also, how do I think about -- I know you don't provide kind of quarterly, but how do I think about first half versus second half in terms of billings and -- and RPOs? Thanks.

Remo Canessa -- Chief Financial Officer

Yeah, I mean a lot of -- a lot of questions in there, but I appreciate you bringing it up -- bring it up. RPO decline, you know, it's primarily related to federal. Federal is a big piece of our business. And when you look at federal, federal contracts, even though they're multiyear contracts, we only take federal in -- in -- you know, for one year in our CRPO.

So, that -- that was a big driver, you know, for that. When you take out basically federal, you know, out of the contract duration, really contract durations are comparable year over year and also quarter over quarter. Discount levels, no, not really seen anything, you know, on the discount level perspective. You know, I'd say it's the same and has been the same for a while.

First half, second half, you can expect billings to be, you know, in the 42% range in the first half and, you know, the rest basically in the second half. But the RPO, you know, basically relates to -- you know, primarily relates to federal business which is one year -- one year recognized.

Tal Liani -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Fatima Boolani of Citi. Your line is open.

Fatima Boolani -- Citi -- Analyst

Good afternoon. Thank you for taking my questions. Jay, this one's for you. You were very explicit about the success in the federal business coming from very strong winds and partnerships with federal SIs.

So, I wanted to better understand what the moat and differentiation is. And if you can help explain to us why this wouldn't necessarily cannibalize your direct business, which you're executing just fantastically.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

So, on direct business versus channel business, almost all of our business is supposed to be channel. A few customers insist that they must do a deal directly with us. So, the channel is supposed to bring leverage. The more channel partners are working closely with us, the more heavy lifting they do better our productivity, better our sales acceleration happens.

So, it's important for us. Now, in a transformation sale like ours, the channel wasn't quite ready to say, hey, tell me the latest box I'm ready to sell. We had to work with them to show them transformation. Federal government is driving big transformation at all levels.

The president's executive order is asking for zero-trust architecture and a large number of systems integrators in the federal market who actually need technology like ours to make it happen. And in federal, it becomes even more interesting as you must have certification up to certain levels. There are FedRAMP certifications at the medium level and high level and whatnot in our SI. And we have done most of that.

So, with certifications leveraging those system integrators, we are able to drive transformation. And I think we are in very good shape sitting there for the big market working side by side with our partners. So, there's no cannibalization. Did I make a clear, or did I miss something?

Fatima Boolani -- Citi -- Analyst

No, that's -- that's super clear. Thank you.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Hamza Fodderwala of Morgan Stanley. Your line is open.

Hamza Fodderwala -- Morgan Stanley -- Analyst

Hi, good evening. Thanks for taking my question. Remo, regarding your comment on the sales changes and the impact of the full-year billings guide, is it -- are you anticipating the leadership change will drive a broader restructuring in the sales org like you saw a few years ago when Dali came on board, or is it going to be more incremental? Thank you.

Remo Canessa -- Chief Financial Officer

Yeah, so the leadership we have in our sales organization is very strong, you know, what Dali has created. I don't see, you know, significant changes. Maybe, you know, Jay can speak to it.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah.

Remo Canessa -- Chief Financial Officer

But I don't see significant changes. And again, the structure that we've built, you know, under Dali's leadership was a very strong, basically, structure.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah. You know, in many ways, our sales process at Zscaler is very similar to ServiceNow, [Inaudible]. It's consultative; it is top-down selling; it's enterprise-focused really. So, we expect the same kind of stuff to carry on.

There needs to be -- there will be ongoing refinements but don't expect any big changes. Some of the things, as I talked to Mike early on, as he's understanding the organization, you'll see probably more focus on top account program. We have a big opportunity to take our large customers and double, triple, or quadruple the ARR with that because our platform supports it. You're going to see more focus on verticals.

We already have some level of verticals. Public sector is a vertical for us. Health care, you'll see more focus there. You also going to see more persona focus in our sales staff.

And I mentioned earlier on, too, you'll probably see more focus on global system integrators as they drive some of the large transformations but -- but no significant changes.

Hamza Fodderwala -- Morgan Stanley -- Analyst

Helpful. Thank you.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah.

Operator

Thank you. One moment, please. Our next question comes from the line of Matthew Hedberg of RBC. Your line is open.

Matt Hedberg -- RBC Capital Markets -- Analyst

Great, thanks for taking my question. Remo, a question for you on the macro. There's been a couple of questions on billings and RPO and obviously the federal strength. But I guess maybe I'm just a little confused because when I look back at your Q4 script, you know, when you talk about the macros, you said -- you noted global uncertainty, but it seemed to me like there was a change in tone from your comments here.

I think you said, you know -- you noted customer sentiment is starting to stabilize. So, I guess I'm just sort of curious, you know, what drove that comment that things are starting to stabilize versus last quarter when you noted uncertainty. And is there something that happened during the quarter or anything that kind of prompted you to maybe change the script a bit from -- from 4Q?

Remo Canessa -- Chief Financial Officer

Yeah, I'll let Jay comment to it.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Yeah, I think what I commented last time was there's a slight reduction in scrutiny of the deals. That was a term I exactly used. I think what we were seeing now, we are seeing there's no change in macro the way we have been seeing. So, macro is not playing a role at this stage to say the forecast need to be assuming macros not getting any worse than it has been.

Matt Hedberg -- RBC Capital Markets -- Analyst

Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Shrenik Kothari of Baird. Your line is open.

Shrenik Kothari -- Robert W. Baird and Company -- Analyst

Yeah, thanks for taking my question, and congrats on the great quarter, Jay, Remo. It's great to see your focus on large transformative deals in top accounts as you just highlighted, Jay, the ongoing traction with bundle offerings across your emerging new products contributing to the new business. So, all of that speaks to -- to create in-house kind of innovation model that you have talked about. Jay, how do you see the role of -- of strategic M&A play in expansion plans as we are starting to see with some others, especially around cloud and data security? And what, if any -- any potential areas to focus? And, Remo, can you provide the new versus upsell split in the quarter and how it compares to the expected the 40/60 mix? Thanks.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

That's a very good question. So, with tighter funding and lots of security companies out there, we're seeing lots of attractive opportunities coming out of way. We -- we are looking at a number of innovative technologies and strong development teams. It's an option.

It's done a number of small ones in the past some time. Yes, there are some areas, interesting technologies, especially in the new world of data and AI kind of stuff. It's an option we are keeping. I think you will not see us trying to buy revenue through an M&A.

They're going to see us buying innovative, disruptive technologies that can help us get to market sooner, faster is important, and that integrates with our platform. I hate to see acquisition being done where you have stand-alone products, they don't work together with each other. But we are actively exploring the areas. There's no reason why we should not be.

Remo Canessa -- Chief Financial Officer

Yeah, and the new and upsell was 45% new, 55% upsell. On our year-end call, we said we expect upsell to be above 60%. That's still our expectation for the year, but for the quarter, it was 55% upsell.

Shrenik Kothari -- Robert W. Baird and Company -- Analyst

Got it. Thanks a lot, Jay, Remo. Appreciate it.

Operator

Thank you. One moment, please. Our next question comes from the line of Brian Essex of J.P. Morgan.

Your line is open.

Brian Essex -- JPMorgan Chase and Company -- Analyst

Hi, good afternoon, and thank you for taking the question. I guess, Remo, I wanted to dig into margins and, you know, specifically maybe gross margins. I mean you guys are about three times the size you were two and a half years ago, but you've hovered kind of in this just below 81% gross margins, give or take 50 basis points or so. And I appreciate the comments you had that emerging products will initially have lower gross margins.

I think that's been the case for some time. But how do we think -- as you continue to grow at an accelerated pace and scale, how can we expect that to impact your margins? How are you managing your infrastructure? And then, maybe just an adjacent comment on sales and marketing, it seems as though that was quite a bit lower than billings. Did you -- did you hold back on sales and marketing spend ahead of the arrival of Mike and Joyce? Thank you.

Remo Canessa -- Chief Financial Officer

Yeah, a few questions. Did we hold back sales and marketing spend, you know, with -- no problem -- with -- do we hold back sales and marketing spend? Not really. You know, it just -- it's just the way things worked out. You know, maybe a little bit on the marketing side, but that's about it, but not -- not really.

From -- from a gross margin perspective, our stated gross margin has been between 78% and 82%, And you're right, Brian, we've been in the 80% range for a long time. You know, the beauty of Zscaler, quite frankly, is the platform and technology that's been created. When I -- when I started here, we're doing 30 billion transactions per day. You know, we are doing 360 billion transactions per day right now, and we still have 80% gross margin.

The benefit that we have is we can make decisions related to maximize gross margin or, you know, to get, you know, applications -- or get, you know, applications or increase the strength of our product, you know, by going through public cloud. So, we balance that. I would expect gross margins to be in that 78% to 82% long term. You know, short-term, midterm, I'd expect the 80% gross margin range.

If we need to shift our focus, you know with more, you know, increasing our margins, we will. But we do manage it, we do look at it, and you know, the emerging products do carry lower gross margins. And we'll keep on innovating. We're not going to slow down building more products.

Brian Essex -- JPMorgan Chase and Company -- Analyst

That's helpful. Thank you.

Remo Canessa -- Chief Financial Officer

Thank you.

Operator

Thank you. OK. Thank you. And that is all the time we have for questions today.

I'm going to turn the call back over to Jay Chaudhry, CEO, for any closing remarks.

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

My sincere thanks to our employees, our customers, and partners for delivering a strong quarter. Thank you for your interest in Zscaler. We look forward to seeing you at some of the investor conferences. Thanks.

Remo Canessa -- Chief Financial Officer

Great. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

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

Jay Chaudhry -- Founder, Chairman, and Chief Executive Officer

Remo Canessa -- Chief Financial Officer

Brad Zelnick -- Deutsche Bank -- Analyst

Saket Kalia -- Barclays -- Analyst

Alex Henderson -- Needham and Company -- Analyst

Joel Fishbein -- Truist Securities -- Analyst

Rob Owens -- Piper Sandler -- Analyst

Joe Gallo -- Jefferies -- Analyst

Gabriela Borges -- Goldman Sachs -- Analyst

Jonathan Ruykhaver -- Cantor Fitzgerald -- Analyst

Patrick Colville -- Deutsche Bank -- Analyst

John DiFucci -- Guggenheim Partners -- Analyst

Tal Liani -- Bank of America Merrill Lynch -- Analyst

Fatima Boolani -- Citi -- Analyst

Hamza Fodderwala -- Morgan Stanley -- Analyst

Matt Hedberg -- RBC Capital Markets -- Analyst

Shrenik Kothari -- Robert W. Baird and Company -- Analyst

Brian Essex -- JPMorgan Chase and Company -- Analyst

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